Yes, you can beat up the IRS legally if you prepare adequately. The following example shows how one client prepared for such an undertaking.
Joe, age 74, owns 52 percent of Success Co., an S corporation. Joe has two sons, Tom, age 47 and Dick, age 43, both of whom have been in business with Joe since they graduated from college. Joe’s daughter, Harriet, is not and never will be involved in the business. Each of his children owns 16 percent of Success Co. Joe lost his wife last year.
Here is a list of Joe’s assets:
Various liquid investments $190,000
52 percent of Success Co. $1,630,000
Real estate leased to Success Co. $600,000
Balance in Rollover IRA $780,000
Residence & summer home $435,000
Joe’s lawyer just completed Joe’s estate plan and correctly computed the estate tax (using 2011 rates) at $1,419,771. The lawyer’s only recommendation: Buy $1.5 million in insurance to pay the tax.
Joe called me for a second opinion, and during our conversation, he articulated five specific goals:
- He wishes to control Success Co. (and the rest of his assets) for as long as he lives.
- He wants Tom and Dick to each own 50 percent of Success Co. after he passes on.
- He wants to maintain his lifestyle for as long as he lives.
- He wants to ensure that the dollar value Harriet receives from his estate should be equal to the amount that each of her brothers receive.
- He wants each of his children to receive one-third of what he is worth now, with all taxes paid in full.
What follows is the plan we implemented for Joe and the strategies we selected to accomplish Joe’s five specific goals.
- We recapitalized Success Co. (a tax-free transaction) so that Joe now owns 52 percent of the controlling voting stock (52 of 100 shares) and 52 percent of the nonvoting stock (5,200 of 10,000 shares).
We transferred the liquid investments and the real estate to a family limited partnership (FLIP). As the general partner (owning 1 percent of the FLIP), Joe keeps control of these assets. He will make annual gifts ($12,000 each) of limited partnership interests to his children. These limited interests (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35 percent) for tax purposes. As a result, Joe can give about $19,000 of limited FLIP interests every year to each child, yet for tax purposes, the interests are only worth $12,000.
- Joe sold the 5,200 shares of nonvoting stock to a defective trust for $1.5 million plus interest. The trust paid for the stock with a note. Success Co. will distribute S Corporation dividends each year to the trust, which will then pay off the note to Joe.
Tom and Dick are beneficiaries of the trust, and each will own half of the 5,200 shares when the note is fully paid and the trust terminates. Joe’s 52 voting shares will go to Tom and Dick when he dies. The shares owned by his daughter, Harriet, will be redeemed by Success Co., according to a new buy/sell agreement, when Joe passes on. Then Tom and Dick will each own 50 percent of Success Co.
- Joe’s flow of cash to maintain his lifestyle will come from a small salary from Success Co., note payments from the trust (the entire $1.5 million plus the interest is tax-free to Joe because of the defective trust) and distributions from the rollover IRA.
As a final backup, Joe will enter into a death benefit agreement with Success Co. that will pay him $75,000 per year starting when he retires (although he probably never will) and continuing until the day he dies.
- We created a Subtrust (using the rollover IRA and Success Co.) to purchase a $1.5 million life insurance policy. The entire $62,187 annual premium will be paid out of plan funds, and because of the subtrust, none of the $1.5 million policy proceeds will be included in Joe’s estate. Appropriate language in Joe’s will and revocable trust ensures this goal is accomplished.
- Joe’s residence (worth $355,000) was transferred to a qualified personal residence trust (QPRT). The QPRT was set up in such a way that Joe could stay in the residence for as long as he lived, yet it would not be part of his estate.
If Joe gets hit by a bus the day after the plan described above is put in place, then this goal will be accomplished (along with his other goals). The longer Joe lives, the less the IRS gets and the more the kids get (in excess of the $3,635,000).
One warning: The above story does not explain all the technical details of Joe’s plan. For your own plan, work with an tax advisor who knows, understands and has worked with the strategies used for Joe. A will and trust alone will not get the job done.
Do you need help getting started on your own beat-up-the-IRS-legally plan? Read “Tax Secrets of the Wealthy” for step-by- step instructions. Send $367 to: Blackman Kallick Bartelstein, LLP Book Division, 10 South Riverside Plaza, 9th Floor, Chicago, Illinois, 60606. You can also call me at (847) 674-5295 for a second opinion about your existing estate plan.