Successor Planning

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Just completed your estate planning?  Let’s be sure.  You have a Will?  Super.  Powers of Attorney?  Terrific.  Living Will?  Excellent.  Now, have you checked the designations on your retirement plan?  Life insurance?  Health Savings Accounts?

While a Will remains a critical part of an estate plan, it doesn’t get the whole job done for most modern estates.  For dealership owners, executives, and managers, a retirement plan (an IRA, 401(k) or the like) likely represents significant value.  Disposition of these accounts is directed primarily, if not exclusively, through beneficiary designations and not through a Will.  Other employment-related benefits such as dealership group term life insurance and health care savings accounts also pass by their beneficiary designations.  Significantly for dealers, the proceeds of life insurance acquired as security for financing, or for key-man or buy-sell purposes, will pass only by beneficiary designations even where a stock purchase agreement or loan document directs use of the proceeds.  In short, whatever your Will says, it generally has no effect on assets with beneficiary designations.

Having no designated beneficiary, naming the wrong person or not having a contingent beneficiary designated are three common scenarios we see.  Each can have significant negative consequences.  For tax purposes, because most retirement plans are funded with after-tax dollars, naming the right beneficiary affords the opportunity to defer taxable income and minimize tax.  Failing to update beneficiaries after significant life events such as divorce or death of a spouse or child can result in plan benefits being paid to the wrong person or to a minor for whom a guardianship may need to be established through the courts.  While making these arrangements, it is best to check that beneficiaries named in other places (i.e. your dealer franchise agreement) are up-to-date and match the estate plan set forth in your Will.

More complex estate planning requires focused coordination between beneficiary designations and Will or Trust provisions.  This sort of planning can protect vulnerable beneficiaries (young children or beneficiaries with special needs or a history of substance abuse or mental health challenges).  Second marriages may necessitate special attention to planning with retirement plan assets and insurance to balance the beneficial interests of spouses and children.  But whether your estate requires complex or simple planning, your plan is not complete without consideration of those all-important beneficiary designations.

Always consult your professional advisors on the tax and distribution implication for naming beneficiaries.

New audit rules put into place by the Internal Revenue Service (the “IRS”) at the beginning of this year will have an impact on tax partnerships which may have significant ramifications for some dealers. Historically, many dealers put their dealership and real estate assets into entities that are taxed as “pass through” entities for tax purposes. The S corporation was the preferred form for the dealership entity, and limited partnerships were used for holding real estate. More recently, the limited liability company has come into its own as an entity for holding both real estate and dealership operations. For tax purposes, limited partnerships are taxed as partnerships, and most multiple-member limited liability companies are as well.

Under the prior partnership tax rules, if the Internal Revenue Service audited a tax partnership and found a deficiency, they would have to assess the deficiency against each partner individually for their share. Under the new rules, the IRS may assess and collect any tax obligation owed as a result of an audit at the partnership level, regardless of the relative ownership of the partners. In stark contrast to the previous tax regime, the IRS will no longer have to chase after all of the partners.

For entities that have a single owner, or whose ownership has remained unchanged between the tax year being audited and the date of the audit, this rule does not represent a significant change in any partner’s tax liability. Where an entity undergoes a change in ownership, however, the current owners will end up paying, through the partnership, the tax liability of the former partners. Even where a partner has not left the partnership, where there has been a change in the ownership percentages of the partners, some partners will effectively be paying for tax liabilities that should have been paid by other partners.

For tax partnerships that were formed before the change in the law, the language in their existing governing documents is unlikely to address the new rules. Most tax partnerships are eligible to opt out of this treatment, but the governing documents for the tax partnership need to be clear on how the determination to opt out is made. The election to opt out is an annual election that has to be made as part of filing the tax partnership’s tax return, and the governing documents for the entity will have to be amended to provide for this election to be made. Additionally, the new rules replace the previous concept of “Tax Matters Partner” with a new “Partnership Representative” who will represent the tax partnership in all aspects of an IRS audit.

The new rules give this Partnership Representative broad powers to act unilaterally on behalf of the tax partnership under the audit rules. This broad authority can be modified by the entity’s governing documents, for example, to provide that the Partnership Representative must obtain the consent of a certain percentage of the owners before agreeing to extend the statute of limitations, or agreeing to a settlement with IRS. The governing documents should also address the selection and removal of the Partnership Representative. If a Partnership Representative is not appointed by the tax partnership, the IRS has the authority to appoint someone of its choosing to act in that capacity.

The new audit rules introduced substantial complexity in an attempt to provide flexibility to tax partnerships in dealing with partnership level tax assessments. The Partnership Representative, who is charged in dealing with the IRS throughout the audit process, may need certain information from the owners in order to determine which alternative is best for the partnership and its owners in dealing with an assessment of additional tax. The Partnership Representative will also need the ability to require the owners to take certain actions, such as filing amended returns or paying their portion of the tax assessment directly to the IRS. Where a partner does not comply, the operative documents must also provide for an appropriate remedy for the other partners.

Because the Partnership Representative will have broad authority to act on behalf of the partnership, the question of indemnifying that person becomes important. Where the decisions made by the Partnership Representative affect each owner differently, there is the possibility for disgruntled owners to make a claim against the Partnership Representative. The concern of personal liability of the Partnership Representative should be evaluated on a case by case basis; however, like with Tax Matters Partners under the old rules, indemnification of the Partnership Representative is likely appropriate, so long as they carry out their duties in good faith and within the terms of the governing document.

Additional issues arise when there is a transfer of ownership in the partnership. Where an owner has exited a partnership or there has been change in percentage ownership, the agreement must address the issue of what happens if there is an audit of a pre-sale or pre-transfer tax year. Changes in tax liability for tax years before the transfer may assess additional liability to someone who is no longer an owner. That liability may fall on new owners who did not gain any benefit from those tax years, without some requirement that the prior owner pay his or her share for tax years during which they were partners. Any sale or transfer document of an interest in a tax partnership must now contain provisions addressing this possibility.

Dealers owning their dealership or real estate through an entity taxed as a partnership should review their partnership or limited liability company agreements to make certain that they adequately deal with these new rules.

Having recently advised clients in commercial transactions where one or more parties lacked legal capacity, we were reminded of the essential role of Durable General Powers of Attorney in an estate plan. Though none of us wants to think about ourselves or our older family members losing mental capacity, we have to accept that it does happen. When the family matriarch can no longer make sound business decisions she needs to rely on a substitute decision maker to manage her interests. Without advance planning to appoint an Agent under a power of attorney, the only solution may be to petition the local court to declare the matriarch incapacitated and appoint a person or a financial institution as guardian. That’s a time-consuming and potentially expensive process involving family doctors, lawyers and a court hearing. When the time comes to sell a business interest or real estate, the guardian will have to seek separate court approval, resulting in more delay and more expense.

A Durable General Power of Attorney (“DGPOA”) can in most cases, avoid that cost and delay. Under a DGPOA, a person (the “Principal”) appoints one or more other persons as “Agent” to exercise certain powers on behalf of the Principal relating to financial and business matters, all for the benefit of the Principal. Crucially, the DGPOA is effective after the Principal lacks legal capacity. If and when the Principal loses capacity or the willingness to conduct financial or business dealing, the Agent steps in to assist or make decisions for the Principal.

Every Dealer and every owner of corporate stock or other equity interests in a dealership entity should have a DGPOA. An Agent acting under a DGPOA has the discretionary authority to vote the stock to approve mergers and acquisitions, sell real estate and manage other dealership matters without court approval. By making an early decision about who should step in if necessary, the Principal executing a DGPOA saves valuable time and the very real costs of working through a guardianship later on.

In 2014, Pennsylvania enacted significant changes to the law governing Powers of Attorney which changes became effective January 1, 2015. We advise our auto dealer and other business clients on the inclusion of effective and flexible DGPOAs in their succession plans. We encourage clients to review existing documents and can assist in determining if revisions are needed.

Questions involving DGPOAs in particular or business succession planning in general may be directed to any member of McNees’ Auto Dealer Practice Group.