Create Tax-Free Wealth

If you are a successful business owner—with a potential estate tax liability—pay attention. Joe's corporation (Success Co., an S corporation) had accumulated $1.4 million cash over a 25-year period while operating as a C (taxpaying) corporation. Only $300,000 was needed to operate the business. The only way for Joe to get all or a portion of this extra money in his pocket was via a dividend with a tax cost of over 40 percent. Unacceptable!

Here's the plan. Success Co. entered into a split-dollar plan (a way to pay for life insurance) for a $3 million second-to-die life insurance policy (on Joe and his wife, Mary) to be owned by an irrevocable life insurance trust (ILIT). Until the death of the surviving spouse, Success Co. will pay all of the annual premiums.

As part of the plan, Joe transferred sufficient stock to Mary so each owned (through a revocable trust) a 50 percent interest in Success Co. Stock owned by the spouse who died first would pass to a trust for the benefit of the surviving spouse so that the survivor would control the corporation.

Let's look at the tax results: (1) The premium payments made by Success Co. are taxfree to Joe and Mary; (2) After the second death (when the $3 million in insurance proceeds is collected), Success Co. will be repaid every dollar it advanced during the years (also taxfree); and (3) The balance of the proceeds ($2.4 million or more) will be paid to the ILIT (free of income and estate tax). This amount will more than pay for the $1.2 million in projected estate tax liability. The balance (over $1 million) would go taxfree to Joe and Mary's children and grandchildren.

Flexibility. Your corporation—C or S—or partnership does not need a pool of money; premiums can be paid out of future earnings. The insurance does not have to be secondtodie; it can be on a single life (usually the stockholder/owner).

Transferring Your Business?...

The goal of most successful business owners is to have their kids continue the family business. In many cases, they leave half their business to each child if they have two kids, a third to each child if they have three kids, and so on.

Does this simple transfer plan work when not all of your kids are in the business? The unfortunate answer is that such a transfer plan almost always fails. Simply put, for a multitude of reasons, the kids fight.

What should be done to avoid such family feuds? The answer is to arrange a transfer plan that allows your business children to wind up with the entire business. Sometimes the makeup of the owner's assets allows such a plan to be easily accomplished—just leave the business assets to your business kids and the nonbusiness assets to your nonbusiness kids.

But what happens when there is a shortage of nonbusiness assets? Here's a plan that works. Give at least one share of stock to each child, whether or not in the business. Now, all of the kids are stockholders. The stockholders enter into a buy/sell agreement allowing your business child to buy the shares of his/her siblings at fair market value after you pass on. The business child or children purchase the business (the corporation redeems the nonbusiness children's stock) and wind up owning all of the business. The nonbusiness kids wind up with cash. The terms of the agreement should allow the business to pay for the shares of your nonbusiness children over a period of years using the cash flow of the business.