2. Joe can borrow (tax-free) against the property if he needs cash.

3. A sale of the property is subject to only one capital gains tax, which Joe can report on the installment method if he takes back a mortgage for a portion of the
purchase price. Joe might even exchange it tax-free for another piece of property (called a “1031 exchange”).

4. When Joe dies, his heirs get a raised basis, for example: Say Joe bought the property 25 years ago for $100,000, and it is now fully depreciated down to $20,000 (the cost of the land). The value of the property on his date of death is $620,000. Now get this – that built-in $600,000 of profit escapes income tax. Forever! And also this – Mary now owns the real estate (free of income and estate taxes) with a brand new tax basis of $620,000… Just as if she had bought the property for the $620,000 price. Yes, she can depreciate this property (except for the value of the land) using her new $620,000 tax basis, which will shelter her rental income.

5. The property can be put into a Family Limited Partnership (FLIP), which has many tax and non-tax benefits. For example, a $1 million piece of real estate transferred to a FLIP can receive a discount for estate tax purposes of about $350,000. The estate tax savings could be as high as $157,500 (using current estate tax rates)

And, oh yes, when Mary dies, the law allows her to repeat the raised-tax-basis trick (to raise the value of the property at her death) all over again when she leaves the property to the kids.
Now you know why owning real estate in a corporation is not only a tax trap, but it also prevents you from reaping a tax harvest during your life, at your death and beyond.
Want to learn more tax tricks that will save you a bundle?… take a peek at my website: www.taxsecretsofthewealthy.com. If you have a question call Irv (847-674-5295).

Actually, we could write a small book about the various facts and circumstances that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

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 has 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

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

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 that impact on how-to-remove-real estate from your corporation. The book would answer many questions. Stuff like: Are you a C corporation or an S corporation? Are there retained earnings? And how much? How much has the real estate appreciated? And on and on.

Each additional fact might change the tax strategy needed to answer the question — to cover all the possibilities is beyond the scope of this column. Instead, let’s set up the facts and circumstances that represent over 95 percent of the calls and the recommended solution to get-the-real-estate-out-of-the-corporation problem.

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 has 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

As you read what follows, keep in mind that you don’t have to know how to build a car in order to drive one. Put it another way: Don’t sweat the technical details; simply concentrate on the unbelievable favorable tax results.

Here’s the process:

• Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives (ownership of 99 percent of the FLIP) limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a one percent general partnership interest. As the general partner Joe has all the voting rights and makes all the decisions.

• Success Co. leases the real estate from the FLIP for $100,000 per year.

• An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000, because it’s in the FLIP-for tax purposes.

• Success Co. contributes 99 percent of its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe’s Family Foundation). Let’s pause to follow the money. Success pays $100,000 rent to the FLIP; the FLIP pays $99,000 to the CLT, which makes contributions to Joe’s foundation.

• First some information: According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the one percent remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000 (the $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest). Simply put, Success Co. owns an asset that according to the IRS is worth only $31,000. Joe’s children buy the one percent remainder interest from Success Co. for $31,000.

• After eight years the CLT ends. Joe’s children, who are the beneficiaries of the CLT receive and now own 99 percent of the limited FLIP interests. Remember, they bought (and own) the other one percent from Success Co. eight years ago. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation, owned 100 percent by Joe’s children. And there is a bonus: The real estate is also out of Joe’s estate. The entire transaction is tax-free to the FLIP, the CLT, Joe, the kids and Success Co. (might owe tax on the $31,000 sale).

Now one warning: The above is an easy way to get your real estate-tax-free-out of your corporation. But you must use experienced advisors who know how to dot the ‘i’s and cross the ‘t’s.

Okay, try this quick quiz: What is the most valuable asset you own? Hands down, almost every business owner answers, “My business.” Good! Next question … What’s your business worth? Silence! Yes, the final and most common answer is no answer — given 15 seconds or 15 months.

What happens in real life when those same business owners or their families must value the business? Stuff happens! Things like gifts of the family business stock to the kids; death (requiring valuation for estate tax purposes); or divorce (where valuation becomes an expensive legal battle).

Or, how about buying or selling a business? The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.Here are three business valuation myths that I hear from business owners and their families when I consult with them. First, the business is worth book value (usually this value is too low); second, the value is eight to 10 times after-tax earnings (usually this value is too high); and third, an S corporation is worth more than a C corporation (a corporation that pays income tax) because an S corporation doesn’t pay income tax. (This is just plain wrong. There’s no difference in value.)

Visualize this: There are two piles of stock in front of you. One pile is made up of publicly traded stock, like Microsoft, IBM and Exxon Mobil Corp. with a total value of $4 million. The second pile is the stock of Your Family Business, Inc. (YFB, Inc.), also worth $4 million by the “right” (even the IRS would agree) valuation method. Think for a minute. Which pile is worth more? Right, the first pile: the publicly traded stock. Just call your broker and you can have the full $4 million in your bank account, less the broker’s commission, in a few days. What about the value of the second pile-YFB, Inc. stock? Well, the fact is that for tax purposes the courts give you a discount for general lack of marketability of about 35 percent, or about $1.4 million.

So, for tax purposes the stock of your $4 million family business is only worth $2.6 million. Surprise! Even the IRS has come around to agree with such discounts. The discount will, in this example, save your estate about $700,000 in estate taxes.

What is the most common reason for valuing a family business? Hands down, when dad (or mom or both) want to transfer the business to the kid(s). Now during dad’s life.

Dad usually has three basic requests: (1) “Make sure my lifestyle (and my spouse’s) can be maintained for life”; (2) “Want to control my business (and my other assets for as long as I live”; and (3) “Transfer my business to my kids tax-free (no income tax, capital gains tax or other taxes).”

Yes, all three basic requests are easy to accomplish if you employ the proper tax-strategies: The core strategies are (1) a well-done valuation (acceptable by the IRS), which is easy to do; (2) a recapitalization (creates voting and nonvoting stock); (3) use an intentionally defective trust (avoids all taxes on transfer of nonvoting stock to kids).

But we need some readers to volunteer their family businesses so we can structure a plan(s) and then write about them in future columns. Real names will be withheld. Don’t worry about your exact facts Maybe you have only one kid in the business; maybe two or more; maybe some in the business, some not; or maybe no kids in the business and you want to get the business to one (or more) employee(s) (and, of course, they have no money).

Just two ground rules: (1) You really want to transfer your business to your kids, other family members or employees (no hypotheticals) and (2) your business has a real fair market value of $3 million or more (your best guess of what a real buyer would pay). Just call me (Irv Blackman) at 239-417-9732 and let’s chat about your exact situation.

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.

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.

A short conversation with the caller explains why such a sale is a terrible idea — for Joe, and for the kids.

Let’s start with the kids, in this case Joe’s son, Steve, who wants to buy Success Co. for $1 million.

Follow these strangling tax numbers: Steve must earn about $1.66 to have $1 left to pay to Joe (40 percent in income tax on $1.66 is 66 cents in tax). Steve pays the full $1 to Joe. Steve cannot deduct any portion of this $1 because the purchase of stock (Success Co. or any other stock) is simply a nondeductible capital expenditure.

If Success Co. is a C corporation, any interest paid by Steve (in addition to the principal stock purchase amount) is generally not deductible. Steve could deduct this interest against portfolio income (interest and dividends on other investments).

Rarely do the kids have such investments. But Steve can make all the interest deductible simply by electing S corporation status.

What about Joe? Steve pays Joe that $1 (plus interest). Joe must pay a capital gains tax (typically 15 percent) on the dollar and pay his top tax bracket (typically 40 percent, including State and Federal income taxes) on the interest income.

OK, Joe has 85 cents left after paying the capital gains tax on the $1. If Joe doesn’t spend that 85 cents (he usually has it at death), the tax collector gets up to 55 percent (using 2011 rates) for estate taxes. That’s another 47 cents, leaving Joe’s heirs with only 38 cents out of the $1.

Let’s review. Steve had to make $1.66 for Joe to leave his family 38 cents.

Or would you believe that would turn into $1,660,000 for Steve to make while Joe’s family only gets $380,000.

That’s lousy tax planning!

Joe and Steve can avoid these tragic tax results. So can you. How?

Apply the above $1 example to the price you want to get for your business if you sell to one or more of your kids. You’ll immediately notice that the IRS gets more out of the sale of your business than you or your family combined. The lesson is simple. Don’t sell your business to your kids.

Watch this column for the right way for you to get a lifetime flow of income for you (and your spouse if you are married) and transfer your business to your kids without the IRS getting into your pocket.

You’ll want to take a look at the following strategies: Electing S corporation status; use of an intentionally defective trust to transfer your business to your kids — tax-free (yet stay in control for as long as you live).

One more thing: Do not transfer your business (by sale or otherwise) to the kids without putting three other plans in place: (1) a lifetime tax plan, (2) a retirement plan and (3) an estate plan.

Want to learn more about how to shield yourself and your family from the IRS when you transfer your business? Browse my Web site at www.taxsecretsofthewealthy.com.

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.

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.

Would you believe that the basic tax law, the Internal Revenue Code and regulations, is about 50,000 pages long with no logical, organized theme? There’s also a constant stream of Internal Revenue Service rulings and case law. No one person can know it all—not Congress, which passes the law, nor the IRS, which enforces it.

There are three main ways the federal tax law picks your pocket and becomes your legal partner: payroll taxes, the income tax and the estate tax. So, how can you fight back? One day, just for fun, we (four tax guys) started to count the ways to legally get around paying the three taxes listed. We were just getting warmed up when we counted 227 options and stopped. The following are five areas in which you can save money from taxes:

1. Payroll Taxes. This money-stealing parasite is persistent and expensive: This year, $16,404 on the first $106,800 of your earnings goes to the tax man. That’s a scandalous 9.76 percent. For earnings of more than $106,800, you pay an additional 2.9 percent.

Here are examples of the three most common ways to lose payroll taxes to the IRS: The first mistake involves Joe, the owner of an S corporation who taxes a large salary (often $500,000 or more) and takes a huge bonus at the year’s end to bring down profits. For this S corporation, a tax-free dividend instead of compensation would save a bundle of unnecessary payroll taxes and would cost no more in income taxes. A second payroll tax mistake is when owners’ wives and moms take a salary when they either don’t work or are overpaid. It is much better tax-wise to give them a gift. The third mistake is operating a business as an LLC, which makes all income to the owner(s) subject to payroll taxes.

2. Asset Protection. In a heartbeat, your family wealth, including your business, can be depleted or even destroyed by a lawsuit.

Keep your business thin by keeping only those assets—typically, necessary cash, inventory and receivables—needed for operations in your business. Here are some basic sub-strategies: Elect S corporation status; personally own (via separate LLCs) any new real estate or expensive equipment, and lease it to your operating company; and never own delivery vehicles in your operating company. Put the vehicles into a separate corporation or LLC.

The sad fact is, we can’t protect the assets inside of your operating company, but we can protect you and your spouse. All of your significant assets are simply retitled using typical lifetime planning documents—such as family limited partnerships, LLCs and appropriate trusts.

3. Life Insurance. You can save money in taxes whether you, your spouse or your kids own the insurance.

Critical issues concerning life insurance are premium cost, the death benefit and the tax due on the benefit at death (usually the estate tax). The following are common ways to modify insurance plans to save premiums or increase the death benefit without additional costs:

• For single life or second-to-die insurance, you can get a cash-surrender value of more than $200,000 on a policy that is 9 years old or older. This results in significantly more death benefit for the same premium cost or a significantly reduced premium cost for the same death benefit.

• If you, the husband, are at least 55 years old, worth more than $5 million and have insurance on your life only, you are wasting premium dollars. Second-to-die coverage with your wife will typically give you the same death benefit for about 35 percent less premium cost.

• If you have more than $400,000 in a qualified plan such as a 401(k) or IRA, that amount is subject to a double tax (income and estate) of as much as 73 percent to the IRS. On average, you can turn every $270,000 of after-tax dollars into $3 to $5 million (tax-free), depending on your age and health. This plan works for second-to-die or single life insurance.

4. Business Succession. This affects your business and your business kids. The typical business owner wants to transfer the business to his kid(s) so that he and his kid(s) don’t get killed by taxes. He also wants to treat his non-business kids fairly, ensure that he controls his business for as long as he lives and ensure that the company stock stays in the family by never going to a kid’s ex-spouse. Every one of these goals is easily accomplished. Best of all, the business can be transferred tax-free, with no income tax, gift tax or estate tax for the owner or the kids.

5. Estate Plan. A proper estate plan is actually two plans: a lifetime plan and a death plan. The plans are designed to cover every significant tax-saving possibility—from the minute the lifetime plan is created until after you get hit by the final bus (covered by the death plan).

Read slowly, chances are you will see some of yourself or someone you know.

Joe, 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, Joe spelled out his goals:

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

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

• Make sure he can maintain his lifestyle for as long as he lives

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

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 your 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 interest (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35%) 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 nonvoting 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.

The beneficiaries of the trust are Tom and Dick who will each own half of the 5,200 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 (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 8 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 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 that 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. (All your wealth to future generations, while totally eliminating the impact of the estate tax.)