Guess what? All those beautiful dollars in qualified plans (profit-sharing, 401(k), IRA and the like) may only be worth 10 cents to 30 cents each after taxes. That's because the IRS hits you with the three taxes: income (up to 40 percent), estate (up to 55 percent) and excise tax (always 15 percent when it applies).
Guess what? All those beautiful dollars in qualified plans (profit-sharing, 401(k), IRA and the like) may only be worth 10 cents to 30 cents each after taxes. That's because the IRS hits you with the three taxes: income (up to 40 percent), estate (up to 55 percent) and excise tax (always 15 percent when it applies). Then, of course, your city, county or state gets a piece of the action.
Job One is to figure how much of your plan money goes to taxes. Suppose you have $1 million in all your plans and the estimated tax burden is $800,000. Ouch!
Can anything be done about it? Yes! Here are the two most common ways: The junk money strategy and the subtrust strategy.
Both strategies use a common denominator: the tax-emaciated dollars (called "junk money") buy a life insurance product (usually second-to-die) The eventual proceeds of the life insurance (say $1 million) go to your family tax free. Simply put, you have turned $200,000 of after-tax value into $1 million tax-free. There's usually plenty of money still in the plan. For example, currently the cost for a second-to-die policy for a husband and wife (both age 65) is about $15,000 per year.
The junk money strategy starts by using your plan dollars to buy an annuity. A portion of the annuity is used to fund the life insurance premium.
The subtrust is created as part of your qualified plan (actually the current plan is amended or a new plan created). Then your plan trustee gives the necessary premium dollars to the trustee of your subtrust to pay the policy cost.
Not An S Corporation?As far as I know, there is nothing better in the tax law than these two strategies.
Here's the story: Joe was about to buy the stock of a C corporation for $1.2 million payable over eight years plus interest at prime, all evidenced by a note. In addition, another $0.6 million was to be paid by the C corporation to be divided between a covenant-not-to- compete and a consulting contract to the seller for three years. The idea was to make the $0.6 million deductible as paid. Joe intended to get the money to pay the principal and interest on the $1.2 million note by taking a bonus twice a year when the note payments became due.
Without getting too detailed, here is a list of the most obvious tax blunders that would have befallen Joe and his C corporation.
The amount of the covenant is not deductible over the three-year payment and not-to-compete period; instead, it can only be written off over 15 years.
Here's how to get the transaction done: