Page 36 - MetalForming May 2010

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). Want to consult? Need a second opinion? Contact Irv:
Blackman, Kallick, Bartelstein 10 S. Riverside Plaza, Ste. 900 Chicago, IL 60606
phone: 847/674-5295
e-mail:
Blackman@EstateTaxSecrets.com www.taxsecretsofthewealthy.com
Two phone calls in the same week from readers rang my (it’s-time-to- write-a-succession-planning-arti- cle) bell. The first call is a succession planning horror story. The caller unnec- essarily loses millions to the IRS. The second call makes me want to explode: another spent-a-lot-of-money-on- lawyers-and-still-don’t-know-what-to- do tax tragedy.
First, we’ll spell out the facts behind each call, then the succession problems, and finally, you’ll be surprised by the simple solutions in both cases.
If you are a business owner with a succession plan problem, chances are you are about to learn how to avoid your own Achilles’ heel pain, and avoid losing a ton of taxes to the IRS.
The first caller (Joe) sold his business (Success Co.) to his sons (Sam and Sid) four years ago for $3 million, payable over eight years, plus interest at 5.25 percent on the unpaid balance. Today the balance due is $1.4 million.
Let’s assess the tax damage to Joe and his sons. First the boys: Sam and Sid are in a 40-percent tax bracket (state and federal combined). To have $1 million (after-tax) to pay their dad, they must earn $1.66 million, then pay $660,000 in income tax. Since the price is $3 million, the ultimate income tax burden to the boys will be $1,980,000 (3 x $660,000).
How will Joe be taxed? Well, his tax basis for his Success Co. stock (100 per- cent of the company) was $287,000 (let’s round it to $300,000). So, Joe’s capital gain over the eight years will be $2.7 million ($3 million less $300,000). What’s his capital gains tax? A mere $405,000 ($2.7 million x 15 percent).
Can you believe this tragic tax pic- ture? The boys must make $4,980,000,
while the family gets eaten alive by a tax burden of $2,385,000 ($1,980,000 for Sam and Sid, plus $405,000 for dad). Only $2,595,000 remains of that $4,980,000—truly a tax travesty.
Note: Since the boys can deduct the interest paid to their dad, while Joe must pay tax on this interest, the net tax result is a wash.
Now, the $2,385,000 question—Is there some way that Joe and the boys could have avoided that $2,385,000 tax? The answer is a yes!
Joe should have transferred the stock to Sam and Sid using an intentionally defective trust (IDT). An IDT is a sim- ple, quick and easy strategy: Joe sells the Success Co. stock to the IDT for a $3 million note. The cash flow of Success Co. is used to pay the note, plus interest. When the note is paid, the trustee dis- tributes the stock to the beneficiaries, Sam and Sid. Neither Sam nor Sid pay even one penny in taxes for the stock. Because an IDT is intentionally defective for income-tax purposes, Joe, courtesy of the IDT tax law, receives the entire $3 million plus interest tax-free—not one cent in capital gains tax or income tax.
Note: The interest paid to Joe via the IDT is not deductible.
The tax savings are $2,385,000 as explained above. It should be noted that the transaction is structured in such a way that Joe keeps control of Success Co. until the day he dies or until paid in full, his choice.
My advice: Want to sell your closely held business stock to your kids or other relatives, key employees or fellow non- related stockholders? Look into an IDT.
Now, let’s take a look at the second caller’s problem. Sam owns 10 percent ofGoodCo.,andisoneofatotalof10
34 METALFORMING / MAY 2010
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BLACKMAN ON TAXES IRVING BLACKMAN
Succession Planning—Often Your Achilles’ Heel—How to Avoid the Pain