Do you own (all or part of) a closely held business? Sooner or later, like it or not, you must deal with what is commonly called the "succession planning problems." Hands down, the reason most readers of this column call me is for help with their business succession plan.
Interesting, most callers do not have an estate plan or, if they do, the plan is out of date. Let me say it loud and clear: There is no way to do a succession plan right, unless it is part of a comprehensive (a tax-saving strategy for every significant asset you own) estate plan.
But most readers are not even aware of their most valuable asset (often called "lifetime equity growth" or LEG for short). LEG is your ability to earn income (of all types for the rest of your life) and the fact that the value of most of your assets (because of inflation and/or simple increase in intrinsic worth) will grow over time. Plain logic tells you that LEG is crying out for a lifetime tax plan. Remember, you aren't dead yet.
Also, remember, the estate tax can do no damage until you (you and your spouse, if married) go to heaven. If you are a guy, life expectancy is in the age 75 to 77 range… add 3 or 4 years for the ladies. As you get older, the life expectancy tables move the age up: for example, a 70-year old male has 13 more years to live; an 80-year old, almost 8 more years.
Stop and take a minute. Guesstimate your life expectancy. Write down how many years your LEG probably will be increasing your taxable wealth (and your potential estate tax liability). And that's why you need a lifetime plan: to keep your LEG in the family, instead of losing it to the tax collector.
Following is an example of a typical reader (Joe) who called me asking about a succession plan problem that ultimately blossomed into the three plans — succession, estate and lifetime — listed above.
Joe (age 61) owns 100% of Success Co. (an S corporation). Joe and his wife Mary (age 59) have three children. Only one of the children (Sam) works in the business. Joe called me with a simple question: What's the best way to get Success Co. to Sam without getting beat up with taxes? After a short conversation Joe agreed to send me some written information (about him, his family, Success Co. and his other assets).
Once I received the information, I called Joe and asked him some questions. It soon became clear that Joe had three main goals: (1) Avoid tax on the transfer of Success Co. to Sam; (2) Treat the two non-business kids fairly; and (3) create an estate plan that would get his wealth to his family (children and grandchildren) without being reduced by the estate tax when Joe and Mary die.
"Yes", I told Joe, the above goals are doable, but only with the creation of a lifetime plan, in addition to the other plans to be created. Joe agreed. Following is a brief description of the four plans (of course, they all dovetailed) we created for Joe. (In the end, really only one comprehensive plan.)
The succession plan
The easy-to-do strategy is called an intentionally defective trust (IDT) and will accomplish Joe's goal — no tax to Joe when Success Co. is transferred to Sam. A professional business valuation expert valued Success Co. at $16 million, but because of discounts allowed by the tax law, Success Co. was sold to the IDT for $9.6 million (for tax purposes). Joe was able to keep control of Success Co. by retaining the voting stock (100 shares) and selling the nonvoting stock (10,000 shares) to the IDT.
An IDT saves about $200,000 (in taxes for the buyer (Sam) and the seller (Joe) combined) for each $1 million of the price ($1.92 million taxes saved… 9.6 times $200,000).
Treat non-business kids fairly
Here's Joe’s special problem: Joe does not want the two non-business kids in the business, yet he wants to treat these two kids equally to Sam. But here's the killer that none of Joe's professionals could solve: Success Co. is worth $16 million (before discounts), but all of his other assets (two homes, 401(k) plan, stock portfolio, the real estate Success Co. rents and some other minor assets) only total about $6 million... too much ($16 million) for Sam, but not enough other assets (only $6 million) for Sam's siblings. What to do?
The answer is simple: Make each of the three kids equal one-third beneficiaries of the IDT. The trustee is instructed to keep the stock until the last of Joe and Mary dies. Then, the properly drawn buy/sell agreement kicks in. The IDT distributes the stock to the two non-business kids, and the stock is immediately redeemed (bought by Success Co.) using the life insurance proceeds that funded the buy/sell to pay for the stock.
Note: If Joe dies first, the voting stock immediately goes to Sam so he can continue to run Success Co.
Estate, lifetime plan
We updated the wills and trusts for Joe and Mary. Nothing fancy. Most important was to make sure that all aspects of these new documents are compatible with the three other plans. The heart of any estate plan is always the lifetime plan. Why? The typical estate planning documents (really death documents) are essential, but they do nothing until you die. Sorry, but then it's too late to save estate taxes.
Sure, life insurance only pays after death, but buying life insurance is clearly a lifetime decision (typically when you and/or your spouse are young enough and healthy enough to make the premium cost acceptable).
The lifetime plan includes a wage continuation plan for Joe when he can no longer work, as part of the plan to maintain Joe's and Mary's lifestyle for the time frame covered by life expectancy as discussed earlier in this article… and maybe, we hope, for longer. We used other tax-saving strategies: (a) a family limited partnership for the income real estate and stock portfolio; (b) a qualified personal residence trust for the two residences; (c) the 401(k) plan to help pay some of the required insurance premiums; (d) created a new management company to give special fringe benefits to Joe and Sam allowed by the tax law; (e) and a lifetime gifting program to the kids and grandkids to reduce the potential estate tax liability.
When all the plans were done, Joe was amazed at how quick and easy it was to accomplish every one of his goals. Joe quipped, "I'm a LEG up now." One warning: all of the details of the above plans, and possible tax traps if done wrong, are not given. Only work with competent and experienced professionals.
Want to learn more about this fascinating subject? Browse my website at: www.taxsecretsofthewealthy.com. There's a ton of tax-saving information. In a hurry or have a question, call me (Irv) at 847-674-5295.
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.