Wealth
Continued from page 41
2016 Issue 3 | GearedUp
How estate planning can help and
where the valuation discount fits in
Certain estate planning strategies,
some of which benefit from the use of
valuation discounts, are available to assist
Planet Fitness franchise owners avoid or
reduce federal – and often state – estate
taxes and, in some cases, maintain access to
the assets as well. In the example above, the
use of these strategies could save potentially
$9.8 million in federal estate taxes.
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Valuation discounting
The IRS values property based upon
its fair market value. If you own 100 percent
of your Planet Fitness franchise, then, if the
franchise is valued at $30 million, at your
death your estate would be taxed on the
full $30 million in value. However, if your
franchise is structured (now or through
planning) so that you own both voting and
non-voting shares, there is an opportunity
to take advantage of a“valuation discount.”
Here’s how it works:
Assume your 100 percent ownership
interest is structured so that you own
100 percent of the voting control (e.g., all
Class A voting interests), and you own
100 percent of newly created non-voting
interests (e.g., all Class B non-voting
interests). The non-voting shares are not
worth the same amount as the voting
shares because they have no control over
the company. These shares have value, but
it is a reduced (or discounted) value. You
can transfer these shares, and their value,
out of your taxable estate, retaining full
operational control over your franchise.
Valuation firms will evaluate the fair
market value of your franchise and then
apply a discount for lack of control and
a discount for lack of marketability and
determine an appropriate discount to apply
to your non-voting shares. Frequently, your
non-voting shares will be discounted in the
neighborhood of 25 to 30 percent. That is
akin to a sale of 25 to 30 percent.
Transferring discounted non-voting
shares can significantly reduce your
estate taxes
The most common technique to
reduce, or in some cases to eliminate, your
federal estate tax is to transfer some of the
Planet Fitness assets – usually non-voting
interests as described above – into one (or
more) irrevocable trusts that benefit family
members. The assets transferred, and
future appreciation of those assets, will not
be included in your taxable estate.
Best of all, you (the franchise owner)
can leverage this transfer significantly
by gifting a portion to an irrevocable
trust (using a portion of your federal
gift tax exemption) and then selling a
larger portion to the trust, in exchange
for a promissory note. This is where the
potential loss of valuation discounts
impacts the transaction.
An example of how it works: John
Smith owns Geared Up, LLC as either a
single member or multi-member LLC. If
the company only issued voting interests when formed, it is a straightforward
process to recapitalize the LLC operating
agreement to provide for non-voting
interests as well. It is these non-voting
interests that will be central to the estate
planning strategies we have used successfully with numerous Planet Fitness clients
already this year.
Assume John’s Planet Fitness company
is worth $30 million. He will retain all of
his voting interests and will remain in full
control of the company. But if his interests
are structured properly, we can assist him
in transferring his non-voting interests into
one or more irrevocable trusts, removing
the value – and the appreciation – from his
taxable estate.
If John is conservative, he may
decide to transfer only a portion of his
non-voting interests. Let’s say he starts by
agreeing to transfer non-voting interests
with a fair market value of $13.3 million.
A modest 25 percent valuation discount
would mean that the discounted value of
that interest is $10 million (often valuation
discounts can be as high as 40 percent,
depending on the circumstances).
We would then advise John to:
• Gift $1 million to the new irrevocable trust (in either cash, marketable
securities, or by transferring some of the
non-voting interests), and
• Sell $9 million to $10 million of
his discounted non-voting Planet Fitness
interests to the trust.
John will have transferred $13.3
million of assets into the trust, removing
these assets from his taxable estate, using
at most $1 million of his federal gift and
estate tax exemption. He can also allocate
a GST tax exemption to the gift, which
means the amount gifted will pass to
future generations without any GST tax,
currently also at 40 percent.
That’s not all. The future appreciation
of all the assets in the trust will be removed
from his taxable estate, saving him a
minimum of 40 percent on the appreciation. We call this an“estate freeze,”because
the amount of federal estate tax is frozen
at today’s values, with no federal estate tax
imposed on the appreciation.
Meanwhile, John receives income
from the trust because the trustee of the
trust will sign a promissory note to finance
the sale of the $9 million to $10 million in
non-voting interests.
• The promissory note can be an
interest-only note, at the current applicable federal rate (AFR), compounding
annually, for a specified period of time (up
to 30 years).
• Each year, John will receive income
from the trust – at the October long-term
AFR compounding annually rate of 1.95
percent, over a 20-year term, the yearly
principal and interest payment to John
would be approximately $608,620.
At the end of a 20-year period,
assuming an annual 5 percent growth in
assets in the trust:
• Value of the shares in the trust:
$25,746,161.
• Estate tax savings in year 20: $5.898
million (assuming 40 percent estate tax,
after deducting the amount of federal estate
and gift exemption that passes free of tax).
Types of trusts that may be utilized
For married owners, it is often
beneficial to transfer the assets into a
Spousal Limited Access Trust, or SLAT.
The beneficiaries of the SLAT will be the
spouse of the owner and any children. So
the assets are removed from the owner’s
taxable estate, but are still available to be
used for the benefit of the owner’s spouse
and children. We refer to the spouse’s
interest as a“safety net.”
For non-married owners, certain
Intentionally Defective Irrevocable Trusts
(IDITs) can be utilized in a similar fashion,
benefiting family members, friends or
charities.