Posts Tagged ‘c corporation’

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Everything you should know about who should own business real estate

Saturday, May 30th, 2009

The first commandment of my someday-I-will-write-it bible of taxation would be “Thou shalt not put real estate into a corporation.”
We see it at least a dozen times year: When readers of this column ask us to do a tax consultation (usually for transfer/succession/estate planning), we find the business real estate in a separate C corporation (sometimes an S corporation) and leased to the operating corporation. Often, the real estate is owned by the operating corporation. Wrong! All are wrong. Actually a tax disaster waiting to happen. Why?
Someday, when you try to get the real estate (invariably, depreciated down to a low tax basis and appreciated in value) out of the corporation, you will run straight into a double tax. Again – why? Well, the first tax will hit the corporation when the real estate is sold (or transferred to the stockholders). Problem is, the sales proceeds are stuck inside the corporation and there are only two ways to get at those proceeds: via a dividend or a corporation liquidation. Sorry, both are subject to a second tax. A transfer of the property to the stockholders also triggers a double tax.
So what’s the answer?… Imagine a business owner (Joe) who is married to Mary. Joe should take title at the time the real estate is purchased and then lease it to his operating corporation. Here are some of the tax goodies that can come Joe’s way over time:
1. The rent Joe collects is not subject to social security tax (or other payroll taxes), nor does the rental income interfere with his social security benefits.

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).

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

Want To Get Real estate Out Of Your Corporation — Tax Free?

Monday, April 20th, 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 that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

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 has 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

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

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 that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

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 has 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

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

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Posted in Corporate Tax, Estate Tax, Planning | 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 »

Why Your Estate Tax Plan Often Flunks The Real-Life Test

Wednesday, April 15th, 2009

While thumbing through the pages of a trade journal, I ran across this quote, “We install 90 percent of what we sell. That’s one big advantage we have over (names one of the biggest square-footage discount chains).”

You know the routine: the thing-a-ma-jig doesn’t work. “The manufacturer,” says the installer; “improperly installed,” counters the manufacturer.

Ultimately-after some grief and probably more dollars — and it works.

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

Joe died, survived by his wife, Mary, three grown kids (one managed Joe’s family business, Success Co.) and seven grandchildren. Success Co. was a C corporation. Aside from owning their residence (worth $800,000) and Success Co. (valued at $10.3 million at Joe’s death), before Joe died, he and Mary enjoyed about $350,000 of after-tax spendable personal income. In addition, they owned various personal property and a nice summer home with a total value of over $1 million.

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

The professionals crafted a good traditional estate plan: no tax due at Joe’s death (the marital deduction) and enough insurance (second-to-die) to pay the projected estate tax at Mary’s death. An irrevocable life insurance trust owned the second-to-die policy on Joe’s and Mary’s lives.

The estate plan probably would get an “A” in the classroom. But here’s the unfortunate big lifetime detail the professional team missed:

Mary, a healthy age 64, did not have enough cash flow to maintain her lifestyle. Joe’s $550,000 salary, plus generous perks from Success Co., stopped when he died.

Aside from the usual lifestyle cash needs, Mary needed $46,000 per year to pay the second-to-die insurance premium. Also, she wanted to continue providing for the college education of three of her grandchildren (the other five had completed their education paid for by Joe and Mary).

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

First, the solution to Mary’s immediate problem: the cash flow to maintain her lifestyle. The marital trust (created in Joe’s revocable trust as part of his estate plan) owned 90 percent of Success Co. (Mary owned the other 10 percent). We simply had the stockholders (the marital trust and Mary) elect S Corporation status for Success Co.

Now the large corporate profit can provide the income stream Mary needs, as the beneficiary of the marital trust (90 percent) and as a direct owner (10 percent).

What lesson should be learned from this sad tale? The first lesson is that estate planning (as practiced all over the United States) is really death planning, put ’em in the vault and wait to die. Do the documents (a will and a trust or two).

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

Whether you call it estate planning, lifetime planning, wealth transfer planning or whatever, your master plan must include three separate plans:

(1) a lifetime plan to transfer your wealth while you are alive (and, yes you can control your wealth for as long as you live);

(2) a retirement plan that provides the after-tax cash flow needed to maintain your lifestyle for you (and your spouse) for as long as you (or your spouse) live;

(3) a transfer/succession plan for your business (that gets the value of the business out of your estate tax-free) to your business kids (or other successor).

Whether your master plan is done or is yet to be done, make sure it includes the three plans listed above. And always get an independent second opinion.

Finally, make sure that the professionals who create your plan know in advance 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.

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by Irv Blackman

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