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Tax Update and Savings Strategies for High Net Worth Individuals

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

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  1. Tax Update and Savings Strategies for High Net Worth Individuals Michael A. Africk Tuesday February 14, 2012

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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%

  12. 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)

  13. 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)

  14. 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

  15. Tax Relief and Job Creation Act of 2010 • Increased the gift and estate exemptions * 2012 index inflated to $5,120,000

  16. 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

  17. 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

  18. Tax Relief and Job Creation Act of 2010 • Section 179 and bonus depreciation * Benefits contractors through decoupling

  19. 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

  20. 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

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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

  26. 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

  27. 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”

  28. 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

  29. 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

  30. 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

  31. 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)

  32. 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

  33. 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

  34. 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

  35. 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

  36. 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

  37. 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)

  38. 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)

  39. 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

  40. 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

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