Media Center

McNees Insights- Estate Planning – Fall 2015

September 18, 2015

In this issue: Transferring The Family Business – Timing Is Everything  l  Have You Considered A Reverse Mortgage?

Transferring The Family Business – Timing Is Everything

By Vance E. Antonacci

One of the most important factors to consider in any business succession plan is the timing of the transition of ownership. Whether a sale or a gift (or combination of the two), no transition should occur before the next generation of leaders is identified and developed. However, a business owner should not unduly delay once the succession planning stars have aligned.

Interest Rates

Many planning techniques for business succession plans work best in a low interest rate environment. A full discussion of these techniques is beyond the scope of this article. In general, however, a lower interest rate environment is beneficial for succession planning because lower interest rates allow for better opportunities for the seller to finance the sale of equity or allow for smaller payments if a GRAT (grantor retained annuity trust) is utilized.

A transfer also may be preceded by a distribution to the ownership group that is financed through a borrowing. A “leveraged dividend” or “leveraged distribution” will allow the transferring owners to extract value from the business, and the balance sheet leverage will depress the value of the equity being transferred. Obviously, lower interest rates translate into a greater amount that can be borrowed.

Finally, a succession plan may involve the transferee borrowing funds from a third party (such as a bank) so that the transferor is paid in full at the closing of the transaction that implements the transfer of equity. In this case, lower interest rates clearly benefit both parties – the seller can expect a higher purchase price due to low rates and the purchaser can be more confident in borrowing funds if a lower interest rate applies to the repayment of the loan.

Income Tax Issues

Income tax rates have risen considerably in recent years. In addition to the increase in capital gains rates, most business sales will result in the application of the 3.8% Net Investment Income surtax, raising the effective federal tax rate to 23.8%. Pennsylvania’s 3.07% income tax rate will also apply, and there is a risk this tax rate will increase as well. It is unlikely we will see any significant retreat in tax rates given the level of government debt and amount of entitlement programs that need to be funded (don’t forget that increasing interest rates will increase the borrowing costs of the federal, state, and local governments, which in turn will lead to an increase in the consumption of tax revenues for debt service).

Another consideration is that business transfers often are seller financed. Normally, the seller elects the installment method of reporting his or her gain on the sale so that the taxable gain – and tax due – matches the receipt of installment financing payments by the seller. Pennsylvania does not allow installment reporting for sales of personal property such as stock, partnership interests, or LLC interests, so a sale before Pennsylvania’s income tax rates rise could be important in a larger transaction.

Finally, if there is an installment sale, the death of the note holder can present note holder challenges to the note holder’s estate. If your Will provides for the debt to be forgiven, then there will be “debt cancellation” income to the estate, which could create a tremendous income tax burden for the estate. So, getting started sooner rather
than later (and with lower interest rates) hedges
against this risk.

 Valuation Rules 

Generally speaking, the transfer of a family business involves the transfer of equity interests that qualify for a valuation discount for lack of marketability and lack of control. For example, the current owner of a corporation or LLC would transfer non-voting ownership interests (the lack of control discount), and transferability of those interests would be restricted by a “buy-sell” Agreement (the lack of marketability discount).

 Under section 2704 of the Internal Revenue Code, the Treasury Department is granted the authority to issue regulations that disregard certain “restrictions” in determining the value of a family owned business if the restriction does not really reduce the value of such interest to the person receiving the business interest. In general, any restriction that decreases the value of an equity interest is disregarded for transfers between family members if the transferor and transferee end up with control of the business as a result of the transfer. An important exception is that a restriction imposed by state law cannot be disregarded. For example, state law restrictions on the rights of limited partners must be respected.

A high ranking Treasury official indicated earlier this year that proposed regulations would be issued in the Fall that expand the reach of section 2704. Specifically, the category of restrictions that are ignored for valuation purposes will be expanded. While it is not clear what the

substance of the proposed regulations will be, there is little reason to believe that the proposed regulations will be taxpayer friendly. There is also a risk that the proposed regulations will be effective when released instead of when finalized after the comment period and that existing entities will not be grandfathered under the new regulations.

The loss of valuation discounts could be a significant blow to tax efficient succession planning. Although the threat of the proposed regulations should not be the sole reason to act, it may be the reason that pushes a succession plan to the finish line.


A succession plan takes years to put into place. There are many tax, financial, and, most importantly, family considerations that need to be addressed. Nevertheless, it is important to act upon a plan once the plan is in place. Forces outside of your control, such as interest rates and tax laws, could derail a plan before it is implemented.

Have You Considered A Reverse Mortgage?

By David M. Watts, Jr.

Are you at least 62 years of age and have 50% or more equity in your primary residence?  Then the reverse mortgage, also referred to as a home equity conversion mortgage, is something you might want to think about.  Reverse mortgages are not just those for those who need income supplementation in order to maintain their standard of living, but also can be used for many other useful purposes.  Money withdrawn from the equity in your home via a reverse mortgage is not subject to federal income tax, since you are basically borrowing from yourself, and when the loan is eventually repaid at a sale of your residence, any gain resulting from the sale is not taxed because of the special rules relating to the sale of personal residences.

 The proceeds from a reverse mortgage can be withdrawn in a lump sum, taken in periodic payments or drawn from a line of credit.  Payments from a reverse mortgage can be used to (1) defer taking social security, thus increasing your social security payments when you decide to take them; (2) postpone taxable withdrawals from your retirement plan until age 70 1/2,  thus allowing your retirement plan to continue growing for additional years without being reduced by periodic distributions; or (3) avoid having to sell your appreciated investments should you need income in excess of the dividends and interest generated by those investments.

A reverse mortgage is a nonrecourse loan which never has to be repaid except from the proceeds from the sale of your residence.  When the reverse mortgage is applied for, the amount that can be borrowed is determined and depends on your age; whether you decide to take the reverse mortgage as a lump sum, periodic payments or as a line of credit; and the amount of equity you have in your home.  Any loan encumbering the home when you apply for the reverse mortgage must be repaid, and that becomes part of the reverse mortgage loan.  While interest accrues through the term of the loan, the amount that has to be repaid can never exceed the proceeds from the sale of your home.  No mortgage payments are required during the term of the loan, although some types allow you to pay down the loan and reborrow later should you desire to do so.  The nonrecourse aspect of the loan is paid for through mortgage insurance, with rates varying from .5% to 2.5%, depending on the amount of equity you have in your home and the amount you choose to borrow. Other fees that must be paid when applying for a reverse mortgage include standard loan fees such as closing costs and possibly, depending on the vendor, title insurance and loan origination fees; these amounts can be borrowed as part of the loan.  All applicants for a reverse mortgage must be interviewed by a HUD-approved counselor, for which there is also a fee.  The interest rate on a reverse mortgage can be variable or fixed; the variable rate generally allows you to borrow a greater amount.

The reverse mortgage can be used by you to buy a new “right-sized” residence provided you can come up with at least 50% of the equity in the new residence from the sale of your old residence or from other sources (but not borrowed).  This can allow you to free up cash from the sale of your primary residence, or to buy a more upscale residence than your income would otherwise allow, as there would be no monthly mortgage payments.  Of course, you must keep the payment of property taxes, insurance, utilities and other expenses of maintaining the home up to date, and a failure to do so could require that the reverse mortgage be repaid in full.

 The reverse mortgage is repaid when the residence is sold at the later death of you and your spouse (if applicable) or within 12 months after you move from your residence, whichever occurs first.  Repayment is made only from the sale proceeds, and no further payment is due even if the outstanding loan balance exceeds the sale proceeds.  A reverse mortgage should not be used when you expect one or more of your heirs to inherit your house, since your heirs will inherit an encumbered property with a loan that must be repaid, and it may well be the case that there is little or no equity in residence at that time.

 There are companies that specialize in reverse mortgages, such as Reverse Mortgage Funding LLC, or you may want to contact your own bank to see what products it offers.

© 2015 McNees Wallace & Nurick LLC

McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.


Vance E. Antonacci

Related Practices

Estate Planning