Editor's Note: This article is part of the Financial Advisor series "How I Solved It." Advisors describe a client with a problem and what they did to help.
When the founder of a family-owned manufacturing firm began working with financial advisor Sam Brownell, he was concerned about the long-term planning issues that keep many small business owners awake at night. The client’s big questions revolved around estate taxes, passing along his values and principles to future generations and how to prepare his offspring to potentially take over the business.
Even with the recent tax law changes, which give an $11.4 million exemption in 2019, the client’s estate will be taxed at the federal level, said Brownell, founder of Stratus Wealth Advisors. The company, in Silver Spring, Md., includes a fee-only RIA firm founded by Brownell in 2013 and legacy planning and business valuation services.
Based on how the client had set up his existing trusts, his heirs would’ve been looking at assets with $600,000 to $800,000 dollars of capital gains that were unrealized, he said.
The business owner, like many of Brownell’s clients, had worked hard throughout his life to build his business and to provide for his family. He wanted to avoid a situation where “the first generation makes it, the second generation preserves it and the third generation spends it all,” said Brownell.
Brownell’s first step was to take a close look at his client’s two trusts. The assets in the revocable trust would get a step-up in basis upon the client’s death, giving them a higher market value to minimize the beneficiaries’ capital gains tax. The assets held in the irrevocable trust would not get the step-up.
The assets in the client’s irrevocable trust, which included traditional financial securities, tended to have a lower cost basis. The revocable trust contained business assets that had a fairly high cost basis, especially in relation to the client’s other assets, because over time he’d made a lot of investments in his business.
Brownell helped complete an asset swap, which entailed moving the client’s investment assets into the revocable trust and relocating his business assets into the irrevocable trust. His ability to swap “dollar-for-dollar amounts,” he said, could reduce the heirs’ collective capital gains by as much as $800,000.
He coordinated the asset swap with the client’s estate attorney and ensured that the irrevocable trust included flexibility that enabled the business owner to continue to receive interest income, dividends and other payments from the trust while still alive.
Brownell also worked closely with a CPA to obtain the best financial information, particularly when valuing the client’s nontraditional assets. This enabled him to provide documentation that supported his actions and that can be recreated if the client is audited. “The last thing you want to do is come up with a strategy that lands your client in tax court,” he said.