BECAUSE SUCCESSION planning is so essential to business owners and their families, I believe that this article, covering some of the most important points I’ve talked about before, bears repeating.
Always remember, your succession plan - whether transferring your business to your kids, selling it to employees or some other buyer - must never stand alone. Properly done, your succession plan must be a part of a comprehensive plan including all the points in the following four-point checklist.
1. A wealth transfer plan for every significant asset (really a specific target strategy for each separate group of assets. We’ll identify the strategies and four asset groups later);
2. A succession plan for your business (get your business out of your taxable estate but control it for as long as you want);
3. A retirement plan for you and your spouse (assures a flow of income to maintain your lifestyle for as long as you or your spouse live); and
4. The three plans above must be implemented during your life. Your will and trust (no matter how long and fancy) can never protect your family and business, because these documents only speak when you die.
What happens if you don’t plan or have only a will and trust? In a heartbeat, one-half (or more) of the wealth it took you a lifetime to accumulate will be lost to the IRS. Your business may have to be sold to pay taxes.
Can these gut-wrenching results be avoided? Yes, and easily.
Let’s look at the specific strategies that you can use to protect the four specific types of assets you might own.
Your business. Never (and I mean never) sell your business to younger members of your family. You and your kids will get socked for three unnecessary taxes. For example, say you (Joe) want to sell your business to your son (Sam) for $1 million. Sam must earn $1.67 million and pay $666,000 in income tax (the first tax) to have $1 million left to pay Joe. Typically, Joe will suffer a capital gains tax of $180,000 (the second tax). Only $720,000 left. When Joe dies, the estate tax robs another 50% (or more). Now only $360,000 is left. Out of $1.67 million.
Try this easy-to-do (by a knowledgeable professional) strategy process. Strategy No. 1: A recapitalization. Create voting stock (say 100 shares) and nonvoting stock (say 10,000 shares). It’s a tax-free transaction. Transfer the nonvoting stock to the business kid(s) - here Sam - via strategy No. 2 (grantor attained annuity trust) or strategy No. 3 (intentionally defective trust).
These three strategies combine to accomplish these welcome results:
1. Joe’s business is out of his estate;
2. Joe controls his business (via the voting stock) for as long as he lives;
3. No capital gains tax for Joe;
4. No estate tax for Joe’s family; and
5. No income tax for Sam.
Residence. Use a qualified personal residence trust to get your residence out of your estate, yet you and your spouse can live in it until the day you die.
Because funds in a pension plan, profit-sharing plan, 401(k), rollover IRA or similar qualified plan are subject to a double tax (income tax and estate tax), your family typically gets only 27 cents out of every dollar. The IRS confiscates 73 cents.
The most common strategy (a subtrust) turns the tables on the IRS. One of our clients used a subtrust to turn $1.2 million in his rollover IRA (his family would have only received $324,000) into $6.5 million of tax-free dollars. Our client files are bursting with similar subtrust examples.
All other assets. We are talking about everything else you own (such as real estate, stocks and other investments). This includes every asset you own, except your business, residence and funds in a qualified plan. Here’s a list of the most common strategies in real-world practice.
1. A family limited partnership keeps you in total control, locks out creditors, reduces your estate tax and provides total flexibility. Almost every person with an estate tax problem winds up using a FLIP.
2. A charitable remainder trust is used when you have a highly appreciated asset. It eliminates capital gains tax and actually makes you money by giving to charity.
3. A charitable lead trust enriches your family and your favorite charity. IRS is an unpaid spectator. You substitute charity for IRS, but it does not cost your family even one penny.
4. An irrevocable life insurance trust keeps life insurance out of your estate.
One final point: How do you know your succession plan and wealth transfer plan is done, and done right? Make the final test.
Ask two questions: Will my family wind up with all my wealth? Also, are your assets protected from lawsuits or creditors? If the answer is not an unequivocal "yes" to both questions, you know you better get a second opinion.
So, this is the plan to serve the readers of this column: If you have a question contact me, Irv Blackman at 847/674-5295.
If you want to learn more:
1. Look at my website: www.taxsecretsofthewealthy.com;
2. Now let’s help others while you help your family. Read the book "Tax Secrets of the Wealthy," on which this article is based. Because of the unusual circumstances, we are donating all books purchased by readers of this column. All proceeds will be donated to a charity (such as the Red Cross) arising out of the tragedy on Sept. 11. Make your check payable to the Red Cross or other tragedy-related charity of your choice for $187. The regular price of the book is $367. Send your check for $187 (if you choose to send more, or if you don’t want the book, the entire amount will be given to charity) to: Wealth Book/Charity Plan, Blackman Kallick Bartelstein LLC, 300 South Riverside Plaza, Chicago, IL 60606. Please attach your business card or letterhead to your check.
Irving Blackman is a partner in Blackman Kallick Bartelstein, phone 312/207-1040, e-mail [email protected]