Month: October 2017

Many investors, especially more risk-averse ones, hold much of their portfolios in “income investments” — those that pay interest or dividends, with less emphasis on growth in value. But all income investments aren’t alike when it comes to taxes. So it’s important to be aware of the different tax treatments when managing your income investments.

Varying tax treatment

The tax treatment of investment income varies partly based on whether the income is in the form of dividends or interest. Qualified dividends are taxed at your favorable long-term capital gains tax rate (currently 0%, 15% or 20%, depending on your tax bracket) rather than at your ordinary-income tax rate (which might be as high as 39.6%). Interest income generally is taxed at ordinary-income rates. So stocks that pay dividends might be more attractive tax-wise than interest-paying income investments, such as CDs and bonds.

But there are exceptions. For example, some dividends aren’t qualified and therefore are subject to ordinary-income rates, such as certain dividends from:

• Real estate investment trusts (REITs),
• Regulated investment companies (RICs),
• Money market mutual funds, and
• Certain foreign investments.

Also, the tax treatment of bond interest varies. For example:

• Interest on U.S. government bonds is taxable on federal returns but exempt on state and local returns.
• Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also might be excludable on your state return.
• Corporate bond interest is fully taxable for federal and state purposes.

One of many factors

Keep in mind that tax reform legislation could affect the tax considerations for income investments. For example, if your ordinary rate goes down under tax reform, there could be less of a difference between the tax rate you’d pay on qualified vs. nonqualified dividends.

While tax treatment shouldn’t drive investment decisions, it’s one factor to consider — especially when it comes to income investments. For help factoring taxes into your investment strategy, contact us.

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Did you know that if you’re self-employed you may be able to set up a retirement plan that allows you to contribute much more than you can contribute to an IRA or even an employer-sponsored 401(k)? There’s still time to set up such a plan for 2017, and it generally isn’t hard to do. So whether you’re a “full-time” independent contractor or you’re employed but earn some self-employment income on the side, consider setting up one of the following types of retirement plans this year.

Profit-sharing plan

This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. (As a self-employed person, you’re both the employer and the employee.) You can make deductible 2017 contributions as late as the due date of your 2017 tax return, including extensions — provided your plan exists on Dec. 31, 2017.

For 2017, the maximum contribution is 25% of your net earnings from self-employment, up to a $54,000 contribution. If you include a 401(k) arrangement in the plan, you might be able to contribute a higher percentage of your income. If you include such an arrangement and are age 50 or older, you may be able to contribute as much as $60,000.

Simplified Employee Pension (SEP)

This is a defined contribution plan that provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2018 and still make deductible 2017 contributions as late as the due date of your 2017 income tax return, including extensions. In addition, a SEP is easy to administer.

For 2017, the maximum SEP contribution is 25% of your net earnings from self-employment, up to a $54,000 contribution.

Defined benefit plan

This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit for 2017 is generally $215,000 or 100% of average earned income for the highest three consecutive years, if less.

Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit. You can make deductible 2017 defined benefit plan contributions until your return due date, provided your plan exists on Dec. 31, 2017.

More to think about

Additional rules and limits apply to these plans, and other types of plans are available. Also, keep in mind that things get more complicated — and more expensive — if you have employees. Why? Generally, they must be allowed to participate in the plan, provided they meet the qualification requirements. To learn more about retirement plans for the self-employed, contact us.

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Any business owner developing a succession plan should rightfully assume that regular business valuations are a must. When envisioning the valuation process, you’re likely to focus on its end result: a reasonable, 

defensible value estimate of your business as of a certain date. But lurking beneath this number is a variety of often hard-to-see issues.

Estate tax liability

One sometimes blurry issue is the valuation implications of whether you intend to transfer the business to the next generation during your lifetime, at your death or upon your spouse’s death. If, for example, you decide to bequeath the company to your spouse, no estate tax will be due upon your death because of the marital deduction (as long as your spouse is a U.S. citizen). But estate tax may be due on your spouse’s death, depending on the business’s value and estate tax laws at the time.

Speaking of which, President Trump and congressional Republicans have called for an estate tax repeal under the “Unified Framework for Fixing Our Broken Tax Code” issued in late September. But there’s no guarantee such a provision will pass and, even if it does, the repeal might be only temporary.

So an owner may be tempted to minimize the company’s value to reduce the future estate tax liability on the spouse’s death. But be aware that businesses that appear to have been undervalued in an effort to minimize taxes will raise a red flag with the IRS.

Inactive heirs and retirement

Bear in mind, too, that your heirs may have different views of the business’s proper value. This is particularly true of “inactive heirs” — those who won’t inherit the business and whose share, therefore, may need to be “equalized” with other assets, such as insurance proceeds or real estate. Your appraiser will need to clearly understand the valuation’s purpose and your estate plan.

When (or if) you plan to retire is another major issue to be resolved. If you want your children to take over, but you need to free up cash for retirement, you may be able to sell shares to successors. Several methods (such as using trusts) can provide tax advantages as well as help the children fund a business purchase.

Abundant complexities

Obtaining a valuation in relation to your succession plan involves much more than establishing a sale price, transitioning ownership (or selling the company), and sauntering off to retirement. The details are many and potential conflicts abundant. Let us help you anticipate and manage these complexities to ensure a smooth succession.

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If you’re an executive or other key employee, you might be rewarded for your contributions to your company’s success with compensation such as restricted stock, stock options or nonqualified deferred compensation (NQDC). Tax planning for these forms of “exec comp,” however, is generally more complicated than for salaries, bonuses and traditional employee benefits.

And planning gets even more complicated if you could potentially be subject to two taxes under the Affordable Care Act (ACA): 1) the additional 0.9% Medicare tax, and 2) the net investment income tax (NIIT). These taxes apply when certain income exceeds the applicable threshold: $250,000 for married filing jointly, $125,000 for married filing separately, and $200,000 for other taxpayers.

Additional Medicare tax

The following types of exec comp could be subject to the additional 0.9% Medicare tax if your earned income exceeds the applicable threshold:

• Fair market value (FMV) of restricted stock once the stock is no longer subject to risk of forfeiture or it’s sold,
• FMV of restricted stock when it’s awarded if you make a Section 83(b) election,
• Bargain element of nonqualified stock options when exercised, and
• Nonqualified deferred compensation once the services have been performed and there’s no longer a substantial risk of forfeiture.

NIIT

The following types of gains from stock acquired through exec comp will be included in net investment income and could be subject to the 3.8% NIIT if your modified adjusted gross income (MAGI) exceeds the applicable threshold:

• Gain on the sale of restricted stock if you’ve made the Sec. 83(b) election, and
• Gain on the sale of stock from an incentive stock option exercise if you meet the holding requirements.

Keep in mind that the additional Medicare tax and the NIIT could possibly be eliminated under tax reform or ACA-related legislation. If you’re concerned about how your exec comp will be taxed, please contact us. We can help you assess the potential tax impact and implement strategies to reduce it.

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With so much data flying around these days, it’s easy for a company of any size to get overwhelmed. If something important falls through the cracks, say a contract renewal or outstanding bill, your financial standing and reputation could suffer. Here are four ways to get — and keep — your business data in order:

1. Simplify, simplify, simplify. Look at your data in broad categories and see whether and how you can simplify things. Sometimes refiling documents under basic designations such as “vendors,” “leases” and “employee contracts” can help you get better perspective on your information. In other cases, you may need to realign your network or file storage to more closely follow how your company operates today.

2. Implement a data storage policy. A formal effort toward getting organized can help you target what’s wrong and determine what to do about it. In creating this policy, spell out which information you must back up, how much money you’ll spend on this effort, how often backups must occur and where you’ll store backups.

3. Reconsider the cloud. Web-based data storage, now commonly known as “the cloud,” has been around for years. It allows you to store files and even access software on a secure remote server. Your company may already use the cloud to some extent. If so, review how you’re using the cloud, whether your security measures are adequate, and if now might be a good time to renegotiate with your vendor or find a new one.

4. Don’t forget about email. Much of your company’s precious data may not be in files or spreadsheets but in emails. Although it’s been around for decades, this medium has grown in significance recently as email continues to play a starring role in many legal proceedings. If you haven’t already, establish an email retention policy to specify everyone’s responsibilities when it comes to creating, organizing and deleting (or not deleting) emails.

Virtually every company operating today depends on data, big and small, to compete in its marketplace and achieve profitability. Please contact us regarding cost-effective ways to store, organize and deploy your company’s mission-critical information.

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Business owners may not be able to set aside as much as they’d like in tax-advantaged retirement plans. Typically, they’re older and more highly compensated than their employees, but restrictions on contributions to 401(k) and profit-sharing plans can hamper retirement-planning efforts. One solution may be a cash balance plan.

Defined benefit plan with a twist

The two most popular qualified retirement plans — 401(k) and profit-sharing plans — are defined contribution plans. These plans specify the amount that goes into an employee’s retirement account today, typically a percentage of compensation or a specific dollar amount.

In contrast, a cash balance plan is a defined benefit plan, which specifies the amount a participant will receive in retirement. But unlike traditional defined benefit plans, such as pensions, cash balance plans express those benefits in the form of a 401(k)-style account balance, rather than a formula tied to years of service and salary history.

The plan allocates annual “pay credits” and “interest credits” to hypothetical employee accounts. This allows participants to earn benefits more uniformly over their careers, and provides a clearer picture of benefits than a traditional pension plan.

Greater savings for owners

A cash balance plan offers significant advantages for business owners — particularly those who are behind on their retirement saving and whose employees are younger and lower-paid. In 2017, the IRS limits employer contributions and employee deferrals to defined contribution plans to $54,000 ($60,000 for employees age 50 or older). And nondiscrimination rules, which prevent a plan from unfairly favoring highly compensated employees (HCEs), can reduce an owner’s contributions even further.

But cash balance plans aren’t bound by these limits. Instead, as defined benefit plans, they’re subject to a cap on annual benefit payouts in retirement (currently, $215,000), and the nondiscrimination rules require that only benefits for HCEs and non-HCEs be comparable.

Contributions may be as high as necessary to fund those benefits. Therefore, a company may make sizable contributions on behalf of owner/employees approaching retirement (often as much as three or four times defined contribution limits), and relatively smaller contributions on behalf of younger, lower-paid employees.

There are some potential risks. The most notable one is that, unlike with profit-sharing plans, you can’t reduce or suspend contributions during difficult years. So, before implementing a cash balance plan, it’s critical to ensure that your company’s cash flow will be steady enough to meet its funding obligations.

Right for you?

Although cash balance plans can be more expensive than defined contribution plans, they’re a great way to turbocharge your retirement savings. We can help you decide whether one might be right for you.

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Various limits apply to most tax deductions, and one type of limit is a “floor,” which means expenses are deductible only if they exceed that floor (typically a specific percentage of your income). One example is the medical expense deduction.

Because it can be difficult to exceed the floor, a common strategy is to “bunch” deductible medical expenses into a particular year where possible. If tax reform legislation is signed into law, it might be especially beneficial to bunch deductible medical expenses into 2017.

The deduction

Medical expenses that aren’t reimbursable by insurance or paid through a tax-advantaged account (such as a Health Savings Account or Flexible Spending Account) may be deductible — but only to the extent that they exceed 10% of your adjusted gross income. The 10% floor applies for both regular tax and alternative minimum tax (AMT) purposes.

Beginning in 2017, even taxpayers age 65 and older are subject to the 10% floor. Previously, they generally enjoyed a 7.5% floor, except for AMT purposes, where they were also subject to the 10% floor.

Benefits of bunching

By bunching nonurgent medical procedures and other controllable expenses into alternating years, you may increase your ability to exceed the applicable floor. Controllable expenses might include prescription drugs, eyeglasses and contact lenses, hearing aids, dental work, and elective surgery.

Normally, if it’s looking like you’re close to exceeding the floor in the current year, it’s tax-smart to consider accelerating controllable expenses into the current year. But if you’re far from exceeding the floor, the traditional strategy is, to the extent possible (without harming your or your family’s health), to put off medical expenses until the next year, in case you have enough expenses in that year to exceed the floor.

However, in 2017, sticking to these traditional strategies might not make sense.

Possible elimination?

The nine-page “Unified Framework for Fixing Our Broken Tax Code” that President Trump and congressional Republicans released on September 27 proposes a variety of tax law changes. Among other things, the framework calls for increasing the standard deduction and eliminating “most” itemized deductions. While the framework doesn’t specifically mention the medical expense deduction, the only itemized deductions that it specifically states would be retained are those for home mortgage interest and charitable contributions.

If an elimination of the medical expense deduction were to go into effect in 2018, there could be a significant incentive for individuals to bunch deductible medical expenses into 2017. Even if you’re not close to exceeding the floor now, it could be beneficial to see if you can accelerate enough qualifying expense into 2017 to do so.

Keep in mind that tax reform legislation must be drafted, passed by the House and Senate and signed by the President. It’s still uncertain exactly what will be included in any legislation, whether it will be passed and signed into law this year, and, if it is, when its provisions would go into effect. For more information on how to bunch deductions, exactly what expenses are deductible, or other ways tax reform legislation could affect your 2017 year-end tax planning, please contact us.

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