Limited Liability Companies: The Entity of Choice for Estate and Business Planning
The limited liability company (“LLC”) is rapidly becoming one of the most popular, as well as useful, tools for estate and business succession planners and their clients.
As the Virginia Limited Liability Company Act celebrates its twentieth anniversary this year, it is a good time to examine why the LLC has become the entity of choice for businesses in Virginia and North Carolina, as well as many other states throughout the country.
As a point of reference, the most common types of business entities are as follows:
– A sole proprietorship is an unincorporated business that is owned and operated by a single individual. This individual is entitled to all profits, but is also personally liable for all obligations of the sole proprietorship.
– A general partnership is an association of two or more individuals to carry on, as co-owners, a business for profit. Generally, each partner shares equally in the profits and loses of the partnership, and each is personally liable for all obligations of the partnership.
– A limited partnership is similar to a general partnership, but must maintain at least one general partner and one limited partner. General partners maintain management and control of the limited partnership, while the limited partners contribute the financial resources for operation of the partnership. In most cases, general partners are personally liable for the obligations of the partnership, while the limited partners are generally liable only to the extent of their investment.
– A corporation is an entity with distinct management and ownership. Corporations are typically classified as either a stock corporation, a non-stock corporation, or a professional corporation. While the owners are generally shielded from liability, corporations are often complex and cumbersome entities, which must conform to extensive federal and state laws governing their existence and operation.
A limited liability company can be viewed as a hybrid of a partnership and a corporation, extracting the benefits of those entities while avoiding many of their disadvantages. While the owners of sole proprietorships and general partnerships are subject to personal liability, an LLC is a separate legal entity that limits the personal liability of its owners, similar to a corporation. But while corporations are subject to double taxation, an LLC has the option of classifying itself as a partnership for income tax purposes, meaning that it will be taxed only on one level.
What, you might ask, does this have to do with estate and business succession planning? To answer this question, consider an individual who owns real estate that is used as rental property. If the rental property is titled in the owner’s individual name and one of the tenants suffers an injury on the property, then the owner may be personally liable for the tenant’s damages. This means that any judgment will be satisfied from the owner’s personal assets, bank accounts, salary, etc. Conversely, if the house is titled in the name of an LLC created by the property owner, then any judgment would be against the LLC and not against the owner personally.
The other primary advantage of an LLC is the tax benefit. For example, a corporation provides limited liability to its owners (i.e., the shareholders), but is subject to double taxation, meaning that it is taxed at the corporate level (i.e., the corporation gets taxed on its income) as well as the owner level (i.e., the shareholders then pay tax on the income they receive from the corporation). On the other hand, the income received by an LLC (such as rental income) is taxed only at the individual owner level. The owner of the LLC will report any income the owner receives from the LLC on the owner’s personal income tax return, but the LLC itself will not incur any tax liability.
Finally, the advantages of an LLC are not limited to limited liability and favorable tax treatment. LLCs also provide:
– Greater flexibility in structure;
– Centralized management;
– Potential continuity of life; and
– Free transferability of membership interest.
All of this has led to an explosion in the popularity of LLCs. From 2004 to 2007, LLCs were created in greater numbers than were corporations in both Virginia (over 53,000 more LLCs created) and North Carolina (over 34,000 more LLCs created).
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How Can We Teach Our Children the Value of a Dollar?
Description
Techniques for teaching children the value of a dollar include providing an allowance, encouraging children to save a portion of their allowance, chipping in a percentage of savings as “interest,” helping children to establish a bank account, and establishing a lending agreement, with interest, when children want to borrow money from you.
Start teaching your children at a young age that money is earned by working and that you should spend less than you earn. To help them understand what it’s like to get paid on a schedule, you may want to begin paying an allowance. Then help your children set goals for how they spend and save their allowance. It’s important, however, to make sure that you stick to the payment schedule; otherwise your lessons about financial responsibility may be undermined.
Experts differ on whether or not allowances should be tied to household chores. Although many people say children will learn more about personal responsibility if they are not paid for pitching in around the home, others feel it teaches them valuable lessons about working and earning.
Instill the Saving Habit
You should also encourage your children to save a portion of their allowance for a special goal, even if they’re just putting money in a piggy bank each week. As they save money, you might reward them with a small additional amount, just like a bank pays interest. At the end of each month, calculate how much your children have saved and then chip in a certain percentage as interest.
To reinforce your discussions about saving, you might also consider plotting a visual chart of their savings so they can easily monitor their financial progress.
Most community banks will allow children to open first accounts with low minimum deposits. Some even have accounts especially marketed to kids to make the learning process fun. Make sure that your children receive an online or printed statement so they can see the progress of their savings efforts, as well as the interest that accrues.
Borrowing and Compounding
When your children want something that they can’t quite afford, discuss the value of saving versus borrowing. If you do extend credit, use a written IOU, establish a repayment schedule, and charge interest. By doing this, you’ll be teaching them about financial responsibility.
As your children get older and perhaps take on part-time jobs to earn more money, their savings will likely amass at a quicker rate. This is an ideal time to review the lesson of compounding, or the ability of earnings to build upon themselves over time. Explain how compounding can be more dramatic over time; the longer money is left alone, the greater the effect. This can lead into a discussion about investing and risk — how certain investments with a greater ability to compound over time may also entail greater short-term risks.
As Benjamin Franklin once said, “An investment in knowledge always pays the best interest.” So remember that answering your children’s questions honestly and in terms they’ll understand can help them begin life on sound financial footing.
Required Attribution
Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
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© 2011 McGraw-Hill Financial Communications. All rights reserved.
October 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP®, a local member of FPA.
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The “Safety Net” Principle
by Dan Federman, CFP(r)
If you think about it, financial planning comes down to having a safety net for just about anything you can think of. The purpose of the safety net is to catch you just in case you fall from the high wire on which you thought you could walk.
There are plenty of examples of safety nets in our daily lives:
- A nurse uses gloves when handling a patient to prevent spreading diseases.
- A pilot has an “eject” button (and parachute) if the plane goes down.
- If the electricity goes out, use a back-up generator to avoid interruptions.
- Cars have airbags and seatbelts in case of an accident.
- Hikers carry a first-aid kit, compass, water, snacks, and blankets in case they get lost or injured.
Another way to view the safety net principle is to have a “Plan B” if “Plan A” does not work out. In the world of financial planning, here are some common examples of safety nets:
Emergency cash reserves -If you lose your job and need to pay for basic expenses or unforeseen expenses such as a mechanical problem with your car, you may need to dip into your emergency fund. The importance of having access to cash during times of crisis cannot be overstated.
Retirement Plan - By building up retirement savings in a 401k or IRA, you will not need to depend (as much?) on assistance from the government or relatives when you reach retirement age.
Professional Liability Insurance - more commonly known as Errors and Omissions (“E and O”) insurance, used by lawyers, consultants, accountants, brokers, and other professionals. In the medical world, a doctor clearly would not want to operate without medical malpractice insurance.
Personal Liability Insurance - If something happens to another person on your home property (or as a result of an auto accident), they may pursue you as being liable for damages. A Personal Liability Umbrella policy can provide coverage above and beyond what your home or auto insurance coverage provides.
Life Insurance - is such a critical tool in financial planning (or “safety net” planning). When someone dies, whether he is a parent, spouse, or a business partner, if others depend on him for their livelihood, there needs to be an insurance policy on that breadwinner to replace his/her income in the unthinkable (but inevitable) event of their death.
Disability Insurance - Similar to life insurance, if a key breadwinner gets into an accident and is unable to go back to work, the “safety net principle” suggests that it would be a great idea to have a disability policy to replace a percentage of his or her income to help sustain the dependents’ lifestyles.
Short-term disability Insurance - In the case of short-term disability, it does not even need to be an “accident” as a qualifying event. It can be something as common as “Maternity leave.” Having a baby is considered a qualifying event to claim short-term disability payments.
Long-term care Insurance – If you need nursing home care, and have assets to protect, the “safety net principle” would suggest it is a good idea to have a long-term care policy in place to kick-in in the unthinkable event that you may need nursing home care, assisted living, or home healthcare if you are unable to handle 2 out of the 6 “activities of daily living.”
Spendthrift Trust - Let’s say you have amassed a nice fortune that you would love to pass on to your children. However, you are concerned about your child’s spending habits, in spite of your efforts to teach him or her how to save and build wealth. By meeting with an estate attorney and building a clause into the trust that limits the amount that can be withdrawn at a certain age, also known as a spendthrift clause, you can create a “safety net” to prevent your son or daughter from spending down their inheritance too fast.
Estate Taxes – This is becoming less relevant, but the law could change at any time. Under current law, people with a net worth greater than $10 million can plan their estates to minimize excessive estate taxes that will go to the government instead of their heirs or favorite charities.
Naming a Guardian for your children - If you do not name a guardian for your minor children in your will, the state will take on this responsibility. Also, you may need to name a “financial guardian” or trust if you leave an inheritance to minor children.
Financial Power of Attorney - In the event you are unable to sign your tax returns or other financial documents due to disability, you want to name a power of attorney BEFORE the disability occurs. This means if you don’t have one in place, get started on this today.
Medical Power of Attorney - If your health declines to the state that you can no longer communicate with others, the person named in your medical power of attorney will communicate for you. This communication can be to your doctors and other health care providers.
Investments - Since no one can predict the future, it makes sense to diversify your investments to spread the risk of something going wrong when one particular investment does not work out.
Mortgage - By locking in a 30-year mortgage, especially at today’s low interest rates, you can free up cash flow that can be used toward savings and investments, i.e. YOUR SAFETY NET.
This list is by no means comprehensive. Please feel free to comment on this article and add your own examples of safety nets. By thinking in terms of safety nets, you will be able to sleep better at night knowing that you have a Plan B in the event of a crisis.
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What Is a Hardship Withdrawal?
Description
A hardship withdrawal is a special type of distribution from an employer-sponsored retirement plan, which the IRS allows only for participants who can prove they are facing an “immediate and heavy financial need.”
A hardship withdrawal is a special type of distribution from an employer-sponsored retirement plan, which the IRS allows only for participants who can prove they are facing an “immediate and heavy financial need.” However, the IRS does not require retirement plans to allow hardship withdrawals. Instead, it leaves that decision up to each individual plan.
To determine whether your plan allows hardship withdrawals, ask your plan sponsor or plan administrator. You can also check in the plan document, which is the official communication that details all of your plan’s rules and regulations.
The money a participant receives from a hardship withdrawal can be taken from his or her accumulated elective contributions, but not from earnings on those contributions. Employer contributions may also be included in a hardship withdrawal, but only if the plan allows.
In order to qualify for a hardship withdrawal, a participant must prove that the money will be used to pay for at least one of the following expenses:
- Medical care for the participant, the participant’s spouse, dependents, and/or beneficiaries.
- The purchase of the participant’s principle residence (not including mortgage payments).
- Post-secondary education expenses for the participant, participant’s spouse, dependents, and/or beneficiaries.
- Payments to prevent eviction or foreclosure.
- Funeral costs.
In addition, the worker requesting the hardship withdrawal needs to have previously obtained all other possible distributions and non-taxable loans available through the retirement plan.
The amount of a hardship withdrawal may not exceed the amount of the participant’s stated financial need, and will be subject to ordinary income taxes and a 10% early withdrawal penalty. Participants who receive a hardship withdrawal are not allowed to repay the money back to the retirement plan and are generally not allowed to resume contributions to the plan for six months.
Required Attribution
Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
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© 2011 McGraw-Hill Financial Communications. All rights reserved.
October 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP®, a local member of FPA.
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Canaries in the Coal Mine
There is a disconnect between investment returns and investor returns. In fact, we often state that investor behavior is the number one determinant of lifetime investment outcomes. i.e. it’s not about picking the best stock, best fund, best fund manager, or finding the best times to buy and sell investments. What IS important is to continue to save and invest throughout your lifetime, and to stay invested for the simple reasons that a) no one can predict the future; and b) when markets rise, they rise too fast to “jump off the sidelines” to join the party.
In spite of this sage wisdom to diversify and stay the course, there are plenty of people who use their “lizard brain” when making investment decisions, and as a result tend to make terrible timing decisions with their investments. The Lizard-Brain is associated with “survival instincts.” It is different than the “Thinking Brain,” the side that makes rational decisions. If you are facing a life-threatening crisis, “fight or flight” can come in handy. But when it comes to investing, acting on fears can be disastrous to your financial health.
We have a name for individuals who have an uncanny knack for calling major turning points in the financial markets. We fondly call these people “Canaries in the Coal Mine.” In the 19th and early 20th Centuries, canaries were used in coal mines as “early-warning systems” for toxic gases or fumes. Canaries, being tiny birds, would choke or die earlier than a miner would if exposed to these gases. In other words, canaries acted as a warning of danger or trouble yet to come.
In our version of “Canaries in the Coal Mine,” these individuals either become “irrationally exuberant” during rising markets (warning us of a possible impending correction); or downright panicky during falling markets (alerting us to a possible reversal of a bearish trend). When these individuals become bold enough to take action, i.e. “buy at the tops” or “sell at the bottoms,” markets always seem to have a way of doing the exact opposite almost immediately after the individuals take action.
Obviously, if these individuals happen to be our clients, we listen intently and acknowledge their concerns. If necessary, we adjust their asset mix. However, we also continuously EDUCATE these individuals about the basics of investment principles: i.e. focus on the long-term, remain diversified across a variety of asset classes, and rebalance your portfolio when the risk/reward mix shifts away from your desired target. By understanding these basic, time-tested investment principles, and by sticking to a disciplined strategy, investors are much less likely to “jump off the cliff” during each financial crisis; and are more likely to act rationally and live their lives without being obsessed by the financial markets.
If you find yourself, in today’s volatile stock market environment, making bold predictions about dire consequences such as hyper-inflation, stock market crashes, or skyrocketing interest rates or gold prices, consider that you may be a “Canary in the Coal Mine.”
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