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Yes, you can beat the estate tax, legally, and easily

Saturday, May 30th, 2009

If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant, and CPA), you can and will develop a plan to beat the IRS. Every time. And legally.
Unfortunately, the goal of the typical estate planner is to reduce estate taxes. Our goal is always the same: eliminate the robber-like estate tax.
There are three types of readers of this column that call me for help: The reader who (1) has an estate plan but needs a second opinion, (2) has no plan, or (3) has been working on a plan for years and just can’t seem to get it done. Which type are you?…. Write your answer here ____________.
You might be interested in knowing that no matter which type you are, you have lots of company. Here are the percentages: (1) need a second opinion – 55%; (2) no plan – 15%; (3) working on a plan, can’t get it done – 30%.
Following is a real-life, second-opinion plan that should help you no matter which category you happen to be in: A 61-year old from Ohio, who winters in Florida, (let’s call him Joe) falls into the first opinion category. Joe’s letter says in part: “I… enclosed all the information… you asked for. My current plan [it was two short wills and two long revocable trusts. One of each for Joe: the others for his wife Mary] looks good… but somehow I don’t feel comfortable… So request… a second opinion.”
Joe and Mary turned out to be a very interesting case, yet, sadly and as is often the case, contains some common estate plan errors. Sure, their documents – wills and trusts – were near perfect. Problem is they just didn’t work. Let’s see why. Joe and Mary are worth just over $8 million, plus Joe has a number of life insurance policies totaling $2.7 million on his life that name Mary as the beneficiary. The $8 million includes $1.9 million in Joe’s rollover IRA with Mary as beneficiary. The balance of the assets ($6.1 million) – Joe’s business, their Ohio and Florida residences, some rental real estate and other investments – are all held in joint tenancy by Joe and Mary.
The wills and trusts – 46 pages in total – were designed by a large law firm to pass Joe’s and Mary’s assets in a highly organized plan, first to the survivor of Joe and Mary and then to their children and grandchildren. Because Joe is 4 years older than Mary (and females outlive males by about 4 years), it was assumed that Joe would pass on first.
Okay, suppose Joe goes to heaven first in 2009. Everything, and we mean everything (because of the joint tenancy) would go directly to Mary. Joe’s trust would get nothing and be a worthless stack of papers. Mary would get her $2.7 million in insurance. For the same reason – named beneficiary – Mary gets the $1.9 million in the IRA. What about the other assets – worth $6.1 million? All to Mary immediately. Let me repeat: because property held in joint tenancy goes to the survivor.
It should be pointed out that if Mary had died the day after Joe, the tax bite would have exceeded $3.1 million (using current 2009 estate tax rates, top rate of 45%) on the $10.7 million now owned by Mary. Their kids would net only about $7.6 million.
What’s the lesson to be learned from this second opinion story: a will and a revocable trust – no matter how terrific – standing alone can never be a complete estate plan.
We used a number of strategies to change Joe’s and Mary’s estate plan: (1) a qualified personal residence trust for the residences, (2) an intentionally defective trust to transfer Joe’s business to the kids…Tax-free, (3) an irrevocable trust for the insurance, (4) retirement plan rescue for the IRA to pay for the additional life insurance needed, (5) a family limited partnership
to hold the balance (real estate and investments) of their assets, and (6) an organized future-gift-giving program to their children and grandchildren. With minor changes, the original wills and trust were left alone.
Important Note: I predict that Congress will (before December 31, 2009), amend the estate tax law to make the first $3.5 million of your taxable estate tax-free. So for a married couple, $7 million can escape the estate tax monster.
After the above strategies and completed plans are put in place, if Joe and Mary get hit by the same bus, the kids would net, after taxes, about $11.2 million (includes the additional life insurance in strategy (4) above). The longer Joe and Mary live, as the future-gifting program – over time – is implemented, the more tax-free dollars will be transferred to the kids.
If you would like a second opinion on your current estate plan, please send the following information:
1. For Your Business. Your last year-end financial statement (all pages).
2. Personal. A current personal financial statement for you and your spouse.
3. A family tree. Your name and birthday. Same for your spouse, children, children’s spouses and your grandchildren.
4. Documents. Hold them for now. We will request them at a later date.
5. All phone numbers where you can be reached: business, home, cell.
Send to Irv Blackman, SECOND OPINION, 4545 W. Touhy Avenue, Lincolnwood, IL 60712. What’s our job?… To create the right plan for you, your family, and your business… and to coordinate and work with your professionals. If you have a question call Irv at 847-674-5295.
Okay, that’s the plan. Let’s hear from you.

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Posted in Corporate Tax, Estate Tax, Featured | No Comments »

Yes, It’s OK To Beat Up The IRS — Legally, Of Course!

Wednesday, April 15th, 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 (age 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, following is how Joe spelled out his goals:

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

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

3. Make sure he can maintain his lifestyle for as long as he lives.

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

5. 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 you 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 interests (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35 percent) 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 non-voting 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.

Because the trust is defective for income tax purposes, every dime that Joe receives (both for principal to pay off the note and interest) is tax-free. The beneficiaries of the trust are Tom and Dick who will each own half of the 5,200 non-voting 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 (remember, 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 eight 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 No. 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 who 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.

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An Easy Way For The Kids To Buy Their Parents’ Stock — Tax-Free

Tuesday, April 7th, 2009

Do you want to transfer your business to your kids? Read this:

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!

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

Please write a check to the IRS for $3,167,000

Sunday, April 5th, 2009

Through the years, our office has listened to an endless stream of taxpayers complain about the income tax.

But if you ever want to see anger, frustration and bitterness, meet with the beneficiaries (usually the kids) of an estate when they are told to write a seven- or eight-figure check to the IRS — for estate taxes.

Taxes that could have been avoided with proper planning.

Tragic!

A recent post-death estate planning consultation got us thinking about what you are now reading. Yes, the estate tax was exactly $3,167,000 after Mom died; Dad had died six years earlier. The really sad part of this story is that Dad’s and Mom’s entire estate tax liability could have been legally avoided with a rather simple estate plan.

Mom and Dad were survived by three kids and eight grandchildren. The business that Dad started back in the mid-50s was worth $4.5 million and owned 100 percent by Mom when she died.

According to Dad’s estate tax return, the business, which he left to Mom, was worth $2.9 million when he died. No estate tax (because of the marital deduction) was paid when Dad died.

Dad and Mom had a typical estate plan: a will and a trust. The trust created two trusts: one trust to take advantage of passing $1 million tax-free (the amount that was tax-free when Dad died) and a second trust to capture the marital deduction.

The tax-free amount is $2 million in 2006, rising to $3.5 million in 2009 and back to $1 million in 2011.

There is no estate tax if you die in 2010. I’m betting Congress will change these amounts before 2010 (or sooner).

The real answer (to why many people procrastinate and don’t complete a comprehensive estate plan during their life) is the deceased person whose estate caused the tax did not have to personally write that big check to the IRS.

Whenever we are about to plan an estate, we estimate the amount of estate tax that ultimately will be due.

Then we ask the client to write a check to the IRS for that amount. The client always gets the point. Then, we plan the estate so the client’s wealth goes to their family, instead of the IRS.

The plan must be a lifetime plan, that implements the proper strategies, as necessary, during your life. A plan contained in the typical will and trust-like Mom’s and Dad’s above-only enriches the IRS.

The person (your executor) who must write the check to pay your estate tax is helpless when it comes to minimizing or eliminating the estate tax. Only you, while you are alive, can eliminate the estate tax… by creating the proper comprehensive estate plan.

Here are the three things you can do to drive the estate-tax devil away:

(1) Learn all you can (this column is a good start);

(2) No matter what your age, put a complete estate plan into place now (then monitor it every two to four years);

(3) Only work with experienced professionals who can show you how to pass all your wealth — intact —to your family (if you are not sure, get a second opinion).

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Don’t go overboard with one kind of tax strategy

Saturday, April 4th, 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 their businesses, their situations, their problems. In spite of 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 discussing an estate plan, son Sam calling at the request of dad Joe agreed to send me some typical information: tax returns, financial statements and a copy of the existing plan. About one week later, a heavy box arrived with a five-inch stack of documents. About four inches worth were nine separate family limited partnerships. They were the same except each partnership owned a different asset: the family business, a residence, investments, etc.

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 drunk on partnerships.

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

Using the computations of the adviser, the IRS would get more than $2 million in estate taxes. Another $1.1 million of IRS enrichment was likely because of a gross misuse of the partnership strategy.

What does a family limited partnership accomplish? It allows you as a general partner to totally control the use of any asset transferred to the partnership yet reduce the value of the assets transferred. For example, $1 million of assets transferred to a partnership are usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percentestate-tax bracket would reduce your estate-tax burden by $192,500. Not bad!

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

Used properly, a partnership is almost a perfect tax tool. In general, don’t use them to own the stock of your family business. Nor should one be used for non-income-producing personal assets, like a home or car. It’s a valuable strategy for almost every other asset you might own: publicly traded stocks and bonds, real estate, you name it.

Without covering every detail, we terminated the partnerships that held the family business and two family homes. The business elected S corporation status and was transferred to an intentionally defective trust, and the residences were transferred to qualified personal residence trusts. Those 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 partnerships to pay the premiums on second-to-die life insurance on Joe and his wife, which was owned by an irrevocable life insurance trust that we created. That trust 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 plan, depending on how long Joe and his wife live.

One warning: This is an example of overindulgence in one tax strategy. Although the above descriptions cover the main points of how Joe’s problems were solved., this is not a do-it-yourself kit. There are a number of traps and exceptions. Only proceed with the help of an expert.

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Posted in General Tax Strategies, General Tax Talk, Uncategorized | No Comments »

Save by getting the real estate out of the corporation

Friday, April 3rd, 2009

Do you have real estate in your corporation? If so, raise your hand and keep reading. About once a month, we get a call at the office asking a question something like this: “How can I get real estate out of my corporation without being taxed to death?”

Actually, we could write a small book about the various facts and circumstances you should consider. The book would answer many questions:

Are you a C corporation or an S corporation?

Are there retained earnings? How much?

How much has the real estate appreciated?

Each additional fact might change the tax strategy needed. To cover all the possibilities is beyond the scope of this column.

Instead, let’s set up the facts and circumstances that cover more 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

The typical facts and circumstances. Joe owns Success Co., a C corporation with a large amount of retained earnings and one or more pieces of real estate that have significantly appreciated in value. Most of the time the real estate has a building on it, but it could be vacant. (If Success Co. is an S corporation, it has a large amount of old C corporation earnings frozen in place, and the same real-estate facts).

The Solution. Keep in mind that you don’t have to know how to build a car in order to drive one. Don’t sweat the technical details; just concentrate on the unbelievable favorable tax results.

Here’s the easy six-step process:

1. Joe forms a family limited partnership outside of Success Co. Then Success Co. contributes vacant land to the partnership. (If the land is improved, Success Co. keeps the improvements as leasehold improvements.) Say the land is worth $1 million. In exchange, Success Co. receives ownership of 99 percent of the limited partnership. Joe contributes $10,000 in cash for a 1 percent general-partnership interest. As the general partner, Joe has all the voting rights and makes all the decisions.

2. Success Co. leases the land for $100,000 a year.

3. An independent appraiser values the limited partnership interest at $600,000 after applying a 40 percent discount for lack of marketability. Yes, the $1 million property is worth only $600,000, because it’s in the limited partnership merely for tax purposes.

4. Success Co. contributes 99 percent of its limited partnership to a charitable trust with the following terms: The partnership will pay $99,000 a year to the trust for eight years. (Typically the trust then makes contributions to Joe’s Family Foundation. Follow the money: Success pays $100,000 rent to the partnership, the partnership pays $99,000 to the trust and the trust contributes to Joe’s foundation.

5. Joe’s children buy the remaining 1 percent interest from Success Co. According to the IRS, the value of the $99,000 the trust will receive over the eight years is $569,000. So the value of the part of the partnership that Success Co. still owns is $600,000 minus the $569,000, or $31,000. Simply put, Success Co. owns an asset that according to the IRS is worth $31,000. That’s how much Joe’s children pay.

6. After eight years, the trust ends. Joe’s children, who are the beneficiaries of the trust, receive and now own the 99 percent of the limited partnership. Remember, they bought the other 1 percent from Success Co. eight years ago. So Success Co. and the trust are out of the picture.

Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children.

And there’s a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the partnership, the trust, Joe, the kids and Success Co, except that Success might owe tax on the $31,000 sale.

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Posted in Corporate Tax, General Tax Strategies, Investment Strategies, Uncategorized | No Comments »

How to invest your accumulated cash profits

Friday, April 3rd, 2009

Business owners have many legitimate complaints these days: taxes, regulations, competition (from home and abroad), can’t find good people.

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).

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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.

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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.

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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.

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Posted in Corporate Tax, Estate Tax | No Comments »

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