Masonry Magazine July 1980 Page. 19
MONEY-SAVING IDEAS FOR MASON CONTRACTORS
Who Benefits from Estate Planning- Client or IRS?
A report recently released by the Independent Business Institute, Akron. Ohio, points out that most so-called estate planning is actually estate-tax planning. The objective is to devise a way to pay estate taxes so the heirs can obtain their inheritance without having to mortgage or sell it to pay off the taxes.
Even most arrangements which purport to reduce taxes merely shift the burden to current expenses or create a gift-tax liability. Old, standard estate-planning arrangements suffer from very serious and expensive flaws, primarily from a tax standpoint, that are further exaggerated by our soaring inflation rate, according to the report.
Gifting stock ownership of a business is a popular tactic. Between the owner and his wife, $6,000 worth of stock can be given annually to each heir-or, if the wife owns no stock, the owner can give $3,000 worth to the heir and the same to the wife, and she can give it to the heir. But if the business is worth, say, $500,000, inflation pushes its value up faster than it can be given away! On a calculator, run the value of the business into the future, with the owner's stock going down by $6,000 in gifts per heir each year and upward at a 15% inflation rate-and you will quickly see the futility of this method for a business of any major value, the report points out.
Another popular arrangement is to have the heir buy the owner's stock. This means giving him a raise and letting him use the extra money to buy the stock. But all stock purchases are after taxes for every dollar the owner gets, the IRS will get another one. Again, a calculation of the actual tax loading makes this impractical for a business of any significant value.
Another version, the report says, is to give some stock to the heir, then the owner gradually sells his stock back to the business. But the objection is the same: stock is always purchased with after-tax dollars; in this case, after the business taxation. Once again, for every dollar the owner gets (which is taxable), the IRS gets another. This is merely an IRS-enrichment scheme, says the Independent Business Institute.
Trusts Are Complicated But Legal
Trusts form an extremely complex subject, but stripped to basics, a trust is a legal entity, just like a corporation. Gifting stock to a trust which will hold it on behalf of the heirs was once a very popular approach. And it still is-too much so, because of sweeping changes in tax law in the last few years. Gifts to a trust are taxable. Further, the owner loses control of the business when 51% of the stock goes into the trust. Even if he retains vicarious control by being the trust executor, the gifts are still taxable... and the IRS loves it! Just as bad, the trust must be irrevocable to be of value-and the laws are changeable. The Institute warns: A trust can become a horrible trap as the laws change.
Preferred stock schemes are common: generally they involve giving the heirs some common stock and then trading the owner's common for preferred. But the value generally follows the vote, so if the vote is given to the heir by making the preferred nonvoting (thus making the heir's stock the only outstanding voting stock), it is a taxable gift. If the owner retains the vote (by having the preferred be voting) it will be taxed at estate time. Worse yet, the income on the preferred is taxed as a dividend-not deductible by the business, and highly taxed as received. Another arrangement the IRS appreciates, the Institute says.
Insurance-funded buyouts come in many variations, but the insurance generally goes to pay taxes and eliminate a stockholder (the deceased). Years ago, this worked, the IBI report states. But with 15% inflation, it is impractical. At 15%, everything doubles in value every 5.5 years: 4X in 11 years, 8X in 16.5 years, 16X in 22 years. Who can afford to buy insurance to cover the taxes at those valuations?
Long-term Buyout a Good Inflation Hedge
The only technique which appears to offer protection against inflation, control for the present owners, and elimination of estate taxes is a long-term buyout (installment sale) of the business to the heir or heirs, the report advises. Generally, the heir sets up a corporation to make the purchase and hires the present owner as its president, with a noncancellable, life-time employment contract. This gives the present owner full and free control, plus long-term income, which is as it should be.
Then the heir's corporation buys out the parent's business over 10 to 20 years, using the cash flow to make the payments. The terms of the father's employment contract let him throw the deal into default if he changes his mind. tax laws change, or anything else goes wrong. The owner gets total inflation protection, no estate taxes on the business, a modest current income-tax liability, full operating control over the business, and ability to cancel the deal. Which is a hard package to equal. It is however, somewhat involved legally from a tax standpoint, and many accountants and attorneys are not familiar with the techniques involved, the report cautions.
If the subject interests you, send a stamped, self-addressed #10 envelope to the Independent Business Institute, P.O. Box 159, Akron, OH 44309, and ask for its report. "Why Should the IRS Be Your Major Heir?" It is free to business owners and their heirs.
A major article on estate planning was also carried in the August, 1979 issue of Masonry.