The Tax-Advantaged CEO

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* Supplemental Pensions. Although you may never have heard of a secular trust -- a way to guarantee supplemental pensions and deferred compensation for key executives -- the technique has become increasingly popular since the mid-1980s and offers some appealing tax advantages.

Secular trusts work like this: A company places an amount -- say $10,000 -- in a trust for an executive. Unlike a cash bonus, the money, plus any interest it accumulates after yearly taxes, will be available only at retirement, at which time distributions are at least partially tax-free to the executive. Because corporate funds have actually been set aside for the executive -- and under trust rules cannot be touched by anyone other than the executive even if the company goes under -- the executive has to pay tax on that money the year it goes into the trust. That may seem a little unfair, since the executive can't actually use the funds until retirement. But there's still an overall tax advantage to the strategy because the company takes an immediate tax deduction that, on a $10,000 fund contribution, is probably worth $3,400. The executive's tax liability is probably only $3,100.

That's where arbitrage comes in -- because there's room for maneuvering with the tax spread ($300, in the above example). Your company could simply take the deduction and run, assuming that even if your managers grumble about the early tax bill, they'd still rather have the money in a secular trust than not at all. But, as is more common, you could pay $3,100 directly to your executives to cover their tax liability, and pay the remaining $6,900 into the secular trust. That shields your key executives from having to pay taxes out of their own pockets while guaranteeing the company's $10,000 deduction. Best of all, secular trusts can be combined with vesting schedules or forfeiture provisions to help tie an executive to your company over the long haul.

A variation on the secular trust is an equally obscure pension technique known as the rabbi trust, originated by a Long Island synagogue to provide a retirement fund for its rabbi. The chief difference is that funds contributed to a rabbi trust can be removed by creditors if a company goes bankrupt. That potential risk means the executive has no tax liability until the funds are withdrawn at retirement, when the distribution will be fully taxable. But it also means there's no tax deduction for the corporation until that point.

EMPLOYEE BENEFITS

Last year's tax package deserves credit for extending another tax subsidy, the deduction for education assistance. As the law stands now, your company can deduct education expenses of up to $5,250 per employee as long as you reimburse employees before December 31, 1991.

This deduction can apply to expenses for all course work, even non-job-related studies. To qualify you must make the benefit available to all your employees and you must document that in your employee manual or other materials. One other caveat: the deduction applies only to course costs, not to travel or other expenses.

ESTATE PLANNING

* Estate Freeze. Perhaps the best news for business owners comes from the 1990 repeal of a provision in the 1987 tax law that had eliminated, as a practical matter, one of the most popular estate-planning techniques, the so-called estate freeze. Under the freeze, owners can give away future growth in their businesses -- either to children or to key employees -- without paying any immediate or future gift or estate taxes on that growth.

For owners ready to tackle the task of estate planning, the savings can be enormous. As Peter Faber, a partner at the New York City law firm of Kaye, Scholer, Fierman, Hays & Handler, explains: "If I owned 100% of the stock in a business worth $10 million and simply gave it or left it to my daughter, I'd owe about $5.5 million in gift taxes. If I waited until it grew to $12 million, I'd owe even more. But if I used the estate-freeze technique instead, I'd avoid immediate gift taxes and manage to pass along all the future growth in the business, tax-free."

In simple terms, here's how an estate freeze works. Owners turn in to the corporation their existing common stock, exchanging it for a set of preferred stock shares created by the company. The common and preferred shares can be designed to have roughly equivalent value, so there's no immediate tax on the swap. The preferred shares pay the owner a regular dividend but will not increase in value. Instead, future growth belongs to the child or employee who, at the time of the freeze, purchases common stock. The purchase price is low because most of the corporation's value is in the preferred stock. The kids or employees can eventually buy the preferred stock, but in the meantime the government is willing to let them have the common stock, which represents all future growth, for a nominal price.

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