When I was young (in the early 1950s) I had my first consultation with a closely held business owner client who had the it's-time-to-transfer-my-business-to-the-kids itch. Since then, technology, rules, regulations and ever-expanding complexity have changed the way all of us do business. But when it comes to the goals typical business owners pour out of their minds and hearts, nothing has changed.
Joe, a 62-year-old reader of this column, is almost a carbon copy of my 1950 client. Joe has four main goals concerning his business. (1) He wants to transfer his business (Success Co.) to his two sons, Sam and Tom. (2) He wants to keep control of Success Co. for as long as he lives. Joe owns 51 percent of Success Co.'s stock, and 49 percent is owned equally by Sam and Tom. (3) He wants to treat his three children who are not in the business fairly. Finally, (4) he wants to pay as little estate tax as possible.
Funny, but the two biggest transfer fears of the '50s are still going strong in the new century. What are they? Here's a hint. The No. 2 fear is taxes—estate taxes that is. And the all-time No. 1 transfer-to-the-kids fear? Control! Yes—and get this—almost all owners are frozen with fear when it comes to passing control to their own flesh and blood. So much so that many business owners go to the big business in the sky and force their survivors to pay their estate taxes because they held more than 50 percent of the business' common stock.
OK, here's the plan we put in place about 50 years ago, and the almost identical plan we created for Joe in 2000. Joe, Sam and Tom turned all of their stock (common) in to the corporation and took back two types of common stock in exchange—voting common (100 shares) and non-voting common (10,000 shares). This transaction is tax-free and works for both C corporations (tax-paying) and S corporations. Joe then gave his 5,100 non-voting shares to Sam and Tom. Joe now owns less than 1 percent of the stock (51 shares of voting stock) yet retains voting control of Success Co. Just what Joe wanted—low value for estate tax purposes, high control. No fears. Perfect!
The plan 50 years ago used a combination of common stock and preferred stock to make the gifts to the kids. Joe used a GRAT (grantor retained annuity trust) to give the non-voting stock to Sam and Tom.
How did we get enough wealth to the non-business kids to treat them fairly? Fifty years ago we had the profit-sharing plan buy insurance on the client's life. Back then the insurance proceeds coming from a profit-sharing plan were estate tax free. In 2000 we used different strategies but attained the same tax-free result: second-to-die life insurance with Joe's wife, Mary, using the rollover IRA and a subtrust. It should be noted that second-to-die life insurance, IRAs and subtrusts did not exist 50 years ago.
What hasn't changed in the past 50 years? We had the ability back then and absolutely still have the ability today to get ALL your wealth—every dime of it—to your family, just as if the estate tax did not exist, and to keep you in control of your wealth for as long as you live. The strategies needed have changed, but the final result has not.
As regular readers of this column know, we do a reader test from time to time. So, if you have an estate problem or own an interest in a closely held business, you are invited to join the next test. To participate, please send copies of the following information: your last business year-end financial statement and tax return; your last personal tax return (Form 1040) and a current personal financial statement for you and your spouse; a family tree with names and ages for your spouse, kids and grandchildren; and wills and trusts for you and your spouse.