The tax consequences of selling mutual funds
Do you invest in mutual funds or are you interested in putting some money into them? If so, you’re part of a large group. According to the Investment Company Institute, 116 million individual U.S. investors owned mutual funds in 2023. But despite their widespread use, the tax rules involved in selling mutual fund shares can be complex.
Review the basic rules
Let’s say you sell appreciated mutual fund shares that you’ve owned for more than one year. The resulting profit will be a long-term capital gain. As such, the maximum federal income tax rate will be 20%, and you may also owe the 3.8% net investment income tax. However, most taxpayers will pay a tax rate of only 15% and some may even qualify for a 0% tax rate.
When a mutual fund investor sells shares, gain or loss is measured by the difference between the amount realized from the sale and the investor’s basis in the shares. One challenge is that certain mutual fund transactions are treated as sales even though they might not be thought of as such. Another problem may arise in determining your basis for shares sold.
A sale may unknowingly occur
It’s obvious that a sale occurs when an investor redeems all shares in a mutual fund and receives the proceeds. Similarly, a sale occurs if an investor directs the fund to redeem the number of shares necessary for a specific dollar payout.
It’s less obvious that a sale occurs if you’re swapping funds within a fund family. For example, you surrender shares of an income fund for an equal value of shares of the same company’s growth fund. No money changes hands, but this is considered a sale of the income fund shares.
Another example is when investors write checks on their funds. Many mutual funds provide check-writing privileges to their investors. Although it may not seem like it, each time you write a check on your fund account, you’re making a sale of shares.
Figuring the basis of shares
If an investor sells all shares in a mutual fund in a single transaction, determining basis is relatively easy. Simply add the basis of all the shares (the amount of actual cash investments), including commissions or sales charges. Then, add distributions by the fund that were reinvested to acquire additional shares and subtract any distributions that represent a return of capital.
The calculation is more complex if you dispose of only part of your interest in the fund and the shares were acquired at different times for different prices. You can use one of several methods to identify the shares sold and determine your basis:
- First-in, first-out. The basis of the earliest acquired shares is used as the basis for the shares sold. If the share price has been increasing over your ownership period, the older shares are likely to have a lower basis and result in more gain.
- Specific identification. At the time of sale, you specify the shares to sell. For example, “sell 100 of the 200 shares I purchased on June 1, 2020.” You must receive written confirmation of your request from the fund. This method may be used to lower the resulting tax bill by directing the sale of the shares with the highest basis.
- Average basis. The IRS permits you to use the average basis for shares that were acquired at various times and that were left on deposit with the fund or a custodian agent.
As illustrated, mutual fund investing may result in complicated tax situations. We can answer any questions you may have and explain how the rules apply to your situation.
© 2024
4 ways businesses can better control cash flow
From the minute they open their doors, business owners are urged to keep a close eye on cash flow. And for good reason — even companies with booming sales can get into serious trouble if they lack the liquidity to compensate employees and pay their bills. Here are four ways businesses can better control cash flow.
1. Stick with the budget
Although creating and maintaining a detailed annual budget can be tedious and contentious, it’s fundamental to good cash flow management.
Items in your budget should align with your stated strategic goals for the year. If you can’t effectively argue how an item enables a particular goal, question its merit. Doing so will help you avoid unnecessary spending and keep funds available for valid business needs.
Also bear in mind that, for analytical purposes, a budget is useful only if you update it regularly to accurately reflect actual spending. For example, you may have overbudgeted or underbudgeted on some items and, thus, spent more or less than anticipated.
2. Check your statement of cash flows
Most companies should generate financial statements, preferably those that conform to Generally Accepted Accounting Principles (GAAP). Financial statements that comply with GAAP typically have three major parts:
- The income statement,
- The balance sheet, and
- The statement of cash flows.
Naturally, when monitoring cash flow, you’ll want to focus on that last one.
The purpose of this document is to report your business’s net increase or decrease in cash. The statement factors in the cash inflows and outflows of daily operations, asset purchases, sale proceeds, and financing activities. Because it excludes noncash accounting items, you can use it to catch potential cash flow problems.
If you want to get the most from your statement of cash flows, generate one monthly. But quarterly or, at the very least, annual statements can be useful for identifying cash flow trends.
3. Exercise expense management
Maintaining accurate, up-to-date expense records will keep you in a strong position to effectively manage cash flow and strive for profitability. As you review the data, look for ways to reduce day-to-day operating expenses. For example, you may save money by outsourcing areas of the business such as human resources, payroll and benefits management, or information technology support.
If you have inventory, reconsider your approach to its management. Under the “just-in-time” approach, for instance, businesses buy items or materials only when necessary. As a result, your carrying costs for storage, insurance, interest payments and other factors are lowered. This approach isn’t feasible for every company. But if logistical support in your market has improved in recent years, it may be a beneficial option.
4. Mind your timing
At the end of the day, cash flow is all about the timing of revenue coming in and payments going out. Look for ways to stabilize the two.
For instance, conduct credit and reference checks on new customers to validate their payment histories and minimize collection risks. Also, prevent invoicing errors and costly collection delays by maintaining current and accurate customer account data.
Send invoices promptly, using electronic billing methods as much as possible. Establish sound, methodical procedures for following up on past-due accounts. Don’t wait until they’re 60 or 90 days late.
Watch your payables, too. Generally, you shouldn’t pay invoices earlier than required unless offered a discount. As feasible, use your buying power for large-volume or frequent purchases as leverage to negotiate discounts, free or low-cost financing, or extended payment terms.
Go with the flow
Effective cash flow management is something many small to midsize businesses struggle with. But there are ways to put and keep the odds in your favor. For help succeeding at this mission-critical task, contact us.
© 2024
Social Security tax update: How high can it go?
Employees, self-employed individuals and employers all pay Social Security tax, and the amounts can get bigger every year. And yet, many people don’t fully understand the Social Security tax they pay.
If you’re an employee
If you’re an employee, your wages are hit with the 12.4% Social Security tax up to the annual wage ceiling. Half of the Social Security tax bill (6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer, so you never actually see it. Unless you understand how the Social Security tax works and closely examine your pay statements, you may be blissfully unaware of the size of the tax. It’s potentially a lot!
The Social Security tax wage ceiling for 2024 is $168,600 (up from $160,200 for 2023). If your wages meet or exceed that ceiling, the Social Security tax for 2024 will be $20,906 (12.4% x $168,600). Half of that comes out of your paychecks and your employer pays the other half.
If you’re self employed
Self-employed individuals (sole proprietors, partners and LLC members) know all too well how hard the Social Security tax can hit. That’s because they must pay the entire Social Security tax bill out of their own pockets, based on their net self-employment income. For 2024, the Social Security tax ceiling for net self-employment income is $168,600 (same as the wage ceiling for employees). So, if your net self-employment income for 2024 is $168,600 or more, you’ll pay the maximum $20,906 Social Security tax.
Projected future ceilings
The Social Security tax on your 2024 income is expensive enough, but it could get worse in future years — much worse, according to Social Security Administration (SSA) projections. That’s because the Social Security tax ceiling will continue to go up based on the inflation factor that’s used to determine the increases. In turn, maximum Social Security tax bills for higher earners will go up. The latest SSA projections for Social Security tax ceilings for the next nine years are:
- $174,900 for 2025,
- $181,800 for 2026,
- $188,100 for 2027,
- $195,900 for 2028,
- $204,000 for 2029,
- $213,600 for 2030,
- $222,900 for 2031,
- $232,500 for 2032 and
- $242,700 for 2033.
These projected ceilings are not always accurate (they could be higher or lower). If the projected numbers pan out, the maximum Social Security tax on wages and net self-employment income in 2033 will be $30,095 (12.4% x $242,700).
Your future benefits
Despite what you pay in, you might receive more in Social Security benefits than you pay into the system. An Urban Institute report looked at some average situations. For example, a single man who earned average wages every year of his adult life and retired at age 65 in 2020 would have paid about $466,000 in Social Security and Medicare taxes. But he can expect to receive about $640,000 in benefits during retirement. Of course, there are many factors involved and each situation is unique. Plus, these calculations don’t account for the interest the Social Security tax dollars would have earned over the years.
Some people think the government has set up an account with their name on it to hold money to pay their future Social Security benefits. After all, that must be where those Social Security taxes on wages and self-employment income go. Sorry, but this is incorrect. There are no individual accounts — just a promise from the government.
Is the Social Security system financially solid? It’s on shaky ground. Congress has known that for years and has done nothing about it (although there have been many proposals on how to fix things). A Social Security Administration report states that “benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted. At the point where the reserves are used up, continuing taxes are expected to be enough to pay 76% of scheduled benefits.”
The agency adds that “Congress will need to make changes to the scheduled benefits and revenue sources for the program in the future.” These changes could include a higher age to receive full benefits, additional Social Security tax hikes in the form of higher rates, some tax-law revision that effectively implements higher ceilings or a combination of these.
Stay tuned
The Social Security tax paid by many individuals will continue to go up. If you operate a small business, there may be some strategies than can potentially cut your Social Security tax bill. If you’re an employee, you need to take Social Security into account in your financial planning. Contact us for details.
© 2024
How family businesses can solve the compensation puzzle
Every type of company needs to devise a philosophy, strategy and various policies regarding compensation. Family businesses, however, face additional challenges — largely because they employ both family and nonfamily staff.
If your company is family-owned, you’ve probably encountered some puzzling difficulties in this area. The good news is solutions can be found.
Perspectives to consider
Compensation issues in family businesses are often two-pronged because they can arise both 1) within the family and 2) between family and nonfamily employees. Salary inequities among siblings, for example, can breed resentment and fighting. However, simply paying them all the same salary can also create problems if one works harder and contributes more than the others.
Second, family business owners may feel it’s their prerogative to pay working family members more than their nonfamily counterparts — even if they’re performing the same job. Although owners naturally have the best interests of their loved ones at heart, these decisions may inadvertently lower morale among essential nonfamily employees and risk losing them.
Nonfamily staff may tolerate some preferential treatment for family employees, but they could become disgruntled over untenable differences. For instance, nonfamily employees often reach a breaking point when they feel working family members are underperforming and getting away with it, or when they believe family employees are behaving counterproductively or unethically.
Ideas to ponder
Effectively addressing compensation in a family business calls for a clear, objective understanding of the company’s distinctive traits, culture and strategic goals. A healthy dash of creativity helps, too. There’s no one right way of handling the matter. But there are some commonly used strategies that may be helpful in determining compensation for the two major groups involved.
When it comes to family employees, think beyond salary. Many family businesses intentionally keep salaries for these individuals low and make up the difference in equity. Because working family members are generally in the company for the long haul, they’ll receive increasing benefits as their equity shares grow in value. But you also must ensure their compensation is adequate to meet their lifestyle needs and keep up with inflation.
Incentives are usually a key motivator for family employees. You might consider a combination of short-term rewards paid annually to encourage ongoing accomplishments and long-term rewards to keep them driving the business forward.
On the other hand, nonfamily employees typically recognize that their opportunities for advancement and ownership are generally more limited in a family business. So, higher salaries and a strong benefits package can be important to attracting and retaining top talent.
Another way to keep key nonfamily staff satisfied is by giving them significant financial benefits for staying with the company long term. There are various arrangements to consider, including phantom stock or nonqualified deferred compensation plans.
You can do it
If your family business has been operating for a while, overhauling its approach to compensation may seem overwhelming. Just know that there are ways to tackle the challenges objectively and analytically to arrive at an overall strategy that’s reasonable and equitable for everyone. Our firm can help you identify and quantify all the factors involved.
© 2024
What might be ahead as many tax provisions are scheduled to expire?
Buckle up, America: Major tax changes are on the horizon. The reason has to do with tax law and the upcoming elections.
Our current situation
The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made sweeping changes. Many of its provisions are set to expire on December 31, 2025.
With this date getting closer each day, you may wonder how your federal tax bill will be affected in 2026. The answer isn’t clear because the outcome of this November’s presidential and congressional elections is expected to affect the fate of many expiring provisions. A new political landscape in Washington could also mean other tax law changes.
Corporate vs. individual taxes
The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers, with the highest tax rate reduced from 39.6% to 37%. But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. Tax legislation could still change the corporate tax rate.)
In addition to lowering rates, the TCJA revised tax law in many other ways. On the individual side, standard deductions were increased, significantly reducing the number of taxpayers who benefit from itemizing deductions for certain expenses, such as charitable donations and medical costs. (You benefit from itemizing on your federal income tax return only if your total allowable itemized write-offs for the year exceed your standard deduction.)
In addition, through 2025, certain itemized deductions are eliminated. Others are more limited, including those for home mortgage interest and state and local tax (SALT).
For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships.
The expiring provisions will affect many taxpayers’ tax bills in 2026, unless legislation extending them is signed into law.
Possible scenarios
The outcome of the presidential election in less than five months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four possible scenarios:
- All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
- All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
- Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
- Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.
How your tax bill will be affected in 2026 will partially depend on which one of these scenarios becomes reality and whether your tax bill went down or up when the TCJA became effective back in 2018. That was based on a number of factors including your income, your filing status, where you live (the SALT limitation negatively affects more taxpayers in certain states), and whether you have children or other dependents.
Your tax situation will also be affected by who wins the presidential election and who controls Congress. Democrats and Republicans have competing visions about how to proceed when it comes to taxes. Proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).
The tax horizon
As the TCJA provisions get closer to expiring, it’s important to know what might change and what tax-wise moves you can make if the law does change. We’ll keep you informed about what’s ahead. We’re here to answer any questions you may have.
© 2024
Businesses have options for technology leadership positions
To say that technology continues to affect how businesses operate and interact with customers and prospects would be an understatement. According to the Business Software Market Size report issued by market researchers Mordor Intelligence, the global market size for commercial software is projected to reach $650 million this year and $1.10 trillion by 2029.
And that’s just software. Companies must also contend with technological issues such as hardware, skilled labor, strategy and cybersecurity. Just one of the resulting demands that this pressure is putting on businesses is a keen need for tech leadership.
If your company has grown to the point where it could use an executive-level employee with specialized knowledge of and laser focus on technology issues, you have plenty of options.
Positions to consider
Here are some of the most widely used position titles for technology executives:
Chief Information Officer (CIO). This person is typically responsible for managing a company’s internal IT infrastructure and operations. In fact, an easy way to remember the purpose of this position is to replace the word “Information” with “Internal.” A CIO’s job is to oversee the purchase, implementation and proper use of technological systems and products that will maximize the efficiency and productivity of the business.
Chief Technology Officer (CTO). In contrast to a CIO, a CTO focuses on external processes — specifically with customers and vendors. This person usually oversees the development and eventual production of technological products or services that will meet customer needs and increase revenue. The position demands the ability to live on the cutting edge by doing constant research into tech trends while also being highly collaborative with employees and vendors.
Chief Digital Officer (CDO). For some companies, the CIO and/or CTO are so busy with their respective job duties that they’re unable to look very far ahead. This is where a CDO typically comes into play. The primary purpose of this position is to spot new markets, channels or even business models that the company can target, explore and perhaps eventually profit from. So, while a CIO looks internally and a CTO looks externally, a CDO’s gaze is set on a more distant horizon.
Chief Artificial Intelligence Officer (CAIO). Did you really think you were going to make it through a technology article without reading about AI? Yes, more and more businesses are taking on executives whose primary responsibility is to create the company’s overall AI strategy and ensure it:
- Aligns with the business’s overall strategic goals, and
- Enhances the company’s digital transformation, which many businesses are continuing to undergo as they adapt to new technologies.
CAIOs are also typically responsible for understanding the global and national regulatory environments regarding AI, as well as ensuring the business uses AI ethically.
Big decision
Adding an executive-level position to your company is clearly a big decision. Along with making a sizable outlay for compensation and benefits, you’ll likely spend considerable time and resources on the search and onboarding processes. So be sure to discuss the matter thoroughly with your existing leadership team and professional advisors. Our firm can help you identify and project all the costs involved.
© 2024
Consider borrowing from your corporation but structure the deal carefully
If you own a closely held corporation, you can borrow funds from your business at rates that are lower than those charged by a bank. But it’s important to avoid certain risks and charge an adequate interest rate.
Basics of this strategy
Interest rates have increased over the last couple years. As a result, shareholders may decide to take loans from their corporations rather than pay higher interest rates on bank loans. In general, the IRS expects closely held corporations to charge interest on related-party loans, including loans to shareholders, at rates that at least equal applicable federal rates (AFRs). Otherwise, adverse tax results can be triggered. Fortunately, the AFRs are lower than the rates charged by commercial lenders.
It can be advantageous to borrow money from your closely held corporation to pay personal expenses. These expenses may include your child’s college tuition, home improvements, a new car or high-interest credit card debt. But avoid these two key risks:
1. Not creating a legitimate loan. When borrowing money from your corporation, it’s important to establish a bona fide borrower-lender relationship. Otherwise, the IRS could reclassify the loan proceeds as additional compensation. This reclassification would result in an income tax bill for you and payroll tax for you and your corporation. (However, the business would be allowed to deduct the amount treated as compensation and the corporation’s share of related payroll taxes.)
Alternatively, the IRS might claim that you received a taxable dividend if your company is a C corporation. That would trigger taxable income for you with no offsetting deduction for your business.
Draft a formal written loan agreement that establishes your unconditional promise to repay the corporation a fixed amount under an installment repayment schedule or on demand by the corporation. Take other steps such as documenting the terms of the loan in your corporate minutes.
2. Not charging adequate interest. The minimum interest rate your business should charge to avoid triggering the complicated and generally unfavorable “below-market loan rules” is the IRS-approved AFR. (There’s an exception to the below-market loan rules if the aggregate loans from a corporation to a shareholder are $10,000 or less.)
Current AFRs
The IRS publishes AFRs monthly based on market conditions. For loans made in July 2024, the AFRs are:
- 4.95% for short-term loans of up to three years,
- 4.40% for mid-term loans of more than three years but not more than nine years, and
- 4.52% for long-term loans of over nine years.
These annual rates assume monthly compounding of interest. The AFR that applies to a loan depends on whether it’s a demand or term loan. The distinction is important. A demand loan is payable in full at any time upon notice and demand by the corporation. A term loan is any borrowing arrangement that isn’t a demand loan. The AFR for a term loan depends on the term of the loan, and the same rate applies for the entire term.
An example
Suppose you borrow $100,000 from your corporation with the principal to be repaid in installments over 10 years. This is a term loan of over nine years, so the AFR in July would be 4.52% compounded monthly for 10 years. The corporation must report the loan interest as taxable income.
On the other hand, if the loan document gives your corporation the right to demand full repayment at any time, it’s a demand loan. Then, the AFR is based on a blended average of monthly short-term AFRs for the year. If rates go up, you must pay more interest to stay clear of the below-market loan rules. If rates go down, you’ll pay a lower interest rate.
Term loans for more than nine years are smarter from a tax perspective than short-term or demand loans because they lock in current AFRs. If rates drop, a high-rate term loan can be repaid early and your corporation can enter into a new loan agreement at the lower rate.
Avoid adverse consequences
Shareholder loans can be complicated, especially if the loan charges interest below the AFR, the shareholder stops making payments or the corporation has more than one shareholder. Contact us about how to proceed in your situation.
© 2024
Certain charitable donations allow you to avoid taxable IRA withdrawals
If you’re a philanthropic individual who is also obligated to take required minimum distributions (RMDs) from a traditional IRA, you may want to consider a tax-saving strategy. It involves making a qualified charitable distribution (QCD).
How it works
To reap the possible tax advantages of a QCD, you make a cash donation to an IRS-approved charity out of your IRA. This method of transferring IRA assets to charity leverages the QCD provision that allows IRA owners who are age 70½ or older to direct up to $105,000 of their IRA distributions to charity in 2024. (For married couples, each spouse can make QCDs for a possible total of $210,000.) When making QCDs, the money given to charity counts toward your RMDs but doesn’t increase your adjusted gross income (AGI) or generate a tax bill.
Keeping the donation amount out of your AGI may be important for several reasons. When distributions are taken directly out of traditional IRAs, federal income tax of up to 37% in 2024 will have to be paid. State income taxes may also be owed. That tax is avoided with a QCD. Here are some other potential benefits of a QCD:
- It can help you qualify for other tax breaks. For example, having a lower AGI can reduce the threshold for itemizers who can deduct medical expenses, which are only deductible to the extent they exceed 7.5% of AGI.
- You can avoid rules that can cause some or all of your Social Security benefits to be taxed, and some or all of your investment income to be hit with the 3.8% net investment income tax.
- It can help you avoid a high-income surcharge for Medicare Part B and Part D premiums, which kick in if AGI is over certain levels.
Keep in mind: You can’t claim a charitable contribution deduction for a QCD not included in your income. Also keep in mind that the age after which you must begin taking RMDs is now 73, but the age you can begin making QCDs is 70½.
To benefit from a QCD for 2024, you must arrange for a distribution to be paid directly from the IRA to a qualified charity by December 31, 2024. You can use QCDs to satisfy all or part of the amount of your RMDs from your IRA. For example, if your 2024 RMDs are $20,000 and you make a $10,000 QCD, you’d have to withdraw another $10,000 to satisfy your 2024 RMDs.
Other rules and limits may apply. QCDs aren’t right for everyone. Contact us to see whether this strategy would make sense in your situation.
© 2024
Could a 412(e)(3) retirement plan suit your business?
When companies reach the point where they’re ready to sponsor a qualified retirement plan, the first one that may come to mind is the 401(k). But there are other, lesser-used options that could suit the distinctive needs of some business owners. Case in point: the 412(e)(3) plan.
Nuts and bolts
Unlike 401(k)s, which are defined contribution plans, 412(e)(3) plans are defined benefit plans. This means they provide fixed benefits under a formula based on factors such as each participant’s compensation, age and years of service.
For 2024, the annual benefit provided by 412(e)(3)s can’t exceed the lesser of 100% of a participant’s highest three-year average compensation or $275,000. As with other defined benefit plans, 412(e)(3)s are funded only by employers. They don’t accept participant contributions.
But unlike other defined benefit plans, which are funded through a variety of investments, 412(e)(3)s are funded with annuity contracts and insurance. In fact, the IRS refers to them as “fully insured” plans. The name “412(e)(3)” refers to Section 412(e)(3) of the Internal Revenue Code, which authorizes the plan type’s qualified status.
Under Sec. 412(e)(3), defined benefit plans funded with annuity contracts and insurance aren’t subject to minimum funding requirements — so long as certain conditions are met. Companies sponsoring these plans don’t have to make annual actuarial calculations or mandatory contributions. However, they risk penalties if a plan’s insurer doesn’t satisfy certain obligations. In other words, the plan needs to be safely insured.
Potential benefits
Some experts advise relatively older business owners who want to maximize retirement savings in a short period to consider 412(e)(3)s because of the way defined benefit plans differ from defined contribution plans. That is, business owners who sponsor and participate in defined benefit plans can take a bigger share of the pie — particularly if they have few, if any, highly compensated employees. Meanwhile, they can also enjoy substantial tax deductions for plan contributions.
In addition, 412(e)(3)s may be more attractive than other defined benefit plans for some small business owners. Although they tend to sacrifice potentially higher investment returns, these plans offer greater flexibility by using potentially lower-risk and easy-to-administer annuity contracts and insurance. They might also appeal to closely held business owners who want to maximize tax-deductible contributions to a retirement plan in the early years of ownership.
As is the case with all defined benefit plans, however, sponsors must have the financial stability to support their plans indefinitely. So, 412(e)(3)s usually aren’t appropriate for start-ups.
Administrative requirements
Tax-favored treatment for 412(e)(3)s isn’t automatic. These plans must meet various requirements as spelled out in the tax code.
For example, as mentioned, 412(e)(3)s must be funded exclusively by the purchase of annuity contracts or a combination of annuity contracts and insurance. Sponsors must buy the contracts and/or insurance from insurers licensed by at least one of the 50 states or the District of Columbia.
Also, the contracts must provide for level annual (or more frequent) premium payments starting on the date each participant joins the plan. Premium payments need to end no later than the normal retirement age of a participant — or by the date the individual ceases participation in the plan, if earlier.
These are just a couple examples of the rules involved. It’s critical to fully understand all the requirements before sponsoring a plan.
An intriguing possibility
A 412(e)(3) plan may be an under-the-radar choice for some businesses under the right circumstances. For help choosing the best plan for your company, contact us.
© 2024
Be aware of the tax consequences of selling business property
If you’re selling property used in your trade or business, you should understand the tax implications. There are many complex rules that can potentially apply. To simplify this discussion, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year.
Note: There are different rules for property held primarily for sale to customers in the ordinary course of business, intellectual property, low-income housing, property that involves farming or livestock, and other types of property.
Basic rules
Under tax law, your gains and losses from sales of business property are netted against each other. The tax treatment is as follows:
1. If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. (In other words, none of the rules that limit the deductibility of capital losses apply.)
The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. Under these rules, amounts are treated as ordinary income, rather than capital gain, because of previous ordinary loss or deduction treatment.
There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of long-term capital gain.
Different types of property
Under the Internal Revenue Code, different provisions address different types of property. For example:
- Section 1245 property. This consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually real property that performs specific functions). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.
- Section 1250 property. In general, this consists of buildings and their structural components. If you sell Section 1250 property that’s placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% plus the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% plus the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.
Other rules apply to, respectively, Section 1250 property that you placed in service before 1987 but after 1980 and Section 1250 property that you placed in service before 1981.
As you can see, even with the simple assumptions in this article, the tax treatment of the sale of business assets can be complex. Contact us if you’d like to determine the tax implications of transactions, or if you have any additional questions.
© 2024