Archive for the ‘General Tax Strategies’ Category

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How To Turn A Tax Tragedy Into A Miracle

Monday, April 13th, 2009

Do you have a large amount of money in an IRA, profit-sharing plan, 401(k) or other qualified program? Or know someone — family, friend or co-worker — who does? If so, this article will save you a ton in taxes and show you how to dramatically increase your after-tax wealth.

This is one of those good-news, bad-news situations. First, the bad news. Someday the money in your plan will be distributed: to you or your beneficiaries. If you happen to be wealthy, those beautiful bucks which took decades to accumulate will be worth somewhere in the 27 percent range. The IRS gets the rest in taxes. Yep, typically you lose around 73 cents out of every dollar because you are required to pay two taxes on your plan distributions: income tax and estate tax. It’s even worse in high-tax states like New York (check with your accountant). How do I define wealthy? You are irrevocably in the highest income tax bracket (say 40 percent, state and federal) and highest estate tax bracket (55 percent, using 2011 rates). Sorry, but the tax collector will take the lion’s share of your plan’s assets whether you get distributions during life, or they go to your heirs after death.

Can anything be done to prevent this robbery? Yes! Here comes the good news. Regular readers of this column know I’m part of a national tax network (other professionals who work together and share tax knowledge). Some experts in the network have devised two tax concepts to enrich your family instead of the IRS. These concepts are designed to help individuals who have accumulated large amounts (from $200,000 to millions of dollars or more) in their plans.

Suppose you have $1 million (fill in your own exact number) in one plan or all of them combined. If you fail to take advantage of one or both of these concepts you will lose $730,000 (or more) in taxes to the IRS. Just take 73 percent of the amount in all your plans, and you can clearly see the full tax-disaster picture. Of course, your local tax collectors (state, as well as your local county or city) may grab an additional piece of the action.

Now, let’s look at each concept separately.

The first concept — called the “Single Premium Strategy (SPS)” — combines three strategies: (1) an immediate-pay annuity (typically a joint-life annuity if you are married); (2) a life insurance policy (second-to-die if you are married) and (3) an irrevocable life insurance trust. In one real-life case, an unmarried reader of this column turned $325,000 into $2,878,385 (all taxes paid). Another reader, who is married, turned $270,000 into $3,496,063 (all taxes paid). Single or married, it’s smart to get an exact quote of how much tax-free wealth an SPS would create for you and your family.

Another concept, called “Retirement Plan Rescue” (RPR), uses the funds in the plan to buy the insurance: either for a single life or second-to-die for a husband and wife. A married reader (Joe) used an RPR to buy $10 million of second-to-die insurance, which will go to his kids tax-free. Joe actually turned $567,900 into $10 million. Joe’s wife Mary called the entire transaction a “tax miracle.”

You’ll also be surprised at how easy these strategies are. So, if you are lucky enough to be wealthy, but unlucky enough to have a substantial amount of assets in a qualified plan — IRA, profit-sharing, 401 (k) or similar plan — you owe it to your family to take a closer look at the tax-miracle concepts. It’s easy.

I have arranged for readers of this column to get a free analysis of their plans for both of these concepts. Just fax (1) your name and birthday (also your spouse if married); (2) total amount in all your plans combined; and (3) all phone numbers (business/home/cell) where you can be reached to (847-674-5299). You are welcome to include other information, questions or problems concerning you, your business or your family.

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Why Your Real Estate Plan Often Flunks The Real-Life Test

Monday, April 13th, 2009

While thumbing through the pages of a trade journal, I ran across this quote, “We install 90 percent of what we sell. That’s one big advantage we have over (names one of the biggest square-footage discount chains).”

You know the routine: the thing-a-ma-jig doesn’t work.

“The manufacturer,” says the installer.

“Improperly installed,” counters the manufacturer.

Ultimately — after some grief and probably more dollars — it works.

Now, there’s a game you don’t want to play with your estate plan. Try this real-life tax horror story.Joe died, survived by his wife Mary, three grown kids (one 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 $10.3 million at Joe’s death), before Joe died, he and Mary enjoyed about $350,000 of after-tax spendable personal income.

In addition, they owned various personal property and a nice summer home with a total value of over $1 million.About five years before he died, Joe 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 good traditional estate plan: no tax due at Joe’s death (the 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” in the classroom.

But here’s the unfortunate big lifetime detail the professional team missed: Mary, a healthy age 64, did not have enough cash flow to maintain her lifestyle. Joe’s $550,000 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 for the college education of three of her grandchildren (the other five had completed their education paid for by Joe and Mary).

None of the professionals accepted responsibility for Mary’s lack of necessary spendable income. Worse yet, they had no suggestions to solve the problem.First, the solution to Mary’s immediate problem: the cash flow to maintain her lifestyle. The marital trust (created in Joe’s revocable trust as part of his estate plan) owned 90 percent of Success Co. (Mary owned the other 10 percent). We simply had the stockholders (the marital trust and Mary) elect S Corporation status for Success Co. Now the large corporate profit can provide the income stream Mary needs, as the beneficiary of the marital trust (90 percent) and as a direct owner (10 percent).

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 you (or your spouse) live; and (3) a transfer/succession plan for your business (that gets the value of the business out of your estate tax-free) to your business kids (or other successor).

Whether your master plan is done or is yet to be done, make sure it includes the three plans listed above. And always — I mean always — get an independent 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 the you (and your spouse) die.

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Don’t Get Stuck In These IRS Tax Traps

Wednesday, April 8th, 2009

If you own a business and your estate plan uses or intends to use any of the four commonly used techniques (actually tax traps) discussed in this article, you will unnecessarily enrich the IRS.

Guaranteed!

Let’s set-up the typical family-business situation we see at least 100 times every year. Joe, who is married to Mary, owns Success Co. Sam, their son, runs the business and someday will replace Joe. They have other children who are not active in the business.

The traps are listed here in order of the most serious and most frequent blunder.

The marital deduction. After Joe’s death, Mary will own Success Co. or a large portion of it in her own name or in some kind of marital trust. That’s great, when Joe dies. No estate tax. But when Mary goes, the IRS gets its pound of flesh. Remember, the marital deduction only defers tax; it’s not intended to be a tax saver.

A Section 303 redemption. Success Co. can redeem as much of Joe’s stock as necessary, free of any income or capital- gains tax to pay Joe’s (or Mary’s) death taxes and other estate costs. Sounds good. But the fact is, the money that comes out of Success Co. goes straight to the IRS.

Section 6166. Because Success Co. is a major asset in Joe’s (or Mary’s) estate, the estate tax can be paid in installments for up to 15 years with interest at a very low rate. Not only does the IRS get the estate tax, it now gets (even though a low percentage) interest to boot.

Normally this column tells you what to do to win the tax game, as opposed to telling you what not to do. OK, then. Here’s what you must do to check your estate plan and know it’s right for you and your family:

• The strategies you use must be initiated during your life (such as gifts, a grantor retained annuity trust or a family limited partnership), not at death (the three traps described in this article).

• When the entire plan is in place, your advisor should show you clearly that your total wealth will go to your family without being reduced in value by even one dime of estate taxes.

• Your advisor must get you into some kind of tax-free environment, such as an irrevocable life-insurance trust or some kind of charitable trust, immediately.

• You control your assets for as long as you live (or at least as long as you want) with the use of voting/nonvoting stock, a family limited partnership or various trusts.

• Finally, your assets are protected from creditors and lawsuits.

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Conquer the Estate Tax Legally

Wednesday, April 8th, 2009

When it comes to the wealth-robbing estate tax, almost every reader of this column who calls me asks this or a similar question.

“Irv, can you help me avoid (or beat/or kill/or finesse/and many more variations) the estate tax?” Often, an obscenity or two are tossed into our conversation.

If you are worth about $6 million (or less), the answer to the question is almost always “Yes.” Worth more? Usually, “No.”

Let’s talk real numbers: Say Joe is worth $10 million and Jack, $20 million. Both are married. Joe’s estate tax damage (using 2011 rates) would be about $4 million and Jack’s a tragic $9.5 million.

The higher your wealth, the less your chance for killing the estate tax. Ah, but we can always — yes, always — entirely avoid the impact of the estate tax.

For example, if you are worth $8 million, we know how to get the full $8 million (all taxes paid in full) to your family, or, if you are worth $80 million, the entire $80 million to your family.

Yes, it can always be done, whether you’re single or married, young or old, and even insurable or uninsurable.

Let’s play the game together. Substitute your own numbers into the little example that follows: Suppose you are worth $12 million and married.

(a) Subtract $2 million ($1 million if single), which leaves $10 million;

(b) then 50 percent times $10 million gives you your bitter estate tax bite;

(c) add 55 percent for your worth in excess of the $10 million.

Now, here’s the secret for legally avoiding the estate tax: create tax-free wealth. There are two ways: charity and life insurance. Both — if you do them right — put you in a tax-free environment.

Here’s a real-life story of Joe (a 63-year old business owner from Nebraska and married to Mary, age 62), who winters in Florida. Joe and Mary are worth $23 million. Using our little example, the estate-tax monster would eat $11.05 million of their wealth.

We designed a comprehensive and coordinated succession plan and estate plan for Joe and Mary that included four significant strategies:

(1) an intentionally defective trust to transfer Joe’s business to his two business kids, tax-free;

(2) a family limited partnership for their investment assets (a stock and bond portfolio and real estate);

(3 and 4) using two different life-insurance strategies, which are described below.

A side note before continuing: Every case is different. A big factor for Joe and Mary was their health: excellent for their age.

Now, Strategy No. 3: Joe had $.8 million in his company’s 401(k) and $1.5 million in various IRAs, which we transferred into the 401(k), a tax-free transfer.

Then we used a strategy called the “Qualified Plan Rescue” (QPR) for the 401(k) that purchased $6.5 million of second-to-die life insurance on Joe and Mary.

Because of double taxation — first income tax and then estate tax — the $2.3 million in the 401(k) (without the QPR) would only net about $600,000 to Joe’s heirs. Sorry, but the tax collector would get the rest: $1.5 million.

The QPR allows the entire $6.5 million of life insurance to go to Joe’s and Mary’s heirs, tax-free. In effect, we turned $.6 million into $6.5 million. Neat!

One more point: We showed Joe how to invest his $2.1 million funds in his 401(k) in TIPs (“transfer insurance policies,” a form of senior settlements). TIPs earn in excess of 16 percent on average per year, without risk. Joe’s investments were averaging only 7% per year with stocks, bonds and mutual funds. TIP investments are the creative idea of a 14-year-old public company (trades on the NASDAQ) that has paid a 16.36% average annual return since it has been in business.Ask your professional to check out QPRs and TIPs.

Finally, Strategy No. 4: Joe and Mary needed an additional $5 million of life insurance. At their age (if you don’t use a QPR) the premiums are steep. We used a strategy called “premium financing” (PF) to buy $5 million of life insurance on Joe’s life. PF allows you to buy life insurance without paying your premiums in cash. Instead, premiums are paid by having a trust you create pay each premium by the trustee signing a nonrecourse note to the lending bank. Interest is added to the loan.

All premium loans, plus accrued interest, will be paid out of the death benefits when Joe dies. The only costs paid by Joe are to the banks for initiating and maintaining the loan: about $60,000 paid the first year and an additional $180,000, which will be paid in small amounts each year to age 100.

Here a real economic home run: getting $5 million tax-free to Joe and Mary’s heirs for a small out-of-pocket cost of $240,000 (or less), which is paid over about a 30-year period.

No question about it, PF is the most inexpensive way to buy life insurance (whether you buy $5 million, $10 million or more). You must qualify to use PF: be credit worthy and worth a minimum of $5 million.

These subjects — QPR, TIPs and PF — always create a blizzard of questions. So, if you would like to get more information about a QPR (and/or TIPs), send me your birthday and your spouse’s birthday. Also the total value of all of your qualified plans: 401(k), IRAs, etc. (total should be $100,000 or more). Write “QPR” at the top of the page.

Interested in TIPs? Fax the estimated amount you may invest ($50,000 minimum).

You must be an accredited investor. Write “TIPs” at the top of the page.For all inquiries please include your name, your company name, home or business address, e-mail address and all phone numbers where you can be reached (home, business and cell).

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A Review of Gift-Tax Rules to Enchance Your Family’s Wealth

Tuesday, April 7th, 2009

Applause! Applause!

Congress in 1998 buried an old and onerous gift-tax killer rule. Yet few people are aware of the tax-saving advantages of the new law.

First, some background. Gifts to your spouse are sheltered by an unlimited marital deduction, no matter how much the gift — during life or at death — there is no gift tax or estate tax. For lifetime gifts to all other individuals, the first $12,000 ($24,000 if married) is also exempt from tax.

A gift-tax return is generally not required for gifts qualifying for the marital deduction. On the other hand, a gift-tax return must be filed for all gifts in excess of $12,000 per donee (the person receiving the gift) per year.

Just like your income-tax return, your gift-tax return is due on April 15. For example, taxable gifts made in 2005 should have been reported on a gift-tax return filed by April 15, 2006. The IRS has three years from the date a gift-tax return is filed to make a gift-tax assessment. So, if the IRS decides four years down the road that a gift was worth more than the value shown on your timely filed gift-tax return, it’s out of luck. The IRS cannot assess any additional tax on the gift.

In the past, there was a catch.

Again, some background. The estate and gift taxes are unified so that a single graduated rate schedule applies to cumulative lifetime and death transfers. As a result, the final tax on your estate depends on the amount of taxable gifts made during your life.

The more lifetime taxable gifts, the higher your estate tax.

Sad but true, the courts allowed the IRS to revalue gifts — even after death — in order to determine the decedent’s estate tax. While it was too late to assess additional gift taxes on the gift (because the three-year time period had run out), the revalued gift could bump the estate into a higher tax bracket and cost — often huge — additional estate-tax dollars.

If the IRS claimed that a lifetime gift — very often the stock of a family business — was seriously undervalued, the tax on the estate would skyrocket. The estate had a tough time proving that a business valuation made years earlier (5, 10, 15 years or more) was and is still correct.

OK, let’s hear the drumroll for the new law:

For gifts made after Aug. 5, 1997, the IRS can no longer revalue lifetime gifts for estate-tax purposes. You must only jump through one hoop: report the gift on a gift-tax return. The value of the gift must be shown on the return or disclosed on the return or an attachment in a manner adequate to disclose to the IRS the nature of the gift.

After three years, the IRS (and you) are bound by the values shown on the return.

The door is, however, still open for the IRS to revalue some gifts:

• Any gift made prior to Aug. 6, 1997;

• A gift-tax return is filed, but the gifts are not properly disclosed or reported;

• Gifts not shown on a return;

• No gift tax return was filed because you thought the gift was worth $12,000 or less.

Here’s what to do for absolute protection:

Except for cash gifts under $12,000, report all gifts — particularly gifts involving the stock or an interest in any kind of family business or partnership — on a timely filed gift-tax return.

The more you are worth, the more your estate plan should include a well-thought-out lifetime plan, which includes a gifting program to the next generation.

Generally, cash gifts are a no-no. Leveraged gifts (usually involving a family limited partnership (FLIP), intentionally defective trust (IDT) or one or more of the dozens of life insurance strategies, are smart. They beat up the IRS legally and keep you in control of the gifted assets for as long as you live.

Gifting (using an FLIP, IDT or life insurance) is only one of 22 strategies used to legally avoid the estate tax. Learn how and when to use all the strategies —whether you are worth $2 million or $20 million.

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Please write a check to the IRS for $3,167,000

Sunday, April 5th, 2009

Through the years, our office has listened to an endless stream of taxpayers complain about the income tax.

But if you ever want to see anger, frustration and bitterness, meet with the beneficiaries (usually the kids) of an estate when they are told to write a seven- or eight-figure check to the IRS — for estate taxes.

Taxes that could have been avoided with proper planning.

Tragic!

A recent post-death estate planning consultation got us thinking about what you are now reading. Yes, the estate tax was exactly $3,167,000 after Mom died; Dad had died six years earlier. The really sad part of this story is that Dad’s and Mom’s entire estate tax liability could have been legally avoided with a rather simple estate plan.

Mom and Dad were survived by three kids and eight grandchildren. The business that Dad started back in the mid-50s was worth $4.5 million and owned 100 percent by Mom when she died.

According to Dad’s estate tax return, the business, which he left to Mom, was worth $2.9 million when he died. No estate tax (because of the marital deduction) was paid when Dad died.

Dad and Mom had a typical estate plan: a will and a trust. The trust created two trusts: one trust to take advantage of passing $1 million tax-free (the amount that was tax-free when Dad died) and a second trust to capture the marital deduction.

The tax-free amount is $2 million in 2006, rising to $3.5 million in 2009 and back to $1 million in 2011.

There is no estate tax if you die in 2010. I’m betting Congress will change these amounts before 2010 (or sooner).

The real answer (to why many people procrastinate and don’t complete a comprehensive estate plan during their life) is the deceased person whose estate caused the tax did not have to personally write that big check to the IRS.

Whenever we are about to plan an estate, we estimate the amount of estate tax that ultimately will be due.

Then we ask the client to write a check to the IRS for that amount. The client always gets the point. Then, we plan the estate so the client’s wealth goes to their family, instead of the IRS.

The plan must be a lifetime plan, that implements the proper strategies, as necessary, during your life. A plan contained in the typical will and trust-like Mom’s and Dad’s above-only enriches the IRS.

The person (your executor) who must write the check to pay your estate tax is helpless when it comes to minimizing or eliminating the estate tax. Only you, while you are alive, can eliminate the estate tax… by creating the proper comprehensive estate plan.

Here are the three things you can do to drive the estate-tax devil away:

(1) Learn all you can (this column is a good start);

(2) No matter what your age, put a complete estate plan into place now (then monitor it every two to four years);

(3) Only work with experienced professionals who can show you how to pass all your wealth — intact —to your family (if you are not sure, get a second opinion).

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You can win big-time by investing in others’ life insurance

Sunday, April 5th, 2009

The stock market is uncertain. Often net losses exceed net gains. So-called traditional safe investments — CDs, treasury bonds, municipal bonds and the like — offer only paltry returns.

Is there an investment that can match the potential high returns of successful stock market investors, yet has the prime characteristic (no-risk) of traditional safe investments?

Yes!

Chances are you have never heard of investments called life settlements. They also are often called Transferable Insurance Policy or TIP(s). The best way to understand how a TIP works is by an example.

Let’s say Joe, 68 years old, owns a life insurance policy with a $500,000 death benefit and a $60,000 cash surrender value (CSV). Joe would like to stop paying premiums. Of course, he can cancel the policy and get the $60,000 CSV from the insurance company.

An investor (really a group of investors) buys Joe’s policy for $150,000 — paid in cash to Joe immediately. The investors now own the policy. The investors will receive the $500,000 death benefit when Joe dies.

Let’s say you are one of the investors. You invest $100,000. You will wind up with a diversified portfolio of TIPs. One of the TIPs will be a fractional interest in Joe’s $500,000 policy — say 3 percent — or $15,000.

This TIP (Joe’s) will pay you exactly $15,000 (includes your principal — amount invested — and profit) when Joe dies. The insurance companies love people like Joe when they terminate their policies. And why not? The insurance company pays a mere $60,000 for the CSV and is off the hook for a $500,000 death benefit.

Terminated policies are highly profitable for insurance companies. Of course, they want to keep the entire life settlement industry a secret. Why? Because investors — like you — now have found a simple and easy way to help the Joes of the world and at the same time stand tall in the profit shoes of the insurance companies. Neat!

As a TIP investor, you can enjoy:

• An average rate of return of 16.32% per year.

• Not worrying about the market being volatile or whether it goes up or down.

• The guaranteed return of your principal, as well as your profit.

• And best of all, keep 100 percent of the profit because there are no fees or costs when you buy a TIP.

What are the tax consequences of your TIP profits?

There are only two simple rules: (1) The tax on your profit is deferred until you actually receive your principal and profit; (2) Your profit is taxed as ordinary income (profit earned by a qualified plan-profit-sharing, 401 (k), IRA and the like-are deferred until distributed).

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Don’t go overboard with one kind of tax strategy

Saturday, April 4th, 2009

Professionally, my second love is writing this column. My first love is consulting with the people who read it.

Every family I work with is different. So are their businesses, their situations, their problems. In spite of these differences, I’m rarely surprised by anything totally new. But one reader sent me something I had never seen before.

Here’s the story.

After about an hour on the phone discussing an estate plan, son Sam calling at the request of dad Joe agreed to send me some typical information: tax returns, financial statements and a copy of the existing plan. About one week later, a heavy box arrived with a five-inch stack of documents. About four inches worth were nine separate family limited partnerships. They were the same except each partnership owned a different asset: the family business, a residence, investments, etc.

As I thumbed through the papers, I couldn’t help thinking about the drunk who was told, “A shot of whiskey each day is good for you.” The guy who did Joe’s estate plan was clearly drunk on partnerships.

One thing should be made clear: I am an enthusiastic cheerleader for the use of limited partnerships in estate planning. Use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

Using the computations of the adviser, the IRS would get more than $2 million in estate taxes. Another $1.1 million of IRS enrichment was likely because of a gross misuse of the partnership strategy.

What does a family limited partnership accomplish? It allows you as a general partner to totally control the use of any asset transferred to the partnership yet reduce the value of the assets transferred. For example, $1 million of assets transferred to a partnership are usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percentestate-tax bracket would reduce your estate-tax burden by $192,500. Not bad!

A familylimited partnership is also a great asset-protection strategy. Creditors can’t get at the assets in the partnership. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a partnership is almost a perfect tax tool. In general, don’t use them to own the stock of your family business. Nor should one be used for non-income-producing personal assets, like a home or car. It’s a valuable strategy for almost every other asset you might own: publicly traded stocks and bonds, real estate, you name it.

Without covering every detail, we terminated the partnerships that held the family business and two family homes. The business elected S corporation status and was transferred to an intentionally defective trust, and the residences were transferred to qualified personal residence trusts. Those are similar concepts that allow you to heavily discount the value of the assets transferred to them.

We used the liquid assets in two other partnerships to pay the premiums on second-to-die life insurance on Joe and his wife, which was owned by an irrevocable life insurance trust that we created. That trust removes life insurance from the taxable estate of the husband and wife.

When all the smoke clears, Joe and his four children, including Sam, will be enriched $4 million to $7 million more than the original overkill plan, depending on how long Joe and his wife live.

One warning: This is an example of overindulgence in one tax strategy. Although the above descriptions cover the main points of how Joe’s problems were solved., this is not a do-it-yourself kit. There are a number of traps and exceptions. Only proceed with the help of an expert.

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Save by getting the real estate out of the corporation

Friday, April 3rd, 2009

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

Actually, we could write a small book about the various facts and circumstances you should consider. The book would answer many questions:

Are you a C corporation or an S corporation?

Are there retained earnings? How much?

How much has the real estate appreciated?

Each additional fact might change the tax strategy needed. To cover all the possibilities is beyond the scope of this column.

Instead, let’s set up the facts and circumstances that cover more 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

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

The Solution. Keep in mind that you don’t have to know how to build a car in order to drive one. Don’t sweat the technical details; just concentrate on the unbelievable favorable tax results.

Here’s the easy six-step process:

1. Joe forms a family limited partnership outside of Success Co. Then Success Co. contributes vacant land to the partnership. (If the land is improved, Success Co. keeps the improvements as leasehold improvements.) Say the land is worth $1 million. In exchange, Success Co. receives ownership of 99 percent of the limited partnership. Joe contributes $10,000 in cash for a 1 percent general-partnership interest. As the general partner, Joe has all the voting rights and makes all the decisions.

2. Success Co. leases the land for $100,000 a year.

3. An independent appraiser values the limited partnership interest at $600,000 after applying a 40 percent discount for lack of marketability. Yes, the $1 million property is worth only $600,000, because it’s in the limited partnership merely for tax purposes.

4. Success Co. contributes 99 percent of its limited partnership to a charitable trust with the following terms: The partnership will pay $99,000 a year to the trust for eight years. (Typically the trust then makes contributions to Joe’s Family Foundation. Follow the money: Success pays $100,000 rent to the partnership, the partnership pays $99,000 to the trust and the trust contributes to Joe’s foundation.

5. Joe’s children buy the remaining 1 percent interest from Success Co. According to the IRS, the value of the $99,000 the trust will receive over the eight years is $569,000. So the value of the part of the partnership that Success Co. still owns is $600,000 minus the $569,000, or $31,000. Simply put, Success Co. owns an asset that according to the IRS is worth $31,000. That’s how much Joe’s children pay.

6. After eight years, the trust ends. Joe’s children, who are the beneficiaries of the trust, receive and now own the 99 percent of the limited partnership. Remember, they bought the other 1 percent from Success Co. eight years ago. So Success Co. and the trust are out of the picture.

Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children.

And there’s a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the partnership, the trust, Joe, the kids and Success Co, except that Success might owe tax on the $31,000 sale.

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How to invest your accumulated cash profits

Friday, April 3rd, 2009

Business owners have many legitimate complaints these days: taxes, regulations, competition (from home and abroad), can’t find good people.

The list goes on and on. Always has, always will.

Yet the pride of the American capitalistic system is the successful family business. These entrepreneurs have found their way through, around or over the seemingly endless obstacles to become a “successful business owner.”

An SBO for short.

For the purposes of this article, SBOs have excess funds to invest (other than back into the operation of their business that produced the funds in the first place). Typically these excess funds are in one (or more) of three places: (1) still in the business, (2) in their (or spouse’s) name or (3) in a qualified plan (profit-sharing, 401(k), IRA or similar plan).

Over the years, the quote that follows has been nicknamed the SBO’s lament:

“I know how to make money in my business, but when it comes to making money with my investment money, either I don’t have time to watch it, don’t know how to watch it or rely on my investment advisor. When the market is up, my advisors do fine, when it’s down they do lousy.”

For the past couple of years, the lament usually ends with, “Now the market is lousy (or down, or uncertain, or similar words). What should I do?”

Now, regular readers of this column know that I am a tax planner prone to finding legal ways to avoid all types of taxes — particularly estate taxes. To do this requires, among other things, getting my client’s personal balance sheet.

Here’s what I can tell you that the balance sheets reveal about the investments of SBOs (and also other estate planning clients). Their success (or failure) in the stock market and a myriad of other investments, in general, mirrors the Dow Jones: happy on the way up and painful on the way down.

Usually, real estate investments are a winner.

Now what about that excess cash? Terrible results. Almost always the investments are conservative: divided between (1) CDs and money market funds, (2) municipal bonds and (3) a “zillion” variety of annuities. After taxes and inflation, your net earnings on (1) investments are typically less than 3 percent, sometimes even negative. Those income tax free bonds, (2), not only have a low rate of return, but fall in value when interest rates rise. Annuities, (3), could fill a large book to describe all the varieties and, most of all, the complaints from clients.

Never has a client told me that he/she is happy with the results of an annuity. (Sure would like to hear from a reader who has personally had a positive experience with any annuity.)

As you can imagine, almost every estate planning consultation with an SBO — and other clients — requires serious consideration concerning the client’s investments: safety, risk, tax consequences, rate of return and other factors. We discuss alternate investments, considering, among other things: profitability, risk and how taxed.

Currently, the most popular alternative investment is senior settlements (SS), also called Life Settlements. The following quote from The Wall Street Journal and USA Today (and other sources) tells you why SS are becoming such a popular investment.

“Life Settlements (have become a) trillion dollar industry, dominated by institutional investors including Berkshire Hathaway (billionaire Warren Buffet’s company), AIG and CNA. Their pursuit of this market is related to the degree of safety, high yields in excess of 15 percent per year and the fact that a Life Settlement is not affected by market forces.

“Life settlements are a very good option for the investor who has as his or her investment philosophy a desire for a secure, safe and ‘no risk’ investment. It is for your ‘nest egg’ money. It is not considered a security by SEC. Therefore it is not normally provided as an investment option by stock brokers.”

Of course, your question is: “Can a little guy (as opposed to an institutional investor) invest in SS?

Yes, it’s all made possible by a small, publicly traded (on the NASDAQ) company. Its average rate of return an SS investments has been 16.28 percent per year on average during the company’s 14-year operating history.

If you want to make a killing on your investments, SS are not for you. But if a 16 percent-plus rate of return, with no market risk is of interest to you (or your IRA, 401(k) or other qualified plan) fax me (847-674-5299) your name, address, phone numbers (business/home/cell) and estimated amount to invest ($50,000 minimum, for accredited investors).

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by Irv Blackman

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