It’s a Family Affair – Split-Dollar Life Users Should Take Heed of Court’s Ruling

It’s a Family Affair – Split-Dollar Life Users Should Take Heed of Court’s Ruling

Oh, how I enjoy a dysfunctional family story.

My parents are gone now and it’s been years since we’ve all gotten together, brother and sisters, nephews and nieces, aunties, uncles, cousins and those special friends embraced as family – the poor devils.

We love each other dearly in my clan – desperately, even, as if no one else understands us, appreciates us, would have us. Do I detect knowing nods across the ether, my friends?

You see, there was strife within the walls of our stereotypical 1950s-style ranch – in every dream home a heartache, as the song laments.

Christmas and New Years, ever soiled with regrets: Monopoly games sullied by cheating; Boggle competitions that still wash blood sisters with tears; that fresh-baked pie meant for everyone, that vanished to crumbs – Paul was in the kitchen alone, who else could have eaten it?

He still feigns disgust at the notion: one man eating a whole pie, my mother’s rich pumpkin! Why, it would take a monster with a Tyrannosaur’s maw to do it, says Paul, masterfully innocent to this day. I know what he did!

I’m thankful for this: there’s no family business to run. We each have careers: Paul is a playwright; Annie-Bannanie, as dad called her, a retired RN; Mary’s an administrative manager; me, you more or less know. The distance keeps us together; not all families are so lucky.

They say the grandkids burn down the family shop, sparking the powder spread by the second generation. That’s not truly fair;     most wealthy families do their best, plan hard, build strong fortifications to protect their members, perhaps from each other. But even their best efforts slip off the boat dock at times.

Consider the case of the Morrissette family. If we apply Lieutenant Columbo’s inquisitive method, we can learn about estate planning and taxes, the kaleidoscopic uses of permanent life, and the inestimable value of good tax planners – and attorneys. Now that I think, Columbo isn’t our best model: no one was literally murdered. Ghouls out there can always place hopes in the next generation.

We know the scandal of their family drama because it ended up in court. Not the lively criminal variety, but the lowest floor of the dungeon of justice: tax court. The IRS went after them – note to all listeners, expect more of same. President Joe Biden is seeking an $80 billion supplement to help the tax grabbers ferret out dodgers. Don’t expect mercy or fine reason.

The family did OK in court, mind you. Most of the IRS’s points were struck down, though not for want of vigor on the agency’s part. One commentator called the IRS’s strategy the ‘throw it against the wall and see what sticks’ approach. In other words: attack on all fronts, we’ll win a point somewhere. The scattergun ploy is hard to parry and the legal expenses are high, though minor compared to losing.

I tripped past the word ‘most’ to soften the blow. The brothers had been using a vehicle of interest: a split-dollar agreement, or SDA. This scheme is based on permanent life insurance; it’s not a product or policy per se, but an agreement between parties. It’s commonly used as a form of deferred executive compensation, usually tied to performance or service term targets.

In the case of the Brothers Morrissette, an SDA was employed to keep the business in the family beyond their ultimate demise. It was a well-meaning gesture, but they built too complex a structure. Each brother had a trust; the family business had its own, set up by the parents; and each was paying the other’s bills. I’m fond of the word ‘Gordian’ and can only lament that when a champion came to unravel their knot, it was the IRS, sword drawn.

The whole family business was a – what was that other Greek word I just used? – yes, a kaleidoscope of trusts and odd structures, but in essence, the brothers ended up with fully paid permanent life policies on each other, to buy out the first-to-go’s shares. The company paid the premiums; part of the death benefit would repay them; then the balance of the multi-million death benefits would go to the brother-survivors to buy out their bro’s morbid shares. I’m exhausted and confused just typing it up.

The parents knew their sons – jealous, differently abled, variously loyal to blood, yet devoted to the company, a money machine – and anticipated trouble when the boys were unsupervised. They set up trusts. They brought in the tax lawyers. Plan, plan, plan. Dad founded their firm in 1944; it’s a generational thing: prudence and wisdom. Still, mistakes were made.

During a brief episode of cooperation, the sons found too much real estate in mom’s assets (dad, the founder, had wisely taken the eternal powder): a huge estate tax bill was waiting for them. With atypical prescience, they restructured her estate (mom was down with dementia, alas). The SDA was only part of a much bigger program. Yet it all seemed prudent and the court generally concurred.

The judge noted the brothers were clearly aiming at tax advantage, but said this was OK, as long as everything was structured to honestly achieve ‘non-tax business purposes’. Clever for once, boys: under the law, you can’t dodge taxes as an aim in itself. In structuring an estate, every step taken requires a direct business purpose. That’s my read of the judge’s ruling; jot it on your blotter, as I’m fond of saying.

But wait, said the judge, there’s just a couple of things… Oh brothers, your soundest intentions are undone in execution. Dodging one bullet, they were struck by the next: a ‘good faith’ valuation mistake. The SDA called for the brothers to pay the company trust $30 million; after some backflips, they “turned it into $7.5 million for estate tax purposes. They should have known…” and I’ll cut the quote here from the judge’s ruling, ‘nuff said.

The boys weren’t trying to break the law. Yet they made a mistake that’s common in reasoning, and estate planning, too: just because something is rationally constructed, doesn’t mean it’s correct. The law presumes good sense, no matter what your family history says.

When mitigating taxes, the presiding judge provides watchwords to remember in 2021 and beyond: non-tax business purposes; reasonable valuations and appraisals. I’ll add this: don’t skimp on your tax lawyer. As always, the ‘debil’ jumps up in the details, and the Morrissette boys may be facing one helluva tax penalty.

No parallel problems in my goofy, median-American unbalanced family. Mary’s buying a house now; she just wrote to say that in my “dotage” I can come live with her. Wow, but… I’m not the burdening type. Still, the Boggle board beckons, and she knows all of mom’s recipes.

Let the gaming roll on, with no losses to lament: it’s only Monopoly dollars. The Lavrakas family knows how to rock a party at holiday time.

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