Irv Blackman Irv Blackman
Independent Financialservices Professsional

What's the Risk of an Outdated or No Estate Plan? Lose Half of Your Wealth to the IRS

July 1, 2010


President Theodore Roosevelt said it: “In any moment of decision, the best thing you can do is the right thing. The next best thing is the wrong thing. And the worst thing you can do is nothing.”

This is the story of two brothers: Joe and Moe. Joe (age 68) did the right thing by creating his estate plan at an early age, monitoring and updating it as necessary.

Moe (age 72) on the other hand was a champion procrastinator. He did very little estate planning and what he did was out of date. However, when it came to business, according to Joe, Moe was on the ball. He had a knack for spotting problems, solving them quickly and multi-tasking with timely efficiency within his many areas of responsibility—the perfect business partner.

Let’s flash back to when the brothers started the business, Little Co. They struggled in the beginning. Yet slowly but surely the business grew in sales and profitability. Market share and profits increased almost every year. By any standards Joe and Moe were a success and became rich.

From the very beginning Joe insisted on a buy/sell agreement for Little Co., funded by life insurance. At Joe’s insistence the stock was valued every year and additional insurance acquired to fund the increased value of Little Co.

Way to go, Joe! His buy/sell agreement insistence ultimately saved the day. You’ll love the story, which follows.

First, a few more facts, mostly about Moe to set the scene for his train-wreck-tax disaster for failing to put a comprehensive estate plan in place.

Moe had five kids, two of them (Sid and Sam) worked for Little Co. Sid and Sam were chips off the old block—good at business. Joe and Moe often talked about how the two boys would ultimately own and run Little Co. Joe had three kids, but none ever worked for Little Co. nor showed any interest in doing so.

Although Joe and Moe took exactly the same salary and enjoyed equal distributions from the large profits of Little Co. (an S corporation), their individual net worth was significantly different. Aside from the value of Little Co., Joe was worth $23 million. He watched and managed his personal wealth, often seeking professional help. Moe was worth $15 million, plus his interest in Little Co. Moe simply did not pay attention to the millions of dollars he drew out of Little Co. over the years.

The only semblance of an estate plan for Moe was his 22-yr.-old will leaving everything he owned to his wife, Molly. From time to time Moe would talk about building a comprehensive estate plan like Joe’s, including transferring his share of Little Co. to Sid and Sam. Unfortunately, Moe died, suddenly, two weeks before his 79th birthday. Procrastination and the IRS were the clear victors.

Of course, the buy/sell agreement kicked in. According to the agreement Little Co. had a value of $23 million—$11.5 million for Moe’s 50-percent share. The insurance on Moe’s life was $11 million. A few days after Little Co. received the $11 million in insurance proceeds (which was tax-free), Little Co. redeemed (bought) Moe’s stock for $11.5 million cash.

Moe’s widow, Molly (age 76), now was worth $26.5 million. No estate tax was due because of the marital deduction, but when Molly dies, the IRS will get its many pounds of flesh (the exact amount depends on the estate-tax rates when Molly dies).

Another sad footnote: Molly, somewhat of a health nut, became uninsurable about a year before Moe died. The most basic estate-planning strategy would have been a large second-to-die life-insurance policy on Moe and Molly (both of whom were healthy and very insurable until near the end of this drama). The policy in an irrevocable life insurance trust (like Joe and his wife had) would have yielded millions of dollars of estate tax-free insurance for Moe.

Joe now owned 100 percent of Little Co. Sid and Sam were ready to take over the company, but they owned no stock. Uncle Joe, as als, wanted to do the right thing. So, after consulting with me, he sold half of his Little Co. stock to an intentionally defective trust (IDT) for $11.5 million and made the beneficiaries of the trust his nephews: Sam and Sid.

Under the tax-law rules, the $11.5 million plus interest to be collected by Uncle Joe from the IDT will be tax-free. How will Sam and Sid pay for the stock, which they will receive from the IDT after Uncle Joe is paid in full? The IDT is a tax miracle worker. Sid and Sam will not pay one penny. The company’s cash flow will be used to pay Uncle Joe.

When the IDT is finally done (Uncle Joe paid and the stock distributed to Sam and Sid) Moe’s sons will own 50 percent of Little Co. (25 percent each) and Uncle Joe will own the other 50 percent, just the Moe wanted it.

The buy/sell agreement was updated with appropriate language, to accommodate all possibilities—basically disability, death or any type of transfer—for Sam, Sid and Uncle Joe. Life insurance was acquired for Sam and Sid.The intent of the new buy/sell agreement is that when Joe dies, Little Co. will redeem Joe’s stock and his two nephews will own 100 percent of Little Co. Since Joe is still insurable, additional life insurance was acquired to cover the then fair market value of Little Co.

Every detail of the plans for Joe, Sam and Sid (before and after Moe’s death) are not included in this article. The most important points to take a: 

  1. Prepare a comprehensive estate plan and the IRS will not become a partner sharing in your family’s wealth. 
  2. Failure to keep your estate plan updated guarantees the IRS a big pay day when you die.
Want to learn more about how to do your estate plan right? Browse www.tax-secretsofthewealthy.com. There’s a mountain of free information. In a hurry, call Irv at 847/674-5295. MF
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