This is a big deal. We are talking big money.

Typically, the IRS gets 50 to 55 cents out of every life-insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000. Your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

Mistake No. 1 — A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies: The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax (AMT) that can steal up to 20 percent of the proceeds — and the net proceeds (after the AMT) can only get into the hands of your family by paying a second tax via a taxable dividend (ouch!).

If an S corporation, the proceeds (although not subject to the AMT) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend (a terrible and tax-expensive idea).

Mistake No. 2 — The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate (or your spouse’s estate). You just guaranteed the IRS a big — unnecessary — payday.

Mistake No. 3 — The policy (with cash surrender value) is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

So what should you do? Here are the typical recommendations we give to our clients so that, you and your family — instead of the IRS — win the insurance tax game.

For Mistake No. 1 — Transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value (a tax-free transaction). Next, transfer the policy to a Wealth Creation Trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For Mistake No. 2 — Transfer the policy to a Wealth Creation Trust.

For Mistake No. 3 — If you are insurable, dump the old policy and replace it with a new policy to be owned by a Wealth Creation Trust. First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy (insures you and your spouse) will give you significantly more bang for your insurance premium dollar. Second, determine how to reduce the premium cost:

(1) if your company has a 401(k) or other qualified plan look into a “Subtrust.” The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun.

(2) Whether you need single life (only you are insured) or second-to-die, check out “premium financing.” You don’t pay any premiums to get a large ($5 million or more) amount of insurance, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps, but simple to avoid when you know the tax ropes.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost-income and estate-while I’m alive? … When I die? … When my spouse dies?

The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

Mom or Dad wants to transfer the family business to one or more of the children. But the money to fund the buyout at the death of the parent/stockholder —insurance on the parent’s life — is in the wrong place.

Here’s a foolproof way of getting the job done, according to an IRS letter ruling:

The father, Joe, worked with his son, Sam, in a business founded by Joe. The stock of the corporation was owned 25 percent by Joe, 4 percent by Sam and the balance by five other children not active in the business.

Joe had two main objectives: First, to have his stock go to Sam after his death and, second, to make sure that his wife, Mary, would be financially secure for the rest of her life.

Joe and his son developed a plan to accomplish these objectives. They entered into a buy-sell agreement requiring Sam to buy his father’s shares from his estate after his death at fair market value. To fund the purchase, Sam would use the proceeds of a life insurance policy on his dad’s life.

The corporation owned the insurance policy and paid the premiums. Joe intended to buy the policy from the corporation for its cash-surrender value and gift the policy to his son. From then on, Sam would pay all premiums. Great news!

The IRS ruled that, under these conditions, Sam could collect the insurance proceeds income tax-free (IRS Letter Ruling 8906034).

There are two more tax goodies that flow as a result of this ruling.

One, when Sam buys Joe’s stock from his estate, the sale of the stock by the estate is income tax-free.

Why? Under the tax law, the estate gets a new tax basis equal to the stock’s fair market value at the date of Joe’s death.

Two, since Mary is the beneficiary of Joe’s estate, there is no estate tax. Why? An estate is entitled to a 100 percent marital deduction for all property passing to a spouse, Mary in this case.

What could be better? No income tax. No estate tax.

Sam owns 100 percent of Joe’s stock.

Mary is financially secure.

Perfect!

Is there an investment that can match the potential high returns of successful stock market investors, yet has the prime characteristic (no-risk) of traditional safe investments?

Yes!

Chances are you have never heard of investments called life settlements. They also are often called Transferable Insurance Policy or TIP(s). The best way to understand how a TIP works is by an example.

Let’s say Joe, 68 years old, owns a life insurance policy with a $500,000 death benefit and a $60,000 cash surrender value (CSV). Joe would like to stop paying premiums. Of course, he can cancel the policy and get the $60,000 CSV from the insurance company.

An investor (really a group of investors) buys Joe’s policy for $150,000 — paid in cash to Joe immediately. The investors now own the policy. The investors will receive the $500,000 death benefit when Joe dies.

Let’s say you are one of the investors. You invest $100,000. You will wind up with a diversified portfolio of TIPs. One of the TIPs will be a fractional interest in Joe’s $500,000 policy — say 3 percent — or $15,000.

This TIP (Joe’s) will pay you exactly $15,000 (includes your principal — amount invested — and profit) when Joe dies. The insurance companies love people like Joe when they terminate their policies. And why not? The insurance company pays a mere $60,000 for the CSV and is off the hook for a $500,000 death benefit.

Terminated policies are highly profitable for insurance companies. Of course, they want to keep the entire life settlement industry a secret. Why? Because investors — like you — now have found a simple and easy way to help the Joes of the world and at the same time stand tall in the profit shoes of the insurance companies. Neat!

As a TIP investor, you can enjoy:

• An average rate of return of 16.32% per year.

• Not worrying about the market being volatile or whether it goes up or down.

• The guaranteed return of your principal, as well as your profit.

• And best of all, keep 100 percent of the profit because there are no fees or costs when you buy a TIP.

What are the tax consequences of your TIP profits?

There are only two simple rules: (1) The tax on your profit is deferred until you actually receive your principal and profit; (2) Your profit is taxed as ordinary income (profit earned by a qualified plan-profit-sharing, 401 (k), IRA and the like-are deferred until distributed).

The list goes on and on. Always has, always will.

Yet the pride of the American capitalistic system is the successful family business. These entrepreneurs have found their way through, around or over the seemingly endless obstacles to become a “successful business owner.”

An SBO for short.

For the purposes of this article, SBOs have excess funds to invest (other than back into the operation of their business that produced the funds in the first place). Typically these excess funds are in one (or more) of three places: (1) still in the business, (2) in their (or spouse’s) name or (3) in a qualified plan (profit-sharing, 401(k), IRA or similar plan).

Over the years, the quote that follows has been nicknamed the SBO’s lament:

“I know how to make money in my business, but when it comes to making money with my investment money, either I don’t have time to watch it, don’t know how to watch it or rely on my investment advisor. When the market is up, my advisors do fine, when it’s down they do lousy.”

For the past couple of years, the lament usually ends with, “Now the market is lousy (or down, or uncertain, or similar words). What should I do?”

Now, regular readers of this column know that I am a tax planner prone to finding legal ways to avoid all types of taxes — particularly estate taxes. To do this requires, among other things, getting my client’s personal balance sheet.

Here’s what I can tell you that the balance sheets reveal about the investments of SBOs (and also other estate planning clients). Their success (or failure) in the stock market and a myriad of other investments, in general, mirrors the Dow Jones: happy on the way up and painful on the way down.

Usually, real estate investments are a winner.

Now what about that excess cash? Terrible results. Almost always the investments are conservative: divided between (1) CDs and money market funds, (2) municipal bonds and (3) a “zillion” variety of annuities. After taxes and inflation, your net earnings on (1) investments are typically less than 3 percent, sometimes even negative. Those income tax free bonds, (2), not only have a low rate of return, but fall in value when interest rates rise. Annuities, (3), could fill a large book to describe all the varieties and, most of all, the complaints from clients.

Never has a client told me that he/she is happy with the results of an annuity. (Sure would like to hear from a reader who has personally had a positive experience with any annuity.)

As you can imagine, almost every estate planning consultation with an SBO — and other clients — requires serious consideration concerning the client’s investments: safety, risk, tax consequences, rate of return and other factors. We discuss alternate investments, considering, among other things: profitability, risk and how taxed.

Currently, the most popular alternative investment is senior settlements (SS), also called Life Settlements. The following quote from The Wall Street Journal and USA Today (and other sources) tells you why SS are becoming such a popular investment.

“Life Settlements (have become a) trillion dollar industry, dominated by institutional investors including Berkshire Hathaway (billionaire Warren Buffet’s company), AIG and CNA. Their pursuit of this market is related to the degree of safety, high yields in excess of 15 percent per year and the fact that a Life Settlement is not affected by market forces.

“Life settlements are a very good option for the investor who has as his or her investment philosophy a desire for a secure, safe and ‘no risk’ investment. It is for your ‘nest egg’ money. It is not considered a security by SEC. Therefore it is not normally provided as an investment option by stock brokers.”

Of course, your question is: “Can a little guy (as opposed to an institutional investor) invest in SS?

Yes, it’s all made possible by a small, publicly traded (on the NASDAQ) company. Its average rate of return an SS investments has been 16.28 percent per year on average during the company’s 14-year operating history.

If you want to make a killing on your investments, SS are not for you. But if a 16 percent-plus rate of return, with no market risk is of interest to you (or your IRA, 401(k) or other qualified plan) fax me (847-674-5299) your name, address, phone numbers (business/home/cell) and estimated amount to invest ($50,000 minimum, for accredited investors).

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.

It is very rare to analyze the estate plan, particularly the life insurance policies, of a real-life client and find that all is as it should be.

Typically, we find the wrong kind of insurance. Wrong ownership. Wrong beneficiaries. Wrong tax consequences. It goes on and on.

This is a big deal. We are talking big money. Typically, the IRS gets 50 cents to 55 cents out of every life insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000, but your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

• Mistake No. 1

A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies. The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax — which can steal up to 20 percent of the proceeds — and the net proceeds after the tax can only get into the hands of your family by paying a second tax via a taxable dividend. Ouch!

If an S corporation, the proceeds (although not subject to the alternative minimum tax) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend — a terrible and tax-expensive idea.

• Mistake No. 2

The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate. You just guaranteed the IRS a big, unnecessary payday.

• Mistake No. 3

The policy, with cash surrender value, is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

What should you do? Here are the typical recommendations we give to our clients so that you and your family — instead of the IRS — win the insurance tax game.

In the case of mistake No. 1, transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value, a tax-free transaction. Next, transfer the policy to a wealth creation trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For mistake No. 2 transfer the policy to a wealth creation trust.

And for mistake No. 3, if you are insurable, dump the old policy and replace it with a new policy to be owned by a wealth creation trust.

First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy insures you and your spouse will get significantly more bang for your insurance-premium dollar.

Second, determine how to reduce the premium cost: (1) if your company has a 401(k) or other qualified plan look into a subtrust. The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun; (2) Whether you need single life (only you are insured) or second-to-die, check out premium financing. You don’t pay any premiums, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost — income and estate — while I’m alive? When I die? When my spouse dies? The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

Is there an investment that can match the potential high returns of successful stock market investors, yet has the prime characteristic — no risk — of traditional, safe investments?

Yes!

Chances are you have never heard of this investment: life settlements, often called transferable insurance policies or TIPs. The best way to understand how a TIP works is by an example.

Joe, 68, owns a life insurance policy with a $500,000 death benefit and a $60,000 cash surrender value (CSV). Joe would like to stop paying premiums. Of course, he can cancel the policy and get the $60,000 CSV from the insurance company.

A group of investors buys Joe’s policy for $150,000, paid in cash to Joe immediately. The investors now own the policy. The investors will receive the $500,000 death benefit when Joe dies.

Let’s say you are one of the investors. You invest $100,000. You will wind up with a diversified portfolio of TIPs. One of the TIPs will be a fractional interest in Joe’s $500,000 policy — say 3 percent, or $15,000.

Joe’s TIP will pay you exactly $15,000 — including your principal (the amount you invested) and profit — when Joe dies. Insurance companies love people like Joe when they terminate their policies. And why not? The insurance company pays a mere $60,000 for the CSV and is off the hook for a $500,000 death benefit.

Terminated policies are highly profitable for insurance companies. Of course, they want to keep the entire life-settlement industry a secret. Why? Because investors — like you — now have found a simple and easy way to help the Joes of the world and at the same time to stand tall in the profit shoes of the insurance companies.

As a TIP investor you can enjoy:

– an average rate of return of 16.28 percent per year;

– not worrying about the market being volatile or whether it goes up or down;

– the guaranteed return of your principal, as well as your profit; and, best of all,

– keeping 100 percent of the profit because there are no fees or costs when you buy a TIP.

What are the tax consequences of your TIP profits? There are only two simple rules:

– The tax on your profit is deferred until you actually receive your principal and profit (always a fixed amount).

– Your profit is taxed as ordinary income.

Even the big-hitter investors are buying life settlements. Following is a quote from the May 18 issue of The Wall Street Journal:

“AIG (American International Group Inc., the insurance giant) has bought less than 1,500 policies since 2001. … A few years ago, Berkshire Hathaway Inc., the investment vehicle of billionaire investor Warren Buffett, began buying life settlements, according to securities filings.”

Ask your professional adviser to check out life settlements for your personal investments and qualified-plan funds.