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Yes, you can beat the estate tax, legally, and easily

Saturday, May 30th, 2009

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

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Everything you should know about who should own business real estate

Saturday, May 30th, 2009

The first commandment of my someday-I-will-write-it bible of taxation would be “Thou shalt not put real estate into a corporation.”
We see it at least a dozen times year: When readers of this column ask us to do a tax consultation (usually for transfer/succession/estate planning), we find the business real estate in a separate C corporation (sometimes an S corporation) and leased to the operating corporation. Often, the real estate is owned by the operating corporation. Wrong! All are wrong. Actually a tax disaster waiting to happen. Why?
Someday, when you try to get the real estate (invariably, depreciated down to a low tax basis and appreciated in value) out of the corporation, you will run straight into a double tax. Again – why? Well, the first tax will hit the corporation when the real estate is sold (or transferred to the stockholders). Problem is, the sales proceeds are stuck inside the corporation and there are only two ways to get at those proceeds: via a dividend or a corporation liquidation. Sorry, both are subject to a second tax. A transfer of the property to the stockholders also triggers a double tax.
So what’s the answer?… Imagine a business owner (Joe) who is married to Mary. Joe should take title at the time the real estate is purchased and then lease it to his operating corporation. Here are some of the tax goodies that can come Joe’s way over time:
1. The rent Joe collects is not subject to social security tax (or other payroll taxes), nor does the rental income interfere with his social security benefits.

2. Joe can borrow (tax-free) against the property if he needs cash.

3. A sale of the property is subject to only one capital gains tax, which Joe can report on the installment method if he takes back a mortgage for a portion of the
purchase price. Joe might even exchange it tax-free for another piece of property (called a “1031 exchange”).

4. When Joe dies, his heirs get a raised basis, for example: Say Joe bought the property 25 years ago for $100,000, and it is now fully depreciated down to $20,000 (the cost of the land). The value of the property on his date of death is $620,000. Now get this – that built-in $600,000 of profit escapes income tax. Forever! And also this – Mary now owns the real estate (free of income and estate taxes) with a brand new tax basis of $620,000… Just as if she had bought the property for the $620,000 price. Yes, she can depreciate this property (except for the value of the land) using her new $620,000 tax basis, which will shelter her rental income.

5. The property can be put into a Family Limited Partnership (FLIP), which has many tax and non-tax benefits. For example, a $1 million piece of real estate transferred to a FLIP can receive a discount for estate tax purposes of about $350,000. The estate tax savings could be as high as $157,500 (using current estate tax rates)

And, oh yes, when Mary dies, the law allows her to repeat the raised-tax-basis trick (to raise the value of the property at her death) all over again when she leaves the property to the kids.
Now you know why owning real estate in a corporation is not only a tax trap, but it also prevents you from reaping a tax harvest during your life, at your death and beyond.
Want to learn more tax tricks that will save you a bundle?… take a peek at my website: www.taxsecretsofthewealthy.com. If you have a question call Irv (847-674-5295).

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Winning the tax game for a family business requires solving two sets of problems: money, and human

Wednesday, May 6th, 2009

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

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Want to learn how to turn your qualified plans from a dangerous tax trap into a great tax advantaged victory

Wednesday, May 6th, 2009

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

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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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by Irv Blackman

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