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Employ recent tax legislation changes to turn your older, wealthier and selfemployed tax clients into profitable financial planning clients. With fullycoordinated structuring techniques, you can increase your client’s cash flow and protect their assets while reducing income and estate taxes.
Focus on strategies that are only available to the self-employed. Look at the latest ideas in college funding. Help your older clients make the right decisions on retirement account contributions and distributions.
OBJECTIVES:
Accepted for PFS and EA credit.
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Chapter 1 - Top Tax-Saving Strategies for Small Business Owners
Learning Objectives
After completing this chapter, you should be able to
Introduction
This chapter includes a selection of the best tax-saving breaks available to small business owners after recent tax-law changes and developments.
Business Co-Owners Need Buy-Sell Agreements
When the client is a business co-owner, he/she should almost certainly have a written buy-sell agreement in force. Why? Because the agreement can turn the client's closely held ownership interest into a much more liquid asset, prevent the entry of unwanted new owners, and deliver important tax advantages. Here is the story.
A buy-sell agreement is a contract between the co-owners or between each co-owner and the business entity. It has two main non-tax purposes:
Buy-Sell Agreement Basics
When certain events occur, the business ownership interest must be sold - or at least offered for sale - to the other co-owners and/or to the corporation, partnership, or LLC. The triggering events that will activate the agreement are specified in the document. These should include death, disability, and attainment of retirement age. Other triggering events (such as the desire of a co-owner to withdraw his/her equity from the business for whatever reason, loss of professional license, bankruptcy, and so forth) can also be listed to suit the preferences of the coowners.
The buy-sell agreement should specify a method to determine the price for the ownership interest and terms regarding how that amount will be paid out. Common methods include setting a fixed per-share price, using an appraised fair market value (FMV) price, or following a formula price based on a multiple of earnings, cash flow, or book value. Picking an appropriate valuation method involves assessing the nature of the business and its expected growth. As explained later, the price-setting method that is chosen should be one that will stand up to IRS scrutiny for estate tax purposes.
To the withdrawing owner, or heirs of a deceased owner, the buy-sell agreement represents a right of first refusal granted to the remaining owners or to the business entity (corporation, LLC, or partnership). If that right is not exercised, the withdrawing owner is typically free to sell his/her ownership interest to an outsider.
To the remaining owners - or the business entity - the agreement represents an obligation to buy out the withdrawing owner if a potential outside buyer is unacceptable or cannot be found.
Key Point. A buy-sell agreement guarantees there will be a market for the withdrawing owner's interest. It also guarantees the remaining owners will have control over who can join the party. This is a good deal for all concerned.
Depending on where the money for the buyout is coming from, a buy-sell agreement will fall into one of the following three categories:
Redemption Agreements
Under a redemption agreement, the business entity itself (corporation, LLC, or partnership) is obligated to buy out the withdrawing (or deceased) owner.
For a C corporation business, a stock redemption can raise the challenge of avoiding dividend treatment for the redemption payments. Specifically, redemption payments are treated as dividends to the extent of the corporation's current or accumulated earnings and profits unless one of the exceptions under IRC Sec. 302(b) or 303(a) applies. [See IRC Secs. 301(c)(1), 302(b), 302(d), 303(a), and 317(b).]
Avoiding dividend treatment is usually possible as long as all of the withdrawing owner's stock is redeemed, including stock attributed to the withdrawing owner via his/her ownership of certain entities. [See IRC Sec. 302(b)(3), (b)(5), and (c).] When dividend treatment is successfully avoided, the redemption payments are treated as made in exchange for the withdrawing owner's stock, which means favorable capital gains treatment for him/her [IRC Sec. 302(a)].
How to Structure C Corp Stock Redemptions as Sales
With a redemption of C corporation stock, the federal income tax consequences depend on whether the corporate payments for the client's redeemed shares are treated as dividends or as proceeds from selling her stock. Before the Jobs and Growth Tax Relief Reconciliation Act of 2003, the client surely did not want dividend treatment, because dividends were taxed as ordinary income at rates of up to 38.6%. Now it may not matter. Or, it may still be important. Read on.
The exact federal income tax treatment for distributions (payments) from a C corporation to a shareholder to redeem some or all of the shareholder's stock depends on the amount of the corporation's current or accumulated earnings and profits (E&P).
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