The rise of startup culture has led to many entrepreneurs achieving high levels of wealth at a young age. The founders of these high-growth companies are often young, single, or just starting a family, with a significant portion of their wealth tied up in their companies’ equity investments.
Although traditional estate planning is important, this group is not immediately interested in it. They urgently need expert advice on how best to mitigate often burdensome state and federal income taxes in the event of a cash flow crisis.
Providing the right advice requires a unique approach that emphasizes income tax planning but does not exclude traditional inheritance tax planning. To make matters worse, the window of opportunity to implement specific tax strategies is usually narrow, as clients are primarily focused on running their business or planning an exit.
Here are four ways advisors can add strategic value to the financial world of high-growth entrepreneurs.
Identify innovative income tax strategies
Minimizing income taxes is critical for young, high-net-worth entrepreneurs, even if they don’t always recognize the need. Tax strategies around company stocks are one area where advisors can add particular value. Such stocks often rise in value quickly and represent the ideal asset for tax planning.
One area of focus should be Section 1202 of the Internal Revenue Code, known as the Qualified Small Business Stock (QSBS) Exclusion, which provides an exemption from federal income tax on the sale of stock in a “qualified” small business. Most states follow the federal rule and provide a tax exemption, with a few notable exceptions such as California, New Jersey and Pennsylvania.
Many business owners are either unaware of the QSBS exemption or have not thought carefully about what they should do to maximize the benefits. This neglect can result in a large tax bill when it comes time to prepare an IPO, negotiate financing, or seek a buyer for the business. Ideally, QSBS planning should occur well before a contract is signed and at a time when valuations are low.
Create non-traditional trust structures
The new concept reverses some concepts of traditional trust planning by attempting to include the entrepreneur as a beneficiary rather than focusing exclusively on transferring wealth to future generations. Founders are often young, do not yet have a family, and are uncertain about the size of their potential wealth creation. Because of this, they are ambivalent about gifting stock to others. A strategy that includes the founder as a potential beneficiary goes a long way toward addressing these issues.
Integrate charitable giving strategies
Nonprofit planning is a cornerstone of any planning playbook. The next generation of entrepreneurs are known to value social impact, so the discussion of nonprofit planning is all the more relevant.
Gifting strategies should be based on a combination of factors, including the donor’s individual tax situation, the type of assets being gifted, and the donor’s philanthropic goals. Some options include establishing a charitable remainder trust, establishing a private foundation, establishing a donor-advisory fund, and incorporating charitable features into family foundations.
Don’t neglect basic estate planning
While high net worth entrepreneurs need to focus on income tax planning first, as an advisor you can add significant value and give them peace of mind by ensuring they do not neglect traditional estate planning. Depending on their age and experience, they may not have estate planning in place. It is important to convey to them the value of complete estate planning, including a will, revocable trust, power of attorney and health care proxy, so their family is protected and their future plans are clear.
Estate planning for high-income entrepreneurs should include strategies to address potential estate tax liquidity problems created by a concentrated position in corporate stock.
One way to do this is through an irrevocable life insurance trust. This trust keeps life insurance proceeds out of your client’s taxable estate by placing the insurance in a trust. It then provides beneficiaries with a tax-free distribution upon the client’s death. This is a good way to address any post-death liquidity issues (for example, to pay estate taxes or preserve property).
*This article is an abridged summary of “Playbook for advising young wealthy entrepreneurs“, published in the June issue of Trusts and estates.
