Archive for the ‘General Tax Talk’ Category

The Wall Street Business Model is Broken

Friday, January 7th, 2011

Finally, a profitable way to fix it

Because this is a tax column, when readers call me to consult, taxes – usually concerning business transfer or estate planning – are at the center of the stage. Most callers are business owners.

Can you guess what the most common request for nontax help has been through the years and still is today?… Hands down, it is “Irv, how should I invest ______?” Okay, let’s fill in the blank: (1) my personal funds, (2) my IRA, (3) my company’s excess funds and (4) my company’s pension plan, profit-sharing plans or 401(k). Often the funds belong to mom or dad, the kids, one or more trusts or an estate.

Most business owners complain, “I don’t have time to handle my own investments” or “my investments turn sour” (“lousy,” or “lose money” or similar complaints).

Since the drubbing the stock market (read Wall Street) took during the recent recession, callers, including my estate planning clients, are pleading for investment help. Sorry, not my skill.

But their constant cries for help motivated me… not to become an investment expert, but to try and determine if there is a logical, profitable and safe alternative to the current way Wall Street does business.

What I discovered about Wall Street startled even me. This is a tough subject. I am about to kill some sacred cows. Let’s start by putting the current Wall Street business model on the table: The investor (Joe) buys a stock, bond or mutual fund. He pays a commission. If Joe has an investment advisor (Sam), he also pays Sam a management fee. Okay with me, if Sam delivers by having Joe’s portfolio go up in value.

But wait, what if the value of Joe’s portfolio goes down?… way down?… like 20%, 30%, even 40% or more? Everyone knows the sad answer: The same commissions and fees continue… increasing your losses. Can you name another industry or even one business that survives over time when it does not deliver its promised product or service?

How has this insane business model survived decade after decade? My research reveals the answer. Jim Shepherd, the author of the Shepherd Investment Strategist says it best:

“The media now calls the last ten years the “lost decade.” But it did not seem “lost” as they reported… Instead, viewers [of TV, radio listeners and print readers] were hit with an unceasing litany of omission and positive spin, effectively coloring a gloomy economy consistently brighter, But why the spin?

Because the media relies on advertisers… they must report the news in a manner that pleases the advertiser or the advertiser takes their business elsewhere… large brokerage houses… want investors to keep buying, or at least not sell stocks. The media is pressured to report financial releases as “news” in as positive a manner as possible.

Over the last decade, this positive spin met its purpose: it kept most investors in equities, even though equities lost almost 35% over ten years!”

Shocking!

Bad enough. But even worse, my research revealed what should be a national scandal. Some quotes from an excellent article by Eleanor Laise in January, 2009 titled, “Big Slide in 401(k)s Spurs Calls for Change,” exposed the scandalous story:

“About 50 million Americans have 401(k) plans, which have $2.5 trillion in total assets, estimates the Employee Benefit Research Institute… In the 12 months following the stock market peak in October 2007, more than $1 trillion worth of stock value held in 401(k)s and other “defined contribution” plans was wiped out…

“the most obvious pitfall…401(k) plans. Shift all retirement – planning risks – not saving enough, making poor investment choices – to untrained individuals, who don’t have the time, inclination or know-how to manage [the risks].”

The plain fact is that the investment losses outlined above are the result of an invest-in-equities, buy-and-hold mentality.

To be thorough, my decision was to research traditional conservative investments. First, municipal bonds: A large number of reliable sources thought municipal bonds (and bonds in general) could be the next bubble about to break. Why?… Interest rates are at an historic low. If (more likely when) rates go up as predicted, along with anticipated inflation, the value of bonds will plummet.

Any hope for other conservative investments? Well, take a deep breath and read what Kiplenger said in its November 2010 newsletter:

“Short-term interest rates are headed even lower… to zero on certificates of deposit with terms under 12 months as well as money market accounts. The average for CDs now 0.85% and likely to slip an additional 5 basis points a month… Money market accounts are typically paying even less, roughly half a percent.”

Now we are ready for the good stuff… information that will help you recapture the profits of yesteryear. Let’s start by looking back at how easy it was during the 1980s and 1990s to hire an investment advisor and get those delightful profitable results as the equity markets roared higher.

What changed?

As we entered the 21st century, the market switched from a bull market to a secular bear market. A what? Secular bear markets are defined as periods of great volatility (drastic up and down price movements in stocks, indexes, mutual funds and other investments) of investment returns with little or no upward price movement, even though the trading range is large.

For example, say an index today is at 1,000. The index yo-yos back and forth over some period of time (it could be a week, month, year or more) within a range that reaches a high of 1,333 and a low of 691. At the end of the period (say two years) the index closes at 1015… a tiny 15 points up… a rise of only 1.5%.

Such secular bear market periods last – based on market history – between 17-25 years on average.

Following are the unhappy numbers of what actually happened during the last four secular bear markets with the S&P 500 stock index.

Market Period Annualized Rate

Of Return
2000 to present (11/30/10)* Loss of .43%
1966 to 1982 Gain of .83%
1929 to 1953 Gain of 1.69%
1906 to 1924 Loss of 4.29%

* Current secular bear market should end between 2017 and 2025.

The lesson is clear: Buying and holding securities just does not work during secular bear markets.

The real question is, can you make money  during a secular bear market? Yes, but only if you have a proven plan that identifies when market conditions (related to your portfolio) clearly show a change in market direction may be coming.

This is where the investment strategy known as “TREND FOLLOWING” shines. This strategy does not attempt to predict market or stock movements. Instead, the strategy capitalizes on the natural market’s movements (really the volatile ups and downs) whenever or wherever they occur. Trend following managers take advantage of what is actually happening in the market, rather than trying to guess what may happen in the future.

Trend following turns volatility from a foe into a friend. A trend is a strong, sustained move that can last from several days to a number of years. A trend may be rising or falling and is applicable to any specific security or index… or a commodity (like oil, gold or the Euro).

How does a portfolio manager who is a trend follower make money?… He waits for the market to develop a new trend and then invests with that trend, holding that position until there
is a reversal. The manager does not invest at the exact bottom because he wants confirmation that a turn (reversal) has occurred. Likewise, the manager will generally not sell at the exact top (which is more easily identified after the fact). The manager will sell after a clearly identified change in trend (reversal). Therefore, the manager is able to capture 80%-90% of the trend.

What a great concept… You make money when the same investment trends up and make money again when it reverses and goes back down… Then start all over again. Fine, I like it. But where do you find a trend-follower manager with a proven track record?

Enter lady luck. Success! Found a firm that has been using the trend following strategy since 2006. The results: Positive double-digit annual returns every year… and when the stock market crashed in 2008, their return was up over 23%! (Remember, prior results do not necessarily predict future results.)
An exciting fact: The system was designed and implemented by a portfolio manager hired by Sir John Templeton to manage a mutual fund in an advisory firm owned by Sir John’s family. The portfolio manager also received a 5-star rating for the last 10 years.
If you want to make a killing in the market, this strategy is not for you. However, if you want to shoot for a conservative, steady and proven return, you’ll embrace the trend following system.

The SEC rules require that you (and your spouse combined) must be worth at least $1.5 million (including your home, IRA and other assets). Want more information? Send me (Irv) a fax (to 847-674-5299) with your name, address and all phone numbers (business, home, cell)… on your stationery if you own a business. Mark “TREND FOLLOWING” at the top of your fax.

Posted in General Tax Talk | Comments Off

Careful: when your well-meaning professional says, “it won’t work,” it usually means, “i don’t know” (10/09)

Wednesday, March 10th, 2010

I’ll bet the farm that this article will save many business owners (who want to transfer the family business to their kids) a ton of taxes.

Let’s set the stage by quoting an email a loyal column reader sent to me: “Mom is 82 with an estate worth about $20 million. Included is an S corporation, recently valued at $1 million for IRS purposes. My dad started the company and ran it until he died two years ago.”

“Sam [my brother] and I [Larry] are the only heirs and want to continue to run the company. You state in your articles that the estate tax can be avoided completely [true]. Mom has excellent tax attorneys and CPAs who say it can’t be done with an S corporation… they have done what they can… but my brother and I will end up with a $7 million tax bill payable over 15 years.”

Note to the editor: If the article has too many words, eliminate the following that is underlined.

Over the years, the above quote describes two important facts: (1) Succession is the most common problem that perplexes business owners who want to sell /transfer their business to their kids (or employees) and (2) their professional advisors are stumped when it comes to most tax effective way to implement the sale/transfer.

First, let me come to the defense of my fellow CPAs and lawyers (I am both). None of us knows it all. Certainly not your author, who is by education, reputation and experience supposed to be a tax expert. Well, the fact is I don’t know how to prepare my own tax return (it’s done by one of the partners – a smart woman CPA – of the CPA firm I founded over 50 years ago). Yes, experience is a key factor, but significantly more important is to know who to call – either in your

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own firm or another firm when necessary – when you don’t know the answer to your client’s problem(s).

Next, let’s (1) set up the problem the way it comes up most often in real-life (the

business owner is married); (2) what most professionals get wrong; and finally (3) the solution.

Okay, here’s the typical problem: Joe (married to Mary) owns Success Co., which is worth say $10 million. Steve, Joe’s son, runs Success Co. The plan proposed by Joe’s professionals is for Steve to buy Joe’s stock for $10 million (to be paid over 10 years).

Steve must earn about $16 million, pay $6 million in income tax to have the $10 million to pay Joe. Joe must pay about 1.5 million in capital gains tax… only $8.5 million left. So, Steve must earn a stratospheric $16 million for Joe’s family to keep $8.5 million. That’s nuts.

Lesson #1: A Sale of all (or even a portion of your stock) to your kids is a lousy idea for tax purposes.

Sometimes professionals use various strategies (most likely a stock redemption or stock purchase agreement) requiring insurance on Joe’s life as a means to get the company stock to Steve. Better than Lesson #1, but the IRS will collect estate taxes on every dime of that life insurance (roughly $4.5 million to the IRS on $10 million of insurance using 2009 tax rates). In most real-life cases the insurance is either too much (stock was gifted to Steve while Joe was alive) or too little (Success Co.  just kept growing in value).

Lesson #2: Life insurance can play an important part in your estate planning, but never (and I mean NEVER) use it in a business succession plan to get your Success Co. stock to your business kids. You’ll always guarantee the IRS a big pay day when you go to the big business in the sky.

Now, let’s give credit to the professionals Sam and Larry’s Mom are using. They avoided the pitfalls in Lessons #1 and #2. True, there would be an unnecessary $7 million estate tax bill, but they jumped on Section 6166 of the Internal Revenue Code, which allows certain business owners to pay their estate tax liability over a 15-year period, plus a low rate of interest (not

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deductible) on the amount of estate tax due. Never in my 50-plus years of practice have I used Section 6166 as part of an estate plan. Why?… It cannot save a penny of taxes, just stretches out the time of payment.

In every case my network of professionals has been able to pass all of each client’s wealth (whether worth $5 million or $50 million – or more) to their heirs 100% intact (no tax or all taxes paid in full). For example, if the client is wroth $5 million, the entire $5 million to the client’s heirs, if $50 million, the entire $50 million to their heirs.

Lesson #3: Never use Section 6166 as part of your overall estate tax plan. Instead, create a comprehensive plan (as described below) to eliminate the estate tax.

Now let’s turn to the solution for the typical family business owner (the Joe’s of the world) who wants to transfer his business to his kid(s). Most business owners have four kinds of assets: (1) the business (Success Co.); (2) a residence (often 2 or more); (3) funds in a qualified plan (for example, an IRA, 401(k), profit-sharing plan or similar plan); and (4) investments (like real estate, stocks, bonds cash, CDs and other investments)

The solution (really a System to create a comprehensive plan) requires two plans: first a traditional will and trust (one for Joe and one for Mary). This is really a death plan. It cannot save you a dime in taxes. It just defers the estate tax blow until both Joe and Mary have gone to heaven.

The second plan – a lifetime plan – beats up the IRS… legally.

Let’s look at the lifetime-plan strategies most often used in practice. The System uses strategies that are implemented during your life and are based on the assets you own.

1. Your business. We use an intentionally defective trust (IDT), which means the trust is intentionally defective for income tax purposes. What does this accomplish?… The transfer of the Success Co. stock (typically nonvoting stock, while Joe keeps the voting stock and control) is tax-free. The tax savings – compared to selling the stock to the kids – usually are

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$456,000 per $1 million of the value of Success Co. ($5,016,000 for Sam and Larry’s mom; $4,560,000 for Joe).

2. Residence(s). The most common  strategy is called “50/50.” We transfer the title of each residence by having 50% owned by Joe’s traditional trust and the other 50% owned by Mary’s trust. Tax result?… We get about a 30% discount for estate tax purposes (for example a $600,000 house is only valued at $420,000 in the estate). Of course, Larry’s mom cannot take advantage of this strategy (her husband is gone).

3. Funds in qualified plans. These funds are double taxed. Sorry, but the IRS winds up with about 70%, the family only 30%. For example, $1 million in a rollover IRA will only yield $300,000 to the family. Ouch! We use strategies like a subtrust or retirement plan rescue to boost that $300,000 to the $2 million to $7 million range (all tax-free) depending on age and health of the business owner (and spouse if married).

4. Investments. A family limited partnership (FLIP) is almost always the strategy of choice. Joe transfers his investments to a FLIP (could be more than one FLIP). Immediately the value of the assets transferred to the FLIP are discounted about 35% for tax purposes. Hey, $1 million of intrinsic value is a worth only $650,000 for tax purposes… yields estate tax savings of $158,000. Works for Joe… and Larry’s mom too.

5. Still an estate tax liability: Often 1 through 4 above kills the estate tax liability. But what if it doesn’t?…. We fall back on one of about 20 life insurance strategies to create tax-free wealth (Easier if you are married,  like Joe and Mary because you can buy second-to-die insurance, which cost much less in premiums than single life) to pay the estate tax.

What if the business owner is uninsurable (and so is his wife if married)?… We then use a strategy called a charitable lead trust (works very similar to life insurance) to create tax-free wealth for the heirs. That’s exactly what Jacqueline Kennedy – who was uninsurable – did to get her heirs about $250 million… tax-free.

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Lesson #4: The System as described above always works (kills the estate tax)… whether you are young or old, married or single, insurable or uninsurable.

If your professional does not eliminate all of your estate tax burden, get a second opinion.

Posted in General Tax Talk, Irv Talk | Comments Off

At last, a tax law (captive insurance) that actually cuts your cost of doing business, while you and your business enjoy tax-advantaged benefits (05/09)

Friday, March 5th, 2010

The Internal Revenue Code is not a friendly creature. It is designed to “taketh” your money; “giveth” is not in its vocabulary. Yet, there is a section of the Code [Section 831(b)], dealing with captive insurance companies (Captives) that when properly used, is primarily an income tax-saving machine for your business and can be structured to offer tax-advantaged benefits that create wealth for you (or even your heirs).

A real tax winner.

About 80% of the Fortune 500 take advantage of the Captive benefits. But much smaller businesses can join the tax-saving/wealth-building fun. If you own all or a part of a business, listen up, you’ll love what you are about to read.

Note: The Obama administration has made it clear: Income tax rates on high earners are going up. As you are about to learn, a Captive is an especially welcome friend in a rising-tax-rate environment.

It’s difficult to find a CPA or lawyer who has even heard of Captives. The few that know Captives exist (like yours truly for many years) don’t have a clue of how to take advantage of the many benefits offered by Captives for family owned businesses or small public companies.

Just what is a Captive?… First and foremost it is a bona fide insurance company, an insurer established to provide coverage for the company or people who founded it. An example is the easiest way to explain Captives.

First, a simple example: Joe owns Success Co, which has some “uninsured risks” (explained in greater detail later) that his current property and casualty insurance (PCI)

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company will not insure. Joe creates New Co. (a Captive), a corporation, which is an insurance company (covering Success Co.’s uninsured risks). The stock of New Co. is owned by Joe’s children.

Now for the fun part. Suppose the insurance premium for the uninsured risks are determined (professionally by a consulting actuary) to be $500,000 per year. Success Co. pays the $500,000 premium to New Co. The entire premium is immediately deductible by Success Co. like any other PCI. You’ll like this: Under the Captive rules, all of the $500,000 is income tax-free to New Co.

Say Success Co. is in a 40% tax bracket (state and federal combined). Success Co. is only out of pocket $300,000 ($500,000 less $200,000 in tax savings). New Co. has the entire $500,000 to invest. A good start. But remember, New Co. is a Captive and must hold the $500,000, plus earnings as a fund to pay potential claims for the risks it insurers.

Next, let’s explain “uninsured risks.” Every business has risks: some insured, some uninsured. The most common risks – like workmen’s compensation, vehicle, property and general liability – are transferred to a third-party (your traditional property and casualty insurance carriers) and are insured risks.

Now let’s list some typical “uninsured risks,” the kind that you can’t buy coverage for in the traditional insurance market (as you scan down the list below, check off those that apply to your business):

  • Litigation defense/asset protection
  • Loss of a key customer
  • Loss of a key supplier
  • Change in a law/regulation/ruling
  • Product warranty
  • Product liability
  • Professional liability
  • Strikes/labor problems
  • Traditional policy exclusions/deductibles
  • Employment practices

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The list could go on and on. You probably have one or more uninsured risks peculiar to your business. Go ahead, add ‘em on.

Let’s face it, your business is self-insured for all of the above risks, either by choice or because the risk just can’t be insured commercially. A Captive reduces the amount needed to fund such possible future losses. How?… The premiums paid to your Captive are immediately deductible.

There are many more ways that the use of a Captive can save your business significant insurance costs. Following are two (of dozens of possible) examples:

Example #1. You own a new (or very up-to-date) building in an area with “zone coverage.” Your building is in total compliance with stringent building codes. Many older buildings in the zone are not complaint. Your building can obtain lower rates from your Captive if you can show that your building is a better risk than the Zone’s rating.

Example #2. Success Co. pays premiums to the Captive to insure for litigation defense, strikes and product warranty. Remember with a commercial insurance company (CIC), if the insured has no losses, the CIC keeps the entire premium. No refunds.

Even though a Captive cannot reduce (actuarially determined) premiums, a financial windfall results (unused reserve) if the insured’s actual losses are less than actuarially predicted. For example, suppose Joe’s Captive (New Co.) has an unused reserve. A portion of the unused reserve can be (a) refunded to Success Co.; (b) reduce future premiums; or (c) paid to the Captive’s shareholders (Joe’s children) as a dividend. Three nice fringe benefits.

There are a number of other what I call “fringe benefits” to a Captive structure. Following are a few: (a) Someday liquidate your Captive and take out the unused reserve at capital gains rates; (b) have the Captive invest a portion of its reserve funds to pay premiums for life insurance on the Captive’s founder or his family members (in effect, deducting the life insurance

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premiums); (c) use the Captive as an estate planning strategy, passing the Captive (and any life insurance proceeds) to your heirs.

Make no mistake, your Captive must be formed and operated for a business purpose. The Captive must demonstrate that it is, in fact, acting as a proper insurance company. Follow the rules and the IRS is not a problem. Try to fool the IRS by forming your Captive to take advantage of only the tax-advantaged fringe benefits, without a real business purpose, is almost certain to cause the loss of the sought-after benefits.

No attempt is made in this article to explore all the rules, traps and opportunities in forming your own Captive. It is essential that you work only with qualified, experienced advisors that specialize in Captives. The right advisors can easily tailor your Captive to fit you, your business and your circumstances perfectly.

Now the key question: Is a Captive for you?… If costs were not an issue, the answer would be a resounding ‘YES’ for almost every business. Unfortunately, costs are a factor. For a Fortune 500 company, it’s a slam dunk: The insurance cost savings and tax-benefits are well worth the required costs to create and administer a Captive.

If you can answer ‘Yes’ to any of the following questions, you should strongly consider forming a Captive:

    1. Is your before-tax profit $1 million (or more) per year?
    2. Are your traditional insured property and casualty expenses $1 million (or more) per year?
    3. Is one (or more) of the “uninsured risks” listed above (or one you added) a significant factor in your business?… and worth a premium of about $200,000 a year (or more)?

Logic tells you that the larger your business, the more likely a Captive should be a top priority for your next year’s business plan (i.e. make $1 million – before-tax – or more, Captive is

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a must). Costs are easily covered by Captive benefits.

But what about smaller family businesses?… The answer can be ‘Yes’ with a new strategy the experts have perfected, if your before-tax profits are in the $250,000 per year range. Benefits are the same as for a larger company but costs are substantially reduced.

What, you are even smaller?… well, we need your help. Show this article to the decision maker(s) of your trade association. Have your trade association adopt a Captive program… then you and the other members can participate. The cost is minimal.

Finally, if you are lucky enough to be a Florida resident and your business is located in any other state there is a little known – legal – tax strategy that enhances your tax savings.

How can you learn if a Captive will work for your business? Please fax the following (on your company letterhead) to 847-674-5299: Your name, title, type of business, total number of employees and any other information you think would be helpful. Also include all phone numbers where you can be reached (business, home, cell). If a trade association, please fax on your letterhead and include number of members and name of decision maker. Please mark “Captive” at the top of your fax.

Posted in Corporate Tax, General Tax Talk | Comments Off

Irv didn’t invent taxes, just 227 ways to beat them…legally! (01/09)

Tuesday, March 2nd, 2010

Would you believe just the basic tax law – the Internal Revenue Code and the regulations – have about 50,000 pages (small print). Complex! Changes abound! Most of all, no logical, organized theme!

Then there’s a constant stream of IRS rulings and case law. No one person can know it all… certainly not the geniuses in Congress that pass the law… or the IRS that is the designated driver to enforce it.

There are three main ways the federal tax law picks your pocket and becomes your legal partner: first, by taking a portion of your income in two ways… (1) payroll taxes and (2) income tax and finally, a huge slice of your wealth via (3) the estate tax.

Outrageous!

The purpose of this article is to show you how to fight back. One day, just for fun, we (four tax guys) started to count the ways to legally get around paying the three taxes listed. We were just getting warmed up, got to 227 and simply stopped.

Following are five of the dozens of tax-saving areas that come up most often, are not known by most professionals or prevent the biggest loss of your money to the IRS or others. All examples are of real-life taxpayers and readers of this column who asked for help.

A. Payroll taxes. This money-stealing parasite is persistent and expensive: in 2009 $16,404 to the taxman (employer and employee share) on your first $106,800 of earnings. That’s a scandalous 9.76%. Earnings above $106,800 (there is no limit) pay an additional 2.9%. Here are the three most common lose-payroll taxes-to-the-IRS mistakes: (1) Joe (the owner of an S corporation) taxes a large salary (often $500,000 or more) and takes a huge bonus at year end (to bring profits down). A dividend (tax-free if you are an S corporation) instead of

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compensation, would save a bundle of unnecessary payroll taxes and cost not one penny more in income taxes. (2) Wives (and often moms) of the owner taking a salary (either don’t work or way overpaid). Much better taxwise to give ‘em a gift. (3) Operating a business as an LLC, which makes all income to owner(s) subject to payroll taxes… a no, no. Fortunately, there is a way out of this payroll tax trap.

A check of our consulting files over the past three years revealed 11 different ways to save $10,000 or more per year on payroll taxes per reader/client.

B. Asset Protection. In a heartbeat your family wealth (including your business) can be depleted – even destroyed – by a law suit.

For your business, the core strategy is to keep your business thin: Only keep those assets – typically, necessary cash, inventory and receivables – needed for operations in your business. Here are the basics sub-strategies: (1) Elect S corporation status; (2) Any new real estate or expensive equipment (include the little stuff if it adds up) should be owned by you (via separate LLCs) and leased to your operating company. (3) Never, I mean NEVER, own delivery vehicles in your operating company. Put the vehicles into a separate corporation, LLC or just put your best entrepreneur-type driver in business and rent your old vehicles.

The sad fact is… we can’t protect the assets inside of your operating company. That’s why the above precautions. But we can protect you (and your spouse). We do it automatically, without additional cost, as part of your estate plan. All of your significant assets are simply retitled using typical lifetime planning documents – like a family limited partnership, LLCs and appropriate trusts – to protect your assets.

C. Life insurance, whether owned by you (or your spouse or kids), your business or some kind of trust. You are about to be delighted by what you read. Sorry, some of you will be horrified.

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Part of every estate plan we do is to have an insurance expert analyze all existing life insurance policies on you, your spouse and fellow business owners (stockholders or partners). Let’s start with the three critical issues concerning life insurance: (1) premium cost, (2) the death benefit and (3) the tax (usually the estate tax) due at death on the benefit.

Over the 45+ years that I have dedicated my practice to the estate planning area, we (me, an insurance expert and, when necessary, a lawyer with insurance expertise) have looked at over 1,000 insurance portfolios. Only four times did we find everything perfect. All the rest of the times (except when the insured was no longer insurable because of health issues), we were able to modify the insurance plans and save premiums (on average about $30,000 per year) or increase the death benefit (from $500,000 to as high as $11 million) without additional premium costs. Following are the most common situations that always delight our clients: (if the FACTS fit or are close to your situation, make sure to read the RESULTS.

1. FACTS: A cash surrender value over $200,000 on a policy that is 9 years old or older… can be single life or second-to-die. (RESULT: Significantly more death benefit for same premium cost or significantly reduced premium cost for same death benefit)

2. FACTS: You (the husband) are 55 years old (or older), worth $5 million (or more), and have insurance on your life only. (RESULT: You are wasting premium dollars… second-to-die coverage with your wife will typically give you the same death benefit for about 35% less premium cost.)

3. FACTS: You have $400,000 (or more) in a qualified plan (probably a 401(k) or IRA), which is subject to a double tax (income & estate) of up to 73% to the IRS. (RESULT: On average, you can turn every $270,000 of after-tax dollars into $3 million to $5 million (tax-free), depending on your age and health… works for second-to-die or single life.

4. FACTS: You are worth $10 million to $40 million (or more). (RESULT: You can buy $10 to $40 million of [single life or second-to-die] coverage with no out of pocket premium cost.)

A simple fact: Over 99% of the time a second opinion of your insurance situation, followed by proper planning, will save you significant premium dollars, increase the death benefit and/or make the insurance proceeds tax free. Be smart. Get a second opinion.

D. Your business and your business kids (essentially business succession). Here are the goals the typical business owner with kids in the business gives me:

1. Transfer the business to my kid(s) so I and my kid(s) don’t get killed by taxes.

2. Show me how to treat my nonbusiness kids fairly.

3. Make sure I stay in control of my business for as long as I live.

4. Make sure the company stock stays in the family (never goes to a kid’s ex-spouse).

Every one of the above goals is easily accomplished. We have done it hundreds of times. And best of all, the business can be transferred tax-free: no income tax, gift tax or estate tax for the owner or the kids.

E. Estate plan. A proper estate plan is actually two plans: a lifetime plan and a death plan. The plans are designed to cover every significant tax-saving possibility (many more than 227 ways)… from the minute the lifetime plan is created until you get hit by the final bus (covered by the death plan)… and yes, even after you’re gone.

The above is only the tip of the iceberg in don’t-lose-taxes-to-the-IRS planning. Want to learn more?… Browse my website: www.taxsecretsofthewealthy.com… Or in a hurry, call me (847-674-5295).

Posted in General Tax Strategies, General Tax Talk | Comments Off

How to turn a tax tragedy into a wealth-building miracle

Wednesday, April 29th, 2009

Do you have a large amount of money in an IRA, profit-sharing plan, 401(k) plan or other qualified plan? Or know someone — family, friend or co-worker-who does? Then, this article will not only save you a ton of taxes, but will show you how to dramatically increase your after-tax wealth tax-free.

This is one of those bad-news, good-news tax stories. First, the bad news. Some day the money in your plan must be distributed: to you or your beneficiaries. If you make the mistake of becoming rich, those beautiful dollars that took you decades to accumulate will be worth only in the 27 percent range to you and your family. You see, the IRS will get the rest in taxes. Yep, typically you will lose about 73 cents out of every dollar because you must pay two taxes on your plan distributions: income tax and estate tax. It’s even worse in some high-tax states like New York (check with your accountant).

How do I define rich? 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 assets whether you get plan distributions during life, or the distributions go to your heirs after death.

Can anything be done to prevent this tax 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). Well, some of the 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 your plans 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 tax action. Now, let’s look at each concept separately.

The first concept — called the Single Premium Strategy (SPS) — to overcome the tax robbers combines three strategies:

• An immediate-pay annuity (typically a joint-life annuity if you are married);

• A life insurance policy (second-to-die if you are married) and;

• 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.

The second concept is named Retirement Plan Rescue (RPR) When using an RPR, your qualified plan 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 the above strategies are to do. So, if you are lucky enough to be rich, but unlucky enough to have a substantial part of your wealth in a qualified plan (IRA, profit-sharing, 401 k or similar plan), you owe it to your family to take a close look at the above two tax-miracle concepts and it’s easy to do.

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

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Don’t Lose A Lifetime Of Wealth To The IRS

Saturday, April 18th, 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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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 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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Sick of paying tax? Call a tax doctor for a second opinion

Friday, April 3rd, 2009

Often, I feel like an old-fashioned country doctor makin’ house calls. But there is a difference: my patients are sick of paying taxes.

Recently, I visited a successful family business in North Carolina, owned by a semi-retired 64-year-old named Joe and run by his son, Sam, a 36-year-old.

Joe called me. He wanted a second tax opinion for a business transfer plan and an estate plan put in place by Sam (with the advice of his professional advisors, the “best” estate planning team in the county) almost two years ago.

Wow, this patient was really sick (running a high tax fever, bleeding lots of tax dollars).

This is the story of the symptoms, the diagnosis and the “magic tax potions” that cured the patient.

First, the facts:

Joe owns 98 percent of two corporations: a profitable S corporation (Success Co.), which operates a string of stores, and a C corporation (a tax-paying corporation, called R/E Co.), which owns real estate leased to Success Co.

The real estate has an income tax basis of $1 million, but a current fair market value of about $6 million. Sam owns the remaining two percent of the stock of both corporations. Each of the corporations is the owner and beneficiary of a separate $1 million insurance policy on Joe’s life.

Four more little details:

• Joe’s second wife, Mary, is 45 years old and they have a premarital agreement that gives Mary the income from one-half of the value of Joe’s assets at his death for as long as Mary lives. But get this: none of the stock of Success Co. can be used to provide Mary her income.

• An artificially low price in a buy/sell agreement would force Joe’s estate to sell his stock in Success Co. back to Success Co. and the same for R/E Co. (Result: Sam would then own 100 percent of both corporations.)

• Joe has two other grown children who are not in the business.

• Joe is not insurable.

The diagnosis:

• The $1 million in life insurance payable to R/E Co. would kick up an unnecessary alternative minimum tax.

• The full $2 million of insurance would be included in Joe’s estate because he controls both corporations, but the $2 million (less the alternative minimum tax of about $150,000) would belong to the corporations, not Joe’s estate.

• There are not enough liquid assets to satisfy the obligation to Mary. Worse yet, if the obligation to Mary is met, there would be zero dollars (outside of the corporations) to pay an estimated $3.5 million estate tax liability. Simply put, the estate would be broke.

Our objectives to cure Joe’s tax illness are clear:

• Reduce the value of Joe’s estate.

• Get cash to fund the obligation to Mary.

• Pay the estate tax.

Here are the five major tax medicines I recommended to cure Joe’s business transfer and estate plan:

• Merge R/E Co. into Success Co. This maneuver is tax-free. R/E Co. is worth about $6 million as a real estate investment company but, as part of the operating company, its value is reduced by at least $2 million for estate tax purposes. Estate tax saving — over $1 million.

• Transfer the nonvoting stock (created after the merger) to a grantor retained annuity trust (GRAT), which reduces the value of Success Co. by about 40 percent for estate tax purposes. This maneuver saves about $.5 million in estate taxes.

• Joe takes the $2 million in insurance policies out of the corporations and gives it to his children. Result: The value of Joe’s estate drops about $2 million and will save another $1 million plus in estate tax.

• Change Joe’s will to put the entire estate tax obligation on the children. The $2 million in income tax-free/estate tax-free insurance proceeds will handle the entire estate tax load when Joe dies.

• Make sure Joe’s will qualifies for the 100 percent marital deduction for Mary’s one-half share, thus deferring any estate tax on this portion of Joe’s estate until Mary dies. Yes, there are other details and nuances in the plan, including gifts to Joe’s children, but these five tax medicines cured the patient.

What’s the lesson to be learned from this true-life Joe/Sam/Mary story? Always, yes always, get a second opinion after your estate plan is done, preferably before any documents are signed.

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Want to keep top execs?

Friday, March 27th, 2009

I spend most of my consulting time putting together wealth transfer plans for successful business owners. About half of my clients bring up two critical and related operational problems:

• “How do I keep my top executives?” (The headhunters — usually working for a competitor — are always circling.)

• “How do I attract new quality people?”

The problem is not new. It’s been a problem in the past and likely will get worse in the future as the bidding war for talented people escalates.

What to do?

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

What quickly became clear was that almost 100 percent of the best key people had the souls of entrepreneurs. But for various reasons they did not want to strike out on their own or couldn’t — usually because they couldn’t raise the required capital.

Solving the top-executive problem turned out to be simple.

Mimic ownership — give ‘em the same challenges as an owner and, if they’re successful, most of the rewards.

Additional interviews just kept confirming the original solution.

The top non-owner executives wanted four core benefits of ownership:

• A piece of the action (a share of company profits).

• Getting paid when they were sick or became disabled.

• Receiving adequate retirement pay when it was time to leave the company.

• Death benefits for their family. Most executives put it this way, or in similar words: “Like my piece of the equity if I get hit by a bus.”

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

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

A piece-of-the-action plan

Typically, this is a percentage of the profits in excess of a specific dollar amount. Often, the percentage grows as the business and profits grow.

For example, Sam Topgun will get 4 percent of all before-tax profits in excess of $200,000 per year. Profits in excess of $400,000 will be entitled to 6 percent.

Say the amount earned under the plan for year one, or any subsequent year, is $21,000. Usually, Sam will get about one-third ($7,000) in cash, and the balance ($14,000) is deferred. The deferred portion is invested for Sam’s benefit.

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

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

Disability

The employee gets paid when sick or disabled — whether for a day or for a lifetime. This benefit is covered by long-term disability insurance.

It is essential that disability is defined word for word in your agreement — the same as it is defined in the disability insurance contract.

Retirement

The side fund (described above) supplements any regular retirement program, like a 401(k) or profit-sharing plan.

Typically, the executive is allowed to direct the investment of the side fund, which remains an asset of the employer.

The tax consequences of the arrangement:

• The side-fund earnings are taxable to the employer.

• When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income.

If the employee leaves for any reason — except for disability, death or retirement — the entire side fund is forfeited by the employee and remains the property of the company.

Hence, the name “golden handcuffs.”

A set amount of money at death

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

We have been doing these nonqualified plans for years.

Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings:

• This column does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always, and we mean always, work with an experienced adviser. Years of experience have proved that the right agreement will make your good people even better.

• Sadly, we have never seen an agreement that will make a bad employee even a little bit better.

In a way, getting and keeping good people is a frustrating subject. The reason: We have never been able to develop a cookie-cutter solution.

Yes, the four core benefits are almost always the same or similar. But the bells, whistles and unique requirements of each situation make it impossible to write a complete report — much less a book — on the subject.

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