It’s no secret that business owners find tax laws frustrating. That frustration was best expressed in a letter I received from a reader we’ll call Joe. The following excerpt from Joe’s letter is unchanged except for the names.
He writes “Mary and I have spent the better part of a year creating a plan to leave our worldly goods to our two single sons, one of whom is in our business.
“You can see from our wills, revocable trusts and the two green manuals [from a group of professional advisors specializing in business succession and estate planning], our tax attorney and our CPA, that we are trying to do the right thing. Just what that means I don’t know, but it seems to be that if Mary and I went to Las Vegas and lost every dime there would be no taxes. . . yet if we live a reasonably decent life and try to pass on our savings to our children and to charities, Uncle Sam steps in and decimates a lifetime of savings.”
Documents and financial data (actually the same information made available to Joe’s advisors) accompanied the letter. What’s so interesting about Joe and Mary is that they are a poster couple for the six most common “maintaining your lifestyle” and estate tax problems.
Those problems are:
- How to transfer your family business when you have one child (or more) in the business and one child (or more) not in the business.
- How to maintain your (and your spouse’s) lifestyle for as long as you live.
- How to invest your excess funds.
- How to treat your children fairly.
- How to transfer your wealth to your children (or other family members) without being “decimated” by the IRS.
- How to control your business for as long as you live.
It should be noted that all of Joe’s advisors are smart, experienced practitioners in their respective areas of practice. So why was Joe still searching for better results than this group could deliver? Simply put, Joe saw red whenever he thought of the $1 million-plus tax bill that he was told he would owe the IRS. Below is the basic plan we implemented for Joe and Mary. As you read on, ponder whether the same or a similar plan would address your problems for the rest of your life and after you pass on.
The core plan consists of six steps: 1) The business is transferred to the business child (or children) using an intentionally defective trust; 2) A subtrust or retirement plan rescue (using qualified plan funds) is used to purchase second-to-die life insurance on Joe and Mary (proceeds go to the children tax-free); 3) A family limited partnership (FLIP) is created to hold all of Joe’s and Mary’s assets (usually investments such as real estate, stocks and bonds); 4) An annual gifting program is started immediately to transfer the FLIP interests to the children (typically, the non-business children); 5) The death documents (the will and the trust) are designed to clean up all of Joe’s and Mary’s goals and asset distributions that were not accomplished during their lifetimes by the first four steps of the plan.
Notice that the first four steps are carried out while Joe and Mary are alive—a must if they want to maintain their lifestyle and win the estate tax game.
Joe and Mary will control all of their assets, including the business, for as long as they live. The plan is essentially a lifetime tax plan. The secret is to do not only lifetime planning, but also death or estate planning.
After our plan is implemented, the wealth that will ultimately go to Joe’s and Mary’s children will be in excess of $5 million. Instead of losing over $1 million to the IRS, we created additional tax-free wealth. Most importantly, Joe and Mary can maintain their lifestyle—allowing for an inflation rate as high as five percent—for as long as they live.