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Tax Reform Resource Center
by H2R CPA Team
Employee stock ownership plans (ESOPs) offer closely held business owners an exit strategy and a tax-efficient technique for sharing equity with employees. But did you know that an ESOP can be a powerful estate planning tool? It can help you address several planning challenges, including lack of liquidity and the need to provide for children outside the business.
An ESOP in action
An ESOP is a qualified retirement plan, similar to a 401(k) plan. But instead of investing in a selection of stocks, bonds and mutual funds, an ESOP invests primarily in the company’s own stock. ESOPs are subject to the same rules and restrictions as qualified plans, including contribution limits and minimum coverage requirements.
Typically, companies make tax-deductible cash contributions to the ESOP, which uses the funds to acquire stock from the current owners. This doesn’t necessarily mean giving up control, though. The owners’ shares are held in a trust, and the trustees vote the shares.
An ESOP’s earnings are tax-deferred: Participants don’t recognize taxable income until they receive benefits — in the form of stock or cash — when they leave the company, die or become disabled.
Retirement and estate planning benefits
If a large portion of your wealth is tied up in a closely held business, lack of liquidity can create challenges as you approach retirement. Short of selling the business, how do you fund your retirement and provide for your family?
An ESOP may provide a solution. By selling some or all of your shares to an ESOP, you convert your shares into liquid assets. Plus, if the ESOP owns 30% or more of the company’s outstanding common stock immediately after the sale, and certain other requirements are met, you can defer or even eliminate capital gains taxes. How? By reinvesting the proceeds in qualified replacement property (QRP) — which includes most securities issued by U.S. public companies — within one year.
QRP provides a source of retirement income and allows you to defer your gain until you sell or otherwise dispose of the QRP. From an estate planning perspective, a simple but effective strategy is to hold the QRP for life. Your heirs receive a stepped-up basis in the assets, eliminating capital gains permanently.
If you want more investment flexibility, you can pay the capital gains tax upfront and invest the proceeds as you see fit. Or you can invest the proceeds in qualifying floating-rate long-term bonds as QRP. You avoid capital gains, but can borrow against the bonds and invest the loan proceeds in other assets.
If estate taxes are a concern, you can remove QRP from your estate, without triggering capital gains, by giving it to your children or other family members. These gifts may be subject to gift and generation-skipping transfer taxes, but you can minimize those taxes using traditional estate planning tools.
Weigh the pros and cons
ESOPs offer significant benefits, but they aren’t without their disadvantages.
Contact H2R CPA at 412-391-2920 or firstname.lastname@example.org to determine if an ESOP is right for you or if you have any questions about estate planning or tax planning.
by Kathy D. Sisler, CPA, CGMA
Before the Tax Cuts and Jobs Act, owners of pass-through entities and sole proprietors embraced the idea of a retirement plan for their employees, since it provided them with a tax deduction and permitted them to set aside retirement money for themselves. If you’re a professional firm, a retirement plan contribution might be an even better idea than before.
There’s been a lot of discussion around the new Qualified Business Income (QBI) tax deduction since the passage of the tax bill. But how does that impact your retirement plan if you are a pass-through business owner like an S-Corporation, an LLC or a sole proprietor? What if you are a specified service business?
The 20% deduction is limited in 2018 for owners with income greater than $315,000 (married) or $157,500 (single). Once income exceeds $415,000 (married) or $207,500 (single) the deduction is completely eliminated. Remember, if your income is under the threshold, you get the entire deduction, regardless if you are in a service industry or not. Making a retirement plan contribution can drive income down, allowing not only money to be set aside for your retirement, but driving your income under the threshold for the 20% deduction.
For example, Rob is 50 years old, married and is a partner in a service firm. His share of the profits are $375,000. By maxing out his 401(k) contribution and maximizing his profit sharing contribution of $60,000, his income drops to $315,000 and he is now entitled to a 20% QBI deduction of $63,000. Federal income tax on his taxable income is $43,299 instead of $66,468 computed without the 20% deduction. Rob has saved $23,169 in income tax, contributed $60,000 to his retirement and has reduced his taxable income by $93,232.
Members of firms with even higher profits might benefit from other types of plans which permit them to contribute larger amounts to their retirement. Of course, establishing a new plan entails time and money, but the savings could well outweigh the effort and cost.
There is just about one month left to establish a plan for 2018 and each person’s circumstances are unique, requiring some planning and decision making and a signed plan document before December 31st.
Contact H2R CPA at 412-391-2920 or email@example.com if you have questions about your individual or business tax planning.
Recommended Reading: Qualified retirement plans can provide additional tax savings for business owners
by H2R CPA Team
Because qualified retirement plan contributions lower the taxable income of business owners of passthrough entities (sole proprietorships, partnerships, S corporations, and LLCs), increasing contributions can qualify business owners for additional tax deductions under the Tax Cuts and Jobs Act that they would not otherwise have been eligible to receive, such as the new qualified business income (QBI) deduction (Sec. 199A).
See article below from the AICPA website for details and contact H2R CPA at 412-391-2920 or firstname.lastname@example.org with any questions you may have.
Why small business owners should have a qualified retirement plan
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