One powerful sheltering solution the founder can turn to is an executive compensation LLC (also called a business continuation LLC). In this solution, a separate entity is established to hold the upside value of the company, which eases the process of leadership and capital succession. The upside can be delivered via profits interests, which transfer upside value in a new LLC without triggering any tax at grant. Furthermore, the value of profits interests at liquidation is taxed at the favorable capital gains rate.10 Alternatively, the upside can be delivered via a capital infusion derived from life insurance death benefits or disability benefits that are paid to the succession LLC.
A business continuity LLC can be an extremely effective means of value transfer. It can reduce tax by 80 percent or more compared to bonusing value directly to succession executives as compensation. It provides key executives with a welcome degree of control over their futures by establishing a unified leadership and capital succession solution. It conveys a sense of loyalty to the executives and earns their loyalty in return. And it is highly flexible—enabling the founder to reallocate units if and when the leadership roster of the organization changes.11
The ultimate paradox of business is that growth enables scale, but it also triggers complexity, which defeats scale. Ensuring that sheltering solutions work together in a harmonious way is not only good financial hygiene, it also is enormously important to business success. Working with a strong advisory team helps map sheltering solutions to the growing company.
When private companies consider sheltering solutions, we always seek to direct their focus to first achieving maximum purpose, not simply maximum gain. The goal is to select and shape a set of sheltering solutions into a coherent tax reduction strategy that fulfills business and personal needs.
Private companies should create a sheltering strategy that addresses and optimizes returns for three primary internal stakeholders: owners, key executives, and the company itself. To achieve this, we typically begin by seeking to understand the “value gap,” that is, the difference in value between what an owner needs to retire and current resources. Then, we seek to enlist and embed the power of nudges to help key executives attain their long-term financial goals. Finally, we seek to fit the sheltering strategy within a resilient value architecture, which articulates how owners and executives will enter, share value, and eventually leave the company via tax advantaged Sell·Pay·Convey® solutions.12
Sheltering solutions are powerful tools, indeed. Be sure your company is taking full advantage of them.
1Fidelity Investments, Fidelity Participant Marketing Analytics. Based on 410,000 financial wellness visits and 250,000 completed financial wellness assessments from 6/16/16 – 8/31/2016.
2 Employee Financial Wellness Survey , PwC April 2017, page 15.
3 For more information on the power of nudges, see Richard H. Thaler and Cass R. Sunstein,Nudge: Improving Decisions About Health, Wealth, and Happiness (Yale University Press, 2008).
4 Richard H. Thaler and Shlomo Benartzi, Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving (Journal of Political Economy, 2004) Jobs to be Done
5 “Behavioral Decision Making in Americans Retirement Savings Decisions”, Social Security Office of Retirement and Disability Policy
6 See Chapter 12: Retirement Wealth in EBRI Databook on Employee Benefits (Employee Benefit Research Institute, July 2014)
7 See article on Synthetic Equity on the www.boldvalue.com website. Sagemark Consulting, 2013
8 The full FICA tax of 7.45% (combined of 6.2% and 1.45%) is assessed up to the social security wage base of $127,200 (2017). Above this amount, only the Medicare portion of 1.45% tax is assessed.
9 The $54,000 limit on a Q-PSP is inclusive of the $18,000 401(k) limit, if a 401(k) exists.
10 The Profits Interest: The Frank Lloyd Wright Approach to Ownership and Incentives, Mark C. Bronfman.
11 The primary asset held by a business succession LLC is often a term life insurance policy. Accordingly, the capital accounts of the individual members have limited value – making the buy-in and buy-out low cost and flexible as administered by the Managing Member (typically the owner of the operating company).
12 See Equity Rules: Shaping powerful equity models via Sell · Pay · Convey®
* Licensed, not practicing.