Posts Tagged ‘1 million’

Don’t Let ‘Estate-Tax-Itis’ Drain The Family Wealth

Wednesday, April 15th, 2009

Adreaded disease is spreading like wildfire — in all 50 of the United States.

It debilitates most successful business owners, then, ravages some or all of the kids and eventually hurts the grandkids.

Known by various names, the most common name is “estate-tax-itus.” It drains family wealth.

Some people don’t even know they have the disease. Most know because they have the painful symptoms (a huge tax bill) and search in vain for a cure. They attend seminars, read articles, special reports and books. They go from advisor to advisor looking for relief.

The key question is: “Is there a cure?”

The answer is a resounding :Yes!”

This article shows you how to start the process to totally cure estate-tax-itus for yourself, your family and your business — every time, no matter how young or old you are, whether you are worth $1 million, $10 million (or much more).

There are many ways to fight the disease, but the best way is to build a “tax-immune system.” For best results, start today.

Here’s a three-step process that works every time. Steps No. 1 and No. 2 make the diagnosis. Step No. 3 accomplishes the cure.

Step No. 1: Prepare a personal financial statement for you and your spouse. Divide your assets into the following five categories.

— Residence

— Business

— Qualified plans (pension, profit-sharing, 401(k), rollover IRA or other qualified plans)

— All other assets (typically, investments)

— Life insurance

Step No. 2: Make a list of your goals (actually three lists) — (1) for you and (if married) your spouse; (2) for your family (typically children and grandchildren); and (3) your business.

Here are the typical core goals we see in practice:

For list (1) — Maintain your lifestyle for as long as you (husband and wife) live and allow you to control your assets for as long as you live;

For list (2) — transfer your assets to the children and grandchildren intact — free of the estate tax-and educate your grandchildren;

For list (3) — transfer your business to the business child (or children) tax-free and treat the non-business children fairly.

Step. No. 3: Find an advisor who knows how to identify and implement the exact tax strategies that accomplish your goals using the specific assets on your financial statement.

Following are the are most often-used strategies we use in our practice to accomplish a typical client’s goals, based on the assets owned.

Your Residence. Use a Qualified personal residence trust to remove the residence from your estate, yet live in it and control it for as long as you live.

Your Business. Transfer your business to the business children using an Intentionally Defective Trust. It removes the business from your estate, transfers business to kids (tax-free to you and the kids), yet allows you to keep control for life (because you retain voting control).

Qualified plans. The funds in these plans are double-taxed, robbing your family of about 75 percent of the plan funds (i.e. the tax collectors get about $750,000 if you have $1 million in the plans, your family receives only $250.000).

Create a Subtrust or retirement plan rescue (RPR) to buy life insurance. This usually triples (or more) the amount you have in the plan, and your heirs get it all tax-free. For example, $1 million in the plan (worth only $250,000 to your family) will turn into $3 million (or more) for your family with a Subtrust or a RPR. And the entire $3 million is tax-free.

All other assets. Transfer these assets (all your assets, except those in the first three categories; for example, publicly traded stocks, bonds, real estate and other investments) to a family limited partnership, which legally reduces the value of these assets for tax purposes by 35 percent (yes, $1 million of real estate, stocks, bonds, etc. are only worth only $650,000 for tax purposes.)

Insurance. Get it out of your corporation and transfer all policies you or your spouse own to an irrevocable life insurance trust (But a Subtrust is best, if you can use it. See 3. above). Also, check out premium financing, a wonderful concept that allows you to buy huge amounts of life insurance ($3 million, $10 million or more) without paying premiums.

Finally, if your estate plan is already done, and it does not effectively eliminate the estate tax, get a second opinion.

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Selling Your Business To Your Kids Is A Tax No-No

Monday, April 13th, 2009

About once a month I get a call from a reader (call him Joe) of this column who wants to sell his business (call it Success Co.) to his kids.

A short conversation with the caller explains why such a sale is a terrible idea — for Joe, and for the kids.

Let’s start with the kids, in this case Joe’s son, Steve, who wants to buy Success Co. for $1 million.

Follow these strangling tax numbers: Steve must earn about $1.66 to have $1 left to pay to Joe (40 percent in income tax on $1.66 is 66 cents in tax). Steve pays the full $1 to Joe. Steve cannot deduct any portion of this $1 because the purchase of stock (Success Co. or any other stock) is simply a nondeductible capital expenditure.

If Success Co. is a C corporation, any interest paid by Steve (in addition to the principal stock purchase amount) is generally not deductible. Steve could deduct this interest against portfolio income (interest and dividends on other investments).

Rarely do the kids have such investments. But Steve can make all the interest deductible simply by electing S corporation status.

What about Joe? Steve pays Joe that $1 (plus interest). Joe must pay a capital gains tax (typically 15 percent) on the dollar and pay his top tax bracket (typically 40 percent, including State and Federal income taxes) on the interest income.

OK, Joe has 85 cents left after paying the capital gains tax on the $1. If Joe doesn’t spend that 85 cents (he usually has it at death), the tax collector gets up to 55 percent (using 2011 rates) for estate taxes. That’s another 47 cents, leaving Joe’s heirs with only 38 cents out of the $1.

Let’s review. Steve had to make $1.66 for Joe to leave his family 38 cents.

Or would you believe that would turn into $1,660,000 for Steve to make while Joe’s family only gets $380,000.

That’s lousy tax planning!

Joe and Steve can avoid these tragic tax results. So can you. How?

Apply the above $1 example to the price you want to get for your business if you sell to one or more of your kids. You’ll immediately notice that the IRS gets more out of the sale of your business than you or your family combined. The lesson is simple. Don’t sell your business to your kids.

Watch this column for the right way for you to get a lifetime flow of income for you (and your spouse if you are married) and transfer your business to your kids without the IRS getting into your pocket.

You’ll want to take a look at the following strategies: Electing S corporation status; use of an intentionally defective trust to transfer your business to your kids — tax-free (yet stay in control for as long as you live).

One more thing: Do not transfer your business (by sale or otherwise) to the kids without putting three other plans in place: (1) a lifetime tax plan, (2) a retirement plan and (3) an estate plan.

Want to learn more about how to shield yourself and your family from the IRS when you transfer your business? Browse my Web site at www.taxsecretsofthewealthy.com.

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How To Turn A Tax Tragedy Into A Miracle

Monday, April 13th, 2009

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

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

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

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

Now, let’s look at each concept separately.

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

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

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

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

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A Big valuation victory For Our Side

Monday, April 13th, 2009

I’d like to hug every judge who had a hand in this classic Tax Court decision: [Estate of Davis, 110 TC 35, 6/30/98]. Instead of giving all the dull facts and all the technical stuff in the case, this article deals with what the result means to you, the average business owner who someday must value your business for tax purposes.

You (Joe) operate your family business (Success Co.) as a corporation. The assets of Success Co. include a number of appreciated assets; for example, investments in stocks, land and buildings. Also many assets subject to deprecation — mostly equipment — are on the books for much less than their current value. Now suppose Success Co. is correctly valued at $5 million. The value of the various assets that Success Co. owes is $4 million, but has only a book value of $3 million. So, if Success Co. were to sell the assets or actually liquidated (neither Joe nor Success Co. intend to sell the assets or liquidate), there would be a $1 million profit. Say the tax (state and federal) on the profit would be $400,000. The question that faced the court was could the value of the corporation be reduced by $400,000 to $4.6 million? “Yes,” said the court, turning thumbs down on the IRS’s claim to ignore this built-in-gains discount (actually the potential tax due for an asset sale or corporate liquidation).

Applause! Applause! for the court. Think about it: That discount of $400,000 could save Joe about $210,000 in estate taxes.

As a practical matter, this case allows you to take three distinct valuation discounts: (1) a discount for lack of marketability; (2) discount for built-in gains of assets, even if you don’t intend to sell them or liquidate (technically a part of the marketability discount); and (3) a discount for minority interest if you are transferring 50 percent or less of your stock to one person (for example, Joe Gives 30 percent of his Success Co. stock to each of his two children). After these three discounts, a $5 million company may only be worth in the $3 million range for tax purposes. Or a $2 million discount, yielding estate tax savings of about $1.1 million. Truly a great victory!

Now a personal puff of pride for our office, which has a large valuation department. We have been taking similar discounts for built-in gains for years.

The right value of your business, whether transferring to your kids, for estate planning or for other purposes, is one of the most important tax-impact considerations in the law.

Do you have a business valuation problem — particularly if you want to transfer your business to another family member — that is driving you up the proverbial “tax wall?” Then you are welcome to call me (847-674-5295). Let’s chat about your exact situation.

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Conquer the Estate Tax Legally

Wednesday, April 8th, 2009

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Sunday, April 5th, 2009

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

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

Taxes that could have been avoided with proper planning.

Tragic!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Save by getting the real estate out of the corporation

Friday, April 3rd, 2009

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

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

Are you a C corporation or an S corporation?

Are there retained earnings? How much?

How much has the real estate appreciated?

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

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

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

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

Here’s the easy six-step process:

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

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

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

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

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

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

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

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

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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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