2004 Wealth Transfer Plan Test Reveals a Mess

BACK IN EARLY 1995 I wrote a long column headlined, “A new plan to beat the estate tax.” The column said in part:

“If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant and CPA), you can and will develop a plan to beat the IRS. Every time, legally.

“Remember, the goal of the typical estate planner is to reduce estate taxes. My goal is to eliminate taxes.”

What I went on to say was that readers who call me for help usually fall into one of three broad categories: the owner who has an estate plan but needs a second opinion; the entrepreneur who has no plan; or the guy who’s been working on a plan for years and just can’t seem to get it done.

Recognize yourself? Consequently, a decade ago, I said that my staff and I would like every reader who wants a second opinion or needs help completing his estate plan to join the tax-planning test. We said:

“We will do a transfer/estate plan (and any necessary valuation) for each reader. We will report back to you (through this column) how many readers responded, how many we could and could not help, and a summary of the tax tools and techniques used to help the readers who respond.”

Since 1995, we have done the test almost every year. Well, the results are in for 2004. In all, 12 readers responded; nine were in either Category 1 or Category 2 and, of course, were easy to help using the tax tools and techniques described in this column over the years.

One of the respondents, a 65-year-old from Oregon, Joe, fell into the second opinion category. Joe’s letter said in part: “I enclosed all you asked for. I feel that I have a complete package, but it doesn’t hurt to get another opinion.”

Joe is a perfect example of a successful business owner of his generation. Started from scratch. Built a successful business (Success Co.). Wants to transfer Success Co. to Sam, his son. Joe is divorced and remarried. Works hard and plays hard. Rich, but doesn’t feel rich. But in general, a happy camper.

But his “complete package” (estate/wealth transfer plan) is a disaster.

What’s amazing is that Joe’s assets (type and mix) and his objectives represent an almost perfect cross section of all 12 respondents. Read on. No doubt, you’ll see yourself.

Joe basically had five types of assets:

1. A residence worth $500,000 (all values rounded);

2. Success Co. ($4.5 million);

3. Profit-sharing plan ($800,000);

4. Other assets, real estate and other investments ($2.5 million); and

5. Life insurance (death benefit of $500,000).

For estate tax purposes, if Joe got hit by the proverbial truck and his wife, Mary, predeceased him, his estate would be worth $8.8 million. (Note: Joe is no longer insurable. Mary is.) Taxes at Joe’s death, using his present wealth transfer plan and 2011 tax rates would be about $3.5 million.

What are Joe’s objectives? The same as any other self-made man — maintain his lifestyle, control all his assets and pay as little estate tax as possible.

And then Joe, with an I-know-it-can’t-be-done laugh, asked: “Irv, maybe you can get all of my assets to my family ... no reduction for taxes?”

The first step was to reduce the value of Joe’s assets for estate tax purposes, yet keep him in control. Without covering every detail and nuance of the plan, this is what we did on an asset-by-asset basis:

1. Transferred his residence to a qualified personal residence trust;

2. Sold the business to an intentionally defective trust — only the non-voting stock (which we created), while Joe kept all the voting stock;

3. Profit-sharing plan (our magic bullet, which is discussed later);

4. Transferred all other assets to a family limited partnership; and

5. Transferred the life insurance to an irrevocable life insurance trust.

These five strategies lowered the total value of the five assets for estate tax purposes to about $3.5 million. We used up almost all of Joe and Mary’s unified credits ($1 million tax-free for each) in the process, leaving a potential tax liability (when Joe and Mary both die) of about $2 million.

Since we already have $500,000 of potential insurance proceeds parked in the irrevocable life insurance trust, we only need about $2 million more of tax-free wealth to get all of Joe’s assets to his family intact and after all taxes. What to do? Joe was not insurable.

We decided to buy a $2 million second-to-die life insurance policy (on Joe and Mary), using a subtrust as part of the profit-sharing plan. When all the smoke clears and both Joe and Mary have passed on, the $2 million will go to Joe’s family — free of the estate tax — to pay any estate tax liability that may be due.

Final result: Every one of Joe’s objectives will be accomplished and his entire lifetime wealth (about $9 million) will go to his family — intact and all taxes paid in full.

Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/207-1040, or via e-mail at [email protected].