Last month, we told you about Joe. Joe was advised by his lawyer and accountant to sell his business, Success Co., to his daughter for $1.8 million. He called me for a second opinion before signing the papers. These are the goals Joe outlined:
- Retire next month, when he turns 65.
- Sell Success Co. to his daughter Susan. (She and her husband work in the business.)
- Get a lifetime flow of income from the business for himself and his wife, Mary.
- Save income and estate taxes.
- Control his assets, including the business, for as long as he lives.
- Treat his two nonbusiness children fairly.
A quick valuation (taking legal discounts allowed under the tax law) indicated that the business was worth in the $1.1 to $1.2 million range for tax purposes. The business is likely to enjoy modest growth in value (about 5 percent per year). Joe’s other assets—including his residence ($350,000), 401(k) ($650,000), investments ($500,000) and life insurance of $600,000—total $2.1 million and are held in joint tenancy by Joe and Mary. Mary was the beneficiary of Joe’s insurance and the 401(k). Success Co., a regular, tax-paying corporation, usually wound up with annual before-tax profit of about $300,000 to $400,000 after paying Joe a $175,000 salary.
Last month, I discussed how I advised Joe not to sell Success Co. This saved him about $350,000 in income tax (technically capital gains tax). I also went over the strategies used to save (eliminate, in this case) estate tax. In this column, I will present the advice I gave in response to the rest of Joe’s goals.
- I convinced Joe not to totally retire. He slowed down from 60-70 hours a week to 18 to 20 hours a week. Joe’s salary is now $2,500 per month, plus his usual fringe benefits.
- Instead of selling Success Co. to Susan, we “sold” half of it (but only nonvoting stock) to an intentionally defective trust (IDT). The sale to the IDT is tax-free.
- Success Co. elected S corporation status. With Joe’s reduced salary, it should make $400,000 to $500,000 per year. Half ($200,000 to $250,000) will go to Joe and Mary as dividends. These dividends, plus Joe’s salary, Joe and Mary’s Social Security, and their investment income, will provide more income than they need to maintain their lifestyle. Joe will also be collecting $500,000 plus interest from the sale to the IDT.
- Joe will control his assets as follows. He will control Success Co. via the voting stock and the residence as the trustee of the QPRT. He directs the investments of his 401(k) account, and he is the only voting general partner of the FLIP.
- The wills and trusts (for Joe and Mary) were drawn to have all Success Co. stock go to Susan, then $2 million of the final estate assets to each of the two nonbusiness kids. Any excess goes one-third to each child.
Now a warning: Every detail, rule and possible tax trap of Joe and Mary’s plan is not given. Make sure you work out your plan with qualified and experienced experts.