How To Keep Your Wealth In The Family

The tax law frustrates successful business owners at every turn. Never have I seen this frustration expressed better than in a letter from a reader of this column (Let's call him Joe). A portion of the letter follows, though the names have been changed.

"Mary and I (Joe) spent the better part of a year creating a plan to leave our worldly goods (worth about $4.1 million) to our two single sons, one of whom is in our business.

"You can see from our wills, revocable trusts, the manuals from the Family Planning Group (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 me that if Mary and I went to 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."

The letter was accompanied by the same documents and financial data made available to Joe's three advisors. What is so interesting about Joe and Mary is they are a poster couple for the millions of family business owners facing these estate tax problems:

• 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 value your business,
• how to treat your children fairly,
• how to get your wealth to your children without being "decimated" by the IRS,
• how to maintain your lifestyle after retirement and
• how to control your business for as long as you live.

It should be noted that all of Joe's advisors were smart and 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 blue every time he thought of the $1 million-plus tax bill he was told he must pay to the IRS. Since Joe and Mary are like so many other family business owners (the amount of wealth is almost immaterial; it could be $2 million, $30 million or more), following is the basic plan we implemented for them. It is also the five-step core plan we create for most business owners who want to finesse the estate tax and get 100 percent of their wealth to their family, all taxes, if any, paid in full. As you read, think how the same or a similar plan would solve your problems.

1. The business is transferred to the business child using a grantor retained annuity trust.
2. A subtrust, using qualified plan funds like a profit-sharing plan, 401(k) or rollover IRA, 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 is created to hold all of Joe's and Mary's other assets (except their residence, business and profit-sharing plans).
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 (will and trust) clean up all goals that were not accomplished by the first four steps.

Notice the first four steps are done while Joe and Mary are alive—a must if you want to win the estate tax game. A will and trust (really an estate plan, as opposed to a lifetime tax plan) just can't get the job done.

Joe and Mary will control all their assets—including the business—for as long as they live. Again, we want to pound this point home: The plan is essentially a lifetime tax plan (the first four steps). The real secret is to do lifetime planning, not just death or estate planning like Joe's advisors did.

After the five-step plan was in place, the wealth that ultimately will go to the children of Joe and Mary will be $4.5 million. We actually created additional (over their original $4.1 million) tax-free wealth instead of losing more than $1 million to the IRS.

As regular readers of this column know, we do a reader test from time to time (Joe was part of the last reader test.) So, if you have an estate tax problem or own an interest in a closely held business, you are invited to join the test.

In order to participate, please send copies of your business's last year-end tax return; your last personal tax return and a current personal financial statement; a family tree that includes your name, age and birthday, plus those of your beneficiaries; and estate documents and trusts for you and your spouse.