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Tax Update and Savings Strategies for High Net Worth Individuals. Michael A. Africk Tuesday February 14, 2012. Learning Objectives . Review some changes impacting your income taxes in 2012 and 2013 (maybe) Learn various strategies that can reduce one’s gift and estate taxes
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Tax Update and Savings Strategies for High Net Worth Individuals Michael A. Africk Tuesday February 14, 2012
Learning Objectives • Review some changes impacting your income taxes in 2012 and 2013 (maybe) • Learn various strategies that can reduce one’s gift and estate taxes • Review potential business planning techniques
About CliftonLarsonAllen (“CLA”) • More than 50 years of quality, service and experience • Among the nation's top-10 accounting firms • Unprecedented emphasis on serving privately held businesses and their owners • 3,600 professionals, including 500+ partners • More than 90 locations in U.S. • Organized through industry lines
CLA Primary Industry Services • Agribusiness and Cooperatives • Construction and Real Estate • Commercial and Service • Dealerships • Employee Benefit Plans • Financial Institutions • Health Care • Manufacturing and Distribution • Nonprofit and Governmental
CLA Highly Specialized Services • Organized as public accounting/advisory, wealth advisory and outsourcing entities • Strong partner engagement leadership • Understanding the goals of the owners • Understanding the goals of key management • Focused on improving your business • Recognized as technical leaders within industry • Continually developing services that can make our clients more successful
Construction and Real Estate Group • Serving over 600 contractors and real estate companies • More than 60 professionals devoted to industries • Typical $5m-$250m, some smaller and some larger • Expertise claims assistance and litigation support services • Mergers and acquisitions – negotiation and due diligence • Operational and Lean Accounting consulting • Valuation and purchase/sale price analysis • Governance and strategic consulting • Core assurance services • Cost allocation and FAR audits
Construction and Real Estate Industries • Heavy Construction/Heavy Highway • General Contractors • Special Trade Contractors • Engineering, Architecture and Surveying • Real Estate Holding Companies • Industrial Rental/Development • Commercial Rental/Development • Housing Development • Land Development • Property Management
Small Business Jobs Act of 2010 • Signed in September 2010 • Improved Section 179 Depreciation • New and used property purchased in 2010 and 2011 • Increased to $500,000, phase out starts at $2.0 • Extended Bonus Depreciation • Retroactive restated for 2010 • New tangible property only • 50% bonus depreciation • Contractors will also benefit
Small Business Jobs Act of 2010 • S Corporation Built-In Gains Tax • Holding period reduced to 5 years • Sale in 2011 • Holding period reinstated to 10 years • Sale in 2012, thereafter • Break on Self Employment Tax • Health insurance is deductible from SE Tax
Tax Relief and Job Creation Act of 2010 • Signed in December 2010 • Bush tax cuts and business incentives expire in 2010 • Extended Bush cuts to 2012 • Extends business incentives through 2012 • Extends gift and estate exemptions through 2012 • Reduced social security tax for employee 2% through December 2011
Tax Relief and Job Creation Act of 2010 • Ordinary Income Tax Rates Sunset in 2012 2011/12 Ordinary Rates 35% 33% 28% 25% 15% 10% 2013 Ordinary Rates 39.6% 36% 31% 28% 15% 15%
Tax Relief and Job Creation Act of 2010 • Other Favorable Tax Rates will Sunset in 2012 2011/12 Rates LT Cap Gain – 15% Qualified Div – 15% 2013 Rates LT Cap Gain – 20% Qualified Div – 39.6% • Selected Extenders • AMT exemption (2011). Watch for extension • Non phase out of personal exemptions (2012) • Higher education credit (2012) • IRA Charitable Contributions (2011)
Tax Relief and Job Creation Act of 2010 • Business Extenders • Research and Development Credits (2011) • Expensing of remediation costs (2011) • Energy Extenders • Maximum $2,000 Energy efficient installations (2011) • Maximum $500 Energy efficient appliances (2011) • Biodiesel Tax Credits (2011) • Alternative Fuel Tax Credits (2011) • Fuels Credits (2011)
Tax Relief and Job Creation Act of 2010 • Estate and Gift Tax Restoration • Significantly increased the federal exemption • Portability of unused portion to surviving spouse • Heightens need to properly file estate tax returns • Planning Opportunity • High exemption levels • Low asset values • Low interest rates • More on this later
Tax Relief and Job Creation Act of 2010 • Increased the gift and estate exemptions * 2012 index inflated to $5,120,000
Tax Relief and Job Creation Act of 2010 • Extends Section 179 • New and used qualified property • Sets 2012 limit at $125,000 • Limited by profits earned • Section 179 before bonus depreciation • Will increase Job % complete for certain assets
Tax Relief and Job Creation Act of 2010 • Improved Bonus Depreciation • Only new tangible property • Sets 2011 at 100% and 2012 at 50% • Includes leasehold improvements • Cannot be lease between related parties • Common ownership of 80% • Contractors lose tax advantage • Decoupling not available in 2011 • Bonus Depreciation for job related equipment • Increases job % complete • Do not expect tax savings • Increase bonus depreciation on cars by $8,000
Tax Relief and Job Creation Act of 2010 • Section 179 and bonus depreciation * Benefits contractors through decoupling
Tax Relief and Job Creation Act of 2010 ACTION STEPS: • Consider accelerating income into 2012 • Trigger capital gains by sale of securities • Elect out of bonus depreciation and/or Section 179 • Defer business expenses and itemized deductions • Convert traditional IRA to Roth • Consider increased gifting in 2012 • More on this later in the presentation
Patient Protection and Affordable Care Act • Signed in March 2010 • Beginning in 2013, individuals and trusts will be subject to a Medicare HI (surtax) of 3.8% • Those with modified gross income over $200,000/$250,000 will be subject to tax
Patient Protection and Affordable Care Act • Tax on net investment income • Interest and Dividends • Net capital gains • Rents and Royalties • Consider earnings from passive activities • Example • MFJ taxpayer with income of $300,000 • MFJ taxpayer with net investment income of $40,000 • Since income exceeds threshold by $50,000, all of the net investment income would be subject to 3.8% tax • If net investment income was $60,000 taxed on $50,000
Patient Protection and Affordable Care Act ACTION STEPS: • Convert traditional IRA to Roth in 2012 • Structuring of interest from related parties • Utilize tax-deferred investments to control of timing of income, e.g., annuities, life insurance cash values and deferred comp • Maximize qualified plan and deductible IRA contributions in 2013 • Municipal bonds • Trigger Installment sales
Complex Income and Estate Tax Savings Ideas NameAcronymUse Employee Stock Ownership Plan ESOP Eliminate Income Taxes Succession Planning Reciprocal Trust Arrangement ------ Estate Planning Grantor Retained Annuity Trust GRAT Estate Planning Succession Planning Family Limited Partnership FLP Estate Planning Opportunity
ESOP – What is it? • An ESOP is a Tax Qualified, Defined Contribution, Employee Benefit Plan (ERISA) • “Qualified” in that sponsoring company and selling shareholder receive various tax benefits • Invests primarily in the stock of the sponsoring company • Provides ownership to employees
ESOP – How does it work? (Leveraged) 1. CompanysetsupanESOPTrust 2 2. Bank or SH lend $ to Company 3. Company lends $ to ESOP 4. ESOP buys stock from SH (s) Company Lender 5. SH’s relinquish stock with collateral to bank 3 ESOP 6. Shares are allocated to the accounts of eligible employees within the ESOP based on salary 5 1 4 7. Employees receive stock or cash after they retire or leave the company, a vesting schedule applies Shareholders 6 Employees
ESOP – When should it be used? • Shareholder’s retirement or buyout • Equity instrument for raising capital • Charitable giving plans • Family transitions • Interested in eliminating income tax • Company’s with strong employee management • Encourage employee ownership • Create benefit for Employees
Spousal Trust – What is it? • Creating two irrevocable trusts • Typically done with spouses • Good to have similar types of assets • The goal is to reduce or possibly eliminate estate taxes • Need good counsel for structure • Watch for “Reciprocal Trust Doctrine”
Spousal Trust – How does it work? S1 S2 • S1 forms Trust • S1 contributes $5m • S2 is beneficiary • C1 and C2 are beneficiaries $5.0m $5.0m • S2 forms Trust • S2 contributes $5m • S1 is beneficiary • C1 and C2 are beneficiaries S2 S1 C1 C1 C2 C2
Spousal Trust – When should it be used ? • Control over assets is desired • Assets in trust are likely to appreciate • Sufficient liquid assets in both trusts • After consulting with estate planner • After consulting with estate lawyer
GRAT – What is it? • An irrevocable trust • GRAT has a specific term (2 – 10 years) • Parent transfers property to GRAT • Parent receives a fixed annuity payment • Assets revert to children • IRS Interest rate at 1.4% • Zero-Out GRAT creates no gift taxes
GRAT – How does it works? • Benefits best seen with example • Facts for example • Use a two year GRAT • Transfer 10% of S Corp Stock to GRAT • Value of Company is $20,000,000 • Minority interests get discounts • Gift of 10% estimated at $1,400,000 (30% discount)
GRAT – How does it works? • At end of term, stock goes to beneficiary Gifts Assets to Zeroed-out GRAT 10% shares of CLA Construction Valued at $1.400,000 Receives 2 annuity payments from GRAT of approx. $720,000
GRAT – How does it work? • End of term, Parent received $1,440,000 • Assume you sell Company for $20,000,000 • 10% to child is $2,000,000 • Just moved $600,000, plus taxes out of your estate • S Corporation provides cash flow to fund annuity payments
GRAT – When should you used it? • S Corporations stock transfers • Minimize estate taxes • Considering sale of Company • Parent (Grantor) pays income taxes • Goal is to outperform interest rate if no sale of stock • If GRAT does not outperform wasted cost of GRAT • Fairly flexible
FLPs - What is it? • A partnership created by the transfer of property by two or more individuals • Allows for joint ownership of family-owned assets • Two classes of partners – general and limited “FLP 1” “FLP 2” • Allows for transfer of FLP interests • Enables discounts on the transfer of the FLP interests
Diagram of CLA Family Limited Partnership Formation and Funding of Family Limited Partnership Phase One CLA Family Limited Partnership .5% GP interest .5% GP interest $2,50,000 assets $2,500,000 assets 49% LP interest 49% LP interest John CLA Mary CLA
Diagram of CLA Family Limited Partnership Gifting of FLP Interests (Discounted) John CLA Mary CLA 24.5% LP interest 24.5% LP interest 24.5% LP interest 24.5% LP interest Susie CLA (daughter) Bobby CLA (son) Susie CLA (daughter) Bobby CLA (son)
Diagram of CLA Family Limited Partnership Final Structure of FLP CLA Family Limited Partnership John CLA (.5% GP interest) Mary CLA (.5% GP interest) Bobby CLA (49% LP interest) Susie CLA (49% LP interest)
FLPs – When should it be used? • Shifting Income to lower brackets of children and grandchildren • Removes appreciation from estate • Minority and Marketability discounting • Great time with $5.0 exemption • Asset protection
Questions • Michael A. Africk, CPA • Mike.africk@cliftonlarsonallen.com • 847-597-1810 Construction and Real Estate Team (Chicago) Jeff Tyner Herb Brenner Mariana Aguilar Rob Nowak Shane Turner Suk Szeto Dave English Jennifer Richards Beth Silver Dan Kirby