Tax Laws That Work For You
Knowing Your Options to Make Good Decisions
Passive vs Ordinary
Passive earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not materially involved. As with non-passive income, passive income is usually taxable; however, it is often treated differently by the IRS. Portfolio income is considered passive income by some analysts, in which case dividends and interest would be considered passive. Capital gains are taxed at a 15% or 20% rate presently.
Ordinary income is usually characterized as income other than (long-term) capital gain. Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a sole proprietorship, partnership or LLC. Rents and royalties, after certain deductions, depreciation or depletion allowances, and gambling winnings are also treated as ordinary income. A “short term capital gain”, or gain on the sale of an asset held for less than one year of the capital gains holding period, is taxed as ordinary income. Ordinary income is taxed on the graduated income scale up to 39.5% presently.
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The objective of this exercise is to gain a deeper understanding of the types of taxation and how the transfers and sale of certain assets have different tax liabilities.
With the proper tax planning prior to a sell you could defer your liability to the next generation and provide them with a non -taxable insurance policy that could pay these taxes for them.
Granted not all people have large portfolios with high volume incomes at the sell. However, saving $20,000 in taxes is just as good as saving $200,000.
Use the RED Links
A tax liability is the amount of taxation that a business or an individual incurs based on current tax laws. A taxable event triggers a tax liability calculation, which is the tax base of the event multiplied by a tax rate. Tax liabilities are incurred due to earning income, a gain on the sale of an asset or other taxable events.
An account that postpones tax liabilities until a future date as an ordinary income tax. A deferred account refers to one where there is a deferral of tax, usually in accounts specifically designed for retirement, such as a traditional method Individual Retirement Account (IRA). In the U.S. Deferred accounts have proved to be enormously popular since their introduction, especially as fewer companies offer pensions and the burden of saving for retirement has shifted to individuals.
Self Directed plans such as IRA or 401k’s each have benefits and potential tax liabilities. Usually resulting in a capital gains tax of 15% to 20% which can be less than your individual ordinary income tax rate. Both plans require the asset to remain inside the plan to avoid the capital gain tax. Roth’s however are tax free, since you didn’t have a deduction to begin with, but only on the original investment.
Transfers or rollovers. When you roll over a retirement plan distribution, you generally don’t pay tax on it until you withdraw it from the new plan. By rolling over, you’re saving for your future and your money continues to grow tax-deferred. If you don’t roll over your payment will be taxable unless it’s a Roth and there are penalties for early distributions on any retirement plan. So, getting proper consultation is important.
Self-insure is a method of managing risk by setting aside a pool of money to be used if an unexpected loss occurs. Theoretically, one can self-insure against any type of loss. However, in practice, most people choose to buy insurance against potentially large, infrequent losses. For example, at minimum, most people carry auto insurance and health insurance.
One of the primary goals of a captive insurance company is to provide improved risk management for an organization.
The tax status of the captive insurance company for U.S. federal income tax purposes is an important consideration. If the captive qualifies as an insurance company, then premium paid to the captive is tax deductible by the insured entity, and the captive is allowed favorable tax treatment under Subchapter L of the Internal Revenue Code. After the premium is earned, in one year, the captive has a distributable income for it’s shareholders as a dividend. Remember your insuring your own liability and therefore the shareholder of the Captive.
Building Up Retirement with Tax Consequences
In general, sellers prefer to sell their corporate stock (or business interest in a partnership or LLC), while buyers prefer to purchase the assets of the business. A plethora of tax issues accompany this decision and must be addressed early in the negotiation process and maybe an installment sale is the answer.
Tax history is replete with attempts to obtain a lump sum payment and installment sale tax treatment. There are, however, legislatively-created exceptions to the rule, such as IRC 1031 (like-kind exchange of property) and IRC 1042 (sale to an ESOP). These are known as deferred exchanges.
In most cases, the business situation dictates whether the sale is to be paid in a lump sum or in installments.
A 1031 exchange is a section of the U.S. Internal Revenue Service Code that allows investors to defer capital gains taxes on any exchange of like-kind properties for business or investment purposes (rental property). Taxes on capital gains are not charged on the sale of a property if the money is being used to purchase another property – the payment of tax is deferred until property is sold with no re-investment.
An employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit (ERISA) plan designed to invest primarily in the stock of the sponsoring employer. ESOPs are “qualified” in the sense that the ESOP’s sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often used as a corporate finance strategy and are also used to align the interests of a company’s employees with those of the company’s shareholders.