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 That potential risk means the executive has no tax liability until the funds are withdrawn at retirement, when the distribution will be fully taxable.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.
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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.
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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.
The 1990 tax law left one real risk. "If the IRS decides that the preferred stock an owner receives in place of his common stock is worth much less than the original common stock's value -- usually because it doesn't pay an adequate dividend -- the owner will have to pay a gift tax on the transfer," warns Arthur H. Rosenbloom, chairman of MMG Patricof & Co., an international investment banking firm in New York City. To avoid that, peg the preferred stock's dividend and other characteristics at levels that match those of publicly traded preferred stock with similar characteristics.
* GRITs. The opportunities for using grantor retained income trusts (GRITs), another once-popular tax-and estate-planning technique, have narrowed, but there are still some tax advantages. In the past, business owners could have used GRITs to reduce the gift taxes that come due when transferring their businesses to their children. Owners who used them would hold on to the investment income from their businesses over a specified number of years, even though they had passed ownership of the companies over to an irrevocable trust.
GRITs can still be used to pass on ownership of a residence, whether it's a yearlong or vacation home. "So if a man owns a $1-million residence and knows he plans to retire to Florida in 15 years, he can transfer ownership of the home to a 15-year GRIT whose beneficiary is his son or daughter," suggests Richard Rothberg, a trusts-and-estates partner at the New York City law firm of Kronish, Lieb, Weiner & Hellman. The IRS would then assign a present value to the gift, based on actuarial tables pegged to the owner's age, life expectancy, and the length of the GRIT; if those tables assigned, say, a 25% present value, the owner would have to pay gift taxes on only a $250,000 transfer, though the house was worth four times as much.
GRITs may also still be used with gifts of artwork and other tangible personal property.
* Selling the Business. Don't listen to people who say there's no way to avoid taxes on the sale of a business. You can make use of a device called a charitable remainder trust, which is a trust that at some point passes on to a charity everything that remains in it.
"It comes into play when someone has a low cost basis [valuation at the time you start up or purchase a company] in his business and the potential to sell it at a very nice profit," explains Douglas Brown, president of Sherwood Trust Consultants, in Springfield, Mass. "He sets up a charitable remainder trust and gives it a life term, after which the trust will go to the charity. He donates his stock to the trust and then receives an immediate charitable income-tax deduction." The trust then sells the stock to an outside buyer (ideally, the buyer has already been identified and oral negotiations have taken place); the purchase price passes into the trust, where it earns investment income (possibly tax-free) and continues to pay the founder an agreed-upon rate of return over the rest of the trust's lifetime.
