Welcome - U.S. Senator George S. LeMieux
Overview: Tax Increases - Adi Rappoport, Gunster
View from the Hill - Arshi Siddiqui, Akin Gump
The Legal Perspective - David G. Bates, Gunster
The Investment Perspective - John Caple, Comvest
Wealth Preservation Techniques - Lisa A. Schneider, Gunster
Closing, Q&A - U.S. Senator George S. LeMieux
The Impending Tax Storm…are you prepared?
Overview: Tax IncreasesAdi Rappoport, Gunster
2013: The Impending Tax Storm
Pre-2001 Law
Top Ordinary Income Rate 39.6%
Top Capital Gains Rate 20.00%
Tax Rate on Dividends 39.6%
Tax Rate on Interest, Rents, Royalties, and Other Ordinary Investment Income
39.6%
Estate/Gift Tax Exclusion Amount $675,000
Estate/Gift Tax Rate 55%
2013: The Impending Tax Storm
• How did we get here?
– EGTRRA – Economic Growth and Tax Relief Reconciliation Act of 2001
• Reduced marginal income tax rates• Marriage penalty relief• Gradual elimination of phase out for personal exemptions• Gradual elimination of phase out for itemized deductions• Estate and gift tax (death tax) reform and elimination in 2010• Sunset Provision – revert to prior law after December 31, 2010
How Did We Get Here?
– JGTRA – The Jobs and Growth Tax Relief Reconciliation Act of 2003
• EGTRRA provisions accelerated• Reduced capital gains rates• Reduced dividends tax rate• Increased expensing limits for small businesses• Bonus depreciation increased and extended• Sunset provision also applies to JGTRA
Tax Rates Post-JGTRA
Post-JGTRA Law
Top Ordinary Income Rate 35.0%
Top Capital Gains Rate 15.0%
Tax Rate on Dividends 15.0%
Tax Rate on Interest, Rents, Royalties, and Other Ordinary Investment Income
35.0%
Estate/Gift Tax Exclusion Amount $1,000,000
Estate/Gift Tax Rate 55%
How Did We Get Here?– TRUIRJCA – Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010• Income tax rates retained for 2011 and 2012, including
capital gain rates and qualified dividend rates• Estate tax reinstated for 2011 and 2012, with a top rate of
35%. Exemption amount of $5 million per individual in 2011 and will be indexed to inflation in following years. Estates of people who died in 2010 can choose to follow either 2010's or 2011's rules.
• Portability of estate tax exemption among spouses• Payroll tax deduction – 2% on employee’s portion• Sunset extended to December 31, 2012
How Did We Get Here? – 2010 Health Care Act as Amended by the 2010 Health
Care Reconciliation Act• The 2010 Health Care Act increases the employee portion
of the Medicare Hospital Insurance tax after 2012 by an additional tax of 0.9% on wages received in excess of the applicable threshold amount.
• After 2012, the 2010 Reconciliation Act imposes an unearned income Medicare contribution tax on individuals, estates, and trusts.
• For individuals, the tax is 3.8% of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (MAGI) over the applicable threshold amount.
2010 Healthcare Act• Net investment income =
– gross income from interest, dividends, annuities, royalties, and rents; and – net gain (to the extent taken into account in computing taxable income) attributable
to the disposition of property other than property held in a trade or business to which the Medicare contribution tax doesn't apply
– Less certain allowable deductions
• MAGI = adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income, net of the deductions and exclusions disallowed with respect to the foreign earned income.
• Threshold Amount = $250,000 for joint returns or surviving spouses, $125,000 for separate returns, and $200,000 in other cases – not indexed for inflation
2013: The Largest Tax Increase in the History of the World!Pre-2001 Law 2012 Law 2013 Law
Top Ordinary Income Rate 39.6% 35.00% 40.50%
Top Capital Gains Rate 20.00% 15.00% 23.80%
Tax Rate on Dividends 39.6% 15.00% 43.40%
Tax Rate on Interest, Rents, Royalties, and Other Ordinary Investment Income
39.6% 35.00% 43.40%
Estate/Gift Tax Exclusion Amount
$675,000 $5,120,000 $1,000,000
Estate/Gift Tax Rate 55%*Plus a 5% tax surcharge on
estates in excess of $10,000,000
35% 55%*Plus a 5% tax surcharge on
estates in excess of $10,000,000
Example - $20 million Business
December 31, 2012 January 1, 2013
Sales Price for Business $20,000,000 $20,000,000
Total Taxes $3,650,000 $5,190,000
Net to Client $16,350,000 $14,810,000
Client has business worth $20 million ($5 million of inventory with a basis of $1 million) and $15 million goodwill). Business is taxed as a pass through entity. The difference between a cash sale on December 31, 2012 and January 1, 2013 is significant:
Business Tax Planning in 2012• Business owners contemplating exit may want to accelerate
sale to 2012– Electing out of installment method– Accelerating gain recognition on prior transactions
• C Corporations should consider paying dividends in 2012• Consider accelerating gains through distributions or change in
entity classifications• Consider accelerating dispute settlements
Estate Planning Example: $10 Million Gift• Assuming no previous gifts, in 2012, gifts or other testamentary transfers in the
incremental amount of $5.12 million ($10.24 million for married couples) can be made completely tax free; whereas, the same transfer made in 2013 will incur an immediate tax of $2.111 million ($4.222 million for married couples).
December 31, 2012 January 1, 2013
Gift $10,240,000 $10,240,000
Total Taxes $0 $4,222,000
Net Client Outlay $10,240,000 $14,462,000
Estate Planning in 2012
• If one chooses to make taxable gifts in 2012, for amounts transferred over the exemption amount, the effective rate of tax is 20 percentage points less than the 2013 rate.
• In addition, assuming the donor survives for at least three years, the gift tax paid will be removed from the future taxable estate resulting in an effective savings of as much as 39.25 percentage points, before time value considerations.
• A $100,000 gift in excess of exemptions at today’s rates results in gift tax of $35,000 and a total outlay of $135,000. One would have to provide for a pre-tax bequest in one’s estate of $222,222 to transfer the same $100,000 to an heir at the 55% estate tax rate that is scheduled to return in 2013.
15
The View from the Hill
Arshi Siddiqui, Partner
16
What issues are in play in the Lame Duck?
Issue SummaryBush Tax Cuts Enacted in 2001 and 2003, the “Bush tax cuts” are due to expire on December 31. In the absence of a legislated
extension, the top marginal rate will increase from 35% to 39.6 %. In addition, other features of the Bush tax cuts, such as marriage penalty relief and expanded child care tax credits, will revert to pre-2001 levels. This is really two issues as there is a related debate regarding whether to extend the current tax policy for only those making $250K and below or for all tax payers.
AMT “patch” The so-called AMT “patch” which prevents over 22 million taxpayers from having to pay the alternative minimum tax will expire on December 31.
February tax relief package The recently-enacted Social Security payroll tax relief, unemployment benefits, and Medicare physician payments will also expire at year’s end.
Budgetary “sequester” Enacted as part of the August 2011 debt ceiling increase, a $1.2 trillion sequester (equally-divided, across-the-board cuts in defense and discretionary spending) will take effect on January 1, 2013.
Capital gains and dividends In the absence of a legislated extension, the current 15% rate on capital gains will increase to 20% and the current 15% rate on dividends will increase to 39.6%, effective January 2, 2013.
Federal estate tax The current 35% estate tax rate and $5 million exemption will expire on December 31 and will revert to a 55% rate and $1 million exemption.
Healthcare taxes • The Affordable Health Care Act in 2010 established a 3.8% tax on investment income (interest, dividends and capital gains) will take effect on January 1, 2013 for individuals with incomes above $200,000 and $250,000 for joint returns.
• Also enacted was a 0.9% increase in the Medicare payroll tax rate will also take effect on January 1 for high-income individuals.
“Tax extenders” Various so-called “tax extenders” (such as the R&D tax credit) already expired at the end of 2011. Other, newly expiring “tax extenders” (such as various renewable energy tax incentives) will expire at the end of 2012. In addition, “bonus” depreciation which allows a 100% deduction for certain capital investments, expired at the end of 2011.
Debt ceiling increase The current statutory debt ceiling may be reached in the Fall of 2012, requiring “extraordinary” debt management measures by the Treasury Department to prevent default prior to 2013. Another legislated increase in the debt ceiling will be required no later than the first quarter of 2013. It is important to note that while the tax policy agenda described above is both expansive and economically significant, an increase in the debt ceiling is considered of critical importance to prevent an unprecedented default on its obligations by the United States government.
17
What comes after the “Lame Duck”Tax Reform
Key questions
Will it be revenue neutral, or contribute to deficit reduction? What is the baseline? Does it include both corporate and individual reform?
Moving pieces
Reduced rates Base-broadening
o Repeal tax expenditures: ie tax credits and accelerated depreciation
o Reduce non tax expenditures: ie interest deductibility International reforms Transition rules
David Bates, Esq.
Potential Transactions
• Sale of Business– Sale of Assets
• Sell all assets or certain specific assets• Generally requires shareholder approval• May generate appraisal rights for dissenting
shareholders• Company may be forced to retain liabilities
Potential Transactions
– Sale of Stock• Sell the stock of the business• Viability of this alternative depends on availability of
purchaser(s) and perceived value of the equity• Some sellers may be forced to accept discounted sales
price• May be restricted in a shareholders’ agreement or
similar document• New shareholders will have significant rights and
powers
Potential Transactions
– Merger or other Business Combination• Generally requires shareholder approval• May generate appraisal rights for dissenting
shareholders
Potential Transactions• Financing Transaction
– Can be structured as a company financing with a distribution of all or part of the proceeds to the shareholders
– Not generally available to all companies– Issuance of additional equity dilutes the owner’s
position– New shareholders will have significant rights and
powers
Potential Transactions• Payment of Dividend
– Company declares dividend to its shareholders to get cash out of the company
– Dividend must generally be made pro rata to all shareholders based on their ownership
• Some shareholders may not need or want this dividend depending on their circumstances
– Availability of this transaction will depend on company’s financial situation• Florida corporate law imposes insolvency test
– Company’s Board of Directors must approve dividend payment
Potential Transactions
• Transfer of Appreciated Assets– Company or individual may be able to transfer
appreciated assets to another entity or to a charity
• Such a transfer may allow company or individual to pay taxes at today’s rates and may have other tax advantages
What Can Business Owners Do Today?
• Critically and realistically evaluate the status of the company
• Initiate clear communications with all interested or relevant parties
• Ensure that all applicable legal documentation is in place
• Prepare critical path analysis of required items• Have good advisors in place
Possible Roadblocks
• Require substantial investments of time, management attention and money
• Short time frame• Require the cooperation or action of third
parties, and these parties may not be sensitive or agreeable to or to your time requirements
• All owners may not have the same imperatives, agendas and timing
Possible Roadblocks
• Business valuations in some sectors are depressed
• Require the restatement or cleaning up of prior financial statements and tax returns
• Existing documents or relationships may prohibit or impair these transactions
Do Not Let the Tail Wag the Dog
Some Risks and Caveats
• No business owner should pursue any of these transactions purely on tax-related grounds
• These tax changes may not occur or may not be as severe as anticipated
• A transaction may result in foregoing some or all of the company’s future economic success
• A transaction will still generate tax liabilities• A transaction may generate appraisal rights or
litigation involving dissident shareholders
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
M&A MARKET OVERVIEW
JUNE 2012
John Caple, Managing Director
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Annual Middle Market M&A Activity
31
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
$0
$500
$1,000
$1,500
$2,000
$2,500
0
2,500
5,000
7,500
10,000
12,500
15,000
Deal Value Number of Transactions
Dea
l Val
ueN
umber of Transactions
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Quarterly Middle Market M&A Activity
32
For the Quarters Ended March 31, 2008 – 2012
Quarterly M&A Middle Market Transaction Volume
For the Quarters Ended March 31, 2008 – 2012
Quarterly M&A Middle Market Transaction Value
Q1 200
8
Q2 200
8
Q3 200
8
Q4 200
8
Q1 200
9
Q2 200
9
Q3 200
9
Q4 200
9
Q1 201
0
Q2 201
0
Q3 201
0
Q4 201
0
Q1 201
1
Q2 201
1
Q3 201
1
Q4 201
1
Q1 201
20
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Undisclosed Under $100mm $100-$250mm $250-$500mm Above $500mm
Q1 200
8
Q2 200
8
Q3 200
8
Q4 200
8
Q1 200
9
Q2 200
9
Q3 200
9
Q4 200
9
Q1 201
0
Q2 201
0
Q3 201
0
Q4 201
0
Q1 201
1
Q2 201
1
Q3 201
1
Q4 201
1
Q1 201
2$0
$50,000$100,000$150,000$200,000$250,000$300,000$350,000$400,000$450,000
Under $100mm $100-$250mm $250-$500mm Above $500mm
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Private Equity Capital Overhang
33
2006 2007 2008 2009 2010 2011$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
$0
$100
$200
$300
$400
$500
$600
$700
$436
$530$576 $560
$477$424
Cumulative Overhang Under $100M $100M - $250M $250M - $500M $500M - $1B$1B - $5B $5B +
Capi
tal R
aise
d
Cumulative O
verhangFor Years Ended December 31, 2006 – 2011($ in billions)
$424 Billionin “Dry Powder”
(1) Estimated buying power calculated as the cumulative overhang divided by the three-year average equity contribution to LBO transactions.Source: Pitchbook.
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Average Leverage Multiples of Middle Market LBO Loans
34
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q1 120.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
4.9x
4.8x
4.1x4.0x
3.4x
3.8x 3.8x
4.3x4.7x
4.7x
5.6x
4.5x
3.3x
4.2x 4.3x4.1x
FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Average Equity Contribution for LBO Transactions
35
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q1 1215%
20%
25%
30%
35%
40%
45%
50%
>$50MM EBITDA <$50MMEBITDA
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Middle Market LBO Valuation by Transaction Size
36
0.0
2.5
5.0
7.5
10.0
12.5
Median EBITDA Multiples by Transaction Size
2005
7.8
8.3
8.8
2006
7.6
8.4
8.8
2011
6.3
8.0
9.1
Q1 12
6.9
10.1
10.8
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Impact of Bush Tax Cuts Expiration on Quarterly Middle Market M&A Volume
37
Q1 2008
Q2 2008
Q3 2008
Q4 2008
Q1 2009
Q2 2009
Q3 2009
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Undisclosed Under $100mm $100-$250mm $250-$500mm Above $500mm
Bush Tax Cuts Expire
C O N F I D E N T I A
L
PRIVATE EQUITY
THE COMVEST GROUP
Summary
38
• The middle market M&A environment is slow and we expect it to remain that way for the next several years
-Lots of capital available for good companies and we expect multiples to continue to remain high as private equity funds raised in 07/08 need to deploy capital
-Companies with a story and smaller deals are much harder8 Private equity funds are mostly focused on “good companies”8 Cash flow lending is either expensive or not available for
smaller deals (<$10M EBITDA) and storied credits -This dynamic is likely to remain for the foreseeable future
8 Lack of lending driven by 09/10 loss experiences – not a good business
8 Limited number of “turnaround” or “value” PE players
• Whether the coming tax deadline will have significant impact is impossible to predict.
-Last time the tax expiration was heavily discussed but we saw no increase in deals
-There are many variables and unanswered questions
What A Difference A Day Makes: Wealth Preservation Strategies
For The Business Owner
IRS Circular 230 Disclosure: Pursuant to IRS Regulations, neither the information, nor any advice contained in this communication (including any attachments) is intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Lisa A. SchneiderShareholder
Private Wealth ServicesGunster
Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010
(the “2010 Act”)
• Forbes Magazine: “…the most favorable wealth transfer planning provisions in modern time.”
• The Wall Street Journal: “December’s historic tax legislation was a sweet deal for families.”
• Bloomberg: “Estate Measure Creates Window to Give Children up to $10 million Tax-Free.”
• New York Times: “Gift Bonanza”
Analysis of Potential Growth in GST-Exempt Trust (Assumes prior use of Pre 2011 $1,000,000 gift tax exemption)
• First 20 years of the Trust’s term income and gains are accumulated
• After 20 years the 3% income yield is distributed, and asset values continue to grow at 5%
• Assets appreciate at a rate of 5% annually with a 3% income yield for a total annual return of 8%
• Time between generations is 70 years
Funding• Option 1: Fund Trust with a gift of $4 million in
cash or marketable securities (no discount; no leverage)
• Option 2: Fund Trust with a gift of $4 million in non-controlling interests in closely held entities or hedge funds (assuming 25% combined discount for lack of marketability and lack of control)
Tax Savings of Multi-Generational GST-Exempt Trust Option 1 Option 2
Initial Taxable Gift $ 4,000,000 $ 4,000,000
Pre-discount Value $ 4,000,000 $ 5,333,333
Value at Year 9 EOY $ 7,996,019 $ 10,661,357
Value at Year 20 (EOY) $ 18,643,829 $ 24,858,437
Annual Distributions Starting Year 21 $ 559,315 $ 745,753
Asset Value at Change from Child to Grandchild Generation (Year 70) $ 213,796,236 $ 285,061,630
Taxes Saved at First Generation Change $ 74,828,683 $ 99,771,570
Asset Value at Change from Grandchild to Great-Grandchild Generation (Year 140) $ 6,505,055,249 $ 8,673,406,456
Taxes Saved at Second Generation Change $ 2,276,769,337 $ 3,035,692,260
Combined Tax Savings at First 2 Generations $ 2,351,598,020 $ 3,135,463,830
Notes: 1. All income tax liability on the Trust's income will be reported on Grantor's individual income tax return. May wish to include ability to "turn-off" grantor trust status or include discretionary tax reimbursement power for an Independent Trustee. 2. To the extent that Trust must pay its own tax liability after grantor trust status terminates, Trust makes greater distributions, or earns lower than assumed rate of return, growth in Trust's total value may be slower than projected.
Will Congress “Recapture” or “Claw Back” Your Gift Later?
• Taxpayer makes a $5.12 million gift in 2012 and dies in a year when the estate tax exemption has been reduced to $1 million (2013?) Does Taxpayer’s estate owe estate tax on the $4.12 million “extra gift” made in 2012?
Was Recapture Intended By Congress?Probably Not…But…
• The 2010 Act sunsets in 2013, so the estate of a donor who dies in 2013 or beyond may be subject to “recapture” or “clawback” of a significant portion of the lifetime gift
• Result: Estate of donor owes estate tax on lifetime gift based on pre-2001 estate tax rates (55%)– Bad news: If the transferred assets depreciated in value,
the estate tax may still be imposed at higher date-of-gift values
– Good news: Post-transfer appreciation will still escape estate tax
Recommendation• Proceed with utilizing $5.12 million exempt amount
notwithstanding risk of recapture.• Why?
– Removes all future appreciation from estate.– Take advantage of discounting which may not apply in the future.– Resulting tax is not greater than the estate tax which would have
been paid if no gift had been made (in most cases).– First step in business succession planning
Lifetime Transfer Planning In 2012
• Clean-up Gifting:– Forgive intra-family loans-avoid potential audit issue– Pay off Childrens’ Mortgages– Equalize annual exclusion gifts along family lines– Gift retained general partnership/voting interests in
gifted entity to avoid inclusion at death– Make a lump sum insurance payment to reduce future
taxable gifts– Gift vacation residence to minimize domicile challenge
exposure
Lifetime Transfer Planning In 2012
• Gifting Closely-Held Business Interests
– Planning prior to sale: pass entity interest at reduced value Plan early
– Succession planning: transfer leadership, family values and equity
– Leverage Gifts With Discounts: closely-held entities like family partnerships and LLCs attract valuation discounts for gift tax purposes• Lack of marketability• Minority Interest• Transfer Restrictions
Lifetime Transfer Planning In 2012
– Timing Is Everything: Lock-in valuation discounts before legislative changes eliminate discounts
– Hard To Value Assets: Recent cases approve certain formula clauses to avoid payment of gift tax
– Maintaining Control: Recapitalize to voting/non-voting prior to gifting
– Business purpose upon entity creation
Lifetime Transfer Planning In 2012– Gifts or Sales to Grantor Trusts(“IDGTs”) are an
extremely powerful tool for reducing tax in very large estates• Use $5.12 million exemption amount to “seed” trust• Avoid gain recognition on assets purchased with seed
gift• Grantor’s payment of annual income taxes=additional
tax-free gift• Ability to use lifetime exemption and retain income
flow through promissory note• Dynasty trust planning (360 years in Florida)
Lifetime Transfer Planning In 2012
• GRATS:– Zeroed-out GRATS do not use significant gift tax
exemption but are valuable tools for transferring appreciating assets while interest rates remain low
– June 2012 hurdle rate is 1.2%– Greenbook Proposal to require minimum gift and
maximum term
Gifting Considerations
• Income needs: gift vs sale (or combination)• Basis of assets - trigger gain when capital gains rates
are low or defer?• Spousal access to income• Control issues• Restricting access by children & grandchildren• Potential discounts• Liquidity needs
Thank you
To download seminar materials, please visit
www.gunster.com/taxstorm
