Top Strategies for Independent Pharmacy Owners to Reduce 2018 Taxes

Transcription

1 Top Strategies for Independent Pharmacy Owners to Reduce 2018 Taxes presented by Lawrence C. Barrett, CLU, ChFC, AEP Independent Pharmacy Consulting Group, LLC Private Wealth Advisor June 28, 2018 Lawrence C. Barrett is a registered representative of Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer. Member SIPC. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Independent Pharmacy Consulting Group, LLC is a marketing name used to conduct business through Lincoln Financial Advisors Corp. CRN Disclosures Lawrence Barrett is an employee with Independent Pharmacy Consulting Group, LLC/Sagemark Consulting. The conflict of interest was resolved by peer review of the slide content. This seminar is for informational purposes. All situations are different and this seminar does not have regard to the specific planning objectives, financial situation and the particular needs of any specific person who may view this seminar. The information presented is not intended or should be construed as investment advice and is not a recommendation for retirement savings. Tax Reduction Strategies presented are provided for informational purposes. Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances. Lincoln Financial Advisors Corp. can provide access to third party unaffiliated resources to assist business owners in Exit Planning. 1

2 Learning Objectives 1. Discuss 2018 tax laws and the implications for business and real estate ownership. 2. Outline how to use current tax deductions to generate future tax free retirement income. 3. Discuss strategy changes and next steps regarding business taxes. Your Presenter for Today s CE Presentation Lawrence C. Barrett, CLU, ChFC, AEP Private Wealth Advisor, Registered Representative 44 years of experience in financial services industry Graduated from Ohio Northern University in 1971 Bachelor of Science in Business Management and Marketing Has worked with Independent Pharmacies since the late 1970s Speaks to pharmacy students on becoming a successful business owner Frequent CE speaker for Cardinal Health, NCPA, buying groups, and state pharmacy associations 2

3 Top Strategies for Independent Pharmacy Owners to Reduce 2018 Taxes Learning Objectives 1. What do tax reform law changes look like for Discuss the Basic Business Deduction chart (IRC Section 199A). 3. Discuss the 2017 Tax Cuts and Jobs Act and its impact on business planning. 4. Explore retirement strategies designed to help the pharmacy owner accumulate significant wealth using current tax deductions and generating tax free retirement income. The 2017 Tax Cuts and Jobs Act 3

4 The 2017 Tax Cuts and Jobs Act Tax Rates Individual Tax Rate: The Act preserves seven tax brackets, with a top rate of 37% for income starting at $500,000 (indexed) for single individuals and heads of households and at $600,000 (indexed) for married individuals filing joint returns. Corporate Tax Rate: The top corporate tax rate is 21% under the Act, effective beginning in This reduced top income tax rate applies to any entities that are subject to income taxation under Subchapter C. The 2017 Tax Cuts and Jobs Act History of the Corporate Income Tax The Corporate income tax rate is cut from 35% to 21%. The lowest rate since the Great Depression. 4

5 BASIC BUSINESS DEDUCTION CHART (IRC Section 199A, Effective 1/1/ /31/2025) The IRC section 199A deduction is available to individual taxpayers, trusts and estates. Service Business? No Non Service Business taxable income over the threshold amount? $157,500/$315,000 No Deduction is 20% of QBI Yes Yes Service Business taxable income over the threshold amount? $157,500/$315,000 Yes No Deduction is 20% of QBI Non Service Business taxable income over full phaseout amount? $207,500/$415,000 No Reduced Deduction Amounts between $157,500 & $207,500 (S) $315,000 & $415,000 (MFJ) Deduction = Phaseout of deduction for amount over threshold and less than full phaseout amount. Service Business taxable income over full phaseout amount? $207,500/$415,000 Yes No Deduction Available No No Reduced Deduction Amounts between $157,500 & $207,500 (S) $315,000 & $415,000 (MFJ) Deduction = Phaseout of deduction for amount over threshold and less than full phaseout amount. Yes Allowable Deduction/Limitation Lesser of (A or B): (A) 20% x QBI or (B) Greater of: (i) 50% x W 2 Wages or (ii) 25% x W 2 Wages + 2.5% of Unadjusted Basis of tangible depreciable property Specified Service Businesses: Services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or any business where the business's principal asset is the reputation or skill of one or more of its employees or owners. Specified services does not include engineering or architecture services. Services consisting of investing and investment management, trading, or dealing in securities, partnership interests, or commodities are also covered as specified services. Qualified Business Income (QBI): From pass through entities (e.g., a sole proprietorship, a partnership, a disregarded entity, an LLC taxed as a partnership or s corporation, or an s corporation) is the net amount of items of income, gain, loss, and deduction from an eligible trade or business, except for items of capital gain and loss, and certain dividends from REITs, cooperatives, and publicly traded partnerships. This does not include reasonable compensation paid to the taxpayer/shareholder of an s corporation or guaranteed payments to a partner. However, QBI excludes investment type income (e.g., dividends and interest). Additionally, income must be U. S. based income. W 2 Wages: In general, W 2 wages is the sum of wages subject to withholding, elective deferrals, and deferred compensation paid by the Qualified Trade or Business (QTB) during the taxable year. BASIC BUSINESS DEDUCTION CHART (IRC Section 199A, Effective 1/1/ /31/2025) The IRC section 199A deduction is available to individual taxpayers, trusts and estates. Service Business? No Non Service Business taxable income over the threshold amount? $157,500/$315,000 No Deduction is 20% of QBI Yes Yes Service Business taxable income over the threshold amount? $157,500/$315,000 Yes No Deduction is 20% of QBI Non Service Business taxable income over full phaseout amount? $207,500/$415,000 No Reduced Deduction Amounts between $157,500 & $207,500 (S) $315,000 & $415,000 (MFJ) Deduction = Phaseout of deduction for amount over threshold and less than full phaseout amount. Service Business taxable income over full phaseout amount? $207,500/$415,000 Yes No Deduction Available No Reduced Deduction Amounts between $157,500 & $207,500 (S) $315,000 & $415,000 (MFJ) Deduction = Phaseout of deduction for amount over threshold and less than full phaseout amount. Yes Allowable Deduction/Limitation Lesser of (A or B): (A) 20% x QBI or (B) Greater of: (i) 50% x W 2 Wages or (ii) 25% x W 2 Wages + 2.5% of Unadjusted Basis of tangible depreciable property Specified Service Businesses: Services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or any business where the business's principal asset is the reputation or skill of one or more of its employees or owners. Specified services does not include engineering or architecture services. Services consisting of investing and investment management, trading, or dealing in securities, partnership interests, or commodities are also covered as specified services. Qualified Business Income (QBI): From pass through entities (e.g., a sole proprietorship, a partnership, a disregarded entity, an LLC taxed as a partnership or s corporation, or an s corporation) is the net amount of items of income, gain, loss, and deduction from an eligible trade or business, except for items of capital gain and loss, and certain dividends from REITs, cooperatives, and publicly traded partnerships. This does not include reasonable compensation paid to the taxpayer/shareholder of an s corporation or guaranteed payments to a partner. However, QBI excludes investment type income (e.g., dividends and interest). Additionally, income must be U. S. based income. W 2 Wages: In general, W 2 wages is the sum of wages subject to withholding, elective deferrals, and deferred compensation paid by the Qualified Trade or Business (QTB) during the taxable year. 5

6 The 2017 Tax Cuts and Jobs Act How Tax Reform has impacted Business Planning? Increased Section 179 Expensing Current Deduction of Capital Expenditures Limit on Interest Deductions Corporate Alternative Minimum Tax Repealed Impact on multiples Valuation Like Kind Exchanges Entertainment Expenses NOL Carryforwards Split Dollar for Executives and Shareholders Deferred Compensation The 2017 Tax Cuts and Jobs Act Choice of Entity MYTH #1: It is going to be easy to determine a Choice of Entity! MYTH #2: We should convert to a C Corp! MYTH #3: Redemptions are now more favorable, we should set up a redemption of shares at death! MYTH #4: We can always design a family business to take advantage of the QBI deduction! 6

7 2018 Deduction Considerations Discuss with your CPA/Accountant Vehicle Purchase Home Office 20% Deduction Pass through Qualified Business Income (QBI) Personal Property Renovations or Starting a New Store Inventory Children on Payroll 2018 Key Tenants Discuss with your CPA/Accountant Deductions Conversions Tax Bracket Elimination Deferral 7

8 Takeaway # 1: Tax Planning is more important than ever. Taxes have increased and are expected to increase as federal deficits continue to grow and interest rates rise. Takeaway # 2: The Federal Tax Code is 74,608 pages, complex and overwhelming. Using the Tax Code properly can provide many tax reduction strategies that may save you hundreds, thousands, and even millions of dollars. 8

9 Takeaway # 3: You must engage the services of a tax professional proactive in identifying tax reduction strategies and opportunities. Proactive Reactive Inactive The accountant is the brave soul that comes onto the battlefield after the battle has been fought and counts the dead and bayonets the wounded. Are You Fragmented or Coordinated? A fragmented approach results in the failure to completely address the business owner s fundamental needs or to properly transition business success into personal success. 9

10 Top Strategies for Reducing Taxes in 2018 Congressional Incentives for Oil & Gas Development 10

11 Oil & Gas Development Internal Revenue Code not a tax loophole Congress quest for energy independence Intangible Drilling Costs / Depletion / Deprec. Costs incurred to drill and complete well May range from 70 85% of total cost to drill Functional Allocation Amount of cost allocated to investor May range from 80 95% tax deduction. Passive Loss Rules / Alternative Minimum Tax Example George has taxable income of $1,500,000 and decides to invest $250,000 into an oil & gas investment. Total Investment $250,000 Cash Outlay $160,000 Tax Savings $90,000 Cash Outlay Recouped 5 6 yrs. $160,000 Total Invest. Recouped 8 9 years $250,000 Investment Returns Continue years Returns from each well may vary. 11

12 Recovering Passive Losses This PIG is a CASH COW Recovering Passive Losses Passive Activities Trade or business no material participation Rental activities* special $25,000 allowance** Passive Activity Loss Passive losses in excess of passive income Form 8582, Suspended Losses Passive Activity Income Offsets passive activity losses Creates tax free income / cash flow 12

13 Example Phil has suspended passive losses from his rental real estate properties reported on Form 8582 which he cannot deduct. Suspended Passive Losses $185,000 Passive Income Generator ($250,000) $12,500 Passive Losses $12,500 Tax Free Income $12,500 Suspended Passive Loss $172,500 Tax Aware Investing Use IDCs to shelter taxable ordinary or passive income or the taxable proceeds from the sale of your pharmacy or real estate Utilize suspended passive losses by creating passive income to generate tax free cash flow Oil & Gas $90,000 annually PIG/PAL $12,500 annually ($125, yrs.) 13

14 Retirement Plans Interested in Maximizing your 401(k) Plan contributions? Additional tax deductions and increased retirement savings? Retirement Plan Types DEFINED CONTRIBUTION PLANS DEFINED BENEFIT PLANS INDIVIDUAL RETIREMENT PLANS 14

15 Safe Harbor 401(k) Plan Owner can contribute the maximum annual deferral amount of $18,500 in 2018 (plus $6,000 if age 50 or older). Owner receives additional savings from company matching contributions To avoid the IRS non discrimination (ADP/ACP) tests: Elective: 100% of employee elective contribution on first 4% of compensation; or Non Elective: 3% contribution of compensation for all eligible employees Cash Balance Plan Hybrid Plan DEFINED BENEFIT PLAN TRAITS Annual actuarial calculations. Participant s account credited with a set percentage of yearly compensation plus interest charges. Employer assumes investment risk. DEFINED CONTRIBUTION PLAN TRAITS Value of benefits determined on an individual account basis (but are not segregated into individual accounts). 15

16 Cash Balance Plan Example Peter is looking to increase his retirement savings but also wants to reduce his annual income tax liability. He sets up a Cash Balance Plan in conjunction with his Safe Harbor 401(k) Plan. Name Age Pay 401(k) Employer Safe Harbor Employer Cash Balance Owner 56 $265,000 $24,000 $13,000 $182,850 $219, % Employee 1 28 $47,000 $1,800 $1,410 $705 $3, % Employee 2 29 $67,000 $3,275 $2,010 $1,005 $6, % Employee 3 33 $49,000 $1,900 $1,470 $735 $4, % Employee 4 50 $88,000 $0 $2,640 $1,320 $3, % Employee 5 38 $79,000 $3,400 $2,370 $1,185 $6, % Employee 6 51 $64,000 $3,000 $1,920 $960 $5, % TOTAL $659,000 $37,375 $24,820 $188,760 $250,955 Contributions to Employees $11,820 $5,910 $17,730 Contributions to Owner $13,000 $182,850 $195,850 % of Contributions to Owner 92.0% Total % of Pay Retirement Plans Safe Harbor 401(k) Plan Maximize 401(k) contribution Cash Balance Plan Owner receives 92% of total contributions Employer Tax Deduction $213,580 Owner Retirement Savings $219,850 16

17 1031 Like Kind Property Outright Sale of Real Estate Original Cost $500,000 Improvements 100,000 Less Depreciation (148,000) Taxable Basis $452,000 Sales Price $1,000,000 Taxable Basis 452,000 Taxable Capital Gain $548,000 TAX CALCULATION Capital Gain Deprec. 25% $37,000 Long term Capital 20% 80,000 Total Federal Tax $117,000 Seller is left with only $883,000 to reinvest 17

18 1031 Like Kind Property Defined The following are examples of like kind property: The following is not considered like kind property: Any property used in a trade or business or as an investment including planes, boats and vehicles but most often associated with real estate or land. Condos or Apartments Single Family or Duplexes Industrial Property Commercial Property Retail Property Raw Land The use by the taxpayer i.e. investment, business, or trade is more critical than the type of property. Stock in trade or property held for sale Stocks, bonds or notes Inventory Personal residence Construction or fix/flips for resale Partnership or LLC member interest The 1031 Exchange Timetable The critical time limits at work here are: 3 parties (usually): exchanger/buyer/seller Facilitated by a qualified intermediary. 45 day rule / 180 day rule (no extensions) Time limits begin to run on the date the exchanger transfers the relinquished property to new buyer The date of transfer is the date of recording or transfer of the benefits and burdens of ownership 18

19 The 1031 Exchange Mechanics BUYER Cash Relinquished Property TAXPAYER Relinquished Property Replacement Property QUALIFIED INTERMEDIARY Cash Replacement Property SELLER 1031 Like Kind Property Original Cost $500,000 Improvements 100,000 Less Depreciation (148,000) Taxable Basis $452,000 Example Relinquished Property Replacement Property Taxable Gain Replacement Value Greater $1,000,000 $1,200,000 $0 Replacement Value Less $1,000,000 $950,000 $50,000 Seller pays no capital gains and invests the full value of the property 19

20 Personal Goodwill Why is Personal Goodwill Important? C Corporation $2,000,000 S Corporation $2,000,000 Corporate Tax $763,250 Personal Tax (C Liquidation) $247,350 Personal Tax (S Pass Thru) $400,000 TOTAL TAX LIABILITY $1,010,600 Difference in Tax Liability $610,600 20

21 Personal vs. Enterprise Goodwill Reputation Expertise Skill Knowledge Relationships with Customers Answer the following sample questions: How involved are you in the day to day operations of your pharmacy? What percentage of your pharmacy s revenues are attributable to your efforts? Would your pharmacy profits decline considerably if you were not there? How much? What are the reasons customers are attracted and retained by your pharmacy? Personal Goodwill Requirements Two Important Steps Personal Goodwill Appraisal Personal Goodwill Purchase Agreement 21

22 Personal Goodwill Example C Corporation Sale Price = $3.25M Inventory $500,000 Fixed Assets $150,000 Goodwill $2,450,000 Restricted Covenant $150,000 Personal Goodwill $1,100,000 Corporate Goodwill $1,350,000 Personal Goodwill Elect S Corporation Status 5 Year BIG Tax Pass Through Entity Capital Gains Tax Savings $751,000 C Corporation Personal Goodwill Personal Goodwill Capital Gains Tax Savings $299,000 22

23 Restricted Property Trusts Restricted Property Trust The Restricted Property Trust (RPT) is a vehicle for successful business owners to mitigate income taxes and appreciate assets. This plan offers considerable pre tax contributions, tax deferred growth, and tax advantaged distributions. 23

24 Restricted Property Trusts (RPT) What is a Restricted Property Trust (RPT)? An employer sponsored plan for owners and/or key executives. Provides a 100% corporate tax deduction and only partial income inclusion for the participant. Primary objective is to provide tax favored long term cash accumulation and income distribution in a conservative vehicle. What are the tax characteristics of an RPT? Each annual contribution made to a welfare benefit trust is fully deductible by the employer based upon Internal Revenue Code (IRC) Section 162 and Section 419, and only partially taxable to the participant. Each annual contribution is fully deductible by the employer on account of transferring property that is subject to substantial risk of forfeiture based upon Internal Revenue Code (IRC) Section 162, Section 402, and Section 83(h) Asset growth is in the cash value of a life insurance policy and is, therefore, tax deferred. The policy is delivered to the participant at plan termination, at which time a portion of the cash value is taxable. Restricted Property Trusts (RPT) Is an RPT a qualified plan or form of deferred compensation? Not a qualified plan subject to limits and tests It does not impact contributions to your qualified plan. Not a deferred compensation plan where the corporation only receives a deduction equal to the inclusion of the participant. Is an RPT for everyone? Absolutely not. First, the planned funding period and any plan extensions must be for no less than 5 years. If the company is unable to make the annual contribution to the RPT in any year, the assets inside the plan are forfeited to a predetermined charity of the owner s choice. Is there an annual contribution limit? The annual contribution limit is tied to reasonable compensation. This typically allows a high income earning business owner to contribute several hundred thousand dollars per year or more. 24

25 Restricted Property Trusts (RPT) How does an RPT achieve such results? Fully tax deductible contributions are made by the business to a Restricted Property Trust for a select group of participants. Of the contribution, a portion is considered current taxable income to the participant. The remaining portion of the contribution funds the life insurance and is not considered taxable income to the participant. RPT treatment depends upon the provisions of the life insurance contract. RPT tax treatment depends upon a Key Trust Provision o The employer must make the selected annual contribution each year for the restricted period o The restricted periods are in 5 year increments. o Failure to make the annual contribution causes both the policy to lapse and the surrender proceeds to be given to a charity of your choosing (i.e. known as a risk of forfeiture ). Restricted Property Trusts (RPT) 10 Year Plan $350,000 Total Contributions Business Entity makes deductible contribution of $50,000 annually to Restricted Property Trust for 10 years. Assets grow tax deferred. Business Entity Male, Age 45 Participant recognizes income on $15,000 of contribution (making a 83(b) election and on economic benefit cost of death benefit. If Business Entity fails to make annual contribution, the Restricted Property Trust surrenders the policy and distributes trust corpus to charity. RPT $2,011,494 Whole Life Policy Death Benefit payable to Participant s chosen beneficiary if death were to occur during trust funding period. Death benefit equal to $2,627,928 at end of year

26 Restricted Property Trusts (RPT) Restricted Property Trust distributes policy to Participant at end of trust period. After distribution and withdrawal for tax payment, the death benefit of $1,135,976 is still in force. Immediate Tax Efficiency Tax rate = 13.4% vs. 40% $132,920 Net tax savings $950,680 supplemental taxfree income to Participant $286,834 income tax free Death Benefit RPT $2,011,494 Whole Life Policy Individually Controlled Whole Life Policy 1. Non Taxable disbursements to Participant of $950, Tax Free Death Benefit to Beneficiary. 3. Non Taxable exchange to other insurance policy. Participant recognizes income on policy cash value in excess of value created by Sec. 83(b) election and economic benefit costs. Tax due is paid directly from the policy s cash value. Non taxable disbursement of $103,629 to Participant to fund estimated tax cost of trust distribution. Restricted Property Trusts (RPT) 26

27 Restricted Property Trusts (RPT) 10 Year Plan $350,000 Total Contributions Business Entity makes deductible contribution of $50,000 annually to Restricted Property Trust for 10 years. Assets grow tax deferred. Business Entity Male, Age 55 Participant recognizes income on $15,000 of contribution (making a 83(b) election and on economic benefit cost of death benefit. If Business Entity fails to make annual contribution, the Restricted Property Trust surrenders the policy and distributes trust corpus to charity. RPT $1,286,292 Whole Life Policy Death Benefit payable to Participant s chosen beneficiary if death were to occur during trust funding period. Death benefit equal to $1,767,644 at end of year 10. Restricted Property Trusts (RPT) Restricted Property Trust distributes policy to Participant at end of trust period. After distribution and withdrawal for tax payment, the death benefit of $772,510 is still in force. Immediate Tax Efficiency Tax rate = 14% vs. 40% $130,198 Net tax savings $684,420 supplemental taxfree income to Participant $109,408 income tax free Death Benefit RPT $1,286,292 Whole Life Policy Individually Controlled Whole Life Policy 1. Non Taxable disbursements to Participant of $684, Tax Free Death Benefit to Beneficiary. 3. Non Taxable exchange to other insurance policy. Participant recognizes income on policy cash value in excess of value created by Sec. 83(b) election and economic benefit costs. Tax due is paid directly from the policy s cash value. Non taxable disbursement of $98,683 to Participant to fund estimated tax cost of trust distribution. 27

28 Restricted Property Trusts (RPT) The Cashflow Quadrant EMPLOYEE You have a job TIME = $ NO LEVERAGE SELF EMPLOYED You own a job TIME = $$ NO LEVERAGE 100% x 1 = INCOME YOU x JOB = INCOME 10% of Wealth, 90% of Population Trading Time for Money Starting Over Every Day at Zero Source: Kiyosaki, Robert (2017) Why the Rich are Getting Richer E B S I 1% x 100 = INCOME YOU x PEOPLE = INCOME 90% of Wealth, 10% of Population Income Not Dependent upon Your Presence BUSINESS OWNER You own a system & people work for you PEOPLE = $$$ LEVERAGE INVESTOR Money works for you $$$ = $$$$$ PASSIVE INCOME 28

29 The Cashflow Quadrant Tax Percentage Paid: 40% Tax Percentage Paid: 60% E B S I Tax Percentage Paid: 20% Tax Percentage Paid: 0% Source: Kiyosaki, Robert (2017) Why the Rich are Getting Richer The 2017 Tax Cuts and Jobs Act A Conversation with Business Owners around Choice of Entity Individual Business Owners value gap for retirement Executive Compensation for Key Employees Business Succession 29

30 uestions? Thank You for Attending presented by Independent Pharmacy Consulting Group, LLC Lawrence C. Barrett, CLU, ChFC, AEP Chagrin Boulevard, Suite 300 Cleveland, OH Phone: (216) Toll Free: (800) x

31 Top Strategies for Independent Pharmacy Owners to Reduce 2018 Taxes Supplemental Information presented by Lawrence C. Barrett, CLU, ChFC, AEP Private Wealth Advisor June 28, 2018 Lawrence C. Barrett is a registered representative of Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer. Member SIPC. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Independent Pharmacy Consulting Group, LLC is a marketing name used to conduct business through Lincoln Financial Advisors Corp. This handout is for informational purposes. All situations are different and this handout does not have regard to the specific planning objectives, financial situation and the particular needs of any specific person who may review it. The information included is not intended to be and should not be construed as accounting advice. Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances. Lincoln Financial Advisors Corp. can provide access to third party unaffiliated resources to assist business owners in Exit Planning. CRN

32 Multi-Dimensional Federal Tax System Determining the Marginal Tax Rate for Various Types of Income in 2018 Self- Individual Couple's L/T Gains Pass-Thru Wage Employed AMT Income Income Income Ordinary & Qual. Business Earned Earned Net Inv. AMT Exemption Above Above "Type" Income Dividends Deduction Income Income Income Rate Phase-Out $0 $0 Taxable 10% -2% $9,525 $19,050 Taxable 0% 12% $38,600 $77,200 Taxable -2.4% 7.65% 15.3% $38,700 $77,400 Taxable 22% -4.4% 26% N/A $128,400 Earned 7.65%/1.45% 15.3%/2.9% 0% $82,500 $165,000 Taxable $128,400 N/A Earned 24% -4.8% $157,500 N/A Taxable 1.45% 2.9% $191,500 $191,500 AMTI 0% $200,000 $250,000 Earned 32%/24% Up to 29% / $200,000 $250,000 AGI 15% -4.8% $200,000 N/A Taxable 35%/24% $207,500 N/A Taxable N/A $315,000 Taxable 35%/32% 0% / Up to N/A $400,000 Taxable 29% N/A $415,000 Taxable 2.35% 3.8% 35% 3.8% $425,800 $479,000 Taxable 28% $500,000 N/A AMTI 7%/0% $500,000 $600,000 Taxable 0% $781,200 N/A AMTI 0% 37% 20% N/A $1,000,000 AMTI 0%/7% N/A $1,437,600 AMTI Income thresholds based on estimated 2018 inflation adjustments (where applicable). Where two rates are shown, the first applies to individuals, the second to married couples Chart originally created by Michael Kitces for the November/December 2012 issue of The Kitces Report.

33 Capital Gain Tax Complexity Long-Term Capital Gains Rate Single Taxpayers Married Filing Jointly Head of Household Married Filing Separately 0% Up to $38,600 Up to $77,200 Up to $51,700 Up to $38,600 15% $38,600-$425,800 $77,200-$479,000 $51,700-$452,400 $38,600-$239,500 20% Over $425,800 Over $479,000 Over $452,400 Over $239,500 The 3.8% Medicare Surtax would apply when adjusted gross income is greater than $200,000 for single and $250,000 for married filing jointly. The use of a tax los is limited. Taxpayers can take losses equal to their gains plus an additional $3,000 in one tax year. Tax losses not used in the current year can be carried forward indefinitely. Source: Internal Revenue Service, Tax rates effective 1/1/2018.

34 Investment Taxation Non-Qualified Divided Income Short-Term Capital Gains Interest Income Subject to the highest possible tax rates Top Tax Rate 40.8% (a) Qualified Dividends Long-Term Capital Gains Municipal Bond Interest* Unrealized Capital Appreciation Tax Favored Income Tax Free Top Tax Rate 23.8% (a) Top Federal Tax Rate 0% Pre-Tax Returns Rarely Equal After-Tax Returns *Generally for municipal bonds, no federal income tax unless the taxpayer is in AMT and owns private activity bonds. (a) Includes Medicare Surtax of 3.8%. Source: Internal Revenue Service

35 Tax Implications of Asset Allocation Account Type Asset Class Pre-Tax Market Value Pre-Tax Weights After-Tax Market Value After-Tax Weights 401(k) Stocks $ 1,500,000 75% $ 900, % Roth IRA Bonds $ 500,000 25% $ 500, % Total Portfolio $ 2,000, % $ 1,400, % Note: Withdrawals at the end of the investment horizon are assumed to be taxed at a rate of 40%. After-tax asset allocation is what matters. After-tax portfolio optimization is different. Use multiple tax structures in the accumulation phase to provide options in drawdown.

36 The Tax Cuts and Job Acts of 2017 Summary Tax Current Rules Additional Information Individual Income Tax Rates 10%, 12%, 22%, 24%, 32%, 35%, and 37% Top tax rate was 39.6% Standard Deduction $12,000 (single); $24,000 (married joint filers) Personal exemptions are gone Long-Term Capital Gains Tax Rates Net Investment Income Tax 3.8% Alternative Minimum Tax (AMT) Exemption Amount 0%, 15%, and 20% No Change $70,300 (single); $109,400 (married joint filers) Corporate Tax Rate 21% Down from 35% Applies when modified adjusted gross income exceeds $250,000 for married filing joint or $200,000 for singles. The AMT exemption phaseout begins at $1,000,000 for married joint filers and $500,000 for all individual filers. Estate and Generation-Skipping Transfer Tax Gift Tax 40% (for estates over $11.18 million) $22.36 million for a married couple 40% (for total gifts over $11.18 million) Annual gift tax exclusion amount is $15,000 Source: Internal Revenue Service, 2018 Data

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