After business hours, the American male business owner likes company … female company. My experience, as a tax planner, with guys who have lost their former brides via death or divorce could fill a book — a big book.
From a tax-planning viewpoint, once the first (could be second, third, etc.) marriage ends, the ex-husband falls into one of three distinct categories. Each category requires different economic and tax strategies. Let's take them one at a time.
This is by far the biggest group with the biggest estate tax problems, economic problems and a host of other potential problems. Following is a partial list of the most common facts and circumstances that cause the problems (later we’ll discuss how to solve these never-ending problems). I’m going to use Joe and his new wife Mary as an example, however, please note that the below does not pretend to cover every problem between him and her in any second marriage, but it covers the six problems seen most often in a real-life estate planning practice.
1. Age difference: Two 60-year-olds (or any other close ages) is a different tax ballgame as compared to when Joe is 15 or more years older than Mary.
2. Health issues: When serious, tax planning must be hurried. If you have a health issue, start your estate planning now since time is critical.
3. Kids: The possibilities are endless … only Joe has kids from a prior marriage; only Mary has kids; both have their own kids; the kids get along with each other or don't; kids love or hate the step-parent; kids marry and some or all of the family hates the son-in-law or daughter-in-law; Joe adopts Mary's kids or does not. The list could go on and on.
4. There is no premarital agreement or there is one (that leaves Mary little or nothing). It's nice when the marriage lasts for the long-term, has been great and both Joe and Mary want to ignore all (or part) of the premarital documents.
5.One or more of the kids is in the business and one or more of the kids are not. There are two major issues here: When there is more than one kid who will ultimately own the business how do you treat the business kids equally yet give control to the clear leader (assuming there is a clear leader) when dad retires or dies? Also, how do you treat the business kid(s) and non-business kid(s) fairly?
You may be wondering how do we keep the kids equal, yet give control to the clear leader when transferring Joe’s business? We create voting (say 100 shares) and non-voting stock (say 10,000 shares). The clear leader gets enough extra voting shares to have voting control and is shorted an equal number of non-voting shares.
6. And finally, the major problem facing the typical Joe and Mary: Joe wants to provide for Mary (really maintain her lifestyle) if he gets hit by the proverbial bus first, but he wants to leave as much as possible to his own kids.
Let's solve the toughest problem (No. 6.) first. A qualified terminable interest property (Q-TIP) is the perfect solution. In a nutshell, here's the two-step strategy:
Step 1: Joe transfers his business, tax-free, to the business kids using an intentional defective trust (IDT). The IDT gets Joe’s business out of his estate while Joe is alive, yet Joe keeps control of the business until he draws his last breath.
Step 2: All of Joe's other assets — typically the resident(s); the IRA(s); all other qualified plans, such as a 401(k) or profit-sharing plan that have been rolled into an IRA during Joe's life; and investment type assets, such as real estate, stocks, bonds and other investments, go into the Q-TIP at Joe's death. Mary has a life estate: living in the residence to the day she dies and enjoying the income from the other assets for as long as she lives. No estate tax is due at Joe's death.
What happens when Mary dies? The Q-TIP show is over. All of the assets go to Joe’s children (and/or grandchildren). Estate tax is now due based on the value of the assets that pass to the children or grandchildren. Second-to-die life insurance usually is purchased on Joe and Mary to cover the estate tax due when Mary dies. The premiums on second-to-die life insurance are significantly less than buying insurance on only Joe's life. Also, the death benefit comes immediately after the second Joe and Mary dies when that ornery estate tax is due.
The documents, will and trusts that contain the rest of the estate plan for Joe and Mary have the appropriate clauses and language to deal with each and every one of the problems and issues listed above. Over the years, with the exception of curing health issues and settling family quarrels, the provisions in the various estate planning documents (usually a trust) solve theses issues. Once we finish the planning for clients in this second marriage category, the clients are amazed.
Ready to marry again?
Are you ready to tie the knot again? If so, do it. But before you say "I do," the about-to-be bride and groom must sign a prenuptial agreement. Failure to do so makes a lot of unhappy campers, particularly the spouse with the most wealth. If the marriage becomes a winner, it's easy to blow off the prenuptial and play the estate planning game as described above in Category No. 1.
Maybe you are not married, but have a significant other. When I ask a client if they will marry down the road the answers vary from no to maybe or someday, or some variation of the three. Whatever the answer when the relationship is solid and for the long-term then Joe is committed to taking care of Mary, maintaining her lifestyle if she outlives Joe.
What's the estate tax problem? Because Joe and Mary are not married, there is no marital deduction, no Q-TIP. If Joe dies before Mary, the estate tax is due now. With a Q-TIP, the monster estate tax is not due until both Joe and Mary have gone to heaven.
So what is the plan? We create a Q-TIP-type trust. We fund the trust with the assets needed to maintain Mary's lifestyle: typically the residence and income producing assets. Mary has a life estate only, living in the residence and receiving the income from the assets. At her death the assets go to Joe's kids and grandkids.
The only fly in the ointment is that the estate tax is due at Joe's death. When Joe is insurable, insurance on his life is the simple answer. Of course, the policy death benefit (D/B) must be set up (usually an irrevocable life insurance trust), so none of the D/B is subject to estate tax.
One final comment: The many problems (and the even more solid tax-winning solutions to those problems) of this article's subject matter cannot be covered in just one article. So be warned: Start your planning — call and make an appointment today — with an experienced professional. Done right, everyone, except the IRS, wins. Done wrong, only you, and your loved ones, lose.
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, e-mail [email protected], or on the Web at WWW.TAXSECRETSOFTHEWEALTHY.COM.