Published 5/16/2011

New IRS Rules Make Estate Planning Easier

Legally beating up the IRS has always been challenging, but it’s one of my favorite indoor sports. The new tax law, which started January 1, 2011 and will end December 31, 2012, certainly will provide positive estate-planning results.

Irvine Blackman, Brian I. Whitlock

Congress made two significant tax changes: It combined the gift and estate tax into a single tax, and it made the tax-free amount $5 million if you are single and $10 million if you are married. You can still give $13,000 ($26,000 if married) to each donee per year. Gifts greater than $5 million ($10 million if married) are taxed at a rate of 35 percent.

Now, to legally eliminate the estate tax, I have created a system that dovetails two plans: a lifetime plan and an estate plan (death plan).

Gifts are always a part of your lifetime plan. The new $5 million per person limit (compared to the previous $1 million) is a perfect fit for my system. There are many ways to take advantage of the opportunities opened up by the new tax law.

For example, Joe (age 67), who is married to Mary (age 64), owns Success Co. His son Sam helps him manage it. Joe has five key goals: Maintain his and Mary’s lifestyle for as long as they live; transfer Success Co. to Sam without getting killed by taxes; treat his two non-business kids fairly; keep absolute control of his assets until the day he dies; and avoid paying taxes to the IRS after both Joe and Mary pass on.

Joe and Mary’s major assets include Success Co., which is valued at $11.0 million; a main residence and summer cottage, which are valued at $2.8 million; Success Co.’s 401(k), which is valued at $1.6 million; and various other investments, including cash, stocks and bonds, which are valued at $8.2 million.

Joe and Mary currently have a traditional estate plan (A and B trusts, which are often called “marital trusts” and “family trusts”). Although both are healthy, Joe has only $1.2 million in insurance on his life (policy owned by Success Co.). Joe and Mary’s situation is screaming for a lifetime plan that integrates the new law into the system. The following is the plan dictated by the system.

1. Transfer Success Co. to Sam. Joe recapitalized the business by creating 100 shares of voting stock and 10,000 shares of non-voting stock. He kept the voting stock and absolute control of Success Co. The non-voting stock is entitled to various discounts (totaling about 40 percent) under the tax law. So, the non-voting stock is worth (after discounts of $4.4 million) only $6.6 million for tax purposes.

Next, Joe created an intentionally defective trust (IDT). Half the non-voting stock ($3.3 million) was gifted and half was sold to the IDT. The half sold to the IDT will use the cash flow of Success Co. to pay the $3.3 million to Joe. A long-existing tax law concerning IDTs will enable Joe to receive all of the $3.3 million, plus interest, tax-free. Sam is the beneficiary of the IDT and will receive all the non-voting stock. When Joe goes to the big business in the sky, the voting stock will go to Sam.

2. Remove two homes from the estate. We created a qualified personal residence trust (QPRT) for the two homes. The QPRT enables Joe and Mary to live in both homes as long as either is alive. Both homes will be out of their estates for tax purpose.

3. Multiply the 401(k). This turns a double-tax problem into tax-free wealth. The insane tax law double taxes (income tax and estate tax) all qualified plan funds, such as 401(k), IRA, profit-sharing and similar plans. Your family gets about 30 percent, and the tax collectors receive 70 percent. We used a strategy called a retirement plan rescue to buy $6 million of second-to-die life insurance on Joe and Mary. Using this strategy, the entire $6 million goes to the family, tax-free.

4. Leverage investment assets into tax-free wealth. We enhanced the two following strategies with gifts:

• An intentionally defective trust (IDT)

Joe gifted $4 million in cash to a second IDT (using more of the $10 million available to Joe and Mary). Then, Joe substituted a note payable to the IDT, with interest of 6 percent per year, in exchange for the $4 million in cash. So, Joe was now obligated to pay $240,000 in interest per year to the IDT. However, interest is tax-free to the trust. The trust used most of the interest funds to pay premiums on a new $8.5 million second-to-die life insurance policy on Joe and Mary. When Joe and Mary die, $4 million of the insurance proceeds will pay off the note.

• A family limited partnership (FLIP)

Joe transferred the balance of the investment assets ($4.2 million) to a FLIP. Because of discounts allowed by the tax law, the FLIP interests are only worth $2.8 million for tax purposes. The 12 donees—the three kids, their spouses and the six grandchildren—will receive annual gifts of $312,000 (12 × $26,000). So, in about 9 years, all of the FLIP will have been given to the family, but Joe will still control the assets in the FLIP as the only voting partner.

In light of the fresh opportunities created by the new law, you should consider joining the tax-saving fun. Review you current plan, or get a second opinion.