TU Section5

Section 5 – A Tax-Free Environment – Good for Your Tax Health and Your Economic Health


The easiest way to keep your current wealth and create tax-free wealth is to get into a TAX-FREE ENVIRONMENT… As soon as you can. And stay there… for as long as you live, at death, and beyond.

How do you get into a tax-free environment?… The answer lies in the proper use of:

  1. Life Insurance Strategies
  2. Charitable Strategies

The System shows you how to get into a tax-free environment — quickly and easily — and how to stay there. It starts the first day your Wealth Transfer Plan is implemented… continues for life… and survives death.

A common sport at our office is a bull session with the specific goal of creating new ways to beat up the IRS… But always legally. The conversation invariably turns to an all-important question: How can we get our clients into a tax-free environment? The right answer yields huge tax benefits.

So, let’s start answering the question by looking at…



The fact is… the life insurance company doesn’t want your money if it doesn’t think you are going to live. Look at it this way: The insurance company is betting you will live to or past your life expectancy. You are betting you will die before your life expectancy.

Why then do the wealthy buy so much life insurance?…

For tax reasons… And to create tax-free wealth.

Here’s something most people don’t know: the tax tricks The Strategies allow you to do in the tax-free environment of life insurance.

  1. During your life
    1. The earnings on the cash surrender value (CSV) of an insurance policy accumulate tax-free.
    2. If you borrow a portion of the CSV, the loans are tax-free and, in effect (with the right kind of policy), give you a tax-free flow of income.
  2. At death
    1. The excess of the policy proceeds received by your heirs over the amount of premiums paid (clearly an economic profit) is income tax-free.
    2. Policy proceeds used to repay loans are also income tax-free.
    3. The estate tax (if you use a WEALTH CREATION T, SUBTRUST or other appropriate Strategies) on the policy proceeds is zero (tax-free).


Yes, life insurance is the only tax-advantaged product we know of that can deliver lifetime tax-free (income tax) benefits and also deliver tax-free (both income tax and estate tax) benefits at death. But to receive the benefits, you must do Each Specific Strategy (as explained in The System) exactly right.

Do it wrong, and the tax law will crush you.

As a practical matter, if you are wealthy (and trying to transfer your wealth), life insurance is, when done right, a tax-favored wealth-building investment.


A premium of $17,500 per year for 15 years (for Warren, a 50-year-old client from Florida) or $263,000 bought Warren a $1 million policy. If Warren lives for 15 years or more, the profit will be $737,000; if he lives for less than 15 years, the profit will be larger.

Almost the same for a married couple: The annual premium for a $1 million second-to-die policy (a husband-and-wife client from the Boston area, both 60 years old) is $15,900 for 15 years (a total of only $239,000).

Both of the above policies are owned by WEALTH CREATION Ts.


Both clients are in a tax-free environment for life and will stay there at death. The Florida client created $737,000 of tax-free wealth ($1 million less the $263,000 policy premiums), which will ultimately go to his nonbusiness daughter (his son got the family business).

The Boston couple created $761,000 of tax-free wealth. They had no business and bought the policy as an investment.


The key question. Always ask this question about each existing policy on your life: What is the tax cost — income and estate — when I die? The answer should be ZERO. If not, and your decision is to keep the policy in force, do what is necessary to make the answer ZERO. This usually means:

  1. All policies (that you keep) out of your corporation.
  2. All policies into a WEALTH CREATION T.

Important: Make a decision separately for each policy (the same as if you were examining a stock portfolio or any other group of investments).

Then, ask this question: Based on what is available in the marketplace today, should I keep this policy? Get (from your insurance advisor) a current policy run to age 95 or older. Dump and replace as necessary. Never drop an existing policy until the replacement policy is in place.


A client (Josh, age 59) from Alabama had a $5 million (death benefit) portfolio of insurance: $3 million second-to-die (with Joy, his wife, age 60) owned by Josh and $1 million on Josh’s life owned by his S corporation (Success Co.). Josh also owned a $1 million policy on his life. The CSV of all of the policies totaled $358,396 and the annual premiums were $25,594 (so low because some of the older policies self-carried — required no more premium payments).

Josh had $768,000 in the Success Co. profit-sharing plan, which created a SUBTRUST that purchased $5 million of second-to-die insurance on Josh and Joy.

Results / Benefits

  • Josh and Success Co. pocketed the entire $358,396 of CSV (tax-free).
  • All future premiums will be paid by the SUBTRUST, so Josh and Success Co. save $25,594 in premiums each year.
  • The $5 million of insurance proceeds will go to Joy’s and Josh’s heirs free of all taxes. Tax Savings: about $2.8 million.


PREM FIN is a new way to buy life insurance for a high-net-worth individual who needs or wants a substantial amount of life insurance.

The typical objectives are:

  1. Purchase the insurance for a minimum out-of-pocket dollar outlay.
  2. Leverage your wealth by paying the premiums without liquidating any of your investments or otherwise changing your normal cash flow.
  3. The insurance proceeds must be estate tax-free.
  4. Reduce or eliminate the gift-tax consequences (do not eat up your annual gift tax exclusions and unified credit) of premium payments to make the proceeds estate tax-free.
  5. Create additional tax-free wealth.


Mac and Joy (clients from Fort Worth Texas) are worth $40 million and need $20 million of second-to-die insurance. The premium cost is $225,000 a year. Sure, Mac and Joy can afford the premiums, but they would have to sell some assets to pay the premiums. Capital gains taxes would be incurred. Mac says, “No” to that idea. Nor does he look kindly at the large gift tax that would be incurred as the premium costs are gifted to an irrevocable life insurance trust (ILIT) each year. The ILIT is the owner and beneficiary of the policy. Mac’s and Joy’s children are the beneficiaries of the ILIT.

Mac and Joy decide to use PREM FIN to pay the annual premiums. Following is a summary of the PREM FIN process:

  1. The ILIT buys the policy and will pay the premiums.
  2. Instead of paying the premiums with cash, the premiums are paid by loans, which are borrowed by the ILIT.
  3. The interest due on the loans may be deferred (and paid at death out of policy proceeds) or the interest is paid in cash.
  4. The lender requires collateral to secure its loans. The policy itself is pledged as collateral. The cash surrender value (CSV) during life and the death benefit of the policy are the primary collateral.
  5. Any additional collateral required (almost always required in the early years after the policy is issued) must be supplied by Mac and Joy. So, Mac and Joy supply the additional collateral: a stock and bond portfolio they already own. (In most cases, Mac and Joy would go to their local bank and use their collateral to back up a letter of credit from the bank. Then, the letter of credit would be used as the additional collateral.)
  6. Each year as the CSV grows, typically, the amount of required additional collateral is reduced.
  7. When the CSV has grown large enough to adequately secure the loan, Mac and Joy can take back their additional collateral. (If a letter of credit was involved, it would be cancelled.)
  8. When the second of Mack and Joy dies, all loans (including any unpaid interest) are paid out of the policy proceeds.


Since Mac and Joy need $20 million of insurance coverage, the amount of the policy must be greater than $20 million (say $24 million). PREM FIN requires two death benefit amounts: (1) gross death benefit, $24 million in this case and (2) net death benefit, $20 million. The difference, $4 million, will be used to pay off the loans and any unpaid interest. The $20 million net death benefit will be paid to the ILIT, which will use the funds for the benefit of its beneficiaries (Joe’s and Mary’s children and grandchildren).

Results / Benefits

  • Mac and Joy created $20 million of additional wealth without paying any premiums in cash. The insured — here Mac and Joy — may incur modest transaction fees to the lender, usually a bank).
  • Not one cent of the $20 million at death or the premium payments (paid by loans) during life is subject to gift tax, income tax or estate tax.





Chad (a client from the Pittsburgh area) gifts property worth $1.2 million, with a tax basis of $200,000 to a CHAR RMNDR T. An annuity of 6% (of the $1.2 million), or $72,000 will be paid to Chad and Cindy (Chad’s wife) each year for as long as either Chad or Cindy is alive.

Results / Benefits

Without getting technical, these are the tax pleasures a CHAR RMNDR T delivers:

  • Capital gains tax. When the CHAR RMNDR T sells the appreciated property (resulting in an $1 million profit), the profit is tax-free to Chad and the trust. Immediate tax savings: $150,000 in capital gains taxes.
  • Income tax deduction. Chad gets a charitable deduction of $320,000 (according to IRS tables). As a result, instead of Chad paying $150,000 in capital gains tax, Chad is awarded $112,000 ($320,000 x 35%) in cash by the IRS (because of reduced income taxes, state and Federal combined).
  • Estate tax. There is none.
  • Actually create after-tax wealth. By now you probably know the next step. Chad causes a WEALTH CREATION T to buy an insurance policy (second-to-die with Cindy) for $1.2 million to replace the value of the property put into the CHAR RMNDR T. If Chad and Cindy had died still owning the $1.2 million in property, the IRS would have taken 55 percent, or $660,000. The WEALTH CREATION T preserves the full $1.2 million for the family.


A CHAR LEAD T is often the last straw (Strategy) used to break the back of the IRS and allow wealthy clients to finish the job of passing ALL of their wealth — intact — to their heirs.


In 1999, David (a client in the Chicago area) presented us with an interesting problem. He had an investment worth $1 million with a tax basis of about $900,000. The investment earned just a tad over 10 percent a year. David was torn: He wanted to save this investment to give to his son, Sam (46-year old college professor) as a retirement present on Sam’s 60th birthday. But David also wanted to make a substantial gift to his Favorite College’s building fund drive.

Here’s what we did: David transferred the $1 million investment to a CHAR LEAD T that will pay $50,000 (5 percent of $1 million) to Favorite College for 14-years. Then the property will go to Sam (when he is 60 years old).

Results / Benefits

  1. Amount (FMV) of gift $1,000,000
    Less — Gift Tax Deduction (value of 14-year charitable income interest) 426,975Taxable gift (to Sam) $ 573,025*
  2. Payment to charity (14 years x $50,000) $ 700,000
  3. Estimated tax-free distribution to Sam at end of 14 years $1,960,000**

*Not subject to a gift tax in cash because this was the first taxable gift David made in his life (Remember, in 1999 the first $650,000 in taxable gifts was tax-free.)

**David will get almost $2 million out of his estate (and to his son tax-free). The taxable gift ($573,025) will be included in David’s estate at his death.


The subject, transferring your business, deserves a book. As a matter of fact in 1988, Irv Blackman wrote a 443-page book titled, Transferring the Privately Held Business. The System includes many of The Strategies and techniques taken from his old book (now out of print). The goal in this part of the tutorial is not to cover the entire transfer / succession subject, but rather to cover those areas that most professional advisors miss or do wrong.


You want to sell your business to your son (Stan). Each $1 million of the price is subject to three taxes:

  1. Stan must earn $1.666 million; at 40 percent the income tax is $666,000… only $1 million left.
  2. Stan pays you $1 million for your stock (assume zero tax basis). Your capital gains tax is $150,000… now only $850,000 left.
  3. At your death, the IRS gets another $467,500 for estate tax. It’s nuts! Stan must earn $1.666 million for the family to keep only $382,500 ($850,000 less $467,500).


The tax rates may change, but the concept—a wealth killer—illustrated above will never change.


Almost all closely held business owners would like to control their businesses to the day they die without paying the tax price for keeping control.


Here’s a strategy we use dozens of times every year:

Ian owns 100 percent of Success Co. He turns all of his stock (common) into the corporation and takes back two types of common stock in exchange — voting common (say 1,000 shares) and nonvoting common (say 100,000 shares). This transaction, called a “recapitalization,” is tax-free. It works for both C corporations and S corporations. Ian then gives (typically via a GRAT or an IDT, when an S corporation and a FLIP when a C corporation) the nonvoting stock to his kids. Ian can own as little as 1 percent of all the stock (1,000 shares of voting stock in this example) and still retain 100 percent of the voting control. Just what he wanted — low value for his stock, total control of the corporation. Perfect!


Now that you know what not to do (never sell your business to your kids) and what to do (create voting / nonvoting stock followed by a GRAT, IDT, or FLIP), here’s how to accomplish the rest of your transfer/succession goals.

The Strategies and The System show you how to:

  1. Use a Buy/Sell agreement (Strategy #22C) to keep the stock of Success Co. in your family when one (or more) of your children (who owns Success Co. stock) gets divorced.
  2. Value your stock for tax purposes (Strategy #22B)so you get the three discounts allowed by the IRS:
    • discount for general lack of marketability
    • minority discount
    • discount for nonvoting stock
    • All the discounts when combined, allow you to reduce the value of your business (for tax purposes) by about 48 percent. Think about it: You can transfer $1 million (it can be any amount) worth of stock using a fair market value of only $520,000 (52 percent of $1 million) for tax purposes to transfer your business to your family.
  3. Transfer your business to the business children (Strategy #22D) and treat the non-business children fairly (Strategy #22E)… every time.
  4. Handle a sale of your business to employees or other non-family members to minimize (or easily eliminate) the tax cost.

The ultimate success of any Wealth Transfer Plan that you create is only as good as the final steps you take to implement and complete the Plan. Want to learn how to complete your Plan the right way? read more here…