Page 266 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

252 The Complete Guide to Executive Compensation

Tax Shelters. Tax avoidance is the main attraction of tax shelters for many highly
compensated executives. This typical shelter consists of a group of investors who have formed
a partnership, thus enabling them to claim personal deductions (not available to an
association or corporation) proportionate to their personal investment in the partnership.
Tax shelters were created (and are periodically massaged) by Congress to encourage invest-
ment in ventures where the risk/reward ratio is otherwise not sufficiently attractive. The 1986
Tax Reform Act removed much of the appeal of tax shelters. Contrary to popular belief, tax
shelters were not designed with the sole purpose of allowing millionaires to avoid taxes. In
exchange for the right to currently reduce taxable income and/or receive future income as
capital gains rather than ordinary income, the individual accepts a higher risk of protecting the
investment than otherwise might be the case. In real estate, it is speculation that land and prop-
erty will appreciate favorably in terms of inflation. With gas and oil drilling, it is the probability
of a successful strike. With equipment leasing, it is the belief that the supply of equipment will
not be greater than the demand for the period of investment. Therefore, it is important that the
executive identify and prioritize personal objectives regarding deferral of income,
capital gains versus ordinary income, security of investment, and degree of desired liquidity.
The problem, therefore, is not finding a tax shelter but, rather, finding one that meets the
investment caliber of the executive and provides an opportunity for economic value as well as
tax write-offs. One of the major problems facing some executives, who have benefited from
significant depreciation write-offs, is how to dispose of heavily depreciated property without
massive tax liabilities. Furthermore, many tax shelter opportunities that meet the economic
requirements are not timed in an effective manner for a particular executive. Unfortunately,
too often executives give more consideration to purchasing a particular $50,000 car than to
investing $500,000 in a specific tax shelter.
Estate Planning. A key objective in estate planning is not simply to minimize taxes when the
executive dies, but to provide an orderly plan whereby the executive’s assets are delivered to
the proper individuals in the most tax-effective manner, which includes minimizing the tax
impact on the estate of the executives spouse. Estate plans should be periodically reviewed,
especially, when the person changes jobs, moves to a different state, gets married, gets
divorced, a family member is added or one dies, or assets change significantly.
Put in place shortly after the beginning of the century, estate taxes were intended to
reduce the concentration of wealth. As shown in Table 6.9, although the federal estate tax is
scheduled to disappear in 2010, it will return a year later unless legislation extends the
disappearance. The 2001 Tax Relief Act, which phases out federal estate taxes, also eliminated
the state tax credit to the federal estate tax bill by 2005. But many states have passed laws to
replace the lost taxes. Effective financial planners will ensure all appropriate tax-avoidance
measures are used. Perhaps one of the best measures is to take advantage of the unlimited
number of individuals one can give up to $12,000 annually ($24,000 with spousal consent) for
as long as one lives without any tax impact to self or recipient.
Certainly, the most basic provision is a properly executed will. A person who dies with-
out a will is said to have died intestate, and the appropriate state law(s) will apply. Normally,
these specify a certain percentage of the estate to the children and the remainder to the
spouse. It is not uncommon for executives to include personal secretaries or others (e.g.,
barber, chef, driver, gardener, housekeeper, or maid) in the will. It is not only a form of
“thank you” but also a severance payment. In doing so, care must be taken to ensure it is not
considered too generous by the family or too paltry by the recipients.