Before you start reading this column, let's look back at 2014. Last year is the first year in memory when there was no significant change in the tax law: neither income tax or estate tax. So, for tax planning purposes, 2015 should mirror 2014.
We analyzed my clients' files to determine the strategies most used in 2014 to legally beat up the IRS. Seven strategies, which follow, rose to the top as the clear winners. For ease of reading in every strategy that follows, our tax hero is Joe (who owns Success Co.). Please keep in mind that all numbers are rounded.
1. Family Limited Partnership (FLIP): Joe owned $10 million of various investment assets: real estate, cash-like assets, stocks and bonds. After transferring these assets to the FLIP, the assets are only worth $6.5 million (because of a 35% discount allowed by the law) for tax purposes. Result: estate tax savings of $1.4 million.
2. Intentionally Defective Trust (IDT): Joe wants to transfer Success Co. to his son, Steve. Suppose Joe sells Success Co. (worth $10 million) to Steve. The result is a tax tragedy. Steve must earn about $17 million, pay $7 million in income tax to have the $10 million to pay Joe. Then Joe must pay about $2 million in capital gains tax ... only $8 million left. Unbelievable, Steve must earn a stratospheric $17 million for Joe's family to keep $8 million. That's nuts!
An IDT, under the Internal Revenue Code, allows the transfer (from Joe to Sam) to be tax-free to both of them. No income tax. No capital gains tax. Wow! Also, Joe keeps absolute control of Success. Co. for as long as he wants.
3. Captive Insurance Company: A Captive is a bona fide insurance company (property and casualty). For example, Success Co. (in a 40% — state and federal — income tax bracket) pays Captive (owned by Joe's children) a $500,000 premium. Success Co. deducts the premium, so is only out-of-pocket $300,000. Captive receives the $500,000 tax-free and can invest the entire $500,000. Over the years your Captive will accumulate millions of dollars, which will ultimately go to the Captive owners (Joe's kids) at only capital gains rates.
4. Retirement Plan Rescue (RPR): An RPR does two things. First, it avoids the double tax (income and estate) that qualified plans, such as profit-sharing plan, 401(k) and IRA funds are subject to. Secondly, it uses the plan funds to create additional tax-free (no income tax, no estate tax) wealth. Typically, each $250,000 to $350,000 in the plan is used to create about $1 million of tax-free wealth. Have $250,000 (or more) in your IRA, 401(k) or other qualified plans? Look into an RPR.
5. Private Placement Life Insurance (PPLI): The prime purpose of PPLI is to turn your taxable investment profits and income (whether capital gains, dividends or interest income) into tax-free income. Imagine $1 million ($10 million or whatever) compounding tax-free over many years. If you have a large investment portfolio, you will be delighted with your PPLI.
6. Personal Residence "50/50 Title Strategy:" This strategy works on every residence you own (whether one, two or more). For example, you own a main residence worth $2 million and a country home worth $1 million. The 50/50 Title Strategy entitles you to a 30% discount, making your main residence worth only $1.4 million for estate tax purposes... the country home value is reduced to $700,000. Result: $360,000 in estate tax savings simply by changing titles.
7. Premiums Financing (PF): This combines knowhow involving the tax law, a bank loan and the insurance industry. Result: You can buy a large insurance policy (either single life or second-to-die) with a death benefit of about $8 million (usually more), even to
$100 million, depending on your age and health. You don't pay premiums. Instead, bank loans pay the premiums, which are paid back when you go to heaven.
If you are worth more than $10 million, check out PF. It almost sounds too good to be true. You use your current wealth as leverage to create additional tax-free wealth without spending any of your current wealth. But it is true.
Finally the above strategies, when combined with the more traditional estate plans, almost always eliminate your potential estate tax burden, no matter how much you are worth. For example, if you are worth $40 million, the entire $40 million will go to your heirs, all taxes — if any — paid in full. Fill in your own net worth. Typically, your estate plan must use at least two or more of the above strategies to get all your net worth to your heirs.
Every one of the above strategies are accepted by the IRS. None create any problems. But one warning: each strategy must be done right (easy to do when you know how). So, make sure you work with an advisor that is experienced with the strategies you are interested in to help you win the tax game.
Irv Blackman, CPA and lawyer, is a retired partner of Blackman Kallick 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.