Reduce inheritance taxes by giving gifts! The inheritance tax is the same thing as the estate tax in the United States, but with a different name depending on the country that you are talking about. The inheritance tax is a tax that is supposed to be levied on the richest people after they die, especially if they have a considerably large estate at that point in time. However, this is not always the case, and in fact, a lot of people find that they are being forced to pay an inheritance tax even though they do not have a particularly large estate. The reason for this is that housing costs continue to increase – and since your house is considered to be one of your assets, it is included in your estate. The inheritance tax is considered by some people to be a highly unfair tax due to the fact that the people who owned the estate had already paid their taxes before death. However, the inheritance tax is still in effect, and it can cost anywhere between forty and fifty percent of your estate over a certain maximum amount. Depending on where you are, that amount will change. Essentially, anybody who has more than that base amount in their estate will be charged 40-50% of any assets that they owned over that amount. One thing that you can do in order to reduce the amount of inheritance tax you end up paying is to check and see if there are any loopholes in the tax law that you can use to your own advantage. One thing that you should consider, for instance, is that some countries will allow you to give a large amount of money to a family member or survivor tax free. If there is anybody who you would like to have inherit a large monetary gift, then you should definitely consider doing this before you die. This might even reduce the total amount of your estate to the point where you will not have to pay any inheritance taxes at all. This also goes for gifts. It is possible to give gifts to as many people as you would like before you die, just so long as the total value of each gift does not exceed a certain amount. By planning ahead and making gifts, you should be able to reduce the amount of inheritance taxes that your estate will owe after your death.
What’s the Best Way to Pay a Business Owner’s Estate Taxes?
A critical element to business succession planning is making certain the business owner’s estate will have the cash to pay estate taxes without having to sell the business. This article will examine the advantages and disadvantages of four such commonly used techniques – IRC Section 6166, IRC Section 303, Graegin loans, and life insurance. IRC Section 6166 IRC Section 6166 permits the legal representative of the business owner’s estate to pay the portion of the estate tax attributable to the business in installments. During the first four years, interest only is due. Thereafter, annual installments of both interest and principal are due over 10 years. While Section 6166 can be useful, it does have several drawbacks. First, in order to qualify under Section 6166, the business interest must exceed 35% of the business owner’s adjusted gross estate. Second, interest accrues at the rate of 2% on the deferred tax on the first $1,340,000 (indexed for inflation) of the business interest in excess of the applicable estate tax exclusion amount. But the interest rate on the deferred tax in excess of that amount bears interest at 45% of the rate applicable for tax underpayments (i.e., the short-term applicable federal rate plus 3% adjusted quarterly). Moreover, the interest paid under IRC Section 6166 does not qualify as an administration expense and is not deductible on either the estate tax return (Form 706) or on the estate’s income tax return (Form 1041). Third, the IRS can place a tax lien on the business until all installment payments are met. This lien may make it difficult for the business to borrow from banks and other lenders. Finally, the IRS can demand immediate payment of all unpaid taxes if the estate misses one scheduled payment, or if there is a sale or exchange of one-half or more of the business. IRC Section 303 IRC Section 303 permits heirs to get cash out of a corporation (either a C corporation or an S corporation) with minimal or no income tax consequences to the extent needed to pay federal and state death taxes, costs of estate administration, and funeral expenses. Thus, Section 303 can help an estate escape a forced sale of the business to pay estate taxes, without having a partial stock redemption taxed as a dividend. But Section 303 is not without its disadvantages. First, the stock’s value must exceed 35% of the deceased shareholder’s adjusted gross estate to qualify. Second, where will the cash to redeem the decedent’s stock come from? The corporation may not have excess cash with which to redeem stock. And, if the corporation attempts to accumulate cash to redeem stock, it may be subject to a 15% accumulated earnings tax. IRC Sections 531-537. Finally, like any other redemption, Section 303 redemption can alter the ownership percentages of the surviving shareholders. Graegin Loans In Graegin v Commissioner, 56 T.C.M. 387 (1988), the Tax Court allowed an estate to deduct (as an administration expense on the estate tax return) the interest on a loan used to pay estate taxes. In Graegin, the estate consisted mostly of closely-held stock and had very little liquidity. So, instead of selling stock; or redeeming stock under IRC Section 303; or paying the estate tax on installments under IRC Section 6166, the estate borrowed the funds to pay estate taxes from a wholly-owned subsidiary of the closely-held corporation. The note provided that all principal and accrued interest was due in a single balloon payment at the end of the note term, and neither principal nor interest could be prepaid. The Tax Court allowed the estate to deduct the entire balloon interest payment. Of significance is that the amount of interest payable be certain. Therefore, the note cannot permit prepayment of interest or principal. In addition, in order for the balloon interest to be deductible, the estate must show that it had no way of paying estate taxes other than the forced sale of illiquid assets. Otherwise, the interest payment is not a reasonable and necessary administration expense. See PLR 200513028 (Sept. 15, 2004). Unfortunately, the Tax Court in Estate of Black v Commissioner, 133 T.C. No. 15 (Dec. 18, 2009), struck a blow to Graegin loans. In Black, the estate entered into a Graegin-type loan with an FLP. The Tax Court ruled that the loan was not “necessarily incurred” within the meaning of Treas. Reg. Sec. 20.2053-3(a) and, therefore, the interest (approximately $20,296,274) was not a deductible administration expense under IRC Section 2053(a)(2). The Tax Court found that the FLP could have redeemed the estate’s partnership interest shortly after the taxpayer’s death in order to provide the funds with which to pay the estate tax. This fact rendered the loan unnecessary. The Tax Court also emphasized that the decedent’s son stood on both sides of the loan – as the general partner of the FLP and the executor of the estate. But, it’s not clear from the Tax Court’s ruling whether the outcome would have been different if an independent party had served as the executor. The problem with the Tax Court’s reasoning in Black is that, had the FLP redeemed the estate’s partnership interest shortly after the deceased partner’s death, the IRS would likely have included in the decedent’s estate any partnership interests gifted during the decedent’s lifetime. In Estate of Erickson v Commissioner, T.C.M. 2007-107, an FLP provided funds for the payment of the deceased partner’s estate tax liabilities. The Tax Court in Erickson reasoned that this was tantamount to making funds available to the decedent resulting in retained enjoyment and, thus, estate tax inclusion under IRC Section 2036(a)(1). Life Insurance The complexity and potential challenges of using Section 6166, Section 303, or Graegin loans, reinforces the advantages of using an irrevocable life insurance trust (“ILIT”) to pay estate taxes. An ILIT offers the following advantages: 1. The accumulation of cash values is not subject to current income taxation; the trustee can access cash values tax free (by surrendering to basis and/or borrowing); and the death proceeds are not subject to income taxes. 2. Gifts of life insurance premiums of up to $13,000 ($26,000 if married) can qualify for the annual gift tax exclusion, thereby avoiding current gift taxes. 3. Gifts of life insurance premiums also decrease the grantor-insured’s estate, potentially lowering federal estate taxes. 4. For two reasons, the internal rate of return for most insured’s will be favorable compared to alternative investments. First, in the case of a premature death, the insurance policy produces an unparallel return on investment. Second, since the death benefit is income tax free, the projected rate of return is enhanced. The internal rate of return can be calculated and easily illustrated by the insurance advisor. 5. Finally, life insurance provides the business owner’s estate the liquidity it needs exactly when it’s needed, regardless of whether the estate qualifies under Section 6166, Section 303, or Graegin. The death proceeds received by the ILIT can be used to purchase assets from the business owner’s estate or to loan funds to the estate or to the business directly. An ILIT can also play a role in the other strategies discussed above. For example, if at the time of the business owner’s death the estate qualifies under Section 6166 and the interest rates are favorable, paying the estate tax in installments may prove useful. But, if the estate subsequently runs into problems paying the installments, the ILIT can assist by purchasing assets from the estate or loaning funds to the estate on favorable terms. The same is true with a Section 303 redemption. Assuming the estate qualifies for Section 303 treatment, but the corporation does not have sufficient cash to redeem the deceased shareholder’s shares. The ILIT could loan a portion of the death proceeds to the corporation to help it consummate the redemption. This is preferable to having the corporation be the owner and beneficiary of the policy, thereby increasing the value of the business for estate tax purposes. Finally, if the ILIT loans the business owner’s estate the funds it needs to pay estate taxes and structures the loan to be a Graegin loan, the estate may qualify to deduct all of the balloon interest (as an administration expense). Of course, this assumes that the IRS does not successfully challenge the loan under the rationale of the Black case. In summary, an ILIT is a popular and effective tool to help meet the estate liquidity needs of a business owner. Due to its tax-advantaged status, an ILIT is an ideal way – standing alone or in conjunction with other planning opportunities – to fund estate taxes, thereby assuring that the family business stays in the family
How to Save Taxes with an S Corporation
Ever wondered why so many small businesses—more than 3,000,000 at last count—operate as an S corporation? Simple. An S corporation saves business owners big taxes in three separate ways:
First, as compared to regular corporations (sometimes called C corporations), S corporation owners can use the business’s losses incurred during the early lean years on the owner’s personal returns as deductions. For example, suppose a new S corporation suffers a $20,000 loss its first year and that the corporation is equally owned by two shareholder-employees, Smith and Jones. Smith and Jones each get a $10,000 business deduction on their individual tax returns because of the S corporation loss. This $10,000 deduction might save them each as much as $4,000 in federal and state income taxes.
A second, big S corporation benefit: As compared to almost every other business form, S corporations can save their owners self-employment or Social Security/Medicare taxes. Suppose, for example, that Adams, Brown and Cole independently each own businesses that make $90,000 a year in profits. Each business owner may pay $13,000 in income taxes. But, unfortunately, that’s not the only tax they pay. Each owner also pays self-employment or Social Security/Medicare taxes.
For example, Adams operates his business as an LLC and therefore pays 15.3%, or roughly $13,500, in self-employment taxes on his profits.
Brown operates his business as a C corporation which pays all of its profits to him as a salary. Accordingly, Brown (through his corporation) also pays 15.3%, or roughly $13,500, in Social Security and Medicare taxes.
Cole’s situation is different. Cole operates his business as an S corporation which means that Cole can split his $90,000 of profits into two payment amounts: salary and S corporation distributions. Suppose that Cole says only $40,000 of his profits are salary and takes the other $50,000 as a “dividend” distribution. In this case, Carter pays the 15.3% Social Security/Medicare tax only on the $40,000 in salary. Carter therefore pays roughly $6,000 in Social Security/Medicare taxes—and annually saves $7,000 in taxes as compared to Adams or Brown.
S corporations also, sometimes, provide a third form of tax savings because S corporations don’t pay corporate income taxes. This means that S corporations avoid the often-talked about “double-taxation” problem. However, the “no corporate income taxes” benefit often isn’t a savings for small corporations and their owners.
But let me explain. Suppose that two corporations each earn the same pretax profit of $100,000 and are owned by Ms. DaVinci who pays the highest federal income tax rate of 35%. One corporation is an S corporation and the other is a C corporation. The S corporation can distribute the entire $100,000 in profits to DaVinci as dividends because there is no corporate income tax. DaVinci then pays $35,000 in personal income taxes on the S corporation profits, which means she nets $65,000 in after-tax profits from the S corporation. In comparison, the C corporation can’t pay the entire $100,000 in profits to DaVinci. The C corporation first pays $22,250 in corporate income taxes. When the C corporation pays the remaining $77,750 to DaVinci as a dividend, DaVinci pays another $11,663 in 15% “dividend” taxes on the C corporation profits. This means that DaVinci nets roughly $66,000 in after-tax profits from the C corporation profits. In this case, DaVinci saves money with a C corporation in spite of having to pay the corporate income tax.
How to Get S Corporation Benefits
To create an S corporation and receive S corporation tax savings, you need to do two things: First, you must incorporate the business either as a regular corporation or as a limited liability company. Second, you need to make an election with the IRS to have the corporation or LLC treated as an S corporation. The S election is made with form 2553, available from the www.irs.gov web site. Note that some states (such as New York) require a separate state S election.
A final tip: S corporations can save you thousands of dollars annually, but your tax savings can’t start until you elect S corporation status. If you’re interested is electing S status to save on taxes for next year, you may want to call your tax advisor or attorney right now!
How To Minimize Your Taxes On Wealth
Taxes on wealth or simply wealth tax is the tax levied on the value of wealth owned by a person. As the term ‘wealth’ carries with it a broader meaning, generally capital transfer taxes (which include inheritance tax and gift tax), property tax, and capital gains taxes are some times invariably referred to as wealth taxes.
Taxes on wealth were first introduced in Europe, aimed at reducing the growing wealth gap between the rich and the poor. It was meant to raise revenue for addressing pressing social requirements and also to discourage the attitude towards amassing wealth.
Still, in countries across the world, majority of wealth is concentrated at the hands of fairly small number of people. Ideally taxes on wealth cuts down the disparities in wealth rather than the income, which actually is the determinant factor on how the scales are weighed for the next generations.
Also, taxes on wealth can bring about vertical as well as horizontal equity, which income tax fails to achieve. For example, neither a wealthy person nor a poor one with no income will pay income tax. But the wealthy ones need to cough up wealth tax while the poor need not.
But, as critics puts down, taxes on wealth can actually cause inefficiency by discouraging wealth producing economic initiatives. Also, the revenue generated by imposing taxes on wealth may not be that productive as the theory suggests. The wealthiest form only a small percentage of the population and by nature they are adept at avoiding taxes while remaining themselves within the contours of law.
Taxes on wealth comes in two forms – the capital transfer taxes that are levied when wealth change hands and the annual wealth taxes. Capital transfer taxes can occur either at death – also called inheritance tax – or via donation (gift tax). Some people tend to believe that Capital Gains tax to be a form of taxes on wealth. But in realty, capital gains tax is the taxation on the income obtained on capital and not a wealth tax on the capital.
Ideally, taxes on wealth should not be severe on the tax payers even if they have lots of wealth. Instead, after the minimum slab of no taxation, the taxes on wealth percentage should increase at increments, depending on the value of wealth in dollars. Such a fairer taxation not only increases the revenue but also goes a long way in bringing down the inequality aspect as well.
But with intelligent investing, one can save a lot that other wise goes as wealth tax. But that requires careful thought and advanced planning. May be a tax professional could help one in this regard.
Protecting Assest From Lawsuits and Creditors
Protecting assets from lawsuits and creditors while saving income and estate taxes.
Preserving wealth and hard earned dollars is becoming a great concern and a high priority in this litigious society. Many businesses and individuals who have failed to plan for potential financial difficulties by structuring their assets have found themselves wiped out almost overnight. The risk of exposure to potential lawsuits exists in every aspect of today’s society, including: * Personal injury. * Lawsuits related to auto or home ownership. * Job-related lawsuits, including wrongful termination; breach of contract; malpractice; officer and director liability; workers’ compensation. * Governmental agency exposure, including the IRS and state regulatory departments. * Divorce and remarriage. * Investment-related lawsuits. * Major medical illnesses or elderly care requirements.
The purpose of asset protection planning is to structure legally a client’s wealth and assets in such a manner that they cannot be reached by lawsuits and/or creditors in the event of a large judgment (i.e., lawfully minimize one’s exposure to the possibility of losing one’s home, retirement, savings and other family assets) and, at the same time, save on estate and income taxes.
Protection planning strategies
In general, the following asset protection techniques are used in any plan and can also be used to save income and estate taxes. 1. Trusts: Transfers can be made to a trust that retains legal ownership of the property free from creditors’ claims. 2. Pensions, life insurance and annuities: These assets are generally exempt from seizure by a creditor as they are protected under state exemption laws. 3. Mortgages and secured debt: Secured debt can be used as a technique to tie up the equity in one’s property. 4. Marital property agreements: An agreement can be entered into that will shield at least one-half of the community (husband and wife) from being exposed in the event of a judgment. 5. Corporations: A corporation can be used to limit one’s personal liability exposure. 6. Partnerships: A family partnership, if structured properly, is very difficult for a creditor to enforce a judgment against. 7. Donations and gifts: Transfers to children or third parties, if done properly, can place property beyond the reach of creditors. Note: Each of these techniques offers certain advantages and disadvantages from not only an asset protection standpoint, but also from a tax and estate planning standpoint. Obviously, tax and estate planning is also a large part of estate protection planning.
Protecting a business: Practitioners know that a client’s business can be set up as a corporation to shelter their personal assets from liability. But many professionals are under the false assumption that a corporation will not shield a doctor, attorney, accountant, engineer and other professionals. In fact, the corporation shields professionals from everything except malpractice. Nonmalpractice claims such as accidents, employee wrongful acts and breaches of contract can be significant.
Taking business protection a step further, corporate business assets may be owned by a children’s trust, and the trust may lease the assets back to the corporation. If the corporation is sued, the assets would not be vulnerable because the trust owns them. This arrangement could also save taxes if structured properly, with the lease payments qualifying as a business expense.
Protecting a home: Equity in a home can be a vulnerable asset. An individual who owns a home free of debt can protect it by taking out a mortgage and investing the proceeds in a retirement asset such as an annuity or insurance policy. Under state law, creditors may not be able to touch an annuity or insurance policy, and the home will no longer be vulnerable since it is tied up with a mortgage.
Conclusion
Structuring ownership of family and business assets to provide maximum protection from creditors makes good business sense. If possible, timely action before getting involved in financial or legal problems (as opposed to last minute transfers) makes it easier to withstand a challenge.