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Did your lawyer (inadvertently) rip you off

Wednesday, April 29th, 2009

Joe (a 63-year old reader of this column who hails from Iowa, but winters in Florida) almost cried when talking to me on the phone. He said, “I still want to kick myself for thinking my estate plan was done. For years I was convinced that my plan was perfect.

“I never stopped reading and studying. You know, articles. Even books. All my professionals assured me my plan was the best it could be. I religiously attended seminars. I consulted regularly with my CPA and several lawyers. All confirmed that the estate plan drawn by my lawyer Mike was right for me and Mary (Joe’s wife).

“It never occurred to me that so many estate planning experts could be so dead wrong or that there’s a better way to transfer my business to the kids and deal with my other assets. Not until a friend brought me a small pile of your articles.

“I immediately read and reread the articles. The next day, I went to Mike’s office. Basically he gave three reasons why the dozens of concepts and ideas in your articles wouldn’t work for me: don’t apply to me, never heard of it or he’ll check it out and call me.”

The above summarizes about 20 minutes of Joe telling me about his years of planning with Mike (a friend and well-respected lawyer who specializes in estate planning).

Then, I asked Joe a series of blunt questions. His answers revealed Joe’s professionals had crafted a traditional estate plan.

My bet is that 90 percent of you married guys reading this article also have a traditional estate plan. What is it? Here’s the traditional plan Joe had (See if it sounds like your estate plan, as you read further).

Joe’s plan centers on two basic strategies: First, the plan takes advantage of the unified credit (actually $2 million is tax-free in 2006, 2007 and 2008; rising to $3.5 million in 2009. There is no tax in 2010. In 2011 the credit falls to $1 million). By using a two-trust arrangement (most often called Trust A and Trust B; marital trust and family trust or similar names), Joe and Mary each will escape tax on the amount of their unified credit, depending on their year of death. Second, the couple’s plan takes advantage of the marital deduction, which means zero estate tax when the first of Joe or Mary passes.

That’s it: the traditional estate plan that we see in all 50 states. That was Joe and Mary’s plan. Is your plan the same? Similar?

What’s the guaranteed result? The plan prevents the IRS from collecting a dime at the first death (of either Joe or Mary). Good! However, when the second spouse dies, the IRS gets its pound of flesh. In this couple’s case it’s a ton. If their wealth stayed the same, from today until the day both deceased, their estate tax would have been $4,655,000.

You’ll love the rest of the story.

Joe said, “Irv will you give me a second opinion?” I agreed. Joe sent me a standard package of information (tax returns and financial statements — both business and personal; family tree; and his estate plan documents). After two more telephone conversations, we pinned down Joe’s goals: for him and Mary, his successful business (wanted to leave it to his middle son) and his family (four kids and six grandchildren).

Three weeks later I called Joe and outlined the wealth transfer plan I had created (with the help of my network lawyer, Don). Joe’s family will receive every dime of his and Mary’s wealth, probably more (we actually created additional tax-free wealth because we took advantage of the tax-free environments, particularly strategies involving life insurance and charity — available in the tax law). Gone was the $4,655,000 estate tax obligation to the IRS.

A delighted Joe couldn’t help feeling ripped off by his lawyer’s traditional estate plan. Don and I explained that Mike’s plan was the norm.

After our comprehensive plan was reduced to writing (five new documents and some modifications to the trusts that Mike wrote), we submitted the new plan and documents to Mike. He was easy to work with. Don and I answered his stream of questions. Mike — after about three weeks of “review and research” (his words) — fully endorsed our plan.

For me this is a rewarding story, because it shows that the message we try to deliver — you can always win the estate tax game — is getting through to the readers of this column

If you are married and have a traditional estate plan (the same or similar to Joe’s), most likely your plan is not complete.

Think second opinion.

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Posted in Estate Tax, Family Tax Issues, Tax Strategies | No Comments »

Most Estate Plans Enrich The IRS, Not Your Family

Friday, April 17th, 2009

While scanning the pages of one of the trade journals that carries this tax column, a headline for an ad intrigued me: “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).”

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

“The manufacturers,” pleads the installer.

“Improperly installed,” counters the manufacturer.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Think Fast: What’s Your Business Worth?

Thursday, April 16th, 2009

Give the right answers and you can win big bucks on many TV game shows. Typically, the host only allows about 15 seconds for the contestant to give the right answer.

Okay, try this quick quiz: What is the most valuable asset you own? Hands down, almost every business owner answers, “My business.” Good! Next question … What’s your business worth? Silence! Yes, the final and most common answer is no answer — given 15 seconds or 15 months.

What happens in real life when those same business owners or their families must value the business? Stuff happens! Things like gifts of the family business stock to the kids; death (requiring valuation for estate tax purposes); or divorce (where valuation becomes an expensive legal battle).

Or, how about buying or selling a business? The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.Here are three business valuation myths that I hear from business owners and their families when I consult with them. First, the business is worth book value (usually this value is too low); second, the value is eight to 10 times after-tax earnings (usually this value is too high); and third, an S corporation is worth more than a C corporation (a corporation that pays income tax) because an S corporation doesn’t pay income tax. (This is just plain wrong. There’s no difference in value.)

Visualize this: There are two piles of stock in front of you. One pile is made up of publicly traded stock, like Microsoft, IBM and Exxon Mobil Corp. with a total value of $4 million. The second pile is the stock of Your Family Business, Inc. (YFB, Inc.), also worth $4 million by the “right” (even the IRS would agree) valuation method. Think for a minute. Which pile is worth more? Right, the first pile: the publicly traded stock. Just call your broker and you can have the full $4 million in your bank account, less the broker’s commission, in a few days. What about the value of the second pile-YFB, Inc. stock? Well, the fact is that for tax purposes the courts give you a discount for general lack of marketability of about 35 percent, or about $1.4 million.

So, for tax purposes the stock of your $4 million family business is only worth $2.6 million. Surprise! Even the IRS has come around to agree with such discounts. The discount will, in this example, save your estate about $700,000 in estate taxes.

What is the most common reason for valuing a family business? Hands down, when dad (or mom or both) want to transfer the business to the kid(s). Now during dad’s life.

Dad usually has three basic requests: (1) “Make sure my lifestyle (and my spouse’s) can be maintained for life”; (2) “Want to control my business (and my other assets for as long as I live”; and (3) “Transfer my business to my kids tax-free (no income tax, capital gains tax or other taxes).”

Yes, all three basic requests are easy to accomplish if you employ the proper tax-strategies: The core strategies are (1) a well-done valuation (acceptable by the IRS), which is easy to do; (2) a recapitalization (creates voting and nonvoting stock); (3) use an intentionally defective trust (avoids all taxes on transfer of nonvoting stock to kids).

But we need some readers to volunteer their family businesses so we can structure a plan(s) and then write about them in future columns. Real names will be withheld. Don’t worry about your exact facts Maybe you have only one kid in the business; maybe two or more; maybe some in the business, some not; or maybe no kids in the business and you want to get the business to one (or more) employee(s) (and, of course, they have no money).

Just two ground rules: (1) You really want to transfer your business to your kids, other family members or employees (no hypotheticals) and (2) your business has a real fair market value of $3 million or more (your best guess of what a real buyer would pay). Just call me (Irv Blackman) at 239-417-9732 and let’s chat about your exact situation.

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Posted in Corporate Tax, Estate Tax, Family Tax Issues, Planning, Tax Strategies | No Comments »

A smart way to transfer your business

Friday, April 3rd, 2009

This article is about an old IRS letter ruling that is one of my favorites. It might be labeled “The lazy man’s way to plan your business transfer.“

The ruling shows you how to take advantage of some favorable tax law while avoiding pitfalls. Good stuff!

Well, there is one slight problem to using the technique: You must drop dead before your family can enjoy the benefits of Letter Ruling 9116031.

But wait, hold the phone. The ruling has one redeeming quality. Really!

First, the facts: Joe, his wife, Mary, and their children owned all the stock in a family business. Joe died in 1990 and Mary inherited all of his stock.

(Note: Mary’s tax basis — for computing capital gains — is the fair market value (FMV) of the stock on the day Joe died. For example, if the FMV was $1 million and she sold it for $1 million, there would be no capital gains tax.)

The fact that Joe’s tax basis, while he was alive, was $25,000, is immaterial. Mary immediately sold all of her stock back to the corporation.

Here’s the general rule: When you or any member of your family sells stock back to your corporation (called a redemption), the redemption is usually taxed as a dividend — a tax disaster.

But there is a special tax-saving exception for a family member who has owned the stock for 10 years or more: If he/she divests all interest in the company (including any position as an officer or director), the redemption is treated as a sale (gets favorable capital gains treatment, instead of being a dividend).

Since Mary sold all (stock she owned before Joe died and stock she inherited from him) of her interest in the corporation, the purchase by the corporation of her shares was considered a bona fide sale (redemption) and not a dividend — a big tax victory.

When all the smoke cleared, not only had Mary escaped a big dividend income tax bill, but she had succeeded in effectively transferring the business to her children. How? Since the kids now owned all the remaining issued and outstanding stock, they owned 100 percent of the business.

To sum up: Mary walked off with a near-tax-free capital gain, (the price paid to Mary for the stock was a bit more than the exact FMV of the stock inherited from Joe) while the kids walked off with the business.

A fantastic tax result.

Stop and think about your own business succession plan for a moment. Isn’t that the result you want — a fantastic tax-free (for income, gift and estate taxes) result? Yes, you can get that tax-free result every time.

More often than not, succession plans are implemented during life, which means there is a second issue (the first issue is tax-free): control.

The typical business owner wants control of his business for as long as he lives. So, when you sit down with your professional advisors, make sure you accomplish a perfect solution to the two key issues: (1) a tax-free transfer and (2) keeping control for as long as you live.

If any other result is offered (no matter how good or smart it sounds), get a second opinion.

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Posted in Corporate Tax, Estate Tax, Tax Strategies | No Comments »

Tax Secrets of the Wealthy: These M7 Strategies Are Simply Magnificent

Wednesday, April 1st, 2009

More than 90 percent of contacts with readers of this column are specific questions or concerns involving the “Magnificent Seven” (M7). What are the M7?

Actually, they are seven separate strategies designed to answer the questions and at the same time to save huge amounts of estate tax or create huge amounts of wealth (usually tax-free).

Using just one M7 is fun. Two or more is party time.

So let’s visit with each M7 partygoer — first the specific questions, then the answer and the strategy (to eliminate any concerns). Remember: Each M7 you are about to meet represents a most popular strategy according to readers of my column in the past two years.

• M7 No. 1 — “How can I get my family business (Success Co.) out of my estate, transfer it to my kids yet keep control for life?”

Create voting and non-voting stock, then transfer the non-voting stock to your business kids. Also use these strategies: a recapitalization to create the non-voting stock and an intentionally defective trust to transfer the stock. The voting stock, which you keep, maintains your control. All the strategies are tax-free — to you, your kids and Success Co.

• M7 No. 2 — How can I earn large returns every year without risk?”

Invest in senior settlements/transferable insurance policies (TIPs). The average TIP rate of return per year is in the 12- to 14-percent range, available from a 14-year-old company that is public (on the NASDAQ). Minimum investment is $50,000 for qualified investors.

• M7 No. 3 — “How can I avoid the double tax (income and estate) that hits all qualified plans (like an IRA, 401(k) profit-sharing)?”

Use a subtrust. It’s true: The tax collector can get up to 73 percent of your plan funds (that’s $730,000 per $1 million). Your family gets only $270,000. A subtrust allows you to use plan funds to buy life insurance (usually second-to-die). One reader turned $240,000 into $4.5 million of tax-free life insurance.

• M7 No. 4 — “How do I know if my completed (or proposed) estate plan is done and done right?”

Easy. You must be able to answer “Yes” to both of these questions: (1) Do you have and will you continue to have absolute control of your business and other assets? And (2) Will all of your wealth pass intact — every penny of it — to your family when you die. “All” means if you, for example are worth $6 million, the entire $6 million (fill in your own net worth number) to your family. If you can’t answer ‘Yes’ to these two questions, get a second opinion from an independent professional.

• M7 No. 5 — “I have significant excess cash or cash-like assets (municipal bonds, certificates of deposits, and the like). I’m conservative. Hate risk. Are there any tax-advantaged investments for me?”

Yes, conservative investment life insurance (CILI) that is really a conservation investment. The insurance company agrees to guarantee you that upon your death your heirs will receive the sum of the following: (1) All premiums you paid (say you paid $20,000 per year for 20 years. Your heirs will get back the entire $400,000), plus (2) a guaranteed rate of return on all premiums paid (usually around 3%), plus (3) the death benefit as a bonus (say $1 million, but could be more or less depending on your age and health). Get a personal quote. You’ll be delighted. And oh, yes, all earnings and the death benefit (all three items) are tax-free.

• M7 No. 6. “Is there a way to reduce the value of my business for tax purposes?”

Absolutely! Take advantage of the three discounts allowed by the tax law: (1) lack of marketability, (2) minority interest and (3) non-voting stock is worth less than voting stock. Result, a $2 million business after discounts, is worth, (for tax purposes) in the $1.1 million to $1.2 million range.

• M7 No. 7 — “Is there any way to finance the cost of life insurance to significantly reduce the out-of-pocket cost of the insurance?”

Yes, it’s called premium financing. The strategy is easiest to explain by example. A 60-year-old reader got $5 million of insurance with a total cost (to be paid over his life) of $368,000. A 56-year-old husband with a 56-year-old wife bought $5 million with a total projected outlay of only $79,000. You must be worth a minimum of $5 million (more is better) and be 65 years young or younger.

Of course, you want to get to know one or more of the M7 people better. More info. Maybe you have a question. Will the strategy work for you, your family and your business?

Here’s what to do: Contact me with the following: (1) identify the M7 strategy you want to learn about; (2) your name, address and all phone numbers where you can be reached; (3) your birthday and same for other family members if insurance is involved; (4) a short statement of your specific facts; (5) fax to 847-674-5299 or e-mail me at wealthy@blackmankallick.com with “M-7 query” in the subject line.

I’ll summarize the best responses (all identities to be withheld) in future columns.

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Posted in Estate Tax, Family Tax Issues, General Tax Strategies, Insurance, Investment Strategies, Planning, Tax Strategies | No Comments »

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by Irv Blackman

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