Posts Tagged ‘strategy’

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Want To Get Real estate Out Of Your Corporation — Tax Free?

Monday, April 20th, 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 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.

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Posted in Corporate Tax, Estate Tax, Planning | 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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Posted in Estate Tax, Family Tax Issues, General Tax Strategies | No Comments »

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 »

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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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 »

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by Irv Blackman

First and foremost, Irv Blackman is both a CPA and a lawyer. Irv is a tax guy. Stay tuned to the site by signing up for the RSS feed.