018 | Guest Encore: Recap – Wisdom from Our Experts

[00:00:00] Patrick: Welcome to the vital strategies podcast, your go to resource for expert insight in the ever evolving world of tax finance and wealth building today on the podcast, we have a special episode where we’re going to review some of the highlights from our experts from previous shows. Feel free to go back and listen to those shows to get all the insight everyone had to offer.
[00:00:20] Patrick: We’re going to revisit our discussion with Walt Dallas and his insight on how to use a business development corporation to maximize deductions. Then we’re going to hear from Bruce Gendine and discuss the power of a cash balance plan. Brad Etheridge talks about the power of selling your business to your employees through an ESOP.
[00:00:38] Patrick: Then we have two level three tax strategies that are great opportunities for business owners with Chad Spitzer discussing captive insurance and Ken Crabb talking about how to deduct life insurance premiums through the Restricted Property Trust. Finally, we wrap up with some highlights from Derek Ripp and successfully transitioning out of your business.
[00:00:57] Patrick: I’m your host, Patrick Lonergan, and I’m thrilled to share highlights from some of the experts we’ve had on the show. Let’s dive in. First up is Walt Dallas.
[00:01:05] Patrick: You were talking about some of the strategies that we can use inside of the business development corp. Can you walk us through some of the most common strategies you have in there? What the benefits are from a, both personal perspective and tax benefit.
[00:01:19] Walt: Yeah, sure. Can. Um, one of the things that we noticed is that a lot of people like to do Tax plans for the income tax benefits. But as I mentioned, we have to have a proper business purpose for the business development company and the C corporate, you know, which is our C corporation to exist.
[00:01:36] Walt: And so. We, um, noticed that we’ve been harping on marketing for years and years. You know, clients need to be marketing, they need to be spending money on marketing. There’s some categories, like anesthesiologists really have a hard time spending money on marketing because they have, they’re captured by, you know, hospitals and patients and places like that.
[00:01:55] Walt: And so, um, as we harped on that, we started getting into some, imagine that a lawyer starting getting into marketing. Uh, we’re one of the worst ones at it. Our plans, brother, and they’re good at it. New Clyde spent 600 grand a year on marketing. That’s why he’s making so much money. But we have seen the people that spend money in marketing, their top line grows, grows and grows and grows year after year.
[00:02:19] Walt: As we do our annual reviews, we’ll go back and look at a pattern of, Hey, what are your spending for, um, marketing and what’s your top line doing? And we found that the top line was going up. And so we had a challenge from an auditors with IRS, uh, for a particular case. And, uh, we said, this business development company has helped this guy make more money.
[00:02:39] Walt: And the guy just said, nah, and they said, we show you, we show you his, um, for the last five years, his advertising expenses has gone up and up and up. This is the pattern and look at his top line. Sure enough, top line followed the bottom line and the gal’s making more money, even, you know, of course, on a gross method.
[00:02:57] Walt: And then as they make that extra dollar, you know, the expenses of overhead related to that extra dollar or nothing. So the net goes way up too. And so that’s been a really cool thing to see. And that’s just not one client, but it is one client in that particular audit, but it happens more and more, you know, for, for particular clients that really believe in the marketing and run their business development company correctly.
[00:03:20] Walt: It’s been a great benefit. You mentioned the ownership of the stock. And we, of course, we use outside shareholders to make sure we comply with the control group rules and the guys that utilize the outside shareholders and really take advantage of those guys for their marketing ideas. Uh, there’s a lot of benefits for that too.
[00:03:38] Walt: Yeah,
[00:03:38] Patrick: very good. One thing that the Supreme court has said is it is no problem to utilize the tax code to your benefit and pay the least amount of tax possible. So. Do you find a lot of clients are doing things before they engage with you that they could be taking tax deduction for that they’re not?
[00:03:56] Patrick: Just about every client I’ve ever looked at is not taking
[00:03:59] Walt: advantage of the tax deductions that they could have. I think, you know, I’ve been doing this a long time and I’ve had one or two clients that have come in that are doing everything that we have on our lists. Kudos to them, but it’s, it’s a rare deal.
[00:04:13] Walt: One of the hard things is, is bidding. The tax plans into a business. And so it works together. So it actually, the structure works and that’s one of the things that we do real well, our process is pretty simple. We’ll take a look at the tax returns and then we have a questionnaire. We’ll send the clients and they’ll kind of tell us what they’re spending on those various categories.
[00:04:33] Walt: And then we’ll figure out what sort of items fit them. And sometimes we look at the information, we get it back. It’s like, you don’t say they’re in our shoe box, you know, our box of sand. And it just, we can’t help you. That is a bit rare too. I’d say one out of 10 potential clients that come through will say, sorry, we can’t help.
[00:04:52] Walt: You just don’t fit what we do. One of the categories that don’t fit are W 2 employees, you know, they’re really just out of luck. They can’t, they can’t get deductions. It’s the, the single business owner that are great clients for us because the single business owner can make it happen and control the way he gets paid.
[00:05:09] Walt: And also if he’s got a family, we can utilize the family for some additional benefits on that.
[00:05:14] Patrick: You’re touching on a great point. Who’s an ideal client for your strategy? What do they look like from a. Net income through the business. And you already mentioned, you know, a single owner, is it sort of disqualify somebody if there’s two partners in a business, could we set up two business development companies?
[00:05:32] Patrick: Is that an option? Yeah. Can you, can you just talk through a few of those, those things for us? Generally it’s
[00:05:38] Walt: a one owner business has repeatable income stream makes about um, 400, uh, of net income of taxable income or up, and that’s really a great client we have some. Plaintiff’s attorneys in our database and our client base, but sometimes their income just kind of goes way up and way down and that gets to be problematic.
[00:05:59] Patrick: Wasn’t that great information from Walt? Next, we’re going to hear from Bruce Gendine.
[00:06:05] Bruce: During that time, I’ve had wonderful relationships with investment sponsors and insurance companies who have many times asked me or my firm to help them design products that would fit the qualified plan arena and to help them market those plans through their financial advisor networks.
[00:06:25] Bruce: Well, in 2018, I was fortunate enough to find a firm that wanted to buy my third party administration and marketing firm. And after a suitable period of transition, I started working with Scott McHenry at McHenry Advisors. Uh, we had collaborated for, oh, probably four or five years prior to that. And so we’ve had a wonderful opportunity because what it does is it provides tremendous continuity for the financial advisor and their clients.
[00:07:00] Bruce: We’re a full service, third party administration and consulting actuarial firm. We have nine actuaries on staff. We administer somewhere north of 2, 000 pension plans. And we have clients in all 50 states.
[00:07:16] Patrick: I can just say we’ve worked with a couple different firms and, uh, working with you and McHenry has been, just made our job so much easier as advisors to help our clients.
[00:07:28] Patrick: Make sure that everything gets implemented well and you’re really on top of everything, which we appreciate. And it’s also fun to bring unique opportunities to you and be able to brainstorm some of the solutions there. So we, we do appreciate your expertise very much.
[00:07:42] Bruce: Thanks for your kind words. We try very hard, you know, as we say, we try to bring very high level of service.
[00:07:49] Bruce: With Midwestern values,
[00:07:51] Patrick: Bruce, one of the things you’ve helped us implement a number of cash balance plans for our clients. Can you give us the 30, 000 foot overview of what a cash balance plan is?
[00:08:01] Bruce: Sure. A cash balance plan is a pension plan and it’s sort of a. Brother of a defined benefit plan and matter of fact, a cash balance plan comes under all the same limitations and restrictions that a defined benefit plan would, but it’s a hybrid.
[00:08:21] Bruce: So it’s expressed more like it would define contribution plans. There’s a. Pay credit and an interest credit. And so we get away from the accrued benefit, and we’re talking about the account value. While there aren’t separate accounts in these plans, what they have is they have a cash balance that’s due the employee.
[00:08:43] Bruce: What happens is they are all employer functioned and, you know, and contributed. There are no employee contributions to these plans. And they’re very unique in that they are for very successful, closely held business owners and professionals. Client who makes a half a million dollars or more and would like to contribute 100, 200, 300.
[00:09:09] Bruce: 300 or maybe even more annually to their retirement plan.
[00:09:14] Patrick: Are there some examples of where a cash balance plan doesn’t work nearly as well? Is there a particular business or industry that we can look?
[00:09:20] Bruce: I don’t think you can look to a business or an industry except when I, when I say that, you know, if you said, well, I have a client and he has five companies and three of them are manufacturing and they each have 300 employees.
[00:09:36] Bruce: Okay. We have a controlled group. We have 400 employees to deal with and only two owners. Well, it’s hard to overcome that, you know, so size is sometimes an issue, not necessarily the industry. Although there are some industries that are, are a little unique. Like, uh, automobile dealerships are a little unique because one of the things most people don’t know is their highest paid employees turnover.
[00:10:03] Bruce: It’s their sales force. And you are going to incentivize them to stay with a retirement plan. So you tend to have a lot of other people in the plan. And my experience is they have not focused on employee benefits over time. So sometimes they’re not as good. Although we’ve done a number of plans. We’re auto dealerships.
[00:10:26] Bruce: You can use any type of industry. The critical thing is that they’re a successful business. That they have a desire to put money away and save taxes, use it as a tax control tool. And it doesn’t matter how they’re organized. They could be a sole proprietor. They could be a partnership, a C Corp, an S Corp, an LLC taxed in any way they want.
[00:10:52] Bruce: Just a slight difference in accounting makes them
[00:10:55] Patrick: so flexible.
[00:10:56] Patrick: Every time I talk with Bruce, I take away some wisdom. Isn’t he great?
[00:11:01] Patrick: Now we’re going to hear from Brad Etheridge.
[00:11:03] Patrick: So I’d like to just hop in and have you talk a little bit about an ideal scenario, both from a financial perspective and then long term goals that aren’t financially related. In relationship to the entrepreneur and how an ESOP can fit into their lives and how that would work out.
[00:11:21] Brad: Well, that’s a, that’s a lovely softball. You’re lobbying over the net here, so I’ll hit it back nice and slow. So thanks for not starting out with all the tough questions to start with. I mean, in ESOP, for those of you not familiar as an employee stock ownership program, and it’s. One of really three legitimate options that a business owner has when they’re looking at an exit strategy.
[00:11:44] Brad: You know, we work with business owners and employees and it spans the spectrum. I mean, from folks that are ready to sell their company as an example or contemplated, and they just don’t want anything to do with it. They want to get out. They, maybe they don’t have as much of a concern. Of course they care about the employees, but be done with it and walk away.
[00:12:04] Brad: We’re, we’re not a real good candidate for that type of person. Um, let’s give you a great example and it will probably lead into it. Um, you know, if, if most of the entrepreneurs listening to this podcast are Like the ones I’ve worked with for the last 40 years. Cause that’s basically what I’ve done in my professional career is, is tax advantage strategies in that type of, of, um, structure when you, when you’re looking at it, you got a few options and you’re saying, okay, look, I’ve spent the last 20, 30, 40 years building the business.
[00:12:35] Brad: I’ve been given a lot of thought to, uh, to an exit strategy. Cause that’s very difficult. It’s also very difficult because you spend most of your time building it. You know, nobody takes a lot of time to think about what’s that next step. And maybe the kids aren’t going in the business because they went a different direction or maybe they’re not capable of running the business at the level it needs to be run at.
[00:12:55] Brad: So you’re looking at me and you say, okay, Brad, what are we going to do? Uh, let’s talk about my options. Well, option one may be getting it valued and then selling your business to, you know, private equity or to a competitor. Just like in any other sales, pretty much like even selling a house, you know, you’ve got comparables based on your industry.
[00:13:15] Brad: And let’s say that comparable is, you know, five or six times your last year’s EBITDA and you look at the number and you say, okay, great. It’s not a bad number. I’m all right with it. Couple of issues that go along with that is a lot of you are going to end up paying a lot of capital gains, especially if you built that business from scratch, uh, based on what state you’re in.
[00:13:35] Brad: Uh, but between capital gains and state and federal, if your state does have that tax, you can lose a third of that value that you built back on everything above your basis. The other problem with selling to your competitors, there really isn’t any protection for your employees. I mean, if I was one of your competitors, Patrick, and I looked at your business and I had one that was similar, maybe a little bit bigger.
[00:13:57] Brad: Or you’re going to make me bigger. I can afford to buy you because of economy of scale. I mean, I’ve already got my CFO. I’ve got my marketing team. I’m going to eliminate the one that you have because mine’s better or you’d be buying me. So, so a lot of those employee issues can, can be kind of a concern, especially for your long term employees.
[00:14:15] Brad: I mean, yeah, you can always throw money at them on the way out, but that’s at the end of the day, that’s your money. The think a lot of owners don’t think about when they’re selling their business that they really need to think about is. Is, um, you know, I’m going to end up having to go to work for whoever buys me for two or three years.
[00:14:32] Brad: It’s ultra common and usually required that they want a nice transition from the old leadership to the new, and they require a working contract. And they usually have that tied into some earnouts or buyouts or potentially some paybacks or clawbacks if the numbers aren’t hit that you said the company was going to hit.
[00:14:53] Brad: And even if you’re right about your numbers for a couple of years, you got to have some pretty big concerns about the fact that, uh, most of the clients I worked with. They are entrepreneurs. They don’t do real well working for somebody else. And all of a sudden you’re punching the clock on money you’ve already earned and received.
[00:15:09] Brad: It just usually doesn’t end very well. So no protection for those employees, which is tricky and working for somebody else, which is no fun. Okay. So another option, Hey, I’ve got some really good key people have been with me since day one, and I’d really like to see them take the company. I’ll sell it to them.
[00:15:26] Brad: And over time they can pay me. Well, you’re taking a hundred percent of the financial risk in doing that. Number two, most of those people do not have the money to give you to do the buyout. So when you actually physically sit down and you look at the risk that you would take in doing that and the lack of reward and the amount of time that it would take to pay you off on top of paying them for being owners, and they won’t be making much more money because they’re giving it all back to you.
[00:15:50] Brad: They usually get scrapped. So the third option that may make sense for the right type of business is looking at an ESOP or an employee stock ownership program, where you’re selling over time, the value of the company to the employees. Now there’s some really big tax advantages and there’s some big financial advantages to the right kind of seller.
[00:16:11] Brad: What that really requires just to give you the quick thumbnail sketches, you know, you need to have at least 20. Eligible employees, because you got to be able to spread those shares out over time to a group of people. The range that we work in at BTA Business Transition is a company valued at, you know, close to 10 million or close to 10 million up to about 600 million.
[00:16:34] Brad: So our sweet spot’s that 10 to 600 space, and that’s where we’ve done a majority of the ESOPs we’ve put in place over the last 15 years. By the way, if you’re wondering where you fall in the company, you can talk to Patrick and you can get numbers on the company and, you know, we’re, we’re more than happy to sign an NDA and do a quick valuation, uh, you know, without an engagement agreement.
[00:16:56] Brad: Uh, and we do it all the time because if it’s a good fit, great. We want to show you what the numbers will look like. If it’s not a good fit, we’ll show you what you need to do to change them or where you may want to go to get better numbers outside the ESOP arena.
[00:17:08] Patrick: I love the power of an ESOP. Do you see how that can be a powerful tool in the right situation? Chad Spitzer is up next, and we’re going to highlight how captive insurance can work for your business. So when we think about those deductibles, right, I think one of the, can you talk a little bit about how the risk is sort of shared in a captive, even though I have my own company set up?
[00:17:29] Patrick: Can you, can you touch on that? Cause it sounds like, oh, you know, If I’m putting the money into my own entity and then I’m going to have to take it back out. How have I saved any money there on the, uh, uh, that, that big deductible? So, absolutely. So there’s an economic
[00:17:44] Chad: side of that as well, which I think we’re going to touch on it just a bit.
[00:17:47] Chad: First off, it’s, hey, I’m putting money aside and there’s efficiency there financially, but also your captive will participate in a risk pool, which is a reinsurance risk pool where it can, it can share in that burden, say, deductible million dollar deductible so that you’re not having to pay on that full amount.
[00:18:08] Chad: Say I’m just this is just an example. You have the storm come through and you owe a million dollars on your deductible. We file the claim when you’re captive for that million dollar deductible. Your insurance company may pay, say, 250 grand a month. And then our risk reinsurance risk pool will pay 750, 000 of it.
[00:18:27] Chad: So, while there’s a lot of economic efficiencies and putting the money aside in and of itself, there’s also the side of it that you’re getting reinsurance for those deductibles that otherwise just doesn’t really exist out there. Um, and you have the ability to do that in your own insurance company. So, there’s that side of it as well, so that it, You know, levels out your financials a bit where you’re not just going to get a huge five minute expense that you don’t expect when there’s a storm comes through, you get help from a reinsurance risk pool to help cover part of that plan.
[00:18:58] Patrick: Fantastic. Thank you. So, would you say a good fit for, for captive is, uh, So when there’s gaps in the, we’ll call it the commercial market that the business owner can’t get coverage for, we can bring the captive in and sort of fit into some of those, those gaps there. Is that, is that typically how you’re seeing this, um, this strategy used?
[00:19:24] Chad: Yeah, so that was the 1st 1. I talked about was just the deductible side of it. So there’s a few different ways we use it. 1 is big retentions deductibles. Some sort of retention. Do you have any commercial side? Next would be Hey, I would like to cover for certain gaps that I may have in my coverage. You know, we’ve been purchasing our professional liability policy for the last 10 years.
[00:19:45] Chad: All of a sudden the carrier comes in and says, hey, we’re no longer going to cover this situation and they add on an exclusion to that policy or you get denied coverage. When you had a claim that’s heard the idea of the captive is to take on those exclusions that exist and provide a coverage in those scenarios.
[00:20:02] Chad: When you’re being denied coverage, not that it covers everything, but the policy is written more broad to allow for those claims to be able to actually receive coverage in those instances. So, yes, we would then also price in additional policies that backstop what you currently have. So that you can be provided that additional coverage that you may otherwise not have on your commercial side.
[00:20:24] Chad: So the next person could potentially be a candidate. Would be someone that, hey, I’m paying a lot in premium. You know, I have a significant premium expense, 200 or 400 plus thousand dollars that they’re paying premium and feel that, hey, I’m not really even using it that much, but maybe my rate just keeps going up every year because we are in what’s called a hard main market in the insurance world, which is premiums are going up, right?
[00:20:49] Chad: You
[00:20:49] have catastrophic events that are occurring on the
[00:20:53] Chad: property side, storm wise, all of those things. Where it causes these carriers to have massive losses so because of that they make up by charging more premium so those areas May be a fit for some listeners that are paying a significant amount In insurance that don’t have a lot of claims to say is there something I can do in a captive?
[00:21:13] Chad: To set up this entity we set up to take on a portion of that risk To then get some premium savings on the other end. There’s a lot we can do there, right? There can be a group captive structure there can be Hey, we did a fronting carrier involved in reinsurance. There’s a lot we can do. So that’s a long way.
[00:21:31] Chad: It’s flexibility with a single parent captive. Um, to do any one of those things that we kind of discussed, but especially with those that are paying large premium amounts with not a lot of losses, CATS may be something to consider,
[00:21:44] Patrick: um, to see some premium savings. Got it.
[00:21:47] Patrick: Thanks Chad and his team at Higginbotham are some of the best in the business.
[00:21:51] Patrick: Now we’re going to hear from Ken Crabb and his strategy for deducting life insurance premium through your business.
[00:21:58] Ken: So the restricted property trust, historically, we’ve done it with small business owners. Um, average trust probably has one and a half people in it. You can have more than one in anyone trusts. It’s just been recently that we’re now moving toward the public company market because of the federal litigation success.
[00:22:15] Ken: And so that will be, you know, a huge, huge market for us. But with the restricted property trust, a business owner, they’re saying, Hey, I really have a death benefit need. There has to be a business reason to purchase the death benefit. And that’s step number one. What’s the reasonable business purpose? Why are you doing this?
[00:22:34] Ken: And you and I know in the insurance world, the insurance advisors are thinking about the commission and the clients are thinking about the deduction and they’re not thinking about the business purpose. So I’m always taking people back and going great. You want to put 500, 000 in here. I might be able to do that.
[00:22:52] Ken: How old are you? What does your tax return look like? What’s the, you know, if your business isn’t worth 15, 20 million, I’m not going to be able to get that much money in here. And so what happens then, one quick side note, we wrote our first professional athlete in the summer of 2015. And pro athletes are really tough because they’re all young and healthy.
[00:23:11] Ken: Otherwise they wouldn’t be professional athletes. And so, and they’re making tons of money and always wanting to put two common checks into these deals. And unless their name image likeness is a household name, I have no business purpose. So all the athletes that we now have are household names. Um, so that’s.
[00:23:28] Ken: Step one, but back to the macro level, we’re looking for business owners primarily making at least 650, 000 a year. And the reason I like that number, Patrick, is I want every dollar going into my plan to be coming from the top marginal bracket, right? So that’s the starting point to our earlier conversation.
[00:23:47] Ken: When you get into a level three tax strategy that you need to be in the top marginal bracket before you start looking at it, you know, I get phone calls from people making 300, 000 a year and their effective tax rates in the twenties, and I’m like, you’re not ready. You’re not here yet, but once you get into that top marginal bracket, the business is going to write a check.
[00:24:08] Ken: And for every dollar that the business puts in the trust, it’s going to lower the taxable income of the owner by 70 cents. So if they were going to make a million dollars and they put 100, 000 in the trust, they’re going to now pay taxes on 930, 000 and they have a whole life insurance policy.
[00:24:25] Patrick: That’s fantastic.
[00:24:26] Patrick: There’s a few different pieces that, uh, I want to unpack there. So first we couldn’t agree more on the, uh, you know, those marginal brackets. We like talking about level one, level two, level three strategies, you know, level one, we’re taking care of, you know, just some, that good administration bookkeeping level two, you know, we’ve got the 401k plan, maybe a cash balance plan, and then once we’ve filled up level two, now we’re starting looking at level three, because I think there’s another piece that’s worth considering here is like the complexity starts going up, you know, like.
[00:24:56] Patrick: I have a trust, I’ve got life insurance, I’ve got administration. I’ve got some rules that we’ll get into here in a minute that I need to be paying attention to. And so this is not as simple as just putting money in a brokerage account and waiting until I’m to retirement age to get it out. Now, uh, there’s maybe better benefits than that when you start looking at it, but I think that’s a very important piece.
[00:25:16] Patrick: And we don’t really like to see clients try to get down below, you know, the 24 percent bracket at max, anything lower than that. I’m like. The rate you’re earning, you know, we’re going to be paying this tax, you know, why, why deduct 24 percent money to pay it later at 37%. Like that just doesn’t make any sense.
[00:25:33] Patrick: Let’s just stop the deductions here and, uh,
[00:25:35] Ken: that’s
[00:25:38] Patrick: fantastic. So I think moving back to design, it’s an employer sponsored plan. There’s some trust involved. So can you walk us through a few of those pieces and how they, they allow us to get this deduction?
[00:25:49] Ken: Sure. So the first thing we do after we get an approval for the actual life insurance policy, we’re never going to go hire a law firm and pay them for something until we know we can do something with it, and I will say right now, this is just a public service announcement, any entrepreneur listening.
[00:26:04] Ken: They probably have a. 8, 000 leather binder of a trust work in their office. And there’s nothing in
[00:26:12] the
[00:26:12] Ken: great thing about life insurance salesman is we’re going to make sure everything gets in there because we don’t get paid until the planning gets done. So the first thing is get, get an underwriting offer.
[00:26:22] Ken: And then we set up. Trust, the trust is 5, 000 flat, and that’s because of the volume that I do. Normally, this is a very complicated trust. If you went to a law firm from scratch, it’d be 35 to 50, 000. I would bet, um, but we get them done a lot more efficiently than that. And the trust is a grantor trust under subchapter J, the internal revenue code.
[00:26:42] Ken: Uh, technically it’s a 402 B trust employee benefit trust. That’s nice. It’s protected from civil litigation. All 402 B trusts are for folks that get worried about that, but you will You’re funding the trust and then the trust is actually funding the policy. The only thing the trust owns are whole life insurance policies and the trust is also the owner and beneficiary of the policy.
[00:27:08] Ken: So if the insurer dies, the trustee gets a check from the insurance carrier, picks up the beneficiary designation agreement, and then pays it out. And so that’s the intermediary, um, that we’re creating every time. And I should mention it’s additional thousand dollars per person. So a three person trust would be 8, 000.
[00:27:28] Ken: Really it’s the fees. I’m very proud of the fees. I’ve worked really hard to get them that low. Uh, especially on the trustee side, the only fees, the restricted property trust has in year two and beyond is 750 per policy, which is. You know, what’s a cross tested cash balance pension plan? Four grand, five grand every year.
[00:27:47] Ken: Uh, so, and it’s really very reasonable, all tax deductible, but we are going to attach that trust to one corporate entity. I know some of your entrepreneur clients have 15. So when I’m looking for a reasonable death benefit, I’m going to ignore 14 of those companies because I have to justify the amount of the death benefit based on the loan tax return on which I’m providing.
[00:28:10] Ken: So that’s an important point. I have one client. Uh, that had 500 TGI Fridays and for our listeners, please get over that. I thought there were eight TGI Fridays in the United States. Apparently there’s at least 500, but every single Friday’s was in a separate partnership and he had a management company and I could really only ensure his key.
[00:28:29] Ken: Employee value to the management company rather than his 200 million empire.
[00:28:34] Patrick: Got it. So does that trust, uh, move the life insurance out of the entrepreneur’s taxable estate? Do we get some benefit there?
[00:28:43] Ken: No, and really several reasons.
[00:28:45] Ken: One estate planning is a personal purpose. So that would not justify a business deduction. And what we’ve done for estate planning, it stays in there. I’ve had clients, I don’t know how technical you want to be today, but claim the table 2001 rate as a completed gift for an islet. And then when they vest, they roll the policy directly to the islet.
[00:29:06] Ken: I still don’t recommend that because whole life with our PUAs has a lot of cash value per death benefit. So even in my own personal planning, Patrick, I have a very large survivorship IUL with my wife. And a large restricted property trust. I’m planning on funding both of them for 15 years, rolling out of my restricted property trust, and then using the cash value and flipping my SIL from level two, increasing.
[00:29:31] Ken: Maybe we’re starting to geek. You’re getting too excited. You’re already smiling too much.
[00:29:37] Ken: Soon as I get technical, you get all excited about it.
[00:29:39] Patrick: Um, I do. And yes, this is fantastic because I think there’s so many strategies out there that, uh, you can start combining together to, to create some efficiencies They’re absolutely worthwhile. So sorry, I didn’t mean to interrupt, but please continue on.
[00:29:53] Ken: Oh, it’s huge. And so my plan personally is I don’t want to have 4 million in my whole life policy with a 9 million death benefit. I’d prefer to switch my survivorship IUL from level two increasing and then crank that money and make that death benefit go for our three girls. Or if my wife and I need money, the heck with my girls, I can take out an income stream of 285, 000 a year tax free for 20 years.
[00:30:19] Ken: I think the biggest thing that we are supposed to do as planners and the reason I like working with people that see me as one piece of a puzzle and not a shiny new toy. Is because I want to make sure that five years from now, 10 years from now, people still have decisions to make an options,
[00:30:36] Patrick: right? So just build in some flexibility.
[00:30:39] Patrick: Yep. That’s, that’s fantastic. Thank you. So one of the things I want to dig into a little bit more is the trust structure. So we’ve talked a little bit about the trust, but There’s some restrictions to restricted property trust, right? So can we talk a little bit through those restrictions? Cause I think anytime we just like to be very clear, anytime there’s an opportunity for a tax deduction, there’s usually some strings attached to that.
[00:31:04] Patrick: If there’s not, we advise our clients, you should probably run away because it’s too good to be true. And you don’t want the department of justice coming to knock on your door going, Hey, uh, come with us. You’re, you’re going to jail for tax fraud. So can you tell us a little bit about the. Restrictions on the trust.
[00:31:18] Ken: Yeah, for sure. To your point as well. Pre COVID, I used to go to a lot of hotel ballrooms and speak at CPA CE tax conferences, and I was one of six presenters, and I ended up participating in a lot of the other presenters strategies personally, but anytime I heard a guy start off with Hey, here’s a current deduction for an appreciating asset.
[00:31:39] Ken: You get back tax free. I’m like, I’m going to go to the lobby and check my email. Cause I know you can’t do that. You can defer taxes. You can time taxes. You can leverage taxes. You just can’t avoid taxes. So, um, yeah, so the restricted property, the term restricted property comes from section 83 in the internal revenue code, which is titled property transferred in connection with goods and services.
[00:32:03] Ken: The most common form of property that gets restricted in the United States is stock, stock options. Most stock options are 83B property, and I bet you that’s over 90 percent of the restricted property in America. But you can do it with anything. Patrick, if you said to me, Ken, you seem like a great employee, I’d really like to lock you up.
[00:32:22] Ken: I have a garage behind my office that’s worth 30, 000. If you work for me for five years, I will hand you the title to that garage. That is now a plan of restricted property under section 83, which means I could go and say, Hey, Patrick, I love working for you. That garage is the bee’s knees. I’m going to pay tax on that 30, 000, even though I’m not guaranteed to get it in the future.
[00:32:45] Ken: If I go take another job in two years, or you fire me in four years, I am not going to get that garage. And I’m not going to get my tax money back. However, the reason people do it, and if you were at Google back in the day, I hope you made a bunch of 83B elections, but if you elect to include that, and a shopping mall goes up across the street, so my little garage does now work 200, 000 when you hand me the title, it functions like a Roth IRA.
[00:33:09] Ken: That is a non taxable transfer to me.
[00:33:11] Patrick: I love Ken’s creativity and commitment to delivering billionaire strategies to the entrepreneur. Isn’t the restricted property trust brilliant? Finally, Derek Rip shares tips for successfully exiting your business.
[00:33:24] Derek: , I’ll preface by saying that when it gets into the specifics of the. Business operations and closing that gap, we would actually pull in another professional. So there are a lot of people that play in that space. Business consultants, um, coaches, you mentioned a great firm earlier, EOS.
[00:33:43] Derek: I mean, I, I’m familiar, I work with some people from that organization. And again, the, the, the data’s out there, the software is out there. So it’s just a matter of, you know, being able to take the time, have somebody to work with that can build out a roadmap, if you will. And for business owners, it’s really helping them to identify what are the key areas, and usually there’s two or three that they know that need to be improved, and that’s where the focus should really start on, and then you’re just checking off the list and working down to improve the value.
[00:34:13] Derek: But obviously, having a plan is really important. I would argue that successful exit planning is really the overlap of three. Separate areas, uh, but all important areas and the business improvement is one of those. So that’s where those business consultants and. And coaches can come into play the personal financial readiness.
[00:34:35] Derek: So think personal financial planning, and then also, you know, thinking about life after the business sale. So in the Venn diagram, it’s really where those three overlap is where the master plan should be built. So the master plan is all those three pieces. And I think a lot of times business owners, they’re very good at what they do as far as operating their companies.
[00:34:57] Derek: Uh, they probably don’t need. As much advice from third parties like, like us, but they need advice on the big picture planning because again, exit planning is this very vague concept that’s going to, you know, in their mind take place at some point in the future, it can be confusing. And then when that happens, owners just say, you know what, I’ll deal with it later, which is not what we want them to do, but unfortunately that’s often what happens.
[00:35:21] Derek: And so having somebody that can help coordinate those pieces. Is really important. That’s 1 reason why I went and got the certified exit planning advisor designation is to help serve in that function where we know, okay, I’m not an expert in a by in any of these are all these areas by any means. But, you know, I do know people that I could bring in from EOS or other, you know, business consultants, M& A advisors.
[00:35:46] Derek: To address key areas and then, you know, bringing in other professionals when it comes to attorneys, there’s all kinds of different types of attorneys, you know, transaction attorneys, business attorneys, estate planning attorney. So, uh, again, all can be really confusing to the average owner and, uh, having a third party, they can say, now’s the time we need to talk to that estate planning attorney or now’s the time that we need to really make sure we have the transaction attorney lined up.
[00:36:10] Derek: I think it’s helpful as well.
[00:36:12] Patrick: Absolutely. And I think there’s a few things that I want to sort of pull out of there. The first is I love that, you know, when we think about how we, we serve our clients, we try to be this hub that can sort of manage all of those pieces you’re talking about, right? Like, Oh, Hey, here’s an estate planning attorney that we can bring into this discussion.
[00:36:29] Patrick: Here’s, you know, EOS strategic coach, some of these business consulting firms that we can, we can bring in. It just takes the pressure off of the business owner to manage all of that. Right? Like they have enough on their plate. The way it is running a business is hard. They don’t need another thing. And on the list.
[00:36:46] Patrick: And part of the reason why business owners don’t take action on these things is like, it’s overwhelming. It’s too, too complex. I’ll just worry about it later. And then later becomes a problem. So just a couple of things, statistics that I think, um, matter 80 to 90 percent of the owner’s wealth is trapped in their company.
[00:37:04] Patrick: And then. I think this really matters. And I think this gets to the heart of what you were talking about. So that, that 80 to 90 percent can help close the gap, right? Like we’ve got this wealth gap, but all of my wealth’s tied into this business. Like how do we unlock that? You know, and it’s through a sale in some capacity.
[00:37:20] Patrick: Then the next statistic that is shocking, um, but not is, and this gets back to a point we made earlier about, you know, progress being sort of a key. Factor in an entrepreneur’s life. 75 percent of owners profoundly regret selling their business just a year after selling it, you know, cause it sort of takes them out of that progress mode.
[00:37:39] Patrick: Like I have nothing that I can make progress on anymore. So can you talk a little bit more about like. What good planning looks like for the business owner to sort of move into this next phase of life.
[00:37:51] Derek: Yeah, absolutely. Unfortunately, there’s some dismal statistics that again, it doesn’t have to be that way, but especially when you say, you know, the statistic about 75 percent of owners profoundly regret.
[00:38:03] Derek: Selling their business a year after what that tells me is that there wasn’t probably enough planning done in other areas. Maybe they did a lot of planning in their business and work to increase the value and did all those things that we were talking about earlier, but maybe they didn’t do enough planning on what is life after the business sale look like?
[00:38:22] Derek: You know, let’s face a lot of our business owner clients. Our type a, they’re very highly motivated people. They want, they like to work hard. They don’t want to be sitting on the rocking chair, uh, on reach, you know, on the front porch during retirement. So this is part of maybe what I would call the identity crisis because they have had identified with the business that the business It was almost indistinguishable.
[00:38:44] Derek: They were the business for a long period of time and now that’s gone. So what’s that next phase in life look like? And so being able to talk through that in plan and making sure that that is realistic, you know, if you, uh, if you think that you might like to do something, um, but you haven’t really done a lot of it before that, you might want to try it out before you go, I’m going to retire.
[00:39:07] Derek: And then, uh, I’m just going to go fishing or go golfing. It may not be fulfilling. Right. So that’s, I think the important thing is. And for some people that is, um, volunteering other people, it is maybe starting another business or helping out, um, in other ways, but you know, doing something again, I think that’s the key is that business owners have been driven people for the most part, and they need to have identify what that is that is going to help them look forward to getting up every day.
[00:39:35] Derek: And that is definitely one of the things that I think gets overlooked. I also would say that some of this is just how maybe the financial service industry has been trained. They’ve been trained to talk more about traditional financial assets like stocks and bonds and ETFs and mutual funds and haven’t been as trained in terms of.
[00:39:57] Derek: How to incorporate the non security asset being the business, which is again, a very high percentage of a person’s net worth, another statistic that’s unfortunate, but statistically, uh, over 70 percent of businesses that list to be sold on the market do not sell. And that’s discouraging, but, but that’s, again, all these things that we were talking about, that it’s important to make sure that, that you can monetize and get value out of the company.
[00:40:25] Derek: Because if you’re viewed as really just a. A lifestyle business, a lifestyle company, then, uh, you may not monetize that value. That’s, and, and that’s again, how do you unlock that and be able to transition that into, you know, your, your long term financial plan.
[00:40:42] Patrick: That concludes this highlight episode from experts we’ve had on the show. Weren’t those clips great to review? Thank you for listening to the Vital Strategies Podcast. For links to the resources mentioned in today’s show, see the show notes of this episode at vitalstrategies. com forward slash episode 18.
[00:41:00] Patrick: Follow the Vital Strategies Podcast wherever you listen to podcasts, and don’t forget to rate and review the show, letting us know how these tips are helping you pay less tax and build more wealth. We will see you next week. And if you have any questions, topics, suggestions, or would like to share your own success story on the podcast, we’d love to hear from you.
[00:41:19] Patrick: Submit your questions and comments at vital strategies. com forward slash questions for all your tax savings resources, visit our website at vital strategies. com we look forward to having you back next week where we will help you pay less tax, grow your wealth so you can live a great life. [00:00:00] Patrick: Welcome to the vital strategies podcast, your go to resource for expert insight in the ever evolving world of tax finance and wealth building today on the podcast, we have a special episode where we’re going to review some of the highlights from our experts from previous shows. Feel free to go back and listen to those shows to get all the insight everyone had to offer.
[00:00:20] Patrick: We’re going to revisit our discussion with Walt Dallas and his insight on how to use a business development corporation to maximize deductions. Then we’re going to hear from Bruce Gendine and discuss the power of a cash balance plan. Brad Etheridge talks about the power of selling your business to your employees through an ESOP.
[00:00:38] Patrick: Then we have two level three tax strategies that are great opportunities for business owners with Chad Spitzer discussing captive insurance and Ken Crabb talking about how to deduct life insurance premiums through the Restricted Property Trust. Finally, we wrap up with some highlights from Derek Ripp and successfully transitioning out of your business.
[00:00:57] Patrick: I’m your host, Patrick Lonergan, and I’m thrilled to share highlights from some of the experts we’ve had on the show. Let’s dive in. First up is Walt Dallas.
[00:01:05] Patrick: You were talking about some of the strategies that we can use inside of the business development corp. Can you walk us through some of the most common strategies you have in there? What the benefits are from a, both personal perspective and tax benefit.
[00:01:19] Walt: Yeah, sure. Can. Um, one of the things that we noticed is that a lot of people like to do Tax plans for the income tax benefits. But as I mentioned, we have to have a proper business purpose for the business development company and the C corporate, you know, which is our C corporation to exist.
[00:01:36] Walt: And so. We, um, noticed that we’ve been harping on marketing for years and years. You know, clients need to be marketing, they need to be spending money on marketing. There’s some categories, like anesthesiologists really have a hard time spending money on marketing because they have, they’re captured by, you know, hospitals and patients and places like that.
[00:01:55] Walt: And so, um, as we harped on that, we started getting into some, imagine that a lawyer starting getting into marketing. Uh, we’re one of the worst ones at it. Our plans, brother, and they’re good at it. New Clyde spent 600 grand a year on marketing. That’s why he’s making so much money. But we have seen the people that spend money in marketing, their top line grows, grows and grows and grows year after year.
[00:02:19] Walt: As we do our annual reviews, we’ll go back and look at a pattern of, Hey, what are your spending for, um, marketing and what’s your top line doing? And we found that the top line was going up. And so we had a challenge from an auditors with IRS, uh, for a particular case. And, uh, we said, this business development company has helped this guy make more money.
[00:02:39] Walt: And the guy just said, nah, and they said, we show you, we show you his, um, for the last five years, his advertising expenses has gone up and up and up. This is the pattern and look at his top line. Sure enough, top line followed the bottom line and the gal’s making more money, even, you know, of course, on a gross method.
[00:02:57] Walt: And then as they make that extra dollar, you know, the expenses of overhead related to that extra dollar or nothing. So the net goes way up too. And so that’s been a really cool thing to see. And that’s just not one client, but it is one client in that particular audit, but it happens more and more, you know, for, for particular clients that really believe in the marketing and run their business development company correctly.
[00:03:20] Walt: It’s been a great benefit. You mentioned the ownership of the stock. And we, of course, we use outside shareholders to make sure we comply with the control group rules and the guys that utilize the outside shareholders and really take advantage of those guys for their marketing ideas. Uh, there’s a lot of benefits for that too.
[00:03:38] Walt: Yeah,
[00:03:38] Patrick: very good. One thing that the Supreme court has said is it is no problem to utilize the tax code to your benefit and pay the least amount of tax possible. So. Do you find a lot of clients are doing things before they engage with you that they could be taking tax deduction for that they’re not?
[00:03:56] Patrick: Just about every client I’ve ever looked at is not taking
[00:03:59] Walt: advantage of the tax deductions that they could have. I think, you know, I’ve been doing this a long time and I’ve had one or two clients that have come in that are doing everything that we have on our lists. Kudos to them, but it’s, it’s a rare deal.
[00:04:13] Walt: One of the hard things is, is bidding. The tax plans into a business. And so it works together. So it actually, the structure works and that’s one of the things that we do real well, our process is pretty simple. We’ll take a look at the tax returns and then we have a questionnaire. We’ll send the clients and they’ll kind of tell us what they’re spending on those various categories.
[00:04:33] Walt: And then we’ll figure out what sort of items fit them. And sometimes we look at the information, we get it back. It’s like, you don’t say they’re in our shoe box, you know, our box of sand. And it just, we can’t help you. That is a bit rare too. I’d say one out of 10 potential clients that come through will say, sorry, we can’t help.
[00:04:52] Walt: You just don’t fit what we do. One of the categories that don’t fit are W 2 employees, you know, they’re really just out of luck. They can’t, they can’t get deductions. It’s the, the single business owner that are great clients for us because the single business owner can make it happen and control the way he gets paid.
[00:05:09] Walt: And also if he’s got a family, we can utilize the family for some additional benefits on that.
[00:05:14] Patrick: You’re touching on a great point. Who’s an ideal client for your strategy? What do they look like from a. Net income through the business. And you already mentioned, you know, a single owner, is it sort of disqualify somebody if there’s two partners in a business, could we set up two business development companies?
[00:05:32] Patrick: Is that an option? Yeah. Can you, can you just talk through a few of those, those things for us? Generally it’s
[00:05:38] Walt: a one owner business has repeatable income stream makes about um, 400, uh, of net income of taxable income or up, and that’s really a great client we have some. Plaintiff’s attorneys in our database and our client base, but sometimes their income just kind of goes way up and way down and that gets to be problematic.
[00:05:59] Patrick: Wasn’t that great information from Walt? Next, we’re going to hear from Bruce Gendine.
[00:06:05] Bruce: During that time, I’ve had wonderful relationships with investment sponsors and insurance companies who have many times asked me or my firm to help them design products that would fit the qualified plan arena and to help them market those plans through their financial advisor networks.
[00:06:25] Bruce: Well, in 2018, I was fortunate enough to find a firm that wanted to buy my third party administration and marketing firm. And after a suitable period of transition, I started working with Scott McHenry at McHenry Advisors. Uh, we had collaborated for, oh, probably four or five years prior to that. And so we’ve had a wonderful opportunity because what it does is it provides tremendous continuity for the financial advisor and their clients.
[00:07:00] Bruce: We’re a full service, third party administration and consulting actuarial firm. We have nine actuaries on staff. We administer somewhere north of 2, 000 pension plans. And we have clients in all 50 states.
[00:07:16] Patrick: I can just say we’ve worked with a couple different firms and, uh, working with you and McHenry has been, just made our job so much easier as advisors to help our clients.
[00:07:28] Patrick: Make sure that everything gets implemented well and you’re really on top of everything, which we appreciate. And it’s also fun to bring unique opportunities to you and be able to brainstorm some of the solutions there. So we, we do appreciate your expertise very much.
[00:07:42] Bruce: Thanks for your kind words. We try very hard, you know, as we say, we try to bring very high level of service.
[00:07:49] Bruce: With Midwestern values,
[00:07:51] Patrick: Bruce, one of the things you’ve helped us implement a number of cash balance plans for our clients. Can you give us the 30, 000 foot overview of what a cash balance plan is?
[00:08:01] Bruce: Sure. A cash balance plan is a pension plan and it’s sort of a. Brother of a defined benefit plan and matter of fact, a cash balance plan comes under all the same limitations and restrictions that a defined benefit plan would, but it’s a hybrid.
[00:08:21] Bruce: So it’s expressed more like it would define contribution plans. There’s a. Pay credit and an interest credit. And so we get away from the accrued benefit, and we’re talking about the account value. While there aren’t separate accounts in these plans, what they have is they have a cash balance that’s due the employee.
[00:08:43] Bruce: What happens is they are all employer functioned and, you know, and contributed. There are no employee contributions to these plans. And they’re very unique in that they are for very successful, closely held business owners and professionals. Client who makes a half a million dollars or more and would like to contribute 100, 200, 300.
[00:09:09] Bruce: 300 or maybe even more annually to their retirement plan.
[00:09:14] Patrick: Are there some examples of where a cash balance plan doesn’t work nearly as well? Is there a particular business or industry that we can look?
[00:09:20] Bruce: I don’t think you can look to a business or an industry except when I, when I say that, you know, if you said, well, I have a client and he has five companies and three of them are manufacturing and they each have 300 employees.
[00:09:36] Bruce: Okay. We have a controlled group. We have 400 employees to deal with and only two owners. Well, it’s hard to overcome that, you know, so size is sometimes an issue, not necessarily the industry. Although there are some industries that are, are a little unique. Like, uh, automobile dealerships are a little unique because one of the things most people don’t know is their highest paid employees turnover.
[00:10:03] Bruce: It’s their sales force. And you are going to incentivize them to stay with a retirement plan. So you tend to have a lot of other people in the plan. And my experience is they have not focused on employee benefits over time. So sometimes they’re not as good. Although we’ve done a number of plans. We’re auto dealerships.
[00:10:26] Bruce: You can use any type of industry. The critical thing is that they’re a successful business. That they have a desire to put money away and save taxes, use it as a tax control tool. And it doesn’t matter how they’re organized. They could be a sole proprietor. They could be a partnership, a C Corp, an S Corp, an LLC taxed in any way they want.
[00:10:52] Bruce: Just a slight difference in accounting makes them
[00:10:55] Patrick: so flexible.
[00:10:56] Patrick: Every time I talk with Bruce, I take away some wisdom. Isn’t he great?
[00:11:01] Patrick: Now we’re going to hear from Brad Etheridge.
[00:11:03] Patrick: So I’d like to just hop in and have you talk a little bit about an ideal scenario, both from a financial perspective and then long term goals that aren’t financially related. In relationship to the entrepreneur and how an ESOP can fit into their lives and how that would work out.
[00:11:21] Brad: Well, that’s a, that’s a lovely softball. You’re lobbying over the net here, so I’ll hit it back nice and slow. So thanks for not starting out with all the tough questions to start with. I mean, in ESOP, for those of you not familiar as an employee stock ownership program, and it’s. One of really three legitimate options that a business owner has when they’re looking at an exit strategy.
[00:11:44] Brad: You know, we work with business owners and employees and it spans the spectrum. I mean, from folks that are ready to sell their company as an example or contemplated, and they just don’t want anything to do with it. They want to get out. They, maybe they don’t have as much of a concern. Of course they care about the employees, but be done with it and walk away.
[00:12:04] Brad: We’re, we’re not a real good candidate for that type of person. Um, let’s give you a great example and it will probably lead into it. Um, you know, if, if most of the entrepreneurs listening to this podcast are Like the ones I’ve worked with for the last 40 years. Cause that’s basically what I’ve done in my professional career is, is tax advantage strategies in that type of, of, um, structure when you, when you’re looking at it, you got a few options and you’re saying, okay, look, I’ve spent the last 20, 30, 40 years building the business.
[00:12:35] Brad: I’ve been given a lot of thought to, uh, to an exit strategy. Cause that’s very difficult. It’s also very difficult because you spend most of your time building it. You know, nobody takes a lot of time to think about what’s that next step. And maybe the kids aren’t going in the business because they went a different direction or maybe they’re not capable of running the business at the level it needs to be run at.
[00:12:55] Brad: So you’re looking at me and you say, okay, Brad, what are we going to do? Uh, let’s talk about my options. Well, option one may be getting it valued and then selling your business to, you know, private equity or to a competitor. Just like in any other sales, pretty much like even selling a house, you know, you’ve got comparables based on your industry.
[00:13:15] Brad: And let’s say that comparable is, you know, five or six times your last year’s EBITDA and you look at the number and you say, okay, great. It’s not a bad number. I’m all right with it. Couple of issues that go along with that is a lot of you are going to end up paying a lot of capital gains, especially if you built that business from scratch, uh, based on what state you’re in.
[00:13:35] Brad: Uh, but between capital gains and state and federal, if your state does have that tax, you can lose a third of that value that you built back on everything above your basis. The other problem with selling to your competitors, there really isn’t any protection for your employees. I mean, if I was one of your competitors, Patrick, and I looked at your business and I had one that was similar, maybe a little bit bigger.
[00:13:57] Brad: Or you’re going to make me bigger. I can afford to buy you because of economy of scale. I mean, I’ve already got my CFO. I’ve got my marketing team. I’m going to eliminate the one that you have because mine’s better or you’d be buying me. So, so a lot of those employee issues can, can be kind of a concern, especially for your long term employees.
[00:14:15] Brad: I mean, yeah, you can always throw money at them on the way out, but that’s at the end of the day, that’s your money. The think a lot of owners don’t think about when they’re selling their business that they really need to think about is. Is, um, you know, I’m going to end up having to go to work for whoever buys me for two or three years.
[00:14:32] Brad: It’s ultra common and usually required that they want a nice transition from the old leadership to the new, and they require a working contract. And they usually have that tied into some earnouts or buyouts or potentially some paybacks or clawbacks if the numbers aren’t hit that you said the company was going to hit.
[00:14:53] Brad: And even if you’re right about your numbers for a couple of years, you got to have some pretty big concerns about the fact that, uh, most of the clients I worked with. They are entrepreneurs. They don’t do real well working for somebody else. And all of a sudden you’re punching the clock on money you’ve already earned and received.
[00:15:09] Brad: It just usually doesn’t end very well. So no protection for those employees, which is tricky and working for somebody else, which is no fun. Okay. So another option, Hey, I’ve got some really good key people have been with me since day one, and I’d really like to see them take the company. I’ll sell it to them.
[00:15:26] Brad: And over time they can pay me. Well, you’re taking a hundred percent of the financial risk in doing that. Number two, most of those people do not have the money to give you to do the buyout. So when you actually physically sit down and you look at the risk that you would take in doing that and the lack of reward and the amount of time that it would take to pay you off on top of paying them for being owners, and they won’t be making much more money because they’re giving it all back to you.
[00:15:50] Brad: They usually get scrapped. So the third option that may make sense for the right type of business is looking at an ESOP or an employee stock ownership program, where you’re selling over time, the value of the company to the employees. Now there’s some really big tax advantages and there’s some big financial advantages to the right kind of seller.
[00:16:11] Brad: What that really requires just to give you the quick thumbnail sketches, you know, you need to have at least 20. Eligible employees, because you got to be able to spread those shares out over time to a group of people. The range that we work in at BTA Business Transition is a company valued at, you know, close to 10 million or close to 10 million up to about 600 million.
[00:16:34] Brad: So our sweet spot’s that 10 to 600 space, and that’s where we’ve done a majority of the ESOPs we’ve put in place over the last 15 years. By the way, if you’re wondering where you fall in the company, you can talk to Patrick and you can get numbers on the company and, you know, we’re, we’re more than happy to sign an NDA and do a quick valuation, uh, you know, without an engagement agreement.
[00:16:56] Brad: Uh, and we do it all the time because if it’s a good fit, great. We want to show you what the numbers will look like. If it’s not a good fit, we’ll show you what you need to do to change them or where you may want to go to get better numbers outside the ESOP arena.
[00:17:08] Patrick: I love the power of an ESOP. Do you see how that can be a powerful tool in the right situation? Chad Spitzer is up next, and we’re going to highlight how captive insurance can work for your business. So when we think about those deductibles, right, I think one of the, can you talk a little bit about how the risk is sort of shared in a captive, even though I have my own company set up?
[00:17:29] Patrick: Can you, can you touch on that? Cause it sounds like, oh, you know, If I’m putting the money into my own entity and then I’m going to have to take it back out. How have I saved any money there on the, uh, uh, that, that big deductible? So, absolutely. So there’s an economic
[00:17:44] Chad: side of that as well, which I think we’re going to touch on it just a bit.
[00:17:47] Chad: First off, it’s, hey, I’m putting money aside and there’s efficiency there financially, but also your captive will participate in a risk pool, which is a reinsurance risk pool where it can, it can share in that burden, say, deductible million dollar deductible so that you’re not having to pay on that full amount.
[00:18:08] Chad: Say I’m just this is just an example. You have the storm come through and you owe a million dollars on your deductible. We file the claim when you’re captive for that million dollar deductible. Your insurance company may pay, say, 250 grand a month. And then our risk reinsurance risk pool will pay 750, 000 of it.
[00:18:27] Chad: So, while there’s a lot of economic efficiencies and putting the money aside in and of itself, there’s also the side of it that you’re getting reinsurance for those deductibles that otherwise just doesn’t really exist out there. Um, and you have the ability to do that in your own insurance company. So, there’s that side of it as well, so that it, You know, levels out your financials a bit where you’re not just going to get a huge five minute expense that you don’t expect when there’s a storm comes through, you get help from a reinsurance risk pool to help cover part of that plan.
[00:18:58] Patrick: Fantastic. Thank you. So, would you say a good fit for, for captive is, uh, So when there’s gaps in the, we’ll call it the commercial market that the business owner can’t get coverage for, we can bring the captive in and sort of fit into some of those, those gaps there. Is that, is that typically how you’re seeing this, um, this strategy used?
[00:19:24] Chad: Yeah, so that was the 1st 1. I talked about was just the deductible side of it. So there’s a few different ways we use it. 1 is big retentions deductibles. Some sort of retention. Do you have any commercial side? Next would be Hey, I would like to cover for certain gaps that I may have in my coverage. You know, we’ve been purchasing our professional liability policy for the last 10 years.
[00:19:45] Chad: All of a sudden the carrier comes in and says, hey, we’re no longer going to cover this situation and they add on an exclusion to that policy or you get denied coverage. When you had a claim that’s heard the idea of the captive is to take on those exclusions that exist and provide a coverage in those scenarios.
[00:20:02] Chad: When you’re being denied coverage, not that it covers everything, but the policy is written more broad to allow for those claims to be able to actually receive coverage in those instances. So, yes, we would then also price in additional policies that backstop what you currently have. So that you can be provided that additional coverage that you may otherwise not have on your commercial side.
[00:20:24] Chad: So the next person could potentially be a candidate. Would be someone that, hey, I’m paying a lot in premium. You know, I have a significant premium expense, 200 or 400 plus thousand dollars that they’re paying premium and feel that, hey, I’m not really even using it that much, but maybe my rate just keeps going up every year because we are in what’s called a hard main market in the insurance world, which is premiums are going up, right?
[00:20:49] Chad: You
[00:20:49] have catastrophic events that are occurring on the
[00:20:53] Chad: property side, storm wise, all of those things. Where it causes these carriers to have massive losses so because of that they make up by charging more premium so those areas May be a fit for some listeners that are paying a significant amount In insurance that don’t have a lot of claims to say is there something I can do in a captive?
[00:21:13] Chad: To set up this entity we set up to take on a portion of that risk To then get some premium savings on the other end. There’s a lot we can do there, right? There can be a group captive structure there can be Hey, we did a fronting carrier involved in reinsurance. There’s a lot we can do. So that’s a long way.
[00:21:31] Chad: It’s flexibility with a single parent captive. Um, to do any one of those things that we kind of discussed, but especially with those that are paying large premium amounts with not a lot of losses, CATS may be something to consider,
[00:21:44] Patrick: um, to see some premium savings. Got it.
[00:21:47] Patrick: Thanks Chad and his team at Higginbotham are some of the best in the business.
[00:21:51] Patrick: Now we’re going to hear from Ken Crabb and his strategy for deducting life insurance premium through your business.
[00:21:58] Ken: So the restricted property trust, historically, we’ve done it with small business owners. Um, average trust probably has one and a half people in it. You can have more than one in anyone trusts. It’s just been recently that we’re now moving toward the public company market because of the federal litigation success.
[00:22:15] Ken: And so that will be, you know, a huge, huge market for us. But with the restricted property trust, a business owner, they’re saying, Hey, I really have a death benefit need. There has to be a business reason to purchase the death benefit. And that’s step number one. What’s the reasonable business purpose? Why are you doing this?
[00:22:34] Ken: And you and I know in the insurance world, the insurance advisors are thinking about the commission and the clients are thinking about the deduction and they’re not thinking about the business purpose. So I’m always taking people back and going great. You want to put 500, 000 in here. I might be able to do that.
[00:22:52] Ken: How old are you? What does your tax return look like? What’s the, you know, if your business isn’t worth 15, 20 million, I’m not going to be able to get that much money in here. And so what happens then, one quick side note, we wrote our first professional athlete in the summer of 2015. And pro athletes are really tough because they’re all young and healthy.
[00:23:11] Ken: Otherwise they wouldn’t be professional athletes. And so, and they’re making tons of money and always wanting to put two common checks into these deals. And unless their name image likeness is a household name, I have no business purpose. So all the athletes that we now have are household names. Um, so that’s.
[00:23:28] Ken: Step one, but back to the macro level, we’re looking for business owners primarily making at least 650, 000 a year. And the reason I like that number, Patrick, is I want every dollar going into my plan to be coming from the top marginal bracket, right? So that’s the starting point to our earlier conversation.
[00:23:47] Ken: When you get into a level three tax strategy that you need to be in the top marginal bracket before you start looking at it, you know, I get phone calls from people making 300, 000 a year and their effective tax rates in the twenties, and I’m like, you’re not ready. You’re not here yet, but once you get into that top marginal bracket, the business is going to write a check.
[00:24:08] Ken: And for every dollar that the business puts in the trust, it’s going to lower the taxable income of the owner by 70 cents. So if they were going to make a million dollars and they put 100, 000 in the trust, they’re going to now pay taxes on 930, 000 and they have a whole life insurance policy.
[00:24:25] Patrick: That’s fantastic.
[00:24:26] Patrick: There’s a few different pieces that, uh, I want to unpack there. So first we couldn’t agree more on the, uh, you know, those marginal brackets. We like talking about level one, level two, level three strategies, you know, level one, we’re taking care of, you know, just some, that good administration bookkeeping level two, you know, we’ve got the 401k plan, maybe a cash balance plan, and then once we’ve filled up level two, now we’re starting looking at level three, because I think there’s another piece that’s worth considering here is like the complexity starts going up, you know, like.
[00:24:56] Patrick: I have a trust, I’ve got life insurance, I’ve got administration. I’ve got some rules that we’ll get into here in a minute that I need to be paying attention to. And so this is not as simple as just putting money in a brokerage account and waiting until I’m to retirement age to get it out. Now, uh, there’s maybe better benefits than that when you start looking at it, but I think that’s a very important piece.
[00:25:16] Patrick: And we don’t really like to see clients try to get down below, you know, the 24 percent bracket at max, anything lower than that. I’m like. The rate you’re earning, you know, we’re going to be paying this tax, you know, why, why deduct 24 percent money to pay it later at 37%. Like that just doesn’t make any sense.
[00:25:33] Patrick: Let’s just stop the deductions here and, uh,
[00:25:35] Ken: that’s
[00:25:38] Patrick: fantastic. So I think moving back to design, it’s an employer sponsored plan. There’s some trust involved. So can you walk us through a few of those pieces and how they, they allow us to get this deduction?
[00:25:49] Ken: Sure. So the first thing we do after we get an approval for the actual life insurance policy, we’re never going to go hire a law firm and pay them for something until we know we can do something with it, and I will say right now, this is just a public service announcement, any entrepreneur listening.
[00:26:04] Ken: They probably have a. 8, 000 leather binder of a trust work in their office. And there’s nothing in
[00:26:12] the
[00:26:12] Ken: great thing about life insurance salesman is we’re going to make sure everything gets in there because we don’t get paid until the planning gets done. So the first thing is get, get an underwriting offer.
[00:26:22] Ken: And then we set up. Trust, the trust is 5, 000 flat, and that’s because of the volume that I do. Normally, this is a very complicated trust. If you went to a law firm from scratch, it’d be 35 to 50, 000. I would bet, um, but we get them done a lot more efficiently than that. And the trust is a grantor trust under subchapter J, the internal revenue code.
[00:26:42] Ken: Uh, technically it’s a 402 B trust employee benefit trust. That’s nice. It’s protected from civil litigation. All 402 B trusts are for folks that get worried about that, but you will You’re funding the trust and then the trust is actually funding the policy. The only thing the trust owns are whole life insurance policies and the trust is also the owner and beneficiary of the policy.
[00:27:08] Ken: So if the insurer dies, the trustee gets a check from the insurance carrier, picks up the beneficiary designation agreement, and then pays it out. And so that’s the intermediary, um, that we’re creating every time. And I should mention it’s additional thousand dollars per person. So a three person trust would be 8, 000.
[00:27:28] Ken: Really it’s the fees. I’m very proud of the fees. I’ve worked really hard to get them that low. Uh, especially on the trustee side, the only fees, the restricted property trust has in year two and beyond is 750 per policy, which is. You know, what’s a cross tested cash balance pension plan? Four grand, five grand every year.
[00:27:47] Ken: Uh, so, and it’s really very reasonable, all tax deductible, but we are going to attach that trust to one corporate entity. I know some of your entrepreneur clients have 15. So when I’m looking for a reasonable death benefit, I’m going to ignore 14 of those companies because I have to justify the amount of the death benefit based on the loan tax return on which I’m providing.
[00:28:10] Ken: So that’s an important point. I have one client. Uh, that had 500 TGI Fridays and for our listeners, please get over that. I thought there were eight TGI Fridays in the United States. Apparently there’s at least 500, but every single Friday’s was in a separate partnership and he had a management company and I could really only ensure his key.
[00:28:29] Ken: Employee value to the management company rather than his 200 million empire.
[00:28:34] Patrick: Got it. So does that trust, uh, move the life insurance out of the entrepreneur’s taxable estate? Do we get some benefit there?
[00:28:43] Ken: No, and really several reasons.
[00:28:45] Ken: One estate planning is a personal purpose. So that would not justify a business deduction. And what we’ve done for estate planning, it stays in there. I’ve had clients, I don’t know how technical you want to be today, but claim the table 2001 rate as a completed gift for an islet. And then when they vest, they roll the policy directly to the islet.
[00:29:06] Ken: I still don’t recommend that because whole life with our PUAs has a lot of cash value per death benefit. So even in my own personal planning, Patrick, I have a very large survivorship IUL with my wife. And a large restricted property trust. I’m planning on funding both of them for 15 years, rolling out of my restricted property trust, and then using the cash value and flipping my SIL from level two, increasing.
[00:29:31] Ken: Maybe we’re starting to geek. You’re getting too excited. You’re already smiling too much.
[00:29:37] Ken: Soon as I get technical, you get all excited about it.
[00:29:39] Patrick: Um, I do. And yes, this is fantastic because I think there’s so many strategies out there that, uh, you can start combining together to, to create some efficiencies They’re absolutely worthwhile. So sorry, I didn’t mean to interrupt, but please continue on.
[00:29:53] Ken: Oh, it’s huge. And so my plan personally is I don’t want to have 4 million in my whole life policy with a 9 million death benefit. I’d prefer to switch my survivorship IUL from level two increasing and then crank that money and make that death benefit go for our three girls. Or if my wife and I need money, the heck with my girls, I can take out an income stream of 285, 000 a year tax free for 20 years.
[00:30:19] Ken: I think the biggest thing that we are supposed to do as planners and the reason I like working with people that see me as one piece of a puzzle and not a shiny new toy. Is because I want to make sure that five years from now, 10 years from now, people still have decisions to make an options,
[00:30:36] Patrick: right? So just build in some flexibility.
[00:30:39] Patrick: Yep. That’s, that’s fantastic. Thank you. So one of the things I want to dig into a little bit more is the trust structure. So we’ve talked a little bit about the trust, but There’s some restrictions to restricted property trust, right? So can we talk a little bit through those restrictions? Cause I think anytime we just like to be very clear, anytime there’s an opportunity for a tax deduction, there’s usually some strings attached to that.
[00:31:04] Patrick: If there’s not, we advise our clients, you should probably run away because it’s too good to be true. And you don’t want the department of justice coming to knock on your door going, Hey, uh, come with us. You’re, you’re going to jail for tax fraud. So can you tell us a little bit about the. Restrictions on the trust.
[00:31:18] Ken: Yeah, for sure. To your point as well. Pre COVID, I used to go to a lot of hotel ballrooms and speak at CPA CE tax conferences, and I was one of six presenters, and I ended up participating in a lot of the other presenters strategies personally, but anytime I heard a guy start off with Hey, here’s a current deduction for an appreciating asset.
[00:31:39] Ken: You get back tax free. I’m like, I’m going to go to the lobby and check my email. Cause I know you can’t do that. You can defer taxes. You can time taxes. You can leverage taxes. You just can’t avoid taxes. So, um, yeah, so the restricted property, the term restricted property comes from section 83 in the internal revenue code, which is titled property transferred in connection with goods and services.
[00:32:03] Ken: The most common form of property that gets restricted in the United States is stock, stock options. Most stock options are 83B property, and I bet you that’s over 90 percent of the restricted property in America. But you can do it with anything. Patrick, if you said to me, Ken, you seem like a great employee, I’d really like to lock you up.
[00:32:22] Ken: I have a garage behind my office that’s worth 30, 000. If you work for me for five years, I will hand you the title to that garage. That is now a plan of restricted property under section 83, which means I could go and say, Hey, Patrick, I love working for you. That garage is the bee’s knees. I’m going to pay tax on that 30, 000, even though I’m not guaranteed to get it in the future.
[00:32:45] Ken: If I go take another job in two years, or you fire me in four years, I am not going to get that garage. And I’m not going to get my tax money back. However, the reason people do it, and if you were at Google back in the day, I hope you made a bunch of 83B elections, but if you elect to include that, and a shopping mall goes up across the street, so my little garage does now work 200, 000 when you hand me the title, it functions like a Roth IRA.
[00:33:09] Ken: That is a non taxable transfer to me.
[00:33:11] Patrick: I love Ken’s creativity and commitment to delivering billionaire strategies to the entrepreneur. Isn’t the restricted property trust brilliant? Finally, Derek Rip shares tips for successfully exiting your business.
[00:33:24] Derek: , I’ll preface by saying that when it gets into the specifics of the. Business operations and closing that gap, we would actually pull in another professional. So there are a lot of people that play in that space. Business consultants, um, coaches, you mentioned a great firm earlier, EOS.
[00:33:43] Derek: I mean, I, I’m familiar, I work with some people from that organization. And again, the, the, the data’s out there, the software is out there. So it’s just a matter of, you know, being able to take the time, have somebody to work with that can build out a roadmap, if you will. And for business owners, it’s really helping them to identify what are the key areas, and usually there’s two or three that they know that need to be improved, and that’s where the focus should really start on, and then you’re just checking off the list and working down to improve the value.
[00:34:13] Derek: But obviously, having a plan is really important. I would argue that successful exit planning is really the overlap of three. Separate areas, uh, but all important areas and the business improvement is one of those. So that’s where those business consultants and. And coaches can come into play the personal financial readiness.
[00:34:35] Derek: So think personal financial planning, and then also, you know, thinking about life after the business sale. So in the Venn diagram, it’s really where those three overlap is where the master plan should be built. So the master plan is all those three pieces. And I think a lot of times business owners, they’re very good at what they do as far as operating their companies.
[00:34:57] Derek: Uh, they probably don’t need. As much advice from third parties like, like us, but they need advice on the big picture planning because again, exit planning is this very vague concept that’s going to, you know, in their mind take place at some point in the future, it can be confusing. And then when that happens, owners just say, you know what, I’ll deal with it later, which is not what we want them to do, but unfortunately that’s often what happens.
[00:35:21] Derek: And so having somebody that can help coordinate those pieces. Is really important. That’s 1 reason why I went and got the certified exit planning advisor designation is to help serve in that function where we know, okay, I’m not an expert in a by in any of these are all these areas by any means. But, you know, I do know people that I could bring in from EOS or other, you know, business consultants, M& A advisors.
[00:35:46] Derek: To address key areas and then, you know, bringing in other professionals when it comes to attorneys, there’s all kinds of different types of attorneys, you know, transaction attorneys, business attorneys, estate planning attorney. So, uh, again, all can be really confusing to the average owner and, uh, having a third party, they can say, now’s the time we need to talk to that estate planning attorney or now’s the time that we need to really make sure we have the transaction attorney lined up.
[00:36:10] Derek: I think it’s helpful as well.
[00:36:12] Patrick: Absolutely. And I think there’s a few things that I want to sort of pull out of there. The first is I love that, you know, when we think about how we, we serve our clients, we try to be this hub that can sort of manage all of those pieces you’re talking about, right? Like, Oh, Hey, here’s an estate planning attorney that we can bring into this discussion.
[00:36:29] Patrick: Here’s, you know, EOS strategic coach, some of these business consulting firms that we can, we can bring in. It just takes the pressure off of the business owner to manage all of that. Right? Like they have enough on their plate. The way it is running a business is hard. They don’t need another thing. And on the list.
[00:36:46] Patrick: And part of the reason why business owners don’t take action on these things is like, it’s overwhelming. It’s too, too complex. I’ll just worry about it later. And then later becomes a problem. So just a couple of things, statistics that I think, um, matter 80 to 90 percent of the owner’s wealth is trapped in their company.
[00:37:04] Patrick: And then. I think this really matters. And I think this gets to the heart of what you were talking about. So that, that 80 to 90 percent can help close the gap, right? Like we’ve got this wealth gap, but all of my wealth’s tied into this business. Like how do we unlock that? You know, and it’s through a sale in some capacity.
[00:37:20] Patrick: Then the next statistic that is shocking, um, but not is, and this gets back to a point we made earlier about, you know, progress being sort of a key. Factor in an entrepreneur’s life. 75 percent of owners profoundly regret selling their business just a year after selling it, you know, cause it sort of takes them out of that progress mode.
[00:37:39] Patrick: Like I have nothing that I can make progress on anymore. So can you talk a little bit more about like. What good planning looks like for the business owner to sort of move into this next phase of life.
[00:37:51] Derek: Yeah, absolutely. Unfortunately, there’s some dismal statistics that again, it doesn’t have to be that way, but especially when you say, you know, the statistic about 75 percent of owners profoundly regret.
[00:38:03] Derek: Selling their business a year after what that tells me is that there wasn’t probably enough planning done in other areas. Maybe they did a lot of planning in their business and work to increase the value and did all those things that we were talking about earlier, but maybe they didn’t do enough planning on what is life after the business sale look like?
[00:38:22] Derek: You know, let’s face a lot of our business owner clients. Our type a, they’re very highly motivated people. They want, they like to work hard. They don’t want to be sitting on the rocking chair, uh, on reach, you know, on the front porch during retirement. So this is part of maybe what I would call the identity crisis because they have had identified with the business that the business It was almost indistinguishable.
[00:38:44] Derek: They were the business for a long period of time and now that’s gone. So what’s that next phase in life look like? And so being able to talk through that in plan and making sure that that is realistic, you know, if you, uh, if you think that you might like to do something, um, but you haven’t really done a lot of it before that, you might want to try it out before you go, I’m going to retire.
[00:39:07] Derek: And then, uh, I’m just going to go fishing or go golfing. It may not be fulfilling. Right. So that’s, I think the important thing is. And for some people that is, um, volunteering other people, it is maybe starting another business or helping out, um, in other ways, but you know, doing something again, I think that’s the key is that business owners have been driven people for the most part, and they need to have identify what that is that is going to help them look forward to getting up every day.
[00:39:35] Derek: And that is definitely one of the things that I think gets overlooked. I also would say that some of this is just how maybe the financial service industry has been trained. They’ve been trained to talk more about traditional financial assets like stocks and bonds and ETFs and mutual funds and haven’t been as trained in terms of.
[00:39:57] Derek: How to incorporate the non security asset being the business, which is again, a very high percentage of a person’s net worth, another statistic that’s unfortunate, but statistically, uh, over 70 percent of businesses that list to be sold on the market do not sell. And that’s discouraging, but, but that’s, again, all these things that we were talking about, that it’s important to make sure that, that you can monetize and get value out of the company.
[00:40:25] Derek: Because if you’re viewed as really just a. A lifestyle business, a lifestyle company, then, uh, you may not monetize that value. That’s, and, and that’s again, how do you unlock that and be able to transition that into, you know, your, your long term financial plan.
[00:40:42] Patrick: That concludes this highlight episode from experts we’ve had on the show. Weren’t those clips great to review? Thank you for listening to the Vital Strategies Podcast. For links to the resources mentioned in today’s show, see the show notes of this episode at vitalstrategies. com forward slash episode 18.
[00:41:00] Patrick: Follow the Vital Strategies Podcast wherever you listen to podcasts, and don’t forget to rate and review the show, letting us know how these tips are helping you pay less tax and build more wealth. We will see you next week. And if you have any questions, topics, suggestions, or would like to share your own success story on the podcast, we’d love to hear from you.
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