The answer to the three questions in the title of this article is yes, yes, YES.
A long-time reader of this column… (Joe, age 64, from Ohio, but now retired and a resident of Florida) called me. Joe wanted me to do his estate plan, including transferring his business (Success Co., a C corporation) to his son Sam using an intentionally defective trust (IDT).
This article zeros in on the transfer of Success Co. to Sam, who runs the business.
Following are the facts pertinent to why we did not use an IDT to make the transfer, but instead used a little-known strategy called a spousal access trust (SAT).
NOTE: Joe’s facts and circumstances are the same or similar to most readers who call me with a business succession problem.
Now, Joe’s facts: Joe is married to Mary (age 63). They do not have an estate tax problem… not worth enough. They are worth $5.7 million ($1.7 million for their Ohio and Florida homes, $800,000 in a traditional IRA, $500,000 stock and bond portfolio, land and building leased to Success Co. worth $1.1 million, $100,000 in cash… and finally, Success Co. worth in the $1.5 million range).
Success Co. on average makes about $300,000 per year, after Joe’s salary of $95,000 (Joe consults with Sam by phone, fax and email.) The plan is to stop the salary when Joe and Mary can enroll in Medicare and get off the company health care plan.
Then, Sam plans to buy Joe’s (he owns 100%) stock, using an IDT, over a 10-year period: 10% of the stock per year at $140,000 per year.
It should be noted that both Joe and Mary are healthy. I pointed out to Joe that according to the latest life expectancy tables he has 18 years to live to age 82 and Mary has 27 years to live to age 90.
Obviously, Joe or Mary (or both) could outlive the ages on those tables… their $140,000 per year would have stopped and only heaven knows how much inflation will have reduced the value of their spendable dollars.
After some discussion, Joe agreed that their current plan would not work if they were lucky enough to enjoy long/healthy lives.
What to do?
Joe sent me a pile of documents that, together with his input, brought me up to speed on the problem. What Joe did not realize is that his problem is not unique. Most family business owners have been down the same frustrating path.
A sale of your company’s stock kicks up current capital gains tax. A gift of the stock means no more income to Joe and Mary. Variations suffer one or both disadvantages. And inflation, remains an unknown fear factor for as long as Joe and Mary live.
What to do?
Enter a concept called “Spousal Access Trusts.” (SAT). As you will see a SAT solves every issue raised by Joe’s business succession problem.
The first step in creating a SAT for Joe and Mary is to elect S corporation status and divide the Success Co. stock so Joe and Mary each own 50% of the non-voting stock.
NOTE: If you do not have voting/nonvoting stock, it is a simple tax-free transaction to create them. Typically, Joe will keep the voting stock (say 100 shares) and control of Success Co. The nonvoting stock (say 10,000 shares) are gifted to the SATs: 5,000 shares each to Mary’s trust and Joe’s trust.
Now, Joe and Mary can each use a portion of their $5.43 million gift tax free exemption when gifting the nonvoting stock to the SATs.
An important tax note: nonvoting stock is entitled to various discounts of about 40% making the 10,000 shares ($1.5 million value) that were gifted to the SATs worth only about $900,000 (rounded) for tax purposes.
Joe’s trust, in simple terms, gives Mary a right to the trust income for life, and at her death the trust assets go to Sam. Mary’s trust does the same for Joe.
It is critical that the trust for Joe and the trust for Mary be drafted in such a way as to be different, in order to avoid the so-called “reciprocal trust doctrine,” that would pull the gifts back into their estates. So, make sure you work with an advisor who is experienced in drafting and working with SATs.
The operation of the SATs on a year-to-year basis: Joe and Mary are limited to working only with their spouse’s trust to get the income they need from time to time. Any income that they do not take, stays in the trust and will eventually go to their heirs (kids and grandkids)… estate tax-free.
A little summary: The results of the SATs for Joe and Mary are (1) Success Co. is out of Joe’s estate, but he keeps control; (2) the income earned by Success Co. in the future will be available to Joe and Mary as needed; (3) when Joe and Mary go to the big business in the sky, (a) Success Co. will go to Sam and (b) all of the nonused income accumulated over the years in the SATs will go to their heirs… free of the estate tax.
Joe’s comment – “WOW!”
If you have a business succession problem, logic tells you to consider SATs. Got a question: call me (Irv) at 874-674-5295 or email me, firstname.lastname@example.org.
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How to transfer your business (to your kids), yet keep control
When closely help with business owners call me for help with their business successions plan they typically have two goals:
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- keep control for long as they live
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How to legally eliminate your state tax liability
When people of means contact me to help do their estate plans (or review their existing plans), they typically have two goals concerning their estate tax:
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Well, my goal and the goal of this special report is to show you how to eliminate your potential estate tax liability whether you are young or old , married or single, insurable or uninsurable.
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