Knowledge is power, and the right kind of knowledge, if you know what to do with it, has been and always will be an economic powerhouse for you and your business.
Let's start with some new tax laws Congress is likely to pass before 2009 ends. You must divide these new tax-law candidates into two distinct groups: the good guys and the bad guys.
First, the good guys: The current law (for 2009 only) exempts your first $3.5 million of net worth from the estate tax ($7 million for married folks) with the top rate at 45%. The rate for 2010 is zero (no tax, even if you are worth a zillion dollars), and then starting in 2011 a puny $1 million exemption ($2 million if married) and a top rate of 55%. Crazy law!
Two happy new versions are pending in Congress to replace the current estate tax law. The budget outline passed by the House, keeps the 2009 exemption ($3.5 million) and top rate (45%). Even better is the Senate's budget outline that raises the exemption to a delightful $5 million ($10 million for married couples) and — a drum roll please — lowers the top rate to 35%.
I'll bet the farm that we wind up with at least the House version. A compromise between the House and the Senate (more than $3.5 million) could happen too. Also, the gift tax exemption (currently at $1 million) will probably soar to $3.5 million. Yeah!
You won't like the bad-guy possibilities. Say good-bye to a good old friend: LIFO (last-in, first-out). If it is terminated by new law, you'll probably have five to six years to pay the income tax due. The Washington heads are seriously talking about eliminating the long-standing discount rules, typically in the 35-40% range, when valuing a closely held business for tax purposes. A terrible and extremely costly tax change! If you intend to transfer your business to your kids, please don't wait. Take action now! Make your transfer or sale to your kids before the new discount rules become law.
Captive insurance companies
As a business owner you must carry property and casualty insurance (P&C). Every year, you pay your premium dollars (say $400,000) for your usual coverage: workman's compensation, fire, theft, liability, vehicles and other risks. (Healthcare costs are a separate expense.)
Suppose your claims for the year are only $100,000. Sorry, but your insurance carrier keeps the $300,000 excess. Worse yet, the premiums you paid significantly exceed your claims year after year. But hey, you can't complain. That's the way the P&C game is played. Only in a rare year, when your claims — usually one big one — exceed premiums paid, does your insurance carrier become a welcomed friend.
So here's the real question: Is there some way to keep those excess premiums (premiums you paid less claims paid by your carrier) and be covered if a catastrophe strikes?
The Internal Revenue Code, Section 831(b), allows you to form a Captive. You, or more likely a younger member of your family, own the Captive. Say Your Co. pays Captive that $400,000 in premiums, which Your Co. deducts. Captive not only receives the $400,000 tax-free, but invests it for earnings. Premiums plus earnings (unused reserves) are available to pay your claims. A concept called “reinsurance” covers Your Co. should your unused reserve not be large enough to pay claims.
A Captive can insure risks that your regular P&C carrier will not insure (for example, loss of a key customer, supplier or employee, product warranties and an endless stream of other similar risks). You deduct the premiums, Captive receives them tax-free.
A Captive is for you if your annual before-tax profit is in the $1 million range. Check out Captives. You'll be glad you did.
Premium financing for life insurance
Life insurance is required for many purposes — paying estate taxes, providing for your family, paying debts and, if you know how to do it, life insurance is the best tax-advantaged investment. It's an investment that never loses and your profit is tax-free.
One problem with life insurance — the blasted stuff costs money for premiums. Is there some way to have your cake (a large amount of life insurance coverage) and eat it too (no or minimal out-of-pocket costs for premiums)? Because of the current credit crunch, premium financing for life insurance has been on a long vacation, but it's back. Lenders are back in the premium financing game.
How does premium financing work? Instead of you or your trust paying premiums, the lender pays your premiums, creating a loan. Loan interest can be paid or capitalized. Of course, when you go to heaven, the loan is paid back out of the insurance proceeds while your heirs get the balance of the insurance coverage tax-free. Your family is enriched at your death while your premium cost during life is zero or miniscule.
If you need a large amount of life insurance premium, financing is at the head of the class.
Future forecasting
The nature of my work requires me to always keep an eye on what the future world and U.S. economy holds. I'm not smart enough to be both a tax guy and an economist, but I read a lot. My favorite and most accurate economic forecaster is Adrian Van Eck. I've been reading his newsletter for about 25 years, and he never has missed calling a trend — good or bad — in all those years.
A recent quote from one of his newsletters says it all, “Instead of a new Great Depression, we may now be looking at boom years ahead such as we have not enjoyed for a long time.”
There's not enough space in this column to give you all my reasons as to why I'm bullish on the economy turning around. If you are too, plan for success by aggressively seeking new business and tightening your business belt as necessary, but don't downsize. Most of all get your lifetime tax plan and your estate plan done, and enjoy the strategies that make you wealthy.
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.estatetaxsecrets.com.