You’ve had it. After 15, 25 (well, you fill in the number) or more years of building your business, you want out. More than that, you want some of those nice assets out of the family corporation. Some of those assets – excess cash, investments, land, building – are no longer needed in the business and could be owned outside of the business or rented to the operating corporation. One more thing: the kids are ready to run the business, want to buy it and you’re willing to sell it , but one little detail is missing. The kids have no money. What to do?
The best way to show you how to solve this puzzle is by example. Here goes. Joe Success (age 60), who is married to Jane (also 60), owns 100 percent of Go-Go, Inc., which is worth $4 million. Go-Go has 4,000 shares of stock that are worth $1,000 each. Joe’s son and daughter – Jon and Jan – have really been running the business for the past five years. Here is the six-step plan Joe and Jane put into effect.
Step 1: Joe gives 2,000 shares (worth $2 million) to Jon and Jan – 1,000 shares each.
Step 2: Jane joins Joe in the gift tax return, so no cash is required to pay any gift tax to the IRS.
Step 3: Joe gifts 1,000 shares, worth $1 million, to a charitable remainder trust (CRT). The CRT sells the 1,000 shares to Go-Go for $1 million, $200,000 in cash and $800,000 in notes. Under the law, the entire $1 million in the CRT escapes the capital gains tax and the estate tax. Joe and Jane will receive 6 percent of the $1 million ($60,000) per year from the CRT for as long as either one of them lives. In addition, they will enjoy an immediate charitable deduction of $400,000, resulting in $160,000 in actual cash savings on their personal income taxes (state and federal). After Joe and Jane pass on, the balance in the CRT will go to charity.
Step 4: Joe sells his remaining 1,000 shares to Go-Go for $1 million. Go-Go pays for the shares with $300,000 in cash and $700,000 worth of real estate. Joe pays only capital gains rate (using the $300,000 in cash to pay the tax) on the stock profits. He rents the real estate to Go-Go for $85,000 per year.
Step 5: Joe and Mary buy $4 million worth of second-to-die life insurance in an irrevocable life insurance trust (ILIT). When Joe and Mary are gone, the ILIT will collect the full $4 million for Jon and Jan’s benefit, free of all taxes. The annual premium will be about $44,000 per year.
Step 6: Joe resigns. He’s retired.
What’s the result? Jon and Jan now own 100 percent of Go-Go, 50 percent each. Joe and Jan’s cash flow will comfortably maintain their lifestyle for as long as they live. They have an additional $2.7 million in other assets, $2 million of which is income-producing. The kids will wind up with about $7.5 million after taxes (more than Joe and Mary were worth when Joe retired), plus the growth in the value of Go-Go stock. Charity will get about $1 million.
The above scenario is very flexible and can be changed in many ways to fit the exact objectives of any family business. One warning: no attempt is made to cover every tax rule, exception or trap. Get a competent tax expert to help you.
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 firstname.lastname@example.org or call 417-9732. His Web site is taxsecretsofthewealthy.com.