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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.

Tags: 1 million, 401 k plans, annuities, business transfer, capital gains tax, computing capital, dividend income, employee benefit plan, estate planning, Estate Tax, family business, family limited partnerships, family member, favorable tax, fmv, good stuff, income in respect of a decedent, income tax, income tax bill, Insurance, insurance premium, investment interest, IRA, IRS, irs letter ruling, lazy man, note payments, one of my favorites, painful subject, pitfalls, potfolio, predictable response, profit, qualified retirement plan, redemption, return, sacred cows, stock market, strategy, tax deffer, tax disaster, tax free, tax free investments, tax victory, wife mary
Posted in Corporate Tax, Estate Tax, Tax Strategies | No Comments »

Sick of paying tax? Call a tax doctor for a second opinion

Friday, April 3rd, 2009

Often, I feel like an old-fashioned country doctor makin’ house calls. But there is a difference: my patients are sick of paying taxes.

Recently, I visited a successful family business in North Carolina, owned by a semi-retired 64-year-old named Joe and run by his son, Sam, a 36-year-old.

Joe called me. He wanted a second tax opinion for a business transfer plan and an estate plan put in place by Sam (with the advice of his professional advisors, the “best” estate planning team in the county) almost two years ago.

Wow, this patient was really sick (running a high tax fever, bleeding lots of tax dollars).

This is the story of the symptoms, the diagnosis and the “magic tax potions” that cured the patient.

First, the facts:

Joe owns 98 percent of two corporations: a profitable S corporation (Success Co.), which operates a string of stores, and a C corporation (a tax-paying corporation, called R/E Co.), which owns real estate leased to Success Co.

The real estate has an income tax basis of $1 million, but a current fair market value of about $6 million. Sam owns the remaining two percent of the stock of both corporations. Each of the corporations is the owner and beneficiary of a separate $1 million insurance policy on Joe’s life.

Four more little details:

• Joe’s second wife, Mary, is 45 years old and they have a premarital agreement that gives Mary the income from one-half of the value of Joe’s assets at his death for as long as Mary lives. But get this: none of the stock of Success Co. can be used to provide Mary her income.

• An artificially low price in a buy/sell agreement would force Joe’s estate to sell his stock in Success Co. back to Success Co. and the same for R/E Co. (Result: Sam would then own 100 percent of both corporations.)

• Joe has two other grown children who are not in the business.

• Joe is not insurable.

The diagnosis:

• The $1 million in life insurance payable to R/E Co. would kick up an unnecessary alternative minimum tax.

• The full $2 million of insurance would be included in Joe’s estate because he controls both corporations, but the $2 million (less the alternative minimum tax of about $150,000) would belong to the corporations, not Joe’s estate.

• There are not enough liquid assets to satisfy the obligation to Mary. Worse yet, if the obligation to Mary is met, there would be zero dollars (outside of the corporations) to pay an estimated $3.5 million estate tax liability. Simply put, the estate would be broke.

Our objectives to cure Joe’s tax illness are clear:

• Reduce the value of Joe’s estate.

• Get cash to fund the obligation to Mary.

• Pay the estate tax.

Here are the five major tax medicines I recommended to cure Joe’s business transfer and estate plan:

• Merge R/E Co. into Success Co. This maneuver is tax-free. R/E Co. is worth about $6 million as a real estate investment company but, as part of the operating company, its value is reduced by at least $2 million for estate tax purposes. Estate tax saving — over $1 million.

• Transfer the nonvoting stock (created after the merger) to a grantor retained annuity trust (GRAT), which reduces the value of Success Co. by about 40 percent for estate tax purposes. This maneuver saves about $.5 million in estate taxes.

• Joe takes the $2 million in insurance policies out of the corporations and gives it to his children. Result: The value of Joe’s estate drops about $2 million and will save another $1 million plus in estate tax.

• Change Joe’s will to put the entire estate tax obligation on the children. The $2 million in income tax-free/estate tax-free insurance proceeds will handle the entire estate tax load when Joe dies.

• Make sure Joe’s will qualifies for the 100 percent marital deduction for Mary’s one-half share, thus deferring any estate tax on this portion of Joe’s estate until Mary dies. Yes, there are other details and nuances in the plan, including gifts to Joe’s children, but these five tax medicines cured the patient.

What’s the lesson to be learned from this true-life Joe/Sam/Mary story? Always, yes always, get a second opinion after your estate plan is done, preferably before any documents are signed.

Tags: 401 k plans, alternative minimum tax, annuities, business transfer, c corporation, employee benefit plan, estate planning, Estate Tax, family business, income in respect of a decedent, income tax, Insurance, insurance policy, investment income, IRA, IRS, jonathan blattmachr, painful subject, pension plans, planning team, potfolio, premarital agreement, professional advisors, profit, profit sharing, qualified retirement plan, return, s corporation, stock market, strategy, successful family, tax basis, tax bracket, tax deffer, tax dollars, tax free, tax free investments
Posted in General Tax Strategies, General Tax Talk, Uncategorized | No Comments »

Find ways to keep top executives happy in order to attract others.

Monday, March 30th, 2009

Most of my consulting time is spent putting together wealth-transfer plans for successful business owners.

Invariably, about half of my clients bring up two critical and related operational problems:

“How do I keep my top executives?” (The headhunters — usually working for a competitor — are always circling.)

And, “How do I attract new quality people?”

The problem is not new, and more than likely, it will get worse in the future as the bidding war for talented people escalates.

What to do?

Almost 20 years ago, after struggling with the problem for about a year, we decided to develop an organized plan to find the answers. We interviewed our few client/owners who did not have the two problems. We also interviewed their key management people.

Then came the hard part: getting permission to interview the key people at clients that were suffering with the problem.

What quickly became clear was that almost 100 percent of the best key people have the soul of an entrepreneur. Yet for various reasons, they do not want to strike out on their own or couldn’t (usually because they can’t raise the required capital).

Solving the top-executive problem turned out to be simple: mimic ownership, give them the same challenges as an owner and, if successful, most of the rewards. Additional interviews just kept reconfirming the original solution.

The top (nonowner) executives wanted four core benefits of ownership:

• A piece of the action — a share of company profits;

• Pay when sick or disabled;

• Adequate retirement pay when it’s time to leave the company;

• Death benefits for their family. (“Like my piece of the equity if I get hit by a bus,” or similar words, is the way most executives put it.) Over the years we have created hundreds of contracts (the technical name is a nonqualified deferred compensation agreement; the nontechnical name is a golden handcuff agreement) that attract and keep the kind of key people you want in your organization.

Let’s take a closer look at each of the four desired benefits:

• A piece-of-the-action plan — Typically, this is a percentage of the profits in excess of a specific dollar amount. Often, the percentage grows as the business and profits grow.

For example, Sam Topgun will get 4 percent of all before-tax profits in excess of $200,000 per year. Profits in excess of $400,000 will be entitled to 6 percent. Say the amount earned under the plan for year one (or any subsequent year is $21,000).

Usually, Sam will get about one-third ($7,000) in cash and the balance ($14,000) is deferred. The deferred portion is invested for Sam’s benefit. When does Sam get the deferred portion and the accumulated earnings (usually called the side fund)? When the employee becomes disabled, dies or reaches retirement age (the age is usually set around 58 for younger key employees and in the 65-age range for older key people). When the key employee becomes entitled to collect the side fund (say it is $500,000), it usually is paid out in equal annual installments (say 10 years) or $50,000 per year plus the additional investment earnings for that year.

• Disability — The employee gets paid when sick or disabled, whether for a day or for a lifetime. This benefit is covered by long-term disability insurance. It is essential that “disability” is defined word-for-word in your agreement the same as it is defined in the disability insurance contract.

• Retirement — The side fund (described previously) supplements any regular retirement program (like a 401(k) or profit-sharing plan).

Typically, the executive is allowed to direct the investment of the side fund, which remains an asset of the employer. The tax consequences of the arrangement follow: The side-fund earnings are taxable to the employer. When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income.

If the employee leaves for any reason — except because of disability, death or retirement — the entire side fund is forfeited by the employee and remains the property of the company. Hence, the name, “golden handcuffs.”

• Set amount of money at death — When an owner dies, the family can sell the business (assuming it is not transferred to the kids). A similar benefit (really a death benefit) should be given to the employee. Of course, this benefit should be insurance funded. We have been doing these nonqualified plan for years. Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings:

This article does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always — and we mean always — work with a professional advisor. Years of experience have proved that the right agreement will make your good people even better.

Also, and sadly, there is no agreement we have ever seen that will make a bad employee even a little bit better. In a way, this topic of getting and keeping good people is frustrating. This is why we have never been able to develop a cookie-cutter solution. Yes, the four core benefits are almost always the same or similar. But the bells, whistles and unique requirements of each situation make it impossible to write a complete report — much less a book — on the subject.

Tags: annuities, bidding war, company profits, compensation agreement, competitor, death benefits, employee benefit plan, estate planning, Estate Tax, headhunters, income in respect of a decedent, income tax, Insurance, IRS, jonathan blattmachr, key management, nonqualified deferred compensation, painful subject, profit, qualified retirement plan, retirement pay, return, rewards, sacred cows, stock market, strategy, successful business, tax deffer, tax free, tax free investments, top executives
Posted in Corporate Tax, Estate Tax | No Comments »

Multi-generational planning means more wealth for all.

Monday, March 30th, 2009

While browsing though my small mountain of files looking for ideas on what to write, I ran across a 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 certified public accountant and lawyer back in the 1950s, a millionaire was hard to find. Today, millionaires are plentiful. 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.” The Newsweek article by Robert J. Samuelson, like so many other articles, entertainingly explored the problem but offered no solutions.

Let’s set the scene for how you — whether mom and dad trying to give it away tax-free or one of the kids on the receiving end — can, in fact, solve the problem. Let’s start with the elders, mom and dad, who have the wealth.

Fact number one: You aren’t dead yet. Typical estate plans, such as 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 number two: Years of experience have taught us that wealth is always passed to the younger generations of the family. And then the younger generations step into mom’s and dad’s shoes and typically increase the family wealth.

This gives the second generation an even bigger estate tax problem than mom and dad had.

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

Logic tells you that children, particularly 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, we view each generation of the family separately in terms of their special needs and objectives.

Yet, the plan should not be just for mom and dad. It should be a comprehensive and integrated plan for the entire family. Following is an overview of how it’s done.

Keep your wealth — every dollar of it — in your family, instead of losing it to taxes.

• First Generation. Install a lifetime plan that removes wealth from your taxable estate during 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); and 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 Kids—Second Generation. After completing a comprehensive plan for mom and dad, it is easy to project what the financial future of the kids might look like. 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, because of the young ages in this generation, is getting the children into a tax-free environment as soon as possible, a wealth-building must. These plans center on short-term and long-term tax-advantaged strategies that fulfill lifetime needs: education, buying a house, starting a business and, if they don’t go in to the family business, building a retirement fund.

Tags: 1950s, 401 k, 401 k plans, adviser, annuities, asset mix, berkshire hathaway inc, boom, c corporation, certified public accountant, elders, employee benefit plan, estate planning, estate planning lawyer, Estate Tax, estate tax purposes, fact number, family wealth, free wealth, generations, grandkids, income in respect of a decedent, income tax, inheritance, Insurance, insurance premium, IRA, IRS, irs estate tax, jonathan blattmachr, key management, life insurance policy, lifetime plan, millionaire, millionaires, mom and dad, municipal bonds, newsweek, newsweek article, nonqualified deferred compensation, number 72, order of business, painful subject, pension plans, potfolio, predictable response, professional practice, profit, profit sharing, qualified retirement plan, return, robert j samuelson, sacred cows, second generation, stock market, stock market investors, stocks and bonds, strategy, tax blunders, tax bracket, tax deffer, tax free, tax free investments, tax monster, tax returns, transferable insurance policies, wills and trusts
Posted in Irv Talk, Planning, Uncategorized | No Comments »

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).

Tags: 401 k plans, annuities, average rate of return, business owner, business succession plan, case law, charity, conservative investments, consulting contract, dividend, earned wealth, earnings, estate planning, estate planning lawyer, Estate Tax, family wealth, federal tax law, financial statements, first mistake, income tax, income taxes, Insurance, insurance company, internal revenue code, internal revenue service, IRA, IRS, irving l blackman, legal partner, life insurance, life settlement industry, lifetime plan, moneymaker, one person, ow, parasite, payroll tax, payroll taxes, plan business, potfolio, predictable response, professional advisers, profit, qualified retirement plan, return, s corporation, salary, stock market, strategy, tax blunders, tax deffer, tax free, tax free investments, tax man, tax purposes, tax returns, u s treasury bonds
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.

Tags: 401 k plans, annuities, asset protection, assets, bad stuff, business owner, business owners, charity, curtain, egotistical, employee benefit plan, estate planning, Estate Tax, federal estate tax, gross misuse, income in respect of a decedent, income tax, Insurance, insurance premium, investment interest, IRA, IRS, irs representative, jonathan blattmachr, man cry, money strategy, painful subject, pin down, potfolio, profit, profit sharing, sacred cows, scene 1, second opinion, sitting on a cloud, tax blunders, tax deffer, tax free, tax free investments, tax liability, tax monster, tax purposes, tax representative, tragedy, transferable insurance policies, welcome back to earth
Posted in Corporate Tax, Estate Tax, General Tax Strategies, Insurance, Tax Strategies | No Comments »

One happy Mom learned that the right planning can be tax magic.

Friday, March 27th, 2009

Do you have a large amount of retained earnings and excess cash in your corporation, but the double taxing power of the law has your cash locked in the corporation? Most business owners think they are stuck, but there’s a way out.

Here’s a true story of one way to get the job done. You’ll like it. Joe called me with this problem. Joe and his brother Jeff each owned 30 percent of Success Co., which they managed.

His mom, Mary, 66, owned 20 percent in her own name, and a trust created when Joe’s dad died owned the other 20 percent. Mary’s professional advisors recommended that she obtain $2 million of insurance using an irrevocable life insurance trust to pay the estate tax liability that would be due at her death — because of the value of the assets she owned directly in her own name and indirectly as a beneficiary of her deceased husband’s trust. The advisors were right. Mary needed the insurance, but she did not have any chance of coming up with the annual premium requirements of $32,000 for as long as she lived.

I asked Joe lots of questions, conferred with the advisors and requested a large pile of information — stuff like tax returns, financial statements, etc. After discovering that Success Co. had $2.5 million in excess cash, this is what I recommended.

Mary gifts $1.2 million of her Success Co. stock — the total value of Success Co. was appraised at over $8 million — to a charitable remainder trust. The charitable trust agrees to pay Mary $72,000 per year for as long as she lives. At Mary’s death, the balance, called the “remainder,” in the trust would go to charity. Each year Mary must pay $25,000 in income tax on the $72,000 of income from the charitable trust and $32,000 in premiums for the $2 million policy, which is owned by the life insurance trust, or a total of $57,000. This leaves Mary an extra $15,000 per year to buy presents for her grandchildren.

The life insurance trust will give Mary’s children $2 million in insurance proceeds when she dies. The entire $2 million will be tax free: no income tax and no estate tax.

But where does the charitable trust get the income to pay Mary? The charitable trust sells the gifted stock back to Success Co. for $1.2 million.

Let’s summarize Mary’s tax picture. Mary avoids all capital gains tax on the sale of the Success Co. stock. The balance in the charitable trust estimated at $1.1 million at Mary’s death goes to Mary’s favorite charity and is free of income tax and estate tax.

In addition, Mary gets an immediate income tax deduction of about $200,000 for her contribution to the charitable trust.

Simply put, even though Mary avoids both the capital gains tax and the estate tax, the IRS writes her a check. For what, you ask? For the present value of the remainder of the $1.2 million gifted to the charitable trust. This $200,000 (immediate deduction) results in about $70,000 in cash income tax savings for Mary — more expensive presents for the grandkids.

(Note: If Mary had sold the $1.2 million of Success Co. stock directly to the company, it would have been taxed as a dividend, resulting in a whopping tax of $180,000.)

A side note before concluding: There are many other ways to get cash or other types of property out of C corporations in a tax-effective manner. If you have such a problem, as a service to readers of this column, call me with your problem (847) 674-5295.

The use of a charitable remainder trust in tandem with an irrevocable life insurance trust is actually a method for making a tax-advantaged investment for your family. You may actually create wealth and make a real economic profit by giving to charity.

Tags: 5 million, beneficiary, brother jeff, business owners, charitable remainder trust, charitable trust, deceased husband, excess cash, financial statements, grandchildren, income tax, insurance proceeds, irrevocable life insurance trust, life insurance trust, premiums, professional advisors, tax liability, tax returns, total value, true story
Posted in Estate Tax, Family Tax Issues, General 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.)

Tags: dollar value, estate planning, Estate Tax, income tax, Insurance, IRS, lawyer, liquid investments, real estate, reputation, rollover ira, s corporation, second opinion
Posted in Estate Tax, Planning, Tax Strategies | No Comments »

The tax knight and his merry men rescue a distressed taxpayer…

Friday, March 27th, 2009

OK, so it’s a corny title. Yet it sure describes the economic and tax pain of Joe, a 79-year-old widower. Don’t feel sorry for Joe, he’s generally a healthy and happy guy. He hits golf balls, spends lots of time with the grandkids and still goes to work every morning at the successful business he started, which he transferred to his two sons, who now own and run it.

But you should hear Joe howl about the cost of paying the annual insurance premiums on his irrevocable life insurance trust. Joe’s trust owns a $4 million insurance policy on his life with annual payments of $87,000. Yes, he needs the insurance to cover a portion of his potential estate-tax liability. No, he couldn’t buy second-to-die — normally at substantially less premium cost — because his wife was uninsurable when the irrevocable trust bought his policy.

It should be noted that an irrevocable trust protects the death benefits of a life insurance policy from the clutches of the estate tax.

Now, stop for a moment and look at your insurance cost situation. Chances are you’ll find you have one or more of the same complaints as Joe. He’s got three:

• Every year when Joe wrote his check to the trust for $87,000, he got four exclusions of $11,000 each, or $44,000 annually, one for each of his two sons and two grandkids. That left a taxable gift of $43,000 ($87,000 minus $44,000), which eats away at his $1 million lifetime unified credit. No cash gift-tax now. Simply put, the first $1 million of taxable gifts do not require cash to pay the gift tax, but are paid by using your lifetime unified credit. When Joe gets hit by the final bus, those annual taxable gifts will turn into an estate-tax liability (most likely 55 percent of the total of all those annual taxable gifts for Joe). Starting in 2006 the $11,000 is raised to $12,000.

Joe fumes!

• Interest rates are much lower now than when Joe bought the policy. Result, the premiums are much more than the projections made by his insurance agent.

Joe’s expletives are not fit to repeat here.

• Joe’s smart. He figured out that in his tax bracket — state and federal combined — he must earn $145,000 and pay $58,000 in income tax in order to have the $87,000 needed to pay his insurance premium which is actually a gift to the trust. Joe fervently argues that life insurance premiums should be deductible. Good idea. But we need an act of Congress to change the Internal Revenue Code.

Now you know why Joe is a distressed taxpayer.

Readers of this column know I have a network of professionals to help me work my tax magic. So I, the tax knight, and my network of merry men, went to work.

We had Joe’s irrevocable trust restructured with his insurance using a strategy called “premium financing.” Essentially, premium financing is an economic concept where policy premiums are paid by a lending bank. Like before, Joe’s premium financing policy is owned by the trust. When Joe dies the bank loans and accrued interest on the loans will be paid out of the policy proceeds.

Joe’s premium financing is set up for $5 million — net proceeds after paying off the bank — to the trust, and the beneficiaries are his kids and grandkids. Joe’s only potential out-of-pocket costs are $60,000 to initiate the bank loan the year the premium financing is set up. If Joe lives to be 100, the total additional cost will be about $352,000, with varying small amounts to be paid each year to maintain the loan. Of course, if Joe dies sooner, these costs stop.

Now, what are the final results for Joe by using premium financing?

• To start, no more $87,000 annual premium payments — actually, no more premium payments. All three of his complaints disappeared.

• No out-of-pocket costs — not the $60,000 or any portion of the $352,000. Why? Because the cash surrender value of the original $4 million policy owned by his trust was more than enough to cover all of the premium financing costs. The old policy was canceled to free up the cash surrender value and put the premium financing strategy in place without any further out-of-pocket costs to Joe.

Even Joe is happy.

Premium financing is a relatively new concept — easy to understand, complex to implement. It really takes a network of experienced professionals working together. The results create an economic windfall — all tax-free.

But sorry, everyone cannot take advantage of premium financing. You must qualify by bringing two things to the table:

First, you must be insurable or if married, one spouse must be insurable, so your irrevocable trust can buy second-to-die coverage.

Next, you must be worth a minimum of $5 million. The more you are worth and the more investment-type assets such as stocks, bonds or even real estate you have, the more likely you will qualify for this strategy.

Tags: annual insurance, death benefits, Estate Tax, expletives, income tax, insurance agent, insurance premiums, interest rates, irrevocable life insurance trust, irrevocable trust, IRS, life insurance policy, life insurance trust, strategy, successful business, tax liability, taxable gifts
Posted in Corporate Tax, Estate Tax, Family Tax Issues, Insurance | No Comments »

Senior settlements an easy way to get high rate of return!

Friday, March 27th, 2009

When giving my tax-planning, wealth-building seminars, I usually ask the audience, “Do you know the ‘Rule of 72′ and how it works?”

Typically, about one-third of the people raise their hands.

Then I explain the wonderful, helpful Rule of 72:

“Write the number 72 on a piece of paper. Assume you can get a 10 percent rate of return.

Divide 10 into 72. You get 7.2.

What that means is your principal sum will double every 7.2 years.

“For example, $10,000 compounding for a period of 36 years will double exactly five times and give you $320,000.

Stop for a minute — do the simple math yourself. Fun, eh?”

But wait! What if that 10 percent return was subject to a 40 percent state and federal income tax? Then you would have only a 6 percent return — 72 divided by six means 12 years to double your money.

Now your $10,000 will double only three times over the same 36-year period ($10,000 to $20,000, $20,000 to $40,000, and $40,000 to $80,000).

Compare that $80,000 with $320,000 when tax-deferred (or tax-free). A huge difference.

So, now we know two factors that are measurably important to creating wealth: rate of return and tax deferment.

Let’s explore tax deferment first.

If you have money in a qualified plan — 401(k), profit-sharing, IRA or other qualified plan — you are on the tax-deferred road. If you are the proud owner of a Roth IRA or the new Roth 401(k), you can wave your tax-free flag.

Now the hard part: the rate of return. How would you like to average more than a 16 percent rate of return per year? You can. The concept is called senior settlements, or SS.

Let me introduce you to senior settlements by quoting a May 18 article from The Wall Street Journal titled Moving the Market:

“AIG (the insurance giant) has bought less than 1,500 policies since 2001, according to spokesman Wil Nans.

“The industry’s annual returns of 10 percent to 15 percent first attracted European and Asian investors. And a few years ago, Berkshire Hathaway Inc., the investment vehicle of billionaire investor Warren Buffett, began buying life settlements, according to securities filings.”

A senior settlement is simply the purchase of an existing insurance policy from a senior (65 or older) by an investor.

The selling senior, who no longer wants to pay premiums, gets a much larger price for the policy than by taking the cash surrender value from the insurance company. The senior wins. The investor wins by making a large profit without risk (the senior is sure to die).

Can you become one of the investors? Yes. A public company trading on the Nasdaq makes it easy. The average rate of return on senior settlements is 16.36 percent per year and has been more than 16 percent throughout the company’s 14-year operating history.

You can become a senior-settlement investor in one of three ways: taxable, tax-deferred or tax-free. Following are the most common possibilities:

• Taxable. You use your own funds or funds you control, like your corporation or other business entities, family limited partnerships and any noncharitable trust.

• Tax-deferred. Almost everyone can play this profitable game via a qualified plan. The trustees of pension plans or other plans that are not self-directed can join the profitable fun by investing the plan funds in senior settlements for the benefit of all participants.

• Tax-free. A Roth IRA or Roth 401(k) can fatten your tax-free accumulations. Charitable entities — charitable remainder and lead trusts and family foundations — are a perfect fit.

As you can see, we have a very positive attitude toward the potential wealth-building power of senior settlements.

But since senior settlements are probably new to almost everyone reading these words, here’s a suggestion:

Show this column to you professional advisers — CPA, lawyer, banker, financial planner and others.

Discuss senior settlements from at least these two aspects concerning your investments (taxable or otherwise):

1. The next time you are about to make an investment, determine how senior settlements compare with other possible investment choices.

2. Compare existing investments with your long-term (don’t forget to apply the Rule of 72) and short-term (about three to five years) goals.

Tags: aig, asian investors, berkshire hathaway, berkshire hathaway inc, creating wealth, federal income tax, income tax, insurance giant, investment vehicle, IRS, number 72, profit sharing, rate of return, roth 401 k, roth ira, rule of 72, senior settlements, wall street journal, wealth building
Posted in General Tax Strategies, Investment Strategies, Tax Strategies | No Comments »

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