1. Consider establishing an
employee stock ownership plan (ESOP).
If you own a business and need to diversify your investment portfolio, consider
establishing an ESOP. A properly funded ESOP provides you with a mechanism for selling
your shares with no current tax liability. Consult a specialist in this area to learn
about additional benefits.
2. Make a succession plan.
Have you provided for a succession plan for both management and ownership of your business
in the event of your death or incapacity? Many business owners wait too long to recognize
all the benefits from making a succession plan. These benefits include ensuring an orderly
transition and ensuring the lowest possible tax cost. Waiting too long can be expensive
from a financial perspective (covering gift and income taxes, life insurance premiums,
appraiser fees, and legal and accounting fees) and a non-financial perspective
(intrafamily and intracompany squabbles).
3. Consider the limited
liability company (LLC) and limited liability partnership (LLP) forms of ownership.
These entity forms should be considered for both tax and non-tax reasons.
4. Avoid nondeductible compensation.
Compensation can only be deducted if it is reasonable. Recent court decisions have allowed
business owners to deduct compensation when (1) the corporation’s success was due to
the shareholder–employee, (2) the bonus policy was consistent, and (3) the
corporation did not provide unusual corporate perquisites and fringe benefits.
5. Purchase Corporate Owned Life
Insurance (COLI).
COLI can be a tax-effective tool for funding deferred executive compensation, funding
company redemption of stock as part of a succession plan, and providing many employees
with life insurance in a highly leveraged program. Consult your insurance and tax advisers
when considering this technique.
6. Avoid dividend treatment when
a corporation purchases stock from family members.
In certain circumstances, the family member may be treated as receiving a dividend and
have to pay tax at ordinary income rates on the entire amount of the redemption proceeds.
If certain tests are met, the family member may instead report only capital gain equal to
the difference between the proceeds and basis and pay tax at a maximum rate of 20 percent.
Consult your tax adviser before the corporation purchases stock from family members.
7. Consider establishing a
SIMPLE retirement plan.
If you have no more than 100 employees and no other qualified plan, you may set up a
Savings Incentive Match Plan for Employees (SIMPLE) into which an employee may contribute
up to $6,000 per year. You, as employer, are required to make matching contributions. Talk
with a benefits specialist to fully understand the rules and advantages and disadvantages
of these accounts.
8. Establish a Keogh retirement
plan before December 31, 1998.
If you are self-employed and want to deduct contributions to a new Keogh retirement plan
for the 1998 tax year, you must establish the plan by December 31, 1998. You don’t
actually have to put the money into your Keogh(s) until the due date of your tax return.
Consult with a specialist in this area to ensure that you establish the Keogh or Keoghs
that maximize your flexibility and your annual contributions.
9. Take advantage of section
179 expensing.
If you meet certain requirements, you may be able to expense up to $18,500 in purchases of
qualifying property placed in service during 1998, instead of depreciating the
expenditures over a longer time period. For 1999, this limit rises to $19,000.
10. If you’re self-employed,
consider employing your under-18 child.
A child who is under age 18 and employed by his or her self-employed parent in an
unincorporated business is not subject to FICA taxes, and the parent is not responsible
for paying the employer’s portion of FICA taxes. Additionally, the parent is allowed
a tax deduction for the wages paid to the child, and the child’s 1998 standard
deduction will shelter the first $4,250 of wages from tax. In essence, the parent is able
to shift $4,250 of his or her income to each child tax free.
11. Don’t forget deductions for
health insurance premiums.
If you are self-employed (or are a partner or a 2-percent S corporation
shareholder–employee), for 1998 you may deduct 45 percent of your medical insurance
premiums for yourself and your family as an adjustment to gross income. This percentage is
scheduled to increase in future years. The adjustment does not reduce net earnings subject
to self-employment taxes, and it cannot exceed the earned income from the business under
which the plan was established. You may not deduct premiums paid during a calendar month
in which you or your spouse is eligible for employer-paid health benefits.
12. Review whether compensation
may be subject to self-employment taxes.
If you are a sole proprietor, an active partner in a partnership, or a manager in a
limited liability company, the net earned income you receive from the entity may be
subject to self-employment taxes.
13. Don’t overlook minimum
distributions at age 70½ and rack up a 50 percent penalty.
Minimum distributions from qualified retirement plans and IRAs must begin by April 1 of
the year after the year in which you reach age 70½. The amount of the minimum
distribution is calculated based on your life expectancy or the joint and last survivor
life expectancy of you and your designated beneficiary. If the amount distributed is less
than the minimum required amount, an excise tax equal to 50 percent of the amount of the
shortfall is imposed.
14. Don’t double up your
first minimum distributions and pay unnecessary income and excise taxes.
Minimum distributions are generally required at age seventy and one-half, but you are
allowed to delay the first distribution until April 1 of the year following the year you
reach age seventy and one-half. In subsequent years, the required distribution must be
made by the end of the calendar year. This creates the potential to double up in
distributions in the year after you reach age 70½. This double-up may push you into
higher tax rates than normal. In many cases, this pitfall can be avoided by simply taking
the first distribution in the year in which you reach age 70½.
15. Don’t forget filing
requirements for household employees.
Employers of household employees must withhold and pay social security taxes annually if
they paid a domestic employee more than $1,000 a year. Federal employment taxes for
household employees are reported on your individual income tax return (Form 1040, Schedule
H). To avoid underpayment of estimated tax penalties, employers will be required to pay
these taxes for domestic employees by increasing their own wage withholding or quarterly
estimated tax payments. Although the federal filing is now required annually, many states
still have quarterly filing requirements.
16. Consider funding a
nondeductible regular or Roth IRA.
Although nondeductible IRAs are not as advantageous as deductible IRAs, you still receive
the benefits of tax-deferred income. Note that beginning in 1998, the income thresholds to
qualify for making deductible IRA contributions, even if you or your spouse is an active
participant in a employer plan, are increasing.
17. Calculate your tax
liability as if filing jointly and separately.
In certain situations, filing separately may save money for a married couple. If you or
your spouse is in a lower tax bracket or if one of you has large itemized deductions,
filing separately may lower your total taxes. Filing separately may also lower the
phaseout of itemized deductions and personal exemptions, which are based on adjusted gross
income. When choosing your filing status, you should also factor in the state tax
implications.
18. Avoid the hobby loss
rules.
If you choose self-employment over a second job to earn additional income, avoid the hobby
loss rules if you incur a loss. The IRS looks at a number of tests, not just the elements
of personal pleasure or recreation involved in the activity.
19. Review post-death planning
opportunities.
A number of tax planning strategies can be implemented soon after death. Some of these,
such as disclaimers, must be implemented within a certain period of time after death. A
number of special elections are also available on a decedent’s final individual
income tax return.
20. Take advantage of tax
breaks for sales of principal residences.
Single taxpayers who sell their principal residence during 1998 and thereafter may exclude
up to $250,000 of gain that they realize on the sale or exchange. Married taxpayers filing
a joint return can exclude up to $500,000. Taxpayers may use this exclusion once every two
years. Only taxpayers who have owned and occupied a home as a principal residence for at
least two of the five years prior to any sale or exchange may take full advantage of the
exclusion. If the principal residence is held less than two years, the exclusion amount is
prorated.
21. Check to see if you qualify
for the Child Tax Credit.
Beginning in 1998, a $400 tax credit is available for each dependent child (including
stepchildren and eligible foster children) under the age of 17 at the end of the taxable
year. For calendar year 1999, the ceiling on the credit goes up to $500. The child credit
generally is available only to the extent of a taxpayer’s regular income tax
liability. However, for a taxpayer with three or more children, this limitation is
increased by the excess of Social Security taxes paid over the sum of other nonrefundable
credits and any earned income tax credit allowed to the taxpayer. Phaseout of the credit
begins at modified adjusted gross income levels of $110,000 for joint filers ($55,000 for
married taxpayers filing separately) and $75,000 for single filers. Taxpayers will lose
$50 of the credit for every $1,000 (or part thereof) of adjusted gross income (AGI) in
excess of their threshold. The level at which the credit is phased out completely depends
on the number of qualifying children The child credit and the income threshold amounts are
not indexed for inflation.
For more information concerning these financial planning ideas, please call or email us.