If you own a business and your estate plan uses or intends to use any of the four commonly used techniques (actually tax traps) discussed in this article, you will unnecessarily enrich the IRS.
Guaranteed!
Let’s set-up the typical family-business situation we see at least 100 times every year. Joe, who is married to Mary, owns Success Co. Sam, their son, runs the business and someday will replace Joe. They have other children who are not active in the business.
The traps are listed here in order of the most serious and most frequent blunder.
The marital deduction. After Joe’s death, Mary will own Success Co. or a large portion of it in her own name or in some kind of marital trust. That’s great, when Joe dies. No estate tax. But when Mary goes, the IRS gets its pound of flesh. Remember, the marital deduction only defers tax; it’s not intended to be a tax saver.
A Section 303 redemption. Success Co. can redeem as much of Joe’s stock as necessary, free of any income or capital- gains tax to pay Joe’s (or Mary’s) death taxes and other estate costs. Sounds good. But the fact is, the money that comes out of Success Co. goes straight to the IRS.
Section 6166. Because Success Co. is a major asset in Joe’s (or Mary’s) estate, the estate tax can be paid in installments for up to 15 years with interest at a very low rate. Not only does the IRS get the estate tax, it now gets (even though a low percentage) interest to boot.
Normally this column tells you what to do to win the tax game, as opposed to telling you what not to do. OK, then. Here’s what you must do to check your estate plan and know it’s right for you and your family:
• The strategies you use must be initiated during your life (such as gifts, a grantor retained annuity trust or a family limited partnership), not at death (the three traps described in this article).
• When the entire plan is in place, your advisor should show you clearly that your total wealth will go to your family without being reduced in value by even one dime of estate taxes.
• Your advisor must get you into some kind of tax-free environment, such as an irrevocable life-insurance trust or some kind of charitable trust, immediately.
• You control your assets for as long as you live (or at least as long as you want) with the use of voting/nonvoting stock, a family limited partnership or various trusts.
• Finally, your assets are protected from creditors and lawsuits.
