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).

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.

Here’s the sad routine when the gizmo doesn’t work:

“The manufacturers,” pleads the installer.

“Improperly installed,” counters the manufacturer.

Ultimately — after some grief and unnecessary dollars —the gizmo is fixed and it works.

Now, there’s a game you don’t want to play with your estate plan. Try this real-life story of a tax disaster.

Joe died, survived by his wife Mary, four grown kids (one, Sam, managed Joe’s family business, Success Co.) and seven grandchildren. Success Co. was a C corporation. Aside from owning their residence (worth $800,000) and Success Co. (valued at $9.8 million at Joe’s death), Joe and Mary had $275,000 of spendable personal wealth. In addition, they owned various personal property and a nice summer home with a total value of $1.2 million.

About five years before he died, Joe had gathered a team of professionals to do his estate plan: his CPA, a lawyer who specialized in estate planning, and his long-time friend, an insurance agent.

The professionals crafted a great traditional estate plan: no tax due at Joe’s death (the 100 percent marital deduction) and enough insurance (second-to-die) to pay the projected estate tax at Mary’s death. An irrevocable life insurance trust owned the second-to-die policy on Joe’s and Mary’s lives. The estate plan probably would get an A-plus in the classroom.

But here are the unfortunate little lifetime details — told to me by Sam in an urgent phone call the professional team missed:

Mary, a healthy age 65, did not have a flow of income or enough spendable assets to maintain her lifestyle. Joe’s $500,000 salary, plus generous perks from Success Co., stopped when he died. Aside from the usual lifestyle cash needs, Mary needed $46,000 per year to pay the second-to-die insurance premium. Also, she wanted to continue providing the college education for four of her grandchildren( the other three had completed their education, which was paid for by Joe and Mary).

None of the professionals accepted responsibility for Mary’s lack of spendable income. Worse yet, they had no suggestions to solve the problem.

First, the solution to Mary’s immediate problem: The marital trust (created in Joe’s revocable trust as part of his estate plan) owned 85 percent of Success Co. (Mary owned the other 15 percent). We simply had the stockholders (the marital trust and Mary) elect S Corporation status for Success Co. The large corporate profit will easily provide the income stream-via S corporation dividends-she needs, as the beneficiary of the marital trust (85 percent) and as a direct owner (15 percent).

Now, what lesson should be learned from this sad tale?

The first lesson is that estate planning (as practiced all over the United States) is really death planning. Do the documents: a will and a trust or two, put ’em in the vault, and wait to die.

Rather than rehash what should have been done for Joe and Mary, let’s get the first lesson up on the board — loud and clear.

Whether you call it estate planning, lifetime planning, wealth transfer planning or whatever, your master plan must include three separate plans: (1) a lifetime plan to transfer your wealth while you are alive (and, yes you can control your wealth for as long as you live); (2) a retirement plan that provides the after-tax cash flow needed to maintain your lifestyle for you and your spouse for as long as either one of you lives; and (3) a transfer/succession plan for your business. (Note: Not even one of these three was done by the typical traditional estate plan for Joe and Mary.)

If you have yet to do your master plan, make sure it includes the three plans listed above. If your master plan is done and does not include all three of the plans listed above, get a second opinion. And finally, make sure that the professionals who create your plan know in advance that they are responsible for all aspects; he who creates the plan should install it and monitor it to the day you (and your spouse) die.

Remember, just because your estate plan is done, does not mean it is done right. Wouldn’t you want your plan to be in the 10 percent that enriches your family, instead of the 90 percent with a plan that enriches the IRS?

Read slowly, chances are you will see some of yourself or someone you know.

Joe (age 74) owns 52 percent of an S corporation (Success Co.), and each of his three children owns 16 percent of Success Co. He has two boys, Tom (47) and Dick (43), who have been in business with Joe since they graduated from college.

Joe’s daughter, Harriet, was not and never will be involved in the business. Joe lost his first and only wife last year.

Following is a list of Joe’s assets:

• Various liquid investments:$190,000

• 52 percent of Success Co.: $1,630,000

• Real estate leased to Success Co.: $600,000

• Balance in Rollover IRA: $780,000

• Residence and summer home: $435,000

• Total: $3,635,000.

Joe’s lawyer (an estate planning expert with a fine reputation), who just completed Joe’s estate plan, correctly computed the estate tax (using 2011 rates) at $1,419,771. His only recommendation: Buy $1.5 million in insurance to pay the tax.

Joe called me for a second opinion. After a long telephone conference, following is how Joe spelled out his goals:

1. Control Success Co. (and the rest of his assets) for as long as he lives.

2. When he is gone, to have Success Co. owned 50 percent each by Tom and Dick.

3. Make sure he can maintain his lifestyle for as long as he lives.

4. The dollar value that Harriet receives from Joe’s estate should be equal to the amount received by each of her brothers.

5. Find a way to have each of his kids receive one-third of what he is worth now, all taxes paid in full. (Joe laughed a bit at this goal; he didn’t think it was possible).

Stop for a moment. Substitute you own list of assets and goals (remember, if you are married, some day either you or your spouse will be the first to pass on). What follows is the plan we implemented for Joe and the strategies we selected to accomplish Joe’s five specific goals (in the same order as the goals).

We recapitalized Success Co. (a tax-free transaction) so Joe now owned 52 percent of the controlling voting stock (52 of 100 shares) and 52 percent of the nonvoting stock (5,200 of 10,000 shares).

We transferred the liquid investments and the real estate to a family limited partnership (FLIP). As the general partner (owned 1 percent of the FLIP), Joe kept control of these assets. He will make annual gifts ($12,000 each) of limited partnership interests to the kids. These limited interests (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35 percent) for tax purposes. As a result, Joe can give about $19,000 to each kid of limited FLIP interests every year, yet for tax purposes the interests are only worth $12,000.

Joe sold the 5,200 shares of non-voting stock to a so-called defective trust (defective for income tax purposes) for $1.5 million plus interest. The trust paid for the stock with a note. Success Co. will distribute S Corporation dividends each year to the trust, which will then pay off the note to Joe.

Because the trust is defective for income tax purposes, every dime that Joe receives (both for principal to pay off the note and interest) is tax-free. The beneficiaries of the trust are Tom and Dick who will each own half of the 5,200 non-voting shares when the note is fully paid and the trust terminates.

Joe’s 52 voting shares will go to Tom and Dick when Joe dies. The shares owned by sister, Harriet, will be redeemed by Success Co., according to a new buy/sell agreement, when Joe passes on. Then Tom and Dick will each own 50 percent of Success Co.

Joe’s flow of cash to maintain his lifestyle would come from many sources. (a) a small salary from Success Co., plus all of his usual perks; (b) The note payments from the trust (remember, the entire $1.5 million plus the interest is tax-free to Joe because of the defective trust); and (c) distributions from the rollover IRA.

Actually, during the years (about eight to 10) while the note is being paid off, Joe will have more cash than he needs to live. This excess cash will be put into the FLIP (and, of course, will be available for distribution in future years).

Actually, all the assets of the FLIP will be available to Joe if needed.

As a final back up, Joe will enter into a death benefit agreement with Success Co. that will pay Joe $75,000 per year starting when Joe retires (probably never) and continuing until the day he dies.

We created a Subtrust (using the Rollover IRA and Success Co.) to purchase a $1.5 million life insurance policy. The entire $62,187 annual premium will be paid out of plan funds (it won’t cost Joe a penny), and because of the subtrust, none of the $1.5 million ultimate policy proceeds will be included in Joe’s estate.

Appropriate language in Joe’s death documents (will and revocable trust) makes sure Joe’s “goal” will be accomplished; the $1.5 million in tax-free insurance makes this goal easy.

The residence (worth $355,000) was transferred to a qualified personal residence trust (QPRT). The QPRT was set up in such a way that Joe could live in the residence for as long as he lived, yet it would be out of his estate.

If Joe gets hit by a bus the day after the plan described above is put in place, this “goal No. 5” (the entire $3,635,000 to the kids) will be accomplished (along with the four other goals). The longer Joe lives, the less the IRS gets and the more the kids get (in excess of the $3,635,000).

One warning: The above story does not explain all the technical details of Joe’s plan. Only work with a tax advisor who knows, understands and has worked with the strategies used for Joe.

A will and trust alone (no matter how long or how fancy) will not get the job done.

Ah, but tax-deferred. That’s where the action is. The biggest tax-deferred sandbox to play in, by far, is the qualified plan area. They — profit-sharing plans, 401(k) plans, IRAs of all sorts, and others — abound. Billions pour in every year. Employer-sponsored plans are usually the tax-weapon of choice. Non-employer plans (traditional and Roth IRA) give every taxpayer an opportunity to play in this sandbox.

But IRAs have dollar limits. Tax-deferred annuities (annuities) have no limits. You can toss as many dollars as you like into annuities. All are after-tax dollars. Not one cent is deductible. Annuities earning powers are low (more about this defect later). Severe penalties murder your dollars if you want to get out in the early years. Simply put, there’s no liquidity.

So what’s the magnet that draws billions of dollars into this not-such-a-good-deal-investment? Here’s the answer and the magic words: tax deferred.

A word about annuity rates of return: Fixed annuities are the most popular. They currently pay in the three to three and a half percent range per year. (Older annuities, when interest rates were higher, paid more.) The new darling is indexed annuities. Your yield is pegged to some index, typically the S&P, on an annual basis. Often in a (say the S&P) loss year, you are guaranteed a small yield (usually in the one and a half to three percent range). A small percentage rise (say four percent) in the S&P is the exact percentage (four percent) you get, but a large rise is capped at six percent to eight percent (for example, the S&P increased by 14 percent but you only get seven percent.

Okay, so what’s a tax-deferred investment that doesn’t have all the impediments of annuities and has a huge rate of return without risk? Senior settlements.

An example is the easiest way to explain senior settlements. Suppose Joe, age 68, has a $400,000 life insurance policy with a cash surrender value (CSV) of $50,000. Joe would like to stop his annual premium payments. Instead of canceling the policy and taking the $50,000 CSV from the insurance company, Joe sells his policy as a senior settlement, receiving $120,000. Joe’s a happy camper.

Investors bought Joe’s policy. Senior settlements have been around for about 35 years. The tax consequences are a delight. Your tax liability for profits are completely deferred to the day you actually receive back your entire investment and your entire profit.

There’s a public company (trades on the NASDAQ) offering senior settlements. The average rate of return has been 15.82 percent per year throughout the company’s 15-year operating history. If your goal is to make a killing on your investments, senior settlements are not for you. (Just a note: AIG, the giant insurance company, and Warren Buffett’s Berkshire Hathaway Inc. invest in senior settlements.) But if an average rate of return (almost 16 percent), with no market risk, is of interest to you (or one or more of your qualified plans) you are invited to learn more about senior settlements. Just fax me (239-417-9045) your name, address, phone numbers (business/home/cell) and estimated amount to invest (minimum is $50,000 for accredited investors.)

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

Robert J. Samuelson’s well-written article, 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 parents trying to give it away tax-free or one of the kids on the receiving end — can solve the problem.

Let’s start with Mom and Dad, who have the wealth.

• Fact No. 1: 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 No. 2: Years of experience have taught us that wealth is always passed on to the younger generations of the family. And then the younger generations step into the parents’ shoes and typically increase the family wealth. This gives the second generation an even bigger estate tax problem than the parents 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 wealthy. Usually, these children accumulate more wealth than their mom and dad — to be repeated again when the family 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 its special needs and objectives. But the plan should not be just for Mom and Dad; it should be a comprehensive plan for the entire family.

Following is an overview of how it’s done: keeping your wealth — every dollar of it — in your family, instead of losing it to the IRS.

You and your spouse (first generation)

Install a lifetime plan that removes wealth from your taxable estate during your life.

Use strategies like:

• A qualified personal resident trust for your residence.

• An intentionally defective trust for your business.

• A subtrust for your profit-sharing plan, rollover IRAs and similar plans.

• A family limited partnership for your other assets — typically investments like stocks, bonds and real estate.

• 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 allow you to stay in control of your assets, including your business, for as long as you live.

Of course, we’ll dovetail your will and trust (death documents) with your lifetime plan. But when done right, your death documents just clean up what’s left. The first part of the family plan, including a business succession plan, and your wealth transfer plan are completed — tax-free — while you and your spouse are alive.

Your children (second generation)

After we complete a comprehensive plan for Mom and Dad, 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 kids, based on their individual assets and objectives.

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 children into a tax-free environment as soon as possible is a wealth-building must.

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

Then they prove it. They tell me they have parked all or a large amount of their extra cash in what they consider conservative investments.

Most conservative investments are in low-yield, fixed-rate stuff like CDs or U.S. Treasury bonds. But municipal bonds are the hands-down favorite conservative investments.

Here’s a well-known fact: When inflation rears its ugly head, conservative investments are anything but conservative.

Consider just one additional value-eating bandit that walks hand in hand with inflation: interest rates.

Here are the three ways the bandit steals your hard-earned wealth when, for example, you are heavily invested in municipal bonds:

1. The value of the bonds goes down as interest rates go up.

2. You are locked into a low-interest rate until the bond matures or you sell it, probably at a painful loss.

3. Nasty inflation reduces not only the value of the interest you receive, but also the buying power of the already reduced value of the bond (see No. 1 above).

Here’s a quote from the Currency Options Hotline Operating Manual that drives home the devastating economic impact of inflation over time: “If you were somehow able to take one of today’s greenbacks (dollars) back in time to 1940, you would find it worth only about 6.5 cents.”

Sorry, but it looks like inflation — plus the falling value of the dollar against most foreign currencies — will be our rather unwelcome bedfellow for at least the foreseeable future.

What is a conservative investor to do?

Actually, we all know the answer: Find an investment vehicle that overcomes the three evils of rising interest rates.

First, let’s outline the attributes of such an investment; second, identify the investment; and finally, give an example of how the investment works.

Here are the attributes of the investment:

• A higher rate of return than on traditional conservative investments like CDs, Treasury bills and notes, and, of course, municipal bonds.

• The interest rate tends to go up as inflation goes up.

• Your investment will never go down in value and, in fact, will always guarantee you a profit.

• The interest earned and your investment profit are income tax-free.

• Your total investment when you die — original investment, interest earned and profit — escapes the clutches of the estate tax when properly structured.

And now — drumroll, please — the identity of the investment: a particular type of life insurance that I call conservative investment life insurance, or CILI.

Finally, let’s look at an example. (Note: This investment concept works for any age, but is typically used by an individual or a married couple who are 50 or older.)

Joe and his wife, Mary, are both 70. They buy a $1 million second-to-die CILI policy (it could be any amount) with an annual premium of $23,516.

The policy currently earns 5.7 percent.

The payoff on Joe and Mary’s investment comes after the second death. It is determined assuming that after 10 years — age 80 — Joe and Mary get hit by the same bus.

Their heirs, children and grandchildren would receive:

• Death benefit — $1 million.

• Premiums paid ($23,516 times 10 years) — 235,160.

• Interest earned on premiums paid (at 5.7 percent, but it would be higher if interest rates rise or lower if interest rates fall) — $75,411.

• Total amount tax-free to heirs — $1,310,571.

Next, suppose the couple’s second death happens at age 90. Their heirs would get $1,816,458 tax-free.

To summarize the investment:

1. You get your investment (premiums paid) back, dollar for dollar, plus earnings (5.7 percent here).

2. You get a guaranteed bonus, the death benefit ($1 million here).

3. It’s all tax-free (no income tax, no estate tax).