An Estate Plan Case Study

Making adjustments like these to your plan can help eliminate the potential estate tax liability.


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This tax victory story is about Joe. Our old friend is an interesting guy. He’s 61 and married to Mary, age 60. He owns Success Co., a family business professionally valued at $5.6 million. He and Mary have three children and seven grandchildren. One son, Sam, manages Success Co. and will someday own it.

But I believe the most interesting fact about Joe is that he is a member of a study group made up of 20 owners of closely held businesses. The group meets monthly and once a year invites an estate planning professional to talk about how to create the best estate plan.

Each year, one member becomes a case study for this discussion, and this year Joe was the subject of the case study. The presenter, a lawyer named Lenny, recommended a few changes to Joe’s estate plan.

Lenny, like 99 percent of his estate planning peers, is what we call a “traditionalist.” His estate planning goal is to make sure that there is enough liquidity (cash-like assets owned by the client, life insurance or both) to pay the potential estate tax after the client dies. My goals, on the other hand, are much more ambitious: 1) eliminate or reduce as much as possible the potential estate tax liability and 2) maximize the amount of wealth to the client’s heirs (typically the children and grandchildren).

Joe called me for a second opinion on Lenny’s recommendations, and my team and I adjusted his overall estate plan to make sure that he and Mary can maintain their lifestyle, and to keep Joe in control of his assets—including Success Co.—for the rest of his life.

Joe’s overall wealth is about $15 million. This includes the $5.6-million value of Success Co., which nets $1.5 million before tax and after paying Joe a $300,000 salary plus liberal fringe benefits. After taxes, Joe earns about $400,000 to $600,000 more per year than he and Mary spend.

The balance of Joe’s wealth includes two homes (a main residence and a vacation home) worth a combined $2.7 million; $1.7 million in his 401(k) plan; cash, and a stock and bond portfolio totaling $1.8 million; $2.9 million in income-producing real estate; and $300,000 in sundry assets.

There also is $6.2 million in insurance on Joe’s life that, per Lenny’s recommendation, is now owned by an irrevocable life insurance trust (ILIT). This insurance includes a $1.2 million whole life policy and $5 million in 10-year term insurance (with six years remaining in the term).

The following are the key changes and additions we made to Joe’s estate plan:

1. Residences. We changed the titles on both residences so that a trust in Joe’s name owned half of each and one in Mary’s name owned the other half. This reduced the value of the homes by 30 percent for estate tax purposes, a discount of $810,000.

2. 401(k) plan. Qualified plan assets, like a 401(k), IRA and similar plans, are double taxed—first in the form of income taxes and then in estate taxes. We employed a strategy we call a “Retirement Plan Rescue” whereby we will use future income from the 401(k) plan to pay a portion of the insurance premiums we will discuss later.

3. Success Co. grows in value about 10 percent every year. We froze its value within Joe’s estate by having him sell the company to his son Sam via an intentionally defective trust (IDT). By using this strategy, every penny in payment Joe receives from the IDT for Success Co. is tax-free. Just prior to the sale, we also recapitalized the company, creating voting and non-voting stock. Joe retains control of the company via voting stock (less than 1 percent) and sells the non-voting stock (more than 99 percent) to the IDT. A portion of the future cash flow from Success Co. will be used to pay Joe for the non-voting stock and another portion will be used to help pay the premiums for the life insurance discussed below.

4. Stock and bond portfolio. These assets were transferred to a family limited partnership (FLIP), whereby a 35-percent discount allowed under the tax laws reduced their value by $630,000 for tax purposes.

5. Income-producing real estate. These properties were held in three limited liability companies (LLCs), and we transferred the LLC interests to a separate FLIP, which resulted in more than $1 million in discounts.

6. Gifting program. Every year, Joe and Mary will each make a maximum allowable gift of $14,000 to each of their children and grandchildren. They also will take advantage of a portion of the $5.25 million gift-tax-free exemption ($10.5 million for the two of them combined).

7. Life insurance. Since no estate tax is due until after the death of the second spouse, second-to-die life insurance purchased through an ILIT makes more sense than an insurance policy only on Joe’s life. Premiums for the single policy are $19,160 per $1 million of coverage but only $11,102 for the second-to-die policy. Joe dropped his existing whole life policy and added $6.2 million in coverage through a second-to-die policy. The annual premium on this policy will be $67,722 and will be paid for with future income from his 
401(k) and future cash flow from Success Co., as mentioned above.

Victory! Our strategies eliminated all of Joe’s potential estate tax liability.