Recently, I visited a successful family business in North Carolina, owned by a semi-retired 64-year-old (Joe) and run by his son, Sam, a 36-year-old.
Joe called me. He wanted a second tax opinion for a business transfer plan and an estate plan put in place by Joe almost two years ago. First, the facts:
Joe owns 98% of two corporations: a profitable S corporation (Success Co.), which operates a string of stores, and a C corporation (a tax-paying corporation, called R/E Co.), which owns real estate leased to Success Co. The real estate has an income tax basis of $1 million but a current fair market value of about $6 million. Sam owns the remaining 2% of the stock of both corporations. Each of the corporations is the owner and beneficiary of a separate $1 million insurance policy on Joe's life.
Four more little details: (1) Joe's second wife, Mary, is 45 years old, and they have a premarital agreement that gives Mary the income from one-half of the value of Joe's assets at this death for as long as Mary lives. But get this: none of the stock of Success Co. can be used to provide Mary her income. (2) An artificially low price in a buy/sell agreement would force Joe's estate to sell his stock in Success Co. back to Success Co. and the same for R/E Co. (Result: Sam would then own 100% of both corporations.) (3) Joe has two other grown children who are not in the business. (4) Joe is not insurable.
The diagnosis: (1) the $1 million in life insurance payable to R/E Co. would kick up an unnecessary alternative minimum tax; (2) The full $2 million of insurance would be included in Joe's estate because he controls both corporations, but the $2 million (less the alternative minimum tax of about $150,000) would belong to the corporations, not Joe's estate; (3) There are not enough liquid assets to satisfy the obligation to Mary. Worse yet, if the obligation to Mary is met, there would be zero dollars (outside of the corporation's) to pay an estimated $3.5 million estate tax liability. Simply put, the estate would be broke.
Our objectives are clear: (1) Reduce the value of Joe's estate, (2) get cash to fund the obligation to Mary and (3) pay the estate tax. Here are the five major recommendations to cure Joe's business transfer and estate plan: (1) Merge R/E Co. into Success Co. This maneuver is tax-free. R/E Co. is worth about $6 million as a real estate investment company but, as part of the operating company, its value is reduced by at least $2 million for estate tax purposes. Estate tax saving?…over $1 million. (2) Transfer the nonvoting stock (created after the merger) to a grantor retained annuity trust, which reduces the value of Success Co. by about 40% for estate tax purposes. This maneuver saves about $.5 million in estate taxes. (3) Joe takes the $2 million in insurance policies out of the corporations and gives it to his children. Result: The value of Joe's estate drops about $2 million and will save another $1 million plus in estate tax. (4) Change Joe's will to put the entire estate tax obligation on the children. The $2 million in income tax-free/estate tax-free insurance proceeds will handle the entire estate tax load when Joe dies. (5) Make sure Joe's will qualifies for the 100% marital deduction for Mary's one-half share, thus deferring any estate tax on this portion of Joe's estate until Mary dies. Yes, there are other details and nuances in the plan, including gifts to Joe's children, but these five tax medicines cured the patient.
To learn more about business transfer and estate plans send for Transfer Your Corporation to the Next Generation...Tax Free; Transferring Your Business When You have Two or More Children; and How You Can Beat the Estate Tax...Legally. $27 each, $45 for any two, $59 for all three. Book Division, Blackman Kallick Bartelstein, LLP, 10 South Riverside Plaza, Chicago, IL 60606.
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