Page 50 - MetalForming April 2012

Blackman on Taxes By Irving Blackman
The Five Biggest Estate-Planning Mistakes that Enrich the IRS Instead of Your Family
Mistakes in estate plans can cause tax dollars to be lost to the IRS, automatically reducing your children’s inheritance. Recently, I reviewed the estate plan of a well-to-do reader (Joe, age 65) with a net worth of $20.8 mil- lion. The plan, unfortunately, included all of the five biggest mistakes described here.
Mistake #1—Not creating the right succession plan
Joe owns 100 percent of Success Co. (an S corporation), which is run by his son Sam. The company is worth $9.7 mil- lion, grows 5 to 10 percent in revenue almost every year, and profits increase accordingly. Joe’s original plan left Success Co. to his wife (Mary, age 64) and, after her death, to Sam. This is a mistake, because the
plus interest. When the note is paid in full, Sam–as the trust beneficiary–receives the nonvoting stock, tax-free.
Mistake #2—Not avoiding the double tax on qualified plans and IRAs
Between Joe and Mary, they have $1.9 million in the Suc- cess Co. 401(k) plan and various IRAs. Left alone, these funds will be clobbered with a double tax (income and estate tax). Using 2013 tax rates, the IRS winds up with 70 percent of these plan funds and the family a paltry 30 percent.
To avoid this mistake, Joe should use a strategy called retirement-plan rescue (RPR) and purchase $5 million of sec- ond-to-die life insurance on himself and Mary. The policy should be purchased and owned by an irrevocable life-insur- ance trust (ILIT). The beneficiaries of the ILIT are Joe and Mary’s three nonbusiness children (Sue, Sy and Sid), treated equal to Sam. Because of the ILIT, Sue, Sy and Sid will receive every penny of the $5 million tax-free.
Without the new plan, the kids would receive only $570,000 (30 percent of $1.9 million).
Mistake #3—Not putting investments into a family limited partnership (FLIP)
Joe and Mary have $8.1 million in cash, CDs, stocks, bonds and income-producing real estate. They created two FLIPs: one for their real estate and one for their other invest- ments (holding $2 million to be used in Mistake #4). So, the amount put into the FLIPs is $6.1 million. A FLIP, when properly structured in accordance with tax law, is allowed a 35-percent discount, reducing the $6.1 million to $4 million for tax purposes and saving estate taxes on $2 million.
Joe and Mary immediately give separate gifts of $1,026,000 each to Sue, Sy and Sid, including $13,000 from Joe and $13,000 from Mary—the annual gift exclusion allowed with- out any gift-tax consequences. The additional $1 million each used a portion of the $5.12 million one-time gift max- imum allowed per person (or a total of $10.24 million for a married couple) for 2012. (Note: This drops to $1 million per person starting January 1, 2013).
A warning: If you are in the financial position to make large gifts to your kids and grandkids, you have until December 31, 2012 to use your $5.12 million ($10.24 million if married). This window of opportunity is closing.
Mistake #4—Not taking advantage of life insurance as a tax-advantaged investment
There are dozens of core life-insurance strategies and hundreds of variations that allow investors to beat Wall
potential estate-tax liabil- ity grows along with the increasing value of Success Co.
Now is the time to
transfer Success Co. to
Sam. Joe should recapital-
ize Success Co. (create vot-
ing stock (say 100 shares)
and nonvoting stock (say
10,000 shares)—a tax-free
transaction. Joe keeps the
voting shares and absolute control for as long as he lives. Under the tax law, the nonvoting shares are entitled to a deep discount of 40 percent, so for tax purposes these shares are worth only $5.82 million.
Next, Joe should transfer (sell) the nonvoting shares to an intentionally defective trust (IDT) for $5.82 million, taking an interest-bearing note as payment. According to tax law, the entire IDT transaction is tax-free to Joe—neither capital-gains tax nor income tax on the interest to be received while the note is being paid. Even better, Sam does not pay even one penny for the stock. Instead, the cash flow of Success Co. (via S corporation dividends to the IDT) is used to pay the note,
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:
tel. 847/674-5295
Birv@irvblackman.com www.taxsecretsofthewealthy.com
Mistakes in
estate plans can
cause tax dollars
to be lost to the
IRS, reducing
your children’s
inheritance.
48 MetalForming/April 2012
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