Posts Tagged ‘tax purposes’

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 »

A Big valuation victory For Our Side

Monday, April 13th, 2009

I’d like to hug every judge who had a hand in this classic Tax Court decision: [Estate of Davis, 110 TC 35, 6/30/98]. Instead of giving all the dull facts and all the technical stuff in the case, this article deals with what the result means to you, the average business owner who someday must value your business for tax purposes.

You (Joe) operate your family business (Success Co.) as a corporation. The assets of Success Co. include a number of appreciated assets; for example, investments in stocks, land and buildings. Also many assets subject to deprecation — mostly equipment — are on the books for much less than their current value. Now suppose Success Co. is correctly valued at $5 million. The value of the various assets that Success Co. owes is $4 million, but has only a book value of $3 million. So, if Success Co. were to sell the assets or actually liquidated (neither Joe nor Success Co. intend to sell the assets or liquidate), there would be a $1 million profit. Say the tax (state and federal) on the profit would be $400,000. The question that faced the court was could the value of the corporation be reduced by $400,000 to $4.6 million? “Yes,” said the court, turning thumbs down on the IRS’s claim to ignore this built-in-gains discount (actually the potential tax due for an asset sale or corporate liquidation).

Applause! Applause! for the court. Think about it: That discount of $400,000 could save Joe about $210,000 in estate taxes.

As a practical matter, this case allows you to take three distinct valuation discounts: (1) a discount for lack of marketability; (2) discount for built-in gains of assets, even if you don’t intend to sell them or liquidate (technically a part of the marketability discount); and (3) a discount for minority interest if you are transferring 50 percent or less of your stock to one person (for example, Joe Gives 30 percent of his Success Co. stock to each of his two children). After these three discounts, a $5 million company may only be worth in the $3 million range for tax purposes. Or a $2 million discount, yielding estate tax savings of about $1.1 million. Truly a great victory!

Now a personal puff of pride for our office, which has a large valuation department. We have been taking similar discounts for built-in gains for years.

The right value of your business, whether transferring to your kids, for estate planning or for other purposes, is one of the most important tax-impact considerations in the law.

Do you have a business valuation problem — particularly if you want to transfer your business to another family member — that is driving you up the proverbial “tax wall?” Then you are welcome to call me (847-674-5295). Let’s chat about your exact situation.

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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 »

Irv Didn’t Invent Taxes, Just 227 Ways To Beat Them

Saturday, March 28th, 2009

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?  Here are five areas in which you can save money from taxes.

Column from: Modern Machine Shop, Contributed by: Irving L. Blackman

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).

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Posted in Estate Tax, General Tax Strategies, Irv Talk, Retirement Tax Advice | 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.

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Posted in Corporate Tax, Estate Tax, General Tax Strategies, Insurance, Tax Strategies | No Comments »

Don’t flip your lid if you have too many FLIP accounts.

Thursday, March 26th, 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 its business, its situations and its problems. Despite 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, Sam, calling at the request of his dad, Joe, agreed to send me the typical information: some tax returns and financial statements and a copy of the existing estate plan.

About one week later, a large, heavy box arrived with a 5-inch stack of documents. Most of the documents had to do with nine separate family limited partnerships, or FLIPs. All were identical, except each FLIP owned a different asset, like the family business, a residence or investments.

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 FLIP drunk.

One thing should be made clear: I am an enthusiastic cheerleader for the use of FLIPs in estate planning. I use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

The proof: Using the computations of the adviser, the IRS still would cash in for more than $2 million in estate taxes.

Another $1.1 million of IRS enrichment was likely because of a gross misuse of the FLIP strategy.

What does a FLIP accomplish? It allows you to totally control the use of any asset transferred (a tax-free transfer) to the FLIP as the general partner, yet reduce the value of the bundle of assets transferred for tax purposes.

For example, $1 million of assets transferred to a FLIP is usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percent estate tax bracket will reduce your estate tax burden by $192,500. Not bad!

A FLIP also is a great asset-protection strategy. Creditors can’t get at the assets in the FLIP. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a FLIP is almost a perfect tax tool.

In general, a FLIP should not be used to own the stock of your family business. Nor should it be used for non-income-producing personal as sets, like a residence or auto.

It’s a valuable strategy for almost every other asset you might own — publicly traded stocks and bonds, real estate, you name it.

In short, we terminated the FLIPs that held the family business and two family residences.

The business elected S corporation status and was transferred to an intentionally defective trust (IDT), and the residences were transferred to qualified personal residence trusts (QPRTs). An IDT and a QPRT 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 FLIPs to pay the premiums on second-to-die life insurance (on Joe and his wife), which was owned by an irrevocable life insurance trust (ILIT) that we created. An ILIT 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 FLIP plan (depending on how long Joe and his wife live).

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Posted in Estate Tax, Tax Strategies | No Comments »