The Wealth Transfer Plan Test

In early 1995, I wrote a lengthy article for this column titled "A New Plan to Beat the Estate Tax." In part, the article said, "If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant and CPA), you can develop a plan to legally beat the IRS.

"Remember, the goal of the typical estate planner is to reduce estate taxes. My goal is to eliminate taxes."

Generally, there are three types of readers who call me for help: the reader who 1) has an estate plan but needs a second opinion, 2) has no plan or 3) has been working on a plan for years and just can’t seem to get it done. My staff and I would like every reader who wants a second opinion or needs help completing his or her estate tax to join the tax-planning test.

"We will do a transfer/estate plan (and any necessary valuation) for each reader. We will report back to you (through this column) how many readers responded, how many we could and could not help, and a summary of the tax tools and techniques used to help the readers who did respond."

Since 1995, we have performed the test almost every year. The results are in for 2004. A total of 12 readers responded, nine of whom were in either category 1 or category 2.

One of the respondents—a 65-year-old from Oregon, whom we’ll call Joe—fell into the second opinion category. Joe started from scratch and built a successful business, Success Co. He wants to transfer Success Co. to Sam, his son. Although Joe is wealthy, his "complete package" (estate/wealth transfer plan) is a disaster.

What’s interesting is that Joe’s assets (type and mix) and his objectives represent a nearly perfect cross section of all 12 respondents.

Basically, Joe has five types of assets: a residence ($500,000); Success Co. ($4.5 million); a profit-sharing plan ($800,000); other assets, real estate and investments ($2.5 million); and life insurance (death benefit of $500,000). For estate tax purposes, if Joe was hit by the proverbial truck, and his wife Mary predeceased him, his estate would be worth $8.8 million. Taxes at Joe’s death, using his present wealth transfer plan and 2011 tax rates, would be about $3.5 million.

What are Joe’s objectives? For he and Mary to maintain their lifestyle for as long they live; to control his assets, including the business, for as long as he lives; and to pay as little estate tax as possible. Then a skeptical Joe asked, "Irv, can you get all of my assets to my family with no reduction for taxes?"

The first step was to reduce the value of Joe’s assets for estate tax purposes, yet keep him in control. Without covering every detail and nuance of the plan, this is what we did on an asset-by-asset basis: transferred his residence to a qualified personal residence trust; sold the business to an intentionally defective trust (only the nonvoting stock,which we created, while Joe kept all the voting stock); created a profit-sharing plan; transferred all other assets to a family-limited partnership; and transferred the life insurance to an irrevocable life insurance trust (ILIT). These five strategies lowered the total value of the five assets for estate tax purposes to about $3.5 million. Almost all of Joe’s and Mary’s unified credits ($1 million tax-free for each) were used in the process, leaving a potential tax liability (when Joe and Mary both die) of about $2 million.

Because we already have $500,000 of potential insurance proceeds parked in the ILIT, we would need about $2 million additional tax-free wealth to get all of Joe’s assets to his family intact (post taxes). Let’s also keep in mind that Joe was not insurable. The decision was made to buy a $2 million second-to-die life insurance policy (on Joe and Mary), using a subtrust as part of the profit-sharing plan. When all of the smoke clears (and both Joe and Mary have passed on), the $2 million will go to Joe’s family—free of the estate tax—to pay any estate tax liability that may be due. This would ultimately accomplish every one of Joe’s objectives, and his entire lifetime wealth of about $9 million would go to his family, intact with all taxes paid in full.