Denial, procrastination and daily distractions all conspire to prevent business owners from completing the personal planning that is an absolutely vital component of a successful business. Business owners also need to plan for a liquidity event. If an owner becomes incapacitated, a plan must be in place that will allow the business to continue functioning properly and profitably.

In the first of a series of articles discussing estate planning, business succession and exit strategies, Stefan C. Nicholas, a partner at the boutique estate planning law firm of McCullough & Nicholas, P.L.C., Alexandria, Virginia, demonstrates the necessity for planning with clear, concise, no-nonsense logic and reasoning. The subject may be somewhat painful, but the information presented in Stefan’s article is priceless. Read it with care.

Many, if not most successful business owners often overlook the most rudimentary retirement and estate planning. Busy growing and running their companies (focusing on the business instead of themselves), this common oversight can have disastrous consequences for the owner, the owner’s family and the business.

Indeed, it is essential that a business owner address such issues as retirement planning, estate planning and exit strategies many, many years before he or she actually intends to retire. This article introduces three essential elements:

  • ESTATE PLANNING: Basic planning structures that every business owner should have in place.
  • DEFERRED COMPENSATION: Innovative ways to defer compensation while growing your company.
  • EXIT STRATEGIES: Tax advantaged exit strategies to implement when the time to exit finally occurs.


Estate planning is not something to be done only in anticipation of death nor should it be done solely to avoid estate and gift taxes. The biggest benefit to a business owner of estate planning is business continuity in the event of the incapacity or death of the owner.

Should the business owner become incapacitated or die while actively managing the company or while negotiating a sale transaction, and the shares of the company are in his or her name, his or her business can literally grind to a halt as a court sorts out who will have the legal capacity to make critical decisions on the business owner’s behalf.

In some instances, the court may appoint a guardian to run the business under the court’s supervision. Often, as has been the case with attorneys in our office, that guardian will be an attorney who has no idea about how to run the business successfully. That attorney will report to a judge who will have just as little business sense.

In fact, a healthy 43-year-old client passed away while jogging on the George Washington Parkway trail. In the absence of the proper legal structuring that we had drafted but had yet to implement, a judge took over running the company. The company has yet to recover.

A number of very simple solutions can solve the problems that turn on the ownership structure of the business. If the business is a Subchapter ‘C’ corporation with a sole shareholder, it is critical that a key man life insurance policy is in place that will allow a spouse to hire a professional to run the business for the foreseeable future.

If the business is a ‘C’ corporation with multiple shareholders, a properly drafted revocable living trust would provide for the business owner’s designated trustee to step into the owner’s shoes and vote the shares accordingly. If the owner recovers, he or she would regain all powers.

If the business is a partnership, the other partners can run the business in the event of incapacity. To guard against the effects of long-term incapacity or death, partnerships should structure buy-sell agreements, funded by life insurance that will allow the other partners to buy the incapacitated or deceased partner’s interest from that partner’s family. Disability insurance is essential for all persons who wish to maintain their business derived cash flow even if they are unable to work.


During the 1990s boom market, an essential retirement planning feature–the defined benefit qualified plan–was overlooked in favor of defined contribution plans that sought to capture market appreciation. As we have all learned, such plans also capture market depreciation. Meanwhile, some defined benefit qualified plans have begun to look more attractive as they offer an alternative to market risk for business owners.

A qualified plan provides income tax deductions for the employer and tax-deferred contributions and earnings to the employee. Defined benefit plans provide retirement security–income at retirement–and have been subject to minimum funding rules. Traditionally, these plans have been difficult to implement and administer and have not allowed business owners to contribute as much as desired.

A plan that solves the above problems was created almost 20 years ago under Section 412(i) of the Internal Revenue Code but did not gain much attention until the recent market downturn. 412(i) plans are defined benefit qualified plans that are exempt from minimum funding requirements because they are fully insured. Consequently, both contributions and deductions are much larger than under traditional qualified plans. Further, such plans do not require the services of an enrolled actuary, making implementation and administration less difficult and less costly.

Ideal candidates for 412(i) plans are owners of established companies with six or fewer employees. Currently, our firm is advising two partners who each earn approximately $500,000 per year and who will be able to defer up to $300,000 each under the 412(i) plan that is being designed for them.

Should the business owner have too many employees to take advantage of a qualified plan, attention should be given to deferred compensation plans that allow an individual to put off taxation of income, invest such deferred amount and pay taxes at some future point. Generally, such plans are known as non-qualified deferred compensation as they do not fall under the ERISA rules like qualified plans (SEP IRAs, 401(k)s, etc.) and allow for discrimination in favor of highly compensated executives.


A retirement planning technique that doubles as an exit strategy is the employee stock ownership plan (“ESOP”). ESOPs are becoming increasingly popular in the current economic and political climate. For many business owners, the vast majority of their net worth is tied up in their company. For various reasons, they may not want to sell their company outright, but would rather sell only a portion of the company to simultaneously address two objectives: diversify their net worth while maintaining complete control of their company.

Or, they may wish to sell the company in its entirety but have no third party buyer. Basically, an ESOP works by having a bank or other lender loan funds to a company based on an appraisal of the company’s worth. The company then loans the same amount to a trust that benefits the employees. The trust then purchases the shares from the business owner.

Each year the company makes tax deductible contributions to the trust. Such contributions are returned to the company to pay down the amount of the original loan. The company repays the lender in turn. If the business owner retains at least 51% of the voting shares of the company stock after the ESOP transaction, he or she will be the trustee of the ESOP trust and will still have 100% voting control.

In addition, an ESOP transaction can be structured to enable the business owner to indefinitely defer paying capital gains taxes on the stock sale. The ESOP is a tax efficient wealth preservation tool that provides the business owner with liquidity while maintaining control of the company. If less than 100% of the stock is sold, another ESOP round could be done at some point in the future or the business could be sold in its entirety to a third party buyer.

Whether an owner is selling all or part of his or her business in an ESOP or to a third party buyer, tax and estate planning should be an integral part of any such liquidity event. After all, this may be the biggest event of the business owner’s life. Deferral structures allow business owners to invest 100% of the proceeds of the sale on a tax-deferred basis.

As mentioned, certain sales of stock to an ESOP can be tax-deferred if the proceeds are invested in qualified replacement property, namely the sale of “C” corporation stock. For the sale of all other highly appreciated assets, including stock, estate planning vehicles can be implemented to defer and amortize the tax due over the seller’s lifetime providing the ability to invest 100% of the proceeds and to remove the item from the seller’s estate.

Currently, McCullough & Nicholas is assisting in the $50 million sale of a defense contracting company that will result in the seller amortizing the $7.5 million in taxes due over the remainder of his lifetime. Meanwhile, he will have the use of those proceeds that would have been lost to taxes to invest and grow his individual wealth.

In this favorable interest rate environment, even modest appreciation on these investments will allow the seller to retire the tax due over his or her lifetime and to pass far more to his or her beneficiaries free of estate and gift tax.


Finally, because unscrupulous promoters unnecessarily stretch the limits of legitimate tax planning structures beyond the law’s intent, it is essential that business owners assemble a team of qualified professionals to achieve the best result. Every business owner should be careful not to get involved in schemes to avoid taxes but should instead seek structures that provide tax deferral as excellent results can be achieved within the safe harbors provided by legal and accounting rules.

In short, there are many simple steps that business owners can take to achieve these positive results:

  • Insure business continuity in the event of incapacity or death,
  • Maximize the amount being saved for retirement,
  • Provide their company with large tax deductions and
  • Sell all or a part of their companies on a tax-deferred basis.

While different solutions apply to different business owners, it is important that each business owner address the critical issues discussed here in order to maximize the value of their efforts in founding, growing and operating their businesses.

Stefan C. Nicholas, a partner at McCullough & Nicholas P.L.C., can be reached at [email protected]. McCullough & Nicholas, P.L.C. specializes in estate planning and in structuring tax-deferral and asset protection strategies for high net worth individuals. In particular, the firm focuses on helping clients manage the impact that liquidity events have on their personal assets by emphasizing pre-event planning. Previously, Stefan assisted private equity investment funds, multinational corporations, banks and start-up companies in the United States and abroad in merger and acquisition and financing transactions in a variety of sectors, including the acquisition of the Washington Redskins.

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