STRATEGY NO. 1. Are you an S corporation? Be careful. The IRS is on the warpath. Why? Many S corporation owners take small — or sometimes zero — salaries to avoid paying payroll taxes. Instead, they take dividends, which are not subject to payroll taxes. The IRS can catch you in two ways: audit (slim chance) or just by looking at your S corporation tax return, and seeing a small "officer's salary" on pg. 1 of your corporate return (good chance of being caught).
What to do: Get the salary up to a reasonable amount (what you would pay someone else to do what you do). If you render little or no services to your S corporation, a small salary (even zero, if no services) is OK. But make sure to give an officer title to your key people who run the business, so their salaries legitimately show up as "officer's salary" on the S tax return.
If the IRS nails you, it will treat your hoped-for payroll tax-free dividends as salary. Then you will be hung for the unpaid payroll taxes, plus interest and probably penalties (never deductible).
Strategy No. 2. First, some background: Generally, minimum distributions, such as an IRA, 401(k) or a profitsharing plan, must be made from a qualified plan no later than April 1 of the year following the latter of the calendar year in which the employee attains age 701/2 or the calendar year in which the employee retires. There is an exception for a 5% owner who must start taking minimum distributions no later than April 1 following the company's plan year ending during the calendar year in which the employee becomes age 701/2.
Here's an IRS Letter ruling (200453015) that should help some young (about to turn 701/2) readers: Joe is employed by Co. A and Co. B. He is a 5% stockholder of Co. A. Joe is a participant in each company's qualified plan. Joe attained age 701/2 and must start taking minimum distributions from Co. A's plan for the current calendar year and then roll over his balance in the Co. A plan to Co. B plan prior to the end of the same year.
If Joe and Mary had used an intentionally defective trust, their tax would be zero.
Good news! The IRS ruled that Joe is not required to take minimum distributions from Co. B plan for the amount rolled over from the Co. A plan until he reaches his normal retirement date ( the later of 701/2 or retirement).
This plan distribution area is a complex maze of technicalities. Never, but never take your first distribution without the help of an expert.
Strategy No. 3. If you are thinking of selling your business to your kid(s), employee(s), or a mix of your kids and employees (the actual case that follows), you must ask your professional-to read this case: Hurst (2005) 124 TC No. 2.
A victory for our side: The court held that Joe and Mary (50/50 owners of Success Co.) could sell it on a 15-year installment sale and be entitled to lowrate capital gains tax. The buyers are their son and two key employees.
Hate to play I-can-do-better, but if Joe and Mary had used an intentionally defective trust, their tax would be zero.
Have discretionary capital?
No question about it: Everyone would like to have "discretionary capital." Cash, CDs, stocks and bonds easily turned into cash. And you don't need it now. Or ever. You could spend it, give it to charity or burn it without really missing it.
Yes, DC is nice to have. The IRS likes DC too; it will wind up with about 55% of your DC.
Just a little sidebar before we go on: The tax strategies you are about to read are not known by many tax experts or estate planners. Why? Because there are not many people with DC. But if you have DC, read on or pass this along to somebody who does.
Joe (a reader of this column) is 77, has some serious health issues and is married to Mary (age 74 and in good health). Joe has lots of DC. Here's the three-step strategy we structured for Joe and Mary:
Step No. 1. Buy a $1 million second-to-die life insurance policy (on Joe and Mary). Pay for the policy with a single premium (just one payment; never pay another premium) of $347,103.
Step No. 2. Gift Step No. 1 policy to their favorite charity.
Step No. 3. Buy a second $1 million second-to-die policy. Pay annual premiums of $27,281. The policy to be owned by an irrevocable life insurance trust (to keep the $1 million death benefit out of the estates of Joe and Mary).
After considering all the costs and benefits (i.e., premiums, time value of money, estate tax savings, income tax savings for the charitable gift and other factors), Joe's net out-of-pocket investment is only $ 609,000, but $1 million goes to charity and $1 million (tax-free) goes to his kids and grandkids via the ILIT.
And one more point: There are hundreds of variations of the above strategy. The exact strategy depends on your age, health, amount of DC and your goals.
If you are lucky enough to have DC, you have an endless number of taxsaving and tax-free-wealth-building opportunities. The concept works best when you are between the ages of 55 and 89, married or not.
Yes, it's OK to call me — 847/674-5295 — with your questions. And yes, it's OK to have your professional on the line.
Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/207-1040, or via e-mail at [email protected].