R.C. Lim, Attorney and Counselor at Law

Contra Bail-Out

Going into last night’s meetings, it would seem that the Democrats and Republicans alike seemed to support the idea of a swift Treasury-led resolution. Here are two contradictory views on the matter, both of which squarely blame Treasury Secretary Paulson for the problem.

Soros Writes Against the Bail-Out (text):

http://www.ft.com/cms/s/0/9973c5b0-8a6d-11dd-a76a-0000779fd18c.html?nclick_check=1

Chris Whalen Speaks Against the Bail-Out (video):

http://www.cnbc.com/id/15840232?video=868490137

The World’s On Fire

Since everyone keeps asking me for my take on the latest economic news, I figured that I would share a couple of recent interviews that I’ve found that do a noble job of explaining the complicated mess in which we find ourselves.

PBS - Bill Moyer’s Interviews Gretchen Morgenson and Floyd Norris (video)

http://www.pbs.org/moyers/journal/09192008/watch.html

NPR - Terry Gross Interviews Michael Greenberger (audio)

http://www.npr.org/templates/story/story.php?storyId=94686428

Brookings - A Brief Guide To Fixing Finance (text)

http://www.brookings.edu/papers/2008/0922_fixing_finance_baily_litan.aspx

Much of what you see, hear, or read these days is plainly wrong. Importantly, important distinctions are lost because of the esoteric and often secretive world of finance is unknown even to many of those charged with reporting on it.  For instance, naked short selling is probably a big problem while run of the mill short selling is quite useful, even to a bad market.  Also, derivatives had considerably advanced our economy even if the unregulated spasm of can’t-miss and concentrated risk-taking at AIG and elsewhere has not.

The Catch-22 of Business Valuation and the Estate Tax

If you ask an investment banker what the best method to value your business would be, he or she will no doubt avoid giving you a straight answer, tell you that there are many roads into Rome, and then want to sell you the analysis from the fifty methods that she already knows of in addition to the fifty more that she thinks she can dream up.

Among the appraisal methods focused on a firm’s ongoing operations, many use a multiple on the firm’s revenues, earnings, or cash flow. Each of these calculations will lead to a different estimation of a company’s worth. Two times as many estimates (or six total) could be arrived at if one were just to separate historic revenues, earnings, and cash flow from estimated future revenues, earnings, and cash flow figures.

To focus on a firm’s past activities, the estimation might spotlight the assets and liability on the firm’s balance sheet. These estimates of current value might then be adjusted to add or subtract intangible or nonperforming property as required and again to create many separate and unique estimates of the value of your company.

In short, there are many, many theoretically justified methods to evaluate the worth of a firm.^*

But unless you are selling your business or you own a publicly traded company, it’s only an abstract question anyway.

In fact, the U.S. tax code provides a good deal of flexibility to accommodate the many different valuation methods. According to the IRC test, value is what a willing buyer would pay a willing seller, both having reasonable knowledge of the relevant facts, and neither being under a compulsion to buy or sell. [Reg. Sec. 20.2031-1(b)]

“What a clever definition,” you say!

Unfortunately, business owners must think about this question since as a practical matter they risk being on the butt end of things.

The estate tax risk that all family businesses share is that the appraisal of the business occurs for tax purposes when the company’s value is at its highest, but that the actual sale price of the business occurs at its lowest.

“How might this happen?” you ask.

On the death of the owner, a taxable event occurs. Even – or perhaps especially – in circumstances where children would like to continue in the operation of a business, the estate tax might scupper the plan. Unlike most debts incurred by your business, the estate tax is due all at once and any loan incurred to pay the tax obligation won’t generate any new economic value for the firm.

Worse still, the estimate of your business’ value is likely to be done while it is in complete health – with all of it’s key personnel – but actually sold at a distressed price since a time constrained sale is unlikely to realize full value. This is pretty much the equivalent of buying high and selling low.

Fortunately, there are quite a few ways around this problem, but they all require some advance planning.

^*Even if you are to accept the value investor’s credo that discounted cash flow is hands down the best method. There is still the truly pesky issue of one’s selection of a discount rate and its dependence on one’s guess as to the direction of future interest rates.

For assistance from an attorney with expertise in the area of estate planning and business valuation and succession, please contact our firm at (626) 689-4072.

Estate Planning and Islam

Given the awful anti-Muslim attitude that has developed in the United States, it is not a surprise that most of American mainstream media has failed to pick up on the truly explosive growth in sharia-compliant investment products. Currently estimated at $700 billion by Standard and Poors, according to a recent Economist article , sharia-compliant or halal funds could soon reach $4 trillion globally.

The Koran proscribes both speculation and the collection of interest. For fourteen centuries, these maxims were taken as encompassing articles of faith. Hence many of the sharia work-arounds that have developed are very recent creations. For instance, sukuks or Islamic bonds are no more than thirty years old. Sharia-compliant mortgages and sharia hedge funds are still pretty much works in progress.

The development of each of these new sharia investment products requires that estate planners that work with sharia-compliant investment products obtain the specialized knowledge of how these investment products work so that they can address the complicated tax issues created by the financial engineering done to satisfy the religious strictures.

As a simple example, a sharia mortgage is structured so that the lender acquires the property, leases it to the “owner,” and then transfers the property to the property upon completion of the payments. Essentially, it is a sale-leaseback-sale. The nasty problem here is that in most tax jurisdiction, two taxable “transfers” have occurred: one at inception, the other once all payments have been made.

Other issues will arise from the inherently multi-jurisdictional and international problems that are created since the best sharia-compliant money managers will be located in Dubai or elsewhere overseas. However, more important than searching the world for optimal returns will be reducing transaction costs before economies of scale and adequate competition create comparable returns. Until then, careful drafting will be needed to ensure that trustees can justify paying for the “piety premium” for sharia-investment products while also meeting their fiduciary responsibilities as trustees.

Most important to clients, estate planners need to have knowledge of Wasiyyat, or the Islamic law of bequests. Indeed, Islam requires wills conform to its practices and adds yet another layer to the estate planner’s tapestry of rules and laws to consider, mediate between, and fulfill.

For assistance from an attorney with expertise in the area of estate planning and Islam, please contact our firm at (626) 689-4072.

As Usual, All Eyes Are on the Presidential Race, But Watch the Congressional Races If You Are Want to Know Where the Estate Tax Will Be in Two Years

Whoever wins the 2008 Presidential race – McCain or Obama – it is likely that the next administration will be sure to undo much, if not all, of Bush’s tax reform handiwork, including the estate tax exclusion amount. In fact, most estate planners I know are predicting a lower exclusion amount than this year’s $2 million. Both candidates current estate tax proposals, however, would outwardly seem to suggest otherwise.

In an apparent gesture to rally the GOP base, McCain, once an outspoken opponent of the Bush tax cuts, has reversed course to propose making the tax cuts permanent. Similarly with the estate tax, McCain has proposed taxing estates of more than $5 million, or $10 million per couple, at a top rate of 15%.

But is this a workable plan? The obvious issue is the U.S. Treasury’s dependence on continued estate tax revenues. A potentially conflicting commitment is McCain’s promise to balance the budget by 2012. According to the Center on Budget and Policy Priorities, the U.S. Treasury will lose $1 trillion between 2012 and 2021 if the estate tax is permanently repealed. The rub here is that CPBB predicts that $840 billion (nearly all of that) will be lost under McCain’s plan so that from a revenues perspective McCain’s plan is virtually a repeal.

On the other side of the aisle, Obama proposes freezing the estate tax at the 2009 level with an exemption equivalent amount of $3.5 million per person, or $7 million per couple, and a tax rate topping out at 45%. The CBPP’s run of the numbers on Obama’s proposed policy calculates that only $400 billion of the $1 trillion would be lost.

Obama’s view here might shift to the left should he win the election given his often sharp populist rhetoric against estate tax repeal by characterizing it as a subsidy for the Paris Hiltons of the world. It’s probably also worth remembering that Sen. Obama along with Sen. Levin were the initiators of the pending Stop Tax Have Abuse Act.

First, an important similarity: neither candidate proposes eliminating the estate tax. Currently, the estate tax is set to expire altogether in 2010. After 2010, the Economic Growth and Tax Relief Reconciliation Act (EGTRR) and at a minimum Congress will need to act by 2010. However, it is my opinion that Congress will be sure to act before the end of 2009. Failing to amend the estate tax provisions of the EGTRR would create the perverse incentive toward dying early in order to leave a tax free estate in 2010. Hence, a second and probably much more important matter is how the Congressional elections shake out from this next election cycle. As a matter of tax policy, governmentally-incentivized death is grotesque and immoral. Hence the pressure to sign will give either candidate little room for a veto.

To be sure, even the most Draconian estate tax would produce scant revenues as a percentage of the U.S. total. So are estate planners engaged in some self-protective mass delusion? Perhaps. But the ease for Congressional representatives to add to government coffers with little cost in political capital will continue to make estate tax revenues a potential source of new money.