Wednesday, July 22, 2015

Tax Secrets: Get a second opinion


Sometimes writing this column is a joy.  The joy expands into fun when the reader/caller wants a second opinion.
Well, following is the fun story or a reader (Joe), who called with a problem. Joe has been working on a combination lifetime/estate plan for years with his professional advisers. The plan just couldn’t seem to get done. Joe wanted to get a second opinion on what was in place and finally finish the plan.
Joe’s goals have two time frames — (1) during his life and (2) after his death. His lifetime goals are: keep working, but at a slower pace, until the day he dies; keep the business (Success Co., a C Corp.) growing; build his management team that handles day-to-day operations; minimize income taxes; and not sell the business. His afterlife goals are: keep the business in the family (his two business sons would own it 50/50 after Joe’s wife Mary died) and minimize estate taxes. One of Joe’s sons, a doctor, will never be active in the business.
Joe’s present tax plan would beat him up in two ways: (1) income tax wise and (2) at his death, Success Co. would probably have to be sold to pay taxes and to avoid putting the bulk of his wealth (Success Co. currently represents about 65 percent of his wealth and grows in value every year) at economic risk. Success Co. was professionally valued at $16 million.
Following is a list of some of the tax-saving techniques — with the help of my network of professionals — used to help Joe accomplish his goals. Most of the techniques are designed to keep Joe in control (including Success Co.) of his personal wealth, for as long as he lives, reduce the value of Success Co. for estate tax purposes, and slash overall taxes.
1. Success Co. elected S Corp. status. Joe will get S Corp. dividend via an IDT (see 4 below) each year without suffering a second income tax, supplemented by withdrawals from his profit-sharing plan, to assure maintaining his and Mary’s lifestyle.
2. All new equipment (to be purchased by a new LLC, owned by Joe) will be leased to Success Co.
3. All insurance policies (over $4 million) on Joe’s life owned by Success Co. were transferred to Joe and then to an irrevocable life insurance trust, (Both transfers are income tax-free and get the insurance out of his estate and Mary’s estate).
4. Success Co. was recapitalized: 100 shares of voting stock and 10,000 shares of nonvoting stock. After various discounts allowed by the tax law, Success Co.’s value was reduced by 40 percent, reducing the $16 million valuation to $9.6 million (really the value of the nonvoting stock) for tax purposes. Joe sold the nonvoting stock to the intentionally defective trust (IDT) for $9.6 million. He was paid with a note from the IDT for $9.6 million (to be paid from future earnings of Success Co.). Under crazy American tax law, all payments received by Joe to pay off the note (both principal and interest) will be tax-free.
5. Joe will control Success Co. for life via the voting stock.
Joe’s family will save about $160,000 a year in income taxes and payroll taxes. The potential estate tax liability will be reduced from over $4 million to under $500,000 (will be paid with the tax-free life insurance proceeds).