Small Business

Your Complete Guide On How Much to Tip Wedding Vendors

Weddings are complicated ventures whether you are booking the vendors yourself or working with a wedding planner. Expensive, too. And what if we told you that an extra $1,000 is needed for tips. That’s right, tips. It’s smart to budget a little something extra for the makeup artist that made the bride sparkle and the […]

This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.

Is Recession Coming? Watch These Signs

Market experts aren’t the only ones with an ear to the ground. Consumers can keep an eye on these indicators to spot a market downturn on the horizon.

2 Strategies to Reduce Taxes from the Sale of Your Business

Recently, one of my colleagues took me aside and asked what I could do to help a 40-year-old client who sold his business last year for $40 million. He wanted to shelter the proceeds from capital gains taxes and possibly fund a trust for his family. We both already knew that the opportunity to reduce the tax recognition on the capital gain had long passed.

Had he sought our advice long before he was committed to the sale of this business, we could have explored some valuable options. Here are two of them.

The Qualified Small Business Stock Exclusion

One option our client may have considered is to investigate qualifying his business for Small Business Stock treatment under Section 1202 of the Internal Revenue Code (IRC). Section 1202 was added through the 1993 Revenue Reconciliation Act to encourage small business investment. A Qualified Small Business (QSB) is any active domestic C corporation engaged in certain business activities whose assets have a fair market value of not more than $50 million on or immediately after the original issuance of stock, regardless of any subsequent appreciation (IRC § 1202 (d)(1)).

  • SEE MORE Preparing Your Family-Owned Business for Sale?

Qualified Small Business Stock that is issued after Aug. 10, 1993, and held for at least five years before it is sold may be partially or wholly exempt from federal capital gains taxes on the value of the shares sold, up to the greater of $10 million in eligible gain or 10 times the aggregate cost basis in the shares sold in each tax year (IRC § 1202 (b)(1)). Be aware that this limitation applies to each separate shareholder, and a trust, or multiple trusts, established and funded with QSB Stock gifted by a qualified QSB shareholder may enable much more than $10 million in gain exclusion. For QSB shares acquired after Sept. 27, 2010, the capital gain exclusion percentage is 100%, and it is excluded from alternative minimum taxes and the net investment income tax with the same five-year holding requirement (IRC § 1202 (a)(4)).

But only certain types of companies fall under the category of a QSB. To be a QSB, the domestic corporation must engage in a “Qualified Trade or Business” (QTB). Such a business will generally manufacture or sell products, as opposed to providing services and expertise. Businesses that generally will not qualify are those offering services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, banking and insurance, as well as hospitality businesses such as hotels and restaurants (IRC § 1202 (e)(3)).

To qualify and continue as a QSB, the business must follow certain rules (there are many, and these are the most basic): It must be a domestic C corporation when the stock is issued and when sold, and at least 80% of its assets must be used in the active conduct of one or more QTBs during substantially the entire five-year holding period. If the business is already an LLC or S corporation, it may still qualify if the business reorganizes and revokes the subchapter S election and issues new stock in the C corporation, then meets the holding period before selling.

It is critical that management of the company understands all of IRC Section 1202’s requirements and agrees to maintain the business in a manner that continues to satisfy the active business requirement and the asset investment limitations, and avoid the pitfalls related to stock redemptions, tax elections and conversions.

To summarize, in order for the QSB shareholder to claim the tax benefits upon sale, the following must apply: The shareholder may be a person or business not organized as a C-Corp; the QSB stock must be original issue and not purchased in trade for other stock; the shareholder must hold the QSB stock for at least five years; and the QSB issuing the stock must devote more than 80% of its assets toward the operation or one or more QTBs.

The Tennessee Income Tax Non-Grantor Trust Strategy

Most states conform to the QSB stock exclusion and also exclude capital gains tax on QSB stock when sold as required in IRC § 1202. The exceptions are California, Mississippi, Alabama, Pennsylvania, New Jersey, Puerto Rico, Hawaii and Massachusetts. If you live in one of those states, you may want to consider a concurrent trust strategy described below to eliminate all capital gains taxes on the sale of QSB stock. But even in conforming states, the QSB shareholder can claim additional exclusions greater than the $10 million exclusion limitation by gifting into multiple trusts so all the possible gain from the sale is excluded.

  • SEE MORE The Cure for the Great Resignation: Hire Older Workers

Shareholders living in a nonconforming state or expecting an aggregate capital gain much greater than the $10 million cap may use a Tennessee Income Non-Grantor Trust (TING) to eliminate all federal and state taxation on the sale of the QSB stock gifted to the TING prior to an agreement to sell. Tennessee law enables a person who owns a highly appreciated asset, like QSB stock, to reduce or eliminate his resident state capital gains taxes on the sale of the QSB stock through a TING. While several other states also have laws that support this strategy, Tennessee legislators have adopted the best parts of other states’ laws. To be clear, a taxpayer already living in a state with no state income tax may use resident state trusts to spread the capital gain resulting from the sale of QSB Stock.

The grantor will gift the QSB stock to one or more TINGs (a gift of QSB stock is an exception to the original issue rule under IRC § 1202 (h)(2) and the five-year holding period is not interrupted by a gift to a trust under IRC § 1202 (h)(1)). The trustee may then sell the QSB stock in a manner that allows treatment as a long-term capital gain. If the TING makes no distributions in the tax year in which the QSB stock meeting all the requirements is sold, the sale will be excluded from federal and state capital gain recognition.

The Sourced Income Rule Affecting Trust Taxation

The client’s resident state may seek to tax at least some of the income of a nonresident TING if the client’s resident state has a close interest in the trust’s assets, such as through real property located in or a business operating in that state. This is known as the Sourced Income Rule. Some states think they have a sufficient connection to levy a tax on a nonresident trust simply because the settlor or a beneficiary of the trust lives in that state, or the trustee has an office in that state. That broad application of the definition of a resident trust may be misplaced, but many of our clients want to avoid any expense from litigating against a state taxing authority.

However, if the tax savings are substantial, then a client considering a TING should be aware that the Supreme Court has unanimously ruled that the state of North Carolina overstepped its taxing authority when it sought to tax trust income based solely on the residence of a trust beneficiary. North Carolina argued that its taxing authority included any trust income that “is for the benefit of” a state resident. The Supreme Court disagreed and ruled in the case of North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust “that the presence of in-state beneficiaries alone does not empower a state to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain ever to receive it.” This ruling may serve to restrain other state taxing authorities from applying an overly broad application of their resident trust rule.

Both of these strategies used together can be highly beneficial for a QSB shareholder living in a QSB nonconforming state or one who expects the total capital gain from a sale to exceed the $10 million cap on a QSB capital gain exclusion. However, these strategies also require that the QSB management and the QSB shareholder plan many years ahead of any contemplated sale.

  • SEE MORE Planning to Sell Your Business to Key Employees?

How To Start a Wedding DJ Business in 9 Essential Steps

Want to hone your DJ skills? Or maybe show them off? Wedding DJs are in high demand these days. Industry experts expect 2022 to be the busiest wedding season in 40 years, thanks to lockdown romances and postponed ceremonies during the pandemic. A wedding DJ is the focal point of great wedding receptions. They set […]

This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.

Why a Pension Lump Sum Option Is Better Than an Annuity Payment

Often, the decision to take a pension annuity option over an available lump sum option rests on which option provides the greatest income. And that makes perfect sense if all of the other factors relating to this decision are excluded from the due diligence process.

But when considering all the factors that accompany this decision, whether to take a pension annuity option over an available lump sum option becomes more about control than it does the amount of the payment.

The Problems with Pensions

Today we are seeing fewer pensions than we did 20 years ago, and there is a reason for this downward trend.  The truth is that pensions are facing systemic problems, which is why we see private sector companies replacing these defined benefit plans with defined contribution plans, such as 401(k)s.

There was a time when employees worked until they could no longer physically do their job, and when they retired they died shortly after. What we see today is employees retiring much sooner in the cycle and living longer, which translates to significantly higher pension costs that are simply unsustainable.

  • SEE MORE When It Comes to Your 401(k), Trust But Verify

Speaking of sustainability, historically pensions have used 4.5% to 7.5% to calculate their projection of benefits and with interest rates far below this range, it goes a long way in improving the optics of the plans, but does very little to change their actual solvency. 

Interest rates have been far below these percentages for decades and when you couple that fact with a projected 10-year benefit period you can see how the math appears great on paper. But the reality is that if someone retires in their 50s (which is most often the case when a pension is involved) and live well into their 70s and 80s, you can see that 10-year estimates are short of reality.

Nearly 1 million working and retired Americans are currently covered by pension plans that are in imminent danger of insolvency, according to a 2017 Daily News article.

So, what happens if a pension is unable to pay its promised benefits? According to The Heritage Foundation, the Pension Benefit Guaranty Corporation (PBGC), which is similar to the FDIC, found that for a promised benefit of $24,000 a year, they are insured only up to $12,870. 

To compound the problem, this insurance has the same problem as the FDIC. The FDIC has billions in reserves but has exposure to trillions of dollars in banks accounts.  The same issue exists within the PBGC. The promise of insurance benefits is not mathematically supported. If PBGC goes insolvent, that $12,870 promise is really only able to cover $1,500 under the insurance benefit.

The concern here is that when you retire and are relying on an annuity payment from a pension, you are placing a lot of trust in the pension calculations. And if the calculations are off, there is not enough insurance to recover the loss.

A Lump Sum Gives You More Control of Your Assets

I began this article by suggesting that the decision to take a pension annuity payment over an available lump sum option often rests on which option provides the greatest income. But when you add it all up, the decision to accept a lump sum offer is more about controlling and preserving your future income sources than it is the annuity payment you are promised from the pension.

Now, I am not suggesting that all pensions are destined to go broke, but there should be consideration for this possibility when structuring your income sources that are designed to sustain you for the rest of your life.

By accepting a lump sum from the pension, you gain the control over your income assets.  Even if the income generated from the lump sum is less than the promised annuity payment from the pension, you gain control over the assets.

Even without the risk of a default, this lump sum option is a significant factor when you consider the following:

  • Your income needs can fluctuate in retirement, and the control of the assets backing your income gives you flexibility to meet your income needs.
  • You’re in a better position to take care of your spouse if you were to predecease them by owning the assets and leaving them behind for your spouse to continue to receive income.
  • Your heirs can be the beneficiary of the assets after you and your spouse pass when a pension is guaranteed to disinherits your heirs since it doesn’t pass to your children. In some cases, a child could receive a vested portion of the pension not already paid out. 
  • You have access to the assets if there comes a time in your life when you may need cash, and having control over the assets grants you that option.

If You Must Go with an Annuity, Single-Life Option Gives You More Control

Of course, not all pensions have a lump sum option, which means you have no choice but to accept an annuity payment.  If that is you, there are a few things to consider before selecting your irrevocable annuity option.

As with a lump sum, the idea is to move as much into your control as possible. It can be tempting to accept a reduced benefit to support a spouse or loved one after your passing, but this option only hands more control over to the pension.

  • SEE MORE How to Offset Lower Social Security Benefits When a Spouse Dies

A single-life annuity option is often your highest monthly benefit, and it is the quickest way to get the most from the pension in the shortest period of time. The downside to electing this option is that it can leave your spouse with an income shortage because payments would stop after your passing. That is why if you are married and choose to make this election, your spouse must sign off on that decision.

So, you have two options to protect your spouse:

  • You can buy insurance outside of the pension. With this option you would accept the single-life benefit, taking the highest annuity payment and then paying a premium to an insurance contract that would pay a lump sum to the surviving spouse or children if you predecease them. This approach also gives you the flexibility of canceling the policy if circumstances change and the benefit is no longer needed.
  • Or you can buy insurance through the pension. In this case you would go for a joint-and-survivor annuity, electing to take a reduced annuity payment in exchange for the benefit to continue to your spouse if you were to predecease them. Essentially, you are paying for the insurance with your lower benefit amount. It is worth mentioning that this benefit only has one beneficiary, so it would disinherit the children if you choose this option.

The Hidden Costs of a Joint-and-Survivor Benefit

One important factor when going with a joint-and-survivor annuity is the cost of buying the insurance through the pension.  Of course, you have premiums in either scenario but when purchased within a pension there are unique circumstances that most people completely overlook.
If your pension has a cost-of-living adjustment built into it, you should recognize that because a joint-and-survivor benefit is lower, it will receive a smaller cost-of-living increase than a single-life benefit would, which means that the difference between what the maximum benefit and the reduced benefit would be compounds over time. That translates to an ever-increasing cost for the insurance against inflation.

A quick example of this: Say you have a maximum benefit of $5,000 per month with a single-life annuity, and a reduced benefit $4,000 per month with a joint-and-survivor annuity. That leaves you with a monthly cost for the insurance of $1,000 per month. When you factor in a cost-of-living adjustment of 3%, that is 3% on the benefit being received. So 3% on $5,000 would be $150, whereas 3% on $4,000 would be $120, a difference of $30 per month. This income gap compounds over time. Projected out over 20 years, the gap grows to over $1,800 per month.

And if that wasn’t enough of a reason to not buy the insurance from the pension, consider the fact that the longer the pension recipient lives, the fewer years the spouse is receiving the insurance from the pension.  When you think about this, buying the insurance from the pension means that you are accepting an arrangement where you are paying an ever-increasing monthly premium for a decreasing benefit.

And unlike a life insurance policy purchased outside of the pension system, this pension insurance for the spouse only extends to your spouse, unless you were to choose a child as the beneficiary.

Be Careful

Now, if you go with a single-life annuity and choose to purchase the insurance outside of the pension system, it is critical that the type of policy you purchase and the amount of insurance obtained are in alignment with what you need to protect your family.  One misstep in this process can leave your policy at risk of lapsing or expiring, leaving your spouse vulnerable to a significant income gap.

To download my free guide that will take you through the process of determining benefits and the type of life insurance best suited for protecting the benefits, visit www.thepensionelectionguide.com.

Benefits and guarantees are based on the claims paying ability of the insurance company.

  • SEE MORE Choppy Market Impacting Your Retirement Income Plan?
Securities offered through Kalos Capital Inc., Member FINRA/SIPC/MSRB and investment advisory services offered through Kalos Management Inc., an SEC registered Investment Advisor, both located at 11525 Park Wood Circle, Alpharetta, GA 30005. Kalos Capital Inc. and Kalos Management Inc. do not provide tax or legal advice. Skrobonja Financial Group LLC and Skrobonja Insurance Services LLC are not an affiliate or subsidiary of Kalos Capital Inc. or Kalos Management Inc.