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Category Archives: Business Planning
2018 Changes Impacting Estate Planning
Most of us have heard plenty about the changes made to the tax code for 2018 by now. While you may understand that changes in certain deductions and credits may impact income tax, you may have concerns about how the changes may impact your estate planning. Similarly, you may be aware that estate tax exemption amount had increased in 2018 but are not sure to what level and what it means for your personal situation.
For the most part your current estate plan may be sufficient to meet your needs in light of the changes to the law. However, it may be more complex then necessary. It is important to review your estate plan to ensure it allows for flexibility in the event of a subsequent change to the estate tax exemption limits. You want an estate plan to be simple while taking full advantage of the changes and remaining flexible for the future.
First, what are the changes to the law?
Tax Cuts and Jobs Act of 2017
On January 1, 2018, the Tax Cuts and Jobs Act of 2017 (TCJA) became effective. The Act makes significant updates to individual and corporate tax rates, eliminates or modifies many tax deductions and results in changes for estate and business planning. Until such time that regulations are in place, the Internal Revenue Service and tax advisors are still sorting many of the details. Nonetheless there are some key updates that may impact estate planning. For most people the changes will not have a lot of impact on estate planning, but still provides a good opportunity to review their estate plan.
Doubling of the Estate Tax Exemption
One of the most significant estate planning changes for 2018 is the doubling of estate tax exemption amount. While for most people this change will not have a lot of impact on their estate planning, the doubling of the estate tax exemption is quite significant.
Beginning in 2018, the basic estate tax exemption amount increases to $10 million per individual with adjustments for inflation. The IRS has not yet released the inflation adjustment but it is expected that the 2018 exemption amount will be $11.2 million per individual and $22.4 million for a married couple.
Again, this change may not impact most people. However, the change will greatly simplify estate planning for married couples with a combined estate of more than 10 million dollars. Without further congressional action in the meantime, on January 1, 2026, the estate tax exemption amount will revert to the 2017 exemption levels of $5.49 million per individual and $10.98 per married couple. With this in mind, it is important for families with assets exceeding $10 million to plan with flexibility. Often this includes the use of revocable living trusts with certain disclaimer or optional bypass trust provisions.
Increased Gifting Opportunities
The lifetime gift tax exclusion amount also doubled for 2018. The lifetime gift tax exclusion amount is total amount that you can gift during your lifetime without paying gift tax. The new lifetime gift exemption amount mirrors the estate tax exemption amount with an expected adjusted exemption amount of $11.2 million per individual and $22.4 million for a married couple.
With this in mind, it is a good opportunity for those families considering sizable gifting plans to utilize the additional tax-free gift amount while it is available. Since the lifetime gifting exemption is also subject to change it may be advantageous to make additional gifts while exemption amount is higher. By making gifts during your lifetime you can transfer wealth and thereby reducing the overall value of your estate and decreasing your taxable estate.
However, it is important to balance the advantages of lifetime giving with tax basis and estate planning considerations. For example, gifts made during your lifetime will be transferred at your tax basis, or your cost. While distributions of assets through your estate receive a “step-up” in basis equal to the fair market value of that asset upon death. With this in mind, if you are considering lifetime giving you may want to save highly appreciated assets to pass through your estate.
Changes for Pass Through Entities That May Impact Planning
For individuals or families that have rental or investment properties as a part of their overall estate there are advantages to owning these assets through separate pass through entity such as an LLC. Ownership of investment properties through an LLC will provide additional liability protection as well as potential tax advantages.
TCJA changed the tax rate for pass through entities and provides a deduction of up to 20% on qualified business for business income that passes through to an entity to an individual. The modifications to the law and calculation can be quite complicated and are subject to certain limits and restrictions. For example, those with joint income over $315,000 are above the threshold amount and therefore subject to limitations. However, for most pass through entities this change results in a reduction of overall tax.
Another significant change in the law for pass through entities is a change to the partnership audit rules. The update to the law provides for tax assessment and collection at the entity level rather than individual level. This means that if you have assets in an existing LLC, S. Corp. or other pass through entity, or if you are considering setting up a new pass through entity, you need to consider the new requirements.
Practically speaking one of the most significant changes is the requirement to appoint a tax representative for the entity. The tax representative will be the point of contact for the entity in the event of an audit or other tax issue. This involves updating the operating agreement or partnership agreement to include the appointment of a tax representative. For smaller entities, with less than 100 partners or members, you may elect to opt out of these requirements. However, it is important to consult with your CPA to assist you in this process.
If you own a rental or investment property in your name individually, now is a good time to consider transferring your property to an LLC or other pass through entity. However, discuss this with your CPA, attorney and tax advisors first to ensure it is effective for your personal situation.
Overall Considerations
The focus of this entry is primarily on changes that may have an impact on estate planning. However, TCJA made significant modifications to many other tax provisions including reductions in tax rates and changes to many deductions and tax credits. It is important to discuss these updates with your CPA and tax advisors to determine how the changes might impact your personal tax situation.
Even if you think that the 2018 updates to the law may not apply to you, the key to any effective estate plan is flexibility, and regular review of your plan with your advisors. Discuss your estate and gift planning strategies with your attorney, CPA, financial planner, and other tax advisors as soon as possible to ensure you are making the most of your estate plan and gifting strategies.
If you have question regarding estate or business planning contact Kelly O’Brien, Measure, Sampsel, Sullivan & O’Brien, P.C. at (406) 752-6373/ www.measurelaw.com
A Power of Attorney- What is it and Why Might You Need One?
What is a Power of Attorney?
A power of attorney is a document whereby you appoint another individual (called an “agent”) to make financial or heath care decisions for you or transact business on your behalf in the event you are unable to do so for yourself. A power of attorney is typically used in the event of incapacity or disability. However, a power of attorney can also be used simply for convenience in limited circumstances, such as signing legal documents when you are out of the country. A power of attorney can be a useful estate planning tool for individuals of all ages, but it can be especially helpful to have in place as you age. If you wait to execute a power of attorney until your physical or mental condition may be declining, it may be too late.
Types of Powers of Attorney
Power of Attorney for Financial Decisions
A power of attorney for financial decisions allows you to appoint an agent to make financial decisions on your behalf in the event that you are unable to make these decisions yourself due to incapacity or disability. A financial power of attorney can provide immediate powers to your agent. In the alternative, you may execute a financial power of attorney that is not effective until you are determined to be legally incapacitated. Typically the determination of incapacity is made by a licensed physician in your state of residence.
Unless the powers are specifically limited in any way, an agent appointed under a general financial power of attorney can make all types of financial decisions and transact all business on your behalf. These general powers include authority for check writing and banking, real and personal property, taxes, stocks and bonds, business transactions, insurance, legal claims and all other general financial matters. These general powers can be expanded upon to include the powers to make gifts, execute wills or trusts, or change beneficiary designations. The powers can also be specifically limited to include only a particular authority, such as authority to sign real estate documents. All of the specific duties, responsibilities and authorities of a power of attorney in Montana are set out in the Montana Uniform Power of Attorney Act.
Power of Attorney for Heath Care Decisions
A power of attorney for healthcare decisions allows you to appoint an agent to make medical and health care decisions on your behalf in the event you are unable to make these decisions yourself. This includes decisions regarding all types of medical consents and life support issues, as well as decisions regarding medications and health care facilities.
While the appointment of an agent for health care decisions under a power of attorney might include broad powers to make health and personal care decisions, these appointments most often are not effective until you are disabled or incapacitated to the point that you are unable to make or communicate your health care decisions. A power of attorney for health care will typically require the agent to follow your desires as you specifically set out in the power of attorney document itself, or as known to your agent. Typically your agent is required to attempt to discuss the proposed health care decision with you to determine your desires if you are able to communicate in any manner.
What Happens Without a Power of Attorney?
Guardianships & Conservatorships in Montana
If you were to become incapacitated without a power of attorney in place, either suddenly as a result of an accident or due to a long-term disability or mental incapacity, a family member would need to seek appointment as your guardian and conservator through a court order. A guardian is an individual appointed by a court with a duty to manage personal and health care decisions for an incapacitated individual. A conservator is an individual appointed by a court with a duty to make financial decisions and manage finances for an incapacitated individual.
The appointment of a guardian or conservator in Montana requires the filing of a petition with district court. The petition is filed by the individual seeking appointment as the guardian and/or conservator. The petition must state the need for appointment, the specific interest of the petitioner, and set out certain factual allegations regarding the physical and mental state of the alleged incapacitated person. If a conservatorship is sought, then the petition must also include a general statement of property owned by the alleged incapacitated person. A hearing in district court is required to determine the issue of incapacity, as well as to determine the appropriate individual to act as guardian and/or conservator. Notice of the hearing and petition must be served on all interested parties.
In addition, the petitioner must request appointment of a physician, visitor and a separate attorney for the alleged incapacitated person. The physician appointed by the court must examine the alleged incapacitated person and submit a report in writing to the court to explain the mental and physical state of the alleged incapacitated person and whether or not a guardianship and/or conservatorship is appropriate. The court appointed visitor must visit and interview the alleged incapacitated person at their home or residence, as well as interview the petitioner, and submit a report in writing to the court. The attorney is required to represent the alleged incapacitated person to ensure that the guardianship and conservatorship is in his or her best interests.
The process of seeking appointment as guardian and conservator can be time consuming and expensive. Moreover, since it is subject to the court process, it is public, and held in open court. This process can often be confusing and overwhelming for an incapacitated individual.
However, one of the most significant drawbacks of guardianships and conservatorships is that the individual that is appointed by the court may not be the individual that you would have chosen to manage your financial affairs or personal care decisions. By appointing an agent to make financial and health care decisions for you through a power of attorney, you can avoid the need for a guardianship or conservatorship through the court system. A power of attorney allows you to appoint the individual of your choosing to conduct your personal and financial affairs.
Choosing an Agent to Appoint under a Power of Attorney
Choosing an agent to conduct your financial affairs or make your health care decisions requires careful consideration. Your agent has a fiduciary duty to manage your affairs in a manner that serves your best interests according to Montana law. Obviously you want to choose someone that you trust with your utmost personal decisions. The decision of who to appoint also requires consideration of the nature and value of your assets and the relationships between your family members.
Typically, a married individual will nominate his or her spouse as the agent for both the financial and health care power of attorney. However, for a single individual or widow(er) it can often be difficult to determine who to appoint as an alternate agent.
Many people choose to appoint either one or all of their children as alternate agents. If your finances are fairly simple and you have a relatively small family with solid relationships, then appointing one or all of your children may be a good option. Your children are familiar with your assets and intentions, but there is potential for conflict between siblings or misuse by one of your children that oversteps his or her authority or acts in a manner that is counter to your best interests.
Instead, you may decide to appoint a relative or close friend that is not one of your children and not a beneficiary of your estate. Appointing a relative or a close friend can be beneficial because they are familiar with your family dynamics and your assets and intentions. However, relatives and friends may lack experience managing financial assets and may not be immune to family disputes.
As an alternative to your children, relatives, or close friends you may choose to appoint a professional fiduciary. While I do not recommend appointing a professional fiduciary to make personal and health care decisions, the appointment of a professional fiduciary for financial decisions through a financial power of attorney can help to reduce family conflict and can provide neutral management.
Ultimately the choice of who to appoint as your agent under a financial or health care power of attorney is personal. The decision depends on your particular financial assets, health care needs and family dynamics. It is important to consider the factors mentioned above and choose an individual or institution that is responsible, has an ability to work with your family, and is willing to seek the advice of professionals such as physicians, health care providers, estate planning attorneys, financial planners, and CPAs.
Seek Advice
A power of attorney can be a useful tool for estate and incapacity planning. A power of attorney allows you to choose an individual to manage your financial matters and make health and personal care decisions on your behalf, instead of subjecting you and your family to a public court process. Discuss your thoughts and concerns about choosing and appointing an agent with an estate planning attorney and your family members to ensure you make right choice for you and your family.
Why Incorporate Your Small Business?
Clients often ask me why a separate legal entity is a good idea for their business. There are many advantages to setting up a separate legal entity, specifically liability protection. For example, consider a small retail business that is structured as a sole proprietor. The business has some initial success so the owner decides to expand the business. They move to a larger location, increase staff, and expand product lines. However, the expansion results in significantly higher operating costs, so the owner decides to take out a loan to cover some of the costs.
Unfortunately, the business gets behind paying the bills and becomes unable to make loan payments. As a result, the owner defaults on the loan and the lender files a collection action to recover the remaining debt. Because the owner held the business a sole proprietor the lender was able to file the action against the owner, personally, rather than just against the business itself. This meant that the lender could seek recovery from personal assets as well as any business assets. Most of the assets and inventory of the business were already purchased on credit so the creditor looks to personal assets to collect on the judgment. This could result in a judgment which encumbers a personal home and can take a significant amount of time to free personal assets from the judgment. If the business had established the business as a corporation, or other separate entity, the owner could have avoided entangling a personal home with business debt.
Consider Your Business Entity Structure
If you own a small business and want to avoid some of these issues, consider structuring your business as a separate business entity such as a corporation or limited liability company (LLC), limited liability partnership (LLP), or other legal entity. For purposes of this article I use “corporation” or “incorporation” to generally discuss how forming a separate entity can be advantageous to your business. However, the decision about the specific legal structure for your business will impact your tax liability, ownership rights, and business operations. Making the right decision about the legal and corporate structure of your business is critical to your long-term success, so discuss your options with your tax advisor and business attorney to determine what is right for your specific business.
Advantages of Incorporating
Regardless of the specific entity type there are some very compelling advantages to incorporating, or otherwise creating a separate entity for your small business. Among the advantages these include:
- Protection of Your Personal Assets
Perhaps the most persuasive reason for incorporating your small business is protection of your personal assets. A corporation is a separate legal entity which means it can own, buy and sell property; enter into contracts; sue and be sued; and be separately taxed. Moreover, a corporation is responsible for it’s own debts and liabilities.
This separate structure protects the owners, or shareholders, as well as directors and officers from personal liability for corporate debts and obligations so long as corporate formalities are properly followed (as discussed below). This means that creditors of a corporation may only seek payment from assets of the corporation and not the shareholders or directors. Without a separate entity structure such as a corporation, business creditors may be able to pursue the owner’s personal home, car, or bank accounts as Mary’s creditors did.
- Ease of Transfer
Ownership interests in a corporation are held in corporate stock. Corporate stockholders can readily sell or transfer their stock. This also means that shareholders can transfer or even give shares of stock to their family members. The ease of transferability allows business owners to transfer a family business to the next generation in a more seamless fashion. It also increases the ability for the business to add new owners or investors.
Alternatively, transferring ownership in a sole proprietorship or partnership can be an expensive and time consuming process that involves transferring title to property, assigning contracts and often setting up entirely new accounts.
- Perpetual Existence
A corporation is a separate legal entity so it is not dependent on the life of any one individual owner. This allows a business to continue indefinitely despite changes in ownership without disruption. This also provides additional stability for owners and investors and avoids the need for an extensive process to transfer or liquidate the business upon the death of an owner.
- Attracting Investors & Raising Capital
When you incorporate your business it is often taken more seriously by lenders or outside investors. If you have taken the step to incorporate it indicates that you may be more willing to invest time, energy and resources in the business to ensure the long-term success in the business. The willingness to invest in the long-term success of the business makes corporations more attractive to lenders and investors.
In addition, corporations can easily raise capital and transfer ownership by selling shares of stock. This makes it easier for outside investors in invest in corporations, and provides the additional piece of mind associated with the limitation on personal liability.
- Potential Tax Advantages
Corporations may provide certain tax advantages over a sole proprietorship or partnership. It is typically easier for corporations to write off expenses such as pension plans, health insurance premiums and other fringe benefits as tax-deductible expenses. Some corporations are also able to structure the business in a manner to save on self-employment taxes. There are numerous ways in which a corporation may reduce its overall tax liability. It is important that any business discuss these issues with its tax advisors prior to incorporating, or otherwise creating a separate entity for the business.
Maintain Corporate Formalities
The advantages of incorporating a small business are numerous. However to enjoy the benefits, especially the benefit of limited liability protection, the entity must act as a corporation. This means maintaining certain corporate formalities such as using the corporate name, holding annual and special meetings, maintaining meeting minutes and filing annual reports. Furthermore, it is essential not to mix corporate and personal assets or accounts or otherwise use corporate assets to pay for personal debts and obligations.
If you incorporate your business, it is critical to know when to seek legal advice to assist you in maintaining a separate entity structure. Legal advice may be especially beneficial when taking actions such as issuing or purchasing stock, performing business in other states, amending corporate documents, or merging, dissolving or otherwise restructuring the business.
A business attorney can advise you how to incorporate your business, as well as discuss the benefits and drawbacks of specific types of legal entities for your particular business. While incorporating your business will not ensure that your business will always be successful, it can enable you to protect your personal assets.
Business Operating Agreements & Guidelines
Tools to Help Small Business Owners Protect Themselves
Andrea and Susan were old friends that decided to start a small business together in Montana. For them the process of setting up their business was fairly simple; they found a great downtown location for their little gift shop, each invested a small amount of their own money to purchase inventory, and then they were open for business.
Initially they did not form any separate entity, but within a few months of opening they decided to form a limited liability company, or an “LLC.” Andrea found the “Articles of Organization” form, and filed it with the Montana Secretary of State. Over the coming months, both owners would use personal funds to help purchase inventory, in amounts they agreed upon, but they never formalized any agreement regarding using personal funds for the business.
After several years of being in business, Susan decided that she wanted to spend more time traveling and no longer wanted to be involved in the business. At that point in time the gift shop had become quite successful and Susan believed that her interest in the company had become very valuable. With that in mind, Susan approached Andrea to let her know her intentions for leaving the company and suggested that Andrea buy her out of the business.
However, the amount suggested by Susan was shockingly high to Andrea. According to Andrea, Susan was only entitled to her initial investment, which was less than one-third the amount proposed by Susan. Andrea suggested a lower price and unfortunately the two spent the next year arguing over the value of Susan’s interest.
This situation is all too common for small businesses; the owners file a form to become a separate entity such as an LLC or corporation in an effort to protect themselves from personal liability, but fail to actually follow the formalities of a separate entity and fail to execute an operating agreement. The operating agreement is key in determining the value of the business, how individual owners may join or withdrawal from the business, and what happens to an owner’s interest in the event of their untimely death, bankruptcy or other life event.
Observe Business Formalities
First, observance of LLC or corporate formalities is an important factor in determining whether it will be actually treated as a separate entity. If the LLC or corporation is not treated as a separate entity, then the members or shareholders may be held personally liable for the debts and obligations of the company.
Some examples of to how maintain business and personal matters separate include:
· Refrain from commingling business funds or accounts with personal funds. If you are placing personal funds in the business, make sure it is accounted for as a capital contribution, a loan or a reimbursed expense.
· Always make clear when you are acting on behalf of the business, rather than acting in a personal capacity. This may include signing documents in a representative capacity or clarifying your role in a business meeting.
· Do not use funds owned by the business to pay personal debts and obligations. Personal obligations should not be paid directly from business accounts. If you need to make a personal payment, pay yourself first as a member or shareholder of the business, then make a payment from your personal account.
· Maintain written documentation of actions of Members, Shareholders, Directors or Officers. This includes maintaining minutes of your annual meeting and any special meetings, or written consents, signed by all owners.
Create an Operating Agreement (or Shareholder Agreement)
An operating agreement is the document used by the owners or “members” of an LLC. A shareholder agreement is the document used by the owners or “shareholders” of a corporation. For discussion purposes the term “operating agreement” is used here to generally discuss internal documents for the operation of various business types, but a different term may be used for a different type of entity.
An operating agreement is a contract between the members of the LLC and the LLC as a separate entity. It sets out all of the internal terms for the operation of the LLC. These terms may include valuation, distribution of profits and losses, and the withdrawal or addition of a new member.
While an operating agreement may be drafted by an attorney, it is important that the members or owners of the business have a discussion as to the important points of the operating agreement. This ensures everyone is on the same page and has discussed these issues from the beginning of the business, rather than trying to figure out these issues in a disagreement or other unknown circumstance.
Some important issues to discuss in the creation of an operating agreement include:
· What limitations to place on transfers of ownership. Some options to consider include: no transfer without consent of all owners; right of first refusal of company and/or members; limitations on forced buy-outs; or right to remove owners for certain unlawful or unethical actions.
· How to fund a buy-out of an owner. Consider such issues as allowance for installment payments, use of life insurance, or loans.
· How to calculate the value of an ownership interest in the business. Will the value simply be book value, or assets minus liabilities of the company? Or do you want to use a different formula? Do you want to set a price in advance?
· What happens in the event of unforeseen life circumstances? What happens to an owner’s interest in the business when that individual owner retires, wants to withdrawal from the business, becomes disabled, gets a divorce or files for bankruptcy?
Obviously these are just some of the discussion points to consider when creating an operating agreement. A business attorney can advise you on options for your particular business. However, it is important that the business owners discuss these issues prior to starting business, rather than wait until after a dispute arises, like Andrea and Susan.
If only Andrea and Susan had taken some extra time to create an operating agreement when they started their business, they could have spent less time and money arguing back and forth over the value. Instead Andrea could have spent more time focusing on the business and Susan could have spent her time traveling. By taking the time to discuss a potential buy-out in the beginning of their business these women could have saved themselves significant time and money in the long-run.
For advice regarding business formalities, operating agreements or general business law contact Kelly O’Brien at Measure, Sampsel, Sullivan & O’Brien, P.C. at (406) 752-6373
(406) 752-6373/ www.measurelaw.com