Transfer Your Business – Tax Free – To the Kids, Yet Keep Control for Life
Blackman, Irving L
Do you own all or part of a successful closely held family business that you want to stay in the family after you go to the big business in the sky? If so, keep reading.
You are about to read the story of Joe, a reader of this column and a typical consulting client. Joe, age 65, realizes he must create a succession plan to transfer his business (Success Co.) to the next generation. Joe lives 1,200 miles from my office in Chicago, so the entire consultation-not unusual-was conducted by phone, fax and courier. I start by asking Joe (on the phone) to list his objectives. Here are the five most important objectives the typical owner (like Joe) lists:
1. Wants to slow down, but stay active at Success Co., until his last breath.
2. Wants to maintain his lifestyle (and his wife’s) for as long as he (she) lives.
3. Wants to transfer Success Co. to his son Sam, who is the only child active in the business, and wants to keep control of the business to the day he dies.
4. Wants Sam to be able to run Success Co. free of any interference from his brother or sister (neither are active in the business).
5. Wants to reduce (eliminate, if possible) current taxes (income and capital gains) and estate taxes.
If you have similar objectives, you are typical. Following is an easy-to-implement succession plan that will accomplish all five of Joe’s objectives.
First, Elect S Corporation Status
1. Now Joe can take all the profits of Success Co. without getting hit with a double tax. If Success Co. needs the money, Joe can loan it back to the business, which pays him interest on the loan, giving him another source of income
2. Joe can now cut down on the time he puts in and lower his salary. A smaller salary saves money in many ways: less payroll taxes and the unreasonable compensation issue (a sore point with the 1RS if Joe slows down but takes his old, full salary) is eliminated.
Then Recapitalize Success Co. by Issuing Voting and Nonvoting Stock
Let’s say Joe winds up with 10,000 shares of nonvoting stock and 100 shares of voting stock (all common stock). Over time, Joe gives the nonvoting stock to his three kids. Joe can give $11,000 to each child each year, or a total of $33,000. Since Joe is married, double the amount to $66,000 per year without any gift tax consequences. What are the objectives Joe accomplished?
1. Joe reduces his estate by a minimum of $66,000 a year. Remember, if Joe gives $66,000 of stock away this year, but that same stock is worth $150,000 (or whatever the value might be) when he dies, he has reduced his estate by $150,000.
2. Since Joe gifts only the nonvoting stock, he stays in full control of Success Co.-because he retains the voting stock-for as long as he lives.
3. Joe will leave the voting stock to Sam when he dies. Also, an insurance funded buy/sell agreement gives Sam the funds to buy the stock owned by his brother and sister. Thus, when control passes to Sam, there will be no interference from his siblings.
4. The above plan eliminates any income tax or capital gains tax on the transfer. The estate tax will be completely avoided after eight years of stock gifting.
The succession plan described above for Joe is the classic plan for a business owner with a net worth of about $2.5 million (or less) with a business valued in the $1.5 million range (or less). Of course, one size does not fit all. Now, if either your net worth is more than $2.5 million, or your business is valued at more than $1.5 million, then an intentionally defective trust (IDT) is used as the tax-free transfer strategy, instead of the annual gifting strategy used by Joe. An IDT eliminates all taxes: income, capital gains and estate.
It is important to note that this article does not attempt to cover all of the possibilities, opportunities, traps or exceptions. Properly done, your combination business succession plan and estate plan ALWAYS should eliminate the estate tax and capital gains taxes. If your plan does not reduce these potential taxes to zero, get a second opinion.
Want to learn how to create the perfect succession plan for your business? Send for the companion Special Reports (1) TRANSFER YOUR CORPORATION to the Next Generation… Tax Free; and (2) TRANSFERRING YOUR BUSINESS When You Have TWO OR MORE CHILDREN. Also read Strategy #7, “The Magnificent Intentionally Defective Trust (IDT). “As a courtesy to the readers of this column, all three are free. Just send $12 to cover shipping and handling (and a copy of this article) to Book Division; Blackman Kallick Bartelstein, LLP; IO South Riverside Plaza; Chicago, Illinois 60606.
By Irving L. Blackmail
Blackman Kallick Bartelstein, LLP
Copyright Illinois Petroleum Marketers Association Fourth Quarter 2004
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