Do you have a family? A wife? Kids? Grandkids? Then this article is for you. Also, do you own all or part of a business? Then you are the exact target of this article.
This is the estate planning story of a real-life column reader from the Midwest. Joe (grandpa) is married to Mary... they have three kids: Jack and Jill who work in Joe's business (Success Co.), and Jay who is a school teacher. Jill (the youngest child) is the clear leader. All the kids are married. There are eight grandchildren.
Joe and Mary are worth $18.5 million, including Success Co. (professionally valued at $10.7 million), two homes worth $1.8 million, a 401(k) worth $.9 million, various investments, worth $4.9 million (including business real estate leased to Success Co. and a stock/bond portfolio). Finally, there is a $1.3 million (death benefit) life insurance policy on Joe with a $200,000 cash surrender value (CSV).
Grandpa & grandma's estate plan
If Joe and Mary both got hit by the proverbial bus today, the estate tax monster would gobble about $3.4 million. But because Joe and Mary earn (every year) more than they spend, their potential estate tax burden will continue to rise. The following are the basis strategies we used to beat up the estate tax monster:
- Intentionally defective trust. (IDT), used to transfer Success Co. to Jack and Jill tax-free (no income tax, no capital gains tax). Before the transfer (really a sale) to the IDT, we created voting stock (100 shares) and non-voting stock (10,000 shares)... a tax-free transaction. Only the non-voting shares were sold to the IDT.
The tax-law allows a 40% discount on the non-voting shares, yielding estate tax savings of over $1.7 million. Joe kept the voting stock and control of Success Co.
There is an important exception here. About 60% of this column's business-owner readers (for example, Scott) are not well-to-do like Joe. The facts are almost the same or similar to Joe's, but the various assets owned, including Success Co., are only about 20% of the numbers shown for Joe, (i.e. Success Co. is only worth about $2.14 million).
A major issue for the Scotts of the world, is to make sure that Scott and his bride (Sue) can maintain their lifestyle if they live to a ripe old age. In such cases, instead of an IDT, we use a strategy called a Spousal Access Trust (SAT). Why? A SAT removes (the kids now own it) Success Co. from Scott's estate, but Scott and Sue continue to get the income from Success Co. for as long as they live. Lifestyle issue solved.
- Family limited partnership (FLIP). The FLIP is used to protect the investments. The tax law allows a 35% discount of $1.7 million (35% X $4.9 million) for the so called "limited partnership units" (LPU) reducing the estate tax by about $.7 million.
- Gifting Programs. Joe and Mary can gift $14,000 to each donee (here have his three kids and eight grandkids) every year. A total of $308,000 per year (11 donees @ $14,000 = $154,000; $154,000 X 2 = $308,000). Wow!
For kids & grandkids
Now here is how you can start an estate plan for the kids.
- Dynasty trust (DT): The gifts in the three items above will be the LPU portion of the FLIP. The gifts will be made each year to a DT, a truly dynamic estate tax saver. A separate DT trust will be created for each of the three kids. Each kid can enjoy the income from their trust for life and when he or she goes to heaven, their kids (Joe's grandkids) will enjoy the income; and then the same for each future generation. Why is the DT so dynamic? The assets in the trust, in effect, pass from generation to generation, but are free from the grasp of the estate tax monster.
- What if one (or more) of the kids gets divorced? The documents are drawn in such a way that if one the kids (or grandkids) gets divorced, the ex-spouse will not get any of the family wealth.
What about the grandkids? A separate trust is set up for each grandkid to receive the LPU gifts described above. Each trust will provide for the child's education, down payment on a home and ultimately, retirement (all at appropriate ages).
1. A buy/sell agreement concerning Success Co., covering Jack and Jill, was created.
2. Life insurance:
a. The buy/sell agreement is insurance funded.
b. The $1.3 policy on Joe's life was dropped with Joe pocketing the $200,000 CSV (tax-free).
c. A $3 million second-to-die policy on Joe and Mary was purchased in the IDT (proceeds will be tax-free).
d. Each (of the three) DT bought a $2 million policy on each kid to help fund the lifestyle of their kids (the grandkids of Joe and Mary).
Joe and Mary's plan not only eliminated the estate tax, but because of the new life insurance, will create a surplus. And yes, the kids (and even the grandkids) have a good start on their estate plans.
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.taxscretsofthewealthy.com.