If you are a tax sinner, please step forward. Today’s sermon at The First Anti-Tax Church is entitled, “How You Can Enrich the IRS When Transferring Your Business.” Strange title? Not really. It’s the conventional wisdom or what our preacher calls “The Old-Time Tax Religion.”
Following is a true story of good against evil taken straight from the pages of the ever-growing-tax-business bible. If you’re a business owner with two or more children-listen up.
A business owner (age 68) (we’ll call him Joe) from Alabama told me how three employees (ages 38, 45, and 52) had helped build his business (Success Co.) over the years. Profits were plowed back into the business. Today its worth $10 million, with 80 percent owned by Joe and 20 percent owned by the employees. Joe and his wife, Mary, have three children, none active (and not likely to be) in the business.
Joe’s goals are simple: After he passes on, the business should go to the three employees; his three children should get the value ($8 million) of Joe’s share of the business. What’s the conventional wisdom? Have Success Co. own life insurance. The actual amount of insurance is now $11 million. The extra $3 million allows for growth.
The insurance funds a buy-sell agreement. After Joe dies, Success Co. will buy Joe’s stock. Then the employees will own 100 percent of the business. (Good! That’s what Joe wants.) The kids will get the $8 million or more, which is also what Joe wants. Perfect? Joe’s lawyer, accountant, and insurance consultant assured him that this is — by conventional wisdom — the “best” way to go.
What’s wrong with the picture? Each dollar of those insurance proceeds used to buy Joe’s stock will be divided two ways: 55 cents to the IRS; 45 cents to the kids. Unwittingly, the IRS, not Joe’s family will benefit the most from Joe’s business, which took him a lifetime to build.
What to do? The solution may vary with your particular situation (for example, how many kids you have in the business, how many are nonbusiness children, your age, your wife’s age, the value of your business and the value of the rest of your assets). But here’s a plan to beat the pants off of the conventional wisdom and the IRS, legally. And it’s easy to do.
Step one: Get the insurance out of the corporation into Joe’s name and then into an irrevocable life insurance trust. No, the insurance proceeds will be free of the estate tax.
Step two: Recapitalize Success Co. (which will create voting and non-voting stock) so Joe can keep voting control (a tax-free transaction) for as long as he lives. Say there is 100 shares of voting stock and 10,000 shares of non-voting stock. Joe will keep the 100 shares of voting stock (and absolute control) for as long as he lives.
Step three: Create an annual stock-bonus/stock-gift program. Success Co. will give stock bonuses of non-voting stock to the employees. (In a more typical example, the employees would be Joe’s children.) Joe would make annual gifts of Success Co. stock to his children and grandchildren.
This sermon does not attempt to cover all the details of the plan outlined above. Find a professional who knows how to use this structure to craft that transfers most (in many cases all) your wealth free of the estate tax. More importantly, your estate tax liability (whatever the amount) will be transferred, in effect to the insurance carrier.
When all the smoke clears, either your estate tax will be zero or paid 100 percent by tax-free insurance proceeds. It’s time for you and your professionals to get that new-time tax religion.
Want a head start on how to win the transfer/succession/estate tax game? Visit my Web site or call to discuss your specific concerns.
