Taxes are frustrating to nearly every small business owner I speak with. Most people agree that we should all pay our fair share. But after working countless thousands of hours to build a viable business, it’s easy to feel like Uncle Sam’s reaching into our pockets too far. That’s why I focus on helping my clients who own businesses make sure they’re not paying more in taxes than they need to. One great tool we can use in this endeavor is a defined benefit retirement plan. Whatever you want to call it, DB plan, defined benefits pension plan, etc., it can be a killer way to defer a huge portion of your income from taxation.
I realize you might cringe when you read the words “pension” or “defined benefit”. The idea of promising employees a monthly check throughout their retirement may not foster warm and fuzzies. But if you don’thave employees, or only have a few, a defined benefit plan can offer some pretty major tax advantages.
Read on to learn how you might take advantage of them.
For business owners starting to think about the next generation, the phrases”estate tax” or “transfer tax” almost seem like curse words. The bad news is that when you build an estate of a certain size, the IRS wants to get in your pockets regardless of what, when, or how you transfer your assets to beneficiaries. The good news is that there are plenty of strategies available to help you minimize these taxes. The grantor retained annuity trust is one of them, and will be the topic of today’s post. We’ll cover what they are, why they’re beneficial, and how you might go about using one.
Gift Tax Review
Ok – before we dive into the details, let’s review what taxes typically apply when you gift an asset to someone else.
First off, you’re allowed to give away $14,000 per year, per person tax free. If you’re married, you and your spouse are both allowed $14,000 per person per year, or $28,000 total. So, if you and your spouse want to gift each of your kids $28,000 for their birthday every year, you could do so tax free. (It’d be one heck of a birthday present, too).
You also have a lifetime gift exclusion. This is the amount that you can give away, either while you’re alive or after you die, without incurring any federal estate or gift taxes. Anything that exceeds the $14,000 annual limit (or doesn’t qualify) works against your lifetime exclusion. The lifetime gift exclusion in 2017 is $5.49 million, which inches higher with inflation over time. Here again you can combine your lifetime exclusion with your spouse, for a total of $10.98 million.
So let’s say that one year you and your spouse decide to gift your oldest child $128,000. The first $28,000 would be covered under your annual allowance and excluded from tax. The remaining $100,000 would work against your lifetime exclusion. Neither you nor your child would owe tax on the gift, but you’d have worked your lifetime exclusion from $10.98 million down to $10.88 million. If your future gifts (either while you’re alive or after death) exceed $10.88 million, they’ll be subject to the federal gift/estate tax:
“I paid out the ears in taxes this year. How can I reduce my tax burden?”
This is a question I’m hearing a lot from business owners recently. And while it may not sound flashy, the best way to reduce taxes is to incorporate some smart planning into your decision making. More often than not, business owners simply don’t have the time to research and apply the opportunities offered in the tax code.
So to make your life a little easier, today’s post will cover an often unused tax saving opportunity:the Section 105 medical reimbursement plan.
An Overview of Section 105 Health Reimbursement Plans
A section 105 health reimbursement plan is a tax-efficient way to repay your employees for their health care costs. Rather than purchasing group coverage that your qualifying employees can opt into, you allow them to find their own coverage and then reimburse them for qualified expenses. This can include premiums, deductibles, or a wide variety of other out of pocket costs. (Side note, there are section 105 plans that combine traditional group coverage with reimbursement for qualified out of pocket costs, but that’s a subject for a future post).
Whereas this would not have been a popular way to offer benefits a decade ago, it’s more palatable now that individual health insurance is widely available through the state and federal marketplaces.
The main benefits of section 105 plans are the tax advantages. Most small businesses deduct the cost of health insurance premiums for their employees, and possibly for themselves. But when it comes to their own out of pocket health care costs, business owners normally pay for them with taxable dollars. These expenses can be deductible at the personal level, but only when they exceed 10% of your adjusted gross income.
With a Section 105 plan you can deduct your entire family’s medical expenses with without being subject to the 10% AGI floor. Even better, it’s a deduction from income tax at the state and federal levels, AND a deduction from payroll taxes. For some business owners this can be a savings of thousands of dollars per year.
The tax benefits don’t apply to all types of business entities, though. S-Corps don’t get to deduct reimbursements through section 105 plans from state or federal income tax. And if you own a sole prop, a partnership, or an LLC you aren’t considered an employee. That means you can’t be reimbursed by a plan, and would need to employ your spouse in order to reap the benefits.
You own a thriving art supply store in your home town of New Orleans. You’ve put years of your life and thousands of dollars into building the store into what it is now. You make a nice living, and the business mostly runs itself at this point.
Then Hurricane Katrina comes to town. The building you lease is ruined. Your storefront and merchandise are ruined. You have no cash flow to pay creditors, and are forced to close the store.
This is a pretty extreme example, but is exactly what happened to thousands of businesses in the wake of the disaster in 2005. It’s also a risk that can be completely covered with business interruption insurance.
Virtually any disaster that is out of your control and risks your business’s profitability can be covered in a business interruption policy. In other words, you can protect business profits and your personal income from a fire, flooding, earthquake, or other disaster.
This post will cover the ins and outs of business interruption insurance. We’ll address what it does and doesn’t cover, when you should consider buying it, how much coverage you need, and how to purchase a policy.