Second opinion saves reader a fortune

You’ll like this true story. A reader, let’s call him Joe, of this column had completed his transfer-to-his-kids plan and his estate plan in 1996. After 13 years, and still faced with a $5 million estate tax bill, Joe got an itch: he wanted a second tax opinion, and we scheduled a meeting.

First, I reviewed a small mountain of Joe’s old tax returns, financial statements and other documents. Then, we (Joe, his oldest son, his lawyer, his accountant and I) had a five-hour consulting meeting in Joe’s office.

This is Joe’s exciting story. He’s 65 years old, his wife Mary is 63, and they have six adult children – two in the business, three not and one undecided. Joe built a two-employee business, Success Co., into a winner. He’s worth about $14 million. Sadly, Joe’s original 1996 estate plan missed out on opportunities that every reader of this column should know.

Let’s start the story with a flashback to 1996. Success Co. was worth just $2 million. Joe’s professional pulled off a stock recapitalization to freeze the value of Joe’s interest in Success Co., and Joe wound up owning 100 percent of the preferred stock, worth just under $2 million and the kids, 100 percent of the common stock. Since 1996, Joe and Mary have transferred over $1 million of the preferred stock as tax-free gifts (about $22,000 or less per year, per kid) to the kids. Today, in 2009, Success Co. is worth over $9 million, and yet Joe owns only $950,000 of the preferred stock. Way to go, Joe!

Since 1996, Joe kept taking $550,000 to $750,000 in salary per year and Mary, about $50,000. The large salaries, plus another $100,000 or so per year in preferred stock dividends were ballooning Joe’s taxable estate. Without covering every detail and nuance of a rather complex tax plan, here are four significant tactics and strategies we implemented to allow Joe to legally pass all of his wealth to his family – intact – with all taxes paid in full.

One: reverse the recapitalization. The preferred stock disappears. Only common stock – voting and nonvoting – will exists after the reversal. Joe and Mary began to immediately make gifts of almost all of their Success Co. stock to the kids. Although most of these gifts will be taxable for gift tax purposes, the IRS will not get even one cent in gift taxes. Why? The gifts will be less than $2 million – the amount that must be exceeded before any cash is due to the IRS for gift taxes. When all the paperwork is done, Joe will own less than 1 percent of Success Co.’s stock (all voting) and the kids will own more than 99 percent (all nonvoting stock), and Joe will control Success Co. for as long as he lives.

Two: Success Co. elects S corporation status. Because the kids now own almost 100 percent of the stock, Success Co.’s income goes to the kids. Dividends (tax-free) will be used by the kids to pay the second-to-die insurance premiums (see step four).

Three: Joe will take only a modest salary; he intends to slow down; well, maybe. Mary will retire and take no salary, Savings? More than $30,000 a year in payroll taxes. Also, the reduced salary (as well as eliminating the preferred stock dividends) will stop Joe’s mushrooming estate, saving more than $275,000 per year in skyrocketing estate tax liability.

Four: Joe cancels about $2.5 million of existing life insurance policies on his life that were owned by him and Mary and pockets about $250,000 in cash surrender value. He replaces this insurance with second-to-die (Joe and Mary) life insurance of $4 million, to be owned by the kids. What will Joe and his family save? Well, every year, for as long as Joe lives, the insurance premiums for the new policies will be 25 percent less than the premium cost for the old policies, yet the insurance coverage will almost double. But, get a load of this: the new $4 million in insurance – because it’s owned by the kids – will not be taxed in either Joe’s estate or Mary’s estate.

Take this article to your professional advisor. Review it together. Select those tax points that will save you and your family significant tax dollars. Remember, your goal must be to pass all of your wealth (all taxes paid) – intact – to your family; then, do what you must do. If necessary, get help. But do it now!

Want to get a jump-start on your own tailor-made business and wealth transfer plan? Read our new book, “Tax Secrets of the Wealthy.” Send $367, payable to ILB Enterprises, Inc., and receive an instant refund if this book doesn’t save you 100 times its cost. Write to Book Division, ILB Enterprises, Inc., c/o Irv Blackman, 4545 W. Touhy Ave., Apt. 602, Lincolnwood, Ill. 60712.

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 taxsecretsofthewealthy.com.