The rise of startup culture has led to many entrepreneurs achieving high net worth status 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 concentrated in their companies’ equity interests.
While traditional estate planning is important, it won’t immediately interest this group. The timely need is expert guidance on how they can best mitigate often onerous state and federal income taxes on a liquidity event.
Providing the right guidance requires a unique approach that prioritizes income tax planning but doesn’t foreclose 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.
Identify Innovative Income Tax Strategies
Mitigating income taxes is key for young, high-net-worth entrepreneurs, although they may not always recognize the need. Tax strategies surrounding company stock are an area in which advisors can add particular value. Such stock often increases in value rapidly, presenting the ideal asset for tax planning.
One area of focus should be Internal Revenue Code Section 1202, 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 some notable exceptions like California, New Jersey and Pennsylvania.
Many entrepreneurs are either unaware of the QSBS exclusion 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 seek out a buyer for the business. Ideally, QSBS planning should happen well before a deal is signed and while valuations are low.
Create Non-Traditional Trust Structures
The new playbook reverses some concepts of traditional trust planning by seeking to include the entrepreneur as a beneficiary rather than solely focusing on the transfer of wealth to future generations. Founders are often young, don’t yet have families and face uncertainty regarding the size of their potential wealth creation event. As a result, they’re ambivalent about gifting stock to others. A strategy that includes the founder as a potential beneficiary goes a long way to addressing these issues.
Incorporate Charitable Giving Strategies
Charitable planning is a mainstay of any planning playbook. The next generation of entrepreneurs is known to be focused on social impact, so the discussion of charitable planning is all the more relevant.
Giving strategies should be based on a combination of factors, including the founder’s individual tax situation, the type of assets being gifted 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 in family trusts.
Don’t Neglect Fundamental 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 that they don’t neglect traditional estate planning. Depending on their age and experience, they may not have an estate plan. It’s important to walk them through the value of putting a complete estate plan in place, including a will, revocable trust, power of attorney and health care proxy so that their family is protected and future intentions are 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 that 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 the beneficiaries a tax-free distribution on the client’s death. This is a good way to address any liquidity concerns after death (for example, to pay estate taxes or maintain property).
*This article is an abbreviated summary of “Playbook for Advising Young High-Net-Worth Entrepreneurs,” which appears in the June issue of Trusts & Estates.
