Most successful business owners (Joe, the business owner from Kansas, will be our example) have two loves in their life: their family and their business. With rare exceptions, it's family first. But what about the business?
Over the years, I've asked the Joes of the business world the following question: “Do you want your business to continue?” A loud “yes” is always the answer. The longer Joe has been in business and the more success he has enjoyed, the louder and more passionate the “yes” is.
Joe, an avid reader of this tax column, is the perfect poster boy for a successful business owner of his generation. He married his girlfriend, Mary (who is also an avid reader of this column), and started his business, Success Co., from scratch after graduating from high school. Joe and Mary are both 68 years old now, and Joe wants to transfer Success Co. to his son, Sam. In general, Joe is a happy camper, however, his estate/wealth transfer plan/succession plan is a disaster. Mary knows this and prevailed upon Joe to call me.
After my 45 years of experience, working with the readers of this column, it is clear that many successful business owners have basically the same succession plan problems as Joe. The three most common succession problems owners have are selling/transferring the family business to business kid(s) without getting killed by taxes, treating the non-business kid(s) fairly and selling the business to key employee(s) when he/she/they have no money (this comes up when Joe has no child or other relative to take over the business).
When talking with Joe, he told me he has five types of assets: Success Co. worth $6.5 million, a residence worth $700,000, a rollover IRA worth $900,000, other assets, which are mostly real estate and liquid investments worth $3.5 million, and life insurance (death benefit of $800,000).
For estate tax purposes, if Joe got hit by the proverbial truck and his wife Mary predeceased him, his estate would be worth $12.4 million. (Joe is no longer insurable, but Mary is.) Taxes at Joe's death, using his present wealth transfer plan and 2011 tax rates would be about $5.5 million.
Joe also told me his goals: I want Mary and I to maintain our lifestyle for as long as we live; give Success Co. to Sam while paying the least amount of tax, yet I want to control it for as long as I live; and I want each of my two daughters (non-business kids) to receive an equal amount of our estate, the same amount that Sam receives. And then, with an I-know-it-can't-be-done laugh, Joe asked, “Irv - maybe you can get all of my assets to my family…no reduction for taxes?”
The first step I took, requiring five strategies, was to reduce the value of Joe's assets for estate tax purposes, yet keep him in control of Success Co. Without covering every detail and nuance of the plan, this is what was done on an asset-by-asset basis:
Sold Success Co. to an intentionally defective trust. Only the non-voting stock (which we created) was sold while Joe kept all the voting stock, so he kept absolute control of the company. The IDT is a magnificent strategy that allows us to transfer a family business to any person (in our case, a son) tax-free.
Transferred Joe's residence to a qualified personal residence trust.
Created a profit-sharing plan (a magic bullet).
Transferred all other assets, including the real estate and liquid assets, to a family limited partnership.
Transferred the life insurance to an irrevocable life insurance trust.
These five strategies lowered the total value of the five assets for estate tax purposes to about $6.5 million. We used up almost all of Joe's and Mary's unified credits ($1 million tax-free for each) in the process, leaving a potential tax liability of about $3.2 million when Joe and Mary both die.
Since we already have $900,000 of potential insurance proceeds in the ILIT, we only need about $2.3 million more of tax-free wealth to get all of Joe's assets to his family - all taxes paid in full - and accomplish Joe's laughable fourth goal. What to do? Joe was not insurable.
We decided to buy a $3 million second-to-die life insurance policy (on both Joe and Mary), using a subtrust as part of the profit-sharing plan. When both Joe and Mary have passed on, the $3 million will go to Joe's family - free of the estate tax - to pay any estate tax liability that may be due. The final result: Joe's goals will be accomplished, and his entire lifetime wealth (over $12 million) will go to his family - intact - and all taxes paid in full.
Please note that although Joe was not insurable, my insurance consultant persisted with the insurance company and convinced them to accept Joe for second-to-die coverage (the full $3 million) with Mary.
And finally, assume that Joe has no kids in the business, but has Ken, a smart, young key employee who has been running Success Co. for the past eight years. Just substitute Ken for Sam in the above plan. Joe's results will be the same. In addition, we would put in a wage continuation plan for Joe to take effect if he ever quit working or could no longer work. This plan would continue for as long as Joe lived and at his death for as long as Mary lived.
If your succession plan problems are the same or similar to Joe's, the above plan should be a starting roadmap of how to create your own plan. Should you have any questions, just call me at 847-674-5295. You are welcome to have your professional advisor on the line.
Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847/674-5295, email firstname.lastname@example.org or on the Web at www.taxsecretsofthewealthy.com.