Archive for the ‘Corporate Tax’ Category

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How to turn your hidden assets into cash

Wednesday, May 6th, 2009

Does $120,000, $200,000 or more paid to you — in cash — sound interesting? Without any investment, risk or work? We call it the “Hidden Asset Strategy” (HAS).

What is your hidden asset? Simply, it’s your unused insurance capacity. For example, Joe (age 73) has total assets of $5 million (counting the assets of his wife Mary). Joe’s insurance capacity is normally 80-percent of his marital assets or $4 million. Joe can use HAS to sell his insurance capacity for about three-percent, netting him $120,000 (three-percent of $4 million). The $120,000 is taxed as ordinary income.

Who owns the policy on Joe’s life? Investors. They will pay all premiums and receive 100-percent of the death benefits.

Joe is typical of millions of seniors: He owns an asset that he didn’t even know he has and does not need or want life insurance. Or if Joe has $1 million in life insurance, he still has insurance capacity of $3 million, allowing him to use a HAS to receive about $90,000.

There is an endless number of HAS variations. If you are 65 years or older, have insurance capacity, and are insurable (or if not, your spouse is insurable) you can get into the fun of playing one of the many profitable HAS games.

Now back to Joe’s specific example: In order to qualify for Joe’s HAS variation, you must be between the ages of 72 and 86, have assets (including your spouse) of at least $2.5 million and be insurable.

A side (but important) note: Many senior readers of this column don’t need or want life insurance. Sometimes these readers want life insurance, but, in spite of their wealth, can’t afford life insurance because they don’t have the necessary spendable cash flow. Finally, HAS is a way to help these senior readers.

So if you’re a senior (65 years or older), you owe it to yourself and your family to check how a HAS would work for you. If you are still a lucky young whippersnapper (not yet 65), give this article to a senior (typically, your dad or grandfather).

The real question for each and every senior reader is, “How will a HAS work for me?” (Either Joe’s HAS example in this article or the many HAS variations that might be just right for you.)

I have arranged for senior readers (65 years or older and insurable) of this column to submit the information to create a HAS just for you. Here’s the information you should fax (847-674-5299) to me (Irv Blackman): Your name, address, phone numbers (business/home/cell), your birthday (same for your spouse); your net worth (including your spouse). Write “HAS” at the top of the page.

Or if you are 65 (or older) and have any tax question (about insurance or otherwise, call me at 847-674-5295.)

¤

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection.

Posted in Corporate Tax, Estate Tax, Investment Strategies | No Comments »

A time-tested method for making a tax-advantaged investment

Tuesday, April 28th, 2009

Do you have a large amount of retained earnings and excess cash in your corporation, but the double taxing power of the law has your cash locked in the corporation? Most business owners think they are stuck, but there’s an easy way out.

Here’s a true story of one way to get the job done and I think you’ll like it. Joe called me with this problem. He and his brother Jeff each owned 30 percent of Success Co., which they managed. Their mom (age 66) owed 20 percent in her own name, and a trust (created when their dad died) owned the other 20 percent. Mary’s professional advisors recommended that Mary obtain $2 million of life insurance using an irrevocable life insurance trust (ILIT) to pay the estate tax liability that would be due at her death (because of the value of the assets she owned directly in her own name and indirectly as a beneficiary of her deceased husband’s trust).

The advisors were right. Mary needed the insurance, but she did not have a ghost of a chance of coming up with the annual premium requirements of $32,000 per year for as long as she lived.

I asked Joe lots of questions, conferred with the advisors and requested a large pile of information — stuff like tax returns, financial statements, etc. After discovering that Success Co. had $2.5 million in excess cash, this is what I recommended.

Mary gifts $1.2 million of her Success Co. stock (the total value of Success Co. was appraised at over $8 million) to a charitable remainder trust (CRT). The CRT agrees to pay Mary $72,000 per year for as long as she lives. At Mary’s death, the balance (called the “remainder”) in the CRT will go to charity. Each year Mary must pay $25,000 in income tax (on the $72,000 of income from the CRT) and $32,000 in premiums (for the $2 million policy, which is owned by an irrevocable life insurance trust, ILIT for short), or a total of $57,000. This leaves Mary an extra $15,000 per year to buy presents for her grandchildren.

The ILIT will give Mary’s children $2 million (in insurance proceeds) when she dies. The entire $2 million will be tax free — no income tax, no estate tax.

But where does the CRT get the income to pay Mary? The CRT sells the gifted stock back to Success Co. for $1.2 million. Let’s summarize Mary’s tax picture: Mary avoids all capital gains tax on the sale of the Success Co. stock. The balance in the CRT (estimated at $1.1 million) at Mary’s death goes to Mary’s favorite charity and is free of income tax and estate tax. In addition, Mary gets an immediate income tax deduction of about $200,000 for her charitable contribution to the CRT. Simply put, even though Mary avoids both the capital gains tax and the estate tax, the IRS writes her a check. For what, you ask? For the present value of the remainder (of the $1.2 million) gifted to the CRT.

This $200,000 (immediate deduction) results in about $70,000 in cash income tax savings for Mary. Lots more expensive presents for the grandchildren. (Note: If Mary had sold the $1.2 million of Success Co. stock directly to the company, it would have been taxed as a dividend, resulting in a whooping tax of $180,000.)

A side note before concluding: There are many other ways to get cash (or other types of property out of your C corporation) in a tax-effective manner. If you have such a problem, as a service to readers of this column, contact me.

The use of a CRT in tandem with an ILIT is a time-tested method for making a tax-advantaged investment for your family. You actually create wealth (make a real economic profit) by gifting to charity.

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Posted in Corporate Tax, Family Tax Issues, Featured, Insurance | No Comments »

Want To Get Real estate Out Of Your Corporation — Tax Free?

Monday, April 20th, 2009

Do you have real estate in your corporation? If so, raise your hand and keep reading. About once a month, we get a call at the office asking a question something like this: “How can I get real estate out of my corporation without being taxed to death?”

Actually, we could write a small book about the various facts and circumstances that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

Typical facts and circumstances

Joe owns Success Co., a C corporation with a large amount of retained earnings and one or more pieces of real estate that has significantly appreciated in value. Most of the time the real estate has a building on it, but it could be vacant. (If Success Co. is an S corporation, it has a large amount of old C corporation earnings frozen in place, and the same real estate facts).

The solution

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

Do you have real estate in your corporation? If so, raise your hand and keep reading. About once a month, we get a call at the office asking a question something like this: “How can I get real estate out of my corporation without being taxed to death?”

Actually, we could write a small book about the various facts and circumstances that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

Typical facts and circumstances

Joe owns Success Co., a C corporation with a large amount of retained earnings and one or more pieces of real estate that has significantly appreciated in value. Most of the time the real estate has a building on it, but it could be vacant. (If Success Co. is an S corporation, it has a large amount of old C corporation earnings frozen in place, and the same real estate facts).

The solution

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

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

Experience Has Taught Us how To Attract, Keep Great People

Saturday, April 18th, 2009

Our typical consulting assignment is to put together a wealth transfer plan for a successful business owner.

Invariably, the client brings up two critical and related operational problems: “How do I keep my top executives?” (The headhunters — usually working for a competitor — are always circling.) And “How do I attract new quality people?”

No, the problem is not new. It’s been a problem in the past and, more than likely, will get worse in the future as the bidding war for talented people escalates. What to do?

Almost 20 years ago, after struggling with the problem for about a year, we decided to develop an organized plan to find the answers. We interviewed our few client/owners who did not have the two problems; we also interviewed their key management people.

Then came the hard part: getting permission to interview the key people at clients that were suffering with the problem.

What quickly became clear was that almost 100 percent of the best key people had the soul of an entrepreneur. But for various reasons they did not want to strike our on their own or couldn’t (usually because they could not raise the required capital).

The answer turned out to be simple: “Mimic ownership” — give ‘em the same challenges as an owner and, if successful, most of the rewards.

Additional interviews just kept reconfirming the original answers. The top (non-owner) executives wanted four core benefits of ownership: (1) A piece of the action (a share of company profits); (2) get paid when they are sick or become disabled; (3) receive adequate retirement pay when its time to leave the company; (4) and a death benefit for their family (“Like my piece of the equity if I get hit by a bus” is the way most executives put it.)

Over the years we have created hundreds of contracts (the technical name is a nonqualified deferred compensation agreement; the non-technical name is a golden handcuff agreement) that attract and keep the kind of people you want in your organization.

Let’s take a closer look at each of the four desired benefits:

A piece of the action — Typically, this is a percentage of the yearly profits in excess of specific dollar amounts. Often, the percentage grows as the businessand profits grow.

For example, Sam Eager will get 3 percent of all before-tax profits in excess of $200,000 and up to $300,000; 5 percent from $300,000, to $400,000; and 8 percent over $400,000. Suppose the amount for a particular year is $24,000. Usually, Sam will get about one-third ($8,000) in cash and the balance ($16,000) is deferred.

The deferred portion is invested for Sam’s benefit. When does Sam get the deferred portion and the accumulated earnings on this portion (usually called the side fund)? When he becomes disabled, dies or reaches retirement age (the age is usually set around 58 for younger key employees and in the 65-age range for older key people).

When the key employee becomes entitled to collect the side fund (say it is $500,000), it usually is paid out in equal annual installments (say 10 years) or $50,000 per year plus the additional investment earnings for that year.

Disability — The employee gets paid when sick or disabled — whether for a day or for a lifetime. This benefit is covered by long-term disability insurance. It is essential that “disability” is defined “word for word” in your agreement the same as the word is defined in the disability insurance contract.

Retirement — The side fund (described above) supplements any regular retirement program (like a 401(k) or profit-sharing plan). Typically, the executive is allowed to direct the investment of the side fund, which remains an asset of the employer.

Following are the tax consequences of the arrangement: The side fund earnings are taxable to the employer. When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income.

If the employee leaves for any reason-except because of disability, death or retirement-the entire side fund is forfeited by the employee and remains the property of the company. Hence, the name, “Golden handcuffs.”

A set amount of money at death — When an owner dies, the family can sell the business (assuming it is not transferred to the kids). A similar benefit (really a death benefit) should be given to the employee. Of course, this benefit should be insurance funded.

We have been doing these non-qualified plans for years. Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings: (1) This article does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always work with an experienced advisor. Years of experience has proved that the right agreement will make your good people even better. (2) But sadly, there is no agreement we have ever seen that will make a bad employee even a little bit better.

In a way, this getting-and-keeping good people is a frustrating subject. The reason is that we have never been able to develop a cookie cutter solution. Yes, the four core benefits are almost always the same or similar.

—

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection.

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Posted in Corporate Tax, Estate Tax, General Tax Strategies | No Comments »

A Time-Tested Method For Making A Tax-Advantaged Investment

Friday, April 17th, 2009

Do you have a large amount of retained earnings and excess cash in your corporation, but the double taxing power of the law has your cash locked in the corporation? Most business owners think they are stuck, but there’s an easy way out.

Here’s a true story of one way to get the job done and I think you’ll like it. Joe called me with this problem. He and his brother Jeff each owned 30 percent of Success Co., which they managed. Their mom (age 66) owed 20 percent in her own name, and a trust (created when their dad died) owned the other 20 percent. Mary’s professional advisors recommended that Mary obtain $2 million of life insurance using an irrevocable life insurance trust (ILIT) to pay the estate tax liability that would be due at her death (because of the value of the assets she owned directly in her own name and indirectly as a beneficiary of her deceased husband’s trust).

The advisors were right. Mary needed the insurance, but she did not have a ghost of a chance of coming up with the annual premium requirements of $32,000 per year for as long as she lived.

I asked Joe lots of questions, conferred with the advisors and requested a large pile of information — stuff like tax returns, financial statements, etc. After discovering that Success Co. had $2.5 million in excess cash, this is what I recommended.

Mary gifts $1.2 million of her Success Co. stock (the total value of Success Co. was appraised at over $8 million) to a charitable remainder trust (CRT). The CRT agrees to pay Mary $72,000 per year for as long as she lives. At Mary’s death, the balance (called the “remainder”) in the CRT will go to charity. Each year Mary must pay $25,000 in income tax (on the $72,000 of income from the CRT) and $32,000 in premiums (for the $2 million policy, which is owned by an irrevocable life insurance trust, ILIT for short), or a total of $57,000. This leaves Mary an extra $15,000 per year to buy presents for her grandchildren.

The ILIT will give Mary’s children $2 million (in insurance proceeds) when she dies. The entire $2 million will be tax free — no income tax, no estate tax.

But where does the CRT get the income to pay Mary? The CRT sells the gifted stock back to Success Co. for $1.2 million. Let’s summarize Mary’s tax picture: Mary avoids all capital gains tax on the sale of the Success Co. stock. The balance in the CRT (estimated at $1.1 million) at Mary’s death goes to Mary’s favorite charity and is free of income tax and estate tax. In addition, Mary gets an immediate income tax deduction of about $200,000 for her charitable contribution to the CRT. Simply put, even though Mary avoids both the capital gains tax and the estate tax, the IRS writes her a check. For what, you ask? For the present value of the remainder (of the $1.2 million) gifted to the CRT.

This $200,000 (immediate deduction) results in about $70,000 in cash income tax savings for Mary. Lots more expensive presents for the grandchildren. (Note: If Mary had sold the $1.2 million of Success Co. stock directly to the company, it would have been taxed as a dividend, resulting in a whooping tax of $180,000.)

A side note before concluding: There are many other ways to get cash (or other types of property out of your C corporation) in a tax-effective manner. If you have such a problem, as a service to readers of this column, contact me.

The use of a CRT in tandem with an ILIT is a time-tested method for making a tax-advantaged investment for your family. You actually create wealth (make a real economic profit) by gifting to charity.

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Posted in Corporate Tax, Insurance, Investment Strategies | No Comments »

Think Fast: What’s Your Business Worth?

Thursday, April 16th, 2009

Give the right answers and you can win big bucks on many TV game shows. Typically, the host only allows about 15 seconds for the contestant to give the right answer.

Okay, try this quick quiz: What is the most valuable asset you own? Hands down, almost every business owner answers, “My business.” Good! Next question … What’s your business worth? Silence! Yes, the final and most common answer is no answer — given 15 seconds or 15 months.

What happens in real life when those same business owners or their families must value the business? Stuff happens! Things like gifts of the family business stock to the kids; death (requiring valuation for estate tax purposes); or divorce (where valuation becomes an expensive legal battle).

Or, how about buying or selling a business? The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.Here are three business valuation myths that I hear from business owners and their families when I consult with them. First, the business is worth book value (usually this value is too low); second, the value is eight to 10 times after-tax earnings (usually this value is too high); and third, an S corporation is worth more than a C corporation (a corporation that pays income tax) because an S corporation doesn’t pay income tax. (This is just plain wrong. There’s no difference in value.)

Visualize this: There are two piles of stock in front of you. One pile is made up of publicly traded stock, like Microsoft, IBM and Exxon Mobil Corp. with a total value of $4 million. The second pile is the stock of Your Family Business, Inc. (YFB, Inc.), also worth $4 million by the “right” (even the IRS would agree) valuation method. Think for a minute. Which pile is worth more? Right, the first pile: the publicly traded stock. Just call your broker and you can have the full $4 million in your bank account, less the broker’s commission, in a few days. What about the value of the second pile-YFB, Inc. stock? Well, the fact is that for tax purposes the courts give you a discount for general lack of marketability of about 35 percent, or about $1.4 million.

So, for tax purposes the stock of your $4 million family business is only worth $2.6 million. Surprise! Even the IRS has come around to agree with such discounts. The discount will, in this example, save your estate about $700,000 in estate taxes.

What is the most common reason for valuing a family business? Hands down, when dad (or mom or both) want to transfer the business to the kid(s). Now during dad’s life.

Dad usually has three basic requests: (1) “Make sure my lifestyle (and my spouse’s) can be maintained for life”; (2) “Want to control my business (and my other assets for as long as I live”; and (3) “Transfer my business to my kids tax-free (no income tax, capital gains tax or other taxes).”

Yes, all three basic requests are easy to accomplish if you employ the proper tax-strategies: The core strategies are (1) a well-done valuation (acceptable by the IRS), which is easy to do; (2) a recapitalization (creates voting and nonvoting stock); (3) use an intentionally defective trust (avoids all taxes on transfer of nonvoting stock to kids).

But we need some readers to volunteer their family businesses so we can structure a plan(s) and then write about them in future columns. Real names will be withheld. Don’t worry about your exact facts Maybe you have only one kid in the business; maybe two or more; maybe some in the business, some not; or maybe no kids in the business and you want to get the business to one (or more) employee(s) (and, of course, they have no money).

Just two ground rules: (1) You really want to transfer your business to your kids, other family members or employees (no hypotheticals) and (2) your business has a real fair market value of $3 million or more (your best guess of what a real buyer would pay). Just call me (Irv Blackman) at 239-417-9732 and let’s chat about your exact situation.

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Posted in Corporate Tax, Estate Tax, Family Tax Issues, Planning, Tax Strategies | No Comments »

Turn Common Insurance Mistakes Into Tax-Free Wealth

Tuesday, April 14th, 2009

It’s frustrating. Year after year, our office is asked to give a second opinion on the completed estate plans of owners of family businesses. It is rare — very rare — to analyze the estate plan (particularly the life insurance policies) of a real-life client and find that all is as it should be. Typically, we find the wrong kind of insurance. Wrong ownership. Wrong beneficiaries. Wrong tax consequences. It goes on and on.

This is a big deal. We are talking big money.

Typically, the IRS gets 50 to 55 cents out of every life-insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000. Your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

Mistake No. 1 — A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies: The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax (AMT) that can steal up to 20 percent of the proceeds — and the net proceeds (after the AMT) can only get into the hands of your family by paying a second tax via a taxable dividend (ouch!).

If an S corporation, the proceeds (although not subject to the AMT) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend (a terrible and tax-expensive idea).

Mistake No. 2 — The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate (or your spouse’s estate). You just guaranteed the IRS a big — unnecessary — payday.

Mistake No. 3 — The policy (with cash surrender value) is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

So what should you do? Here are the typical recommendations we give to our clients so that, you and your family — instead of the IRS — win the insurance tax game.

For Mistake No. 1 — Transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value (a tax-free transaction). Next, transfer the policy to a Wealth Creation Trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For Mistake No. 2 — Transfer the policy to a Wealth Creation Trust.

For Mistake No. 3 — If you are insurable, dump the old policy and replace it with a new policy to be owned by a Wealth Creation Trust. First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy (insures you and your spouse) will give you significantly more bang for your insurance premium dollar. Second, determine how to reduce the premium cost:

(1) if your company has a 401(k) or other qualified plan look into a “Subtrust.” The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun.

(2) Whether you need single life (only you are insured) or second-to-die, check out “premium financing.” You don’t pay any premiums to get a large ($5 million or more) amount of insurance, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps, but simple to avoid when you know the tax ropes.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost-income and estate-while I’m alive? … When I die? … When my spouse dies?

The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

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Posted in Corporate Tax, Estate Tax, Insurance, Planning | No Comments »

The Best Way To Attract And Keep Great People

Tuesday, April 14th, 2009

Our typical consulting assignment is to put together a wealth transfer plan for a successful business owner. Invariably, the client brings up two critical and related operational problems: “How do I keep my top executives?” (The headhunters—usually working for a competitor—are always circling.) And “How do I attract new quality people?”

The problem is not new. It’s part of the past and, more than likely, will get worse in the future as the bidding war for talented people escalates. What to do?

Nearly 20 years ago, after struggling with the problem for about a year, we decided to develop an organized plan to find the answers. We interviewed our few client/owners who did not have the two problems; we also interviewed their key management people. Then came the hard part: getting permission to interview the key people at clients that were suffering with the problem.

What quickly became clear was that almost 100 percent of the best key people had the soul of an entrepreneur. But for various reasons they did not want to strike our on their own or couldn’t (usually because they could not raise the required capital).

The answer turned out to be simple: Mimic ownership. Give them the same challenges as an owner and, if successful, most of the rewards. Additional interviews just kept reconfirming the original answers.

The top (non-owner) executives wanted four core benefits of ownership: (1) A piece of the action (a share of company profits); (2) get paid when they are sick or become disabled; (3) receive adequate retirement pay when its time to leave the company; (4) and a death benefit for their family (“Like my piece of the equity if I get hit by a bus” is the way most executives put it).

Over the years we have created hundreds of contracts (the technical name is a nonqualified deferred compensation agreement; the non-technical name is a golden handcuff agreement) that attracts and keeps the kind of people you want in your organization.

Let’s take a closer look at each of the four desired benefits:

A piece of the action — Typically, this is a percentage of the yearly profits in excess of specific dollar amounts. Often, the percentage grows as the business and profits grow. For example, Sam Eager will get three percent of all before-tax profits in excess of $200,000 and up to $300,000; five percent from $300,000, to $400,000; and eight percent over $400,000. Suppose the amount for a particular year is $24,000. Usually, Sam will get about one-third ($8,000) in cash and the balance ($16,000) is deferred. The deferred portion is invested for Sam’s benefit. When does Sam get the deferred portion and the accumulated earnings on this portion (usually called the side fund)? When he becomes disabled, dies or reaches retirement age (the age is usually set around 58 for younger key employees and in the 65-age range for older key people). When the key employee becomes entitled to collect the side fund (say it is $500,000), it usually is paid out in equal annual installments (say 10 years) or $50,000 per year plus the additional investment earnings for that year.

Disability — The employee gets paid when sick or disabled — whether for a day or for a lifetime. This benefit is covered by long-term disability insurance. It’s essential that disability is defined word for word in your agreement the same as the word is defined in the disability insurance contract.

Retirement — The side fund (described in one above) supplements any regular retirement program (like a 401k or profit-sharing plan). Typically, the executive is allowed to direct the investment of the side-fund, which remains an asset of the employer. Following are the tax consequences of the arrangement: The side-fund earnings are taxable to the employer. When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income. If the employee leaves for any reason — except because of disability, death or retirement — the entire side fund is forfeited by the employee and remains the property of the company. Hence, the name, golden handcuffs.

A set amount of money at death — When an owner dies, the family can sell the business (assuming it is not transferred to the kids). A similar benefit (really a death benefit) should be given to the employee. Of course, this benefit should be insurance funded.

We have been doing these non-qualified plans for years. Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings: This article does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always, and we mean always work with an experienced advisor. Years of experience has proved that the right agreement will make your good people even better. But sadly, there is no agreement we have ever seen that will make a bad employee even a little bit better.

In a way this getting-and-keeping good people is a frustrating subject. The reason is that we have never been able to develop a cookie cutter solution. Yes, the four core benefits are almost always the same or similar. But the bells, whistles and unique requirements of each situation makes it impossible to write a complete report — much less a book — on the subject. But if you have a question call Irv Blackman at 239-417-9732. Let’s chat about your specific key employee situation and how to keep ’em.

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How You Can Enrich Your Family And Charity Too

Tuesday, April 14th, 2009

Patrick Henry once said, “I have but one lamp by which my feet are lighted, and that is the lamp of experience.” After years of working in the area of wealth transfer, business succession, estate planning and related areas my view of my client’s view of philosophy changed. Why? Experience!

You’ll like what you are about to read: How to actually make money while giving it away.

An important task for tax advisors (particularly those doing estate planning) is to make sure they have a clear understanding of each client’s goals. So, one of the questions yours truly (or my staff) would ask each client was (and still is), “Do you have charitable intent?” Most clients answered, “No” and that was that. For those that said, “Yes,” we had a large arsenal of tax-advantaged charitable strategies that would enrich not only charity, but substantially enrich our clients too. Every client always made an economic-after-tax-profit.

One day (about 10 years ago) we decided to dig a bit deeper when a client said, “No” to our charity question. Following are the two most important questions we asked, the answers and what (to our surprise) we learned.

First, a simple one word question: “Why?” (did you say “No”). About two out of every three clients responded with something like, “I don’t want to reduce the amount of my children’s and grandchildren’s inheritance.”

After learning this, it made good sense to follow with the next question. Actually two questions designed to get a ‘Yes.’ First, “Would you consider making a substantial gift to charity, if it would not reduce your heirs’ inheritance?” And if that didn’t do the trick, then second, “Would you make a large charitable gift if you could actually make an after-tax profit?” Then, almost all clients say “yes” or “show me how” or something similar.

The simple fact is that the tax law has two tax-free environments: charity and life insurance. Marry them and you are on the road to tax heaven. Let’s stay away from the technical stuff (like charitable remainder trusts and charitable lead trusts and their many ways to help you and charity) and look at two basic examples.

Suppose Joe and Mary (married and both age 65) buy a 15-year pay, $4 million second-to-die life insurance policy. The annual premium is $20,618 per $1 million payable for 15 years or a total of $1.237 million ($20,618 X 15 X 4). Joe and Mary set it up so their favorite charity is irrevocably the beneficiary of the policy.

Let’s take a look at the tax consequences of this charitable gesture by Joe and Mary. They are in a 40 percent income tax bracket (counting State and Federal combined), a 55 percent estate tax bracket (using 2011 rates).

First, let’s look at the estate tax picture: in a 55 percent estate tax bracket, the real story is that the IRS paid 55 percent of that $1.237 million. Since it’s gone, the IRS can’t tax it. So, the real out-of-pocket cost to Joe and Mary (after estate tax consideration) is only $557 thousand (45 percent of $1.237 million).

Second, let’s look at the income tax consequences of the transaction. In a 40 percent income tax bracket, Joe and Mary save $8,247 ($20,618 X 40%) each year as a charitable deduction.

Next, Joe and Mary buy $1.6 million of 15-year pay, second-to-die life insurance in an irrevocable life insurance trust (to keep the proceeds out of their estate). What’s the annual premium cost (only for 15 years)? You guessed it. Their annual $8,247 income tax savings.

Finally, let’s put it all together. Favorite charity will wind up with $4 million. Joe and Mary’s family will make over a cool $1 million ($1.6 insurance proceeds less the after tax cost-$557 thousand-of the premiums paid for the gift to charity).

Yes, it’s easy to “enrich your family (actually make a profit) and charity too.”

The above is only the tip of the iceberg. There are dozens of similar strategies to enrich your family while you enrich charity. This example (the one with the best leverage) is “premium financing” where $500,000 can be turned into $6.5 million for Joe and Mary and then shared with their favorite charity. Joe and Mary can divide the $6.5 million, $5 million to their family and $1.5 million to charity (or in any other ratio they desire). Now, $500,000 turned into $6.5 million. That’s tax and economic leverage!

Most of the time favorite charity is your own family foundation, that bears your name. By now you get the idea: if you (or your spouse or both) are lucky enough to be insurable, you can leverage small amounts of capital (a $500,000 investment or less, paid out in small amounts over many years) to mushroom into large tax-free amounts ($5 million or more). Divide your tax-free profits between your family and charity any way you desire.

Join the tax-free wealth-creating fun. For more information on how-to-do it for your family (and/or your favorite charity) send a copy of your personal financial statement to Irv Blackman, 3960 Deer Crossing Court, Unit #102, Naples, Florida 34114. Please include all phone numbers where you can be reached: work, home and cell.

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Retiring? How To Keep Getting Income From Your Business

Monday, April 13th, 2009

Joe, a reader of this column, founded a family business, Success, Inc., that he headed for 24 years. His son, Bill, has been running the business for about six years.

He’s doing a good job too. Joe, age 64, has cut back his work time to three to four hours a day for nine months of the year. The other three months are spent in a warm climate (mostly Florida) or traveling.

As Success grew over the years, Joe took only enough salary to maintain his family’s lifestyle. Simple put, profits were not taken out of Success, but reinvested. The business is still profitable, and it’s Joe’s only source of income. Success is a C corporation (tax paying).

In the past, Joe had taken a rather modest salary during the year, but he took a big bonus (when profits were available) to fund large family cash requirements (college, vacations, condo, etc.). His professionals had advised him to continue this compensation practice — the same salary and bonus arrangement — even though Joe was putting in about one-third of the time of prior years. Joe called me to get a second opinion.

The IRS would probably attack Joe’s current compensation arrangement on two fronts: First, the bonus would be regarded as a dividend, because it’s not taken until after the end of the year when the amount of the profit could be determined; and second, the salary would be regarded as unreasonable (too high) compensation.

Would the IRS win? On the first attack, Joe and the business wouldn’t stand a chance. The IRS would win hands down with the result being a nondeductible dividend for Success, and a taxable dividend for Joe. Second, the IRS could probably knock out about half of Joe’s current salary as being too high for services actually rendered. Unfortunately the (unreasonable) salary issue is tough to pin down (when challenged by the IRS) with any certainty.

What should Joe do? He needs the current income to live. The answer is to kill the C corporation and elect S corporation status. This would automatically remove the unreasonable compensation problem. What about the bonus? As an S corporation, Joe could take a tax-free dividend from Success (up to the amount of S corporation profits). This means that Success’ profits would only be taxed once when taken as an S corporation dividend, instead of twice, when taken from a C corporation as a dividend. A big tax saving! Better yet, the same trick will continue to work when Joe completely retires (take those delightful tax-free dividends).

One more thing: S corporation dividends (the economic equivalent of a bonus to Joe) are not subject to Social Security tax or other payroll taxes … another big tax saving. And here’s an extra bonus: Joe can collect Social Security benefits even if he continues to work for Success.

If you’re not tuned into the many advantages of electing S corporation status, you owe it to yourself to get the true tax facts. So, to be or not to be an S corporation? That is the question.

In practice, many factors can impact your decision. Still have doubts? Call Irv (417-9732) and I’ll walk you through to the right C or S decision.

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