Page 57 - MetalForming April 2016

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Simply put, Joe would be clobbered with federal taxes as well as state income tax.
Now what about the tax cost for Cy? Joe’s lawyer explains that Cy also gets clobbered. Let’s lower the price of Suc- cess Co. to $1 million to make the num- bers easier to follow. If the income tax burden (state and federal combined is 44 percent), Cy must earn $1.78 million, paying about $780,000 in taxes, to have the $1 million to pay Joe. Now remem- ber to multiply these numbers by 5.7 (the price for Success Co. is actually $5.7 million). Also remember, the unpaid balance
always bears tax-
able interest.
cash flow of Success Co. will be used to pay off the note, plus interest.
What is different about an IDT? It is the same as any other irrevocable trust, except that the trust is not recognized for income-tax purposes. The result: Under the Internal Revenue Code, every penny you (the seller) receive is tax- free: no capital-gains tax on the note payments, and no income tax on the interest income. With an IDT, every $1 million of price for Success Co. saves about $195,000 in taxes. Here, given the $5.7 million price, the savings add up to about $1.112 million.
In addition, Cy’s
personal financial
statement must
now show a liability
of $5.7 million,
making it almost
impossible for Suc-
cess Co. to borrow money for growth, as banks want a personal guarantee from the owner.
Disappointed, Joe—an avid reader of this column—called me.
IDT Solves the Problems
An IDT solves these problems for both seller and buyer, and allows Joe to keep control of Success Co. until he is paid in full. The control solution is a simple two-step process:
1) Perform a recapitalization (a fancy name for creating voting and nonvoting stock) to create 100 shares of voting stock, which Joe keeps to main- tain control, and 10,000 shares of non- voting stock, which will be transferred to Cy via the IDT.
2) Joe creates the IDT and sells all 10,000 shares of his nonvoting stock to the trust for $5.7 million, which is paid in full with an interest-bearing note. The IDT now owns the nonvoting stock and Joe has a $5.7 million note receivable from the IDT. The future
www.metalformingmagazine.com
MetalForming/April 2016 55
Blackman on Taxes
Cy is the benefi- ciary of the IDT, and when Joe’s note is paid off, the trustee will distribute the nonvoting stock to Cy. Then, Cy buys the 100 voting shares from Joe for a nomi- nal price, say $1,000. Cy now owns 100 percent of Success Co. Does an IDT work for a transfer to your kids? Yes, just substitute your child's name for Cy in the above exam- ple. When one or more of your chil- dren is involved, an IDT offers two
more important advantages:
1) The fair-market value of the non-
voting stock can be discounted by about 40 percent. For example, if Suc- cess Co. is worth $10 million, the non- voting stock can be valued for tax pur- poses at about $6 million.
2) The trustee of the IDT is instruct- ed to keep the nonvoting stock, so if your child, who is the IDT beneficiary, gets divorced, his or her spouse will have no interest in the stock.
Also, the same IDT strategy can be used to buy out fellow stockholders. So, if your professional advisor ignores the use of an IDT in your succession planning, get a second opinion.
If you have a unique succession problem that is not covered in this arti- cle, contact me. MF
“What is different about an IDT? It is the same as any other irrevocable trust, except that the trust is not recognized for income-tax purposes.”