We come to the rescue of distressed taxpayer

JOE, A 79-YEAR-OLD widower, is feeling economic and tax pain. Don't feel sorry for Joe, he's generally a healthy and happy guy. Still goes to work every day (about 9:30 to an early lunch) at the successful business he started, which he transferred to his two sons, who now own and run it. Hits golf balls. Spends lots of time with the grandkids. But you should hear Joe howl about the cost of funding

JOE, A 79-YEAR-OLD widower, is feeling economic and tax pain. Don't feel sorry for Joe, he's generally a healthy and happy guy. Still goes to work every day (about 9:30 to an early lunch) at the successful business he started, which he transferred to his two sons, who now own and run it. Hits golf balls. Spends lots of time with the grandkids.

But you should hear Joe howl about the cost of funding annual insurance premiums for his irrevocable life insurance trust. Joe's ILIT owns a $4 million life insurance policy on his life with an annual premium of $87,000. Yes, he needs the insurance to cover a portion of his potential estate tax liability. No, he couldn't buy second-to-die (normally substantially less premium cost) because his wife was uninsurable when the ILIT bought his policy.

Note: An ILIT protects the death benefits of a life insurance policy from the clutches of the estate tax.

Now, stop for a moment and look at your insurance-cost situation. Chances are you'll find you have one or more of the same complaints as Joe. He's got three, as follows:

Complaint No. 1. Every year when Joe writes his check to the ILIT (for $87,000), he gets four annual exclusions of $11,000 each ($44,000 total), one for each of his two sons and two grandkids. That leaves a taxable gift of $43,000 ($87,000 minus $44,000), which eats away at his $1 million life-time-unified credit. No cash gift tax now. Simply put, the first $1 million of taxable gifts do not require cash to pay the gift tax but are paid by using your lifetime-unified credit. But when Joe gets hit by the final bus, those annual taxable gifts will turn into an estate-tax liability (for Joe, most likely 55% of the total of all those annual taxable gifts).

Joe fumes! Complaint No. 2. Interest rates are much lower now than when Joe bought the policy. Result, the premiums are much more than the projections made by his insurance agent. Joe's expletives are not fit to repeat here.

Complaint No. 3. Joe's smart. He figured out that in his tax bracket (state and federal combined), he must earn $145,000, pay $58,000 in income tax, in order to have the $87,000 needed to pay his insurance premium (actually make the gift to the ILIT). Joe fervently argues that life insurance premiums should be deductible. Good idea. But we need an act of Congress to change the Internal Revenue Code.

Now you know why Joe is a distressed taxpayer.

Readers of this column know I have a network of professionals (lawyers, insurance consultants, appraisers and others) to help me work my tax magic. So my network and I went to work.

We had Joe's ILIT restructure his insurance using a strategy called "premium financing." Essentially, PF is an economic concept where a lending bank pays policy premiums. Like before, Joe's PF policy is owned by the ILIT. When Joe dies, the bank loans and accrued interest on the loans will be paid out of the policy proceeds.

Joe's PF is set up for $5 million (net proceeds after paying off the bank) to the ILIT, and the beneficiaries are his kids and grandkids. Joe's only potential out-of-pocket costs are $60,000 (to initiate the bank loan) the year the PF is set up. If Joe lives to be 100, the total additional cost will be $352,000, with varying small amounts to be paid each year (to maintain the loan). Of course, if Joe dies sooner, these costs stop.

Now, what were the final results for Joe by using PF?

  1. To start, no more $87,000 annual premium payments — actually, no more premium payments. All three of his complaints disappeared.
  2. No out-of-pocket costs: not the $60,000 or any portion of the $352,000. Why? Because the cash surrender value of the original $4 million policy owned by his ILIT was more than enough to cover all the PF costs. The old policy was cancelled to free up the CSV and put the PF strategy in place without any further out-of-pocket costs to Joe.

Even Joe is happy. PF is a relatively new concept, easy to understand, but complex to implement (it really takes a network of experienced professionals working together). The results create an economic windfall.

But sorry, everyone cannot take advantage of PF. You must qualify by bringing two things to the table:

  1. You must be insurable. If married, one spouse must be insurable so your ILIT can buy second-to-die coverage.
  2. You must be credit worthy, worth a minimum of $5 million. Actually, the more you are worth and the more liquidity (investment-type assets, such as stocks, bonds or even real estate) you have, the more likely you will qualify for this sought-after strategy.

I have arranged to have my network review the individual situations of read-ers of this column interested in PF. Just fax to 847/674-5299 your name, birthday (include spouse if married), your net worth and phone numbers (business, home and cell). Yes, it's OK to call me (847/674-5295) if you have a question.

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]

TAGS: Taxes