Posts Tagged ‘jonathan blattmachr’

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.

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Posted in Corporate Tax, General Tax Strategies, Investment Strategies, Uncategorized | 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: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
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: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
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: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Posted in Irv Talk, Planning, Uncategorized | 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: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Posted in Corporate Tax, Estate Tax, General Tax Strategies, Insurance, Tax Strategies | No Comments »

Stop IRS from taking most of the dollars in your retirement plan

Thursday, March 26th, 2009

I am about to kill a few sacred cows. Qualified-employee-benefit-plan cows to be exact. This is a painful subject.

The best introduction I ever heard of the subject was in a speech by Jonathan Blattmachr, a brilliant New York estate-planning lawyer, who said:

“What I’m going to talk about now is the most heavily taxed receipt in estate planning. …

“It is called income in respect of a decedent, typically known by its initials, IRD.

“I could tell you the story about the physician who came to me with $8 million in IRAs and pension plans. Within a year after he died without planning, his estate had been whittled down to under $800,000. …

“Everybody you know in your neighborhood, the lawyers, the doctors and dentists, are loaded up with income in respect of a decedent.”

And add owners of closely held businesses to the list of those who can get clobbered by IRD. In fact, anyone who has accumulated even a small amount of dollars in a qualified retirement plan is an IRD disease carrier. The disease eats the dollars in pension plans, profit-sharing plans, 401(k) plans and similar plans.

Can it be cured? Yes.

My usual explanation of IRD to a client — “The IRS gets 70 percent or more, while your family gets 30 percent or less” — has a predictable response, ranging from a look of horror to an expletive utterance.

How does this tax robbery take place?

Well, if you are in a high tax bracket and take a distribution during your life from your qualified plan, you are hit with about a 40 percent income tax, including state and federal. Say each distribution is $100,000. This leaves you $60,000.

When you die, another 50 percent (it could be as high as 55 percent) for estate taxes slices the $60,000 in half. Now only $30,000 (30 percent of the $100,000) is left for your family. Taxes gobbled up $70,000.

What if you die with money in your qualified plan? The balance in your account is taxed twice as IRD — once for income tax and a second time for estate tax.

Result? The same 30 percent tax disaster as in the when-you-were-alive example. Yep, 30 cents of each dollar for your family, 70 cents to the tax collector.

A new concept (as far as I know, this author was the first person to write and lecture about it) called the “IRD-avoidance concept” can turn that 30 cents back into a dollar (or $300,000 back into $1 million or whatever the number may be).

Although complex to implement, the concept can be explained as a simple three-step process:

– The plan participant (let’s call him Joe) takes his distribution in the form of an annuity payable for life.

– Joe collects the annuity payments for life.

– Joe uses an irrevocable life insurance trust (often called the “super trust”) to purchase a life insurance policy, using the after-tax balance of the annuity payment to pay the premiums.

What are the tax results?

– Income tax: tax-free.

– Estate tax: no value at death, so no estate tax.

– Income tax: taxable as ordinary income.

Insurance proceeds are free of estate tax and income tax.

If you have about $350,000 or more in your qualified plans (add your pension, profit sharing, 401(k) and IRAs together), you owe it to yourself and your family to check with your tax professional to determine how the IRD-avoidance concept can save you and your family huge amounts of taxes, and also create wealth greater than the original amount in the plans.

Do it.

Tags: , , , , , , , , , , , , , , ,
Posted in Retirement Tax Advice | No Comments »