2011 Year End Income Tax Planning: What Can You Do At This Late Date? Givner & Kaye, A Professional Corporation

Transcription

1 2011 Year End Income Tax Planning: What Can You Do At This Late Date? 1

2 Planning Is Based On Your Predictions: 1. Will rates go up? Down? Stay the same? You must predict the elections. 2. Will client s income go up? Down? Same? You must predict the economy in general, and your client s business in particular. 2 2

3 As A Result Of Your Predictions: 1. Do you want accelerate income into 2011? 2. Or do you want to increase deductions in 2011? We will proceed today on the basis that a tax deferred is a tax saved. 3 3

4 What We Will Cover: 1. The Big, Easy Deductions. P Defined Benefit Pension Plans. P Captive Insurance Companies. P Charitable Alternatives. P Grantor Charitable Lead Annuity Trusts. P Charitable Remainder Annuity Trusts. P Gift of a Remainder Interest In The Residence. P Charitable Limited Partnerships. P Investments. P Oil and Gas. P Real Estate. P Questions and answers (live or by e mail). P

5 Our Process Four Phases Four Engagements Four Fixed Fees (so the clients does not feel on the clock ). Review Design Implement - Maintain 5

6 Upcoming Sessions Of Our Thursday Insights Series 6 6

7 October 20: November 3: How To Hedge Your Assets For Long-Term Care Needs Barry Boscoe IRA and Retirement Plan Beneficiary Designations: Problems and Opportunities Owen Kaye November 17: Protecting The Fiduciary In Real Estate Property Sales Kelly delaat & Rochelle Rosten December 1: Asset Protection Planning: The Advanced Course Owen Kaye December 15: Tax Planning For The Sale of Your Business Bruce Givner January 19: Everything You Always Wanted To Know About Family Trusts But Were Afraid To Ask Bruce Givner 7

8 The Big, Easy Deductions 8 8

9 Defined Benefit Pension Plans 9 9

10 Tax Qualified Employee Retirement Plan Joe Owner The corporation (Plan Sponsor) The Plan Plan committee $ $ The Trust Trustee Employees/ participants 10 10

11 Corporation (plan sponsor) Money goes in define (limit) the contribution Retirement Trust Money goes out define (limit) the benefit Employee/ Participant 11

12 Defined Contribution Plan If you limit how much goes in (IRC Section 415(c) - $49,000), then there is no limit on how much goes out. So if you are going to buy Qualcomm at $1 and have it go to $100, do so in a defined contribution plan; it will not impact your future contributions. Employee/ Participant Bruce@GivnerKaye.com 12

13 Defined Benefit Plan If you limit how much goes out (IRC Section (b), (d) - $195,000), there is no specific limit on how much goes in. So if you want a contribution of more than $49,000 per person, you need a defined benefit pension plan. Employee/ Participant Bruce@GivnerKaye.com 13

14 In General: 1. Overall limits are higher after the 2006 PPA. 2 Minimum contributions are higher. 3. Plans can still be amended or terminated. 4. You can now have three plans, DB, PSP and 401(K). Bruce@GivnerKaye.com 14

15 In General [continued]: 5. If you are covered by PBGC, all three plans can be funded to the max. 6. If you are not covered by PBGC, then only the PSP is limited to 6% of eligible comp. 7. Insurance can be added to DB which increases overall contribution. 8. If you add insurance, the best way is still the old fashioned way. 15

16 In General: Sample maximum contributions at various ages: 35 5 years past service - $65,000 + DC 6% of comp + $16,500 in 401(k) X 2 spouses in year one is $190,000. Over 5 years it s $1,000, $130,000 + $30,000 X 2 spouses = $320,000, or $1,600,000 over 5 years $237,000 + $30,000 X 2 spouse = $534,000 or $2,670,000 over 5 years. Plus life insurance. Using the cushion method the amount in the first year might be it could be 3 to 4 times that amount (though zero in the second year). Bruce@GivnerKaye.com 16

17 Monthly Benefit at RA 62 Contribution Helen 11/16/63 $60,000 $4, $ 29, Michael 3/26/74 $40,000 $2, $ 11, George 10/6/77 $45,000 $3, $ 12, Lucy 9/5/70 $30,000 $1, $ 9, Paul 8/29/76 $25,000 $1, $ 4, Steven 11/18/79 $40,000 $1, $ 5, Gary 8/2/75 $90,000 $3, $ 13, Jane 10/25/57 $250,000 $7, $226, Sam 9/2/51 $250,000 $7, $306, Totals $617, [86.2% for bosses] 17 17

18 If you don t like the law, change the facts. Bruce@GivnerKaye.com 18

19 Is There A Good Set Of Facts? 1. Perhaps there are two businesses there that may not be members of a controlled or affiliated service group; 2. Perhaps there are family members who are providing services who are not currently compensated or not currently compensated enough; 3. Perhaps the rank and file can be covered in a profit sharing plan; Bruce@GivnerKaye.com 19

20 Is There A Good Set Of Facts? [continued] 4. Perhaps there is already a defined contribution level of cost that can be used to offset some of the rank and file cost; and/or 5. Perhaps some of the cost of the highly compensated employees isn t a true additional cost because the boss can take it out of their compensation or the boss can use it as additional compensation to motivate them. Bruce@GivnerKaye.com 20

21 Your Client Will Be Happy (Don t Worry) Bruce@GivnerKaye.com 21

22 Reasons Why The Client Will Be Happy Despite The Apparent Cost 1. There will be turnover short of the end of the vesting period (even when they think (and are proud of the fact that) their turnover is low). 2. There will be turnover short of the end of the accrual period (even when they think (and are proud of the fact that) their turnover is low). 22

23 Reasons Why The Client Will Be Happy Despite The Apparent Cost [continued] 3. They undervalue creditor protection benefits. 4. The accrued benefit might be received income tax free as a disability benefit. Bruce@GivnerKaye.com 23

24 Reasons Why The Client Will Be Happy Despite The Apparent Cost [continued] 5. The value of the assets in the plan can be passed on free of estate tax. 6. Surprise to the financial advisors: the successful business owner does not mind if the employees get the benefits if they stay for a decade!! (They are the ones who helped him make $2,000,000 per year.) Bruce@GivnerKaye.com 24

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26 Captive Insurance Companies 26 26

27 Captive Insurance Companies for the Middle Market Originally used only by the very largest companies, captives are no longer the exclusive tool of those in the Fortune 500. There are now well over 5,000 captives writing over $50 billion in annual premiums. Many of these captives insure middle market companies and successful professionals

28 IRC Section 831(b) A small property and casualty insurer with annual premium income not exceeding $1.2 million pays no tax on its underwriting profits but is taxed solely on its investment income. In this case, the business that pays premium to a captive deducts the premium expense while the captive pays no tax on the underwriting profits

29 Estate Planning Estate planning is an important business continuity consideration for closely held companies and for their owners. A CIC can be a key component in estate planning with the captive being owned by or for the benefit of the next generation and so enabling an in lifetime transfer of pre-tax underwriting profits. A captive may also buy a reasonable sum of life insurance, planning for key man exposures and the execution of buy sell agreements

30 Vermont began licensing captive insurance companies in 1981, and is the largest captive insurance domicile in the U.S. and second largest in the world, in terms of gross written premium, with $11.6 billion in Vermont is also home to 42 of the companies that make up the Fortune 100, 19 of the companies that make up the Dow

31 Common Captive Coverage Property & Casualty * Director & Officer * Subsidence * General Liability * Exclusions * Employment Practices * Deductible Reimbursement * Litigation Defense * Difference in Conditions * Construction Defect * Difference in Limits * Warranty * Workers Compensation * Mold 31 31

32 Captive Insurance Company: Deducting $1,200,000 Per Year Diagram 1: Pre-Setup David Wilmington Trust Company (or some other Delaware Trust Company) Grantor David Dynasty Trust (Delaware Perpetual) $300,000 Trustee David s heirs 32 32

33 Captive Insurance Company: Deducting $1,200,000 Per Year Diagram 2: Set Up The Captive David Dynasty Trust (Delaware Perpetual) 100% owner Delaware LLC (taxed as a C corporation for Federal income tax purposes) $500,000 The captive is exempt from Delaware business income tax. It is treated as one enterprise and, therefore, subject to only one $5,000 minimum annual premium requirement. Each series can receive up to $1.2 million tax free under IRC Section 831(b). Series A : Property & Casualty Risks Series B : Health Plan Liabilities 33 33

34 Business #1 Captive Insurance Company: Deducting $1,200,000 Per Year Diagram 3: Operating The Captive Alternative #1 Business #2 Delaware LLC Business #12 Business #3 Business #11 Business #4 Business #10 Business #5 Business #6 Business #7 Business #8 Business #9 Each business must pay a premium of 5% - 15% of the $1,200,000 total

35 Captive Insurance Company: Deducting $1,200,000 Per Year Diagram 3: Operating The Captive Alternative #2 Delaware LLC Operating Business 49% of the premiums 51% of the premiums Captive Manager s Pool Assume the captive manager re-insures 40% of the risk. Then 11% of the risk is shared among the pool. If there are 8 members of the pool and one has a $1,200,000 casualty, then the other 7 members lose $171,000 each

36 Captive Insurance Company: Deducting $1,200,000 Per Year Diagram 4: Using The Captive s Profits David Dynasty Trust (Delaware Perpetual) Dividends Delaware LLC David as manager LLC used to buy real estate and other investments LLC used to buy real estate and other investments 36 36

37 Charitable Alternatives 37 37

38 Grantor Charitable Lead Annuity Trust 38 38

39 Charitable Lead Annuity Trust Alternate #1 Bunching The Deduction Up Front October, 2011 Section 7520 rate of 1.4% (lower is better) $1,000,000 of real estate generating $50,000 per year in an LLC Valuation discounts of 40% make it $600,000 generating $50,000 $50,000 is an 8.333% payout on $600, Year Term, Remainder To Children Immediate Charitable Gift of $463,542 (77.257%), which saves Mom $209,000 if in a 45% state and Federal bracket [13 year term is 98.4% gift!!] Gift to the children s trust of $136,459, for which a 709 must be filed Mom is taxed on the income each year so she gives back the charitable deduction that was bunched up front 39 39

40 Mom Gives $600,000 of LLC units CLAT Children s trust gets what is left at the end of the 10 year period 8.3% per year - $50,000 for 10 years Children s Trust Charity 40 40

41 Charitable Lead Annuity Trust Alternate #2 Deduction Up Front, No Taxable Income Later October, 2011, Section 7520 rate of 1.4% $1,000,000 of muni bonds generating $40,000 per year in an LLC Valuation discounts of 30% make it $700,000 generating $40,000 $40,000 is a 5.7% payout (annuity) on $700, Year Term, Remainder To Children Immediate Charitable Gift of $369,921 (53%), which saves Mom $166,464 if in a 45% state and Federal bracket [20 years = 99% gift!!] Gift to the children s trust of $330,079, for which a 709 must be filed Mom is taxed on muni bond income each year (zero) 41 41

42 Doesn t Have To Be A Gift Over To The Children Can Come Back To Mom Gives $1,000,000 Mom Mom gets what is left at the end of the 10 year period CLAT Charity 5% per year - $50,000 for 10 years 42 42

43 Caveats: 1. The deduction is limited to 30% of the grantor s contribution base, Section 170(b)(1)(B) (20% in some cases if the trust is funded with capital gain property). 2. The IRS rule in PLR that the 5 year carryover of excess deductions does not apply to gifts to CLTs, although the ruling has been criticized as inconsistent with congressional intent. PLR , citing Section 170(b)(1)(D). 3. Works best when the grantor is in a high bracket in the year of creation and will be in a lower bracket in future years, which makes sense if you think brackets will go down in the future. 4. May be possible to create a Super Trust, owned by the grantor for income taxes but not included in the grantor s estate for estate tax purposes. PLR Client s own private foundation can be the charitable income beneficiary

44 Charitable Remainder Annuity Trust 44 44

45 Charitable Remainder Annuity Trust October, 2011 Section 7520 rate of 1.4% But We Are Allowed To Use August s 2.2% (Higher interest rate is better) (Longer retained term yields lower deduction) $1,000,000, 10 Year Term, 5% payout to Mom Immediate Charitable Gift of $555,535, which saves Mom $250,000 if in a 45% state and Federal bracket 20 year term results in a $198,000 charitable deduction ($89,000 tax savings) 45 45

46 Gives $1,000,000 Mom CRAT 5% per year - $50,000 for 10 years Charity gets what is left at the end of the 10 year period Charity 46 46

47 CRAT August Section 7520 rate of 2.2% Mom, age 71, Retains 5% income for life Immediate Charitable Gift of $416,710, which saves Mom $187,520 if in a 45% state and Federal bracket [not significantly different than the results of a 20 year term] Note: Will Not Work For A 70 year old!!! 47 47

48 Gives $1,000,000 Mom CRAT 5% per year - $50,000 for her life Charity gets what is left when mom passes away Charity 48 48

49 Gift Of A Remainder Interest In A Residence Reg. Section 1.170A-7(b)(3), (4)

50 50 50

51 Charitable Limited Partnerships 51 51

52 Mom and Dad Donate 97% of LP interests Charity 3% GP Contribute $1.0 of appreciated property Limited Partnership Becomes the 97% LP 97% of $1.0 X 90% (to allow for 10% valuation discounts) = $873,000 charitable deduction which saves $392,850 in income tax, but the $1,000,000 stays in the limited partnership

53 Investments 53 53

54 Oil and Gas 54 54

55 EXAMPLE (adapted from Hard Rock Partners 2011-a, L.P.): No Oil & Gas Investment Oil & Gas Investment ($50,000 investment) Gross income $200,000 Gross income $200,000 Taxable income $200,000 IDC deduction ( 50,000) Taxable income $150,000 State Tax 6.5% $ 11,875 State Tax 6.5% $ 8,625 Federal Tax $ 44,070 Federal Tax $ 30,070 Total Tax $ 55,945 Total Tax $38,695 Tax Savings $17,250 (34.5% of $50,000) 55 55

56 Economics: Gas prices are low, meaning any increase will improve investor returns U.S. is the Saudi Arabia of natural gas Work with an experienced operator that has (i) drilled hundreds of wells and (ii) excellent track record in existing developed fields Risk diversification in multi-well programs Return of initial investment in tax benefits and cash in 5 to 8 years Residual income for 20 years or longer 56 56

57 Real Estate 57 57

58 Two methods of depreciation for Commercial Properties: Straight-line method - depreciated over 39 years. Stipulates that an asset must be depreciated by equal amounts each year over its useful life. Example: You buy a commercial shopping center for $10,000,000. The land the center resides on is worth $4,000,000 (40%). The building is valued at $6,000,000. Current law allows you to depreciate commercial properties by equal amounts annually over 39 years. $6,000,000/39 years = $153,846 annually Or calculate by multiplying the building percentage by 2.56%

59 Accelerated Depreciation Same $10.0 one story Shopping Center. Reasonable Cost Segregation allocations and related depreciation figures ($6.0 to Building, $4.0 to land): 5 year property 28% of $6,000,000 = $1,680,000 7 year property 3.5% of $6,000,000 = $ 210, year property 11.84% of $6,000,000 = $ 710, year property 56.66% of $6,000,000 = $3,399,600 Here is the resulting First Year Depreciation: 5 year property = $ 672,000 7 year property = $ 60, year property = $ 71, year property = $ 87,169 Total Depreciation in year one: $890,

60 Accelerated Depreciation Value of building 6,000,000 Bldg. Segregation Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Totals 5 year property 1,680, , , , ,152 87,091 1,549,363 7 year property 210,000 60,000 42,857 30,612 21,866 15, , year property 710,400 71,040 63,936 57,542 51,788 46, , year property 3,399,600 87,169 84,934 82,756 80,634 78, ,061 Totals 6,000, , , , , ,886 2,425,

61 What We Covered: 1. The Big, Easy Deductions Defined Benefit Pension Plans Captive Insurance Companies. 2. Charitable Alternatives Grantor Charitable Lead Annuity Trusts Charitable Remainder Annuity Trusts Gift of a Remainder Interest In The Residence Charitable Limited Partnerships. 3. Investments Oil and Gas Real Estate. 4. Questions and answers (live or by e mail)

62 Questions and Answers 62 62