New IRS rules make estate planning easier

Beating up the IRS, legally, has always been a challenge and also one of my favorite indoor sports. Historically, new tax law brings new challenges, complexity and uncertainty.

Surprise! The new estate tax law (albeit temporary for only two years: 2011 and 2012) will make estate planning easier, without added complexity. And, best of all, you can be certain of the positive results.

The two-year window of opportunity started on Jan. 1, 2011, and sadly will end on Dec. 31, 2012. Let's work together to take advantage of this opportunity for you and your family. Your economic health is at stake. Remember, every day that the sun sets the window closes a bit.

Exactly what is this new tax opportunity? For our purposes, Congress made two significant changes: combined the gift and estate tax into a single tax, and made the amount that is tax-free huge: $5 million if you are single, $10 million if you are married. Certainly, not a big deal for estate tax purposes. (Know anyone planning to die before Jan. 1, 2013?)

Ah, but for gifting, you (and your spouse if married) can each make gifts up to $5 million without incurring one cent in gift tax. In addition, you can still give $13,000 ($26,000 if married) to each donee (person receiving your gift) per year. Gifts greater than $5 million ($10 million if married) are taxed at a flat rate of 35%.

Unfortunately, starting in 2013 the old law is scheduled to come back to haunt us: a paltry $1 million ($2 million if married) and the top rate jumps to a monstrous 55%. Outrageous!

Regular readers of this column known that your author and his network of professionals have developed a system, used in practice with hundreds of real-life clients, that legally eliminates the impact of the estate tax. Essentially, the system creates two plans. First, your planning starts with a lifetime plan. Second is the creation of your estate plan, really your death plan. The two plans dovetail, creating one comprehensive tax plan.

Gifts, by their very nature, are always a part of your lifetime plan. The liberal increase from $1 million to $5 million per person for gifts is a perfect fit into the System.

The balance of this article shows you how the system takes advantage of the opportunities opened up by the two-year window created by the new law. Best of all, you'll see how easy it is to integrate the new law into either your existing estate plan or start from scratch with your first estate plan. The system is the secret.

Let's examine how a typical business-owner reader (Joe) of this column will, with our help, take advantage of the new law. Joe (age 67) is married to Mary (age 64), owns Success Co. and his son Sam helps him manage Success Co.

Joe has five key goals and one "maybe" goal:

1. Maintain his and Mary's lifestyle for as long as they live.
2. Transfer Success Co. (which grows in value almost every year) to Sam without getting killed by taxes.
3. Treat his two non-business kids fairly.
4. Keep absolute control of his assets, particularly Success Co., to the day he dies.
5. Eliminate the loss of taxes to the IRS after both Joe and Mary pass on.
6. The maybe goal: Leave $3 million to his alma mater, as long as the gift does not reduce the inheritance to his kids and grandkids.

Joe's and Mary's major assets are:

Stop for a moment. Substitute your own numbers. Whether your numbers are smaller or larger, you’ll see that the system works for you, just as it does for Joe.

Joe and Mary currently have a traditional estate plan (A and B trusts or as they are often called, a marital trust and a family trust). Although both are healthy, Joe has only $1.2 million in insurance on his life (policy owned by Success Co.).

Yes, Joe's and Mary's situation is screaming for a lifetime plan that integrates the new law into the system. Following is the plan, in the process of being implemented, dictated by the system.

1. Transfer Success Co. to Sam: First we recapitalized (created 100 shares of voting stock and 10,000 shares of non-voting stock to replace the existing common stock) Success Co. Joe is keeping the voting stock and thus absolute control of Success Co. The non-voting stock is entitled to various discounts (totaling about 40%) under the tax law. So the non-voting stock is worth, after discounts of $4.4 million, only $6.6 million for tax purposes. Next, Joe created an intentionally defective trust (IDT). One-half of the non-voting stock was gifted ($3.3 million) and one-half was sold (also $3.3 million) to the IDT. The one-half sold to the IDT trust will use the cash flow of Success Co. to pay the $3.3 million to Joe. Joe, because of long-existing tax law concerning IDTs, will receive all of the $3.3 million, plus interest, tax-free. Sam is the beneficiary of the IDT and will receive all of the non-voting stock. When Joe goes to the big business in the sky, the voting stock will go to Sam.
2. Remove two homes from estate: We created a qualified personal residence trust (QPRT) for the two homes. The QPRT allows Joe and Mary to live in both homes as long as either is alive. Both homes, with a $2.8 million value, will be out of their estates for tax purpose. What’s the current tax cost? We use up another $850,000 of their $10 million. Neat!
3. Multiply the $1.6 million in the 401(k) (turns a double-tax problem into tax-free wealth). The insane tax law doubles taxes (income tax and estate tax) all qualified plan funds, like 401(k), IRA, profit-sharing and similar plans. Your family gets about 30%, the tax collectors 70%. For example, $1 million is divided: $700,000 to federal and state taxes, only $300,000 to your family. Yes, insane! We used a strategy called a retirement plan rescue to buy $6 million of second-to-die life insurance on Joe and Mary. Ready for a tax miracle… The entire $6 million goes to the family tax-free. No income tax. No gift tax. And no estate tax.
4. Leverage investment assets into tax-free wealth: we enhanced two old-friend strategies from the system with gifts. First, an intentionally defective trust (IDT). Joe gifted $4 million in cash to a second IDT, using more of the $10 million available to Joe and Mary. Then Joe substituted a note payable to the IDT, with interest of 6% per year, in exchange for the $4 million in cash, which Joe needed in his own name for various activities. So, Joe was now obligated and did pay $240,000 in interest per year to the IDT, which interest under the crazy American tax law is tax-free to the trust. The trust used most of the interest funds to pay premiums on a new $8.5 million second-to-die life insurance policy on Joe and Mary. When Joe and Mary die, $4 million of the insurance proceeds will pay off the note.

The second strategy is a family limited partnership (FLIP). Joe transferred the balance of the investment assets ($4.2 million) to a FLIP. Because of discounts allowed by the tax law, the FLIP interests are only worth $2.8 million for tax purposes. Counting all the noses of the three kids, their spouses and the six grandchildren totals 12 donees to receive annual gifts of $312,000 (12 x $26,000). So, in about nine years all of the FLIP will have been given to the family, but Joe will still control the assets in the FLIP as the only voting partner. Please note that the beneficiaries of the IDT, the gifts of the FLIP interests and the language in the original estate plan were set up to treat the non-business kids fairly.

And finally, Joe's $1.2 million life insurance policy was taken out of Success Co. and put into an irrevocable life insurance trust (to keep the proceeds out of his estate). After Joe reviewed the entire plan (he particularly liked the tax-free gifts [total of $8.15 million] and the new no-tax life insurance [total of $14.5 million]), he authorized the creation of a charitable lead trust (CLT) that would get $3 million to his alma mater. The CLT did not reduce the inheritance to Joe’s family.

It should be pointed out that every detail and nuance of Joe's and Mary's plan is not set out in this article. In light of the fresh opportunities created by the new law, consider joining the tax saving fun and have your current plan reviewed. Or at least get a second opinion.

Want to learn more? Browse my website: www.taxsecretsofthewealthy.com. Or have a question, call me (Irv) at 847-674-5295.

Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847-674-5295, e-mail [email protected], or on the Web at: WWW.TAXSECRETSOFTHEWEALTHY.COM.