The rise of startup culture has seen many entrepreneurs achieve high net worth at a young age. The founders of these high-growth companies are often young, single, or recently started a family, with a significant portion of their wealth concentrated in the equity interests of their companies.
While traditional estate planning is important, it will not be of immediate interest to this group. The need at the time is expert guidance on how they can best mitigate state and federal income taxes on a liquidity event.
Providing the right guidance requires a unique approach that prioritizes income tax planning, but does not exclude traditional estate tax planning. Adding to the complexity is a typically narrow window to implement specific tax strategies, given that clients are primarily focused on running their business or planning for an exit.
Here are four ways advisors can add strategic value to the financial lives of high-growth entrepreneurs.
Identifying innovative income tax strategies
Income tax relief is essential for young high-net-worth entrepreneurs, although they may not always realize the need. Tax strategies surrounding company shares are one area in which advisors can add particular value. Such stocks often increase in value rapidly, presenting 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 exemption (QSBS), which provides an exemption from federal income tax for the sale of stock in a “qualified” small business. Most states follow the federal rule and offer a tax exemption, with some notable exceptions like California, New Jersey, and Pennsylvania.
Many entrepreneurs are either unaware of the QSBS exemption or have not carefully considered what they should do to maximize the benefits. This neglect can result in a large tax bill when it comes time to prepare for an initial public offering, negotiate financing or look for a buyer for the business. Ideally, QSBS planning should occur well before an agreement is signed and while estimates are low.
Create non-traditional trust structures
The new playbook overturns some concepts of traditional trust planning by seeking to include the settlor as a beneficiary rather than focusing solely on transferring wealth to future generations. Founders are often young, do not yet have families, and face uncertainty about the size of their potential wealth creation event. As a result, they are ambivalent about donating shares to others. A strategy that includes the founder as a potential beneficiary goes a long way in addressing these issues.
Incorporate charitable giving strategies
Charity planning is a pillar of any planning book. The next generation of entrepreneurs is known to be focused on social impact, so discussing charitable planning is even more important.
Giving strategies should be based on a combination of factors, including the founder's individual tax situation, the type of assets being donated, and the founder's philanthropic objectives. Some options include creating a charitable remainder trust, establishing a private foundation, starting a donor-advised fund, and incorporating charitable features into family trusts.
Don't neglect basic estate planning
While HNW entrepreneurs' immediate need will be to focus on income tax planning, as their advisor, you can add significant value and peace of mind by ensuring they don't neglect traditional estate planning. Depending on their age and experience, they may not have an estate plan. It is important to convey to them the value of putting in place a complete estate plan, including a will, revocable trust, power of attorney and health care proxy, so that their family is protected and their future goals are fulfilled. clear.
Estate planning for high-earning entrepreneurs should include strategies to address potential estate tax liquidity issues created by a concentrated position in company stock.
One way to do this is through an irrevocable life insurance trust. This trust keeps the life insurance proceeds out of your client's taxable estate by transferring the insurance into a trust. It then provides beneficiaries with a tax-free distribution on the client's death. This is a good way to address any liquidity concerns after death (for example, paying estate taxes or preserving property).
*This article is an abridged summary of “The Playbook for Mentoring New High Net Worth Entrepreneurs”, which appears in the June issue of Trusts & Estates.