A CPA we work with got a call from a client last year. The conversation went something like this: “Hey, I wanted to let you know we sold the business last week. Things were happening really fast, and we didn’t have a chance to bring you in on the front end. Is there anything you need from us?”
The business was a software company worth over $20 million. The partners rolled up about half of their equity on a tax-deferred basis into the new firm but still had a tax liability of $1.2 million each this year.
The CPA brought this to our attention and asked if we had any ideas. The CPA funded the pension, but it had minimal impact since there was only six weeks of income to use in the pension calculation. We agreed to bring the case to our team and see if we could discover any options to reduce the tax.
With all new engagements, we begin with a survey that has nothing to do with the balance sheet and everything to do with the client’s core values and desired outcomes. As is often the case, the partners’ results were very different. Rather than try to work with them as an entity, we looked at their circumstances individually. As we worked on the plan design, the CPA vetted each step of the process and was brought into team discussions before we presented anything to either partner. When we did present, the CPA led the joint discussion.
For Partner No. 1, we used a unique structure in cooperation with one of our tax mitigation legal specialists that allowed the partner to take a deduction equal to half of his AGI and still retain control and use of his funds. To generate supplemental cash flow, we reached out to a different service provider and set up an income from a real estate venture collateralized by a long-term lease of a Fortune 500 company. The lease has 14 years remaining, but we will likely resell it in five to seven years to maximize value.
For the remaining assets, we placed them in a tactical allocation model with a management fee about 25% less than what a major wire house was charging and with significantly less volatility. In seven to nine years when the roll-up can be liquidated, we will use the same structure that is currently in place, but because we will have advance notice of the liquidation, there will be zero tax owed.
With Phase 1 for this client complete, he saved over $700,000 in federal taxes and paid $100,000 in professional fees, saving him just over $600,000. The CPA made $10,000 in project management fees. Phase 2 will include estate and legacy planning.
Partner No. 2 had most of his proceeds tied up in real estate, which made planning more difficult. We used an alternative investment to offset all of his earned income and cost segregation engineering studies on his real estate to offset about $500,000 of the gains from the sale. The alternative investment will also generate a roughly 12% dividend for the next five years at minimum.
The professional fees for this work totaled $22,000—a $10,000 project management fee to the CPA and $12,000 in fees split between us and our service providers. For an investment of $157,000 and $22,000 in professional fees, the client was able to reduce his tax liability by $376,000. Phase 2 will include designing a similar strategy to Partner No. 1’s, but it will wait until either he is ready to liquidate some real estate or the roll-up liquidation occurs.
Together, the clients were able to reduce their combined $2.4 million tax bill by just under $1 million and have a plan in place to avoid the tax consequences of the future sale of highly appreciated assets. The CPA made $20,000 for about eight hours' work, while we (the CPA and Array Partners) have been introduced to the parent company’s acquisition team and will be introduced to prospective sellers as the company continues its acquisition goals.