Posts Tagged ‘business owner’

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Irv Didn’t Invent Taxes, Just 227 Ways To Beat Them

Saturday, March 28th, 2009

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?  Here are five areas in which you can save money from taxes.

Column from: Modern Machine Shop, Contributed by: Irving L. Blackman

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).

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Posted in Estate Tax, General Tax Strategies, Irv Talk, Retirement Tax Advice | No Comments »

Business appraisal protects your family from unnecessary taxation.

Saturday, March 28th, 2009

Do you know how to make a grown man cry? Tell him his business has been destroyed by fire, flood or an act of God.

Yes, a tragedy. Bad stuff. But, most likely, the loss was insured — a bit of help. It’s even more important if Joe Owner is there on the scene to assess the damage, make plans and start rebuilding. Chances are he will make the business bigger and better than before.

End of Scene 1.

Here is Scene 2. Even the most successful, egotistical and immortal business owner knows that some day he must go to the “big business in the sky.” That will not make Joe Owner cry. He is too realistic for that. But tell him that after he is gone, his present plans, or better yet — lack of a plan — mean the Internal Revenue Service will dismantle his business.

Imagine our departed Joe in heaven; sitting on a cloud; talking to a representative of the revenue service. Joe speaks first.

“Why?” he asks.

“To pay taxes,” answers the tax representative.

“How?” he asks.

“By selling off the assets necessary to pay the tax.”

“When?” he asks.

“Within two years.”

“Why?” Joe demands.

“To pay your federal estate tax liability.”

“How much?” he queries.

“That depends on the value of your business.”

“Good,” says Joe. “I can show you just how little the business is worth without me.”

“Sorry,” responds the IRS representative. “It’s too late for that now.”

The curtain goes down.

Welcome back to earth. Is the above scenario realistic? Yes.

Crazy as it sounds.

If you own a closely held business and don’t pin down its value for tax purposes while you are alive, you are setting yourself up to be mugged by the IRS.

Every business — like it or not — must some day be valued for tax purposes. It is best for it to be done voluntarily, by you (the owner) during life. If not, the valuation will be done in an involuntary situation, after death, by the revenue service.

The only “out” is to sell the business in a real transaction during your life. For most business owners, selling doesn’t make sense for many reasons.

The two most common reasons are: First, the typical business owner wants to transfer the business to his or her kids; or second, wants to keep on working until he or she goes to business heaven.

The message should be clear: Want to save your business and your family untold aggravation, not to mention savings of 55 percent, the highest estate tax bracket in 2011? Then do three things: Find out the value of your business for tax purposes by getting an appraisal. Put a transfer plan, usually to your kids, in place during your life.

And then dovetail the first two steps with your estate plan.

Done right, you can transfer your business to your kids tax-free during your life, beat the estate tax collector legally, and control your business for as long as you live.

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

Gaining wealth is easy when compared with human aspect of tax game

Saturday, March 28th, 2009

Recently, I read an article titled What Makes for Success? by Kemmons Wilson, the founder of Holiday Inn. He said, “It is great to attain wealth, but money is really just one way — and hardly the best way — to keep score.”

Interesting quote, huh?

Most readers of this column call me with tax problems because they have attained wealth (no doubt they have and do keep score with money) and they don’t want to share that wealth with the IRS — perfectly normal. Yet, it’s amazing. Once the reader realizes that we really do know how to pass their wealth — all of it and intact — to their family, the conversation turns to other ways that they might keep score. Sure, they are delighted to find there are legal ways to totally win the estate tax game. But they readily admit that they don’t know how to deal with the other problems (other ways to keep score).

The other problems fall into the general category of little kids, little problems; big kids, big problems.

Stuff like which of my kids should run the business? How do I treat the kids fairly? What about the non-business kids?

What happens if one (or more) of my kids get divorced? How do I take care of my wife (the second one who is 15 years — or more — younger than the caller)? The callers tell me about family problems, business problems and/or assorted personal problems. To me every word is important, even though I’ve listened to so many tales of woe before. But, although similar, each problem has its own peculiar twists and turns.

Let’s face it — stuff happens. After years of solving wealth transfer problems, business succession (usually the business is at center stage) and estate planning problems, experience has taught me that solving only the money problems can never yield a perfect plan.

The human stuff — your spouse and kids support your plan — must be solved too.

What about your son-in-law or daughter-in-law? I know. It sounds like cornball. But if you really want to win the game of life after you have won the money game (really the easy part), you must attempt to solve the human part, the emotional stuff.

Here’s my suggestion to start the process. Make two lists: the money-problem list and the human-problem list.

Solve the money problems first (usually you are home free if you solve these three money problems:

• maintain your lifestyle — and your spouse’s — for as long as you live;

• transfer your business to the business kids — tax-free; and

• kill the estate tax.

Then, it’s easier to tackle the human-problem list. Interesting, many times solving the money problems also solve some (often all) of the human problems.

Finally, you must work with experienced professionals who know how to solve both problems: the money problems and the emotional human problems that come with accumulating wealth and trying to pass it on.

One more thing: Each piece of your plan must be part of a single comprehensive and integrated plan, all implemented at the same time. Piecemeal planning, based on my 50 years of experience, is a disaster that not only enriches the IRS, but fails to satisfy the normal human desires of a typical family and its business.

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

Charity and life insurance can help you conquer estate tax.

Thursday, March 26th, 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, kill, finesse, etc.) the estate tax?” Often, an obscenity or two regarding how the caller feels about the estate tax is tossed in for good measure.

If you are worth around $6 million or less, the answer is almost always yes. If you are worth more, the answer is usually no.

Let’s talk real numbers. Consider that taxpayer Joe is worth $10 million and his neighbor Jack is worth $20 million. Both men are married. Joe’s estate tax estimate, using 2011 rates, would be around $4 million.

Jack’s would top out at a tragic $9.5 million.

The higher your wealth, the lower your chance for avoiding the estate tax.

But there are ways to entirely avoid the impact of the estate tax.

If, for example, you are worth $8 million, there are ways to get the full $8 million (all taxes paid in full) to your family. Similarly, if you are worth $80 million, the entire $80 million can go to your family. It can always be done, whether you’re single or married, young or old, or 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. First, subtract $2 million ($1 million if you’re single), which leaves $10 million. Multiply $10 million by 50 percent to get your bitter estate tax bite. Finally, add 55 percent for your worth in excess of the $10 million.

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

Here’s a real-life story of Joe.

He’s a 63-year-old business owner from Nebraska who winters in Florida and is married to Mary, 62. Joe and Mary are worth $23 million. Using our little example above, 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: an intentionally defective trust to transfer Joe’s business to his kids tax-free, a family limited partnership for their investment assets (a stock and bond portfolio and real estate), and the two different life insurance strategies, which are described below.

A side note before continuing: Every case is different. Different people have various businesses situations and factors. A big factor for Joe and Mary was their excellent health for their age. So insurance was front and center.

Now, to the third strategy: Joe had $600,000 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 created a subtrust 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 $2.1 million in the 401(k) without the subtrust would net only about $600,000 for Joe’s heirs. Sorry, but the tax collector would get the rest, $1.5 million.

The subtrust allows the entire $6.5 million of life insurance to go to Joe and Mary’s heirs tax-free. In effect, we turned $600,000 into $6.5 million. Neat!

One more point: We showed Joe how to invest his $2.1 million in his 401(k) in TIPs, or 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 percent per year with stocks, bonds and mutual funds

Ask your professional to check out subtrusts and TIPs.

The final strategy: Joe and Mary needed an additional $5 million of life insurance. At their ages — if you don’t use a subtrust — the premiums are steep. We used a strategy called premium financing, or 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 though a trust you create that 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 equaling about $60,000 paid the first year and an additional $180,000, which will be paid in small amounts each year to age 100.

It’s an economic home run that nets $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 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 creditworthy and be worth a minimum of $5 million.

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