Turbocharge your lifetime tax planning to conquer the estate tax

Tax Watch

Irv Blackman and Brian Whitlock

Most estate tax plans are really death plans. You do the documents (typically, a will and revocable trust for him and the same for her), put them away for safe keeping, then forget about them. Someday you die and the documents are dug up and read.

What's the result? The IRS is guaranteed a big payday. On average, the family loses 41 percent of its wealth to the tax collectors. Totally unnecessary.

Let's set a new target for you to hit with your estate plan: All your wealth - every dime of it - to your family; all taxes paid in full. For example, if you are worth $3 million, then $3 million to your family; $30 million, then $30 million to your family. Stop for a moment! Think about your current net worth. Then, estimate what amount it might grow to by the time you get hit by the final bus. That future amount is what the IRS will ravage with taxes.

A real-life example (the story of Joe) is the best way to illustrate what you and your family must face when you battle the estate tax monster. Joe (age 63) and his wife Mary (age 61) are worth $11 million. Joe called me for a second opinion.

What was missing? Simply put, a lifetime plan. Burn this into your mind: No matter how fancy the will and trust, death documents cannot whip the IRS. It takes a lifetime plan that dovetails with your death plan (the typical will and trust, which is only the first step you must take to win the estate tax game).

Here are the four main lifetime strategies we used for Joe and Mary (which will work for 19 out of 20 family business owners or retirees reading these words).

Strategy #1. We created a Family Limited Partnership (FLIP) to own their investment assets (the real estate leased to Joe's business and a stock/bond portfolio). We started an annual gifting program to the two nonbusiness children. Estimated estate tax savings, $1.5 million.

Strategy #2. We used an Intentionally Defective Trust (IDT) to transfer Joe's business, Success Co., to his only business child, his son Sam. The transfer from Joe to Sam, using the IDT, is 100 percent tax-free, escaping all income taxes and capital gains taxes. Estimated estate tax savings, $2.2 million.

Strategy #3. We used the funds in Joe's 401(k) to purchase $3 million of second-to-die life insurance (on Joe and Mary). The way we structure the plan, the $3 million will be free of the estate tax. To help pay the premium, we had the 401(k) invest in life settlements (LS). This investment is not subject to market risk and has an average rate of return of 15.83 percent per year. The LS investment is the brainchild of a company that trades on the NASDAQ.

Strategy #4. Joe and Mary own two homes. We put the titles to each home into their existing (death plans) trusts. For example, their Florida home is owned 50 percent by Joe's trust and 50 percent by Mary's trust. Estimated estate tax savings, $350,000.

When the lifetime plan for Joe and Mary was completed, the estimated amount of wealth that will go to their three children is $13 million (which includes the $3 million of insurance), all taxes paid in full. Not only is the impact of the estate tax eliminated, but additional tax-free wealth is created for the family - the typical result of proper lifetime planning.

Here's the lesson to be learned from Joe and Mary: The key to winning the estate tax game is a comprehensive lifetime plan. Properly done, the IRS is out of the game when you go to the big business in the sky.

One final point: Joe will stay in absolute control of all of his assets - including Success Co. - for as long as he lives.

I sure wish there was some way to wave a magic wand and repeat for every reader of this column what we did for Joe and Mary. Start out by showing this article to your professional advisors. If they know how to do your lifetime plan, great. If not, browse my website, www.estatetaxsecrets.com. There's a ton of free "how to" info. Still stuck...call me (Irv) at 847-674-5295.

A Potpourri of Little-known Tax Miracles
It's easy to lose big dollars to the IRS … almost always unnecessarily. Following are some easy-to-do tax-saving and wealth-building strategies we have done hundreds of times, yet are little-known. Why? Because most professional advisors don't know how to implement them.

1. Retirement Plan Rescue (RPR). Qualified retirement plans, like a 401(k), IRA, profit-sharing plan and the like, are double-taxed: First, you get nailed for income tax (say 40% for State and Federal); then you get socked for estate tax (say 55% using 2011 rates). Result: The tax collectors get 73%, your family only 27%. So, if you have $1 million in an IRA, you'll lose $730,000 to taxes. Ouch!

RPR to the rescue. An RPR is a simple life insurance strategy -

either single life or second-to-die - that turns a tax tragedy into a tax victory. Two examples from my client files tell the story: (1) A column reader from Ohio turned $274,000 in an IRA into $2.6 million (a single life policy); (2) Another reader from Florida turned $342,000 in a 401(k) into $4.5 million (a second-to-die policy.)

2. Intentionally Defective Trust (IDT). Do you want to transfer/sell all or a part of your family business to your children, a family member or an employee? Then think IDT. Here's why: An IDT, because of really bad tax law (this time good for our side), allows you to transfer your business tax-free. That's tax-free to you and tax-free to the new owner. The amount of tax savings usually work out to be about $750,000 per $1 million of the fair market value of your business. Works all the time.

3. Deferred income. A darling of the investment world is "deferred annuities." Chances are if you own an annuity, you are an unhappy camper. My clients tell me, "Great taxwise, but a lousy investment." Here's an investment - life settlements (LS) - that beats the pants off of deferred annuities. LS, offered by a public company that sells on the NASDAQ, earns an average of 15.83 percent rate of return per year. And oh, yes, your LS income is deferred until you get back 100 percent of your investment and, at the same time, pocket all your earnings.

4. The 50/50 strategy (50/50). When you get hit by the final bus, your home (or homes if you own two or more) are included in your estate. No question about it, homes are an estate tax trap. The estate tax damage? 55 percent (using 2011 rates) of the fair market value of each home.

How do you get out of this tax trap? 50/50 is the answer. This strategy uses the A/B revocable trusts. Here's what you do: 50 percent of each home is owned by the husband's trust, the other 50 percent by the wife's trust. Now neither has control and according to the often silly American tax law, you are entitled to a minority discount. The discount is in the 30 percent range. So a $500,000 house is only worth $350,0000 for tax purposes. Neat!

5. Family Limited Partnership (FLIP). Now think of your investment type assets - stocks, bonds, real estate and the like. A FLIP can be used for many good purposes including asset protection and a minority discount (just like for 50/50). However, the FLIP discount is in the 35 percent range ($1 million in assets are worth only $650,000 for tax purposes). Or put it this way: You don't lose estate taxes to the IRS on $350,000 out of each $1 million of your investment type assets, transferred to the FLIP. As my grandkids say, "Cool!"

At www.taxsecretsofthewealthy.com you'll find more tax tips from Irv Blackman.

Irv Blackman and Brian Whitlock are CPAs with Blackman Kallick Bartelstein, LLP in Chicago. Also lawyers, they specialize in business succession and wealth transfer. Want to consult? Need a second opinion? Call Irv or Brian at 312-207-1040, e-mail [email protected] or visit www.estatetaxsecrets.com.