The Elder Law Coach

Epi 53: Business Valuation Surprises: The $15 Million Estate Tax Oversight

• Todd Whatley

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Analyzing a real client case reveals how proper business valuation prevented millions in estate tax liability for a family business succession plan. 

• Late 70s couple with three children (one running the family business) needed trust updates
• Initial assumption: $6 million estate ($4M personal assets, $2M business) was non-taxable
• Deeper analysis revealed business actually worth $15-18 million based on revenue multiples
• Without planning, estate would face massive tax bill and business succession challenges
• Business-operating child didn't want to need siblings' permission or owe them money
• Solutions include gifting business interests at current valuation with appropriate discounts
• Restructuring ownership allows fair (not equal) distribution without losing control
• Wealthy clients often don't understand estate tax implications, even with $40M+ estates
• Family businesses, rental portfolios require specialized transition planning
• Business succession requires balancing equalization with practicality

Call the office at 479-601-4119 or visit theelderlawcoach.com to learn about upcoming webinars and the Elder Law Transformation Summit in February 2025.


Be sure to mark your calendar for our Monthly Webinars and for this fantastic weekend.  Visit our website for the webinar schedule and to sign up.  Stay tuned for more information about the Transformational Weekend.

Check out our new website www.TheElderLawCoach.com.

Speaker 1:

Thank you. Specialized experience, Whether you're an established attorney looking to refine your expertise or an emerging lawyer seeking a successful foray into elder law, this is your masterclass. Now let's get started with the luminary in the field. Here's Todd Whatley.

Speaker 2:

That's right. This is the Elder Law Coach and my name is Todd Whatley, and, as always, I am super happy that you have decided to join us today and today I think this is going to be a really good show because it's going to be something that you don't see every day, okay, so this is going to be one of those things. I really do want you to listen, because if it comes up in a meeting, you need to jump on it. And my issue the reason I wanted to do this was two things.

Speaker 2:

Number one this is something that kind of got by me and my buddy, ian, caught it, and it is something that can truly make a difference in a client's life. If you can catch this, it can save them literally millions of dollars in their estate plan and death taxes and things like that. So our goal here is to do everything that we can for the client to try to catch the things that they've never seen, and sometimes even things that I missed, and, um, we want to talk about that. And when I say we, I am here with my buddy, ian Weiner. He's been on here before, he is my certified financial planner buddy and he does my investments and things, not taxes you don't do taxes.

Speaker 3:

I don't prepare taxes. No, we have people for that, todd, there's always a who for that how but that's a story for another day.

Speaker 2:

So this is Ian Weiner, my good friend and certified financial planner, and he was with me Certified exit planning advisor as well.

Speaker 3:

That's right.

Speaker 2:

This is the other one. Could have probably caught that. Yeah, knowing that may have also helped. So, ian, we were in this meeting together, so give us just some general facts and then we'll discuss it.

Speaker 3:

So this is, uh, we're going to protect, we're going to change some of the details to protect the the innocent here. Um, but this is this is based on a real life case that we're in the process of, of working on. Um, so husband and wife come in. They are um late seventies, early eighties, have run a business for you know, the better part of 40 years and have done so successfully. One of their children they've got, let's say, they've got three children. One of their children runs the business.

Speaker 3:

The other two are really not involved, and so the the reason for the conversation in the first place was to review the current trust that they had, update powers of attorney, make sure that they're going to avoid probate successfully and have a plan to eliminate the risk of a guardianship if possible. So what we were focused on was kind of the basics here of everyone needs to do this stuff. They had done a trust years ago, decades ago I think, in another state in this case I think so, and so they wanted to make sure that stuff was right, and so we got in, we began to talk to them and, todd, you can touch on the complexity of the trust it was an AB trust. Is that right An?

Speaker 2:

AB trust with some very complicated distributions that they no longer really wanted to do. But, yeah, it was an AB trust and at that point I did not think that they had a taxable estate and I think that's where Ian jumped in and fixed this. But yeah, I was like you know, this is way too complex for your current situation and we can definitely make this more simple. And that's when you jumped in. You're like, uh, but so something that's great.

Speaker 3:

You know, something that Todd is good at is he wants to simplify as much as possible. You know we're we're not fans of having any complexity. That's unnecessary, but we're open to to doing complex things if that's what the client requires.

Speaker 3:

And so you know, in the conversation we're talking about the assets that they have and what their intentions for these assets are, and let's just use round numbers. Let's say that they value their estate you know, their home and their, we'll say, investable assets at about $4 million, and their valuation for the company was about $2 million. And so initially, when we were talking, we're going okay, they're a married couple, even if that's $6 million altogether okay, currently we don't have a taxable estate and even if the TCJA sunsets as expected at the end of this year, even if that drops down to 7 million each, we're probably okay. And I think normally this is how people would approach this. And so we wanted to get a sense of where does the money go? What's the plan here? How do the kids work? Blah, blah, blah, and two of the children do not work in the business and they want, you know, to have a fair distribution to their kids. And I think that's a key point, because the way that we say it is fair is not always equal Absolutely, and in this case, their other child had really contributed over years you know, even I think, probably the better part of a decade to building and growing this business is basically the you know the principle of the business and drives a lot of the day-to-day and so, okay, is it fair that everything is split equally? And how do we do that equalization? What's the process for that? Because the sibling who runs this business think about it from their perspective. They don't want to have to ask their siblings who have not run the business for permission to continue running the business. But if the shares are distributed equally between them let's say, the son who is running the business has 33% of the company or 34% of the company Well, the other two each have 33. This is a nightmare. I want you guys to see that this is a nightmare if we get this wrong, for everybody involved.

Speaker 3:

And so we started to ask questions. I said, okay, well, how do you value the business? They said, well, the last time we had a valued, you know about 20 years ago, was a couple million bucks. Okay, Well. And they said, well, we value it based on the retained earnings in the corporation. Getting a little bit into the weeds here, that means that this is profit that the company's paid taxes on that are inside the company. But let's call it 3 million bucks is inside the company, okay. And I said and so that's what they value it on, Because in their mind, if they would walk away from the business and shut it down, that's what they could take out of it.

Speaker 3:

And they're in an industry that they're concerned under the current climate, with the current administration, is not going to be a big high growth industry for the next few years. And I said, but what the last couple of years, what's top line revenue been? No, it's, you know, five, 6 million. I said, okay, well, even if you have a slowdown this year, what do you think you'll do? Three to four, okay. Even if you have a slowdown this year, what do you think you'll do? Three to four, okay. And so I said, well, good news, bad news Business is not worth the $3 million in retained earnings.

Speaker 3:

The bad news is it's probably worth three to five times the top line revenue. Oh, and Todd's going oh, so I'll do the math for you. Let's say it's worth, and that's plus the retained earnings, right, because if you're buying the business, you know you're going to buy the retained earnings plus the value of the company. And so let's say that they're doing $5 million a year and that we get a five times multiple on that All of a sudden, the company's worth $15 million plus the $3 million that's in the company. Now, this is I'm pulling up a valuation out of a hat here but the point is, all of a sudden, if we get unlucky, we have a taxable estate right away. Absolutely yeah.

Speaker 3:

And not only do we have a taxable estate, the bigger issue is how do we handle the distribution of this? Where's the? They have a buy-sell, but how does the buy-sell work and how is the buy-sell funded? Because if the parents pass away, the shares get split equally between them. We have a control issue and the sibling who's running the business does not want to have to ask their siblings who have not been in the business permission to do anything. Have to ask their siblings who've not been in the business permission to do anything. Sure, and also that sibling typically is in a position where you know they would love to be able to buy their siblings out, and that's usually what the siblings want is to be bought out. But if it's worth $15 million and we have $3 million in the business, this is a little bit more challenging. Creating $10 million is going to be difficult. How do we and how do we come up with that out of thin air and he was very adamant.

Speaker 2:

My child does not want to owe the other two any money or ask them for permission. We're like, okay, and that makes sense, right.

Speaker 3:

That does make sense. Owner, you know, and you have siblings, or you know your siblings spouses, or even your spouse you would not like for them to have to, you know, pay this off when this, when this happens, and so this is a really interesting example of you know, I think there are times when we have to take our clients at their word, and there's other times when we have to trust but verify, and so something that we're working on is part of the programs that we have is, you know, how do, how do we, as, as Todd and Ian and our our, you know, separate planning firm, how do we provide the kind of trust but verify services to some of our colleagues to make sure that we don't miss anything? Because, let's say, something happens down the road where, you know, these folks decide not to implement recommendations that we have, they pass away, we get into a fight about how the distributions happen, and there's a big issue, and they also happen to have a taxable estate at that same time. Is there some potential that we have some liability in this? And you know, it's not like we live in a non-litigious society, right? And so you know I'm not trying to, but I'm talking to lawyers here, and so you know, you can see how this goes, and the last thing that Todd and I want to do is get dragged into a family deal, and so you know what we're going to come in and do is we're going to come and figure out okay, is there a way and there is how do we let this family have their cake and eat it too?

Speaker 3:

What the parents want, what Todd's clients want, is they want to create a fair distribution, but that may not be equal among their children, and they want to do it in a tax efficient and simple way, and so something that we're talking about is okay, do we begin to gift these shares now, while the limit is higher? Do we lock in the current valuation? And one issue is let's say that this business would normally, under normal conditions, or had there been a different administration in the White House, let's say this business would have traded at a five times earnings multiple, valuing at about between 15 and 18 million. But let's say that, given the current environment, let's say that it would only trade at a three times multiple. You know, if you're buying a business, that you're concerned about the next three to five years how viable it is.

Speaker 3:

You know, and there's some, disfavored, there's some legislative issues it would make sense that we would value it at a discounted valuation. Now, in the long run you know, the business has been in operation for, I think almost 40 years and they've got some, they're pivoting and they're going to do fine. But in the short term this may be something we can take advantage of. So what we can do and we're exploring different ways to do this but what we can do is we can freeze the valuation from an estate tax perspective and we can say, okay, Mr and Mrs Client, let's value the business at what it is today, at this lower valuation, and there may be some restructuring of the business that we do because it's currently a C corporation. That may or may not be the way that we want to transition things. But let's do some gifting, and it's probably to a variety of different irrevocable trusts. But let's gift a good chunk of this and we can get an additional valuation discount. So let's say the business is valued at 12 million, all in 10 million, plus the 2 million or 3 million in retained earnings. Okay, Well, if we're going to be gifting these shares to an irrevocable trust, we also have some control issues that we talked about, the class of shares that we might create or gift could allow for.

Speaker 3:

Now people get in trouble when they do this. Okay, Because they're going to do. Typically this is what happens with family limited partnerships they're going to do a family limited partnership and then get a really big valuation discount and the IRS comes in later and goes well, it wasn't really a 50% discount, we might have given you 15 or 20. And so we will take a conservative valuation. But let's say we can drop another 20% off of the valuation when we're getting it outside of this family's estate valuation, when we're getting it outside of this family's estate. And so let's say they only have to use up $10 million of their between the two of them, $28 million estate tax exemption. We can get it outside of their estate. If we do it right, we can even still get a step up in basis later on.

Speaker 3:

And now we've solved both the potential estate tax issue, which at some point is going to be an issue realistically. And two, we're going to solve the equalization issue. Now, someone who's just preparing documents, that's not going deeper with their clients, would have completely overlooked this. And let's be transparent If we have to update the buy-sell, if we've got to create additional trusts. If we've got to fund those trusts, there's additional legal work that needs to be done and it's in the best interest of the client, but it needs to be done and it's probably two to three times what the baseline transaction was going to be.

Speaker 3:

And so we did a couple of things. We're in the process of solving a huge issue for the client that they didn't really realize that they had. I had no idea. Yeah, this is a multimillion dollar oopsies. Yeah, this is a multimillion dollar oopsies best case scenario. And we're we're doing it in a way that the client gets what they want. What they want to happen is going to happen, because Todd is going to draft the documents to to execute that and that's additional revenue for Todd's firm. This is not unimportant, but you know we don't run a charity right, but we want to do the right thing for the client and by going a little bit deeper and making sure that we're crossing the T's and dotting the I's and trusting the client, but also verifying this information, we're knocking out a whole lot of issues here. So this is one example of, you know, the the financial and the legal side working together to uncover more opportunities for the client and things that we can help to solve.

Speaker 2:

Yeah, it was just just kind of eyeopening. It's like oh yeah, number one, this family had an issue that they had no idea. And number two, we were able to fix it or we're in the process of fixing it.

Speaker 3:

We can fix. It Just depends on which you know how many strategies we can, we can use. And so you know. I think that one of the takeaways I want to make sure I hit here, todd is, you know, this doesn't apply just to families that have businesses, Although if, if someone is a business owner, this this should be a you know bell going off in your head Okay, we need to, we need to see the buy sell, we need to see the operating agreement. How does this work? And two, another place that this kind of planning I think is really, really important is people who they. They wouldn't necessarily say that they have a business, but maybe they have a rental portfolio.

Speaker 3:

Yeah, this is a classic situation. Mom and dad have 10 or 15 rentals they've acquired over the years and, yes, we want to put them in a trust, you know, typically, but we also have. I mean, this is a business. You know past one it's a business. Even one is arguably a business. What's the plan to transition that?

Speaker 3:

If they have multiple kids, Is someone going to, is someone going to do, and how do we? And if they have multiple kids, how do we distribute those assets fairly? I mean, we're working on a case right now slightly different situation. I mean, I think we're talking about probably 200 units is the the particular case kind of out out South here, the person who really drives the bus, the other one is along for the ride, and they're working on an equal distribution of these. But the you know and I'm working with the trustee daughter, I'm working with the trustee sibling and the non-trustee sibling is like wait a minute, wait a minute. This isn't fair, this isn't equal and it's a mess to get that distributed. And so you want to encourage your clients to be thinking about how that distribution is going to go when you pass, particularly with things like real estate.

Speaker 2:

Yep, well, and also just take this opportunity to tell you, listening out there, that just because we deal with taxes and this all the time, it's just like second hand to us. The clients truly don't know sometimes. Was it you that was talking about the client with $40 million and did not know they had a taxable estate? They assumed that all $40 million would just go to their kids.

Speaker 3:

Well, this was an interesting one. So this was a case that I was working on with a colleague of mine. They were in the wine industry and so this is why it was interesting to me Very quickly, this store. They were in a particular part of the country and probably their business is probably worth between $100 million and $130 million is what we're currently valuing it at First gen, probably mid to late 70s. So I want you folks to get this idea right and so we get brought in by another advisor to help with the.

Speaker 3:

This is an islet all day long. We have a huge estate tax issue. This advisor was just out of their depth, basically, and so we're having this conversation with the client and so we're talking through okay, what's the plan for this, what's the plan for this, what's the plan for this? And the question is what's the plan to handle estate taxes? We're trying to get a sense of where this client's at right, because we're thinking, okay, anyone that has $140 million business probably knows that this is an issue. And the guy goes what are you talking about? Like, well, if your estate's over a certain amount, it's like a death tax, basically. And he goes what they would never do, that that's literally what came out of the guy's mouth. It's incredible, wow. And we're like hang on, hang on. And so we spend a few minutes talking through.

Speaker 3:

And so don't assume that just because someone is wealthy that they are sophisticated. Yeah, absolutely, and this is consistent in my experience across the board. Yeah, absolutely, you know. That's to bring in life insurance death benefit into the estate to pay the taxes, because we're above the amount that gifting can really work at, and so we go, okay, well, you know, tell us about the business. You know he's like well, it's all going to go to my kids, you know Okay. And so we go well, are they going to be able to come up with the liquidity?

Speaker 2:

$70 million.

Speaker 3:

Yeah, you know, $70 million within nine months. He goes, he names the kids, he goes. Those guys, no, they're morons. And so this is you can't make this up, it's just, it's too good. But if you've worked with business owners, you know this is how they are.

Speaker 3:

One of the challenges of transitioning money across generations is one generation that builds it. That's not a guarantee that the next generation is going to be competent. It's Almost guaranteed, and so we're working with a couple of different and there's some grats and some different things that we can do, but if you have business owner clients that have really any level of wealth, these are the conversations that we need to be having, regardless of what the administration does In the long run over the next 20 years administration does in the long run, over the next 20 years, the legislative winds are blowing in the direction of making it much harder to pass wealth on, and so you know we need to be proactive and, frankly, you know it's not going to be surprising, you know, if someone's worth a million dollars today and their assets continue to double over the next 10 or 15 years. Clients that you don't think have a taxable estate regular kind of normal folks can get there pretty quickly.

Speaker 2:

Yep, so this is what we do every day. Okay, ian has an office. In my office, we typically see clients together, with their permission, of course, and we've been doing this. Are we pushing two years now? It's about two years and we've been doing this. Are we pushing two years now?

Speaker 3:

It's about two years that we've been working really closely together and I think we do this very well.

Speaker 2:

If this interests you, okay, if this is something that you are truly interested in, I would encourage you. I am starting a series of webinars for the rest of 2025 that will lead up to what we are calling the Elder Law Transformation Summit. It is in February of next year and I think Ian and I have four hours of that that we're going to introduce people to this concept, discuss how this works and go into it, and it truly can't Plus ethics.

Speaker 2:

And fiduciary duty yes, fiduciary duty, ethics, the entire nine and you can see how having someone in thinking that way will increase what the will show what the client needs, which many times we as attorneys can provide those solutions, and so it's in the client's best interest. It's going to save them millions of dollars and clients will gladly pay for that. But you've got to understand how this works and how to do it, and we will show you how to do that. So I encourage you, go, go to the website, call the office and ask for Patricia if you want to get the information on the webinars coming out the rest of this year, and particularly Transformation Weekend. We are limiting it to 15 people and you're going to have to apply and show that this is what you want to do, that you can do it and I will teach you how to do it, okay.

Speaker 2:

So yeah, go to the website, the elderlawcoachcom. Lots of information there. Call the office 479-601-4119. If you have questions, that is my law office, but that will get you to Tricia. Ask about Tricia or just say, hey, I have some coaching questions and they will get you to the right person. Okay, as always. Thank you very much for listening and we will see you next time, okay.

Speaker 1:

Thank you for joining this episode of the Elder Law Coach Podcast. For those eager to take their elder law practice to new heights and are interested in Todd's acclaimed coaching program, visit wwwTheElderLawCoachcom. With Todd Watley by your side, the journey to becoming an elder law authority has never been more achievable. Until next time, keep learning, keep growing and stay passionate about elder law.