STORY TOOLS

• E-mail story
• Comments
• iPod friendly
• Printer friendly

More Latest News

• Collier schools summer bus schedules announced
• Report: UCF players tell of intense workout, coach cursing before Plancher's death
• Traffic enforcement locations for Collier, Lee

Share and Enjoy [?]

Here’s a true tax-victory story. Read slowly if you own all or part of a family business (chances are this story is about you).

Joe, a 61-year old owner of Success Co. (a C corporation) called and wanted to know which of two plans he should choose. Here are the important facts: Joe is married to Mary (53 years old). His son Sam (31 years old) has worked in the business since he was 15. Sam owns one share of Success Co. stock; Joe owns all the rest of the stock: 99 shares. The business is worth about $4 million and has enjoyed about 10 percent net profit growth each of the past five years. This profit growth should continue in the future. Joe’s total net worth is about $9.5 million including a residence, various investments (mostly the real estate leased to Success Co. and a portfolio of municipal bonds) and $900,000 in a profit sharing plan.

Joe asked me to review two plans suggested by his two professionals: his CPA and lawyer. (“Give me a second opinion,” is the way Joe said it.) The core of both plans was a $4 million life insurance policy on Joe’s life.

Plan 1: The life insurance policy would be owned by Sam. Joe would gift Sam the annual premiums. At Joe’s death Sam would buy Success Co.’s 99 shares from Joe’s estate for $4 million.

Plan 2: Success Co. would own the $4 million in life insurance and would redeem (buy) the 499 shares from Joe’s estate.

For either plan, the final results would be exactly the same: Sam would own 100 percent of Success Co., and the estate would have $4 million in cash (the life insurance proceeds) instead of $4 million in stock.

First, the good news: Joe’s estate would owe no income tax on the sale of the stock. Why? Because the estate would get a raised basis equal the fair market value of the 499 shares on the date of Joe’s death. Second, no estate tax because the $4 million of insurance proceeds will wind up in Mary’s trust and receive the benefits of the 100 percent tax-free marital deduction.

Sounds pretty good. Joe liked it.

But he still had one question: “Irv, can you improve the final results of the plans?”

Certainly, either plan is better than no plan at all. As a matter of fact, each of the plans outlined above — or some variations — is the most popular way of transferring a business to the next generation. Sorry, but two problems always cause us to turn thumbs down on any such plans. Why? Because (1) The value of the stock will probably continue to grow and the excess value over the current $4 million value will enrich the IRS by up to 55 cents for each $1 of the excess. That’s $550,000 per million in unnecessary estate tax. Ouch! (2) When Mary passes on, the IRS is guaranteed a big payday; 55 percent (using 2011 estate tax rates) of the $4 million in life insurance. That’s right, the IRS will get $2.2 million and the family only $1.8 million. An outrage!

What should you do if your facts (own all or a portion of a family business that you want to transfer to your younger family members) are the same or similar to Joe’s facts? Here’s the three-step plan we put in place for Joe (and you should consider):

Step 1. Success Co. elected S Corporation Status. We recapitalized (100 shares of voting stock, 20,000 shares of nonvoting stock) the company so Joe would own 99 percent of the voting stock — 99 shares — (Now, Joe could keep control of Success Co. for as long as he lived). Then, Joe transferred the nonvoting stock — 19,800 shares — to an intentionally defective trust (IDT). The IDT gets about 99 percent of the value of Success Co. out of Joe’s estate. Note: Of course, Sam continues to own the same one percent of the shares; now one share of voting stock and 200 shares of nonvoting stock.

Step 2. We used a strategy called a “Retirement Plan Rescue” (RPR) to acquire $6 million of second-to-die-life insurance on Joe and Mary. We also created an irrevocable life insurance trust (ILIT) to own the insurance. None of the $6 million in insurance proceeds will be subject to income tax or estate tax. Every penny will go to Joe’s and Mary’s family tax-free.

Step 3. We created a family limited partnership (FLIP) to hold Joe’s investments and started an annual gift-giving program to give limited partnership interest in the FLIP to Joe’s and Mary’s other two children (neither are in the business).

The three-step plan we substituted for the original two proposed plans will increase the amount of wealth Joe and Mary will leave to their family by an estimated $5.5 million more than either of the two old original plans. Best of all, the new plan has zero impact on Joe’s and Mary’s lifestyle, and they have absolute control of all their assets — including Success Co. — for as long as either of them is alive.

Want to learn how to use the strategies (Joe and Mary used) for your family? Browse my Web site, www.estatetaxsecrets.com. Or if you are in a hurry, call Irv at 239-417-9732.

---

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at wealthy@blackmankallick.com or call 417-9732. His Web site is http://www.taxsecretsofthewealthy.com.