MY USUALLY RELIABLE tax crystal ball makes two predictions: 1) The estate tax will not be repealed in 2003 (the Republican Congress won’t do it — too dangerous, politically); and 2) If the Republicans kill the estate tax, the next time the Democrats get control in Washington, the estate tax will be reincarnated (as it has been three times before).
When it comes to estate tax changes, these are uncertain times. The death of the estate tax would cause some folks to celebrate, others to gnash their teeth.
It would take 60 votes (not the usual 51) for the Senate to kill the estate tax. Don’t bet on it.
A better bet is that the $1 million unified credit (means the first $1 million of your estate escapes tax) will be raised. The exact single amount or multiple amounts (larger unified credits will be phased in over a period of years) is a guessing game.
What should you do? Remember, if the estate tax vampire were to die tomorrow, you would still have to:
- Plan for retirement;
- Transfer your business to the business kids (free of income and capital gains taxes when you do it right);
- Treat the non-business kids fairly;
- Protect your family wealth from creditors, lawsuits and in-laws; and
- Create tax-free wealth for yourself and heirs.
Worse yet, if your plan ignores the estate tax (because it is gone), it is almost certain that when the next “unknown” hits Washington, you’ll have a new estate tax law to rob your wealth.
My advice and the advice of everyone who has family wealth and/or a family business is the same: Do your planning as if the estate tax is and will be a permanent fixture for as long as you live and the life of your kids and grandkids too. If there is an estate tax, a proper plan assures you or your family that not even $1 of your wealth will be lost to the IRS.
Deduct insurance premiums
Borrowing money is a way of doing business. A business often collateralizes a loan with particular assets such as real estate, equipment or inventory. Sometimes the collateral is more indirect, like the general assets of the company and the integrity of management.
The smaller the business, the more important the “integrity of management” identifies with a single driving force — the business owner. He is the person the lender is looking to as the essential means through which the business will find a way to repay the loan plus the interest. What happens if the owner dies?
To protect against the possibility that the death of the owner could mean nonpayment of all or a portion of the loan, many lenders insist on life insurance. The concept is simple and logical: In case the owner dies, the life insurance proceeds will pay the balance of the outstanding debt. Logic dictates that the premiums for such a policy should be deductible as a business expense. Right?
Wrong. The courts have consistently held that premiums paid for a life insurance policy to secure a business debt are not deductible. In a key case, the court gave this reason: If the owner lives and pays the debt, the policy will become a personal asset. If a corporation owns the policy, the same reasoning would apply, because after the debt is paid, the policy will become a general asset of the corporation. (See Ragan v. Comm. TC Memo 1980-94, a classic case.)
Is there any way to get a deduction when you buy life insurance? Yes! Simply buy your policy using the funds in your 401(k) or profit-sharing plan. The policy will be an asset of the plan.
You can even buy second-to-die coverage. If you have an unusual or complicated beneficiary designation (say a bank), use a “beneficiary designation form” (it has various names). Spell out the beneficiaries. For example, “to Oak Bank to pay the balance due, if any, on my unsecured loan dated 3/3/03, then to my wife, Mary...” etc.
You can even roll your IRAs or SEPs into your plan to help pay premiums.
But what if you have lots of funds (say $200,000 or more) in your plan and you need or want insurance? Your accountant has pointed out that to pay, for example, a $10,000 premium, you must earn about $16,666, pay the tax of $6,666 and only then have the $10,000 to pay the blasted premium. But there’s another way. If you use plan funds to buy the insurance, it makes life much easier.
Here’s the discount for this strategy. When you put, say $10,000, into the plan because you deduct the entire amount, your out-of-pocket cost (in a 40% tax bracket) is only $6,000 — $6,000 to pay a $10,000 premium instead of $16,666 is a 64% discount. And wait. Each dollar that the funds you put into the plan earn increases the discount even more.
So the next time you need or want insurance for any purpose, the first place to look for the premium dollars is your qualified plans.
Irving Blackman is a partner in Blackman Kallick Bartelstein, 300 S. Riverside Plaza, Chicago, IL 60606; tel. 312/207-1040, or via e-mail at [email protected].