Posts Tagged ‘estate planning’

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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 »

Plan wisely to accomplish goals for your estate, before it’s too late!

Friday, March 27th, 2009

The facts, problems and solutions of this article are so typical of the readers of this column who call me for help, that I felt compelled to write about it.

Read slowly, chances are you will see some of yourself or someone you know.

Joe, 74, owns 52 percent of an S corporation (Success Co.), and each of his three children owns 16 percent of Success Co.

He has two boys, Tom, 47, and Dick, 43, who have been in business with Joe since they graduated from college. Joe’s daughter Harriet was not and never will be involved in the business. Joe lost his first and only wife last year.

Following is a list of Joe’s assets:

Various liquid investments — $190,000

52 percent of Success Co. — $1,630,000

Real estate leased to Success Co. — $600,000

Balance in Rollover IRA — $780,000

Residence and summer home — $435,000

TOTAL — $3,635,000

Joe’s lawyer (an estate planning expert with a fine reputation), who just completed Joe’s estate plan, correctly computed the estate tax (using 2011 rates) at $1,419,771. His only recommendation: Buy $1.5 million in insurance to pay the tax.

Joe called me for a second opinion. After a long telephone conference, Joe spelled out his goals:

• Control Success Co. (and the rest of his assets) for as long as he lives

• When he is gone, to have Success Co. owned 50 percent each by Tom and Dick

• Make sure he can maintain his lifestyle for as long as he lives

The dollar value that Harriet receives from Joe’s estate should be equal to the amount received by each of her brothers.

Find a way to have each of his kids receive one-third of what he is worth now, all taxes paid in full. (Joe laughed a bit at this goal; he didn’t think it was possible).

Stop for a moment. Substitute your own list of assets and goals (remember, if you are married, some day either you or your spouse will be the first to pass on). What follows is the plan we implemented for Joe and the strategies we selected to accomplish Joe’s five specific goals (in the same order as the goals).

We recapitalized Success Co. (a tax-free transaction) so Joe now owned 52 percent of the controlling voting stock (52 of 100 shares) and 52 percent of the nonvoting stock (5,200 of 10,000 shares).

We transferred the liquid investments and the real estate to a family limited partnership (FLIP). As the general partner (owned 1 percent of the FLIP), Joe kept control of these assets.

He will make annual gifts ($12,000 each) of limited partnership interests to the kids.

These limited interest (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35%) for tax purposes. As a result, Joe can give about $19,000 to each kid of limited FLIP interests every year, yet for tax purposes the interests are only worth $12,000.

Joe sold the 5,200 shares of nonvoting stock to a so-called defective trust (defective for income tax purposes) for $1.5 million plus interest. The trust paid for the stock with a note.

Success Co. will distribute S Corporation dividends each year to the trust, which will then pay off the note to Joe.

The beneficiaries of the trust are Tom and Dick who will each own half of the 5,200 shares when the note is fully paid and the trust terminates.

Joe’s 52 voting shares will go to Tom and Dick when Joe dies.

The shares owned by sister Harriet will be redeemed by Success Co., according to a new buy/sell agreement, when Joe passes on. Then Tom and Dick will each own 50 percent of Success Co.

Joe’s flow of cash to maintain his lifestyle would come from many sources. (a) a small salary from Success Co., plus all of his usual perks; (b) The note payments from the trust (the entire $1.5 million plus the interest is tax-free to Joe because of the defective trust); and (c) distributions from the rollover IRA. Actually during the years (about 8 to 10) while the note is being paid off, Joe will have more cash than he needs to live. This excess cash will be put into the FLIP (and, of course, will be available for distribution in future years). Actually, all the assets of the FLIP will be available to Joe if needed.

As a final back up, Joe will enter into a death benefit agreement with Success Co., that will pay Joe $75,000 per year starting when Joe retires (probably never) and continuing until the day he dies.

We created a Subtrust (using the Rollover IRA and Success Co.) to purchase a $1.5 million life insurance policy. The entire $62,187 annual premium will be paid out of plan funds (it won’t cost Joe a penny), and because of the subtrust none of the $1.5 million ultimate policy proceeds will be included in Joe’s estate.

Appropriate language in Joe’s death documents (will and revocable trust) makes sure Joe’s “goal” will be accomplished; the $1.5 million in tax-free insurance makes this goal easy.The residence (worth $355,000) was transferred to a qualified personal residence trust (QPRT).

The QPRT was set up in such a way that Joe could live in the residence for as long as he lived, yet it would be out of his estate.

If Joe gets hit by a bus the day after the plan described above is put in place, this “goal 5″ (the entire $3,635,000 to the kids) will be accomplished (along with the four other goals). The longer Joe lives, the less the IRS gets and the more the kids get (in excess of the $3,635,000).

One warning: The above story does not explain all the technical details of Joe’s plan.

Only work with a tax advisor that knows, understands and has worked with the strategies used for Joe. A will and trust alone (no matter how long or how fancy) will not get the job done. (All your wealth to future generations, while totally eliminating the impact of the estate tax.)

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Double rewards!

Friday, March 27th, 2009

Patrick Henry once said: “I have but one lamp by which my feet are lighted, and that is the lamp of experience.”

After years of working in wealth transfer, business succession, estate planning and related areas, I changed my view of my clients’ philosophies.

Why? Experience!

You’ll like what you are about to read: How to actually make money while giving it away.

An important task for tax advisers, particularly those doing estate planning, is to make sure they have a clear understanding of each client’s goals. So, one of the questions my staff or I ask each client is: “Do you have charitable intent?” Most clients answer no, and that is that.

In years past when a client answered affirmatively, we had a large arsenal of tax-advantaged charitable strategies that would enrich not only charity, but our clients, too. Every client made an after-tax profit.

One day about 10 years ago, we decided to dig a bit deeper when a client answered negatively to our charity question.

Here are the two most important questions we asked, the answers we got, and to our surprise, what we learned.

• A simple one-word question: “Why?”

About two-thirds of clients responded with something like: “I don’t want to reduce the amount of my children’s and grandchildren’s inheritance.”

After we learned this, it made good sense to follow with the next question — actually two questions — designed to get a “yes”:

• First, “Would you consider making a substantial gift to charity, if it would not reduce your heirs’ inheritance?”

And if that didn’t do the trick, we asked: “Would you make a large charitable gift if you could actually make an after-tax profit?”

Now, almost all clients said “yes” or “show me how” or something similar.

The simple fact is that the tax law has two tax-free environments: charity and life insurance. Marry them and you are on the road to tax heaven.

Let’s stay away from the technical stuff, like charitable remainder trusts and charitable lead trusts and their many ways to help you and charity, and look at two basic examples.

Example 1

Suppose Joe and Mary, married and both 65, buy a 15-year-pay, $4 million second-to-die life insurance policy.

The annual premium is $20,618 per $1 million payable for 15 years, or a total of $1.237 million. Joe and Mary set it up so their favorite charity is irrevocably the beneficiary of the policy.

Let’s take a look at the tax consequences of this charitable gesture by Joe and Mary.

They are in a 40-percent income-tax bracket, counting state and federal combined, and a 55-percent estate-tax bracket, using 2011 rates.

First, let’s look at the estate-tax picture. In a 55-percent estate-tax bracket, the real story is that the IRS gets paid 55 percent of that $1.237 million.

Since it’s gone, the IRS can’t tax it. So, the real out-of-pocket cost to Joe and Mary (after estate tax consideration) is only $557,000 (45 percent of $1.237 million).

Second, let’s look at the income tax consequences of the transaction. In a 40-percent income-tax bracket, Joe and Mary save $8,247 ($20,618 times 40 percent) each year as a charitable deduction.

Next, Joe and Mary buy $1.6 million of 15-year pay, second-to-die life insurance in an irrevocable life insurance trust, to keep the proceeds out of their estate. What’s the annual premium cost for only 15 years? You guessed it — their annual $8,247 income tax savings.

Finally, let’s put it all together. Their favorite charity will wind up with $4 million. Their family will make more than a cool $1 million ($1.6 insurance proceeds less the $557,000 after-tax cost of the premiums paid for the gift to charity).

Example 2

The above is only the tip of the iceberg. There are dozens of similar strategies to enrich your family while you enrich charity.

This example and the one with the best leverage is “premium financing,” where $500,000 can be turned into $6.5 million for Joe and Mary and then shared with their favorite charity. Joe and Mary can divide the $6.5 million — $5 million to their family and $1.5 million to charity — or in any other ratio they desire.

Now, $500,000 is turned into $5.5 million. That’s tax and economic leverage!

Most of the time, your favorite charity is your own family foundation, which bears your name. By now you get the idea. If you, your spouse or both are lucky enough to be insurable, you can leverage small amounts of capital — an investment of $500,000 or less paid out in small amounts over many years — to mushroom into tax-free amounts of $5 million or more. Divide your tax-free profits between your family and charity any way you desire.

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Wealth transfer plan should target needs of each generation.

Friday, March 27th, 2009

While browsing though my small mountain of files looking for column ideas, I ran across a still timely and interesting article in an old issue of Newsweek titled Darling, It’ll All Be Yours — Soon. The article explains how “the inheritance boom is quietly reshaping how we think about death.” How true.

When I began my professional practice as a CPA and lawyer in the ’50s, a millionaire was hard to find. Today, millionaires are bountiful. And when it comes to estate planning, they scurry around trying to find a professional who can lower their estate tax before they get hit by the final bus.

Robert J. Samuelson’s well-written article, like so many other articles, entertainingly explores the problem, but it offers no solutions.

Let’s set the scene for how you — whether you are parents trying to give it away tax-free or one of the kids on the receiving end — can solve the problem.

Let’s start with Mom and Dad, who have the wealth.

• Fact No. 1: You ain’t dead yet. Typical estate plans (separate wills and trusts for him and her) don’t speak until you are dead — too late to beat the tax collector.

The solutions lie in lifetime planning: A lifetime plan keeps you in control of your wealth for as long as you live, yet transfers it — including your business — to your kids and grandkids while you are alive.

• Fact No. 2: Years of experience have taught us that wealth is always passed on to the younger generations of the family. And then the younger generations step into the parents’ shoes and typically increase the family wealth. This gives the second generation an even bigger estate tax problem than the parents had.

Here’s how we solve this do-not-enrich-the-IRS estate tax problem.

Logic tells you that the children — particularly the business children — are likely to become wealthy. Usually, these children accumulate more wealth than their mom and dad — to be repeated again when the family wealth goes to the grandchildren two generations later.

Because of this generation-to-generation wealth transfer pattern, we view each generation of the family separately in terms of its special needs and objectives. But the plan should not be just for Mom and Dad; it should be a comprehensive plan for the entire family.

Following is an overview of how it’s done: keeping your wealth — every dollar of it — in your family, instead of losing it to the IRS.

You and your spouse (first generation)

Install a lifetime plan that removes wealth from your taxable estate during your life.

Use strategies like:

• A qualified personal resident trust for your residence.

• An intentionally defective trust for your business.

• A subtrust for your profit-sharing plan, rollover IRAs and similar plans.

• A family limited partnership for your other assets — typically investments like stocks, bonds and real estate.

• An irrevocable life insurance trust for insurance, probably second-to-die.

All of these strategies — and there are many others — begin their work now, while you are alive, and allow you to stay in control of your assets, including your business, for as long as you live.

Of course, we’ll dovetail your will and trust (death documents) with your lifetime plan. But when done right, your death documents just clean up what’s left. The first part of the family plan, including a business succession plan, and your wealth transfer plan are completed — tax-free — while you and your spouse are alive.

Your children (second generation)

After we complete a comprehensive plan for Mom and Dad, it is easy to project what the financial future of the kids might look like. So as soon as we finish the plan for the first generation, we start a plan for each of the kids, based on their individual assets and objectives.

Your grandchildren (third generation)

The plans for this generation are closely tied to the plans of the two older generations. Probably the most important point to keep in mind is that because of the young ages in this generation, getting the children into a tax-free environment as soon as possible is a wealth-building must.

These plans center on short-and long-term tax-advantaged strategies that fulfill lifetime needs: education, buying a house, starting a business and, if they don’t go into the family business, building a retirement fund.

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

Don’t flip your lid if you have too many FLIP accounts.

Thursday, March 26th, 2009

Professionally, my second love is writing this column; my first love is consulting with the people who read it.

Every family I work with is different. So are its business, its situations and its problems. Despite these differences, I’m rarely surprised by anything totally new. But one reader sent me something I had never seen before.

Here’s the story. After about an hour on the phone, Sam, calling at the request of his dad, Joe, agreed to send me the typical information: some tax returns and financial statements and a copy of the existing estate plan.

About one week later, a large, heavy box arrived with a 5-inch stack of documents. Most of the documents had to do with nine separate family limited partnerships, or FLIPs. All were identical, except each FLIP owned a different asset, like the family business, a residence or investments.

As I thumbed through the papers, I couldn’t help thinking about the drunk who was told, “A shot of whiskey each day is good for you.” The guy who did Joe’s estate plan was clearly FLIP drunk.

One thing should be made clear: I am an enthusiastic cheerleader for the use of FLIPs in estate planning. I use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

The proof: Using the computations of the adviser, the IRS still would cash in for more than $2 million in estate taxes.

Another $1.1 million of IRS enrichment was likely because of a gross misuse of the FLIP strategy.

What does a FLIP accomplish? It allows you to totally control the use of any asset transferred (a tax-free transfer) to the FLIP as the general partner, yet reduce the value of the bundle of assets transferred for tax purposes.

For example, $1 million of assets transferred to a FLIP is usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percent estate tax bracket will reduce your estate tax burden by $192,500. Not bad!

A FLIP also is a great asset-protection strategy. Creditors can’t get at the assets in the FLIP. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a FLIP is almost a perfect tax tool.

In general, a FLIP should not be used to own the stock of your family business. Nor should it be used for non-income-producing personal as sets, like a residence or auto.

It’s a valuable strategy for almost every other asset you might own — publicly traded stocks and bonds, real estate, you name it.

In short, we terminated the FLIPs that held the family business and two family residences.

The business elected S corporation status and was transferred to an intentionally defective trust (IDT), and the residences were transferred to qualified personal residence trusts (QPRTs). An IDT and a QPRT are similar concepts that allow you to heavily discount the value of the assets transferred to them.

We used the liquid assets in two other FLIPs to pay the premiums on second-to-die life insurance (on Joe and his wife), which was owned by an irrevocable life insurance trust (ILIT) that we created. An ILIT removes life insurance from the taxable estate of the husband and wife.

When all the smoke clears, Joe and his four children, including Sam, will be enriched $4 million to $7 million more than the original overkill FLIP plan (depending on how long Joe and his wife live).

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