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It’s true: Real-life is stranger than fiction.

Here are two true-client tax stories — with almost identical facts — involving transferring a family business to the kids. One caused a financial-tax train wreck; the second a tax-free victory.

If you own (all or a portion of) a closely held business and are about to (or will someday) sell/transfer your interest in the business to one or more family members or employees, read this article carefully.

You’ll learn the wrong way and then the right way to make the transfer (and literally save more taxes — income, capital gains and estate combined — than the actual fair market value of your business interest being transferred).

Both stories started with a phone call from a column reader. The first call came from Joe in Chicago, Illinois (my home town).

Here’s Joe’s story:

About a year ago, Joe sold 100 percent of his business (Success Co.) to his Son (Sam) for $5 million, payable by Sam over an 8-year period, plus interest. Joe’s tax basis of Success Co. (started by Joe 28 years ago for $9,000) was near zero (so for our purposes we’ll assume his tax basis is zero).

Let’s take a look at the tax damage when Joe sells his Success Co. stock to Sam. To make it easy to follow the number, let’s assume the prices is $1 million and both Joe and Sam are in the highest tax bracket. Also assume the combined (State and Federal) income tax rate is 40 percent (5 percent State and 35 percent Federal).

Ready… Let’s follow the tragic numbers. Here’s how you figure the tax cost for the $1 million price: (1) Sam must earn $1,666,000 (rounded) and pay $666,000 in income tax (40 percent X $1,666,000). So, Sam has exactly $1 million left, which he pays to Joe. (2) Then Joe must pay $150,000 in capital gains tax (at 15 percent) on his $1 million sales price. Sad, but Joe only has $850,000 left, after taxes.

Amazing! The tax loss to the family is $816,000 ($666,000 + $150,000) for the $1 million stock price.

A lousy deal!

Ask your CPA to compute your exact tax loss if you actually sell your business to your kids.

Of course, your CPA must use (a) your correct tax basis, (b) your correct State income tax rates and the actual price for your stock (must be fair market value or the IRS might complain). Now you know how the heartless tax law can beat you up if you sell your business to your kids (like Joe did). Fortunately, there is a better way. Just follow the lead of the business owner in the next succession plan story.

The second call came from Hank, a Texan (from San Antonio) who wanted to sell his business, Big X, to his daughter Liz. What a pleasure when the client calls before doing the transaction wrong.

We explained to Hank and Liz how an intentionally defective trust (IDT) is used to transfer a family business to the kids or employees… quickly, easily and best of all, tax-free. No need to make any computations.

If you intend to sell all or a portion of your business to your kids(s), here’s how to determine your tax-savings, which are $816,000 (as explained in the first story) per each $1 million of the stock price. Just have your CPA use your exact tax basis, State income tax rate and price for the business.

Then use an IDT. You’ll be delighted. Guaranteed!

One more point when using an IDT: We used nonvoting stock (10,000 shares to make the IDT transfer), while Joe kept the voting stock (100 shares) so he maintains absolute control of Success Co. for as long as he lives.

An IDT is one of the few perfect tax strategies in the entire complex tax world… no downside.

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Irv Blackman is a certified public accountant and lawyer who specializes in estate planning, business succession and asset protection. Contact him at Blackman@EstateTaxSecrets.com or call 417-9732. His Web site is www.taxsecretsofthewealthy.com.