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r. and Mrs. Successful Business Owners (we’ll call their life expectancy of about 20 years, it’s not hard to imagine
them Mr. and Mrs. Subo), now in their mid-60s, have the tax liability getting out of hand (5% growth would add an-
recognized that it’s time to make some critical deci- other $5,000,000 to the tax bill in 15 years under the 2008 tax
sions that affect both business and family. They have built a schedule).
solid and growing manufacturing company over the past 28 Space restrictions prevent the author from discussing strategies
years and wish to keep the family business thriving into the to reduce and/or freeze the size of the taxable estate. Those
next generation. Of their three children, their daughter and one techniques can and should be applied as fully and reasonably
son in their early 30s are active in the business and have shown as possible with the help of qualified tax and legal advisors.
both competence and interest in continuing to grow the com- Whatever is left is subject to estate taxes under two conditions:
pany. The other son has developed his career in education and
is unlikely to participate in the family business. Mom and Dad 1. The government accepts only cash.
want to treat all three equally as they address their estate plan- 2. The government expects to receive cash within nine
ning goals for the present and future. months of death (for a married couple, typically this
About five years ago, in a joint meeting with their estate plan- means the second death).
ning attorney and CPA, it was clear that the Subos’ success was
resulting in the rapid growth of their assets, with far more ex- This presents a particularly glaring problem if the estate’s as-
pected. At that time, their net worth was about $5 million, com- sets are largely illiquid, as is the case for many business owners
prised almost entirely of their business. Their advisors recom- and real estate investors.
mended transferring a minority interest, as large as they were
comfortable with, to an irrevocable trust for the three children. Create Needed Liquidity Double Tax-Free
In that way, all future growth of those assets would occur out- Life insurance is the only method authorized by the Internal
side of the Subos’ estate and therefore avoid estate taxes upon Revenue Code to create income tax free dollars upon death.
death. When structured properly, it can also avoid estate taxes. That’s
Though this made sense economically, Mom and Dad felt why it is such a popular tool for addressing the estate tax li-
uncertain and awkward about giving up some control of the ability. However, when the premiums are substantial, several
company. In addition, though the children were showing good considerations come into play:
promise in their young adulthood, the parents were concerned
that giving too much to them might be a curse rather than a • The estate owner might not have the cash flow or liquid
blessing. They decided to follow their advisor’s recommendation reserves to cover the entire premium.
and gift a portion of their company stock to a children’s trust, • The estate owner might rather have use of the money for
but kept it conservative by transferring 20% of their interest. The business or other investment opportunities.
appraised value of the company at the time was $4,000,000, • Gifting of the premium dollars to an insurance trust (or
but the 20% interest was worth less than $800,000 due to lack the children outright) might exceed the annual gift tax ex-
of marketability and lack of control. So the value reported on emptions ($12,000 per donor per beneficiary in 2008) and
the Subos’ gift tax return was actually less than $600,000 as therefore incur a gift tax liability or force the use of a por-
calculated by a professional appraiser (today that stock is worth tion of the lifetime gift tax exemptions ($1,000,000 per per-
$2,200,000, which translates into an estate tax savings of about son). Though life insurance can for many reasons warrant
$1,000,000). the use of these exemptions, most planners want to try to
Now that this strategy is “old history” for them and the chil- avoid using them if other avenues exist.
dren are five years older and more mature, the Subos wish they
had done more at the time, but they are now focused on how Financing the Premiums Through Private Sources
to make the most of the next steps of their succession plan. The For high net worth individuals, the money needed for life in-
company is now worth $11,000,000 and counting (their 80% surance premiums almost always exists; it’s just in a different
worth almost $9,000,000), with their net worth approaching place than where it needs to be. There are three common sourc-
$12,000,000. Though they are still in good health, they do not es of private loans as well as several commercial lenders who
fight the realization that the day will come when they will no participate in premium financing arrangements.
longer be here. If they were gone today, their estate tax liability
would be nearly $4,000,000. With even modest growth over Continued on Other Side
Reprinted With Permission From Business Insider Magazine’s Third Issue of 2008
Reprinted With Permission From Business Insider Magazine’s Third Issue of 2008