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.

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

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

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

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

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

Almost always, the original reason a client calls is to ask me to create an estate plan that would kill the estate tax.

Everyone loves to beat up the IRS. Ah, such delight when they find out that avoiding the impact of the estate tax is the easy part.

So what’s the hard part?

Satisfying everyone in your family is by far the greatest challenge. Usually, the more kids, the tougher. Remember, those little kids grow up, get married and each “I do” brings a new son-in-law or daughter-in- law. Often, the growing family brings different opinions.

Life goes on.

Well, you get the idea.

Oh, and before we forget: Soon those cute — and almost always wonderful— grandchildren come along. And if you and your spouse live long enough, those little grandbabies repeat the cycle (grow up, marry, have babies of their own). The family grows bigger. That’s good. Yet now there are more family members to satisfy.

Let’s take a closer look at this trying-to-satisfy-every-member- of-the-family problem. What’s interesting is that a bit more than half of the time there is no real problem. Sure, there are differences from time to time, but the typical family knows how to deal with issues as they pop up. Then my job is easy. All efforts can be directed toward creating a plan that solves the lifetime goals of the family.

Beating up the IRS always is one of the goals.

But what happens when one or more of the family members just can’t be satisfied?

Unfortunately, my sad experience is most people do nothing. Since they can’t solve the problem — either as they see it or as some other family member sees it — the problem persists and festers.

Ultimately, Mom and Dad die. It’s tax disaster and the IRS wins.

Can such a result be avoided?

Almost always, the answer is a loud ‘Yes.’

But first, let’s divide the differences into two clear and separate categories: financial (money) and emotional (the full range of human feelings, more often than not without any logical explanation).

Money differences are the most common and are the easiest to overcome to everyone’s satisfaction. How?

Get everyone involved (usually only direct family members and no in-laws, subject to rare exceptions) in the same room at the same time. A moderator posts everyone’s likes, dislikes, wants, goals or whatever else is involved for all to see. Only one person speaks at a time. No discussions. No negotiation.

Each person gets as many turns as needed.

Amazing! Almost every time the posted-on-the-blackboard goals and wants show agreement rather than disagreement. We isolate the differences — almost always about money. Putting in the right tax-saving (income, gift and estate taxes) plan usually solves the money issues.

What happens if there still are differences — serious stuff — not from my viewpoint, but by one or more members of the family?

Remember, doing nothing while waiting for total peace (which rarely comes) among quarreling family members favors the IRS. So we build a tax plan around the agreements and continue to work on the disagreements. The head of the family (usually Mom and Dad working as a team) must make the final call.

A well-structured plan makes tough decisions much easier.

Indeed, perfection should be sought in every tax plan. But the sad fact is that an imperfect plan is way better than no plan for a family that can’t seem to get everyone on the same page.

When I began my professional practice as a certified public accountant and lawyer back in the 1950s, a millionaire was hard to find. Today, millionaires are plentiful. And when it comes to estate planning, they scurry around trying to find a professional who can lower their estate tax before they get hit by the “final bus.” The Newsweek article by Robert J. Samuelson, like so many other articles, entertainingly explored the problem but offered no solutions.

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

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

Fact number two: Years of experience have taught us that wealth is always passed to the younger generations of the family. And then the younger generations step into mom’s and dad’s shoes and typically increase the family wealth.

This gives the second generation an even bigger estate tax problem than mom and dad had.

Here’s how we solve this do-not-enrich-the-IRS estate-tax problem:

Logic tells you that children, particularly business children, are likely to become wealthy.

Usually these children accumulate more wealth than their mom and dad — to be repeated again when the family wealth goes to the grandchildren two generations later. Because of this generation-to-generation wealth transfer, we view each generation of the family separately in terms of their special needs and objectives.

Yet, the plan should not be just for mom and dad. It should be a comprehensive and integrated plan for the entire family. Following is an overview of how it’s done.

Keep your wealth — every dollar of it — in your family, instead of losing it to taxes.

• First Generation. Install a lifetime plan that removes wealth from your taxable estate during life. Use strategies like a qualified personal resident trust for your residence; an intentionally defective trust for your business; a subtrust for your profit-sharing plan, rollover IRAs and similar plans; a family limited partnership for your other assets (typically investments, like stocks, bonds and real estate); and an irrevocable life insurance trust for insurance, probably second-to-die. All of these strategies — and there are many others — begin their work now while you are alive and allow you to stay in control of your assets, including your business, for as long as you live.

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

• Your Kids—Second Generation. After completing a comprehensive plan for mom and dad, it is easy to project what the financial future of the kids might look like. As soon as we finish the plan for the first generation, we start a plan for each of the kids, based on their individual assets and objectives.

• Your Grandchildren— Third Generation. The plans for this generation are closely tied to the plans of the two older generations. Probably the most important point to keep in mind, because of the young ages in this generation, is getting the children into a tax-free environment as soon as possible, a wealth-building must. These plans center on short-term and long-term tax-advantaged strategies that fulfill lifetime needs: education, buying a house, starting a business and, if they don’t go in to the family business, building a retirement fund.

Would you believe that the basic tax law, the Internal Revenue Code and regulations, is about 50,000 pages long with no logical, organized theme? There’s also a constant stream of Internal Revenue Service rulings and case law. No one person can know it all—not Congress, which passes the law, nor the IRS, which enforces it.

There are three main ways the federal tax law picks your pocket and becomes your legal partner: payroll taxes, the income tax and the estate tax. So, how can you 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 when we counted 227 options and stopped. The following are five areas in which you can save money from taxes:

1. Payroll Taxes. This money-stealing parasite is persistent and expensive: This year, $16,404 on the first $106,800 of your earnings goes to the tax man. That’s a scandalous 9.76 percent. For earnings of more than $106,800, you pay an additional 2.9 percent.

Here are examples of the three most common ways to lose payroll taxes to the IRS: The first mistake involves Joe, the owner of an S corporation who taxes a large salary (often $500,000 or more) and takes a huge bonus at the year’s end to bring down profits. For this S corporation, a tax-free dividend instead of compensation would save a bundle of unnecessary payroll taxes and would cost no more in income taxes. A second payroll tax mistake is when owners’ wives and moms take a salary when they either don’t work or are overpaid. It is much better tax-wise to give them a gift. The third mistake is operating a business as an LLC, which makes all income to the owner(s) subject to payroll taxes.

2. Asset Protection. In a heartbeat, your family wealth, including your business, can be depleted or even destroyed by a lawsuit.

Keep your business thin by keeping only those assets—typically, necessary cash, inventory and receivables—needed for operations in your business. Here are some basic sub-strategies: Elect S corporation status; personally own (via separate LLCs) any new real estate or expensive equipment, and lease it to your operating company; and never own delivery vehicles in your operating company. Put the vehicles into a separate corporation or LLC.

The sad fact is, we can’t protect the assets inside of your operating company, but we can protect you and your spouse. All of your significant assets are simply retitled using typical lifetime planning documents—such as family limited partnerships, LLCs and appropriate trusts.

3. Life Insurance. You can save money in taxes whether you, your spouse or your kids own the insurance.

Critical issues concerning life insurance are premium cost, the death benefit and the tax due on the benefit at death (usually the estate tax). The following are common ways to modify insurance plans to save premiums or increase the death benefit without additional costs:

• For single life or second-to-die insurance, you can get a cash-surrender value of more than $200,000 on a policy that is 9 years old or older. This results in significantly more death benefit for the same premium cost or a significantly reduced premium cost for the same death benefit.

• If you, the husband, are at least 55 years old, worth more than $5 million and have insurance on your life only, you are wasting premium dollars. Second-to-die coverage with your wife will typically give you the same death benefit for about 35 percent less premium cost.

• If you have more than $400,000 in a qualified plan such as a 401(k) or IRA, that amount is subject to a double tax (income and estate) of as much as 73 percent to the IRS. On average, you can turn every $270,000 of after-tax dollars into $3 to $5 million (tax-free), depending on your age and health. This plan works for second-to-die or single life insurance.

4. Business Succession. This affects your business and your business kids. The typical business owner wants to transfer the business to his kid(s) so that he and his kid(s) don’t get killed by taxes. He also wants to treat his non-business kids fairly, ensure that he controls his business for as long as he lives and ensure that the company stock stays in the family by never going to a kid’s ex-spouse. Every one of these goals is easily accomplished. Best of all, the business can be transferred tax-free, with no income tax, gift tax or estate tax for the owner or the kids.

5. 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—from the minute the lifetime plan is created until after you get hit by the final bus (covered by the death plan).

“If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant and CPA), you can and will develop a plan to beat the IRS. Every time.

And legally.

“Unfortunately, the goal of the typical estate planner is to reduce estate taxes. Our goal is always the same: to eliminate taxes.

“There are three types of readers who call us for help: readers who (1) have an estate plan but need a second opinion; (2) have no plan; or (3) have been working on a plan for years and just can’t seem to get it done. Which type are you?

“We will do a business succession/estate plan (and any necessary valuation) for each reader. We will report back to you (through this column) how many readers responded, how many we could and could not help, and a summary of the tax tools and techniques used to help the readers.”

Here are the 2004 results. In all, 16 readers (more than we expected) responded; 15 were in either the first or second category and, of course, were easy to help using the tax techniques and strategies described in this column over the years.

A 61-year-old from Ohio — let’s call him Joe — fell into the second-opinion category.

Joe’s letter said in part: “I … enclosed all the information … you asked for. My current plan (it was two short wills and two long revocable trusts — one of each for Joe and for his wife, Mary) looks good … but somehow I don’t feel comfortable.”

Joe and Mary turned out to be a very interesting case, yet sadly, their plan contained some common estate-planning errors. Sure, their documents — wills and trusts — were nearly perfect. Problem is, they just didn’t work. Let’s see why.

Joe and Mary are worth slightly more than $7 million, plus Joe has a number of life insurance policies totaling $2.2 million on his life that name Mary as the beneficiary. The $7 million includes $1.8 million in Joe’s rollover IRA with Mary as beneficiary. The balance of the assets ($5.2 million) — Joe’s business, their residence, some real estate and other investments — are all held in joint tenancy by Joe and Mary.

The wills and trusts — 46 pages in total — were designed by a large law firm to pass Joe and Mary’s assets in a highly organized plan, first to the surviving spouse and then to their children and grandchildren. Because Joe is four years older than Mary, and women outlive men by about four years, it was assumed that Joe would pass on first.

OK, suppose Joe goes to heaven first. Everything, and we mean everything, would go directly to Mary. Joe’s trust would get nothing and be a worthless stack of paper.

This is why: As the named beneficiary, Mary would get the $2.2 million of insurance. For the same reason — being the named beneficiary — Mary gets the $1.8 million in the IRA.

What about the other assets, worth $5.2 million? All to Mary immediately — because property held in joint tenancy goes to the survivor.

It should be pointed out that if Mary dies the day after Joe, the tax bite would exceed $3.5 million (using 2011 estate tax rates) of the $9.2 million now owned by Mary. Their kids would net only about $5.7 million.

What’s the lesson to be learned from this second-opinion story? Standing alone, a will and a revocable trust — no matter how terrific — can never be a complete estate plan.

We used a number of strategies to change Joe and Mary’s estate plan:

• A qualified personal residence trust for the residences.

• An intentionally defective trust to transfer Joe’s business to the kids tax-free.

• An irrevocable life insurance trust for the insurance.

• A subtrust for the profit- sharing plan to pay for the additional life insurance needed.

• A family limited partnership to hold the balance (real estate and investments) of their assets.

• An organized future- gift-giving program to their children and grandchildren.

With minor changes, the original wills and trusts were left alone.

After the above strategies and completed plans are put in place, if Joe and Mary get hit by the same bus, the kids would net, after taxes, about $9.5 million. The longer Joe and Mary live, as the future- gifting program is implemented, the more tax-free dollars are transferred to the kids.

If you want to participate in the 2006 wealth transfer plan test, please send the following information to: Irv Blackman, Wealth Transfer Plan Test, Blackman Kallick Bartelstein LLP, 3960 Deer Crossing Court, unit 102, Naples, FL 34114.

• For your business: Your last year-end financial statement (all pages).

• Personal: A current personal financial statement for you and your spouse.

• A family tree: Your name and birthday. Same for your spouse, children, their spouses and your grandchildren.

• All phone numbers: Business, home and cell.

What’s our job? To create the right plan for you, your family and your business — and to coordinate and work with your professionals. If you have a question, call me at 417-9732.

OK, that’s our plan to help you do your plan — and do it right. Let’s hear from you.