Using Business Dollars to Fund S.O.L.A.R. Insurance Arrangements

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1 Using Business Dollars to Fund S.O.L.A.R. Insurance Arrangements A Self Owned Life And Retirement (S.O.L.A.R.) Insurance Arrangement is an arrangement where an employee purchases a Voya Indexed Universal Life-Global Choice (Voya IUL-Global Choice) policy issued by Security Life of Denver Insurance Company to provide death benefit protection and to help supplement income in retirement. S.O.L.A.R. Insurance Arrangements are designed to reduce the complexity and risks associated with employer sponsored retirement plans. page 1 of 8 When using a S.O.L.A.R. Insurance Arrangement for one or more business owners, consideration needs to be given to whether premiums should be funded directly by the business or with after-tax funds from the business owner. If money is to come directly from the business, how will this be reported? If a distribution is first made to the business owner, how will it be taxed? And if the business owner wants to fund a S.O.L.A.R. Insurance Arrangement on a pre-tax or pre-tax equivalent basis using Select Loans, will this require using a Net Policy Loan? The answers to these questions may depend on whether the underlying business is a sole proprietorship, partnership, C corporation, S corporation, or LLC. The Voya Life Companies and their agents and representatives do not give tax or legal advice. These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor.

2 page 2 of 8 Some of the considerations for business owners include: Different types of business entities have different reporting and filing requirements for tax purposes. Some entities are completely disregarded, some entities file only informational returns, and other entities file returns and pay their own income taxes. For most business owners taxation of distributions from the business will vary depending on whether the distribution is characterized as compensation (salary and bonuses) or a share of profits (dividends and partnership distributions). Compensatory income is typically subject to Social Security and Medicare taxes while profits and dividends are not. Dividends, however, may introduce a second level of taxation to the money being distributed. While S.O.L.A.R. Insurance Arrangements use after-tax money to fund life insurance for death benefit protection and accumulation needs, clients may want to use the full pre-tax amount to pay policy premiums. Clients may then take a Select Loan to pay the income taxes due. Alternatively, where taxes have already been paid through tax withholding, the client may consider taking a Select Loan using a Net Policy Loan (hereafter referred to as taking a Net Select Loan ). A Net Select Loan allows a client to request that a Select Loan be applied to the policy as an additional premium payment to increase the policy premium to its pre-tax equivalent.

3 page 3 of 8 Sole Proprietorships Many businesses do not have an entity separate from the business owner. Such businesses (including doing business as or DBAs ) involve no more than the owner engaging in some activity for profit. These businesses are neither incorporated nor do they have any passive investors. They are disregarded entities for tax purposes. Sole proprietorships neither pay taxes as a business entity nor do they file a separate tax return for reporting purposes. Instead, profits and losses from the business are reported on the owner s individual tax return on Schedule C of Form Moreover, a sole proprietor must pay estimated taxes on a quarterly basis. Because sole proprietorships are disregarded entities for tax purposes, there are no distributions from the business (and thus there is no tax withholding on money received from business activities). The owner is taxed on profits (or losses) from the business as part of his or her ordinary income (at his or her ordinary tax rates). The owner must also pay self-employment taxes (Social Security and Medicare taxes) on all income from the business. Because there is no tax withholding on funds received from the business, and because sole proprietors pay estimated quarterly taxes, these business owners may consider using Select Loans to pay income taxes on the money used to pay Voya IUL-Global Choice premiums. The business owner can write either a personal check or a business check to pay premiums. Then, when quarterly estimated taxes come due, the business owner can take a Select Loan to cover the income taxes associated with the premiums. Example: Henry is a self-employed handy man doing business as Handy Hank. Last year he made a net profit of $50,000. This $50,000 will be reported on Schedule C of his individual tax return and will be subject to self-employment taxes.

4 page 4 of 8 Partnerships A partnership is a collection of two or more persons engaging in an activity for profit. Like a sole proprietorship, a partnership is not a taxable entity for income tax purposes, but operates under a conduit or pass through principle where all of the partnership s income is allocated between the owners based on their proportion of ownership. A limited partnership is a special type of partnership entity that allows for passive investors, but is still not a separate entity for income tax purposes. Unlike sole proprietorships, partnerships must file an informational tax return. The partnership does not pay taxes, but files a Form 1065 to report total business income to the IRS. The partnership attaches to Form 1065 a Schedule K-1 for each partner indicating what portion of the business income is allocated to that partner. The partner pays ordinary income taxes on what is reported on the Schedule K-1 regardless of whether the partner received any actual distributions from the partnership. The partnership must also report compensation paid to individuals as either W-2 income or 1099 income. Partners may receive money from the partnership either as compensation (salary and bonuses) or as a partnership distribution. Money received as compensation is taxed to the partner as ordinary income and is subject to Social Security and Medicare taxes. After paying salaries and bonuses, partnerships can make additional distributions to partners on a pro-rata basis. These distributions are allocated to each partner on a Schedule K-1 and are taxed at ordinary income tax rates (but are not subject to Social Security or Medicare taxes). Because partnership distributions (K-1 income) are not subject to Social Security or Medicare taxes, a partner funding a S.O.L.A.R. Insurance Arrangement may want to consider using such distributions as a source of premium payments. The partner can then use Select Loans to pay quarterly estimated income taxes when they come due. For larger partnerships (such as law or accounting firms) it may make sense to use bonuses to provide for premiums. This would especially be the case if only a few of the partners were using S.O.L.A.R. Insurance Arrangements. Since bonuses would be subject to tax withholding, Net Select Loans may be more appropriate for these cases. Example: Peter and Paul are equal partners in a lawn care business. Peter takes a $40,000 annual salary and Paul takes a $30,000 salary. Last year the business had total profits (pre-salary) of $100,000. This leaves $30,000 of profits after salaries have been paid. Peter will have total compensation of $55,000 ($40,000 salary + $15,000 allocation of profits). $40,000 will be reported as W-2 income and will be subject to Social Security and Medicare taxes. $15,000 will be reported as income on a Schedule K-1 and will be taxed as ordinary income (but not subject to Social Security and Medicare taxes).

5 page 5 of 8 C Corporations The most traditional corporate structure is a C corporation. These entities are created by filing articles of incorporation with the state in which they are formed and by issuing shares of stock to investors (who may or may not be involved in running the business). A C corporation is a separate and distinct entity for tax purposes and must pay income taxes on its earnings (after deducting amounts paid as compensation). C corporations may make non-compensatory distributions to shareholders by declaring dividends. Dividends are taxable as investment income and must be allocated to shareholders in proportion to the number of shares they hold. C corporations file their own tax returns using IRS Form C corporations pay income taxes on net profits (with marginal tax rates ranging from 15% - 39%). C corporations must also report compensation paid to individuals as either W-2 income or 1099 income. Shareholders of C corporations have two potential ways to receive money from the business. First, they can receive money as an element of compensation (e.g., as salary or bonus). Money received as compensation will be taxable to the individual as ordinary income (with marginal rates ranging from 10% %) and would be subject to Social Security and Medicare taxes (6.2% of up to $113,700 of income). However, so long as compensation is reasonable, these amounts will be deducted from the taxable income of the C corporation. Second, shareholders may receive money from the business in the form of dividends. Dividends are taxed at rates from 15% % (including the 3.8% Medicare surtax). Unlike compensation, dividend payments are not deductible to the C corporation. This means that money paid out in dividends has been taxed twice (first as income to the corporation and then as investment income to the shareholder). Because dividend payments result in double taxation, majority shareholders may want to consider using additional compensation as a resource for S.O.L.A.R. Insurance Arrangements rather than declaring additional dividends. If money is received from the C corporation as compensation, it will be subject to tax withholding. In this situation Net Select Loans may be used to restore premium payments to their pre-tax equivalent. Dividends, on the other hand, are typically not subject to tax withholding and so Select Loans may be used to pay taxes when they come due. Example: Chad is a 40% shareholder of Widget Co., a business that manufactures and sells widgets. Widget Co. pays Chad an annual salary of $75,000. After paying salaries and other business expenses, Widget Co. had a net profit of $150,000. Widget Co. elects to retain $25,000 for future expenses and distributes $100,000 as dividends to shareholders. Widget Co. must pay taxes on $125,000. Chad will have $75,000 of salary reported as W-2 income. This $75,000 will be taxed at ordinary income rates and will be subject to Social Security and Medicare taxes. Chad will also have $40,000 of dividends (40% of $100,000) which will be taxed as investment income.

6 page 6 of 8 S Corporations Like C corporations, S corporations are corporate entities created by filing articles of incorporation with the state in which they are formed and by issuing shares of stock to investors (who may or may not be involved in running the business). Unlike C corporations, S corporations are disregarded for income tax purposes and, like partnerships, operate under a conduit or pass through principle where all business income is allocated between owners based on their proportion of ownership. Like partnerships, S corporations must file an informational tax return. The S corporation does not pay taxes, but files a Form 1120S to report total business income to the IRS. The S corporation attaches to Form 1120S a Schedule K-1 for each shareholder indicating what portion of the business income is allocated to that owner. The shareholder pays ordinary income taxes on what is reported on the Schedule K-1 regardless of whether he or she received any actual distributions from the business. The S corporation must also report compensation paid to individuals as either W-2 income or 1099 income. Shareholders may receive money from the business either as compensation (salary and bonuses) or as dividends. Money received as compensation is taxed as ordinary income and is subject to Social Security and Medicare taxes. After paying salaries and bonuses, the S corporation can make distributions to shareholders by paying dividends. Unlike C corporation dividends, S corporation dividends are not taxed as investment income. Rather these dividends are taxed to the shareholders as ordinary income (but with no Social Security or Medicare taxes). Because S corporation dividends are not subject to Social Security or Medicare taxes, a shareholder funding a S.O.L.A.R. Insurance Arrangement may want to consider using such distributions as a source of premium payments. The shareholder can then use Select Loans to pay quarterly estimated income taxes when they come due. Example: Sally is the 100% owner of a catering business organized as an S corporation. Sally pays herself a $50,000 annual salary. Last year the business had profits of $125,000 (pre-salary). Sally will have total compensation of $125,000 ($50,000 salary + $75,000 allocation of profits). $50,000 will be reported as W-2 income and will be subject to Social Security and Medicare taxes. $75,000 will be reported as income on a Schedule K-1 and will be taxed as ordinary income (but not subject to Social Security and Medicare taxes).

7 page 7 of 8 LLCs A relatively new form of business entity is the limited liability company ( LLC ). These entities attempt to provide business owners with the liability shield of a corporation while offering the conduit or pass through principle for taxation. Under regulations which became effective in 1997, LLCs with two or more members can choose whether to be taxed as partnerships, S corporations, or C corporations. Single-member LLCs are treated as sole proprietorships. For any given LLC, determine how the entity has elected to be taxed and refer to the appropriate section above for tax and distribution considerations.

8 page 8 of 8 To learn more about S.O.L.A.R. Insurance Arrangements using Voya IUL-Global Choice, contact your Voya Life Companies Representative or call , Option 4. Visit us at These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor. The Voya Life Companies and their agents and representatives do not give tax or legal advice. This information is general in nature and not comprehensive; the applicable laws change frequently and the strategies suggested may not be suitable for everyone. Each taxpayer should seek advice from his or her tax and legal advisors regarding their individual situation. Voya Indexed Universal Life - Global Choice (Voya IUL-Global Choice), policy form series # /12 has an equity Indexed feature, varies by state and may not be available in every state. It is issued by Security Life of Denver Insurance Company (Denver, CO), a member of the Voya family of companies. Not available in New York. The Index Cap and Index Participation Rate are subject to change for new Index Blocks. All guarantees are based on the financial strength and claims paying ability of Security Life of Denver Insurance Company who is solely responsible for the obligations under its own policies. Policy loans and withdrawals may reduce or eliminate index credits, generate an income tax liability, reduce available surrender value and reduce the death benefit, or cause the policy to lapse. Additionally, loans may limit your ability to make elections to the Indexed Strategy; if a loan results in amounts being deducted from a block prior to its block maturity date, no elections from the Fixed Strategy to the Indexed Strategy will be processed in the 18 months following the loan. Select Loans have the risk that policy performance may be lower than projected if the amount credited to the account value in the Fixed Strategy and/or Indexed Strategy is less than the fixed 6% interest charged on the policy loan Voya Services Company. All rights reserved. CN /01/2014 Voya.com