One thing is certain: All the baby boomers are at an estate-planning age. This generation tends to have three common goals for their plans: eliminate or minimize taxes, maintain control of assets for as long as they live and maintain their current lifestyles. After reviewing countless estate plans to give successful business owners a second opinion, I can tell you that few come close to accomplishing these goals. About half of the estate plans did not include a succession plan.
Joe, age 60, is a poster boy for someone who needs a second opinion on his estate plan. His lawyer Lenny created the plan, yet he failed to create a lifetime plan to go alongside it. To help Joe out, I asked him to send me the year-end financial statements for his business, Success Co., in which he had 100-percent ownership. He also sent me a family tree: He is married to Mary, age 64, and has five kids. Four of the kids work for the family business. He also has nine grandchildren. Joe also sent a personal financial statement showing that he and Mary are worth $49 million.
Here’s some additional information: Success Co. is an S corporation. It earns enough profit to increase Joe’s wealth by about $1.6 million per year.
Here’s a summary of Joe’s significant assets in millions of dollars:
Success Co. (IDT) $20
Two residences (QPRTs) $3
Real estate, rental income (FLIP #1) $7
Cash, stocks, bonds (FLIP #2) $16
401(k) (RPR) $3
TOTAL $49
Joe has two more goals: leave the entire amount of his current net worth to his family, all taxes paid in full, and leave $10 million to his favorite charity as long as this gift does not reduce the inheritance to his kids and grandchildren. To accomplish these goals, he must have a lifetime plan, which is detailed below.
Reduce Asset Value for Tax Purposes
• Success Co. First, recapitalize Success Co. by creating 100 shares of voting stock and 10,000 shares of non-voting stock. The non-voting shares are entitled to various tax discounts, about 40 percent total. So, Success Co. is only worth about $12 million for tax purposes after discounts. Joe sells the non-voting stock to an intentionally defective trust (IDT) for $12 million. The IDT pays Joe with a note, and the cash flow of Success Co. is used to pay the note and interest. The $12 million, plus interest, is tax-free to Joe because of IDT rules. Joe saves $2.3 million from capital gains and income taxes.
At this point, the full value of Success Co. is almost out of Joe’s estate, yet he still has absolute control as the owner of all the voting stock. As the beneficiary of the IDT, his son, Sam, will receive the non-voting stock tax-free when Joe’s note is paid in full. Sam will not pay one cent for the stock.
• Residences. A qualified personal residence trust (QPRT) allows you to transfer up to two residences to your heirs, yet you can live in your homes for as long as you like. Joe and Mary transferred their two homes to two separate QPRTs, removing them from their estate.
• Real estate, rental income. This was transferred to a family limited partnership (FLIP #1). Joe and Mary own 1 percent as general partners and have control of the assets. They also own 99 percent as limited partners with no voting rights, so they are entitled to a tax discount of about 35 percent. Now, this $7 million asset is only worth $4.55 million for tax purposes.
Joe and Mary gift the limited partnership interests to the kids and grandkids. They get a discount and get the asset out of their estate.
• Cash, stocks, bonds. Joe transferred $14 million in stocks and bonds to FLIP #2. This partnership has voting and non-voting interests. After discounts, the non-voting interests were valued at less than $10 million. Using the $5 million per person special gift tax rules (this will drop back to $1 million starting in 2013), he made gifts of all the non-voting units to the kids and grandkids. Remember, it’s $5 million per person, so Joe and Mary made $10 million in tax-free gifts.
Other Lifetime Strategies
• Captive insurance company. We created a captive insurance company so Success Co. can pay $1.1 million to the Captive, which Success Co. deducts. But the Captive receives the entire $1.1 million tax-free. The Captive C corporation is owned by the business children and is out of Joe’s estate.
• Buy-sell agreement. An insurance-funded buy-sell agreement was drawn to make sure the stock of Success Co. stays in the family. All four of the business kids were included.
This is just a small sampling of the different ways you can arrange your estate. No matter how you do it, remember this: Always make sure your plan includes both an estate and a lifetime plan.
