Business Tax Planning for an Obama Presidency
Whether or not you agree with Barack Obama, if you're a successful business owner, you need to plan now to minimize the tax increases an Obama administration seems sure to implement. Why? A bit of upfront planning could easily save you tens of thousands a dollars a year--in some cases, for decades.
Recognize Capital Gains Now
Here's the first and easiest idea to consider: Book any long-term capital gains right now, before 2012 ends.
Here's why: While the IRS taxes long-term capital gains at a relatively low 15% rate, Obama proposes raising this rate to 20% for individual taxpayers making more than $200,000 a year and for families making more than $250,000.
While a 5% rate increase may seem modest, long-term capital gains are often substantial. Long-term capital gains regularly break into seven figures if the gains stem from decades of appreciation in a real estate investment or from decades spent building up a successful business.
Note: The 15% long-term capital gains rates were originally set to expire in 2010, so capital gains rates were probably always at risk of ratcheting back up to some higher level.
Delay Capital Losses Until Later
A quick related point: Because of the way that capital gains and losses are netted, you may want to delay recognizing any capital losses until next year when long-term capital gains tax rates may be higher.
The savings calculations related to this technique are tricky. But delaying a capital loss a few weeks could in many cases save you several thousand dollars because the loss will be applied, or netted against, either capital gains or ordinary income that would otherwise be taxed on a higher rate.
Extract Earnings and Profits Now
If you own a C corporation or former C corporation, you should be aware of a potential tax time bomb that may exist inside your corporation: previously taxed profits retained inside the corporation.
Here's the problem: Right now, if the corporation pays out these earnings and profits to shareholders as dividends, the shareholders pay a modest 15% qualified dividends tax on the dividends. And that's pretty good.
However, this qualified dividends tax rate expires at the end of 2010. And after that, dividends paid from C corporation earnings and profits will get taxed at the shareholder's top marginal rate. That top rate may be close to or even exceed 40%.
You see the savings, right? Paying, say, a 40% tax rate instead of a 15% tax rate will have a huge effect.
Accordingly, to the extent possible, extract previously taxed C corporation profits now, before the qualified dividend tax rate expires or before tax law changes eliminate this legislative loophole.
And a special note for any S corporations that used to operate as C corporations. If you retained some of your C corporation profits during the years you operated as a C corporation, talk with your CPA about this issue, too. You've got the same tax time bond ticking inside your books.
Reconsider the Roth Option
One powerful long-term tax planning technique is worth mentioning for high net worth business owners. If you're someone with more than adequate retirement savings, you may want to setup and use a 401(k) plan to make Roth contributions.
Here's the logic. Typically, high income tax payers can't contribute money to a Roth-IRA account because the Roth-IRA cutoff point is $160,000. Rise above that income level and you lose your Roth eligibility.
However, no income cutoff exists for Roth-401(k) plans. And this opportunity creates a long-term tax saving opportunity for business people who've accumulated substantial assets.
Say you've a fifty-year-old who's got a sizable taxable investment account. In this case, almost without effort, you could transfer $40,000 a year from your taxable investment account to a couple of Roth-401(k) nontaxable accounts for you and your spouse.
In this case, you end up with a million dollars in your Roth-401(k) at the point you retire. You won't have saved any tax (yet) with the 401(k). But the money you've accumulated and the investment earnings on the money won't be taxed. Not ever.
This is big. During your retirement years, having this $1,000,000 of Roth wealth could save you $30,000 to $40,000 a year in income taxes.
And if you've got kids, this tax savings gambit gets even better: Your kids can (with a little bit of clever upfront planning) continue to save the $30,000 to $40,000 a year over their lifetimes.
About the author:
CPA Stephen L. Nelson is the author of Maximizing Employee Retention Credits.