Grantor Retained Annuity Trust: An Easy Way for Business Owners to Reduce Wealth Transfer Taxes

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:

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Using a Section 105 Medical Reimbursement Plan to Reduce Your Tax Bill

“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.

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You’ve Inherited an IRA. Now What?

Inheriting an IRA is quite a bit different than inheriting any other asset. Unlike cash or investments in a traditional investment account, if you inherit an IRA you’ll need to start withdrawing from the account in order to avoid hefty penalties. In this post we’ll cover what your options are when you inherit an IRA, and how you can best manage it for you & your family.

How IRAs are Passed After Death

Whereas many of your assets will be distributed to heirs according to your will, IRAs are instead distributed by contract. Your custodian (the brokerage firm that holds your account, like Vanguard or TD Ameritrade) lets you designate as many beneficiaries and contingent beneficiaries as you like. Once you die, your account bypasses your will, the probate process, and is distributed according to this beneficiary designation.

When account holders don’t designate any beneficiaries things get a little murkier. When the account holder dies, their account is distributed according to their custodian’s default policy. At most custodians this default policy diverts the IRA back to their estate (and goes through probate) but at some it’s diverted to their spouse first. Unfortunately, if the account holder didn’t designate a beneficiary while they were alive, you’re at the mercy of your custodian’s policy.

If the account is indeed diverted back to their estate, it’ll be distributed according to your state’s interpretation of their will. And if they didn’t have one (meaning they died intestate), the state will make its own decision on who should inherit the asset.

The moral of the story? Take advantage of the opportunity to bypass probate, and designate your beneficiaries formally while you’re still alive.

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How to Hire an Accountant

Managing your financial affairs is a big job. You have to keep track of your income, manage your assets for long term growth, pay taxes, and arrange for your estate to be distributed after you die.

You can do some of these things on your own. But others, like writing a will, are jobs you’ll probably want to hire a professional for.

Since we’re in the middle of tax season, I thought it might be helpful to cover exactly what to look for when hiring an accountant. Paying taxes is a fact of life. But if you can find creative ways to reduce the amount of tax you pay, there will be more left over for you and your family. It’s for this reason that an accountant is often one of the professionals families hire for money advice.

You can certainly prepare your own taxes if you prefer. Programs like TurboTax and TaxAct provide quick and affordable ways to compile your financial records and file your taxes.

There is no program that can help you with tax planning, though. TurboTax and TaxAct are great for tax compliance, where you’re reporting on transactions that’ve already happened. But if you’d like to know how you might reduce your tax burden in the future, you’ll need some help making decisions on transactions that haven’t happened yet. This is tax planning, and something that many accountants are very good at.

I covered in a recent post how you can tell whether you need to hire a CPA. Today’s post will cover how to go about hiring one if you do.

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Top Strategies for Managing Incentive Stock Options

Incentive stock options, or ISOs, are a pretty common way for companies to compensate management and key employees. Otherwise known as “statutory” or “qualified” options, ISOs are a way to give management a stake in the company’s performance without doling out a bunch of cash.

While they can have wonderful tax benefits, far too many people who own ISOs fail to exercise them wisely. Some estimates even claim that up to 10% of in the money ISOs expire worthless every single year. If you own incentive stock options but aren’t sure how to manage them, read on. This post will cover a few of the top management strategies at your disposal.

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Turbotax vs. Accountant: When Should You Hire a CPA?

Let me start by saying that I’m a big fan of most tax preparation software. Taxes are a cost in and of themselves. Any way to automate the prep and filing process in a compliant and inexpensive way is A-OK in my book.

But even though they’re easy to use, Turbotax and others are still software programs that have limitations just like any other robot. When your financial picture becomes sufficiently complicated, spending the extra cash to hire a professional can actually save you money in the long run. Here’s my take on when you should ditch the software for an experienced professional.

What You Should Know About Tax Prep Software

When people talk about tax in general, there are really two sides to the conversation: tax planning and tax compliance.

Tax planning is essentially planning transactions before they happen, and making thoughtful decisions that will minimize the total amount of tax you owe. Tax compliance, on the other hand, has to do with preparing your return, filling out forms, and reporting on transactions that have already occurred.

While tax prep software is great and all, it’s really only useful for tax compliance. The more complicated your financial profile becomes, the more decisions you’ll have to make, and the more important tax planning will become.

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Mutual Fund Capital Gains Distributions: What They Are & How to Avoid the Tax Hit

If you’ve ever invested in a mutual fund, you may know that they’re required to distribute at least 95% of their capital gains to investors each year. You may also know from experience that these gains are not always welcome since they come with a tax liability attached.

More often than not these capital gains are not large enough to cause investors to stir. But every year there are a few funds that pass massive unwanted gains on to investors, leaving them with a big, stinky tax bill.

This post may be slightly tardy given that some mutual fund families have already distributed their year end capital gains. Nevertheless, it’s an important topic that you should be aware of and keep an eye out for.

If your objective is to minimize your tax bill (hint: it probably should be) you’ll want to know about upcoming distributions at the end of each year, and avoid them when it makes sense. This post will cover exactly what capital gains distributions are, why mutual funds distribute them, and when and how you might want to avoid them.

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401(k)’s, IRAs & Tax Deferred vs. Tax Exempt Investing

Should I contribute to a traditional or a Roth IRA?

This is a big question I get asked fairly frequently. And really, the conversation expands beyond individual retirement accounts. The decision whether to invest on a tax deferred or tax exempt basis is one you’ll likely make many times over your investing career. Some people prefer a exempt account to “get taxes out of the way”, while others prefer to defer taxes as long as possible in order to “let their money work for them”.

In this post we’ll explore the topic and discuss which situations may be best for either strategy. But first, let’s review exactly what tax deferred and tax exempt investing actually are.

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6 Ways to Minimize Required Minimum Distributions

There’s a plethora of tax advantaged retirement accounts out there today. Enough that the acronyms and numbers can get really confusing…

IRA
401k
403b
457
Profit sharing
SEP IRA
SIMPLE IRA

Just to name a few – trust me, there are more. The reason? The government wants us to save for our own retirement. And by offering an array of tax advantaged accounts, they’re incentivizing us to put money away.

But while the tax advantages are great, the government won’t let us shelter our money from taxes forever. When you turn 70 1/2, they’ll force you start taking withdrawals called required minimum distributions, or RMDs. If you don’t you’ll be subject to a hefty 50% penalty.

This poses quite a problem for many retirees, since each withdrawal raises their tax liability for the year. So for those of you who want to keep Uncle Sam’s grimy mitts off of your hard earned retirement funds, here are six ways to minimize your RMDs:

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401k RMD Rules: A Comprehensive Guide

You’re probably familiar with the term “required minimum distributions” (or RMDs for short). They’re the systematic withdrawals that the IRS makes you take out of an IRA after you turn 70 1/2. But what about for 401k and other qualified retirement plans? What are the 401k RMD rules?

While they largely resemble IRA RMD rules, 401k plans have a few subtle but important differences. And since many people these days are staying at their jobs beyond 70 1/2, it’s a situation that more and more people find themselves in.

To help you navigate the waters, here’s a comprehensive guide to 401k RMD rules, which also applies to 403b, 457, and other qualified plans.

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