Regular readers of this column know my modus operandi: discover the tax secrets of the wealthy and then adapt those secrets to enrich the family business owner. Now, I can’t do it alone. But as a member of a network of professionals (who share ideas and concepts and then help one another implement client tax-savings plans), I regularly run across exciting new tax-saving strategies and wealth-building techniques.
This column is about a new and unique strategy that not only saves taxes but creates tax-free wealth. The subject is life insurance: The big-time friend of the rich and famous. And family business owners too.
Sorry, but this time you really must be rich to play the game. Very rich. So, this article has two purposes: (1) to entertain those (most of us) who like to peek in to see what the rich do and (2) of course, if you happen to be rich (or have a rich relative or friend ... or maybe your boss) you’ll love what you are about to read.
Let’s start with an insurance example that would work for most successful – but not very rich – business owners. Suppose Joe (age 60 and married to Mary, also 60) needs $1 million of second-to-die insurance. Premium cost per year is $11,169. Joe and Mary would create an irrevocable life insurance trust to own the policy. Assume Mary is the second to die 30 years down the road.
The total premium cost would be $335,070 ($11,169 x 30 years). If Joe and Mary wind up in the 50% estate tax bracket, the after-tax cost of the total premium would be only $167,535 (50% of $335,070, which was used to pay premiums is gone and, of course, is not subject to estate taxes). Yet the full $1 million will be received tax-free (protected by the ILIT) by Joe and Mary’s heirs.
Now, suppose Joe and Mary become very rich and are worth $40 million and need $20 million of insurance. The premium cost skyrockets to $223,380 per year. Sure, Joe and Mary can afford the premiums, but they would have to sell some assets to pay the premiums. Capital gains taxes would be incurred. Joe says “no” to that idea. Nor does he look kindly at the large gift tax that would be incurred as the premium costs are gifted to the ILIT each year. Remember, if done right, that $40 million is tax-free. A worthy goal.
What to do? Premium financing — a new wealth-creation strategy may be the answer. Here’s how the strategy works. Instead of paying premiums, Joe and Mary borrow the premium cost from a bank and their total out-of-pocket cost is only the interest on the loans. No capital gains taxes, no gift taxes for Joe and Mary. The bank will wait to collect the premium loans until after the death of both Joe and Mary.
The concept was presented at a fascinating seminar sponsored by Gene Kolasny, an insurance expert and member of my network. In general, annual premiums to use this concept must be about $100,000 or more.
There are two situations where you don’t have to be very rich and yet you may want to use this premium financing concept:
1. You or a relative (usually a parent or grandparent) have reached the age where the annual premium cost is just too high for the amount of the death benefit needed. This concept probably would allow you to get back into the tax-free insurance game because the high premium costs are replaced by low interest costs. It’s worth taking a look.
2. The premium cost is way below $100,000 for one person, but you want to insure two or more people (say for a buy-sell agreement or several key people). The combined premiums will allow you to reach or exceed the $100,000 premium mark.
The variations on this concept are endless. For those with the need, this may be the most valuable tax-saving and wealth building article I have ever written. Please pass it along.
Remember, this column does not attempt to cover all of the many ways that this concept can be used, nor all of the rules, traps and exceptions.
Payroll taxes go up and up
Washington talks about lowering taxes. Send this article to your senator and representative. The message is simple: Payroll taxes are taxes too.
Do you make money by the sweat of your brow? I have news for you, sad news. Social Security taxes have been and continue to be a scandalous burden. The year 2002 will be a banner year for lowering your take-home pay. Read this and weep.
First the basic rules. Social Security taxes are imposed not only on employees and employers, but on self-employed individuals as well. The FICA (commonly called “Social Security”) rate on employers is 7.65%; the same rate applies to employees; and the self-employment rate is a whooping 15.3%.
The total 7.65% for FICA taxes actually has two components; 6.2% is Social Security tax and 1.45% is the Medicare hospital insurance tax. The equivalent figures for self-employment tax are 12.4% for Social Security and 2.9% for MHIT (total of 15.3%).
The Social Security tax is collected based on salary or self-employment income. The ceiling is adjusted annually for inflation. Are you ready for this? The ceiling was $80,400 for 2001. For 2002 the ceiling is lifted an astounding $4,500 to an unbelievable $84,900. And get this: There is no ceiling on the MHIT.
Next, let’s crunch the numbers for 2002, using the higher Social Security tax ceiling of $84,900 and determine the exact stratospheric cost to the employer for an employee (call him Hyer) earning $100,000. Here’s how you make the much-too-high tax computation:
$84,000 x 6.2% = $5,263.80
$100,000 x 1.45% = $1,450.00
Grand total: $6,713.80
And don’t forget, Hyer gets hit for the same amount. Let’s see, that’s $6,713.80 each (for the employer and Hyer), for a total of $13,427.60 for both. Outrageous!
Compare that to the total top cost of $2,808 in 1979 and you begin to wonder when it will stop? And remember, the MHIT (I call it the “maximum hit”) of 2.9% (1.45% x 2) never stops. For example, dare to earn $1 million: Pay the U.S. Treasury the sum of $29,000 just for MHIT. A tax, or highway robbery?
Are you self-employed? The results are even worse. Why? You and you alone must pay the entire tax. For example, the tax for a self-employed business owner (not incorporated) earning $100,000 is the same for Hyer and his employer combined: a thief-in-the-night amount of $13,427.60.
There is one ray of sunshine in all this. You can deduct one-half of the self-employment tax. Tell your professional to see Section 164(f) of the Internal Revenue Code.
The FICA tax is so burdensome that we are constantly looking for legal tax tricks to reduce the compensation subject to this onerous tax.
Irving Blackman is a partner in Blackman Kallick Bartelstein, phone 312/207-1040, e-mail [email protected]