Page 36 - MetalForming September 2009

Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein, LLP and chairman emeritus of the New Century Bank (both in Chicago). Want to consult? Need a second opinion? Contact Irv:
Blackman, Kallick, Bartelstein 10 S. Riverside Plaza, Ste. 900 Chicago, IL 60606
phone: 847/674-5295
e-mail:
Blackman@EstateTaxSecrets.com www.taxsecretsofthewealthy.com
Did you notice that the title of this article does not say “Sell?” Instead, it says “Transfer.” So if you are thinking of having one or more of your kids own your business some day, this article probably can become a new prof- it center for you and your business.
About once a month I get a call from a reader (call him Joe) of this column who wants to sell his business (Success Co.) to his kids. After a short conversa- tion, Joe understands why a sale is a ter- rible idea for Joe and the kids.
Let’s start with the kids. In this case Joe’s son (Steve) wants to buy Success Co. for $1 million (the real fair market value). Follow these strangling tax num- bers: Steve must earn $1.66 to have $1 left to pay to Joe (typically 40 percent in income tax—state and federal—on $1.66 is 66 cents in tax). Steve pays the full $1 to Joe. Steve cannot deduct any portion of this $1 because the pur- chase of stock (Success Co. or any other stock) is simply a nondeductible capi- tal expenditure.
If Success Co. is a C corporation, any interest paid by Steve, in addition to the principal stock purchase amount is generally not deductible. However, Steve could deduct this interest against portfolio income—interest and divi- dends on other investments. Rarely do kids have such investments. But Steve can make all the interest deductible by having Success Co. elect S corporation status.
What about Joe? Steve pays his dad that $1, plus interest. Joe must pay a capital-gains tax (typically 15 percent on the dollar) and pay his top tax bracket (say 40 percent) on the interest income. Okay, Joe has 85 cents left after paying
the capital gains tax on the $1. If Joe doesn’t spend that 85 cents, the IRS gets up to 55 percent (using 2011 rates) for estate taxes. That’s another 47 cents for the tax monster, leaving Joe’s heirs with only 38 cents.
Let’s review. Steve must make $1.66 for Joe to leave his family 38 cents. That would turn into $1,660,000 for Steve— with a $1 million price for Success Co.—to make while Joe’s family only gets $380,000. Lousy tax planning.
Now let’s put some meat on them bones. Suppose Success Co. is worth $6 million. Yes, Steve has to earn a stratospheric $10 million ($6 million times 1.6667) for this family to keep $3.8 million.
Take a minute to apply the above formula to your own Success Co. I know, you don’t want to go there. But fortunately, the tax law has a flaw, offer- ing an easy and better way to transfer your business to your children.
When should the transfer be made? If you are lucky enough to own a fam- ily business currently enjoying big prof- its or larger profits each year, the soon- er you make the transfer, the better. You will freeze the value of your busi- ness and stop the potential loss of estate taxes on your increasing wealth. Unfor- tunately, most family businesses are suffering reduced profits in these tough economic times. Obviously, the value of such businesses are at a low point, giv- ing you a window of opportunity to make a tax-advantaged transfer to your children.
Sounds good. But, if you are typical, under no circumstances do you want to give up control of Success Co. Let’s walk through the simple three-step process
34 METALFORMING / SEPTEMBER 2009
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BLACKMAN ON TAXES IRVING BLACKMAN
With the Economy Lousy, Now is a Great Time to Transfer Your Business to Your Kid(s)