Irv Blackman Irv Blackman
Independent Financialservices Professsional

The Estate-Tax Trap Most High-Net-Worth Owners Fall Into—Don't Become a Victim

September 1, 2010

If your net worth is high enough to be subject to the estate tax, chances are you worked your tail off all or most of your adult life to accumulate your wealth. But draw your last breath and the estate-tax monster wants to devour about half your wealth—not a pretty picture.

It’s sad. Die and your estate pays, but fortunately, you—with the right tax planning —don’t have to lose any of your wealth to the estate-tax monster.

Do you have enough wealth to be clobbered by the estate tax? Then read every word of this article. You’ll learn how to keep your wealth. But first I must ask you to open your mind, because we are about to kill some conventional wisdom of how almost all estate-planning advisors, inadvertently, make you a victim of the estate tax. 

What exactly are these advisors guilty of doing? Traditional estate planning.

What is “traditional estate planning” (TEP)? A TEP is the plan that most advisors use for a married couple. Chances are if your estate plan is done, you have a TEP (and that’s good). A TEP uses a rather simple will, called a “pour-over will” and an irrevocable trust. The will gathers any assets not in the trust when you die and pours these assets into the trust. All your assets are now in the trust, which contains your estate plan. The trust is commonly called an “A/B trust” or “family/residuary trust” or something similar.

Is there anything wrong with a TEP? Absolutely not, assuming it is properly drawn. Then what’s the problem? The TEP is normally the only plan, and a TEP is not designed to save estate taxes. If you are married, it does many other things (which makes a TEP a good start for your estate plan). A TEP does have two minor estate-tax tricks:

  1. The marital deduction defers estate tax until the second death of the husband and wife (but when the second one dies, the IRS gets its pound of flesh); and
  2. The so called “unified credit” in 2009 was $3.5 million per person that passed free of the estate tax, or $7 million for a married couple.

Let’s summarize: If the unified credit continues at $3.5 million, the best a TEP can do—as far as saving you estate tax—is to save tax on the $3.5 million for the first spouse who dies. That’s it.

It’s difficult for me to say what follows: Any claim that a TEP can save you even a dime in taxes, over and above the unified credit, is a myth, hoax and total illusion. If your estate plan consists of only a TEP or even includes an irrevocable life insurance trust (ILIT), chances are you’ve been duped. If your advisor claims otherwise, challenge him/ her to show you where and how in the document that the savings are created.

My motivation for this article is the following e-mail received from a reader (Joe) of this column.

“I am working with a law firm… designing a will and trust (a TEP) and would like you to review them.” I agreed to review the documents if he sent three items: two financial statements (a personal one and the last year-end for his business, Success Co.) and a family tree (name and birthday for Joe, his wife and four kids).

Three days later Joe’s information package arrived. Here’s a few things you should know about the information.

  • A typical TEP was the entire estate plan.
  • The lawyer (Larry) who drafted the TEP (it was very well done) boasted on his stationery that he is a “Board Certified Specialist in Estate Planning, Trust and Probate Law.”
  • Joe (48 years old) owns Success Co. (an S corporation) that he started from scratch, is very profitable and growing. Joe likes Larry professionally, but feels that somehow the plan Larry created falls short of accomplishing Joe’s goals. 
This is what we advised Joe to do:
  1. Retain Larry and sign his documents, after one suggested change.
  2. Since the TEP does not legally speak until Joe dies (when that will be is uncertain, but according to the life expectancy tables, about 35 years) a lifetime tax plan should be created.

Everyone should have two plans: a death plan (TEP) and a lifetime plan. The purpose of the lifetime plan is to employ various strategies so that by the time you die, the estate tax has been eliminated or you have created enough tax-free wealth so that any estate-tax liability is covered. Remember, it’s not what you are worth today that’s socked with the estate tax, but what you or your spouse will be worth after both of you die.

Also remember that Joe, like the typical guy, wants to control his wealth—particularly his business—until he dies.

Here’s a list of 10 strategies we wove into a comprehensive lifetime plan for Joe, his family and his business:

  1. Asset protection strategies to protect Joe’s personal assets and, separately, the business assets.
  2. A management corporation (a C corporation) was set up to provide Joe (but not other employees of Success Co.) with many tax-free fringe benefits (including long-term care and deductibility of medical expenses for Joe’s family).
  3. A family limited partnership for Joe’s investment assets.
  4. A nonqualified deferred compensation plan for Joe’s two key employees (an easy to prevent employees from leaving and competing with you).
  5. A common paymaster to save significant amounts of payroll taxes every year.
  6. A plan to use a portion of the profits of Success Co. to pay for the children’s college education.
  7. Transfer Success Co. to the children tax-free, yet Joe maintains control.
  8. Set up a family foundation and a charitable lead trust as a tax-effective to make substantial charitable contributions without reducing the children’s inheritance.
  9. A strategy to save income taxes whenever a new unit of Success Co. is opened.
  10. How to make the insurance on Joe’s estate tax-free and buy $3 million of second-to-die life insurance using the government’s money. MF

Technologies: Management


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