Alternatives to Taking It with You
Churchley Financial Group president Fred Churchley III has
two words for cable operators who continue to put off estate planning: Bob Magness.
When Magness unexpectedly died in 1996, the late founder of
Tele-Communications Inc. left a huge and complicated estate worth more than $1 billion,
without a detailed financial plan. The result was a hotly contested will and a series of
lawsuits pitting stepmother against sons.
Although the media reports of the day characterized the
surviving Magnesses' legal wranglings as the epitome of greed, what started the legal
shenanigans can be traced to a simple fact: The survivors were saddled with an enormous
estate-tax bill of roughly $500 million.
And that, Churchley said, could have been avoided.
Most of the underlying issues of the Magness estate have
been resolved through a settlement between family members that was reached last year,
although some minor points are still being worked out privately, according to some
Churchley's Englewood, Colo.-based financial-planning firm
specializes in the cable industry and counts some of the largest MSOs in the country as
Although he had no connection to the Magness estate -- he
did say that he had called Magness at least five times in the two years prior to his death
to try to get him to map out a financial plan, to no avail -- he added that the problems
that surrounded the late cable entrepreneur's estate are not uncommon in the cable
Churchley said the Magness situation initially shocked some
cable entrepreneurs into action.
"It helped me," he added. "I still use it to
motivate people to do some planning."
But getting cable-system owners to sit down and plan for
something as morbid as death and taxes is not an easy task.
"These guys are such strong-willed, risk-taking
son-of-a-guns that are going to live forever. It did shock them initially, and then it
became, 'Hey, it's not going to happen to me,'" Churchley said. "It's tough --
these guys really think that way."
While the Magness situation is an extreme case, Churchley
said, it could become more common in light of skyrocketing cable valuations that have
turned some cable entrepreneurs into billionaires literally overnight.
"Magness is the prime guy who didn't do it,"
Churchley said. "And look at the mess of his estate. The other problem was that it
was in the papers every day. He never wanted to deal with his own mortality."
PLANS ARE PRIVATE
Churchley said that by creating an estate plan, Magness
could have kept his family's finances out of the papers. Once a will enters probate, it
becomes public record, but with an ironclad estate plan, many financial matters can be
There are several vehicles that a cable entrepreneur can
set up within an estate plan, including creating charitable remainder trusts, family
limited partnerships, making gifts to family members and Grantor Remainder Annuity Trusts,
Churchley said creating those various plans not only
secures your estate in the event of your death, but it also could save a bundle in taxes
when the business is sold.
Gifting assets to family members is a good initial strategy
to lessen the tax burden. With estate-tax rates ranging between 37 percent and 55 percent,
perhaps the most important first step is taking advantage of gift-tax exclusions available
to both spouses of a business.
Currently, spouses are allowed to gift up to $10,000 each
per year to each child they have. For example, a husband and wife with two children are
able to give each child a total of $20,000 per year tax-free.
In addition, the Internal Revenue Service allows each
spouse an exemption of up to $650,000 in assets tax-free. That amount will climb to $1
million by 2006.
Gifting assets that have the greatest potential for
appreciation is important, as not only the current value of the gifted property is
excluded from the tax, but also future appreciation. Other techniques involve the use of
discounts -- gifting property at a discounted value due to a minority ownership interest,
illiquidity, or the retention of the use of income of the property for a period of time.
Planning an estate strategy can be complicated. But
according to The Burke Group, a Torrance, Calif.-based financial-planning firm, most
individuals, regardless of the amount of their wealth, can formulate an effective strategy
by sticking to three basic techniques: valuation adjustment, giving it away and insurance.
By doing nothing, a person can just about guarantee that 50
percent of his or her estate will go to the government, which Burke Group president Kevin
Burke called "social capital."
Burke said establishing an estate plan allows the
individual and his or her family "to direct that social capital to the general
welfare, but for specifically what they want to affect. The key is to combine valuation
adjustment -- trying to make an asset look like it has a much smaller value for tax
purposes -- and insurance."
Another key point is to get the client to understand that
they can still control an asset without actually owning it, and the government can't tax
what you don't own.
Burke said insurance can play an effective role in helping
to pay estate taxes, provided that the policyholder doesn't live too long.
"In general, insurance, coupled with other planning
techniques, can be a very effective device," Burke said. "But if you live to be
100, life insurance isn't such a good deal."
The policyholder also has to make sure that the insurance policy is set up correctly so
that it is not considered to be a part of the estate after the policyholder dies.
"Insurance is income-tax-free to the
beneficiary," Burke said. "If you own it so you could control it, the value of
the insurance death benefits gets added back into the value of your estate. But if you
never owned it -- if your children owned it and you made a gift of the premium to them
each year -- it will never be subject to estate or income taxes."
CHARITABLE REMAINDER TRUSTS
Michael Smith, a shareholder with Bloomington, Minn.-based
law firm Larkin, Hoffman, Daly & Lindgren Ltd., which specializes in estate planning,
said the charitable remainder trust is a good vehicle for deferring taxes, but like death,
taxes won't be avoided.
"If I've got a business worth $10 million, and I have
put in about $100,000, if I sell the business, I've got a $9.9 million capital gain, and I
have to pay the IRS 25 percent of that in taxes," Smith said.
"But if I take that $100,000 in stock and put it into
a charitable remainder trust, I reserve the right to receive incremental payments over
time," he added. "The current value of that interest may be $60,000, so when I
transfer the stock to the trust, I retain $60,000 of the $100,000 [original investment],
and the charitable reduction is $40,000."
Smith said that upon the sale of the stock -- the trust
cannot be legally obligated to sell the shares, or it will get taxed the full amount
anyway -- the sale by the charitable remainder trust is not taxed. However, the
incremental payments that you receive from the trust -- say, $10,000 per year -- are
"You haven't avoided the tax [with a charitable
trust]," Smith said. "You've deferred it. It's a way to make a gift and to
leverage to a charity."
But that can be a huge benefit, especially in a sizable
estate. By deferring the taxes, the business owner avoids getting hit with a large
lump-sum tax bill.
However, Smith added, at least 10 percent of the value in
the trust has to go to charity at the end of the trust's useful life -- usually about 10
FAMILY LIMITED PARTNERSHIP
Churchley added that setting up a family limited
partnership can also assure a smooth transition -- especially when a system owner has
children that are inside and outside of the business.
"Give the people who are involved in the business
partnerships and the ones who are not limited partnerships," Churchley said.
"It's a very helpful planning technique."
He added that with a family limited partnership, the
parents, or owners, can keep control of the business as general partners, even though they
technically only own 1 percent of the business.
"It's a great way to have your cake and eat it,
too," he said.
Smith said family limited partnerships are a great way for
the owners of the business to retain control while they are gifting out portions of the
value of their business to their children.
But there are costs involved in administering a family
limited partnership -- getting a lawyer to set up the partnership itself; for assignments
of the business and the stock; and getting an appraisal of the limited-partnership units
and, in some cases, the underlying assets. The business owner has to decide whether those
costs are justified by the tax reduction.
"If you're saving 30 percent in taxes, then it's
probably worth the $20,000 to $30,000 to set it up," Smith added.
The basic technique of family limited partnerships,
according to Smith, involves making gifts of minority-ownership interests in existing or
recently created entities. The value of the gifts is discounted due to restrictions such
as a lack of marketability and/or a lack of control.
The value of the underlying assets remains the same, but
the limitations on control and marketability inherent in a minority-ownership interest
reduce the value of the gift for gift-tax purposes.
When properly used, gifts of minority-ownership interests
in family partnerships can substantially reduce the overall estate-tax liability.
With a GRAT, the grantor retains the right to an annual
payment from the trust for a certain term of years. The retained annuity reduces the
amount of the grantor's gift.
GRATs can be useful in leveraging gifts of assets that will
appreciate at a greater rate of return than the expected ROR mandated by the IRS. As of
February 1999, the IRS assumes an average ROR of 5.6 percent.
"You have to understand what's out there and what you
want," Smith said. "Basically, you're leveraging your gifts. Once you realize
that it's a game of leverage, everything else is kind of an offshoot of that."
Most important is to begin planning for the future today,
Churchley said. And that can be a monumental task, given the type of person who usually
runs a successful cable company.
"Tell me when you're going to die and I tell you a
good time to start estate planning," Churchley said. "The hardest thing is to
face your own mortality."
And it is especially difficult for cable entrepreneurs, who
have been focused on building their businesses from scratch, and who don't have the time
or the inclination to think about such morbid events.
But, Churchley said, given the skyrocketing valuations of
cable companies today based on the promise of future services like high-speed data and
digital television, some cable owners who may not have believed that they were in high tax
brackets are quickly finding out otherwise.
Setting up trusts is a good way to avoid getting battered
by the IRS.
"If you're worth $100 million, you can do some gifting
and buy $50 million in life insurance to pay your taxes," Churchley said. "Now,
all of a sudden, you're worth $500 million. It's a different story to try to cover all of
your taxes with insurance; you can't do it."
He added, "Then, you've got to look at selling assets
to pay taxes, giving more to charity, borrowing money to pay taxes and having some life
insurance. As these numbers get bigger, your options get smaller. It's harder to make a
bigger impact on your estate. It's easier at $100 million than it is at $500 million to
make gifts or any other sizable difference. The numbers start working against you."
Churchley said setting up family limited partnerships now
helps the business owner to avoid taxes on future growth.
"Let's say you've got a client who, at 60 years old,
has a cable operator worth about $100 million," Churchley said. "If you set up a
family limited partnership and then start gifting some of these assets in the partnership
to children and grandchildren, as the business grows from $100 million to $200 million,
you can get 80 percent of growth onto another generation. That's like saving $45 million
in estate taxes."
He added, "If he doesn't do anything until he's 70,
now he's worth $200 million. Then, he's limited. You can't get rid of that $50 million in
estate taxes that has just grown. The sooner you do it, the better off you are."
However, Churchley said, while hiring a financial planner
is a good first step in establishing an estate plan, it is just the tip of the iceberg.
"You need a team of people to do this, including an
estate-planning attorney and a member of the accounting profession," Churchley said.
"The first thing I need is objective information: existing wills, trusts, partnership
agreements. If they're a public company, I'll need all of that stuff -- past income-tax
returns, personal income-tax returns, all of that kind of stuff."
He continued, "The next thing is to have a series of
meetings with the client and their spouse and say, 'Pretend there's no tax man: What do
you want to see happen? How much control do you want to keep?' Get them to try to dream
and find out their hopes and aspirations. Are they worried about their children, their
grandchildren? You try to expose them to a series of opportunities."
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