Mr. Walters: "I'm looking for my wife -- she died a few years ago."
Mrs. Johnson: "Not now, she's upset with you. She heard you gave more money to the IRS than to your children, grandchildren and favorite charities combined."
Walters: "Oh, that's estate tax. The IRS collects it after the last spouse dies. I actually had our heirs' and charities' best interests in mind -- my CPA recommended an estate tax reduction strategy after my wife passed away. But it would have cost more than $15,000.
We had already gifted $1 million each -- the IRS allowed that level of gifting with no tax consequences. This new strategy had fees going to the CPA, an estate tax attorney and an appraiser. Why spend that money when I could time my death -- pass away in 2010 when there's no estate tax and save $15,000 that can go to heirs and charities."
Johnson: "But you died yesterday. It's 2011, and the IRS gets almost 55 percent of your $5 million estate. That's $2.75 million to the IRS and only $2.25 million left to others. Your wife said you also gave a 'bonus' to the IRS called GST tax -- what's that?"
Walters: "Generation skipping transfer tax. The IRS gets 55 percent for funds transferred directly to grandchildren. So the IRS is getting even more. I can see why my wife is upset, but I just wanted to keep things simple and save $15,000."
Johnson: "It is simple. The IRS takes more than 60 percent; the rest of the world gets less than 40 percent. Luckily, I didn't need to worry about the IRS."
Walters: "Why not?"
Johnson: "My husband also died a few years ago, but we had already looked into this estate tax situation back in 2005. We didn't need to do anything. There was a declining estate tax rate and the amount of property that would be exempt from estate tax increased each year.
We didn't have to worry about estate tax when the first spouse died because an unlimited amount of property could be passed to the surviving spouse without tax. And there would be no estate tax in 2010, but the old 55 percent maximum tax rate and $1 million exemption amount returned in 2011.
My husband and I only had about $1.5 million total, and we'd get to exempt $1 million each from estate taxes -- our kids would get to keep everything."
Walters: "Was $1.5 million enough for retirement?"
Johnson: "Well, it was tied up in retirement plans. Cash was tight, but once my husband passed away in 2007, I had $1 million from life insurance."
Walters: "The life insurance proceeds went into an ILIT?"
Johnson: "A what?"
Walters: "ILIT -- an irrevocable life insurance trust. It holds life insurance policies and removes the proceeds from estate taxation. The surviving spouse lives off the funds within IRS guidelines. When the surviving spouse dies, there's no estate tax when the funds go to your heirs."
Johnson: "And with no ILIT?"
Walters: "You pay the IRS if your estate is over your $1 million exemption, since it's after 2010."
Johnson: "We had $1.5 million, but the bull market from 2008 to 2010 nearly doubled it to $2.8 million. Also, the insurance proceeds grew to $1.8 million. That's $4.6 million total."
Walters: "And your house?"
Johnson: "It was my parents' house; I didn't pay for it."
Walters: "You have to pay estate tax on the value of your house and all of your property as of the date of your death."
Johnson: "Yikes! With our house, jewelry, cars, furs and other personal belongings, that's another $2 million. So my estate is $6.6 million, and we didn't do any estate planning."
Walters: "Well, there's bad news and good news. Looks like the IRS will get about half of your estate."
Johnson: "What's the good news?"
Walters: "If I tell my wife about your situation, maybe she won't be as upset with me."
Robert N. Greenberger, CPA, PFS, is a tax principal at Tauber & Balser P.C. With more than 20 years of professional experience, he has assisted companies, business owners and high-net-worth individuals with complex income tax and estate tax strategies. He is on the board of the Atlanta Estate Planning Council and has spoken about many tax topics. Reach him at (404) 814-4949 or firstname.lastname@example.org.
In examining and analyzing whether to buy, sell, merge or transfer the stock or assets of a business, certain basic tax concepts must be considered.
When structuring a merger or acquisition transaction, the business owner (who is mindful of these details) can attain a competitive advantage by formulating a tax beneficial acquisition.
Although tax laws have become too plentiful and complex, one area has remained fairly constant - tax-free reorganizations. In terms of structuring a merger or acquisition transaction, IRS Code Section 368 identifies the basic types of tax-free reorganizations and provides for nonrecognition of gain. If IRS rules are followed properly, reorganizations allow businesses tax-free treatment for mergers, acquisitions, recapitalizations, changes in corporate charters and reorganizations in connection with bankruptcies.
Before attempting to choose an appropriate structure for a restructuring transaction, it is necessary to understand the business objectives and constraints. Business owners must consider several factors before the official handshake to finalize the deal.
* What is the expected growth of the target company within its industry?
* What is the appropriate method of financing the transaction?
* Do both companies share the same or similar mission statements, goals and values?
* What will be the impact on employee morale?
* What is the amount of time and cost associated with the business integration?
* What tax attributes will remain with the restructured entity?
The most common question posed to CPAs by their clients are:
* Do the parties to the transaction want an asset sale or a stock sale? Sellers often prefer a stock sale to avoid double taxation; buyers may prefer an asset sale to get a "step up" in basis of the assets purchased. A special election that results in a single level of tax to the seller should be considered ("Section 338(h)(10)" election).
* Do you want the reorganization to be structured as tax-free or partially tax-free?
Qualified tax-free reorganizations usually fall within one of the following categories:
1. Type "A" Reorganization. A statutory merger or consolidation in which two or more corporations are combined and only one survives. "A" mergers are relatively simple and less expensive than other types of reorganizations, but may result in unwanted assets and liabilities that cannot be culled out.
2. Type "B" Reorganization. The acquisition of stock of one corporation in exchange for part or all of the buyer's voting stock. While "B" reorganization limits the purchaser's exposure to liabilities, it is rarely used because the buyer cannot use cash in the exchange (or the transaction becomes taxable).
3. Type "C" Reorganization. A stock for asset exchange.
4. Type "D" Reorganization. A transfer by a corporation of part or all of its assets to another corporation.
Tax-free treatment is premised on the continuity of the business enterprise and continuity of proprietary interest in the combined form. Only those transactions in which the shareholders continue to own an equity stake in the surviving entity qualify for tax-free treatment. The transaction must also have a valid business purpose (other than for mere tax avoidance).
Finally, the surviving corporation must continue the purchased company's historic business or use a significant portion of the target company's assets in a business.
Compliance with the rules of Section 368 does not always avoid gain recognition altogether. A tax-free reorganization may have some tax recognition consequences, such as in the case where "boot" (cash or nonqualifying property) is received. Specifically, the seller will realize gain in the amount of any boot received in the transaction.
An acquisition is one of the most significant events in the life of a corporation. The treatment of mergers and acquisitions accounts for a large and extremely complex set of IRS rules. It is imperative that your CPA and other advisers are involved starting with the early planning stages of a potential merger or acquisition.
Robert N. "Bob" Greenberger, CPA, PFS, is a principal at Tauber & Balser P.C. in charge of the tax department. With more than 20 years of professional experience, he has assisted companies with reorganizations through tax planning and by obtaining favorable IRS rulings. He has served as an instructor on complex tax topics including "Buying and Selling a Business in Georgia." Reach him at (404) 814-4949 or email@example.com.