First is a new realty transfer tax exemption for family farms.

Pennsylvania has a realty transfer tax which is imposed on the value of real estate transferred by deed, instrument or long-term leases.  The tax is imposed at a rate of 1% by the State, and usually 1% at the local level.

Some real estate transfers are exempt from the tax, most notably transfers among family members.  There had been a very narrow exemption for transfers of a “family farm business” to a “family farm corporation”.  However, the narrow definition of these two terms precluded a lot of estate planning and asset protection planning techniques.

Thus, the realty transfer tax was a major obstacle to the use of many estate planning techniques for family farms.  While parents could transfer the family farm to individual family members as an exempt transfer, they could not transfer the farm real estate to many types of entities typically used for estate planning and asset protection planning, even if the entity was wholly owned by family members.

Many techniques used to reduce Federal estate taxes and Pennsylvania inheritance taxes, as well as techniques to transfer farm real estate to multiple family members, require the transfer of the farm real estate to entities such as family limited partnerships or LLCs.  Unfortunately, many families chose not to use such entities due to the large realty transfer tax imposed in the transactions.

Act 85 replaces the narrow definition of “family farm corporation with the new term “family farm business”, and exempts transfers of real estate to a “family farm business” from the realty transfer tax.

“Family farm business” is a broader term, including entities of which at least 75% of the assets are devoted to the business of agriculture, and at least 75% of each class of stock (or other ownership) is continuously owned by members of the same family.

While prior law only exempted transfer to “family farm corporations”, now any kind of entity, specifically including family limited partnerships and LLCs, can receive farm real estate from family members free of the realty transfer tax.

Family limited partnerships are a very effective entity to hold family farms.  Parents can transfer the real estate to the limited partnership, and then transfer limited partnership interests to their children (and grandchildren).  This can reduce taxes, permit management of the family farm, and spread the value of the farm among multiple family members, all of which should greatly aid families in keeping the farm “in the family” for future generations.

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Phantom stock plans are shadows that mimic their real equity counterparts; phantom stock and shadow stock are terms that often are used interchangeably. Although shares of real stock can be traded at will, a phantom stock plan typically does not require investment or confer ownership, so its recipient does not have voting rights.

In making awards under a phantom stock plan, there is a determination of the value of a phantom share or unit in connection with awards to one or more participants. Valuations will be needed for periodic reporting to participants as well as for determinations of amounts payable at the time of settlement.

Phantom stock plans can be designed simply. However, they should be created to meet the company’s needs and objectives in protecting the knowledge and skill base that is represented by the key employees selected for awards. The two types that are most prevalent are:

• The “appreciation-only” or “growth” plan. Under most phantom stock plans, the employer credits an employee account in the form of hypothetical shares of its stock. The stock is known as “phantom” stock and is credited to the employee’s account as are all cash and stock dividends and stock splits which are attributable to his/her phantom shares. No tax is payable by the employee at the time of such crediting.

Upon the termination of his/her employment (due to retirement, death, or other cause), or at a specified future date, the employee becomes entitled to receive an amount equal to the excess (if any) of the market value of all his/her phantom shares on the date of such termination over the value of such shares on the date (or dates) on which the shares were awarded and credited to his or her account. This amount can be paid out in installments over a period of years. Only the growth in value of the phantom stock is paid out.

• The “full-value” plan, in which the award includes the underlying value of the stock. Other phantom stock plans grant units corresponding to shares of stock and credit the same, and not merely the growth in the same, to an employee’s account. The employee’s account also is credited with all cash and stock dividends and stock splits which are attributable to the phantom stock.

Upon termination of service, the employee receives in installments cash equal to the number of shares credited to his/her account. Under this type of plan, the employee is assured of receiving something for his/her shares even if the market value of the stock at the specified future date is less than what it was at the time the stock was awarded to him/her.

Generally, a phantom stock plan or agreement spells out how the program operates and how payments are determined along with various other details, often including:

• Eligibility criteria.
• Vesting schedule.
• Valuation method or formula.
• Settlement and payout events.
• Handling of various termination events, including retirement, death, disability, dismissal and resignation.
• Restrictive covenants.
• Form of payment.
• Provisions for the sale of the company.

Generally, for financial accounting purposes, phantom shares must be treated as an expense over the required service period and the company does not receive its income tax deduction until the benefits are paid. In addition to its incentive components, a phantom stock plan involves deferred compensation and can act like golden handcuffs in retaining key executives. Phantom stock most often is used by privately held companies.

Phantom stock plans can be especially useful in providing the economic benefits of equity without diluting shareholder value. Because recipients of phantom stock lack voting rights, a company can issue these units without altering the governance of the company or worrying about dilution issues. While phantom stock does not dilute the value of real outstanding shares directly, phantom stock awards do have a significant effect on cash flow at payout. This is why some plans have a conversion feature and might pay out in actual stock.

Another advantage to a company is the ability to design an award so that an executive receives no benefit unless vesting conditions are met and, under the appreciation-only model, the company’s value has increased. The fair market value of the stock is commonly used by public companies, while private companies have various approaches. For example, a professional valuation might be preferred but viewed as too costly; many companies then turn to book value. Other approaches include a formula using revenue, EBIDA (earnings before interest, taxes, depreciation and amortization), net income, or a combination of relevant measures; a formula can help with consistency of the valuation over time.

There are many reasons a company would consider a phantom stock arrangement:

• A public company might find that it has insufficient authorized shares to award the desired amount of awards that require actual stock.
• A company’s leadership might have considered other plans but found their rules too restrictive or implementation costs too high.
• The owner(s) might desire to maintain actual and effectual control, while still sharing the economic value of the company.
• There might be ownership restrictions for certain types of entities (i.e., sole proprietorship, partnership, limited liability company), such as the S corporation 100-shareholder rule.
• The objective is to provide equity-type incentives to a restricted group of individuals. For instance, phantom stock can be used in situations involving:
- A corporate division that can measure its enterprise value and wants its employees to have a share in that value even though there is no real stock available.
- A desire to focus on an event or contingency, such as a sale, merger, initial public offering, etc.

A phantom stock plan typically provides a more flexible alternative that is not subject to the same restrictions as most equity ownership plans. For many, the simple desire to use an “equity-like” vehicle without giving up true ownership might be reason enough to implement a phantom stock plan.

Employees generally like phantom stock plans because it allows them to share in the growth of the company’s value without making an investment, and with no risk or very little risk (especially in the “growth plan”).

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Our semi-annual Healthcare and the Family Business seminar brings the experts to the table to help us understand changes and which ones
are important to us. Bring your questions and your notepads!

Don’t be caught unaware by Obamacare, join us for this educational seminar.

Presented by:
Michael A. Alfonso, Sr.,
President and owner of Trilogy Group Benefits, LLC.

Trilogy Group Benefits, LLC was founded in 2009 as a full service corporate benefits broker. Michael has been in business since 1997, but has evolved the firm into an agency that specializes in group healthcare, dental and vision as well as ancillary benefits.

Trilogy Group Benefits is located in Elizabethtown Pennsylvania. They are an independent brokerage firm specializing in group employee benefits. Their focus is Health, Dental, and Vision Insurance. As a compliment they provide ancillary benefits such as group life and short and long term disability. Each year they actively shop the market in an effort to negotiate the most advantageous plan for the organization.

They pride themselves on developing strategies to find solutions for the organizations they serve. Their strength that is most noticed is their very proactive service model.

Registration is only by invitation but you can contact Ed Stevenson for more information via email at edstevenson@keystonefamilybusinesscenter.com or call 717-215-5203.

Place:
Keystone Family Business Center,
624 North Front Street,
Wormleysburg, PA 17043

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Members of the senior generation and their children often do not discuss a plan regarding who gets what assets, duties, and responsibilities, or what will happen when the business owner retires, dies, or leaves the company due to disability.

2. AN OVER-PROMISING PARENT

The parent promises all things to all children but doesn’t put a plan in place to ensure promises are kept. This results in disappointment, anger, and confusion when the owner retires or dies. This uncertainty often seriously damages or destroys a business.

3. UNPREPARED HEIRS

Too much planning focuses on the senior generation “giving” issues and techniques, but not enough on the next generations “receiving” the business. Parents risk leaving their heirs unprepared and open to family conflict when they don’t discuss the nature of their assets or other business-related matters, or they establish trusts without preparing heirs with adequate information or understanding of their responsibilities.

4. DELAYED PLANNING

There are numerous effective ways to help minimize tax and succession problems. Senior generation members often delay making decisions, making it difficult, if not impossible, to implement effective strategies when needed. Early planning is essential.

5. LACK OF LIQUIDITY

Failure to plan ahead can cause havoc and hardship for families who want to buy out the business when the owner is alive, or for survivors who may be faced with debts, expenses and taxes, and no way to meet their obligations. A family without sufficient liquidity to pay such obligations may have few options for succession, and may be forced to sell the business.

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(1)   Failure to Draft a Will

• The rules of intestate succession of the state of residence of the decedent determine who will receive the estate assets. These state rules of intestate succession are a poor substitute for a person’s actual wishes. A will allows you to determine and control who gets what, how they get it and when they are allowed to receive assets of your estate. Often times a trust is drafted as part of a will or as a separate document to provide for management and preservation of assets for those in need of a trust due to youth, lack of financial skills or special needs.
• Without a will, you have given up the right to name a person to administer your estate. Leaving this to state law or a judge is usually not a good idea.
• Without a will some states require a bond for anyone who serves as administrator. If an out of state relative needs to be named or wants to serve as administrator, a posting of bond is almost always required.
• A will allows the naming of a guardian for young children. Most people prefer to name the guardian of their children rather than allow a judge to decide this matter if at all possible.
• Having a well drafted will can help avoid costly, time consuming and often bitter litigation between family members. This is especially the case in second marriages.

(2)   Leaving All Your Assets to Your Spouse

Although it may seem like a good idea, leaving everything to your spouse may not be wise from an estate tax perspective. For 2012, there is a $5,120,000 exemption for any decedent. In 2013, the exemption will drop to $1,000,000. There is talk in Congress of increasing this amount but with the federal deficit and congressional gridlock it may end up this exemption remains at $1 million.

Where a decedent has a will that simply gives everything to the surviving spouse, they have failed to utilize their exemption. When the second spouse dies they include in their estate the assets received from the first spouse to die. If they have a taxable estate that exceeds the then applicable federal exemption, a federal estate tax will result. This excess will be taxed at 35 or 45 percent or more depending on what the law may be at their date of death.

(3)   Owning Assets Jointly or Holding Too Many Assets Jointly:

The problem here is the same as leaving  all your assets to your spouse. Owning too many assets jointly will not allow the married couple to utilize each of their unified credits, since property is transferred automatically to the surviving joint tenant.

In addition, holding property jointly does not completely avoid probate in a husband and wife scenario. Although there may be no probate when the first spouse dies, the survivor will eventually own all the previously owned joint property  that will then be probated and subject to estate administration on the second spouse’s death. So if avoiding probate and keeping one’s estate private is a goal joint tenancy ultimately will not work.

Joint tenancy arrangements can cause major problems where there is a second marriage. If assets pass to the surviving spouse on the first spouse’s death, such assets become the sole property of the survivor. That survivor is free to draft a will that does not provide for the children of the deceased spouse. This can create real problems and expensive, time consuming and contentious litigation.

Transferring of assets into joint tenancy with other family members (not a spouse) raise other problems. Gift tax, gift tax filing responsibilities and income tax issues are some of the problems raised by such scenarios.

(4)   Failure to Own Life Insurance Properly

Naming the beneficiary of a life insurance policy seems simple enough. However, where a second marriage is involved and the spouse is named beneficiary, these proceeds may never end up benefitting the deceased spouse’s children. Where a husband and wife suffer a simultaneous death and small children are named as contingent beneficiaries of the life insurance proceeds, without proper planning a court will have to appoint someone to administer the policy proceeds. The person the court appoints as trustee may not be the person the deceased parties would have chosen. This could be a very expensive and problematic situation which can be solved by drafting an appropriate trust document.

From federal estate tax perspective, people are often surprised that life insurance owned by an individual is included in their taxable estate at death. This may result in federal estate taxes being paid on insurance proceeds at death. To avoid federal estate taxes, often times an irrevocable life insurance trust is utilized to own such policies to remove them from the taxable estate.

To pay premiums on such policy held in trust there can be gift tax implications. However, if the trust is drafted properly and certain documentation and notices are given each year, the insured can make annual gifts to the trusts that qualify for the annual exclusion to pay for the insurance premiums on such policies.

Finally, if a current policy is transferred to an irrevocable trust, care must be taken to account for the 3 year rule under federal law. This rule pulls back into the estate the insurance policy transferred to the irrevocable trust if the taxpayer dies within 3 years of the date of transfer.

(5)   Failure to Have a Gift Giving Plan:

Taxpayers sometime fail to recognize they can give $13,000 per year to as many donees as they desire. In addition, the spouse can join in such a gift for additional $13,000 annual donee exclusion. This will allow for gifts of $26,000 per year to as many donees as desired.

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1. Have there been any changes in the laws that affect the SNT?

1. Do you need to make any changes to the trustees or trust advisors? Perhaps a successor trustee is ill or recently passed away and you need to designate a new successor trustee. Or perhaps you want to consider a corporate trustee if you have not previously designated one.

1. Do you understand tax issues? It is important for you to understand how the income earned in the SNT is reported and on what type of income tax return. Questions you want to review are whether your trust is a “grantor trust” for income tax purposes or whether it is considered a “qualified disability trust.” Also, what are the gift tax reporting implications, if any, when a third party makes a gift to the trust?

1. Is the trustee making any distributions that would cause the beneficiary to lose benefits? Constant monitoring and oversight must be made regarding SNT distributions. For example, if the trust is paying housing costs for the beneficiary, the beneficiary will suffer a reduction in his or her SSI benefit.

1. Are the assets designated to pour into the SNT as intended? Your last will and testament will not control the disposition of certain assets, such as annuities, insurance policies, and retirement plans, if you designate beneficiaries other than the SNT. Your team can help you check and update your beneficiary designations on these assets to make certain that they pass to the SNT at your death, if intended.

This overview and list of questions to be reviewed with your planning team demonstrates that SNT’s are very complex and require careful consideration and planning to ensure that the appropriate SNT has been set up for the beneficiary. By understanding the terms and requirements of the SNT chosen for the beneficiary, you will be in a better position to help protect the beneficiary’s benefits and quality of life.

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