The annual reader test article is always fun for me. The test prevents millions of dollars from being lost to the IRS (by you, the column readers) and gives me enough material for many more articles. The year 2007 was a banner year.
There are three types of readers that call me for help: You 1) have an estate plan but need a second opinion, 2) have no plan, or 3) have been working on your plan for years but just can’t seem to get it done. Which type are you?
Since 1995, we have done the test almost every year. Well, the results are in for 2007. A total of 14 readers responded: 10 were in category 1 or category 2 and, of course, were easy to help using the tax techniques and strategies described in this column over the years; and four wanted a second opinion.
All of the second opinion responses were interesting: None were a tax train wreck. With one exception (the reader had purchased single life insurance coverage, instead of second-to-die), everything that was done was done right. So, what was the problem? It’s what the planners didn’t do that hurt—causing huge amounts of estate tax to be unnecessarily lost to the IRS.
Here’s a typical example: Joe, a 66-year-old from Wisconsin, is married, owns a profitable family business (Success Co.), wants the kids who work at Success Co. to own it someday and wants to treat the non-business kids fairly. Joe also wants to control his assets—including Success Co.—for as long as he lives and wants his current wealth ($11 million) to go to his kids and grandkids.
Joe has a good estate planning lawyer (Leo). The plan Leo implemented for Joe and the stack of documents that contained the plan are perfect. We made no changes. But we added two strategies that make Joe, his wife Mary and his business son Sam, all very happy campers.
Strategy 1: An intentionally defective trust (IDT). First, we did a simple tax-free reorganization, creating 100 shares of voting stock (which Joe will keep to give him control of Success Co. for as long as he lives) and 10,000 shares of nonvoting stock (which is being transferred to Sam—tax free—using the IDT). Success Co. was professionally appraised for a fair market value of $5.2 million. The IDT will remove Success Co. from Joe’s estate and save about $4 million in income tax and capital gains tax (for Joe and Sam combined).
Strategy 2: A retirement plan rescue (RPR). Joe has about $800,000 in his 401(k). Because qualified plan funds (like a 401(k), profit sharing plan or IRA) are double taxed (income tax and estate tax), that $800,000 would be devastated down to about $208,000 to Joe’s family after taxes. Instead, we used an RPR to acquire $4 million of second-to-die life insurance (on Joe and Mary). The insurance death benefit will wind up in an irrevocable life insurance trust (ILIT). The combination of the RPR and the ILIT, in effect, turns $208,000 into $4 million of tax-free wealth for the kids and grandkids.
Even Leo thanked us for introducing him to these two strategies. And yes, we gave him permission to use the documentation for his future estate planning clients.
Well, now it’s time for next year’s test. Let’s hear from you. Or, if you have a question concerning estate planning, business succession or related areas, call Irv at 847-674-5295.