This is a big deal. We are talking big money.

Typically, the IRS gets 50 to 55 cents out of every life-insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000. Your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

Mistake No. 1 — A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies: The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax (AMT) that can steal up to 20 percent of the proceeds — and the net proceeds (after the AMT) can only get into the hands of your family by paying a second tax via a taxable dividend (ouch!).

If an S corporation, the proceeds (although not subject to the AMT) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend (a terrible and tax-expensive idea).

Mistake No. 2 — The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate (or your spouse’s estate). You just guaranteed the IRS a big — unnecessary — payday.

Mistake No. 3 — The policy (with cash surrender value) is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

So what should you do? Here are the typical recommendations we give to our clients so that, you and your family — instead of the IRS — win the insurance tax game.

For Mistake No. 1 — Transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value (a tax-free transaction). Next, transfer the policy to a Wealth Creation Trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For Mistake No. 2 — Transfer the policy to a Wealth Creation Trust.

For Mistake No. 3 — If you are insurable, dump the old policy and replace it with a new policy to be owned by a Wealth Creation Trust. First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy (insures you and your spouse) will give you significantly more bang for your insurance premium dollar. Second, determine how to reduce the premium cost:

(1) if your company has a 401(k) or other qualified plan look into a “Subtrust.” The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun.

(2) Whether you need single life (only you are insured) or second-to-die, check out “premium financing.” You don’t pay any premiums to get a large ($5 million or more) amount of insurance, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps, but simple to avoid when you know the tax ropes.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost-income and estate-while I’m alive? … When I die? … When my spouse dies?

The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

It is very rare to analyze the estate plan, particularly the life insurance policies, of a real-life client and find that all is as it should be.

Typically, we find the wrong kind of insurance. Wrong ownership. Wrong beneficiaries. Wrong tax consequences. It goes on and on.

This is a big deal. We are talking big money. Typically, the IRS gets 50 cents to 55 cents out of every life insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000, but your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

• Mistake No. 1

A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies. The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax — which can steal up to 20 percent of the proceeds — and the net proceeds after the tax can only get into the hands of your family by paying a second tax via a taxable dividend. Ouch!

If an S corporation, the proceeds (although not subject to the alternative minimum tax) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend — a terrible and tax-expensive idea.

• Mistake No. 2

The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate. You just guaranteed the IRS a big, unnecessary payday.

• Mistake No. 3

The policy, with cash surrender value, is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

What should you do? Here are the typical recommendations we give to our clients so that you and your family — instead of the IRS — win the insurance tax game.

In the case of mistake No. 1, transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value, a tax-free transaction. Next, transfer the policy to a wealth creation trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For mistake No. 2 transfer the policy to a wealth creation trust.

And for mistake No. 3, if you are insurable, dump the old policy and replace it with a new policy to be owned by a wealth creation trust.

First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy insures you and your spouse will get significantly more bang for your insurance-premium dollar.

Second, determine how to reduce the premium cost: (1) if your company has a 401(k) or other qualified plan look into a subtrust. The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun; (2) Whether you need single life (only you are insured) or second-to-die, check out premium financing. You don’t pay any premiums, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost — income and estate — while I’m alive? When I die? When my spouse dies? The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

“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: to eliminate taxes.

“There are three types of readers who call us for help: readers who (1) have an estate plan but need a second opinion; (2) have no plan; or (3) have been working on a plan for years and just can’t seem to get it done. Which type are you?

“We will do a business succession/estate plan (and any necessary valuation) for each reader. We will report back to you (through this column) how many readers responded, how many we could and could not help, and a summary of the tax tools and techniques used to help the readers.”

Here are the 2004 results. In all, 16 readers (more than we expected) responded; 15 were in either the first or second category and, of course, were easy to help using the tax techniques and strategies described in this column over the years.

A 61-year-old from Ohio — let’s call him Joe — fell into the second-opinion category.

Joe’s letter said 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 and for his wife, Mary) looks good … but somehow I don’t feel comfortable.”

Joe and Mary turned out to be a very interesting case, yet sadly, their plan contained some common estate-planning errors. Sure, their documents — wills and trusts — were nearly perfect. Problem is, they just didn’t work. Let’s see why.

Joe and Mary are worth slightly more than $7 million, plus Joe has a number of life insurance policies totaling $2.2 million on his life that name Mary as the beneficiary. The $7 million includes $1.8 million in Joe’s rollover IRA with Mary as beneficiary. The balance of the assets ($5.2 million) — Joe’s business, their residence, some 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 and Mary’s assets in a highly organized plan, first to the surviving spouse and then to their children and grandchildren. Because Joe is four years older than Mary, and women outlive men by about four years, it was assumed that Joe would pass on first.

OK, suppose Joe goes to heaven first. Everything, and we mean everything, would go directly to Mary. Joe’s trust would get nothing and be a worthless stack of paper.

This is why: As the named beneficiary, Mary would get the $2.2 million of insurance. For the same reason — being the named beneficiary — Mary gets the $1.8 million in the IRA.

What about the other assets, worth $5.2 million? All to Mary immediately — because property held in joint tenancy goes to the survivor.

It should be pointed out that if Mary dies the day after Joe, the tax bite would exceed $3.5 million (using 2011 estate tax rates) of the $9.2 million now owned by Mary. Their kids would net only about $5.7 million.

What’s the lesson to be learned from this second-opinion story? Standing alone, a will and a revocable trust — no matter how terrific — can never be a complete estate plan.

We used a number of strategies to change Joe and Mary’s estate plan:

• A qualified personal residence trust for the residences.

• An intentionally defective trust to transfer Joe’s business to the kids tax-free.

• An irrevocable life insurance trust for the insurance.

• A subtrust for the profit- sharing plan to pay for the additional life insurance needed.

• A family limited partnership to hold the balance (real estate and investments) of their assets.

• An organized future- gift-giving program to their children and grandchildren.

With minor changes, the original wills and trusts were left alone.

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 $9.5 million. The longer Joe and Mary live, as the future- gifting program is implemented, the more tax-free dollars are transferred to the kids.

If you want to participate in the 2006 wealth transfer plan test, please send the following information to: Irv Blackman, Wealth Transfer Plan Test, Blackman Kallick Bartelstein LLP, 3960 Deer Crossing Court, unit 102, Naples, FL 34114.

• For your business: Your last year-end financial statement (all pages).

• Personal: A current personal financial statement for you and your spouse.

• A family tree: Your name and birthday. Same for your spouse, children, their spouses and your grandchildren.

• All phone numbers: Business, home and cell.

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 me at 417-9732.

OK, that’s our plan to help you do your plan — and do it right. Let’s hear from you.