Small business owners work hard to establish their business and achieve success. However, there may be planning issues that need to be addressed to be sure success continues. Some of these issues may be:

Business Continuation

What will happen to your business at your death? Will your heirs need to sell the business to obtain cash to pay estate taxes and liabilities? Will your heirs and surviving owners work together harmoniously?

Key Employees

Employees are an integral part of a business' success. As a result, you should ask yourself: Could your business continue to be as profitable in the event of the unexpected death of a key employee?

Employee Benefits

A major problem facing many businesses today is attracting and retaining top-caliber employees. As a small business owner, you are aware of the importance of employee benefits and their contribution to your business success.

Key Employee Incentives Plans

Fringe benefits, such as Split Dollar, Executive Bonus, and Deferred Compensation allow an employer to select the employees it wishes to participate and vary the benefits among them. The plans do not have to meet IRS requirements, and there are no IRS mandatory distribution requirements.

Business Continuation

There are three ways a buy-sell agreement may be structured. You should seek the advice of your tax advisors to determine which is the best for you. An attorney will need to prepare the buy-sell agreement. Success in business requires careful planning but there is one contingency that many businesses fail to plan for -- the death of a business owner or key employee. Whether your business is a sole proprietorship, a partnership, or a close corporation the death of a business owner or a key employee can be costly to your business and your family.

With the use of life insurance, cash can be available to assist with the orderly, economical adjustments following the death of a business owner or key employee.

Before any decision is made, your tax advisors should be consulted and an attorney should prepare any business documents that may be needed.

Buy-Sell Agreements

Without proper planning, the premature death of a business owner may result in the business being liquidated, sold to outside parties, or surviving family members may have to become active in the business. To plan for the orderly disposition of the business, a buy-sell agreement should be considered.

A buy-sell agreement can be between shareholders of a corporation, partners of a partnership, or a key employee and a sole proprietor. The agreement obligates the surviving business owners, key employee, or the business itself to purchase the interest of the deceased owner.

Advantages of a Properly Drafted Buy-Sell Agreement

• Creates a guaranteed market for the business interest.
• Allows those who are interested in continuing the business to do so without interference from the deceased owner's heirs.
• Provides liquidity for the estate of the deceased owner by turning the business interest into cash.
• Establishes the value of the business for federal estate tax purposes.

Types of Agreements

Cross Purchase -- This type of agreement involves the business owners (shareholders or partners) entering into an agreement among themselves whereby the surviving owners are obligated to buy the interest of the deceased owner, and the estate of the deceased owner is obligated to sell.

Entity -- This type of agreement binds the business itself to buy the interest of the deceased owner, and the estate of the deceased owner is obligated to sell. If the business is the corporation, this entity agreement is sometimes referred to as a stock redemption agreement.

Wait and See -- If it seems difficult to decide whether to use cross purchase or entity, a "Wait and See" may be utilized. This type of agreement allows flexibility in that it is not decided until the owner's death whether the surviving owners or the business purchases the interest of the deceased owner.

Where does the money come from to purchase the business interest?

Personal Funds of Owners? Most business people do not keep large sums of liquid assets that would be needed to purchase the deceased owner's interest. Most money would be in their businesses.

Sinking Fund? The premature death of an owner may not give the business time needed to accumulate the purchase price.

Borrowed Fund? A bank may not be willing to lend money to a business that has recently lost an owner or the cost of the interest of the loan may be excessive.

Installment Payments? The heirs of the deceased owner may not get the sum or money needed to settle death costs and there is no guarantee future payments will be received if the business fails.

Life Insurance? There are many advantages life insurance offers that the other alternatives do not:

• Life insurance annual premiums are often a small fraction of the death benefit.
• Death benefits are available when needed, regardless of when the owner dies.
• Death benefits are generally federal income tax-free.

Key Employee Insurance

Every business has assets that are protected against loss, whether they are buildings, office equipment or automobiles. However, what is often overlooked is probably the most important asset the business has -- its key employees.

Key employees have several characteristics that distinguish the from other employees, including:

• Having specialized skills that are critical to the success of the business;
• Having a significant client base that might leave the business if the employee were to die.

When a key employee dies, the business needs cash:

• cover the expense of finding, attracting, and training a new employee;
• continue the long-range development programs jeopardized by the death of the key employee;
• assure creditors and customers the business will continue.

There are two primary methods of key employee valuation to determine how much life insurance is needed. One would be to estimate the cost of finding, hiring, and training a replacement. These costs would include employment agency fees, moving expenses, and the owner's time spent interviewing and training the replacement. Another approach is to determine the dollar amount of profit brought to the business each year by the employee and how many years it would take for a replacement employee to perform at the same level of competence.

To be certain the cash will be available when it is needed, life insurance should be considered. The annual premium cost is often a small fraction of the death benefit and death benefit are generally received federal income tax-free.

Split Dollar Plan*

The Split Dollar Plan is a plan whereby the employer and the employee share the premium payments, or the employer pays the entire premium to buy insurance on the employee's life. Usually the employer is guaranteed that, whether the employee lives or dies, it will get back all of its portion of the premium payments.

For the employer, the plan can:

• Provide an incentive for the employee to stay with the employer.
• Provide a way to be selective in rewarding certain key employees.
• Provide a source of liquid funds for the business through policy cash values when the employer owns the policy.

For the employee, the plan can provide:

• Permanent insurance at term rates.
• A hedge against future insurability for life insurance.

Plus, the plan is flexible. The premium can be level for the employee, employer, or both.

*Check with your tax advisor and attorney for applicability.

Executive Bonus Section 162 Plan

The Executive Bonus Plan is a way for an employer to help a key employee meet personal life insurance needs. The employer pays the premium and treats it as additional (bonus) compensation. The key employee is taxed on the bonus. The employer may pay an additional income tax-deductible bonus to offset this tax. The "premium bonus" plus the "tax bonus" can result in low, or no personal expense for the key employee's own life insurance.

For the employer, the plan can:

• Help retain key employees.
• Allow the employer to be selective in rewarding certain key employees.

For the employee, the plan can provide:

• Needed personal life insurance.
• A hedge against future insurability.

1.      How Does It Work?

The executive bonus is easy to implement:

·        The Employee purchases and owns life insurance on his own life.

·        The Employer pays the premium to the insurance company.

·        The premiums are taxable income to The Employee under Section 162 of the IRS code.

·        The Employee owns the life insurance policy including all policy values.

·        The Employee is bonused the tax due each by Employer on the tax due on the premium.

2.      What are the Benefits to The Employee?

·        Employee owns all policy value and his heirs receive the entire death benefit.

·        Employee names his beneficiaries.

·        Employee has complete control over policy cash values with no “strings” attached.

·        Policy values grow tax deferred.

·        Employee has little or no out-of –pocket cost.

·        Substantial policy values are a source of additional income or reserve in the future.

·        Employee tax basis is total premiums paid.

3.      What are the benefits to the Employer?

·        Program is discretionary and need not be offered to others.

·        Customized benefit for the Employee.

·        Plan creation and implementation is simple.

·        No Erisa requirements or red tape.

·        No administration beyond normal payroll.

·        Policy can be self-completing upon disability.

Deferred Compensation Plan

The Deferred Compensation Plan is a contractual arrangement whereby a key employee, usually in a high income tax bracket, will receive a guaranteed number of fixed payments, beginning at retirement, in place of current salary increases or cash bonuses.

For the employee, it can:

• Allow the employee to remain in a lower income tax bracket.
• Provide money at retirement.
• Provide money for the family in the event of death.

For the employer, it can:

• Help retain a key employee.
• Attract a top employee.
• Be used exclusively for select employees.

In the deferred compensation contract, prepared by an attorney, the employer can agree to:

• Pay the employee a specified salary at retirement for a specified number of years.
• Continue payments to the employee's beneficiary if the retired employee dies before receiving the full number of payments.
• Pay a death benefit to the employee's beneficiary in the event of death prior to retirement.

The employee usually agrees to:

• Remain with the employer until retirement.
• Refrain from competing with the employer after retirement.