by Leveraging Your Good Health To Reduce Taxes When You Exit.
Needing insurance is like needing a parachute. If it isn’t there the first time, chances are you won’t be needing it again.
I’m an “idea man”. Good ideas which are implemented have the power to change the world. While my ideas may not be as grand as the invention of the wheel, some are worth considering, especially in the context of succession planning.
Ideas to mitigate taxes are especially helpful to professionals who assist business owners during the process of succession planning because the IRS clearly understands the tax revenue opportunities for Uncle Sam; kind of like a hungry dog salivating at the sight of a fresh piece of meat about to fall off the kitchen table.
When speaking with attorneys, and CPA’s, they enjoy listening to fresh ideas and tax minimization strategies which allow them to look at solving tax problems in different ways. In fact if you’re not careful, half the purchase price can be paid in taxes. There goes your retirement. There are many factors which may ultimately influence the tax bite including:
- The type of legal entity you have chosen for your business- C corporation, S corporation, LLC.
- The structure of your sale- Entity vs. assets.
- The timing of the proceeds- Lump sum or spread over time.
- If you will continue to receive compensation for the work you do for the buyer after the sale.
Life Insurance is unique among most wealth transfer tools in the sense that a relatively small premium is able to generate a disproportionate tax free1 benefit. To design a life insurance plan which matches the needs and solves problems for clients not only requires technical knowledge (legal- tax- estate-personal finance), it takes creativity and an unwavering ethical foundation to always be doing the right thing for the client.
During the succession planning process, there are a myriad of problems which business owners and their families may face. Stephan R. Leimberg, author of The Tools & Techniques of Life Insurance Planning summarizes the issues in five succinct themes:
1- Lack of liquidity: Not enough cash to pay estate taxes , administrative costs, attorneys’ fees, appraisal fees and other death-generated expenses as they fall due.
2- Improper disposition of assets: The wrong thing goes to the wrong person at the wrong time in the wrong manner.
3- Inadequate amounts of income or capital at the client’s death, disability, retirement, or for special needs:
Clients are living longer, having greater medical expenses and faced with debt from college costs during retirement. Adding to the financial burden is the surprisingly higher standards of living and consequence maintenance costs in retirement. Cash value life and disability insurance are obvious answers to part of these problems if the protection is coordinated with other investment planning.
4-The value of the client’s assets has not been stabilized or maximized: I previously wrote about the dilemma Mandolin Brothers faced as a result of the sudden death of Stan Jay. Because Stan had no buy-sell agreement in place with his children, at his passing the business went directly to his spouse. If life insurance was used to fund a buy-sell, the children would have been able to purchase the shares from their mom to continue the business.
5-Excessive transfer costs: The cost of transferring wealth from one generation to another continues to increase because of increasing federal and state taxes, probate costs, attorneys’ fees , and other “slippage.” In many cases the ownership of property is set up in a manner that aggravates rather than minimizes the tax burden and other costs. Life insurance can be set up in a manner that avoids all of these problems.
Life insurance, when designed properly , can be a key component for wealth creation and wealth transfer. In some situations, life insurance premiums may even be deductible. The cost of premiums, to a large extent, is determined by how healthy you are. So quite literally, it pays to be healthy when you apply. Why wait?
1-Different income tax rules may apply if the death benefit is paid in installments instead of as a lump sum. The interest portion (if any) of each installment is generally treated as taxable to the beneficiary at ordinary income rates, while the principal portion is tax free.
Consult your advisor and your accountant to understand fully the ins and outs of how life insurance policies may impact your taxes. BH Wealth Management does not provide tax or legal advice.