Business Structure & Tax Planning

Transcription

1 Vermont Bar Association Seminar Materials Business Structure & Tax Planning September 19, 2014 Killington Grand Resort Killington, VT Faculty: John Cole, Esq. Mark Melendy, Esq.

2 John H.W. Cole, Esquire Paying unnecessary payroll taxes is like throwing money out the window. Learn how to avoid paying unnecessary taxes on your practice profit, your savings for retirement, and your health insurance. Learn how tax free fringe benefits can increase your bottom line. John H.W. Cole, P.C. 3 Worcester Street South Burlington VT (800) Toll Free (802) Facsimile Jcole@erisajd.com Vermont Bar Association 2014 Annual Meeting September 19, 2014

3 BUSINESS STRUCTURE & TAX PLANNING By John H.W. Cole, Esq. Tax Rates Illustration 1 shows the federal tax rates for Illustration 2 shows the Vermont tax rates. Illustration 3 shows how these tax rates apply to Larry the Lawyer s income of $100,000 from his practice. Illustration 4 shows the payroll tax rates, and has an example of how the payroll taxes are calculated. Note that Larry pays more in payroll taxes than he did in state and federal income taxes. Illustration 5 shows the taxes that apply to Capital Gains and Dividends, and the new Obamacare surtaxes. Self-Employed v. S Corporation with Dividend Pass Through Illustration 6 compares the results when an individual is self-employed with the same income in an S corporation, with a pass through of $30,000 of income. Self-Employed v. S Corporation with Plan Funding Illustration 7 compares the results when an individual is self-employed with the same income in an S corporation, and plan funding of $23,000. Self-Employed vs. C Corporation Plan Funding and Medical Benefits Illustration 8 compares the results of operating as self-employed versus incorporated, with an emphasis on retirement plan funding and medical benefits. In a C corporation the cost of health insurance and medical reimbursement comes off the top, as a corporate expense. For the self-employed and for employeeshareholders of an S corporation, medical expenses are pass-through items, to be deducted in arriving at adjusted gross income. The use of a C Corporation results in a greater savings in payroll taxes. In the illustration the savings from incorporating is $7,335 per year. Note that two of the deductible items are 1

4 disability insurance and medical reimbursement. These benefits are only available in C corporations. Self-Employed vs. C Corporation Plan Funding, Single Payer & Medical Benefits Illustration 9 substitutes a single payer tax for the health insurance cost. How the IRS would actually treat this is a guess. The percentage used is 18% for illustration purposes, a number once used by Sen. Peter Galbraith (D-Windham County) for discussion purposes in trying to get Governor Shumlin to address costs of Single Payer. The actual percentage could be much higher. After Tax Investment vs. Before Tax Investment Single Contribution in Year 1 Illustration 10-1 compares the results of investing in a taxable account with investing through a qualified plan sponsored by a corporation. Investing in a taxable account first requires the payment of Federal, State, and FICA taxes on the amount available, $23,000. No taxes are imposed initially on the amount contributed to the qualified plan. The savings in each case are invested for 20 years. In the Taxable Account the earnings are taxed each year. At the end of 20 years, the after tax savings grow to $30,252. The pre-tax savings, in the qualified plan, grow to $73,764, almost two and one half times the after tax savings. If the pretax amount was withdrawn all at once, and taxes are paid on it at 25%, $55,323 would be still available, almost double the amount in the after tax account. But that is not a likely scenario. It is more likely that the saved amount will be withdrawn as needed, over the investor s lifetime. Illustration 10-2 reflects this assumption. A life expectancy of 25 years is assumed (from 65 to age 90). A drop in federal and state bracket is also assumed. The amount withdrawn and spent each year (spendable income) is the beginning balance, plus earnings, minus taxes, divided by the remaining years of the individual s life expectancy (25 years reduced by 1 each year). In 2031 the after tax spendable income available from the plan account is twice that available from the after tax savings account. The gap increases each year 2

5 because the pre-tax savings are still growing tax free, typically in an IRA. Over the 25 year period the individual would have 2.34 times as much spendable income from the use of a qualified plan. After Tax Investment vs. Before Tax Investment Single Contribution in Year 1 Higher Tax Brackets Illustration 11-1 assumes that our erstwhile lawyer is in higher state and federal brackets. In this illustration he incurs an additional tax from investing outside of a plan, the.9% Obamacare surtax, and his earnings incur the 3.8% Obamacare surtax on earned income. The.9% surtax does not apply to plan funding, and 3.8% surtax does not apply to plan distributions. However, his amount available is above the taxable wage base, so the FICA taxes he pays are less of a factor in the computations. Otherwise, the assumptions used are the same as in the previous illustration, except the bracket drop is to 25% and 6.8%, respectively. Illustration 11-2 shows that in 2031 the after tax available spending is slightly less than twice that available from the after tax account. However, in this illustration, the fact that plan distributions are not subject to the Obamacare surtax, and investment distributions are, kicks in. The total after tax spendable income increases accordingly and the total spendable income over the 25 years of retirement is 2.5 times as much. After Tax Investment vs. Before Tax Investment Annual Funding Illustration 12-1 takes funding in the 25% bracket to the next level, and depicts annual savings. Once again the accumulation in a qualified plan dwarfs the amount accumulated in a taxable account. The spendable income from the qualified plan account, shown in Illustration 12-2 is more than twice the spendable amount resulting from savings after taxes. Illustration 12-2 also provides a picture of how much you need to save for retirement. Add the annual withdrawal and income from other investments, to the amount of social security you will receive, and determine the tax from the tables in Illustrations 1 and 2. This will give you an idea of how well you will fare financially at retirement. 3

6 After Tax Investment vs. Before Tax Investment Results of Annual Investment - Higher Tax Brackets Lastly, Illustrations 13-1 and 13-2 provide the results of annual funding for someone in a 33% Federal tax bracket and a 7.8% Vermont tax bracket. The illustration applies to someone netting $275,000 a year to $405,000 per year, and anywhere in between. The accumulation at retirement in the qualified plan is a respectable $1,555,094, compared with $668,449 in the after tax investment account. Over the 25 years of retirement $2,322,464 in after tax dollars is available from the retirement plan, compared with $1,097,158 in the after tax investment account. In the illustrations prepared for this seminar we have depicted results using a profit sharing plan and assumed one working spouse. If two spouses work in the business much greater funding can be achieved, even if they don t receive the same compensation. In addition, in other types of plans, or certain personnel scenarios, higher funding can be achieved without higher income. For example, one client has a salary of $96,000, but funds $40,000, in his profit sharing plan. Another has a salary of $58,000, but funds $24,000, with a staff cost of $2,500. And some clients fund $150,000 to $300,000 for themselves. In the afternoon session on qualified plans we will go through the options to choose in setting up a plan to make it cost effective, the types of formulas available to maximize the funding for partners, and how to fund mega-dollars, if that s your objective. 4

7 Illustration 1 Federal Tax Rates 2014 Single Individuals Taxable Income Percent on Of Amount Over But not over Pay Excess Over 0 9, % 0 9,075 36, % 9,075 36,900 89,350 5, % 36,900 89, ,350 18, % 89, , ,100 45, % 186, , , , % 405, , , % 406,750 Federal Tax Rates 2014 Married Filing Jointly Taxable Income Pay Percent on Of Amount Over But not over Excess Over 0 18, % 0 18,150 73,800 1, % 18,150 73, ,850 10, % 73, , ,850 28, % 148, , ,100 50, % 226, , , , % 405, , , % Standard Deduction - Single 6,200 Standard Deduction - Married Filing Jointly 12,400 Exemptions - 3,950 each * *subject to phased $254,000 single; $305,050 married Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

8 Illustration 2 Vermont Tax Rates 2014 Single Individuals Percent on Of Amount Over But Not Over Pay Excess Over 0 36, % 0 36,250 87,850 1, % 36,250 87, ,250 4, % 87, , ,350 12, % 183, , , % 398,350 Vermont Tax Rates 2014 Married Filing Jointly Percent on Of Amount Over But Not Over Pay Excess Over 0 60, % 0 60, ,400 2, % 60, , ,050 7, % 146, , ,350 13, % 223, , , % 398,350 Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

9 Illustration 3 Example: Larry the lawyer has income of $100,000 from his practice. He is married filing jointly and his wife is unemployed. His deductions total $14, Federal Income Tax Gross Income/adjusted gross income 100,000 Less deductions (14,000) Difference 86,000 Exemptions* (7,900) Taxable Income 78,100 Tax on first 73,800 10,163 Tax on next 4, ,075 Total Federal Tax $11,238 Tax as percentage of income 11.24% Larry's Tax Bracket 25% 2014 Vermont Income Tax Amount Rate Tax Tax on First 60, ,150 Tax on Next 17, ,193 Vermont Income Tax $3,343 Larry is in the 6.8% Vermont Tax Bracket Total State and Federal Income Taxes $14,580 *Assumes under age 65. Exemption doubles at age 65. Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

10 Illustration 4 Larry the Lawyer's Federal Payroll Taxes 2014 Taxed Income OASDI (Social Security)* ,000 HI (Medicare)** Unlimited Total Example: Larry the lawyer has a salary of $100,000 OASDI 100, ,400 HI 100, ,900 Total $15,300 * Employer and employee share 6.2% each ** Employer and employee share 1.45% each Larry paid more in payroll taxes: $15,300 than he did in State & Federal Income Taxes. $14,580 Difference: $720 Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

11 Illustration 5 Federal Taxes Capital Gains and Dividends Bracket Rate 0 to 15% 0% 25 to 35% 15% 39.6% 20% Obamacare Surtaxes Income Threshold Tax Rate Married Earned Income 250, % Single Earned Income 200, % Married Investment Income* 250, % Single Investment Income* 200, % * Does not include qualified plan or IRA distributions, income from an S corporation trade or business. Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

12 Illustration 6 Payroll Tax Savings From S Corporation Dividend Pass Through Self-employed S Corporation Business Income 1040 Line ,000 Initial Profit 100,000 Employer Payroll Tax 1040 Line 27 (7,106) S Dividend Pass Through (30,000) Adjusted Gross Income 1040 Line 37 92,894 State Minimum Tax (300) Deductions 1040 Line 40 (14,000) Available for payroll 69,700 Exemption 1040 Line 42 (7,900) Employer Payroll Tax 4,953 Taxable Income 1040 Line 43 70,994 Wages 1040 Line 7 64,747 Pass Through 1040 Line 17 30,000 Adjusted Gross Income 1040 Line 37 94,747 Deductions 1040 Line 40 (14,000) Exemption 1040 Line 42 (7,900) Taxable Income 1040 Line 43 72,847 Federal Income Tax 10,401 Federal Income Tax 10,401 Vermont Income Tax 2,986 Vermont Income Tax 2,986 Employee Share FICA 7,106 Employee Share FICA 4,953 Total Taxes 20,493 Total Taxes 18,340 Adjusted Gross Income 92,894 Compensation 94,747 Less Taxes (20,493) Less Taxes (18,340) Spendable Income 72,400 Spendable Income 76,407 Federal Taxes Net with S Corporation 76,407 Tax on 1st 73,800 10,163 Net if Self Employed 72, Savings from Incorporating $4,006 Total Federal Taxes 10,401 State Taxes Tax on 1st 60,550 2, , Total State Taxes 2,986 Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

13 Illustration 7 Payroll Tax Savings From Plan Funding in S Corporation Self-employed S Corporation Initial Profit 124,000 State Minimum Tax (300) Business Income 1040 Line ,000 Difference 123,700 Employer Payroll Tax 1040 Line 27 (8,812) Profit Sharing (23,000) Profit Sharing 1040 Line 28 (23,000) Available for Payroll 100,700 Employer Payroll Tax (7,156) Adjusted Gross Income1040 Line 37 92,188 Wages/AGI 1040 Line 37 93,544 Deductions 1040 Line 40 (14,000) Deductions 1040 Line 40 (14,000) Exemption 1040 Line 42 (7,900) Exemption 1040 Line 42 (7,900) Taxable Income 1040 Line 43 70,288 Taxable Income 1040 Line 43 71,644 Federal Income Tax (9,636) Federal Income Tax (9,839) Vermont Income Tax (2,812) State Income Tax (2,904) Employee Share FICA (8,812) Employee Share FICA (7,156) Total Taxes (21,260) Total Taxes (19,900) Adjusted Gross Income 92,188 Compensation 93,544 Less Taxes (21,260) Less Taxes (19,900) Spendable Income 70,928 Spendable Income 73,644 Federal Taxes Spendable Income with S Corp 73,644 Taxable Income 70,288 Self Employed Spendable Incom 70,928 Tax on 1st 18,150 1,815 Savings from Incorporating $2, ,138 7,821 Total Federal Tax 9,636 Federal Taxes Taxable Income 71,644 Vermont Taxes Tax on 1st 18,150 1,815 Taxable Income 70, ,494 8,024 Tax on 1st 60, Total Federal 9, , Vermont Taxes Total Vermont Tax 2,812 Taxable Income 71,644 Tax on 1st 60, , Total Vermont Tax 2,904 Cole/Melendy 2014 VT Bar Assoc. Annual Meeting

14 Illustration 8 Self Employed vs. C Corporation - Plan Funding and Medical Benefits Self-employed C Corporation Amount Available 126,000 Minimum C Corp Tax (300) Business Income 1040 Line ,000 Insurance & Reimbursement* (25,710) Health Insurance 1040 Line 25 (16,800) Tentative Profit 99,990 Employer Payroll Tax 1040 Line 27 (8,954) Profit Sharing (19,950) Profit Sharing 1040 Line 28 (19,950) Employer Payroll Tax (5,688) Adjusted Gross Income 1040 Line 37 80,296 Wages/AGI 1040 Line 7 74,352 Deductions 1040 Line 40 (14,000) Deductions 1040 Line 40 (14,000) Exemption 1040 Line 42 (7,900) Exemption 1040 Line 42 (7,900) Taxable Income 1040 Line 43 58,396 Taxable Income 1040 Line 43 52,452 Vermont Income Tax (2,073) Vermont Income Tax (1,862) Federal Income Tax (7,852) Federal Income Tax (6,960) Employee Share FICA (8,954) Employee Share FICA (5,688) Total Taxes (18,879) Total Taxes (14,510) Adjusted Gross Income 80,296 Adjusted Gross Income 74,352 Less Taxes (18,879) Less Taxes (14,510) Less Insurance & Reimbursement (8,910) Spendable Income 52,507 Spendable Income 59,842 Disability Insurance 2,910 Spendable Income if C Corp 59,842 Medical/Dental Out of Pocket 6,000 Self Employed Spendable 52,507 Total 8,910 Savings from Incorporating $7,335 * Includes Health & Disability Insurance and out of pocket expenses. Other Possible Deductibles: Cell phone, free parking, group term life insurance, employee awards. Federal Taxes Federal Taxes Taxable Income 58,396 Taxable Income 52,452 Tax on 1st 18,150 1,815 Tax on 1st 18,150 1, ,246 6, ,302 5,145 Total Federal Taxes 7,852 Total Federal Taxes 6, Vermont Taxes Vermont Taxes Taxable Income 58,396 Taxable Income 52, , ,862 John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

15 Illustration 9 Self Employed vs. C Corporation - Plan Funding, Single Payer & Medical Benefits Self-employed C Corporation Amount Available 126,000 Minimum C Corp Tax (300) Business Income 1040 Line ,000 Single payer, disability &Reimburseme (29,978) Single Payer 1040 Line 25 (21,068) Tentative Profit 95,722 Employer Payroll Tax 1040 Line 27 (8,954) Profit Sharing (18,000) Profit Sharing 1040 Line 28 (18,000) Employer Payroll Tax (5,524) Adjusted Gross Income1040 Line 37 77,978 Wages/AGI 1040 Line 7 72,213 Deductions 1040 Line 40 (14,000) Deductions 1040 Line 40 (14,000) Exemption 1040 Line 42 (7,900) Exemption 1040 Line 42 (7,900) Taxable Income 1040 Line 43 56,078 Taxable Income 1040 Line 43 50,313 Vermont Income Tax (1,991) Vermont Income Tax (1,786) Federal Income Tax (7,504) Federal Income Tax (6,639) Employee Share FICA (8,954) Employee Share FICA (5,524) Total Taxes (18,449) Total Taxes (13,950) Adjusted Gross Income 77,978 Adjusted Gross Income 72,213 Less Taxes (18,449) Less Taxes (13,950) Less Insurance & Reimbursement (8,910) Spendable Income 50,619 Spendable Income 58,263 Disability Insurance 2,910 Spendable Income if C Corp 58,263 Medical/Dental Out of Pocket 6,000 Self Employed Spendable 50,619 Total 8,910 Savings from Incorporating $7,644 *Includes Single Payer Insurance, Disability & Medical Reimbursement Other Possible Deductibles: Cell phoncell phone, free parking, group term life insurance, employee awards Federal Taxes Taxable Income 56,078 Federal Taxes 50,313 Tax on 1st 18,150 1,815 Tax on 1st 18,150 1, ,928 5, ,163 4,824 Total Federal Taxes 7,504 Total Federal Taxes 6, Vermont Taxes Vermont Taxes Taxable Income 56,078 Taxable Income 50, ,991 Tax Rate ,786 John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

16 Illustration 10-1 After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Single Contribution in Year 1 Single Contribution in Year 1 Amount Available 23,000 Amount Available 23,000 Employer Share of 7.65% (1,634) Taxable Income 21,366 Employee Share of 7.65% (1,634) State Income 6.80% (1,453) Federal Income 25.00% (4,978) Amount Available For Investment 13,301 Rate of Return 6.0% Rate of Return 6.0% Years Invested Before Withdrawals Start 20 Years Invested Before Withdrawals Start 20 Beginning Income Ending Beginning Ending Year Balance Earnings Taxes Balance Year Balance Earnings Balance , (240) 13, ,000 1,380 24, , (250) 14, ,380 1,463 25, , (261) 15, ,843 1,551 27, , (272) 15, ,393 1,644 29, , (283) 16, ,037 1,742 30, , (295) 17, ,779 1,847 32, ,019 1,021 (307) 17, ,626 1,958 34, ,733 1,064 (320) 18, ,583 2,075 36, ,478 1,109 (334) 19, ,659 2,200 38, ,252 1,155 (348) 20, ,858 2,331 41, ,059 1,204 (362) 20, ,189 2,471 43, ,901 1,254 (377) 21, ,661 2,620 46, ,778 1,307 (393) 22, ,281 2,777 49, ,692 1,361 (410) 23, ,057 2,943 52, ,643 1,419 (427) 24, ,001 3,120 55, ,635 1,478 (445) 25, ,121 3,307 58, ,668 1,540 (464) 26, ,428 3,506 61, ,744 1,605 (483) 27, ,934 3,716 65, ,865 1,672 (503) 29, ,650 3,939 69, ,034 1,742 (524) 30, ,589 4,175 73,764 Cole/Melendy VT Bar Assoc. Annual Meeting

17 Illustration 10-2 Withdrawals From After Tax Account Withdrawals From Qualified Plan Earnings Rate 6.00% Earnings Rate 6.00% Year Withdrawals Start 2031 Year Withdrawals Start 2031 Number of Withdrawal Years 25 Number of Withdrawal Years 25 Federal Rate After Retirement 15.00% Federal Rate After Retirement 15.00% State Rate After Retirement 3.55% State Rate After Retirement 3.55% Total Spendable Income 59,642 Total Spendable Income over Retirement Period $139,763 Beginning Spendable Beginning Spendable Year Balance Earnings Taxes Income Year Balance Earnings Withdrawal Taxes Income ,252 1,815 (337) 1, ,764 4,426 3,128 (580) 2, ,462 1,828 (339) 1, ,062 4,504 3,315 (615) 2, ,619 1,837 (341) 1, ,251 4,575 3,514 (652) 2, ,719 1,843 (342) 1, ,312 4,639 3,725 (691) 3, ,756 1,845 (342) 1, ,225 4,694 3,949 (732) 3, ,723 1,843 (342) 1, ,970 4,738 4,185 (776) 3, ,613 1,837 (341) 1, ,523 4,771 4,437 (823) 3, ,419 1,825 (339) 1, ,858 4,791 4,703 (872) 3, ,133 1,808 (335) 1, ,947 4,797 4,985 (925) 4, ,746 1,785 (331) 1, ,759 4,786 5,284 (980) 4, ,250 1,755 (326) 2, ,260 4,756 5,601 (1,039) 4, ,634 1,718 (319) 2, ,415 4,705 5,937 (1,101) 4, ,888 1,673 (310) 2, ,182 4,631 6,293 (1,167) 5, ,001 1,620 (301) 2, ,520 4,531 6,671 (1,237) 5, ,961 1,558 (289) 2, ,380 4,403 7,071 (1,312) 5, ,754 1,485 (276) 2, ,712 4,243 7,495 (1,390) 6, ,367 1,402 (260) 2, ,459 4,048 7,945 (1,474) 6, ,786 1,307 (242) 2, ,562 3,814 8,422 (1,562) 6, ,994 1,200 (223) 2, ,953 3,537 8,927 (1,656) 7, ,976 1,079 (200) 3, ,563 3,214 9,463 (1,755) 7, , (175) 3, ,314 2,839 10,031 (1,861) 8, , (147) 3, ,123 2,407 10,632 (1,972) 8, , (115) 3, ,897 1,914 11,270 (2,091) 9, , (81) 3, ,541 1,352 11,947 (2,216) 9, , (42) 3, , ,663 (2,349) 10,314 Cole/Melendy VT Bar Assoc. Annual Meeting

18 Illustration 11-1 After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Single Contribution in Year 1 Single Contribution in Year 1 Amount Available 52,000 Amount Available 52,000 Employer Share of 1.45% (743) Taxable Income 51,257 Employee Share of 1.45% (743) Medicare 0.90% 461 State Income 7.80% (3,998) Federal Income 33.00% (15,595) Amount Available For Investment 31,382 Rate of Return 6.0% Rate of Return 6.0% Medicar Surtax on Investment Incom Years Invested Before Withdrawals Start 20 Years Invested Before Withdrawals Start 20 Beginning Income Ending Beginning Ending Year Balance Earnings Taxes Balance Year Balance Earnings Balance ,382 1,883 (791) 32, ,000 3,120 55, ,474 1,948 (819) 33, ,120 3,307 58, ,603 2,016 (847) 34, ,427 3,506 61, ,773 2,086 (877) 35, ,933 3,716 65, ,982 2,159 (907) 37, ,649 3,939 69, ,234 2,234 (939) 38, ,588 4,175 73, ,529 2,312 (972) 39, ,763 4,426 78, ,869 2,392 (1,005) 41, ,189 4,691 82, ,256 2,475 (1,040) 42, ,880 4,973 87, ,691 2,561 (1,076) 44, ,853 5,271 93, ,177 2,651 (1,114) 45, ,124 5,587 98, ,713 2,743 (1,153) 47, ,712 5, , ,303 2,838 (1,193) 48, ,634 6, , ,948 2,937 (1,234) 50, ,912 6, , ,651 3,039 (1,277) 52, ,567 7, , ,413 3,145 (1,322) 54, ,621 7, , ,236 3,254 (1,368) 56, ,098 7, , ,122 3,367 (1,415) 58, ,024 8, , ,075 3,484 (1,464) 60, ,426 8, , ,095 3,606 (1,515) 62, ,331 9, ,771 Cole/Melendy VT Bar Assoc. Annual Meeting

19 Illustration 11-2 Withdrawals From After Tax Account Withdrawals From Qualified Plan Earnings Rate 6.00% Earnings Rate 6.00% Year Withdrawals Start 2031 Year Withdrawals Start 2031 Number of Withdrawal Years 25 Number of Withdrawal Years 25 Federal Rate After Retirement 25.00% Federal Rate After Retirement 25.00% State Rate After Retirement 6.80% State Rate After Retirement 6.80% Total Spendable Income $105,852 Total Spendable Income over Retirement Period $264,583 Beginning Spendable Beginning Spendable Year Balance Earnings Taxes Income Year Balance Earnings Withdrawal Taxes Income ,186 3,731 (1,320) 2, ,771 10,006 7,071 (2,249) 4, ,013 3,721 (1,316) 2, ,706 10,182 7,495 (2,384) 5, ,734 3,704 (1,310) 2, ,393 10,344 7,945 (2,527) 5, ,339 3,680 (1,302) 2, ,792 10,488 8,422 (2,678) 5, ,822 3,649 (1,291) 3, ,857 10,611 8,927 (2,839) 6, ,172 3,610 (1,277) 3, ,542 10,713 9,463 (3,009) 6, ,380 3,563 (1,260) 3, ,792 10,788 10,030 (3,190) 6, ,436 3,506 (1,240) 3, ,549 10,833 10,632 (3,381) 7, ,329 3,440 (1,217) 3, ,749 10,845 11,270 (3,584) 7, ,049 3,363 (1,190) 3, ,324 10,819 11,946 (3,799) 8, ,584 3,275 (1,158) 3, ,197 10,752 12,663 (4,027) 8, ,920 3,175 (1,123) 3, ,285 10,637 13,423 (4,269) 9, ,046 3,063 (1,083) 4, ,500 10,470 14,228 (4,525) 9, ,946 2,937 (1,039) 4, ,741 10,244 15,082 (4,796) 10, ,607 2,796 (989) 4, ,903 9,954 15,987 (5,084) 10, ,013 2,641 (934) 4, ,871 9,592 16,946 (5,389) 11, ,148 2,469 (873) 4, ,517 9,151 17,963 (5,712) 12, ,994 2,280 (806) 4, ,704 8,622 19,041 (6,055) 12, ,534 2,072 (733) 5, ,286 7,997 20,183 (6,418) 13, ,749 1,845 (653) 5, ,100 7,266 21,394 (6,803) 14, ,617 1,597 (565) 5, ,971 6,418 22,678 (7,212) 15, ,120 1,327 (469) 5, ,712 5,443 24,039 (7,644) 16, ,233 1,034 (366) 5, ,116 4,327 25,481 (8,103) 17, , (253) 6, ,962 3,058 27,010 (8,589) 18, , (132) 6, ,010 1,621 28,630 (9,104) 19,526 Cole/Melendy VT Bar Assoc. Annual Meeting

20 Illustration 12-1 After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Annual Investment Annual Investment Annual Amount Available 23,000 Annual Funding 23,000 Employer Share of FICA 7.65% (1,634) Compensation 21,366 Employee Share of FICA 7.65% (1,634) State Income Tax 6.80% (1,453) Federal Income Tax 25.00% (5,341) Rate of Return 6.0% Annual Addition to Investment Account 12,937 Rate of Return 6% Years Invested Before Starting Withdrawals 17 Years Invested Before Starting Withdrawals 17 Accumulation at Retirement $321,652 Accumulation at Retirement $687,828 Balance + Total Ending Beginning Ending Year Funding Earnings Taxes Balance Year Balance Earnings Balance , (247) 13, , ,380 24, ,403 1,584 (504) 27, , ,843 50, ,420 2,425 (771) 42, , ,393 77, ,011 3,301 (1,049) 57, , , , ,199 4,212 (1,339) 73, , , , ,009 5,161 (1,641) 89, , , , ,465 6,148 (1,955) 106, , , , ,595 7,176 (2,282) 124, , , , ,426 8,246 (2,622) 143, , , , ,986 9,359 (2,976) 162, , , , ,306 10,518 (3,345) 182, , , , ,416 11,725 (3,728) 203, , , , ,350 12,981 (4,128) 225, , , , ,140 14,288 (4,544) 247, , , , ,821 15,649 (4,976) 271, , , , ,431 17,066 (5,426) 296, , , , ,008 18,540 (5,896) 321, , , ,828 Prepared by John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

21 Illustration 12-2 Withdrawals from After Tax Account Withdrawals from a Qualified Plan Year Withdrawals Start 2031 Year Withdrawals Start 2031 Number of Withdrawal Years 25 Number of Withdrawal Years 25 Rate of Return 6% Rate of Return 6% State Rate After Retirement 3.55% State Rate After Retirement 3.55% Federal Rate After Retirement 15% Federal Rate After Retirement 15% Total Spendable Income $634, Total Spendable Income Available For Retirement $1,303,253 Beginning Annual Total Spendable Beginning Annual Annual Total Spendable Year Balance Earnings Tax Income Year Balance Earnings Withdrawal Tax Income ,652 19,299 (3,580) 13, , ,270 29,164 (5,410) 23, ,876 19,433 (3,605) 14, , ,996 30,914 (5,734) 25, ,550 19,533 (3,623) 14, , ,661 32,769 (6,078) 26, ,613 19,597 (3,635) 15, , ,254 34,735 (6,443) 28, ,003 19,620 (3,640) 16, , ,766 36,819 (6,830) 29, ,651 19,599 (3,636) 17, , ,182 39,028 (7,239) 31, ,484 19,529 (3,623) 17, , ,492 41,369 (7,674) 33, ,423 19,405 (3,600) 18, , ,679 43,852 (8,135) 35, ,382 19,223 (3,566) 19, , ,729 46,483 (8,622) 37, ,272 18,976 (3,520) 20, , ,623 49,272 (9,140) 40, ,996 18,660 (3,461) 21, , ,345 52,228 (9,688) 42, ,448 18,267 (3,389) 22, , ,872 55,362 (10,269) 45, ,517 17,791 (3,300) 23, , ,182 58,683 (10,885) 47, ,084 17,225 (3,195) 25, , ,252 62,204 (11,539) 50, ,021 16,561 (3,072) 26, , ,055 65,937 (12,232) 53, ,191 15,791 (2,929) 27, , ,562 69,893 (12,965) 56, ,448 14,907 (2,765) 28, , ,742 74,086 (13,743) 60, ,635 13,898 (2,578) 30, , ,562 78,532 (14,568) 63, ,586 12,755 (2,366) 31, , ,983 83,244 (15,442) 67, ,121 11,467 (2,127) 33, , ,968 88,238 (16,368) 71, ,051 10,023 (1,859) 35, , ,471 93,532 (17,350) 76, ,172 8,410 (1,560) 36, , ,448 99,145 (18,392) 80, ,267 6,616 (1,227) 38, , , ,093 (19,495) 85, ,104 4,626 (858) 40, , , ,399 (20,665) 90, ,436 2,426 (450) 42, , , ,082 (21,904) 96,178 Prepared by John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

22 Illustration 13-1 After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Annual Investment Annual Investment Annual Amount Available 52,000 Annual Funding 52,000 Employer Share of FICA 1.45% (743) 51,257 Employee Share of FICA 1.45% (743) State Income Tax 8.80% (4,511) Federal Income Tax 33.00% (16,915) Rate of Return 6.0% Earned Income Surtax 0.90% 461 Annual Addition to Investment Account 29,088 Unearned Income 3.80% Rate of Return 6% Years Invested Before Starting Withdrawals 17 Years Invested Before Starting Withdrawals 17 Accumulation at Retirement $668,449 Accumulation at Retirement $1,555,094 Balance + Total Ending Beginning Ending Year Funding Earnings Taxes Balance Year Balance Earnings Balance ,088 1,745 (796) 30, , ,120 55, ,125 3,548 (1,618) 61, , , , ,143 5,409 (2,467) 93, , , , ,173 7,330 (3,343) 126, , , , ,249 9,315 (4,248) 160, , , , ,404 11,364 (5,182) 195, , , , ,675 13,481 (6,147) 232, , , , ,096 15,666 (7,144) 269, , , , ,706 17,922 (8,172) 308, , , , ,545 20,253 (9,235) 348, , , , ,651 22,659 (10,332) 389, , , , ,066 25,144 (11,466) 432, , , , ,832 27,710 (12,635) 476, , ,912 1,040, ,995 30,360 (13,845) 522, ,092, ,567 1,158, ,598 33,096 (15,092) 569, ,210, ,621 1,282, ,690 35,921 (16,380) 618, ,334, ,098 1,415, ,320 38,839 (17,711) 668, ,467, ,024 1,555,094 Prepared by John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

23 Illustration 13-2 Withdrawals from After Tax Account Withdrawals from a Qualified Plan Year Withdrawals Start 2031 Year Withdrawals Start 2031 Number of Withdrawal Years 25 Number of Withdrawal Years 25 Rate of Return 6% Rate of Return 6% State Rate After Retirement 7.80% State Rate After Retirement 7.80% Federal Rate After Retirement 28% Federal Rate After Retirement 28% Unearned Income Tax Rate 3.80% Unearned Income Tax Rate n/a Total Spendable Income 1,097,158 Total Spendable Income Available For Retirement $2,322,464 Beginning Annual Total Spendable Beginning Annual Annual Total Spendable Year Balance Earnings Tax Income Year Balance Earnings Withdrawal Tax Income ,449 40, (15,882) 27, ,555, ,306 65,936 (23,605) 42, ,967 39, (15,800) 28, ,582, ,948 69,892 (25,022) 44, ,354 39, (15,690) 29, ,607, ,451 74,086 (26,523) 47, ,534 39, (15,552) 30, ,629, ,793 78,531 (28,114) 50, ,424 38, (15,383) 31, ,649, ,949 83,243 (29,801) 53, ,940 38, (15,181) 33, ,664, ,891 88,237 (31,588) 56, ,990 37, (14,945) 34, ,676, ,590 93,531 (33,484) 60, ,480 37, (14,671) 35, ,683, ,014 99,143 (35,493) 63, ,310 36, (14,358) 36, ,685, , ,092 (37,623) 67, ,375 35, (14,004) 38, ,681, , ,397 (39,880) 71, ,563 34, (13,604) 39, ,670, , ,081 (42,273) 75, ,758 33, (13,157) 40, ,653, , ,166 (44,809) 80, ,839 31, (12,660) 42, ,627, , ,676 (47,498) 85, ,676 30, (12,110) 44, ,592, , ,637 (50,348) 90, ,134 29, (11,503) 45, ,547, , ,075 (53,369) 95, ,072 27, (10,836) 47, ,490, , ,020 (56,572) 101, ,340 25, (10,106) 48, ,422, , ,501 (59,965) 107, ,782 23, (9,309) 50, ,340, , ,551 (63,563) 113, ,232 21, (8,440) 52, ,242, , ,204 (67,377) 120, ,520 18, (7,497) 54, ,129, , ,496 (71,420) 128, ,462 16, (6,474) 56, , , ,465 (75,704) 135, ,868 13, (5,367) 58, , , ,154 (80,247) 143, ,540 10, (4,171) 60, , , ,603 (85,062) 152, ,268 7, (2,881) 62, , , ,859 (90,166) 161, ,831 3, (1,493) 65, , , ,969 (95,575) 171,394 Prepared by John H.W. Cole, Esq VT Bar Assoc. Annual Meeting

24 (Federal Income Taxation of Capital Gains, Dividends & ACA Surtax) Mark E. Melendy, Esquire Learn how the taxation of capital gains and dividends has changed and if the surtaxes under the Affordable Care Act will apply to you. Melendy Moritz PLLC 18 Elm Street Woodstock VT (802) Telephone (802) Facsimile Vermont Bar Association 2014 Annual Meeting September 19, 2014 mark@melendymoritz.com

25 BUSINESS STRUCTURE & TAX PLANNING By Mark E. Melendy, Esq. Federal Income Taxation of Capital Gains, Dividends and ACA Surtax The distinction between ordinary gain or loss and capital gain or loss is a fundamental element of the Federal income tax system. The requirements for a capital gain or loss are a sale or exchange of a capital asset. The tax treatment of a sale or exchange depends on how long the taxpayer held the property. A capital asset means generally any property except the following: inventory, stock in trade, or property held primarily for sale to customers in the ordinary course of the taxpayer's trade or business; depreciable or real property used in the taxpayer's trade or business; specified literary or artistic property; business accounts or notes receivable; certain publications of the United States Government; certain commodity derivative financial instruments; hedging transactions; and business supplies. 1. Overview There are four categories of gains and losses: short-term and long-term capital gains, and short-term and long-term capital losses. The rules establish a netting mechanism that determines the taxpayer's net short-term or long-term capital gain or loss for the year. Restrictions apply to the deduction of net capital losses; non-corporate taxpayers may deduct capital losses against capital gains and then may deduct no more than $3,000 per year of capital losses against ordinary income. Corporations may 1

26 deduct capital losses only against capital gains. However, nondeductible losses for corporate taxpayers may be carried back to the three preceding years and forward to the five succeeding years and only used to offset capital gains in those years. 2. Taxation of Dividends of Individuals at Capital Gain Rates Dividends from domestic corporations and certain qualified foreign corporations received by non-corporate taxpayers are taxed at the same rates that apply to net capital gain. This treatment also applies for purposes of both the regular tax and the alternative minimum tax. However, payments in lieu of dividends are not eligible for this exclusion. These rules regarding dividends being taxed as net capital gain are generally applicable to tax years beginning after (a) Definition of Qualified Dividend Income. The term qualified dividend income is defined as dividends received from domestic corporations and qualified foreign corporations. It does not, however, include the following dividends: Any dividend from a corporation which for the taxable year of the corporation in which the distribution is made, or the preceding taxable year, is a corporation exempt from tax; Any amount allowed as a deduction for dividends paid by mutual savings banks, cooperative banks, domestic building and loan associations, and other savings institutions chartered and supervised as savings and loan or similar associations under Federal or State law; and Any dividend paid with respect to certain employer securities. It also does not include any dividend on any share of stock that meets either of the following criteria: With respect to which certain holding period requirements are not met (the holding period test ); or To the extent that the taxpayer is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. (b) Special Rules. The following special rules apply with regard to dividends taxed as net capital gain. 2

27 Amounts Taken Into Account as Investment Income. Qualified dividend income does not include any amount which the taxpayer takes into account as investment income. Extraordinary Dividends. If an individual receives, with respect to any share of stock, qualified dividend income from one or more dividends which are extraordinary dividends, any loss on the sale or exchange of such share will, to the extent of such dividends, be treated as long-term capital loss. Treatment of Dividends from Regulated Investment Companies And Real Estate Investment Trusts. A dividend received from a regulated investment company or a real estate investment trust will be subject to certain limitations. As you can see the rules in this area are quite complex. To date, the IRS has issued a host of notices and announcements to provide guidance to taxpayers and practitioners as to how to implement these new statutory provisions. For this reason, the facts of your situation should be carefully reviewed. Please call me at your convenience to discuss how the foregoing is applicable to your personal and tax situation. (c) Capital Gains, Dividends and Surtax Rates. (1) Capital Gains Tax Rates. Short-term capital gains are taxed as ordinary income. Long term capital gains for taxpayers in the 10% or 15% bracket are not taxed. Long term capital gains for taxpayers in the 25-35% tax brackets are taxed at a 15% rate. Taxpayers in the highest tax bracket are subject to a capital gains tax rate of 20%. (2) Qualified Dividends Tax Rates. Qualified dividends for taxpayers in the 10% or 15% bracket are not taxed. Qualified dividends for taxpayers in the 25-35% tax brackets are taxed at a 15% rate. Taxpayers in the highest tax bracket are subject to a qualified dividend tax rate of 20%. (3) Affordable Care Act 3.8% Surtax. This surtax affects married taxpayers with adjusted gross income (AGI) in excess of $250,000, or single taxpayers with an AGI over $200,000. These taxpayers will pay a 3.8% surtax on the lesser of all net investment income 3

28 and the amount by which their modified AGI exceeds $250,000 for married taxpayers or $200,000 for single taxpayers. Modified AGI is the taxpayers' AGI increased by any foreign earned income that was excluded from gross income. What constitutes net investment income is complicated, but essentially, it is net sales proceeds, dividends, royalties, interest, annuities, rents and income earned from passive trade or business activities. There are some exceptions, such as sale of S corporation stock provided the corporation conducts a trade or business and the taxpayer materially participates in the business. Additionally, the 3.8% surtax does not apply to qualified retirement plan and individual retirement account distributions. (4) Additional Hospital Insurance Tax. Married taxpayers filing jointly who earn more than $250,000 and individual taxpayers earning more than $200,000 are subject to an additional Medicare tax equal to 0.9% of their wages over these thresholds. This results in these taxpayers paying a Medicare tax rate on those earnings of 2.35% instead of 1.45%. 4