End of the Year Financing Options to Consider

By | October 8, 2012

It is approximately four weeks before the Presidential election. There is a very good chance that an insurance agency principal will wake up on Wednesday, November 7, and suddenly realize that it is time to sell or perpetuate the agency this year, before tax changes take place. Bush-era tax rates are set to expire at the end of this year, and reality has hit harder than your morning Starbucks.

You may have procrastinated or been busy attending to your client’s risk management needs, but your lack of planning has left you in a risky bind. Countless articles and newsletters from accounting firms warning of tax changes are still on the far corner of your desk. And, time is running out.

Realistically, unless you have been planning a sale or perpetuation of your agency for some time, the likelihood of successfully completing either in the short time remaining in this year is slim. As a refresher, following is what you can expect to become law in the new year.

The sunset of Bush-era tax provisions in 2013 will impact your business and should be planned for now. The 10 percent income tax bracket will disappear, and all remaining tax brackets will increase, notably the top ordinary income tax rates, which will go from 35 percent to 39.6 percent. The timing of the receipt of income definitely will matter.

Simplistically, it would be wise to realize greater income in the current year while deferring losses into ensuing years. In 2013, taxpayers in the lowest brackets will not be able to avoid paying long-term capital gains taxes, and those in higher brackets will see the long-term capital gains rate increase from 15 percent to 20 percent.

In addition, as a result of health care reform legislation, higher income taxpayers also will see an additional Medicare tax hit of 3.8 percent. Business owners and investors will need to realize the right time to sell a business or an appreciated asset will slip by.

Qualified dividends, currently taxed at existing long term capital gains rates, will be taxed as ordinary income in 2013. This means that business owners and investors who have the ability to take a qualified dividend in the current year will greatly benefit.

At the end of 2010, tax relief provisions were extended. You might ask whether congress could vote to extend them once again. If President Obama is reelected, that may be interpreted as a voter mandate to allow the tax provisions to expire, because income tax ideology, particularly related to higher earners, has been a heated and polarizing campaign issue.

While President Obama has stated some support for extending the current rates, it may only be for the lowest brackets, as there is a push to more heavily tax the “millionaires and billionaires,” also known as agency principals, in the top brackets.

So, with less than two months left in this year, what can you do? Consider a bold move to take some money off the table.

Obtain financing and determine a proper amount to withdraw from your business, perhaps 30 percent of the value of the agency, in exchange for a portion of the shares in the business owned by you. This withdrawal can take the form of a qualified dividend and can obtain the most favorable capital gains treatment. In this manner, you will have sold a portion of your business, in essence to yourself; locked in a gain; added to your liquidity; and started a process that you otherwise had been hesitant to undertake.

To get started, speak to your banker and discuss the possibility of borrowing a large sum and removing it from the business, while making your agency’s balance sheet leveraged by the new loan and a sizable position of redeemed, or treasury stock. If you get less than a warm response, seek out a bank or finance company that has expertise lending to insurance agencies. There is not enough time left to teach a bank how to lend to an agency and upon what the value of your business is based. You also will want to obtain an indication of the value of the agency. An experienced lender may be able to point you in the right direction to seek a value.

A senior term loan of five years or less should be sufficient to accomplish this goal and not constrain a well-run, low-debt agency from taking care of this and other strategic missions, such as seeking smaller acquisitions of books of business or producers. You then can consider what to do with the redeemed shares and newfound wealth.

You may consider broadening the ownership of the agency by empowering some of your best and most worthy performers to purchase (yes, purchase) stock in the agency. A good step may be to produce a new class of shares or remove voting rights from the shares in question. You also may consider lending some money back to your business, perhaps to fund the purchase of a competitor, and pay yourself a reasonable rate of interest. This is a way to leverage the funds and give you a decent return on the money invested. You also may consider funding a Roth IRA or other productive use of the money.

As with any transaction involving business planning or taxes, seek expert advice. This is a good first step, incremental, low-risk and reversible, if you suddenly don’t like having more debt. But go ahead — research this, and perhaps put such a transaction in place, because you really wanted to do something this year.

About Robert J. Pettinicchi

Pettinicchi is chief lending officer of InsurBanc, a division of Connecticut Community Bank, N.A., a community focused commercial bank with a specialty in providing banking products and services to independent insurance agencies. Email: rpettinicchi@insurbanc.com. Website: www.insurbanc.com. More from Robert J. Pettinicchi

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Insurance Journal West October 8, 2012
October 8, 2012
Insurance Journal West Magazine

Surplus Lines: State of the Market / NAPSLO Issue; Lloyd’s Syndicate Spotlight; Agency Financial Products Directory: Banks, Funding & Capital for Acquisition