Buy Sell Agreements

When was the last time you reviewed your buy sell agreement?  If you are like most business owners, the most likely answer is NEVER.  Maybe you read it before you signed it when you started the business, and maybe you didn't.  Many buy sell agreements are formula based, that is, they call for the application of a multiple to a business performance measure.  Examples of simple formula based valuation methods are 1 times sales, 5 times net income, or something in between.

The problem with formula based valuations is that a result that may have made sense ten or twenty years ago may not make sense today.  For example, a formula based on a multiple of sales is probably not fair if the business consistently loses money.  Because no one knows if they are going to be a buyer or seller until the buy sell is triggered, it is important that the agreement be fair to both parties.  If the formula isn't fair, it is not uncommon for a costly and time consuming dispute to arise.

The thing to do it get out your buy sell agreement, read it, and ask your accountant to calculate the formula value specified by the agreement, as of December 31, 2010 or any other date.  You may be surprised by the result.  Look at it from the standpoint of both a buyer and a seller, because you don't know which one you will be.  If you were the seller, would you be happy with the price that you would receive?  If you were the buyer, how do you feel about the price to be paid?  What you will probably see is that formula based valuations never yield results that are fair to both parties.

There is a simple and effective solution to the problem of formula based valuations.  That solution is to change the buy sell to require that upon the occurrence of a triggering event, the business be valued by a qualified professional.  The agreement should define the triggering event, the standard of value, and the qualifications or credentials of the valuator.  To avoid disputes, many agreements actually name the individual or firm who will preform the valuation.  It is much easier to agree on such matters when the agreement is drafted then when it is triggered and emotions may be running high.

I learned a lot about buy sell agreements when I did a prepublication review of Chris Mercer's new book  Buy Sell Agreements for Closely Held and Family Business Owners.  If you are interested in purchasing this book, you can do so at  www.mercercapital.com.

Your thoughts and comments are welcome.

How Much Alternative Minimum Tax Do You Pay?

I've been reading and hearing a lot of talk about proposals to increase tax rates for the wealthy, that is, those with taxable income above $250,000.  I imagine there are some places in America where $250,000 of income qualifies you as wealthy, but the New York metropolitan area is definitely not one of those places.  In New Jersey we pay the highest state income tax, real estate tax, and sales tax in the country.  And the worst part is, that thanks to the alternative minimum tax, many of us do not even get any federal tax benefit from paying these taxes.  The alternative minumum tax ("AMT")is a separate computation, one that includes adjustments to your regular taxable income.  The adjustement that affects so many of our clients is the one that disallows the deduction for all state income taxes and real estate taxes.    If the tax computed using the AMT calculation is higher than the regular tax, the alternative minimum tax becomes your tax liability.

As I recall, the AMT was implemented as another way to tax "the rich", especially those who participated in tax shelters.  Although we haven't finished all of our 2010 tax returns, so far 138 of our clients have paid a total of $1,373,000 of alternative minimum tax.  These clients include a single working mother with $84,000 of adjusted gross income, and another individual with $59,000 of adjusted gross income. These examples are some of the many.  I don't think that anyone can argue that either one is "rich", or that the AMT was intended to apply to them.  After all, state income taxes and real estate taxes on a residence are far from qualifying as tax shelters.

However, there is a bright side to the AMT.  If regular income tax rates are increased, those of us who are subject to AMT will not pay any additional income taxes unless the alternative minimum tax rate is also increased, or the regular income tax rate increase causes your regular tax to exceed the AMT.  Many people pay so much AMT that a small increase in the regular tax rates will have no effect on their liability.

The alternative minimum tax is unfair to people who pay high state income and property taxes.  If Congress plans to make changes to our tax code that result in additional tax on individuals and families, I urge them to also change the AMT to eliminate state income taxes and property taxes as an add-back.  I believe that such a change will give AMT relief to most people who are currently subject to it.