Case Study: Restaurant Chain

Annual Revenue: $30 million
Net Income: $3.0 million
Number of Employees: 300
Owners: 6 Partners (all family members)
Founded: 1973
Corporate Structure: Multiple Entities

Their Story:

The owners of this restaurant chain were first introduced to Core Financial in 1997 by their estate attorney who determined they needed more advanced strategies to manage their increasing net worth. What had begun as a mom and pop-run restaurant had turned into a successful multiple location business. However, the owners did not realize all of the liabilities that their success had created. Also, at the time, the patriarch of the family was facing major health issues and there was no succession plan in place. The family faced a lot of uncertainty about the future of their business, which had taken so many years to build. We shepherded them through several strategic changes that not only ended up saving them millions of dollars, but also set up the business for a strong, sustainable future.

Challenge: Crippling $4 Million Estate Tax Liability

In 1997, the father of the family was facing major health issues and estate planning became an urgent matter. Though the family’s four adult children worked in the business, the parents wanted to maintain full control of the operations. The business itself was worth approximately $10 million. At that time, the unified credit for each parent was only $600,000 and, therefore, the family’s taxable estate was valued at $8.8 million. With estate tax rates at 55%, they would have been left owing the IRS approximately $4 million dollars! Since the majority of the family’s wealth was relatively illiquid, taxes of this magnitude would have forced the children to sell some or all of the restaurants in a fire sale.

Solution: Tax-Free Wealth Transfer

Our primary goal was to create a tax-free transfer of wealth to the children upon their parents’ future passing. We had to take several strategic steps in order to achieve that goal. First, we converted their S Corporation to a Limited Liability Company, which allowed us to create two segments of ownership: General and Limited Membership Units. General Members maintain operational control while Limited Members have no controlling interest. Next, we created a 10-year GRAT (Grantor Retained Annuity Trust), where we utilized the parents’ collective $1.2 million estate/gift tax exclusion to gift limited membership units to the children. The parents still maintained control of the business through their general membership units. We then developed an annual gifting plan, whereby each parent gifted $10,000 (Max IRS Limit in 1997) to each of the 4 children, thus disposing of $80,000 per annum over a 10-year period. These gifts were directed to an Irrevocable Life Insurance Trust (ILIT), which would create a tax-free transfer of wealth upon the passing of the parents. Today, the parents own only 1% of the business yet maintain complete control of the operations and the children are well-positioned to take full charge of the business at the appropriate time, without being forced to fire sale any of the company’s assets.

This strategy has had a significant secondary benefit as well. The IRS views a business with multiple ownership interests as worth less than a business where one individual owns 100% of the business; the business is considered to have “limited marketability” and is therefore appraised at a lower value. Now that ownership of the business is split among several family members, it is valued at 30% less than it would have been under one owner. Since 1997, the value of the business has grown from $10 million to $30 million, and as a result of the new structure we created, the majority of that growth has been sheltered from future estate taxes.

Challenge: Too Many Cooks in the Kitchen

As with many family businesses, none of the family members had a clearly-defined role or job description, thus creating problems with accountability and leadership.

Solution: Delicately Provided Objective Solutions

We stepped in and functioned as part-time CFO to help the family objectively determine the best course of action with regard to future roles and infrastructure. We interviewed all key employees and partners to obtain objective information, helping the family members understand their strengths and weaknesses and clarifying their positions and responsibilities within the business. In addition, we performed personal planning for all of the partners which enabled us to better understand the family dynamics and ensure that all of them are able to achieve their personal and professional goals. This included working with attorneys to establish living trusts, structuring other business ventures and performing personal tax and wealth management strategies.

Challenge: $1.2 Million Income Tax Liability

With $3 million dollars in net income, the owners had considerable income tax exposure.

Solution: Maximized Corporate Structure to Substantially Decrease Income Taxes

Our strategy was to create a tax-deductible pension plan that would lower their income tax liability. Since pension plans can be cost-prohibitive if contributions to employees are required, once again, our solution required several steps. It was our intent to identify a revenue stream that did not necessarily require the efforts of employees currently on the payroll. Through our discovery process, we realized that our client generated relatively significant revenue via their catering business, which coincidentally did not require contributions of current employees. All catering was handled by the partners of the organization. We also learned that the family purchased and developed the land for each restaurant. With this knowledge, we created a new C Corporation–a Catering and Property Management Company–in which the owners of the organization were the only employees. Our goal was to direct all catering revenue and a reasonable amount of net income from the other entities (via a property management fee) into this newly-established C Corporation. We then utilized this revenue to pay the owners the necessary wages to create a Defined Benefit Pension plan. This allowed the parents and the children to make tax-deductible contributions to the plan—the parents were each able to contribute $220,000 of tax-deductible dollars. In the end, the strategy reduced the family’s income tax liabilities and allowed the parents’ future distributions to be taxed at a lower rate.

Challenge: Protecting Family Business

Parents were concerned about protecting their hard-earned family wealth from their children’s current and future spouses.

Solution: Formed Tax-Efficient Structure to Protect Family Interests

We worked with their attorney to create an entity-owned buy/sell agreement which would obligate the children’s surviving spouses to sell back his/her shares to the organization through a split dollar life insurance policy. This would allow the business to remain in the family. While achieving the goal of protecting the family business, we were also able to save the family even more money because we funded the agreement through loans from the newly-established C Corporation using discounted dollars—the first $50,000 of income in a C Corp is only taxed at a rate of 15%–instead of monies taxed at regular income tax rates.

Looking Forward:

We have been working with these clients for over a decade and have seen their business go through both good and bad times. We have stood by their side, guiding them to make the best decisions for their business and family. We continue to work very closely with their CPA to explore new opportunities for savings when they arise. Today, the parents have peace of mind, the business is thriving, and the children are working together as a team to perpetuate their family legacy.