As we think about July 4
You know the American Revolution had an element of tax revolt in it. I say this because a Government must be careful to leave enough to its citizens that they might invest it and grow it and use their money to create. As we enter the mid-term election cycle we have the one thing the Chinese don’t have, the freedom to change course and the freedom to object to the direction this country is heading. Most of you know my Republican political leanings, and as a tax attorney what’s best for me, may not be what’s best for the Country. I thank God that I live in the United States. I would not trade living here with living in any other Country in the World. We may have a rough patch of road ahead, but I know that America will rebound. That free Americans will use their freedoms to move forward. It is amazing to me how quickly we can lose our freedoms. This leads me to my tax tale of the day. A girl, Blonda went into a tanning salon and found out that she had to pay 10% more for her tan than last week. Her best friend, Bambi, belongs to the Hot and Hotter Fitness Club. Hot and Hotter in addition to a few weight machines, saunas and bikes have tanning booths (which is included in their monthly fee). The exact same tanning booths that Blonda’s tanning salon has. Bambi pays no surtax, but Blonda does. Makes a lot of sense, right? Have a great weekend.
WHAT THE FAMILY COULD HAVE PLANNED
First, when the father started the business or at least when the boys started working there, he should have considered giving them portions of the business over the years. This would have created minority discounts in the business upon the deaths of the parents. As to the IRA, when Dad got sick, pop the IRA’s right away and don’t withhold any taxes. That way, you get an income tax deduction on the estate tax return. In essence trading a 39% tax for a 50% tax. Make sure Mom has assets in her name alone in case she were to die first. The family should have utilized revocable trusts and perhaps buy some life insurance owned by a Life Insurance Trust or an LLC owned by the sons. These are minimal steps which might have averted this confiscatory scenario. As you can see, for 2011, things can get real ugly and planning should be done.
What should the boys do?
A little post-mortem estate planning. First the wife’s executor should disclaim $1.0 Million of assets preferably in the stock of the company (we’ll explain later). That way, his estate gets to use its $1.0 Million exemption and her estate gets to use her $1.0 Exemption. This reduces the tax by $500,000. Not there yet. However, since she disclaimed her interest in the business, it is still worth $2.5 Million, but her interest may be subject to some discounts as high as 25%. This means that her interest may only be $1.0 Million. That leaves the IRA and the houses and the condo to be taxed at $700,000. Sell the houses, since there is no capital gains there and pay the taxes with the proceeds. That leaves the $800,000 IRA which can be drawn down over time.
What the kids are looking at?
First, the lawyer says to the kids, “we need to determine the value of your father’s business. It throws out an income stream of $300,000 per year. Assuming that you had to hire a manager for $200,000, that’s a $100,000 a year income stream. Given current income rates the amount of principal needed to generate a dividend of $100,000 would be $2.5 Million. So, the store could be worth as much as $2.5 Million, we’ll need to get an appraisal. The rest of the property is pretty easy to determine, its worth about $1.4 Million. So, your dad’s estate is worth $4.9 Million. There is an exemption of $1.0 Million and that’s it. So there will be an estate tax of approximately $2.0 Million on this estate.” The boys were crestfallen. “$2.0 Million? We can’t come up with that kind of money right away.” “It gets worse”, said the lawyer. “Worse, how can it get any worse?” “Well, on the $800,000 retirement account, you have to pay income taxes to liquidate that account. So, you’re looking at income taxes of about $320,000 to take money out of that account in order to pay the estate taxes.” Bruno, Jr. was heart-broken and a bit angry, “you mean that we’ve worked in that store for 20 years smelling feet and in order to continue to own the store we might have to pay the Government $2.32 Million?” “That’s about the size of it”, said the lawyer. “But there is one piece of good news” said the lawyer. “What’s that”? asked Viggo. “The Government might allow you ten years to pay off the tax”.
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