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Would you invest four hours to stop the IRS from taking one-half of your wealth? (03/10)

Monday, March 29th, 2010

Over the years I have asked the above question hundreds of times: when giving one of my many tax-saving seminars, or over the phone when a reader of this column calls me. The response from the audience or the caller is almost always the same: an enthusiastic ‘Yes’, followed by something like, “Irv, how do you do that?”

The answer is… with the System… to be exact, with the comprehensive System. Let’s start by getting an overview of the System. Originally, the System (40 years ago) was designed to reduce the estate tax. But over the years the System has evolved to focus on keeping all of a client’s wealth. Because the System does keep all of your wealth in your family, it automatically eliminates the impact of the estate tax.

For example, if you are worth $6 million, the entire $6 million to your family (all taxes paid in full); if $66 million (it can be more or less), the entire $66 million to your family. Stop for a minute and jot down what you are worth today… better yet, jot down the amount you think you might be worth when you get hit by the final bus. That’s the amount the IRS wants to get at. The System will guide you step-by-step to keep every dollar of your wealth in your family.

Great!

But a properly designed estate plan must do more. It must be comprehensive, which required us to develop a comprehensive System. Just what does comprehensive mean in this context?… Well, experience has taught us that the typical client wants not only an estate plan (really a death plan), but also a lifetime plan that accomplishes at a minimum the following:

1.          To control his wealth, particularly his business, for as long as he lives.

2.          To have strategies in place that help him save income, payroll, capital gains and gift taxes.

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3.          To find the best way to transfer his business to the business children (it can actually be done tax-free).

4.          To treat the nonbusiness children fairly.

5.          To make sure he and his wife can maintain their lifestyle for as long as they  live.

(NOTE: Generally, does not apply to the mega-wealthy – worth about $25 million or more.)

6.          To keep the stock of the family business in the family if one or more of the business children (who owns stock) gets divorced.

A comprehensive plan created using the System handles not only the six “wants” listed above, but almost any tax or economic want of the business owner for himself, his business or his family. The technical aspects of the System are changed or modified as required to deal with changes in the law, economic conditions and other factors over the course of the client’s lifetime, as necessary.

Now, let’s follow how the System was implemented by a real-life reader (Joe) of this column. The System is highly organized into eight specific steps, which are described as follows (using Joe as an example);

Step #1. Joe (married with three kids, two in his business) sent me, as I requested, an information package consisting of: (a) two financial statements – personal and the last year-end for his business; (b) a family tree (name and birthday for all of his potential heirs) and (c) a list of the documents comprising his current estate plan (will get the actual documents later).

Step #2. After my thorough review of the package, Joe and I had a short phone meeting to answer my questions and make sure I understood Joe’s goals – short-term and long-term – for him, his family and his business.

Step #3. I prepared A “Discussion Agenda” in outline form that detailed every strategy that might apply to Joe’s situation for the two plans to be created: (1) an estate plan (really a

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death plan) and (2) a lifetime plan (from today until Joe gets hit by the final bus). The two plans dovetail.

Step #4. We (Joe and I) spent almost one and half hours discussing the items on the agenda and agreed on the plans (death and lifetime) that now needed to be turned into documents. It should be noted that Joe decided not to have his wife Mary on the agenda call (about half of my clients have their spouse on the call). However, at my request, he agreed to get Mary’s consent that the plans we agreed on were okay with her. Joe honored my request and Mary actually called me twice with some good questions. (Joe proudly was on the line for the second call.)

Step #5. Time for my “network” to go to work. The network is my admission, that none of us know it all, certainly not me. So, after the agenda call, I wrote a detailed report for the network lawyer, so he could draft the necessary documents to implement the plans. (Note: Joe sent his current estate plan documents to the lawyer. We kept the documents that were compatible with the new plans and amended or rewrote the rest.)

Then, I informed my network insurance consultant to review Joe’s life insurance policies. (Note: In the end, my insurance consultant was able to increase Joe’s death benefits – from $2 million to $3.45 million – without any increase in annual premiums.)

The lawyer and insurance consultant called Joe to get acquainted, ask questions, answer Joe’s questions and get some additional information so they could do their professional work.

Step #6. The lawyer wrote a “concept” letter that explained every strategy to be used in the new plans. I reviewed the letter, made a few suggestions and the lawyer’s secretary emailed the letter to Joe. It is important to note that the letter had nothing new in it for Joe. The purpose of the letter is always the same: to put in one place all the details of the plans that Joe (me and the lawyer) had agreed to in one place in easy to understand language. Separate calls from me and the lawyer made sure that Joe (and his wife) was comfortable with the plans. When Joe said, “Yes,” the lawyer went to the next step.

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Step #7. The lawyer drafted the necessary documents that together made up the two plans: lifetime and estate. After Joe said the documents were “Perfect,” at our suggestions Joe had his local lawyer review the documents, and Joe signed them in his lawyer’s office. Of course, the local lawyer asked some questions before the signing, and he thanked us for completing a task he did not have the expertise to do.

Step #8. The insurance strategies Joe ultimately used were determined by me and the network lawyer. The  network insurance consultant prepared all the proposals (from six different insurance companies) and explained them to Joe. The amount of insurance (here $3.45 million) was determined by me and Joe. My arrangement with the network insurance consultant is clear: He cannot sell any insurance or suggest and amount. His function is to supply the best possible information, so the client (sometimes with my help) makes the decisions of how much insurance is needed and ultimately bought.

The result of using the System: Joe and his family will save about $3.7 million in estate taxes, and his family will get an extra $1.45 million in tax-free life insurance.

The number of months (from my first contact with Joe until the plans were finally done) was just over five months. How much time did Joe actually spend?… When I asked him he didn’t know exactly, but his best guess was a total of between three and four hours.

Even Joe, a rather conservative and very busy guy, said, “The best investment of my time I ever made.”

One final thought: Whether your estate plan is done or about to be done, check with your advisor to make sure your estate plan will deliver all your wealth to your family and that your lifetime plan works with your estate plan. Any questions, call Irving Blackman, CPA and Lawyer at 847-674-5295.

Posted in Corporate Tax, Headline, Tax Strategies | Comments Off

Are you affluent (wealthy/rich)?… Sad, but you are under attack… it’s time to fight back (02/10)

Monday, March 29th, 2010

Yes, the USA is the greatest country on the planet Earth. Why? … Simply put: our free society and, in a word, “CAPITALISM” (which is defined in Webster’s Dictionary as “The economic system in which the means of production and distribution are privately owned and operated for profit.”) and “CAPITALIST” has two separate definitions: (1) “an owner of wealth used in business” and (2) “wealthy.”

Wow! The above is a perfect description of the typical successful business owner/ reader of this column.

For you entrepreneurs who have worked your tail off (success in business, in my experience, is never plain luck) and have become affluent, you have been shoved into your own separate new minority group, usually referred to as “the rich.” Make no mistake about the rich in America. They are under a relentless attack… In the media… In public… And in private conversations.

Certain politicians love to attack us and propose to take bigger portions of our wealth by various obscene taxing schemes (higher income tax and capital gains rates/killer estate tax rules and rates/a surtax/remove limits on taxing earnings subject to social security taxes). “They can afford it,” is the smug explanation. As a voting group we are a small minority. Our campaign contributions are valued more than our votes.

Sad!

My research has failed to discover an authoritative source as to whom is considered rich. Based on my 50-plus years of consulting with them, here are my three categories: (1) Rich, net worth of $4 million to $10 million (but to varying degrees are still concerned about maintaining

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their lifestyle to the day they die. (2) Ultra rich, net worth of $10 million to $25 million (no longer concerned about maintaining lifestyle). (3) Mega rich, worth more than $25 million (more concerned with not losing any of their net worth and conservatively growing it). Of course, some in this group are worth $50 million, $100 million or more.

Almost all the rich have a fetish about:

  1. Overpaying their taxes (yet begrudgingly are honest taxpayers).
  2. The value of their time.
  3. The efficiency and competency of their employees (particularly top management) and outside professionals (i.e. their CPA and lawyers). Appropriate and timely follow up is a must.
  4. Avoiding hassles and welcoming convenience.

Most of those still in business are on a constant search for relief from stress, time pressure and responsibility. Yet, they rarely become a   member of the “paralysis-by-analysis” club. Try to rip ‘em off and you are toast.

The rich are an essential ingredient of the fabric that makes America great. Let’s take a look at some undisputed facts that prove the rich are a necessary cog in the wheel of a prosperous American economy.

  1. 1. Taxes. How much of the income tax burden is borne by the rich?… The most recent IRS data available shows the top 1% of taxpayers (earned $410,000 or higher in 2007) paid a whopping 40.4% of all Federal income taxes. Amazing, because those taxpayers only made 22.8% of all the reported adjusted gross income. So much for the myth that the rich don’t pay income tax.

Now hear this and share it with everyone you know: In 1993 Burt Hauser, an economist, published new data about the income tax system. As a result, Hauser’s Law was created: “No matter what the tax rates have been in postwar America, tax revenues have remained at about

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19.5% of [gross domestic product] GDP.” The simple truth is that an increase in GDP increases tax revenues, while an increase in tax rates (which sock only the rich) reduce tax revenues.

Want further proof?… Three times in our country’s history, across-the-board income tax rate reductions – during the administrations of John F. Kennedy, Ronald Reagan and George W. Bush – all resulted in increased income tax revenues in the years immediately following the rate reduction.

Hey, you guys in Washington – want more tax revenues?… Increase the GDP, not tax rates.

  1. 2. Jobs. Who creates 2/3 of all the jobs in the United States?… Closely held business… translates into the rich (business owners).
  2. 3. Charity. The rich are the backbone of philanthropy in our country. Their contributions (often in the millions of dollars) fund medical research, universities, hospitals, education and the endless number of other charities in the U.S.

Maybe we can pound these facts into the heads of our politicians: The rich, by any definition, are the only Americans with excess wealth beyond what is needed to meet their basic living expenses. They don’t put this excess wealth in their mattresses. They invest it in Wall Street (support larger companies), put it at risk in their own businesses (create more jobs), fund various charities and yes, are guilty of spending a portion on high-end goods and services (create jobs).

Note: It may surprise you, but most of the rich do not flaunt their wealth. You can’t tell they are rich by the clothes they wear, the cars they drive or the homes they live in.

Redistribute the wealth of the rich and you have socialism, which has created misery wherever it’s been tried. We have seen the wonders of capitalism for over 200 years. It works. The USA is the most powerful and wealthy nation in the world. Anyone in our country, sometimes not even a citizen, has an open door to earn his/her own wealth and become rich.

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Simple logic tells you that destroying the rich by taxing away a large portion of their wealth will not help the poor. In the long run, excessive taxing of the rich will backfire, reducing the tax revenues to Washington.

It’s time for us to fight back… How? Keep your net worth confidential (except for your professional advisors who need to know). Although your tax burden may become more onerous, use every legal trick and strategy to cut your tax bill. There are two taxes we know how to legally avoid: the capital gains tax and the estate tax.

Unfortunately, taxes and politics have been, are and probably will continue to be inexorably intertwined. So most essential: Use a portion of your wealth, time that you can find and all the influence you have to support the candidates for the House and Senate (and when the time comes, president) that understand the economics and will pass the kind of laws that return our country to a level of normalcy where the marketplace, not the government, determines the amount of your wealth.

Now, a seeming shift (which you will see is really not a shift) in subject matter. The tragic earthquake in Haiti has created a need for us to open our hearts and pocketbooks to help the Haitian people. As usual the Red Cross is on the scene helping in every way possible.

Here’s a little plan to help you save a ton of taxes while helping the people of Haiti. My book, Tax Secrets of the Wealthy sells for $367. It really shows you step-by-step how to totally eliminate the estate tax, whether you are worth $3 million or $33 million (or more). Simply write a check to the Red Cross, for any amount, and the book is yours.

Send your check (payable to the Red Cross) to me: Irv Blackman, 3960 Deer Crossing Court, Unit 102, Naples, Florida 34114.

I’ll do two things in return: (1) Send you a copy of Tax Secrets of the Wealthy (as my gift to you) and (2) pay the shipping (via UPS). How much should be the amount of your check?… $50… $100… $1,000 – you decide. Please affix your check to your letterhead with your

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business card (just your name, address and phone number if you are not in business). I’ll forward your check to the Red Cross and ask them to acknowledge receipt directly to you.

As always, if you have a question, call me (Irv) at 847-674-5295.

Posted in Corporate Tax, Tax Strategies | Comments Off

At last, a tax law (captive insurance) that actually cuts your cost of doing business, while you and your business enjoy tax-advantaged benefits (05/09)

Friday, March 5th, 2010

The Internal Revenue Code is not a friendly creature. It is designed to “taketh” your money; “giveth” is not in its vocabulary. Yet, there is a section of the Code [Section 831(b)], dealing with captive insurance companies (Captives) that when properly used, is primarily an income tax-saving machine for your business and can be structured to offer tax-advantaged benefits that create wealth for you (or even your heirs).

A real tax winner.

About 80% of the Fortune 500 take advantage of the Captive benefits. But much smaller businesses can join the tax-saving/wealth-building fun. If you own all or a part of a business, listen up, you’ll love what you are about to read.

Note: The Obama administration has made it clear: Income tax rates on high earners are going up. As you are about to learn, a Captive is an especially welcome friend in a rising-tax-rate environment.

It’s difficult to find a CPA or lawyer who has even heard of Captives. The few that know Captives exist (like yours truly for many years) don’t have a clue of how to take advantage of the many benefits offered by Captives for family owned businesses or small public companies.

Just what is a Captive?… First and foremost it is a bona fide insurance company, an insurer established to provide coverage for the company or people who founded it. An example is the easiest way to explain Captives.

First, a simple example: Joe owns Success Co, which has some “uninsured risks” (explained in greater detail later) that his current property and casualty insurance (PCI)

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company will not insure. Joe creates New Co. (a Captive), a corporation, which is an insurance company (covering Success Co.’s uninsured risks). The stock of New Co. is owned by Joe’s children.

Now for the fun part. Suppose the insurance premium for the uninsured risks are determined (professionally by a consulting actuary) to be $500,000 per year. Success Co. pays the $500,000 premium to New Co. The entire premium is immediately deductible by Success Co. like any other PCI. You’ll like this: Under the Captive rules, all of the $500,000 is income tax-free to New Co.

Say Success Co. is in a 40% tax bracket (state and federal combined). Success Co. is only out of pocket $300,000 ($500,000 less $200,000 in tax savings). New Co. has the entire $500,000 to invest. A good start. But remember, New Co. is a Captive and must hold the $500,000, plus earnings as a fund to pay potential claims for the risks it insurers.

Next, let’s explain “uninsured risks.” Every business has risks: some insured, some uninsured. The most common risks – like workmen’s compensation, vehicle, property and general liability – are transferred to a third-party (your traditional property and casualty insurance carriers) and are insured risks.

Now let’s list some typical “uninsured risks,” the kind that you can’t buy coverage for in the traditional insurance market (as you scan down the list below, check off those that apply to your business):

  • Litigation defense/asset protection
  • Loss of a key customer
  • Loss of a key supplier
  • Change in a law/regulation/ruling
  • Product warranty
  • Product liability
  • Professional liability
  • Strikes/labor problems
  • Traditional policy exclusions/deductibles
  • Employment practices

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The list could go on and on. You probably have one or more uninsured risks peculiar to your business. Go ahead, add ‘em on.

Let’s face it, your business is self-insured for all of the above risks, either by choice or because the risk just can’t be insured commercially. A Captive reduces the amount needed to fund such possible future losses. How?… The premiums paid to your Captive are immediately deductible.

There are many more ways that the use of a Captive can save your business significant insurance costs. Following are two (of dozens of possible) examples:

Example #1. You own a new (or very up-to-date) building in an area with “zone coverage.” Your building is in total compliance with stringent building codes. Many older buildings in the zone are not complaint. Your building can obtain lower rates from your Captive if you can show that your building is a better risk than the Zone’s rating.

Example #2. Success Co. pays premiums to the Captive to insure for litigation defense, strikes and product warranty. Remember with a commercial insurance company (CIC), if the insured has no losses, the CIC keeps the entire premium. No refunds.

Even though a Captive cannot reduce (actuarially determined) premiums, a financial windfall results (unused reserve) if the insured’s actual losses are less than actuarially predicted. For example, suppose Joe’s Captive (New Co.) has an unused reserve. A portion of the unused reserve can be (a) refunded to Success Co.; (b) reduce future premiums; or (c) paid to the Captive’s shareholders (Joe’s children) as a dividend. Three nice fringe benefits.

There are a number of other what I call “fringe benefits” to a Captive structure. Following are a few: (a) Someday liquidate your Captive and take out the unused reserve at capital gains rates; (b) have the Captive invest a portion of its reserve funds to pay premiums for life insurance on the Captive’s founder or his family members (in effect, deducting the life insurance

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premiums); (c) use the Captive as an estate planning strategy, passing the Captive (and any life insurance proceeds) to your heirs.

Make no mistake, your Captive must be formed and operated for a business purpose. The Captive must demonstrate that it is, in fact, acting as a proper insurance company. Follow the rules and the IRS is not a problem. Try to fool the IRS by forming your Captive to take advantage of only the tax-advantaged fringe benefits, without a real business purpose, is almost certain to cause the loss of the sought-after benefits.

No attempt is made in this article to explore all the rules, traps and opportunities in forming your own Captive. It is essential that you work only with qualified, experienced advisors that specialize in Captives. The right advisors can easily tailor your Captive to fit you, your business and your circumstances perfectly.

Now the key question: Is a Captive for you?… If costs were not an issue, the answer would be a resounding ‘YES’ for almost every business. Unfortunately, costs are a factor. For a Fortune 500 company, it’s a slam dunk: The insurance cost savings and tax-benefits are well worth the required costs to create and administer a Captive.

If you can answer ‘Yes’ to any of the following questions, you should strongly consider forming a Captive:

    1. Is your before-tax profit $1 million (or more) per year?
    2. Are your traditional insured property and casualty expenses $1 million (or more) per year?
    3. Is one (or more) of the “uninsured risks” listed above (or one you added) a significant factor in your business?… and worth a premium of about $200,000 a year (or more)?

Logic tells you that the larger your business, the more likely a Captive should be a top priority for your next year’s business plan (i.e. make $1 million – before-tax – or more, Captive is

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a must). Costs are easily covered by Captive benefits.

But what about smaller family businesses?… The answer can be ‘Yes’ with a new strategy the experts have perfected, if your before-tax profits are in the $250,000 per year range. Benefits are the same as for a larger company but costs are substantially reduced.

What, you are even smaller?… well, we need your help. Show this article to the decision maker(s) of your trade association. Have your trade association adopt a Captive program… then you and the other members can participate. The cost is minimal.

Finally, if you are lucky enough to be a Florida resident and your business is located in any other state there is a little known – legal – tax strategy that enhances your tax savings.

How can you learn if a Captive will work for your business? Please fax the following (on your company letterhead) to 847-674-5299: Your name, title, type of business, total number of employees and any other information you think would be helpful. Also include all phone numbers where you can be reached (business, home, cell). If a trade association, please fax on your letterhead and include number of members and name of decision maker. Please mark “Captive” at the top of your fax.

Posted in Corporate Tax, General Tax Talk | Comments Off

YES, YOU CAN BEAT THE ESTATE TAX… LEGALLY AND EASILY

Saturday, May 30th, 2009

If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant, and CPA), you can and will develop a plan to beat the IRS. Every time. And legally.
Unfortunately, the goal of the typical estate planner is to reduce estate taxes. Our goal is always the same: eliminate the robber-like estate tax.
There are three types of readers of this column that call me for help: The reader who (1) has an estate plan but needs a second opinion, (2) has no plan, or (3) has been working on a plan for years and just can’t seem to get it done. Which type are you?…. Write your answer here ____________.
You might be interested in knowing that no matter which type you are, you have lots of company. Here are the percentages: (1) need a second opinion – 55%; (2) no plan – 15%; (3) working on a plan, can’t get it done – 30%.
Following is a real-life, second-opinion plan that should help you no matter which category you happen to be in: A 61-year old from Ohio, who winters in Florida, (let’s call him Joe) falls into the first opinion category. Joe’s letter says in part: “I… enclosed all the information… you asked for. My current plan [it was two short wills and two long revocable trusts. One of each for Joe: the others for his wife Mary] looks good… but somehow I don’t feel comfortable… So request… a second opinion.”
Joe and Mary turned out to be a very interesting case, yet, sadly and as is often the case, contains some common estate plan errors. Sure, their documents – wills and trusts – were near perfect. Problem is they just didn’t work. Let’s see why. Joe and Mary are worth just over $8 million, plus Joe has a number of life insurance policies totaling $2.7 million on his life that name Mary as the beneficiary. The $8 million includes $1.9 million in Joe’s rollover IRA with Mary as beneficiary. The balance of the assets ($6.1 million) – Joe’s business, their Ohio and Florida residences, some rental real estate and other investments – are all held in joint tenancy by Joe and Mary.
The wills and trusts – 46 pages in total – were designed by a large law firm to pass Joe’s and Mary’s assets in a highly organized plan, first to the survivor of Joe and Mary and then to their children and grandchildren. Because Joe is 4 years older than Mary (and females outlive males by about 4 years), it was assumed that Joe would pass on first.
Okay, suppose Joe goes to heaven first in 2009. Everything, and we mean everything (because of the joint tenancy) would go directly to Mary. Joe’s trust would get nothing and be a worthless stack of papers. Mary would get her $2.7 million in insurance. For the same reason – named beneficiary – Mary gets the $1.9 million in the IRA. What about the other assets – worth $6.1 million? All to Mary immediately. Let me repeat: because property held in joint tenancy goes to the survivor.
It should be pointed out that if Mary had died the day after Joe, the tax bite would have exceeded $3.1 million (using current 2009 estate tax rates, top rate of 45%) on the $10.7 million now owned by Mary. Their kids would net only about $7.6 million.
What’s the lesson to be learned from this second opinion story: a will and a revocable trust – no matter how terrific – standing alone can never be a complete estate plan.
We used a number of strategies to change Joe’s and Mary’s estate plan: (1) a qualified personal residence trust for the residences, (2) an intentionally defective trust to transfer Joe’s business to the kids…Tax-free, (3) an irrevocable trust for the insurance, (4) retirement plan rescue for the IRA to pay for the additional life insurance needed, (5) a family limited partnership
to hold the balance (real estate and investments) of their assets, and (6) an organized future-gift-giving program to their children and grandchildren. With minor changes, the original wills and trust were left alone.
Important Note: I predict that Congress will (before December 31, 2009), amend the estate tax law to make the first $3.5 million of your taxable estate tax-free. So for a married couple, $7 million can escape the estate tax monster.
After the above strategies and completed plans are put in place, if Joe and Mary get hit by the same bus, the kids would net, after taxes, about $11.2 million (includes the additional life insurance in strategy (4) above). The longer Joe and Mary live, as the future-gifting program – over time – is implemented, the more tax-free dollars will be transferred to the kids.
If you would like a second opinion on your current estate plan, please send the following information:
1. For Your Business. Your last year-end financial statement (all pages).
2. Personal. A current personal financial statement for you and your spouse.
3. A family tree. Your name and birthday. Same for your spouse, children, children’s spouses and your grandchildren.
4. Documents. Hold them for now. We will request them at a later date.
5. All phone numbers where you can be reached: business, home, cell.
Send to Irv Blackman, SECOND OPINION, 4545 W. Touhy Avenue, Lincolnwood, IL 60712. What’s our job?… To create the right plan for you, your family, and your business… and to coordinate and work with your professionals. If you have a question call Irv at 847-674-5295.
Okay, that’s the plan. Let’s hear from you.

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Posted in Corporate Tax, Estate Tax, Featured | No Comments »

A SIMPLE WAY TO SOLVE YOUR BUSINESS SUCCESSION PROBLEM

Saturday, May 16th, 2009

Own a family business?…. Want to transfer it to your kids? Then you’ll love this article. It’s about an old IRS letter ruling that is one of my favorites. It might be labeled “the lazy man’s way to plan your business transfer.” The ruling shows you how to take advantage of some favorable tax law while avoiding pitfalls. Good stuff! There is a bit of a problem to using the technique: You see, you must drop dead before your family can enjoy the benefits of Letter Ruling 9116031.
But wait, the ruling has one redeeming quality. Really! First, the facts: Joe, his wife Mary and their children owned all the stock in a family business. Joe died in 1990 and Mary inherited all of his stock. (Note: Mary’s tax basis – for computing capital gains – is the fair market value (FMV) of the stock on the day Joe died. For example, if the FMV was $1 million and she sold it for $1 million, there would be no capital gains tax.) Mary immediately sold all of her stock back to the corporation.
Here’s the general rule: When you or any member of your family sells stock back to your corporation (called a redemption), the redemption is usually taxed as a dividend… a tax disaster.
But there is a special tax-saving exception for a family member who has owned the stock for 10 years or more: If he/she divests all interest in the company (including any position as an officer or director), the redemption is treated as a sale (gets favorable capital gains treatment, instead of being a dividend). Since Mary sold all (stock she owned before Joe died and stock she inherited from him) of her remaining interest in the corporation, the purchase by
the corporation of her shares was considered a bone fide sale (redemption) and not a dividend… a big tax victory.
When all the smoke cleared, not only had Mary escaped a big dividend income tax bill, but she has succeeded in effectively transferring the business to her children. How? Since the kids now owned all the remaining issued and outstanding stock, they owned 100 percent of the business. To sum up: Mary walked off with a near-tax-free capital gain, (the price paid to Mary for the stock was a bit more than the exact FMV of the stock inherited from Joe) while the kids walked off with the business. A fantastic tax result.
Here’s some more good stuff about succession planning. Over the years, we have used the above ruling dozens of times with real-life clients and have nicknamed the strategy “The little guy redemption technique.” Here’s why. We use it when the seller is (1) in a very low or zero income tax bracket; (2) the stock price is (by a sort of rule-of-thumb) $600,000 or lower and (3) the seller is not worth enough to have a potential estate tax problem.
For example, the last one we did was for $380,000 for Dad #1, who owned 5% of the stock. The corporation redeemed all the stock paying the full $380,000 with a note payable over 10 years with interest at 6% on the unpaid balance.
Simple! Effective. Really a nice little flow of spendable cash for Dad #1, whose total net worth was only $800,000.
Let’s change the facts, just a bit. Dad #2 (a real client from New York) is in the highest income tax bracket and estate tax bracket. Tax heaven would be to transfer his interest in the corporation (valued at $3 million) tax-free to his kids.
Dad #2’s succession plan must be centered around a strategy called an intentionally defective trust (IDT). An IDT is a tax-saving machine. It’s tax-free to DAD #2. Best of all the “buyer” of the stock (Dad’s kids) do not pay a single penny for the stock. Instead, the kids get
the stock – tax-free – as a beneficiary of the IDT.
The lesson to be learned. Never, but never sell your stock to your kids, unless you are a little guy (as spelled out above). If transferring the stock of your family business to one or more of your children will be a tax burden to (a) you or (b) the children or (c) (in most cases) both, it is a must to find out just how much the family will save in taxes using an IDT. The rule of thumb: The savings are over $600,000 for every $1 million of the stock’s price. In real life, Dad #2 and his kids saved $1,920,000 in taxes (on a stock price of $3 million).
Any questions concerning your own succession planning, browse my website: www.taxsecretsofthewealthy.com. Or in a hurry, call Irv (847-674-5295).

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THE BEST WAY TO TRANSFER YOUR SHARE OF A CLOSELY HELD CORPORATION WHEN YOU AND THE OTHER SHAREHOLDERS DON’T GET ALONG

Wednesday, May 13th, 2009

Many of the columns I write and the seminars I give deal with family business succession planning. Can you guess the most common succession situation and related problems?… Getting the business from Dad and/or Mom to one or more of their kids. Yes, that’s where the action is. And it’s easy – because there is only one decision maker, typically Dad – compared to the subject matter of this article, where there is more than one decision maker.
What’s the subject of this article?…. Business succession involving two or more brothers owning pieces of the same family business. Or it could include sisters. Nephews. Or other relatives. Or one (ore more) nonrelated business owners. All or any combination are included in the following.
It’s sad but true: Brothers disagree. Particularly in business. (We use brothers in the example because that is the most common situation. But if you, the reader, have a different relationship with your business co-owner (for example uncle, cousin or just a nasty person) then substitute it for “brother.” The transfer problems and the solutions are identical).
More often than not, brothers do well running the business together. Yet, try to talk to them about any kind of succession planning… total disagreement.
Most of the time price (of their interest in the business) is the stumbling block. The older brother (or the one who wants out for whatever reason) wants a “too high” price. Deadlock! Year after year. So, nothing happens.. That is until someone gets hit by the final bus. Then it’s too late. The lawyers and , all too often, the courts take over.

Result: Lengthy wrangling. Expensive costs, very expensive fees. Nobody wins.
Following is a solution that works about nine out of ten times. Except for the names everything you are about to read actually happened. Here’s the story: Three brothers – Ed, Ted and Fred – each owned one-third of Success Co. Their Dad left the business to the three boys when he died 31 years ago. Ed and Ted have worked in the business all their adult lives. Fred never worked even a day at Success Co.
Ed (from Wisconsin but winters in Florida) has a son and daughter who work in the business; Ted has one son in the business. Ed and Ted want their kids to continue the business The three young business kids thrive in the business and ultimately want to take over.
Success Co. is an S corporation. (If it had been a C corporation, we would have elected S status). We then recapitalized Success Co. (a tax-free tactic), issuing 300 shares of voting stock and 9,000 shares of nonvoting stock. Each of the three brothers now owned 100 shares of voting stock and 3,000 shares of nonvoting stock.
Ed sold his 3,000 shares of nonvoting stock to an intentionally defective trust (IDT). An IDT is defective in the sense that it is not recognized for income tax purposes (making the sale tax-free), but it is recognized for estate tax purposes. That’s it, a three-step succession plan: (1) be or become an S corporation, (2) recapitalization and (3) sale to IDT. As the beneficiaries of the IDT, Ed’s two kids wind up owning the nonvoting stock, while Ed keeps control via the voting stock.
Of course, Ted – simultaneously with Ed – used the same succession plan to transfer his nonvoting stock to his business son. About seven months later, Fred followed his brothers with an identical plan to get his nonvoting shares to his two kids (not in the business). Fred liked the tax-free sale and getting the value of the nonvoting shares out of his estate.

Note: An IDT saves the family about $700,000 in taxes for each $1 million of fair market value of the business stock being transferred. It’s one of the best tax strategies I have ever used for a client who wants to transfer his business to the kids, yet keep control.
An insurance-funded buy/sell agreement was entered into by the kids, which should avoid any future controversy and is designed to keep the stock in the family (should one of the kids get divorced).
The plan worked. Great! But why doesn’t it work all the time if it’s so wonderful? The noncooperating shareholder can (and sometimes does) hold up the plan in two ways: (1) refuses to sign an S election when the corporation is a C corporation (no signature, no S election), and (2) votes against the recapitalization (and you need the vote).
Even if the “bad-guy” brother tries to wreck the plan as described above, there are other ways – short of legal action – to get your personal succession job done without the signature or vote of all shareholders. We’ll explore these ways in a future article.
Do you have a brother-type succession problem at your business? If so, you are invited to join the reader test…. To solve your problems. We will write up the results of the test and report back to you in this column.
To participate, please send the following information by courier (send copies, do not send original documents) for each owner who is cooperating:
1. Personal. A financial statement for you and your spouse.
2. A family tree. Your name and birthday. Same for your spouse, kids and grandchildren (indicate which kids are in the business).
3. For the business. Your last year-end (a) financial statement and (b) a list of stockholders.
Send to Irv Blackman, Succession Test, 4545 W. Touhy Ave., #602, Lincolnwood, IL 60712. (If you have a question – concerning your own business succession problem – call Irv: 847-674-5295).

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WINNING THE TAX GAME – FOR A FAMILY BUSINESS – REQUIRES SOLVING TWO SETS OF PROBLEMS: MONEY AND HUMAN

Wednesday, May 6th, 2009

Recently, I read an article titled, “What Makes For Success?” by Kemmons Wilson, the founder of Holiday Inn. He said, “It is great to attain wealth, but money is really just one way – and hardly the best way – to keep score.”
Interesting quote, huh? Most readers of this column call me with tax problems because they have attained wealth (no doubt they have and do keep score in money), and they don’t want to share that wealth with the IRS…Perfectly normal. Yet, it’s amazing… Once the reader realizes that we really do know how to pass their wealth – all of it and intact – to their family, the conversation turns to other ways that they might keep score. Sure, they are delighted to find there are legal ways to totally win the estate tax game. But they readily admit that they don’t know how to deal with the other problems (other ways to keep score).
The other problems fall into the category of little kids, little problems; big kids, big problems. Stuff like which of my kids should run the business?… How do I treat the kids fairly?… What about the non-business kids?… What happens if one (or more) of my kids gets divorced?… How do I take care of my wife (the second one who is 15 years – or more –younger than the caller)? The callers tell me about family problems, business problems and/or assorted personal problems. To me every word is important, even though I’ve listened to so many tales of woe before (but although similar, each problem has its own peculiar twists and turns).
Let’s face it. Stuff happens. After years of solving wealth transfer, business succession (usually the business is at center stage) and estate planning problems, experience has taught me that solving only the money problems can never yield a perfect plan.
The human stuff – your spouse and kids support your plan – must be solved too.
What about your son-in-law or daughter-in-law?… A hate or love relationship? I know, it sounds like cornball. But if you really want to win the game of life after you have won the money game (really the easy part), you must attempt to solve the human part…the emotional stuff.
Here’s my suggestion to start the process. Make two lists: the money-problem list/the human-problem list. Solve the money-problem list first (usually you are home free if you solve these three money problems: (1) maintain your lifestyle – and your spouse’s – for as long as you live: (2) transfer your business to the business kids… tax-free; and (3) kill the estate tax.
Then, it’s easier to tackle the human-problem list. Interesting, many times solving the money problems solves some (often all) of the human problems. Finally, you must work with experienced professionals who know how to solve both problems: the money problems and the emotional human stuff that comes with accumulating wealth and trying to pass it on.
One more thing: each piece of your plan must be part of a single comprehensive and integrated plan, all implemented at the same time. Piecemeal planning, based on my 50-plus years of experience, is a disaster that not only enriches the IRS, but fails to satisfy the normal human desires of a typical family.
Call Irv Blackman 847-674-5295 if you want to talk about your stuff: The money problems… The human problems… Or both.

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WANT TO LEARN HOW TO TURN YOUR QUALIFIED PLANS FROM A DANGEROUS TAX TRAP INTO A GREAT TAX-ADVANTAGED VICTORY?

Wednesday, May 6th, 2009

There are many types of qualified plans: pension, profit-sharing, 401(k) and IRAs are the most popular. True enough, each is a great tax strategy if you ultimately need the plan funds for retirement and (1) you are in a low tax bracket when you take the funds out of the plan and (2) your estate is not large enough to kick up an estate tax problem. Perfect for over 90 percent of American taxpayers.
But what happens if you are in the highest income tax bracket when you retire and you have an estate tax problem (say the highest bracket of 45 percent)? Sorry, the IRS has you in a tax trap. No matter when the funds are taken out of the plan (during your life or after your death), the IRS gets 67 percent of the dollars in your qualified plans. Your family only gets 33 percent. The tax trap has been sprung. A tax travesty!
Is there any way out of the trap? Actually, my network of working-together professionals has developed several strategies. The one we use most often is called a “subtrust.”
Here’s a typical example of how a real client used a subtrust: Joe and his wife Mary are both 60 years old. They needed $2 million of second-to-die life insurance to solve their estate tax problem. The premium cost was $22,400 per year; a bit more than Joe wanted to spend. Joe’s 401(k) plan had $400,000 in it. Joe sadly understood that his $400,000 would only net his family $132,000 ($400,000 times 33 percent).
Here’s what we did. We set up a subtrust as part of the 401(k) plan (Plan). The subtrust will pay the annual premium after receiving the funds from the Plan. Since the policy is actually an asset of the Plan, the annual premium payment is a tax-free transaction.
When both Joe and Mary pass on, their family will receive the full $2 million in policy proceeds. No income tax. No gift tax. No estate tax. The subtrust tax strategy, in this case, actually turns $132,000 after-taxes into $2 million after-taxes (actually more because a portion of the original $400,000 401(k) plan funds, plus earnings, will still be in the plan).
If you have $300,000 (or more) in one or more qualified plans (for example, profit-sharing, 401(k) and IRA) and have an estate tax problem, you are in a tax trap. Want to learn more about how a subtrust and other strategies that can get you out of your qualified plan tax trap? Send me (Irv Blackman) a fax at (847-674-5299); include (1) name and birthday; (2) same for your spouse; (3) total amount in all of your qualified plans: and (4) all phone numbers where you can be reached. Mark “Eagle 09-23” at the top of your fax.

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The best way to handle a new business opportunity

Wednesday, May 6th, 2009

Every year, this must happen a million or more times. What? A successful family owned business is presented with or dreams up a new business opportunity with good (maybe even great) profit potential. Maybe a new product. Or a new service. An old customer wants you to make part X; you’ve been making part Y for years. A new store. A new geographic territory. The possibilities are endless.

What does the typical successful family business do with these opportunities? Want to guess? The sad answer: Add them to its present business.

What’s the obvious tax result? More income taxes, with profits of the new business opportunity being taxed at the highest rate. Worse yet, it balloons the family wealth for estate tax purposes. Not a smart tax strategy. You are enriching the IRS, instead of your family?

Whether your kids are babes in arms or experienced business adults active in the family business, this is what you should do with these types of opportunities: (1) Let your kids get all or the lion’s share of the income. (2) Keep all or most of the value of the new venture out of your estate.

There are two basic way s to get this job done right.

Situation 1: You want the kids to own and control everything.

Situation 2: You want the kids to own the venture (for tax purposes), while you control the management.

This is the classical way of handling the first situation. Loan the kids (or their new corporation, Kids, Inc.) the money needed to fund the new venture. Or you borrow the money from the bank and then loan it to Kids, Inc. Charge the going interest rate. The kids can deduct the interest. If you like, you can gift the principal of the loan to the kids at the rate of $12,000 per year ($24, 000 if you’re married) per child.

The second situation is solved in about the same way as the first, except Kids, Inc. issues voting stock (say 100 shares costs you $100 and you own all of it) and nonvoting stock (say 10,000 shares, which the kids own at $10,000). Make additional loans as required. You own less than one percent of the value (for tax purposes) of Kids, Inc., but you have absolute control. Cool!

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How a second opinion enriched Joe and his family at the expense of the IRS

Wednesday, May 6th, 2009

This is a war story. Joe, a 60-year old reader of this column, owned 100-percent of Success Co. He called me and wanted to know which of two estate plans he should choose.

Here are the significant facts: Joe’s wife Mary is 53 years old. His only child Sam, 31 years old, has worked in the business since he was 12. Sam owns one share of Success Co. stock; Joe owns all the rest of the stock: 199 shares.

The business is worth $4 million and has enjoyed about a 10 percent growth in profits in each of the past five years. This growth should continue into the future. Joe’s total net worth is $10 million including a residence, various investments (mostly the real estate leased to Success Co. and a portfolio of stocks and tax-free bonds) and $950,000 in a profit-sharing plan.

The two estate plans Joe asked me to review (“Give me a second opinion” in his words) follow. At the core of both plans was a $4 million life insurance policy on Joe’s life.

Plan 1: The life insurance policy would be owned by Sam. Joe would gift Sam the annual premiums. At Joe’s death Sam would buy Success Co.’s 199 shares from Joe’s estate for $4 million.

Plan 2: Success Co. would own the $4 million in life insurance and at Joe’s death would redeem the 199 shares from Joe’s estate.

In the end, the final results would be exactly the same: Sam would own 100 percent of Success Co. and the estate would have $4 million in cash instead of $4 million in stock. First, the good news: (1) Joe’s estate would owe no income tax on the sale of the stock. Why? Because the estate would get a raised basis equal to the fair market value of the 199 shares on the date of Joe’s death. (2) No estate tax because the $4 million of insurance proceeds will wind up in Mary’s trust and receive the benefits of the 100 percent tax-free marital deduction.

Sounds pretty good. Joe loved it.

Yes, it is a good plan. Certainly better than no plan at all. As a matter of fact, either of the plans outlined above — or some variations — is the most popular way of transferring a business to the next generation. Now the bad news: two problems always cause us to turn thumbs down on any such plan: (1) Joe’s team of professional advisors forgot that Mary did not need the income that would be produced by the $4 million of insurance proceeds. The other $6 million of assets owned by Joe is more than enough to take care of her lifestyle needs. (2) When Mary passes on, the IRS is guaranteed a big payday; 55-percent of the $4 million. That’s right, the IRS will get $2.2 million and the family only $1.8 million. Plus, a huge undeserved bonus to the IRS of 55-percent of the after-income tax balance on the income in (1) above, which is explained in the following paragraph. An outrage!

Continuing with (2) above, watch this tax disaster unfold. Mary is a healthy 53-year old with a normal life expectancy to age 83. Her grandparents, on both sides, all lived to age 92 or older. Good genes.

Mary’s mom and dad are in their late 70s, healthy and lead an active lifestyle. Let’s say Mary lives to age 85. That’s 32 years of earnings on the $4 million in her trust. Let’s use a conservative after-tax earnings of four-percent. Have you any idea of how much that $4 million will grow to in those 32 years? Would you believe $16 million? Really that’s the number. And what do you think the IRS’s bite would be? An amazing $8.8 million. Lousy planning! Yet, that’s the way most business owners, on the advice of their professionals, do it.

What should you do when your facts are the same or similar to Joe’s facts? Here’s the four-step plan we put in place for Joe:

Step 1: Success Co. elected S corporation status. We recapitalized the company so Joe wound up with 99.5 percent of the voting stock-100 shares-(So Joe could keep control of Success Co. for as long as he lived.) Then, Joe sold the non-voting stock-19,900 shares-to an intentionally defective trust (IDT).

The non-voting stock, under the tax law, is allowed to take various discounts. So, the value of the Success Co. stock Joe sold to the IDT, for tax purposes, was only $2.4 million (actually almost all profit, because Joe started Success Co. 31 years ago with $12,000, most of it borrowed.) The IDT trust is a wonderful creature under the tax law that allows Joe to collect the entire $2.4 million (plus interest) tax-free. Also, the IDT takes Success Co. out of Joe’s estate, avoiding another big tax loss to the IRS. Now here’s the tax wow! Once the $2.4 has been paid to Joe, Sam will own all of the non-voting stock, as beneficiary of the IDT (free of all taxes-income, gift and estate taxes).

Step 2: We initiated a strategy called retirement plan rescue (RPR), using the $950,000 in the profit-sharing plan, to acquire a $4 million second-to-die life insurance policy on Joe and Mary. We created an irrevocable life insurance trust (ILIT) to own this policy. Because of the RPR and the ILIT, none of the $4 million in insurance proceeds will be subject to income tax or estate tax. Every penny will be tax-free.

Step 3: Joe decided to invest a portion of the funds in the profit-sharing plan in senior settlements (SS) to help pay the life insurance premiums in Step 2. SS earn an average of 15.82-percent per year without market risk (created by a public company that sells on the NASDAQ).

Step 4: We created a family limited partnership (FLIP) to hold Joe’s investments and started an annual gift-giving program to give interests in the FLIP to Joe’s and Mary’s other two children (neither are in the business).

The four-step plan we substituted for the original proposed plans will increase the amount of wealth Joe and Mary will leave to their family by over $5.5 million (increasing every year Mary lives and growing to over $14 million if Mary lives to age 85, as explained above) more than the original plans.

Joe was right: He sure needed a second opinion.

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