Blackman on Taxes
Secrets About Business Succession, Business Valuation and Estate Planning
When a business owner calls me to consult, the three most common questions are:
1) “Can you help me tax-effectively sell/transfer my business?”
2) “Can you value my business?”
3) “Can you give me a second opinion on my estate plan?”
Experience has taught me that the right answer must encompass all three questions, because: a sale or transfer of the business requires a valuation; a valuation usually involves some kind of sale or transfer (both have significant tax consequences); and if you own a business, your estate plan cannot be complete without a valuation and/or a transfer/sale plan (a succession plan).
The sale or transfer of your business can only take place in one of two important time frames: during your life or after your death. An unplanned sale after death almost always results in a disaster. So, we are going to stay in a lifetime-planning mode to solve your succession problems while you are alive and well.
Business Valuation—The secret is how to maximize the discount of the business for tax purposes. Here’s an example: Success Co. (owned 100 percent by Joe) now is run by Joe’s son (Sam). Joe wants to sell Success Co. to Sam for $8.6 million (the value determined by a professional appraiser).
Now the secret: Joe recapitalizes Success Co. (100 shares of voting stock/20,000 shares of nonvoting stock)—a tax-free transaction. Only the nonvoting stock will be sold to Sam (using an intentionally defective trust, IDT—more explained later). The appraiser updated his valuation, valuing the voting stock at $100,000 and the nonvoting stock at $5.1 million. The nonvoting stock is entitled to various discounts—of 40 percent—under the tax law.
And a big bonus to Joe: keeping the voting stock, so he can still control Success Co.
Sale of Success Co.—Here’s how I explained the tax consequences of a sale to Joe: “If you sell Success Co. to Sam, each $1 million of the price will be socked with three taxes:
1) “Sam must earn $1.666 million. The 40 percent income tax (federal and state) nails Sam for $666,000. Only $1 million is left.
2) “Sam pays you $1 million for your stock (assume zero tax basis). Your capital gains tax enriches the IRS by $200,000…now only $800,000 is left.
3) “At your death, the IRS siphons off another 40 percent, or $320,000, for estate tax…only $480,000 left.”
Now the secret: Instead of an outright sale, sell the nonvoting stock of Success Co. for the same $5.1 million to an IDT. Joe gets paid in full with an interest-bearing note from the IDT.
Sam is the beneficiary of the trust and has no obligation to pay the note. Instead, the cash flow of Success Co. is used to pay the note and interest. Every penny Joe receives for payment of the note, plus interest is tax-free.
Joe and Sam will save about $200,000 in taxes for each $1 million of the price (about $1,020,000 in tax savings).
Second Opinion of Joe’s Estate Plan—In addition to Success Co., Joe and his wife Mary have another $10.4 million in assets, including two homes, a 401(k) and various investments. The estimated tax (income tax on the 401(k) and estate tax), if Joe and Mary both died would be $3.5 million—that is based on their current estate plan.
After our second opinion, the new plan we implement will eliminate the estate tax and create an additional $2.5 million in tax-free wealth (using a combination of strategies to purchase tax-free, second-to-life insurance on Joe and Mary, while funding the premium payments with the 401(k) money, which is subject to double tax: income tax and estate tax).
We also will use other lifetime strategies to eliminate the estate tax: an ongoing annual gifting program to Joe and Mary’s three children and seven grandchildren; and creating a family limited partnership for their investments, and a charitable lead annuity trust.
Conquering the IRS Takes More Than a Local Lawyer
Following is the real-life story of a long-time reader (Joe) of this column. Joe is married to Mary, owns a business (Success Co.), has three kids (one—Sam—who Joe wants to ultimately own Success Co.). Joe hired me to do his estate plan. I told Joe that part of our job was to make sure Mary would be comfortable with our final plans. Joe agreed.
Then it happened. Joe called. Apologetic. Mary suddenly decided she would be more comfortable working with a local lawyer.
“Go with Mary’s wishes,” I said. “Let your local lawyer (Lenny) do the estate plan. When it’s done, I’ll be happy to review it and give you a second opinion, at no charge if I can’t improve your plan by:
1) Covering issues you and Mary should have but Lenny missed, and
2) Save you taxes (and/or create tax-free wealth) because Lenny did not know how to implement the appropriate strategies.”
Then Joe asked, “Irv, how can you afford such an offer?” My response, based on my 50-plus years of experience (about 19 out of 20 times): My second opinion simply reincarnates my original agenda to implement the issues and strategies the local lawyer did not do. In real-life practice, good odds for Joe and me too.
Why do my plans touch more bases and save more taxes than the plans created by the Lennys of the world? In a few words:
The network brings you a team of estate-planning specialists. I personally do the planning (both your lifetime plan and your estate plan). A lawyer (network member) specializing in estate-planning documentation does the endless amount of paperwork and documents.
Insurance plays a part in most estate plans. Our insurance-network consultant analyzes your existing insurance and 70 percent of the time finds a way to significantly increase your death benefit without any additional premium cost.
Other experts are brought in as needed, including business-valuation specialists, experts in foreign taxes and laws, and captive insurance company experts.
And finally, back to Joe and Mary. I reviewed Lenny’s plan. Sure enough, it fell into the 19 out of 20 category. Technically, the plan was correct: a standard A/B trust with a pourover will. It’s what Lenny did not do that screamed for attention.
Some of the lifetime plan issues we implemented were (a) reduce payroll taxes; (b) deduct Joe’s and Sam’s medical expenses; (c) created a captive insurance company; (d) made sure none of the family assets could go to an ex-spouse if any of the kids got divorced… estimated annual tax savings between $80,000 and $100,000.
Some of the estate planning strategies we implemented were: family limited partnership for Joe’s investments; transferred Success Co. to Sam, tax-free, using an intentionally defective trust, while Joe kept control; used a series of asset protection strategies for Success Co. and Joe’s assets; used funds in Joe’s 401(k) and IRA to create $3.5 million of the tax-free life insurance, instead of the funds being double taxed at death—estimated tax savings of about $2.2 million.In the end, even Mary was comfortable. Lenny stayed on as the family lawyer and became a professional friend. MF
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