Tax Secrets: Redefine retirement as ‘slow down’
It is incredible how many business-owner readers of this column call me saying, “Irv, I want to retire.” Then they tell me their story.
Well, you’ll love this war story. It’s true. A reader (Joe) of this column recently called me with a typical, “Irv, I want to retire” request. Then Joe asked me, “Will you value my business (Success Co.) so I know how much to sell it for?” After a short conversation, two important parts of Joe’s business and financial picture puzzle came into clear focus: (1) Joe’s business was valuable and would be easy to sell (he really intends to sell it to his kids), but (2) the tax cost would be murder. Why am writing this article to tell Joe’s story? Because many readers – like Joe – are in the same boat.
An in-depth consultation a few weeks later completed the puzzle. Joe, age 62, is married to Mary (age 60), has three kids: a son and a daughter in the business and a son who is not interested in the business. Joe owns all of the stock of Success Co., a C corporation (a tax-paying corporation). Success Co. owns appreciated assets – land, buildings and goodwill – that are worth about five times their book value on the company’s books. Goodwill, as is usually the case, is not on the books or, put another way, is on the books for zero. Joe started the business 28 years ago with $6,000 of his own money and a large loan from his dad. To keep it simple, let’s say Joe’s tax basis for the Success Co. stock is zero.
Now the economic facts and Joe’s tax problem. The business, including the appreciated assets, is worth $4 million. Great! Unfortunately, the tax hit to the Corporation, if it sold its assets, would be about $1.2 million. What happens when Joe takes the $2.8 million balance out of the corporation?.... Another tax hit. This time about $440,000. True enough, the $2,360,000 left is a nice bundle of cash, but not nearly enough to generate the after-tax investment income estimated at $80,000 to $100,000 per year; depending on interest rates and tax rates) required to maintain the retirement lifestyle Joe and his wife have dreamt about. For Joe to pay almost half of Success Co.’s value in taxes to accomplish his retirement goal is insanity. (A side note to all you business owners who operate as a C corporation and intend to sell your business down the road: Elect S corporation status now.)
What should Joe do? Don’t sell the business to the kids. Keep it. Without covering every detail, here’s the basic plan we created for Joe. Success Co. elected S corporation status. Instead of retiring, Joe slowed down, a lot. The kids run the business anyway. Yes, Joe consults – working half days – about six to 10 times a month, except in the winter when he goes south to Florida. Success Co. usually makes $650,000 to $900,000 per year after a small salary and fringe benefits to Joe. That leaves plenty of room for Joe to take $250,000 (more or less) of S corporation dividends to comfortably fund his annual retirement needs. We also put two additional plans into effect: first, a lifetime plan that assures Joe and Mary can maintain their lifestyle for as long as they live. Second, an estate plan for Joe and Mary, funded by insurance that will eliminate the estate tax.
There are many ways to skin the retirement/transfer-to-your-kids/estate plan cat. Often, when the best way to get the job done is to sell your business to the kids, there is a way to do it tax-free (to you and to the kids).
Want to learn how you can get your best plan done? The right way? Check out my website: taxsecretsofthewealthy.com. Or, if you are in a hurry, call me (Irv) at 847-767-5296. Or email me (firstname.lastname@example.org).