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The family business: a never ending saga… think taxes, economics and human emotions (08/10)

Monday, March 8th, 2010

Almost all readers of this column with tax problems who contact me are owners or part owners of a family business. Each has a unique story… Most would make an exciting, interesting and fascinating real-life TV drama.

The typical owner/caller has one or more problems… which the family can’t solve… nor can their professionals. The problems typically fall into one of three specific categories: (1) taxes; (2) economics or (3) human. It is not uncommon for the same person or family to have a problem or problems that fall into two or all three categories.

If you have any connection to a family owned business, you should enjoy spotting one or more of the problems – in the following mini-case studies – you too may be trying to solve… Even better, discovering the solutions.

When I originally made the problem/solution list to write for this article, there were 18 must-write-about items. Too many. So, I whittled the list down to the seven items in practice that (a) come up the most often; (b) involve the most amount of money; or (c) most professional advisors don’t know what to do.

Here’s the simple format of each case study that follows: (a) start with the facts, (b) state the problem and (c) the solution. My purpose is to clearly show you there is a solution (easy and legal) for each tough problem listed.

In every case study that follows, the owner of the family business (Success Co.) has a name beginning with the letter J, is married and has one or more kids (name begins with an S) who work in the business and will eventually own it.

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Case Study #1. Facts: Joe has two kids (Sue and Sam) who work at Success Co. Joe wants to give them a stock bonus. Sue is single, Sam is married. Problem: Stock could be marital property.

Solution: The stock bonus is okay for Sue, but not for Sam. Here’s why: Sam is married and the stock would be marital property, which a judge, in case of a divorce, might say belongs one-half to Sam’s wife. Ouch!

Burn these three rules into your mind: (a) Any property received prior to marriage is nonmarital property (good); (b) any property acquired after marriage that is received as compensation or paid for with funds that were earned after marriage is marital property (bad if the divorce devil dances); and (c) if you receive the property after marriage by gift or inheritance it is nonmarital property (good).

COMMENT: Divorce is the most common “human” problem that plagues family businesses.

Case Study #2. Facts: Jack wants to sell Success Co. to his son Sid. Problem: The insane tax burden Jack and Sid will suffer. For example… Say the price is $1 million. Sid must earn about $1.6 million, suffer about $600,000 in income tax (State and Federal) to have the $1 million to pay his dad. Jack will be hit with about a $150,000 capital gains tax. Only $850,000 left… Must earn $1.6 million to have only $850,000 left. Truly a tax travesty!

Solution: Transfer the stock from Jack to Sid using an “intentionally defective trust” (IDT). Three big advantages: (a) The entire transaction is tax-free to Sid (saves $600,000) and Jack (saves $150,000); (b) when Sid receives the stock, it is considered a gift under the law (avoids the marital property trap in Case Study #1; and (c) Success Co. is out of Jack’s estate. IMPORTANT NOTE: Jack keeps control of Success Co. by retaining a tiny amount of the shares: voting stock (while nonvoting stock is transferred to Sid).

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Case Study #3. Facts: About 90% of Jim’s wealth is tied up in Success Co., which Jim transferred to his son Sean (who runs the business) using an IDT. Problem: What if Jim and/or his wife live to the biblical age of 120 (or 85 or 95). Will they be able to maintain their lifestyle?

Solution: Have Success Co. create a death benefit agreement (DBA), which is really a wage continuation plan. The DBA kicks in after Jim is paid in full by the IDT and is no longer receiving a salary from Success Co.  When Jim dies, his DBA wages stop and his wife then gets the wages (usually a reduced amount) for her life.

Case Study #4. Facts: Jake has four kids: two (the business kids) work for Success Co., two (the nonbusiness) kids do not. Problem: How do you treat the non business kids “equally” (or “fairly” or “equitably”)?

Solution. The easy solution (when there are enough assets) is to (a) give the nonbusiness kids nonbusiness assets (can include the business real estate if not owned by Success Co.) or (b) simply acquire enough life insurance (if mom and dad are both insurable, acquire second-to-die life insurance because premiums are much less than single life) to accomplish equality. Sorry, but often – for many reasons – the easy insurance solution won’t work. In real-life practice there is always a solution, but the possible facts are endless and each solution must be specially designed for your unique family situation. Call me if nonbusiness kids are your problem.

IMPORTANT NOTE: Once there is a more than one shareholder (including your kids) for your Success Co., you must have what we call a “unit buy/sell agreement.” If you hate your son-in-law or daughter-in-law, this type of agreement assures you they will never own a piece of the family business.

Case Study #5. Facts: Jerry and his three business kids all receive their compensation from Success Co.

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Problem: Their fringe benefits must be the same as for all other employees or the IRS “discrimination” monster will raise its ugly head.

Solution: Form a new Management Co… Frees Jerry and the business kids from the discrimination rules. Then awesome fringe benefits abound: Your own pension plan or 401(k); health care plan (pays all your medical expenses… including spouse and dependent kids); health insurance, long-term care and sales promotion.

A NICE LITTLE TWIST: If you are (or can become) a resident of a no-income tax state (like Florida or Nevada), you can deduct the management fee paid in the income-tax state where the business is located, but the entire fee is tax-free in say Florida. Cool!

Case Study #6. Facts: Success Co. makes over $1 million a year. Problem: Neither Jeff nor his professionals can think of any way to get more deductions to reduce taxable income.

Solution: Form a “captive insurance company” (Captive). You’ll love this. You create the Captive (a real insurance company that insures risks your normal property and casually insurance company will not insure: like loss of a key vendor, customer or employee; strikes; warranty of your goods or services, war, change in law, rules or regulations).

Let’s say Success Co. pays a $500,000 premium to Captive. Success Co. deducts the entire $500,000… but Captive receives same tax-free and invests the $500,000… and the earnings are usually tax-free. Also, the Captive structure allows you to enjoy significant savings on your property and casualty insurance expense.

The larger your company’s before-tax profit, the more tax dollars you can keep instead of losing them to the IRS. Check it (Captives) out.

Case Study #7. Facts: You have a large amount – say $500,000 or more – in a qualified plan (like a 401(k), profit-sharing plan or an IRA). Problem: At current rates (income tax and estate tax) the IRS can wind up with 70% of your plan funds… your family only 30%. What might the numbers look like?… A $1 million IRA can enrich the IRS by $700,000. Outrageous!

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Solution: In most cases you have a choice: a “Subtrust” or a “Retirement Plan Rescue” (RPR). Which one depends on your age, amount in your plan, your goals and other factors. A few examples should get your greed glands flowing: (1) We used a Subtrust to turn an after-tax 401(k) plan amount of $300,000 into $4.5 million of tax-free wealth. (2) A RPR was used to turn a rollover IRA with a $652,000 balance into $3.75 million of tax-free wealth for the kids and grandkids.

Each Subtrust and RPR is designed to meet the client’s exact goals. Either strategy is an opportunity to turn a potential tax disaster into a tax victory. What’s most interesting is that both strategies are easy to do. The IRS loses. You win… BIG!

Finally, a caution that applies to each of the above seven case studies. All of the opportunities, rules, exceptions and an occasional trap have not been covered in detail. So, only work with an experienced professional who has implemented the strategy many times.

Want more information? Browse my website: www.taxsecretsofthewealthy.com. In a hurry, call me (Irv) at 847-674-5295.

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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.

Posted in Corporate Tax, Family Tax Issues, Featured, Uncategorized | Comments Off

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.

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

Exploring the various needs in estate planning

Saturday, May 2nd, 2009

Most of the concepts and strategies you read in this tax column are really answers to questions asked (or concerns, problems or fears told to us) by readers who called our office.

Also tossed into the column is a large helping of our many years of experience consulting with our readers.

About three out of every four readers who call ask a variation of this troublesome question, “What will estate planning do for me, my family and my business?”

The simple answer: The “right plan” will accomplish all your goals. Actually the right estate plan is a group of small plans that all dovetail together.

There are basically two types of plans: a lifetime plan that should start now (in the next two or three months), and a death plan (really your will and trust documents) that can sit in a drawer until you get hit by the final bus.

By far, the lifetime plan is the most important of the two. Let me say it loud and clear: Never, under any circumstances can your will and trust — no matter how fancy or how long — accomplish your lifetime goals. Even worse, standing alone, rarely can your will and trust accomplish your estate planning (death) goals.

Remember, your death documents do absolutely nothing until after you have drawn your last breath.

OK, so lifetime planning is the way to go. The typical business owner (let’s call him Joe) will have three plans: (1) a retirement plan, (2) a business succession plan (who will run the company when Joe slows down, because in practice Joe rarely totally leaves the business until he goes to business heaven) and (3) a business transfer plan (usually leaving the business to Joe’s business child or children) or a sales plan (to key employees or an outside buyer if there are no kids or employees to take over the business).

Can you imagine any of these three lifetime plans being effectively handled in death documents?

The various plans that we, as consultants, create are in response to the goals that you, the client, list. To help you get started on the first task of creating the “right plans,” the balance of this article focuses on the 10 most common goals we hear from clients in the real world. Every one of these goals can be accomplished with ease by employing the appropriate strategy or strategies. You’ll easily recognize which are part of a lifetime plan and which a death plan. As you read, circle the goals that match your goals.

• Maintain our lifestyle (Joe’s and his wife Mary) for as long a we live — intentionally defective trust, S corporation, family limited partnership, retirement plan, TIPs, which stands for transferable insurance policies.

• Control my (Joe’s) wealth — including my business —for as long as I live (voting/nonvoting stock for business, family limited partnership).

• Maintain Mary’s lifestyle for as long as she lives (marital deduction, irrevocable life insurance trust, plus all strategies as shown in 1 above).

• Pass all of my wealth — every dime of it — to my family, instead of losing it to the IRS (strategies as shown in the other eleven items in this list).

• Transfer my business to our business children tax-free (intentionally defective trust; never a sale).

• Treat children (really non-business children) fairly (family limited partnership, irrevocable life insurance trust, subtrust, retirement plan rescue).

• Avoid the huge — up to 80 percent — double tax on my qualified retirement plan, like a profit-sharing plan, 401(k) or IRA-money (subtrust, retirement plan rescue).

• Educate my children/grandchildren (Private retirement plan).

Eliminate the capital gains tax (charitable remainder trust).

• Attract key employees and keep my key employees (nonqualified deferred compensation plan).

An investment without risk that earns 8 percent (could be more or less depending on person who calls). TIPs, an investment that has averaged 15.82% annual return for the past 15 years. Offered by a public company that trades on the NASDAQ. Must be a qualified investor, minimum investment $50,000.

• Establish a family foundation and make gifts to charity without reducing the value of our wealth to be inherited by our family (charitable lead trust and charitable remainder trust).

The goals listed above (followed by the tax strategies that easily accomplish your goals) are actually a good roadmap to help you get started on your own tax plans.

Want to learn more? Discover all the tax strategies and an organized system that shows you how to quickly accomplish all of your goals as you create your own lifetime plan and estate plan. Browse my Web site: www.estatetaxsecrets.com.

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

Did your lawyer (inadvertently) rip you off

Wednesday, April 29th, 2009

Joe (a 63-year old reader of this column who hails from Iowa, but winters in Florida) almost cried when talking to me on the phone. He said, “I still want to kick myself for thinking my estate plan was done. For years I was convinced that my plan was perfect.

“I never stopped reading and studying. You know, articles. Even books. All my professionals assured me my plan was the best it could be. I religiously attended seminars. I consulted regularly with my CPA and several lawyers. All confirmed that the estate plan drawn by my lawyer Mike was right for me and Mary (Joe’s wife).

“It never occurred to me that so many estate planning experts could be so dead wrong or that there’s a better way to transfer my business to the kids and deal with my other assets. Not until a friend brought me a small pile of your articles.

“I immediately read and reread the articles. The next day, I went to Mike’s office. Basically he gave three reasons why the dozens of concepts and ideas in your articles wouldn’t work for me: don’t apply to me, never heard of it or he’ll check it out and call me.”

The above summarizes about 20 minutes of Joe telling me about his years of planning with Mike (a friend and well-respected lawyer who specializes in estate planning).

Then, I asked Joe a series of blunt questions. His answers revealed Joe’s professionals had crafted a traditional estate plan.

My bet is that 90 percent of you married guys reading this article also have a traditional estate plan. What is it? Here’s the traditional plan Joe had (See if it sounds like your estate plan, as you read further).

Joe’s plan centers on two basic strategies: First, the plan takes advantage of the unified credit (actually $2 million is tax-free in 2006, 2007 and 2008; rising to $3.5 million in 2009. There is no tax in 2010. In 2011 the credit falls to $1 million). By using a two-trust arrangement (most often called Trust A and Trust B; marital trust and family trust or similar names), Joe and Mary each will escape tax on the amount of their unified credit, depending on their year of death. Second, the couple’s plan takes advantage of the marital deduction, which means zero estate tax when the first of Joe or Mary passes.

That’s it: the traditional estate plan that we see in all 50 states. That was Joe and Mary’s plan. Is your plan the same? Similar?

What’s the guaranteed result? The plan prevents the IRS from collecting a dime at the first death (of either Joe or Mary). Good! However, when the second spouse dies, the IRS gets its pound of flesh. In this couple’s case it’s a ton. If their wealth stayed the same, from today until the day both deceased, their estate tax would have been $4,655,000.

You’ll love the rest of the story.

Joe said, “Irv will you give me a second opinion?” I agreed. Joe sent me a standard package of information (tax returns and financial statements — both business and personal; family tree; and his estate plan documents). After two more telephone conversations, we pinned down Joe’s goals: for him and Mary, his successful business (wanted to leave it to his middle son) and his family (four kids and six grandchildren).

Three weeks later I called Joe and outlined the wealth transfer plan I had created (with the help of my network lawyer, Don). Joe’s family will receive every dime of his and Mary’s wealth, probably more (we actually created additional tax-free wealth because we took advantage of the tax-free environments, particularly strategies involving life insurance and charity — available in the tax law). Gone was the $4,655,000 estate tax obligation to the IRS.

A delighted Joe couldn’t help feeling ripped off by his lawyer’s traditional estate plan. Don and I explained that Mike’s plan was the norm.

After our comprehensive plan was reduced to writing (five new documents and some modifications to the trusts that Mike wrote), we submitted the new plan and documents to Mike. He was easy to work with. Don and I answered his stream of questions. Mike — after about three weeks of “review and research” (his words) — fully endorsed our plan.

For me this is a rewarding story, because it shows that the message we try to deliver — you can always win the estate tax game — is getting through to the readers of this column

If you are married and have a traditional estate plan (the same or similar to Joe’s), most likely your plan is not complete.

Think second opinion.

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Posted in Estate Tax, Family Tax Issues, Tax 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 »

Don’t lose a lifetime of wealth to the IRS

Tuesday, April 28th, 2009

Many business owners spend a lifetime accumulating wealth for their families, yet lose it to the IRS why?

The tax law frustrates successful business owners at every turn. Never have I seen this frustration expressed better than in a letter from a reader (let’s call him Joe) of this column, a portion of which follows word-for-word (except the names have been changed).

“Mary and I spent the better part of a year creating a plan to leave our worldly goods [Joe and Mary are worth about 4.1 million] to our [two] single sons, one of whom is in our business.

“You can see from our wills, revocable trusts and the two green manuals from the Family Planning Group, [professional advisors specializing in business succession and estate planning], our tax attorney and our CPA, who sat in all of our meetings, that we are trying to do the right thing. Just what that means, I don’t know, but it seems that if Mary and I went to Vegas and lost every dime there would be no taxes, yet if we live a reasonably decent life and try to pass on our savings to our children and to charities, Uncle Sam steps in and decimates a lifetime of savings.”

The letter was accompanied by a stack of documents and financial data, (actually the same information made available to Joe’s threesome of advisors). What’s so interesting about Joe and Mary is that they are a poster couple for the six most common maintaining your lifestyle and estate tax problems — that follow — facing millions of family business owners:

• How to transfer your family business when you have one child (or more) in the business and one child (or more) not in the business;

• How to maintain your lifestyle (and your spouse’s) for as long as you live;

• How to invest your excess funds;

• How to treat your children fairly;

• How to get your wealth to your children (or other family members) without being “decimated” by the IRS;

• How to control your business for as long as you live.

It should be noted that all of Joe’s advisors were smart and experienced practitioners in their respective areas. Then, why was Joe still searching for better results than this group could deliver? Simply put, Joe saw blue every time he thought of the $1 million-plus tax bill he was told he must pay to the IRS. Since Joe and Mary are like so many other family business owners (the amount of wealth is almost immaterial, it could be $3 million, $30 million or more), following is the basic plan (as your read, think how the same or a similar plan would solve your problems: for the rest of your life and when you get hit buy the final bus) we implemented for them. It’s also the six-step core plan (the planning strategies are italicized) we create for most business owners, who want to (1) maintain their lifestyle for as long as they live and (2) to finesse the estate tax and get 100 percent of their wealth to their family. All taxes, if any, paid in full:

1. The business is transferred to the business child (or children) using an intentionally defective trust.

2. A subtrust or retirement plan rescue (using qualified plan funds, typically a profit-sharing plan, 401(k) or rollover IRA) is used to purchase second-to-die life insurance on Joe and Mary (proceeds to the children tax-free).

3. A family limited partnership (FLIP) is created to hold all of Joe’s and Mary’s assets (usually investments, like real estate, stocks and bonds).

4. Invest a portion of available funds (in your qualified plans, business or personal) in senior settlements (SS). Maintaining your lifestyle is easier with SSs, which earn over 15 percent — without market risk-per year. These SSs are made available by a public company (trades on the NASDAQ) that has been enjoying a 15.82 percent rate of return on average for 15 years.

5. An annual gifting program is started immediately to transfer the FLIP interests to the children (typically, the non-business children).

6. The death documents (will and trust) are designed to clean up all of their goals and asset distributions that were not accomplished during their life by the first five steps of the plan. Notice that the first five steps are done while Joe and Mary are alive — a must if you want to maintain your lifestyle and win the estate tax game. A will and trust (really a death plan — as opposed to a lifetime plan) just can’t get the job done.

Joe and Mary will control all their assets — including the business — for as long as they live. Again, we want to pound this point home: The plan is essentially a lifetime tax plan (the first five steps). The real secret is to do lifetime planning, not only death or estate planning (the sixth step), like Joe’s advisors did.

After our six-step plan was put in place, the wealth that will ultimately go to the children of Joe and Mary will be in excess of $5 million. We actually created additional tax-free wealth, instead of losing over $1 million to the IRS. Most importantly, Joe and Mary will be able to maintain their lifestyle — allowing for an inflation rate of up to five percent — for as long as they live.

As regular readers of this column know, we do a reader test from time to time (Joe was part of the last-reader test).

So, if you want to maintain your lifestyle for life, have an estate tax problem or own an interest in a closely held business (particularly if you want to transfer the business to one or more of your kids), you are invited to join the test.

In order to participate, please send the following information (send copies, do not send original documents):

1. For your business — Your last year-end financial statement.

2. Personal — A current personal financial statement for you and your spouse.

3. A family tree — Your name and birthday. Same for your spouse, kids and grandchildren.

4. Estate documents. It’s not necessary to send copies of your wills and trusts to start.

Send to Irv Blackman, Estate Plan Test, 3960 Deer Crossing Court, Unit 102, Naples, FL 34114. (If you have a question call, 239-417-9732).

Just one more point: If you want to learn more about SSs (whether or not you join the Estate Plan Test), please fax your name, address, phone numbers (business/home/cell) and estimated amount to invest (the minimum is $50,000 for accredited investors) to 847-674-5299.

Okay, that’s our plan to help your do your plan. Let’s hear from you.

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Hey kids, ‘Someday It’ll All Be Yours’

Saturday, April 18th, 2009

While browsing through my small mountain of files looking for ideas of what to write, I ran a cross a still-timely and interesting article in an old issue of Newsweek titled, Darling, It’ll Be Yours-Soon.

The article explains how “The inheritance boom is quietly reshaping how we think about death.”

How true.

When I began my professional practice (as a CPA and lawyer back in the ’50s), a millionaire was hard to find. Today, millionaires are bountiful. And when it comes to estate planning, most millionaires scurry around trying to find a professional who can lower the estate tax for them when they get hit by the final bus.

The article (well written by Robert J. Samuelson), like so many other articles, entertainingly explores the problem, but it offers no solutions.

Let’s set the scene for how you (whether you are mom and dad trying to give it away tax-free or one of the kids on the receiving end) can, in fact, solve the problem. Let’s start with the elders, mom and dad, who have the wealth.

Fact number one: You ain’t dead yet. Typical estate plans (separate wills and trusts for him and her) don’t speak until you are dead: too late to beat the tax collector. The solutions lie in lifetime planning. A lifetime plan keeps you in control of your wealth for as long as you live, yet transfers it — including your business — to your kids (and grandkids) while you are alive.

Fact number two: Years of experience have taught us that wealth is always passed on to the younger generations of the family. And when the younger generations step into mom’s and dad’s shoes, they usually increase the family wealth. This gives the second generation (and those who follow) an even bigger estate tax problem than mom and dad had.

Here’s how we solve this do-not-enrich-the-IRS-estate tax problem: Logic tells you that the children — particularly the business children — are likely to become more wealthy than their folks. Usually the business children accumulate much more wealth than their mom and dad, a process to be repeated again when the family business wealth goes to the grandchildren two generations later.

Because of this generation-to-generation wealth transfer pattern, we view each generation of the family separately in terms of their special needs and objectives. So, the plan we create is just not for mom and dad, it is a comprehensive and coordinated plan for the entire family. Following is an overview of keeping your wealth in the family, instead of losing it to the IRS.

First Generation. Install a lifetime plan that removes wealth from your taxable estate during life: Use strategies like (1) a qualified personal resident trust for your residence, (2) an intentionally defective trust for your business ; (3) a subtrust or retirement plan rescue for your profit-sharing plan, rollover IRAs and similar plans; (4) a family limited partnership for your investment assets, and (5) an irrevocable life insurance trust for insurance, probably second-to-die. All of these strategies — and there are many others — begin their work now while you are alive and in control.

Of course, we’ll dovetail your will and trust (death documents) with your lifetime plan. When done right, your death documents just clean up what’s left after your lifetime plan has been implemented. The first part of your family plan and wealth transfer must be completed — tax-free — while you (and your spouse) are alive.

Your Kids-Second Generation. After completing the plan for mom and mad, it is easy to project what the financial future of the kids might look like. So, as soon as we finish the plan for the first generation, we start a plan for each of the adult kids, based on their individual assets, whether in the family business or not, and each of their specific objectives.

The process is the same as for mom and dad, but flexibility (remember, this generation usually is still in the process of trying to accumulate wealth, rather than trying to get rid of it for estate tax purposes) is always a key objective of the second generation.

Your Grandchildren-Third Generation. The plans for this generation are closely tied to the plans of the two older generations. Probably the most important point to keep in mind is that because of the young ages in this generation, getting the youngsters into a tax-free environment as soon as possible is a wealth-building must.

These plans center on short-term and long-term tax-advantaged strategies that fulfill lifetime needs: education, buying a house, starting a business and (if they don’t go in to the family business) building a retirement fund.

—

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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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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Don’t Let ‘Estate-Tax-Itis’ Drain The Family Wealth

Wednesday, April 15th, 2009

Adreaded disease is spreading like wildfire — in all 50 of the United States.

It debilitates most successful business owners, then, ravages some or all of the kids and eventually hurts the grandkids.

Known by various names, the most common name is “estate-tax-itus.” It drains family wealth.

Some people don’t even know they have the disease. Most know because they have the painful symptoms (a huge tax bill) and search in vain for a cure. They attend seminars, read articles, special reports and books. They go from advisor to advisor looking for relief.

The key question is: “Is there a cure?”

The answer is a resounding :Yes!”

This article shows you how to start the process to totally cure estate-tax-itus for yourself, your family and your business — every time, no matter how young or old you are, whether you are worth $1 million, $10 million (or much more).

There are many ways to fight the disease, but the best way is to build a “tax-immune system.” For best results, start today.

Here’s a three-step process that works every time. Steps No. 1 and No. 2 make the diagnosis. Step No. 3 accomplishes the cure.

Step No. 1: Prepare a personal financial statement for you and your spouse. Divide your assets into the following five categories.

— Residence

— Business

— Qualified plans (pension, profit-sharing, 401(k), rollover IRA or other qualified plans)

— All other assets (typically, investments)

— Life insurance

Step No. 2: Make a list of your goals (actually three lists) — (1) for you and (if married) your spouse; (2) for your family (typically children and grandchildren); and (3) your business.

Here are the typical core goals we see in practice:

For list (1) — Maintain your lifestyle for as long as you (husband and wife) live and allow you to control your assets for as long as you live;

For list (2) — transfer your assets to the children and grandchildren intact — free of the estate tax-and educate your grandchildren;

For list (3) — transfer your business to the business child (or children) tax-free and treat the non-business children fairly.

Step. No. 3: Find an advisor who knows how to identify and implement the exact tax strategies that accomplish your goals using the specific assets on your financial statement.

Following are the are most often-used strategies we use in our practice to accomplish a typical client’s goals, based on the assets owned.

Your Residence. Use a Qualified personal residence trust to remove the residence from your estate, yet live in it and control it for as long as you live.

Your Business. Transfer your business to the business children using an Intentionally Defective Trust. It removes the business from your estate, transfers business to kids (tax-free to you and the kids), yet allows you to keep control for life (because you retain voting control).

Qualified plans. The funds in these plans are double-taxed, robbing your family of about 75 percent of the plan funds (i.e. the tax collectors get about $750,000 if you have $1 million in the plans, your family receives only $250.000).

Create a Subtrust or retirement plan rescue (RPR) to buy life insurance. This usually triples (or more) the amount you have in the plan, and your heirs get it all tax-free. For example, $1 million in the plan (worth only $250,000 to your family) will turn into $3 million (or more) for your family with a Subtrust or a RPR. And the entire $3 million is tax-free.

All other assets. Transfer these assets (all your assets, except those in the first three categories; for example, publicly traded stocks, bonds, real estate and other investments) to a family limited partnership, which legally reduces the value of these assets for tax purposes by 35 percent (yes, $1 million of real estate, stocks, bonds, etc. are only worth only $650,000 for tax purposes.)

Insurance. Get it out of your corporation and transfer all policies you or your spouse own to an irrevocable life insurance trust (But a Subtrust is best, if you can use it. See 3. above). Also, check out premium financing, a wonderful concept that allows you to buy huge amounts of life insurance ($3 million, $10 million or more) without paying premiums.

Finally, if your estate plan is already done, and it does not effectively eliminate the estate tax, get a second opinion.

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