C-Corp Asset vs Stock Sale Dilemma

Shareholders of C-Corps often experience significant anxiety when it is time to exit their business. If they are fortunate, they will exit by way of a stock sale. In these cases, their Corporate Tax is $0 and then when the proceeds are distributed to the shareholders, the capital gains taxes will be approximately 20%.

To minimize future taxes and third party liabilities, the majority of buyers prefer to purchase selected assets of the seller rather than its stock. The total taxes associated with the asset sale of a C-Corp is typically more than 50% of the corporate gain (i.e. approximately 40% of the gain over the basis is taxed at the corporation's income tax rate. The gain often drives that corporate rate to the highest level because the gains are treated as ordinary income by the corporation. When the remaining funds in the C-Corp are distributed to the shareholders, they are taxed again at the individual shareholder's capital gains tax rate, normally 20%.

In many cases, C-Corp shareholders receive offers for asset rather than stock sales. Due to the huge tax implications discussed above, the sellers often reject an offer at current fair market value because the net after tax proceeds from the transaction is too low to meet their personal financial requirements. The C-Corp then asks for a higher price and negotiations stall.

How C-Corp Shareholders Can Increase Their Net Gain After Taxes

There is a solution to this dilemma that enables the shareholders of the C-Corporation to increase their net gain after taxes significantly from an asset sale. The following is a summary of how this strategy works.

C-Corp shareholders sell the operating assets of the Company to an asset Purchaser at the negotiated fair value. They leave the cash proceeds from the asset sale inside the Company.

Then, C-Corp shareholders sell the stock of the Seller to another purchaser (Stock Purchaser) in an independent transaction that does not involve the original Purchaser in any way.

In such a transaction, the Stock Purchaser pays the C-Corp shareholders cash upon closing of the stock sale and the Stock Purchaser assumes the ongoing liabilities of the Company, including the corporate tax liability (approximately 40% of the corporate gain) from the sale of the assets of the Company. The shareholders, relieved of the corporate gain liability, are now only responsible for paying the capital gains tax, approximately 20%, on the proceeds received from the Stock Purchaser from sale of the stock.

The transaction works because the Stock Purchaser is in a position to shield the gain from the asset sale with solution assets from other operations. Subsequent to the sale, the Stock Purchaser re-engineers the Seller into a new line of business that is expected to be profitable.

As the new owner of the Seller, the Stock Purchaser is responsible for running the Company on an ongoing basis and satisfying the current and future corporate tax liabilities of the Seller.

Here is an example of how it works:

Let's assume the corporate gain resulting from a C-Corp asset sale is $10M. The shareholders would typically net approximately $4.8M after taxes (in most states) after paying taxes on both the asset sale and the personal capital gains taxes upon distribution of sale proceeds. Utilizing the solution described above, the C-Corp shareholders could net as much as $6.4M after taxes. This represents a gain in take home cash of more than 30% as compared with the traditional asset sale scenario.

Capital Gains Tax Explained

The Capital Gains Tax which is typically also known as CGT is basically charged on the profits that you make over the annual allowance. This means that any gain that you make over the allowance has to be paid for in the form of Capital Gains Tax.

The payment of CGT is different for different people, and also differs in case of the situations that apply. Basically, the amount that you pay for the tax is dependent upon the asset from which you had the capital gain and the time period for which you have been holding the asset before you had the gain.

The tax rules that apply on the capital gains tax differ for the business assets and non-business assets. A rule that was applied in 1998 was about the holding period of the asset and the tax on the capital gain. According to the rule, the longer an asset is held for, the lesser is the tax that has to be paid over the gains from that asset.

Some of the situations that are counted as you having capital gain or loss are the giving away of the asset to someone, your owned asset being destroyed or lost, and several others. In general circumstances, the most common situation which requires you to pay the Capital Gains Tax is when you sell something and you get more amount for it than what you had paid. Giving something away or getting compensation money also entitles you to paying the CGT.

There are also some exceptions that apply to the Capital Gains tax, and if any of those situations occur, you would not be entitled to pay CGT. One of these situations is when you are selling or just passing away belongings, the worth of which is less than six thousand pounds. Giving away the items to a registered charity is also an exception and in this case you don't have to pay the tax.

Another exception to the payment of the CGT is that, if you are selling your privately owned car or selling your primary home, you are not required to pay the Capital Gains Tax. The tax also does not apply to the payments received from premium bonds, personal injury compensation, and lottery winnings.

There are different rates of the Capital Gains Tax that apply for different income levels. Any asset which is your personal principle asset does not require you to pay GCT on it. However, all the investment properties are subject to tax. When paying the Capital Gains Tax, it is important to remember that whatever amount of capital gain you receive gets added to your taxable income before the marginal tax rate can be applied on it.

When you are calculating the amount of the Capital Gains Tax, it is important to remember that the date of sale or acquisition of the asset that is considered is the one mentioned on the purchase/sale contract. The assets on which a discount can be received are those that are in the name of an individual, and there is a specific time period for which it should be owned.

Investing for Children - Which Options Are Best? (Part 2)

Having given due consideration to the strategies in Part 1, let's now consider other tax effective investments to help children with the costs of higher education.

Trust Arrangements

In cases where the donor is confident that the child will have a mature disposition at age 18, a bare trust based investment will offer maximum tax efficiency.

Where more control is required over the investment so that there is, in effect, a "wait and see" approach before the child benefits at age 18, a discretionary trust may be more appropriate.

We will now look at these in more detail. Clearly, in either case, the underlying investment should be made to achieve maximum tax efficiency within the constraints of the required investment parameters.

It is not generally legally possible (although certain life policy exceptions do exist) to make outright gifts of assets to minor children and obtain a valid legal discharge. Indeed, it is not often advisable from a practical standpoint. For this reason trusts can be used effectively.

Two options exist:

Bare Trust

Here the donor could consider an investment into a collective investment (unit trust or OEIC) held subject to a bare trust for the absolute benefit of the child.

The advantages of this structure would be:

Income

Where the grandparent is the donor, income will be taxed as the grandchild's. It is likely that the grandchild will be a non-taxpayer. This means that where dividend income arises, recovery of the tax credit on those dividends will not be possible and so, if this is of importance, an investment in corporate bond funds could be considered.

These generate interest distributions which are paid under deduction of income tax at 20% and this can be recovered by or on behalf of a non-taxpayer.

Alternatively, an investment in an offshore corporate bond fund could be considered. Here interest is paid
gross and so this will avoid the need for a reclaim of tax.

In cases where the parent is the donor of a bare trust for the benefit of his/her minor child who is unmarried and not in a civil partnership, then if the gross income on investments within the trust exceeds 100 gross in a tax year, it would be taxed on the parent. Therefore, if the parent is a higher rate taxpayer, it may be appropriate to invest in low yielding investments and concentrate an achieving capital growth.

Capital growth

Capital gains will be taxed on the child so this could be a useful way, through careful investment management, of using the child's annual CGT exemption of 10,100 (tax year 2010/11).

Moreover, the annual exemption is not restricted according to the number of trusts created by the same settlor. Any gains that exceed the annual exemption in a tax year will probably only be taxed at 18%.

Where investment funds are held in a bare trust and being invested to assist with the future payment of university costs, the collective investment could be gradually encashed over three or four years. The child could draw down on the investment from age 18 and, provided capital gains fall within the annual CGT exemption, in effect enjoy a tax-free stream of capital payments.

Another investment that could be held in a bare trust is a single premium bond. H M Revenue and Customs now takes the view that where chargeable event gains arise on single premium bonds heldsubject to a bare trust, they should be taxed on the beneficiary.

The exception to that is in cases where the beneficiary is the settlor's minor unmarried child not in a civil partnership where the "100 rule" applies (ie. if gross income exceeds 100 in a tax year, it is taxed in full on the parental settlor). However, this rule doesn't apply with a grandparent settlor or a parental settlor once the child attains age 18.

Therefore, if full policy/segment encashments are made from a bond, chargeable event gains may well count as the child's income and so, provided the child is not a higher rate taxpayer, in effect provide a series of tax-free payments.

To facilitate some tax-free encashments to fund the costs of pre- university education the 5% (tax-deferred) annual allowances could be used in the knowledge that on eventual encashment after the child had attained age 18, a tax charge is unlikely to arise. Of course, tax (while important) should not be the only determinant of underlying investment strategy.

Investors should always aim to strike an appropriate balance between investment suitability and tax efficiency - ideally achieving both.

Gifts to bare trusts are PETs and so no immediate IHT would arise. Indeed, they will be totally free of IHT if the donor survives for 7 years.

Discretionary / Flexible Trust

A discretionary trust would give control to the trustees to determine who should benefit from the gift and when. This means that if the child does not have a financial need at age 18 or is not responsible enough to receive cash at that time, the release of benefits could be held back until a later date.

Aside from the 1,000 standard rate band, trustees of discretionary trusts are charged to income tax as if they are additional rate taxpayers. Since 6 April 2010, the tax rates on income above this band arising to discretionary trustees are 50% (42.5% on dividends) regardless of the trust's level of income.

This means that in cases where a grandparent is the settlor, it may be appropriate for the trustees to distribute income to a grandchild beneficiary who is a lower or non-taxpayer in order to recover the additional rate tax paid by the trustees.

Indeed, in these circumstances an interest in possession trust that gives the grandchild a vested right to income but with the trustees having the power to appoint capital may be attractive as this will avoid the beneficiaries having to recover income tax that the trustees have already paid.

In cases where the settlor is the parent of a minor unmarried child beneficiary, it should be noted that
the "100 rule" can apply. This means that if more than 100 of gross income in a tax year is paid out of the trust to the minor child beneficiary of the settlor, it will be taxed on that parental settlor.

Another planning point to consider, where appropriate, might be to trigger the "settlor-interested trust
rules" by including the settlor's spouse in the class of beneficiaries. This would result in the income being assessed on the settlor which would lower the tax rate provided the settlor is not an "additional rate" taxpayer.

Two types of investment may be appropriate for the trust.

Collectives

If income was not to be distributed it would generally, from a tax standpoint at least, be best for the trustees to invest for capital growth, for example in collectives. This will enable them to use their annual Capital Gains Tax exemption, which is normally 5,050, with excess gains only taxed at 28%. However this investment strategy may introduce an increased level of risk into the portfolio.

Should an adult grandchild have a need for cash at or after age 18 in circumstances which would mean the trustees would have a likely CGT liability, the trustees could make an absolute appointment of benefits to the grandchild and claim CGT hold- over relief. This would mean that the gain would effectively be transferred to the beneficiary, who would have his full annual CGT exemption (10,100) to offset against
any capital gains that arise on subsequent encashment.

Investment Bonds

Alternatively, (and especially if the settlor-interested trust or gains oriented collective strategies were not possible or appropriate) in order to avoid the high rate of tax that trustees pay on trust income, the trustees could invest in single premium bonds.

In such circumstances, any chargeable event gains (which will include reinvested income within the bond) will automatically be taxed on the settlor if he/she is alive and UK resident in the tax year in question.

Their top rate of tax may well be lower than that of the trustees. Otherwise, chargeable event gains will be taxed on UK resident trustees at 50%, with a 20% tax credit available in respect of chargeable event gains arising under a UK bond.

A UK single premium bond could thus be a particularly tax attractive investment where there is a desire to invest for growth from reinvested income rather than capital gain.

In cases where the trustees wish to encash the bond to realise cash to make a payment to an adult beneficiary to fund university costs or assist with a mortgage or wedding costs, thought could be given to making an appropriate appointment of capital, and then the trustees assigning the bond to that adult beneficiary.

That would not in itself trigger a chargeable event but future chargeable event gains on encashment of the bond will be taxed on the beneficiary at his/her tax rate which will hopefully be lower than the rate paid by the settlor/ trustees.

Gifts to discretionary trusts are chargeable lifetime transfers but an immediate IHT charge would only arise if the settlor exceeded his nil rate band (on a seven year cumulative basis).

Whilst ten-year periodic charges can arise, these are only likely to be an issue if a substantial amount was being placed in trust which is fairly unlikely in these cases.

The Financial Tips Bottom Line

Children will need help in later life to meet a number of financial commitments - be it university costs, assistance in buying a house or funding the costs of a wedding. All of these costs can be expected to increase in the future.

Unless large sums of capital are available, the only realistic way of financing these costs is for a parent or grandparent to set up an advance programme of saving.

The demise of the Child Trust Fund means that Government help will not be available in the future.

All parents and grandparents / guardians need to be aware of tax-efficient investment products and, where appropriate, trusts to maximise the returns available for the child. Where trusts are used, these can enhance tax efficiency and the trust selected can be tailored to meet the parent / grandparent's and child's circumstances.

Changes to Capital Gain Tax Treatment of a Primary Residence

Just when we think we have the income tax laws regarding real estate figured out, the federal government has to go and change them again! This time the changes come as part of the 2008 Housing and Economic Recovery Act (HERA), H.R. 3221, an attempt on the part of government to help individuals impacted by the current mortgage crisis without spending money to do it. It's called "revenue neutral", which means that they have to collect more money from somewhere to pay for it.

The additional collection relative to real estate comes from a change in the way profits (capital gains) from the sale of a primary residence are (or are not) taxed. Currently, if a person sells a house for a profit (capital gain) after living in it as their primary residence for 2 of the past 5 years, there is no capital gain tax due on $250,000 of the gain for a single person or $500,000 for a couple. They are free to do whatever they want with the money and there are no age restrictions.

Americans are a creative people, particularly when it comes to avoiding taxes, and during the recent boom, this tax provision provided an incredibly easy way to make money. Let's look at a simplified example:

A couple owns a house (their primary residence), a vacation home and a rental house. They sell their primary residence, take $500,000 in tax-free profit and move into their rental house. They live there 2 years, sell it, take $500,000 in tax-free profit, buy a home where they want to retire and move into their vacation home. They live there 2 years, sell the former vacation home, take the tax-free profit and move into their retirement home. 3 sales, no capital gain tax.
The sale of a former rental does have some tax implications regarding recapture of depreciation, but that has been minimal relative to the potential for gain.

Congress has decided that this scenario does not fit the original intent of the law, which was to eliminate capital gain taxes on the increase in value of a person's home. As of January 1, 2009, there will still be no capital gain tax due on a profit generated by the sale of one's personal home where they have lived for 2 of the past 5 years, with the following exception:
If that home was converted to a personal home from a rental or vacation property, capital gain tax will be due on that percentage of the gain equivalent to the percentage of time that the house was used other than as a primary residence since January 1, 2009.

For most homeowners, this change will be of no concern, but many knowledgeable people have incorporated this tax provision into their financial planning. It has always been important to talk with your financial advisor or accountant before making a decision to sell property, and never more so than now.

Tax Benefits of Forex Trading

Forex trading allows you to have the best of both worlds. When stock prices go up, you can benefit from Forex trading. When stock prices go down, you can profit from Forex trading.

Inflation goes up, you can profit from Forex trading. Inflation goes down, you can profit from Forex trading. Similarly, interest rates can go up or down, you will profit from Forex trading.

You have to pay a capital gains tax for any investment in financial markets. Capital gains will be considered short term if it is less than one year. Short term gains are taxed at your current tax rate.

And if you hold the security for more than one year before you take profit, you will have to pay long term capital gains tax. Long term capital gains are taxed at a rate of 15% only.

But if you invest in Forex markets, 60% of your profits will be taxed as long term gains and only 40% will be taxed as short term capital gains whether you hold a currency for one minute, one hour, and one month or more.

Lets take an example. Suppose you invest $10,000 in stocks and $10,000 in Forex. Your tax bracket is 33%. Suppose you made a profit of $10,000 in both stocks and Forex each in six months.

Since your stock investment was less than one year, your profit will be treated as a short term gain. That means you will have to pay your current tax rate of 33% which will be (10,000)(0.33)=$3,300 and your profit after taxes will be only $10,000-$3,300= $6,700.

It doesn't matter whether you took profit in six months or one year in Forex, 60% of your profit will be treated as long term capital gains and 40% will be treated as short term gains. It means 60% of $10,000 will be taxed as long term capital gains at only 15% which is (0.6)(10,000)(0.15)=$900.

40% of your profits in Forex will be taxed as short term capital gains at your current tax rate of 33% which calculates as (0.4)(10,000)(0.33)= $1,320.

So the total tax that you pay on your Forex investment will be ($900) + ($1,320) =$2,220. But your tax on stock investment was $3,300 which is $1100 more than the tax on the same capital gain on your Forex investment.

Tax savings on Forex investment like that can add up fast. Profits can accumulate quickly by investing in the Forex market within your IRA or other tax-deferred retirement account.

IRS Capital Gains Tax - The IRS' Way of Getting a Cut of Your Profits

The IRS capital gains tax is applied to any and all of the profit an individual makes on any capital asset. If you receive pleasure from it, convenience, or a profit, it is considered a capital asset. This includes homes, cars, bikes, recreational vehicles, stocks, and bonds.

The tax is applied when one of these capital assets are sold. There is no upper limit to the amount of profit you gain from a capital asset when it comes to reporting it on the capital gains tax sheet or schedule D, but your losses are limited to $3000 a year.

What most people do not realize is this tax also applies to inherited items. If you received something of value from a relative and decide to sell it, the profit you incur when the transaction takes place is all taxable and has to be reported by law. If the inherited item is stocks in a company, this is considered a capital gain, along with the coin collection.

When an item is sold, the length of time that you owned it is considered into the tax. All items that are held for less than a year are taxed at a higher rate than those considered a long term capital asset. Long term capital assets are items that are held for over 365 days or one year.

If your losses total more than $3000 in one year, the remaining amount can be added to the next year's income tax return, but limited again to only $3000.

The IRS capital gains tax is a way for the government to profit from the wealth of Americans to increase their tax collections.

Of course, the above is not legal or accounting advice - it is for informational purposes only. Before making any decisions regarding legal or tax matters, it is vital that you consult a licensed professional lawyer or tax accountant.

Contributing Bonds and Stocks to Charity to Avoid Capital Gains

Once your bonds have been appreciated you are advised to transfer these bonds to a worthy cause like charity. By doing this you will see a significance on your tax deduction because of this contribution. And you would be able to avoid the capital gains tax which would be due on the sale of the stock.

If you are going to cash in your stocks and bonds you should know that when receiving the funds from your brokerage house there will be a tax imposed and this tax is normally 15% if you have had the stock for at least a year. If you did not hold this particular stock for the entire year you will end up paying a rate of about somewhere between 25 and 30%. When you are complete with the sales of your bonds and have gotten the proceeds you now can contribute the necessary funds to the various charitable organizations.

And in this event both you and the charity organization will benefit from this as if the bonds are transferred straight from the account of your brokerage to the account of the charities brokerage. Because you will not come in contact with these funds there will be no capital gains taxes and also no income tax. An example of this is that you bought 500 shares at CarMax for over a year at $9 dollars per share, for a total cost of $4,500 dollars. This present day that same stock is worth $20 dollars per share or a total of $10,000 dollars.

Commodity Investing and Tax Benefits

With tax season just passed, you may still be hurting from the results. If you requested an extension and haven't filed yet, this topic might be very helpful to you. Aside from the profit potential that you can realize from trading commodities, there are handsome tax benefits as well. The current tax laws separate investment gains and losses into two expansive groups: short-term capital gains and long-term capital gains. This feature is nice because when you are commodity investing, you are allowed to split your profits between the two categories.

To understand the tax benefits of commodity trading, there are a couple of things to learn. Grab the statements from your commodity account and a calculator, and start a spreadsheet; this is quick and fairly easy to grasp. Here are the things you need to do:

1. Understand what short-term capital gains are. Profits from any commodity trade that is held for less than one year are considered short-term capital gains. Short-term capital gains are taxed at the investor's normal tax rate; if you are in the 25% bracket, your short-term gains will be taxed at 25%.

2. Understand what long-term capital gains are. Commodity trades that are held for more than one calendar year are long-term capital gains. Long-term capital gains are taxed at a flat rate of 15% unless you are in the ten percent or fifteen percent brackets and then long-term capital gains are taxed at 5%. For those people who are holding long-term futures contracts, this is obviously a very attractive situation.

3. Add up your profits and losses. This is where you can use your calculator (or your computer if you have some spreadsheet skills). For each transaction you made while commodities trading, enter the amount of profit you made as a positive number and the amount of loss you had as a negative number. For example, imagine that you made three commodity trades; you earned $500 on the first, lost $300 on the second and made $1,000 on the third. To calculate your profits, add the numbers together. $500 - $300 + $1,000 = $1,200; $1,200 would be your profit for the year.

4. Determine your long-term capital gains. For this calculation, take the total number and multiply it by sixty percent. For our example, $1,200 x 0.60 = $720; this is your long-term capital gains on your commodity investing. Now you need to multiply this number by the 15 percent tax rate; $720 x 0.15 = $108. This will be the long-term capital gains tax responsibility on your commodity long-term investing.

5. Determine your short-term capital gains. For this calculation, take the total number and multiply it by forty percent. For our example, $1,200 x 0.40 = $480; this is your short-term capital gains for your commodity investment strategies. Now you need to multiply this number by the 25 percent tax rate (For this example we'll assume this is your rate but we hope it is higher!); $480 x 0.25 = $120. This becomes your short-term capital gains tax responsibility on your commodity investments.

6. Add the two together. Once you add the short and long-term tax numbers together, you have calculated your tax liability for your commodity trading. $108 + $120 = $228.

7. Review your savings. In order to see your savings, multiply your total profit for the year by your tax rate and then subtract your actual tax responsibility from this number. (Remember that we assumed you were in the 25% bracket.) $1,200 x 0.25 = $300; this would have been your liability. $300 - $228 = $72. While on the surface this doesn't seem like a lot but it is actually a 24% reduction in your tax burden for the money you made! 24% can make anyone's investment philosophy look pretty smart!

Conclusion

Because of the method for computing capital gains, commodity investing can be very beneficial from a tax standpoint. Since futures contracts are taxed at a split rate, 60 percent of your earnings from commodity investments are taxed at the long-term capital gains rate and only 40 percent is taxed at the short-term capital gains rate. This is called the 60/40 tax treatment, and it will save you money in taxes. As always you should consult your tax advisor but you will likely be very pleased with your returns!

Capital Gains Deferral in a Business Sale

The sale of business is a challenging and difficult transaction with several complicated aspects. Whether it's the complete sale of a business or simply the sale of a partial ownership interest in a company, one of the most troubling issues created by this disposition is the manner in which capital gains and other taxes are addressed. There are not many options available to a business owner, and the few that are come accompanied by complex rules and regulations. There are also restrictions that can increase future risk and possibly trigger IRS penalties.

We are always looking for ways for our business sellers to maximize their transaction proceeds while keeping as much possible through the use of intelligent tax planning and deal structure. I asked Dan Carroll from Brook Hollow Financial to explain a unique way to defer capital gains taxes that are the result of a business sale.

Large Tax Bill Due upon Sale

Capital Gains, Depreciation Recapture and even Income taxes may be levied against the proceeds of the sale of the business. Depending on the initial amount invested and how much the business has grown, these taxes can consume much of the sale price. Currently the Federal Capital Gains Tax stands at 15%. Most states have a Capital Gains Tax as well, with the total amount often exceeding 20% of the gain. We believe that these rates will have near term upward pressure caused by the need for the Treasury Department to make up for the $800 billion shortfall that will result from the repeal of the Alternative Minimum Tax. Other taxes, particularly if held in a 'C' Corp., can exceed 60% of the transaction.

Loss of Regular Income

When a business is sold, the owner's cash flow stops as well. Therefore, the amount of money that was being produced needs to be replaced. Without this regular income, former business owners are left with a significant gap in what they receive each month and must alter any plans or budgets accordingly.

What to do with the Proceeds

Another major challenge that a business owner will face is what to do with the proceeds of any sale. There are many ways to put this money to work for you, but this often means accepting significant risk and investing in markets without much experience. Alternatively, sellers might mitigate risk, but only at the cost of getting a very low return. Either way, inadequate returns and potential loss of capital are serious risk factors that must be considered.

Need to Mitigate Future Risk

Among the challenges presented by investing the new capital is that there may be different goals for the individual at this stage of his or her career. If the sale is prompted by a desire to move away from daily management and responsibility, or simply to cash out at a good time in the market, the owner may want to revisit his or her goals. A review of the financial needs and expectations may reveal a requirement for total investment certainty. While these alternatives do exist, most do little to provide a reasonable return and can make planning more difficult with these limited resources. The need and desire to mitigate future risk should play an important role in any decisions about your investment plans.

The Traditional Business Sale - Cash Transaction

The cash transaction option is fairly straightforward. The seller is paid cash from the buyer. After any loans or other debts are paid, the funds are then made available to the seller. At this point, the seller must pay federal and state taxes on the proceeds, and then the remaining balance is left to invest. This drastically reduces the principle and lowers any future returns. The stock market and other liquid investments carry very significant market risk, and the individual could lose some or all of the money. On the other hand, the individual could place the money into a guaranteed investment such as a certificate of deposit, but the returns will drastically lag other possible alternatives. Investing on your own requires some planning and active management of the portfolio, but more importantly, it may provide for unpredictable future income necessary to manage and care for an investor and his or her family.

Another Approach - The Installment Sale

The Installment Sale is a mechanism that has been available since the 1930's. In this type of transaction, the buyer of a business agrees to pay the seller a certain amount of money over a fixed period of time. Under this approach, the IRS has ruled that only the amount of distribution in any given year is subject to any applicable taxes in proportion to the total due. The problem here had been reliance upon the buyer to continue to make the payments promised. Often times the business is run poorly and is no longer producing enough revenue to make the promised payments. There has always been recourse in these transactions, so that if the buyer did not live up to his obligation, the seller could foreclose and reclaim ownership of the business. However, this offered little protection if the business has not been run properly or the value lowers for other reasons, since the original seller would now reclaim a much less valuable business.

An Improved Approach - The Installment Sale with Guaranteed Annuity Payments

There is a way to ensure that these types of transactions could still be utilized while eliminating the possibility of default. The transaction takes place as described above, only there is a second transaction that occurs simultaneously. At the time of closing, the buyer purchases an annuity from an A+ rated Annuity company. Therefore the seller receives a guarantee that regardless of the future strength of the business, the payments will be made as agreed upon, and all of the tax deferral benefits remain intact.

The benefits of this type of transaction are as follows:

Seller is able to sell the business without future risk

Tax-deferral creates much greater taxable equivalent return

Flexible planning allows for specific plans tailored to individual needs

Stabilizes future income with certainty for life

Much larger total benefit over time - guaranteed

Payments can continue to pass on to heirs in the event of death

Eliminates need for expensive life insurance

Requires no management responsibility

There are no direct or on-going fees

Expedited closing

A simple way to look at this plan is to compare it to an IRA. With the IRA your investments get to grow on a tax deferred basis for many years and you get the benefit of earning investment returns on the amount not paid in tax. When you draw the funds out of the account, you are then taxed at your then current rate. With the guaranteed annuity installment sale, you may elect to take a portion of the business sale proceeds at close and pay all of the appropriate taxes on that portion.

You then could structure the guaranteed annuity to begin paying you a certain amount starting in 5 years for another 20 years. The investment would be allowed to grow tax deferred for that 5-year period. When you started taking distributions, you would be taxed at the rate you would have been from the original sale transaction. The important thing to remember here is that instead of receiving the entire distribution at closing and paying a huge tax bill up front, you are taking 1/20th of the distribution each year and paying 1/20th of the tax. The remaining portion of the deferred tax stays invested and earns income over the 20-year period. This substantially increases your return on the deferred portion of your sale proceeds.

This mechanism is a great way to secure your proceeds with guaranteed payouts, no ongoing involvement or management responsibility, and beneficial tax treatment. This will ensure the highest possible taxable equivalent return when compared to any fixed-income, guaranteed investment. Remember in a business sale the important number is how much you get to keep.

1031 Tax Deferred Exchange - Many Options That Each Provide Many Advantages

One aspect to choosing 1031 Tax Deferred Exchange is that you will confront numerous options from which to make up your mind and yet be sure that whichever option you choose it will help make you a considerable amount of money such as saving on paying capital gains tax at the time of selling your current investment property in order to acquire a fresh one. In fact, it would be to your advantage to, first of all, seek out professional advice before proceeding further with regard to 1031 Tax Deferred Exchange.

List With Real Estate Brokers

Having decided that 1031 Tax Deferred Exchange is what you want, you must then list with a real estate broker all of your existing properties and also ensure that such list includes an agreement that clearly states that you are using your property to complete 1031 Tax Deferred Exchange.

To be sure, if you go in for 1031 Tax Deferred Exchange, you will then be in a good position to roll-over all of the monies you receive when you sell your investment property which monies in turn must be used to purchase one or even several similar (like-kind) investment properties. However, during closing the proceeds must be transferred to a Qualified Intermediary who will keep the proceeds from the sale till such time as these proceeds are to be used to buy new like-kind property.

As mentioned, 1031 Tax Deferred Exchange permits you to also defer your capital gains tax as long as the entire amount of money from the sale of a property is used in purchasing similar (like-kind) investment properties. Thus, this deferment is tantamount to getting an interest-free loan for the entire amount that you would have spent on the cash sale which means that you get to retain more equity which in turn makes it possible for you to obtain properties with still higher values while of course, using 1031 exchange.

However, 1031 Tax Deferred Exchange is only applicable as long as you sell real estate that is investment oriented and it won't hold true if you are selling personal residential property. Also, the properties in question must be similar or more precisely like-kind which means that if you are exchanging real property then the two properties in question must both be real properties. In fact, there is also nothing stopping you from exchanging a single property for many properties or even buying a single property from the proceeds of many properties.

Unique Tax Characteristics of Exchange Traded Funds

Exchange Traded Funds (ETFs) represent a bundle of assets that look a lot like a mutual fund, only they may be traded during the day just like ordinary stocks (mutual fund units may only be redeemed at the end of the day). ETFs have gained a reputation as a low cost, tax efficient alternative to mutual funds. The only problem with this perception is that it may not be accurate. ETFs that invest in currencies or commodities can create bizarre tax ramifications to which the capital gains tax rate rules simply do not apply. This article will address the tax implications of investing in three forms of ETFs: Plain Vanilla (bundles of company stocks), Currency and Commodity ETFs.

Plain Vanilla ETF
A Plain Vanilla ETF gives the investor a tiny piece of various companies that are held in the fund. Like an Index Mutual Fund a Plain Vanilla ETF is a type of investment company which invests its funds in stocks that mirror some particular market index, such as the S&P 500 or the NASDAQ 100. Plain Vanilla ETFs can be grouped into four basic categories: Broad-Based ETFs, Fixed Income ETFs, International ETFs and Sector ETFs. Broad-Based ETFs follow specific indexes styles such as growth indexes, value indexes, small-cap, mid-cap and large- cap indexes. Fixed Income ETFs track indexes for corporate and Treasury bonds. International ETFs track indexes for foreign countries as well as international regions (i.e. Asia). Sector ETFs track indexes for specific industries such as health care.

Currency ETF
Currency ETFs aren't funds at all but, rather, trusts or limited partnerships that pass income and gains through to their investors. Accordingly, each owner of a Currency ETF takes into account his or her pro rata share of the ETF's income, gain, loss, deductions and other items for the calendar year. If you are an investor in a Currency ETF you will receive a K-1 for the year. This K-1 will itemize each specific type of income and expense passed through to you, the investor. The tax treatment of such income or gains depends on the Fund's underlying positions, so you must read the prospectus to understand the tax treatment of such income, expense, gain or loss. Currency ETFs allow you to capitalize on the strength of foreign currencies relative to the U.S. dollar. Whenever a U.S. investor buys a currency ETF, they are automatically short the dollar in the corresponding currency. This type of strategy allows you to hedge against weakness in the dollar. Currency ETFs can be taxed in eight different ways. Currency ETFs can be taxed as long-term capital gains, short-term capital gains, ordinary income, interest income, part capital gains/part ordinary income, phantom interest (interest not received) and phantom ordinary income (mark to market gains for futures contracts). Currency ETFs can create bizarre tax treatment that even your CPU would not understand.

Commodity ETFs
Like Currency ETFs, Commodity ETFs are not funds but, rather, trusts of limited partnerships that pass income and gains through to their investors. Accordingly, each owner of a Commodity ETF takes into account his or her pro rata share of the ETF's income, gain, loss, deductions and other items for the calendar year. If you are an investor in a Currency ETF you will receive a K-1 for the year. This K-1 will itemize each specific type of income and expense passed through to you, the investor. The tax treatment of such income or gains depends on the Fund's underlying positions, so you must read the prospectus to understand the tax treatment of such income, expense, gain or loss. Commodities are tangible assets used to manufacture and produce goods or services. Specific examples of basic commodity categories include agriculture, energy, livestock, metals, timber and textiles. In the agriculture segment, familiar commodities include cotton, coffee, and wheat. In the energy area, examples of commodities include natural gas and crude oil. In a Commodity ETF you are investing in a basket of commodities, which is good as it provides diversification for your commodity investment portfolio. For commodity ETFs that utilize futures contracts 60% of any gains are taxed at the long-term capital gains rate while the remaining 40% of gains are taxed as short term, which are subject to the investor's ordinary income tax rate. A commodity ETF may be subject to phantom income on mark to market gains required to be recognized by the fund. If the ETF actually holds a basket of precious metals for more than a year, such gains are subject to a 28% capital gains tax rate.

What I want you to take away from this article is to tread lightly when investing in Currency or Commodity ETFs. You must thoroughly understand what type of income the ETF investment will generate and what your tax rate will be for the various types of income generated by the ETF. With tax rising you don't want to be surprised on April 15th by the tax effects of your ETF investment.

Australian Taxation - How Long Should Business Records Be Retained?

A case that was recently decided in the Federal Court highlights a problem in relation to the keeping of business records. During the 1988 income year, a unit trust engaged in the purchase of a significant investment. It was not a good investment. Not too long afterwards the investment was worthless and in May 1993 the investment was sold for $1. This resulted in the unit trust incurring a capital loss of nearly $2.5m.

All of the units in the trust were sold from the original owner to a new owner in two tranches. One was in June 1993 and the other was in June 1995.

Capital losses may only be deducted for tax purposes against capital gains. Put another way, capital losses may not be used as a deduction against normal income. Due to this, the capital losses were carried forward by the unit trust until a capital gain was made by the unit trust in 2001.

The Australia Taxation Office ("ATO") raised amended assessments against the ultimate beneficiaries of the trust and would not allow the capital loss of $2.5m to be set off against the capital gain made in 2001. The beneficiaries objected to this and the matter found its way to the Federal Court.

The main argument of the ATO was that the trust had fundamentally changed through some things that happened in 1993. I won't go into the details of that.

However, the ATO also argued that the taxpayers could not prove that the purchase of the investment occurred in 1988 because, among other things, the primary documents that evidence the transaction no longer existed. This was so even though the financial statements of the unit trust showed the acquisition and there was verbal evidence from the people who actually engaged in the transaction. I note that the financial statements were prepared by a reputable firm of Chartered Accountants.

In his testimony before the court, the original owner of the units said that he did not have any of the business records of any of his companies or entities from 21 years ago. I know of few people that would.

So here's the point. Generally, businesses are required to keep their records for a five year period under the Australian taxation law. But when it comes to capital gains tax, you need to keep records of everything that may be relevant to working out whether you have made a capital gain or capital loss. And, according to the ATO publication "Record Keeping For Small Business", "You must keep these records for five years after you sell or otherwise dispose of an asset...". So, you may need to keep the records for a very long time.

You will note in the case I refer to above that the ATO required the taxpayer to produce business records of a transaction that was 21 years old. Further, the disposal of the investment occurred in 1993, so that was 16 years earlier (not five).

The moral of the story is this: if you think that a transaction may have long term significant tax implications, don't (ever?) throw out the primary documents that relate to that transaction. Keeping an electronic (scanned) image is something that you should consider.

Wishing you easier business.

John M. Jeffreys

Tax Tips - Capital Gains Tax

CGT is payable, in full, on the sale of your PPR if it is not in the name of an individual who lives there. So, if the property is held in the name of a company, trust or anyone else, such as your parents, you will not enjoy a CGT exemption.

SALE OF LAND

Assuming a profit on the sale of land is a capital profit, no tax should be payable on the sale because it was purchased before 20th September, 1985. For the profit to be a capital one -

* The land must have been purchased for some purpose other than to subdivide and sell, for example, farming, home or to operate a business,

* If the profit is a capital one and the property is pre CGT (Capital Gains Tax) no tax should be payable on the sale of the divided lots.

Note that buildings are considered separate assets from the land so constructing buildings on the land to sell compromises the claim that the profit is capital in nature.

DEATH

In most circumstances death will not trigger CGT (Capital Gains Tax), but the CGT clock will start ticking on pre 19th September, 1985 assets, so it is important to have these valued at the date of death. Most pre 19th September, 1985 assets will, in the hands of the executor or beneficiary, have a cost base of market value at the date of death. So when sold CGT will be payable on the difference between the market value at the time of death plus improvements, holding costs and selling costs, and the sale price.

The main residence of the deceased will not attract CGT if sold within two years of death. This applies to pre 19th September, 1985 homes even if they weren't the deceased's home at the date of death. This concession may not apply to post 1985 homes.

SWAPPING

If you are considering swapping houses to claim rental deductions make sure you live in the home before swapping. This will allow you to exempt the home from capital gains tax for up to 6 years. You can move out of your main residence and retain your exemption for CGT. Additionally, at the end of the 6 years you can move back in, then move out again and the 6 years start all over again.

Taxes and Rent to Own - Lease Options

There are some interesting and lucrative advantages of using options as both an optionor and optionee of real estate. Generally speaking, option money is not taxable to the optionor until the option is exercised, expires or is abandoned. I.R.C. Section 1234 (subject to "dealer" rules, discussed below). If it expires or is abandoned, it is taxable to the seller as ordinary income at the time it expires or is abandoned.

A personal residence sold under lease/option may still qualify for capital gains exemption. Under the 1997 Tax Reform Act, gains from the sale of a personal residence seller are exempt so long as the gain is less than $250,000 ($500,000 for married couple). So long as the lease was incidental to the sale, court decisions have held that the property would still qualify as a personal residence and not a rental. See, Solaris v. Commissioner, 776 F.2d 1428 (9th Cir 1985).

The lease and option payments made by the tenant are not tax deductible if the property is used as a residence. If tenant purchases the property, his option payments (including monthly rent credits) become part of his tax basis in the property. The tenant's option payments may be deductible as a capital loss if the buyer is an investor. For example if you lease/option a home to live in, consider using your LLC to take the lease/option, then sublease to yourself individually. If you don't exercise the option from your corporation, have the corporation treat the option money it paid as a loss.

Take A Loss On Your Personal Residence

As you may know, you cannot take a loss on your personal residence if you sell it for less than your basis. You can, however, take a capital loss on an investment property.

Move out of your house and lease/option it to a tenant/buyer for a few years. Report it on your Federal income tax return as a rental on schedule "E." You may now be able to take a loss when the tenant exercises his option to purchase.

Make certain that you make this transaction it look legitimate; the IRS is keenly aware that people in down real estate markets try to "fudge" rental agreements to accomplish a loss on their personal residences.

Watch Out For "Dealer" Classification

If you are an active real estate investor, you should be aware of what the IRS calls "dealer status." If you also buy and sell real estate on a regular basis, you may be considered a "dealer" in real estate properties. A dealer is one who buys with the intent of reselling rather than for investment.

There is no magic formula for determining who is an investor and who is a dealer, but the IRS will balance a number of factors, such as the purpose for which the property was purchased, how long the property was held and how many deals the investor did in relation to other income. If you take option consideration on a "dealer" property, you cannot defer taxation of option consideration under Section 1234 of the Code.

IRS Reclassification

Occasionally, but rarely, the IRS will reclassify a lease/option as a disguised sale. This is more common with equipment leases where the lessee makes rental payments for a number of years then has the option to buy at the end of the term for a nominal amount, such as $1.

The IRS looks at the terms of the deal and the circumstances surrounding the deal to determine whether a sale was intended. For example, if the tenant is paying the taxes and insurance, this looks more like a sale. If a substantial part of the payments on the lease are credited towards purchase, this also looks like a sale. If the option price declines each year rather than increases with the market. . . well, you get the idea - it if looks like a duck and it quacks like a duck, it's a duck!

Most of the reported cases wherein the IRS reclassified a lease/option as a sale involved long-term leases. Thus, a lease/option of only a few years with your tenant is not likely to be re-characterized as a sale. That's why we give tenant/buyers 1 year leases so there will not be an issue down the road.

Becoming UK Non-Resident for Capital Gains Tax ('CGT') Purposes

Many people looking to move overseas for tax purposes are concerned with avoiding Capital Gains Tax. In my experience these fall into two broad categories:

Firstly, individuals that own a number of UK investment properties and are looking to sell up. The massive increase in land/property values in the UK results in potentially huge capital gains and this makes the offshore opportunities look very appealing.

Secondly, there are those individuals that own UK shares (often in their own companies) and are looking to sell. This group aren't as large as the above group (as the UK tax reliefs on shares in trading companies are pretty significant anyway) but they form a large minority.

The CGT advantages

The 'holy grail' for these individuals is to avoid paying CGT completely. This is why becoming non UK resident is so appealing - as it can provide for a complete UK CGT exemption. Property owners in particular could be saving anything from 24% - 40% in tax, and on a gain of £1,000,000 this equates to a substantial sum.

How do you achieve it?

In order to qualify for the CGT advantages you need to ensure that you're non UK resident and non UK ordinarily resident for the tax year of disposal.

Note that it's not just a case of abandoning UK residence - you'll also need to lose your UK ordinary residence status. For many emigrants the best way to achieve this is to leave the UK permanently. Permanent in this context though doesn't mean forever, just a period of at least three years.

Providing you can get this confirmed with the Revenue (eg by purchasing a property overseas, selling or long leasing UK property, having close family overseas and limiting UK visits) you should be able to satisfy this. The number of UK visits will be very important and you should keep these to an absolute minimum, particularly in the three years after leaving the UK. In addition ensure you complete the form P85 on your departure and complete any tax return on the basis on non UK residence.

You'll need to watch the timings as most people will need to ensure that they only sell during a tax year of complete non residence and ordinary residence. In other words if you left the UK before 5 April 2008, you would need to ensure that any disposal was after 6 April 2008 to take advantage of the CGT exemption.

When can you return to the UK

If you are selling assets that you owned when you left the UK you'd need to ensure that you were non resident for a period of at least five complete tax years. If you don't the gain will be charged to UK CGT in the tax year that you return here.

It's therefore important for you to keep a track on the years you've been absent as a non resident to avoid the tax charge on your return. As a non resident you also wouldn't usually need to disclose the gain on any UK tax return - unless it becomes chargeable.

What about overseas tax?

You need to avoid the 'jumping out of the frying pan and into the fire' scenario. There are lots of 'low or no CGT' countries and if you're looking to avoid both UK and overseas CGT you'll need to ensure that you obtain residence in such a country. Good examples here are Cyprus, Malta, Andorra, Monaco, Gibraltar, Channel Islands and the Isle of Man. These countries are examined in detail in my other articles to be found here and at http://www.offshoretax.co.uk and http://www.wealthprotectionreport.co.uk

Capital Gains Tax in Spain

The Spanish Parliament passed the law 35/2006 on 28/11/2006. This modified the 2007 regulations and as a result from the 1st of January 2007 a non-resident owner will pay 19% on the profit that is made on the sale of a property in Spain.

As far as a resident owner is concerned, the capital gains tax in Spain has been increased to 19%. The changes on the non-resident tax are due to a ruling from the EEC that the previous rate that was levied at 35% was discriminatory towards the non-resident European Union property owners in Spain, given that the residents were taxed at a lower rate of 15%. The 2 rates have now been made the same. As of January 2010, this new rate of 19% applies to all sellers regardless of whether they are resident or not and even if they are not citizens of the EU.

Up until 01/01/2007 purchasers of property in Spain from owners who were non-resident were required to withhold 5% of the total purchase price, and pay this directly to the tax authorities in Spain, due to the nonresident seller's capital gains tax liability. The new law has reduced the amount of the retention to 3%.

Vendors who are non-resident and buyers who purchase from non-resident owners are required to make this retention and declare it to the tax authorities.

If they fail to do this the tax authorities in Spain are able to put a charge on the property itself.

As a seller you will be required to file the form 212 in respect of the capital gains tax. On this form the non-resident declares his capital gain or loss when he sells his Spanish property. If the tax is lower than the 3% tax then a refund is applied for and if it is more than 3$ then an extra payment needs to be made.

Capital Gains Tax & Your Primary Residence

Capital gains tax is a tax levied on the profit made on the sales of any property sold. The tax is levied on the difference between the amount the asset was sold minus the original cost of the property and the cost of any improvement made on it. It was introduced to South Africa in October 2001.

Who Pays it?

Everybody resident of the country must pay the tax on all property sold irrespective of the property's location i.e. both properties inside and outside South Africa are taxable. Furthermore, non South African residents that have private assets or businesses in the country are liable to be taxed.

The Details

Each year while you are filing the year's income tax return, the capital gains on all the properties sold including your primary residence will be filed as part of the taxable income. The capital gain is calculated by subtracting the base cost of the property in question from the property's sale price. It should be noted that the property's base cost is not just the original price that you paid to get it. It also includes all other costs that you may have incurred on it such as improvement costs, stamp duty, charges paid to your attorney or estate agent etc.

The South African Capital Gains Tax, CGT, has a few additional rules that apply to the administration of the tax. For example, the first 10,000 rand of your capital gain is excluded from your taxable amount if you are considered as an individual for tax purposes by the South African Revenue Service. Your capital gain less the capital loss gives you your total gain. So, any gain made after the first 10,000 is then taxed at 25% for a primary residence only. On the other hand, a tax of 50% of the total gain will be exerted on a property that is not a primary residence These regulations are applied yearly to the income tax return.

Properties Exempted from the Capital Gains Tax

Under the administration of the tax in South Africa, almost all assets are considered taxable. However, a few of them are exempted. An example is a property that is being occupied by the owner. Other conditions need to be met though. For example, the property's worth should not be more than R1, 000,000 and it should not have more than 2 hectares of adjacent land to the residence. Other assets exempted are personal belongings, earnings from gambling, private automobiles, retirement benefits and annuities etc.

How to Calculate Your Assets

The base cost of your property can be computed using two methods. These are the valuation and time apportionment methods. For the valuation method, the property's value as at October 2001 must be known. For the second method, the capital gain on the property is calculated back in time from the time it was initially purchased to the time it was sold. After this, the gain that occurs after October 2001 is then factored out. This second method is a little bit more complicated to understand and compute.

A Tax System That Promotes Prosperity

When you don't ask the right questions, your chances of reaching the right answers are not very good. That is why this year's showdown over tax rates is going to leave businesses burdened with counterproductive taxes, no matter who wins in November.

The only thing we are really debating is how heavy that counterproductive burden will be. This is unfortunate. A more intelligently designed tax system could help build the more productive, forward-looking economy that both parties, and most voters, say they want.

Democrats argue that we must protect "the middle class" from the threat of tax increases, but should allow rates to rise for "the rich." Republicans counter that, among the Democrats' "rich" are small business owners, who would have to cut payrolls if their tax rates went up. But, not to be so easily defeated in the war of semantics, Democrats raise the point that the category Republicans refer to as "small businesses" actually includes many big businesses as well.(1)

This discussion may be politically useful, but it is economically meaningless. Taxes are ultimately borne by human beings, not by some magical entity called "business." Businesses, large and small, are just the way we organize commercial activity.

Right now, our tax system claims a large share of profits that might otherwise be reinvested in businesses, which slows economic growth and hurts employment. Our system places an especially large burden on the profits of publicly traded corporations. It is as though we want to discourage companies from tapping into the public's savings to foster more growth, or to discourage the public from investing in large enterprises. Neither makes any sense.

If we were truly trying to develop a more rational tax system, we would overhaul the way all business profits - and possibly all income - are taxed. We would tax consumption and leave income alone. Or we would tax only spendable income, such as wages, dividends and other profit distributions, and leave reinvested gains (whether from business profits or personal capital gains) untaxed. In either case, the idea would be to grow the country's supply of wealth and limit its consumption of that wealth.

When most people think of "big business," they are thinking of publicly traded corporations, which are owned by shareholders. Corporations are subject to the corporate income tax, which currently has a top rate of 35 percent.

If profits are reinvested in a corporation, the only tax that has to be paid is the corporate income tax. However, if the profits are distributed to shareholders, in the form of dividends, they are taxed again. Before 2003, dividends were taxed in the same way as any other "ordinary" income received by individuals. Since then, however, dividends have been taxed at the lower rate for capital gains. This has substantially decreased the total percentage of profits that go toward taxes.

Suppose a corporation earned $100, either in 2000 or in 2003, and wanted to distribute the money to shareholders. In 2000, the corporation would first pay 35 percent for the corporate income tax, bringing the amount left for dividends to $65. Then the shareholders that received the dividends would have to pay personal income tax, at a maximum rate of around 40 percent. If all the shareholders were in the top income bracket, they would pay a combined total of $26 in taxes on the $65 in dividends. Of the original $100, $61 would have gone to the federal government, before even considering state and local taxes.

In 2003, the corporation would still have to start out by paying the corporate income tax, which remained at 35 percent. But then, instead of paying the ordinary income tax rates, the shareholders would only have to pay the capital gains rate. That year, the maximum capital gains rate was lowered to 15 percent. In the end, $44.75 of the original $100 would go to the federal government.

When Republicans talk about the "small businesses" that would be harmed by higher personal income tax rates, they are not referring to ordinary corporations, like those discussed above, but to non-public companies known as pass-through entities. These include partnerships, S Corporations, and limited liability companies (LLCs).

Pass-through entities are not subject to the corporate income tax. Instead, their owners report the companies' income on their personal tax returns and pay the applicable personal income tax rates. This is why taxes aimed at "the rich" also affect these types of businesses. (Not all privately held corporations are pass-through entities, so some do pay corporate income tax, but these days the tax is paid primarily by publicly traded businesses.)

Suppose Palisades Hudson Financial Group, which is an LLC, earns $100. The owner, in this case me, reports the income. I pay $35 in federal income tax (at the current top individual rate). Since I have already reported the income, there is no further tax, whether I decide to reinvest the money in the business or take a distribution. I can use the profits to put down a security deposit for a new office in another city, or I can withdraw the money to buy a new flat screen TV for myself. Either way, the total federal income tax I pay is 35 percent.

Even though shareholders in corporations can now pay the lower capital gains tax rate on dividends, the total federal income tax that must be paid to get profits to business owners is lower for non-public pass-through companies than for corporations. This explains, in part, why some large but non-publicly-traded companies are organized as pass-through entities rather than public corporations. Several high-profile companies, including Bechtel Group Inc., Kohlberg Kravis Roberts & Co. and PricewaterhouseCoopers, fall into this category. These companies' partners and shareholders would benefit from lower personal tax rates, just as a husband and wife running their own clothing store would.

Pointing to these large pass-through entities, Democrats argue that Republicans' appeals on behalf of small businesses are nothing but a ruse. Republicans, meanwhile, claim that those big-name companies are just a few extreme examples, and that, for the most part, the businesses that would suffer from higher personal income tax rates are small ones. "The bottom line is that Washington Democrats' tax hike would hit 750,000 small businesses across the U.S.," Michael Steel, a spokesman for House Republican leader John Boehner, told The Wall Street Journal.

But economic progress depends on encouraging businesses of all sizes to grow.

Publicly traded companies are the backbone of the financial markets, one of this country's greatest economic strengths. The markets allow businesses to raise capital efficiently and make it possible for individuals, pension funds and investment firms to freely and cheaply buy and sell stakes in companies. This easy flow of money is what propels an economy forward. However, the double taxation that comes with going public, along with considerable regulatory overhead, discourages companies from taking advantage of this opportunity to grow.

It is not hard to imagine a system of taxation that would prompt businesses to reinvest their money: Stop taking away the money companies want to reinvest. For public corporations, this would mean eliminating the corporate income tax and collecting tax only on dividends paid to shareholders. For pass-through companies, it would mean taxing business profits at the point when an owner withdraws them, rather than at the point when they are earned.

An alternative approach would be to drop the income tax altogether and switch to a consumption-based value-added tax. Either way, businesses would have more money to buy new equipment and hire new employees. They would be better able to compete with foreign rivals, many of which are located in countries where corporate income taxes are very low or nonexistent. And it wouldn't matter nearly so much which businesses were considered "small" and which were considered "big," or whether the owners of the small businesses were also "the rich."

The problem is that if government revenue doesn't come from the big bad corporations, it has to come from human beings: those creatures that think about these things and vote, and who can pick up the phone to complain to someone when they feel overtaxed. It's much easier for politicians to pretend that, when they get money from "corporations" and "big business," human beings aren't involved.

As the debate over taxes continues, we're likely to hear a lot more rhetoric, but not much in the way of substantive ideas to make our tax system promote prosperity rather than impede it.

Sources:

(1) The Wall Street Journal: When Big Business Enjoys Being Small

Inside the Inheritance Tax Mess

I think by now most of you have heard that there's no inheritance tax or estate tax this year. So if you're planning on passing away anytime soon, this would be a good year to do it - at least from an estate planning point of view. I'm kidding, of course. But in case you decide to take me seriously, you should know there's even a gotcha buried in this "giveaway" law.

The little gotcha comes in the form of increased capital gains tax. Here's how the gotcha is going to getcha. Last year, if you inherited an asset, your tax basis/cost basis was the value of that asset on the date you inherited the asset. So if you inherited a stock from a relative or parent that they bought 30 years ago for $50,000, even if the stock is now worth $400,000, you would not pay taxes on the $350,000 profit. This is because your stepped up basis was the market value the date you inherited the property. This was true regardless of what the asset was - it could be real estate, stocks, bonds, mutual funds or whatever the case may be.

Well the rules are different this year. Now, when you inherit property or assets (stocks, bonds, mutual funds, real estate) they are not given the stepped up tax basis. Which is going to put a whole lot more people in the position where they'll have to pay capital gains tax.

So it's kind of a good news/bad news scenario. The good news is you don't have the estate tax, while the bad news is you'll possibly have to pay capital gains tax. I say possibly because there are some exemptions or limits - the first $1,300,000 of assets are not subject to this capital gains tax, but anything above that is. There also is a provision for people who are inheriting a small business, and also for surviving spouses.

I'm honestly not sure how this is going to play out the rest of the year - everything that we're reading seems to suggest that at some point this year, Congress is eventually going to get around to fixing the problem. They do recognize that this capital gains situation is a mess, and the consensus is that this year, and if not, definitely next year, the estate tax exemption will be changed.

And what a mess it is. Last year everybody had a $3.5 million exemption, or $7 million for a couple. This year there is no estate tax, regardless of the size of your estate. And then next year it will be a $1 million dollar exemption, or $2 million for a couple, assuming estate planning is properly done. There just doesn't seem to be any logic behind any of this. From what I have heard, when the law is fixed they may make it retroactive to the beginning of this year. Stay tuned for when we know of an actual, definite law that's in place - when there is we will let everyone know about it and the impact it might have on your personal finances.

Copyright (c) 2010 Brian Fricke

Strategies to Avoid Paying Capital Gains Taxes

A successful self directed investor which has made gains during the year should strategically plan against paying capital gains taxes. Understanding the mechanics of the capital gains tax itself is very important. Following is the way capital gains tax is calculated and what my policy is to keep the share that the tax man is supposed to get. 
 
Capital gains is the difference between the book value and the market value at the time you have disposed of an asset. For example, if you paid $10.00 per share and you purchased 1000 shares the book value would be $10,000.00. If the share value increases to $15.00 per share and you sell your 1000 share position, the (market value) or sale price is $15,000.00. Using these values, your capital gain would be the increase in value between the $10,000.00 purchase price and the sale price of $15,000.00 which is $5,000.00. The capital gain tax applies in the following manner, the first half of the gain ($2,500.00) is free of taxation and the capital gain tax is payable on the ($2,500.00) remaining half. The actual amount payable is figured according to your present income bracket for that calendar year.
 
Now this is how I save paying tax on the remaining $2,500.00. I immediately transfer the funds into my retirement savings plan (RSP) and defer the tax until retirement. Now I not only get to keep the full $5,000.00 but I have generated a tax deferral at tax time. I may have even generated a tax refund when filing my income tax return. Depending on how much time the funds remain in my RSP it may multiply over and over again.
 
There are many ways to defer paying capital gains taxes but this is just one of my strategies. Plan ahead and generate a larger RSP portfolio and pay less tax.

A Guide to Tax Efficient Investing

Trying to invest tax efficiently can be frustrating when the playing field keeps changing. With taper relief, it used to be really efficient to have a large AIM portfolio - now it isn't. You used to get capital gains tax rollover through VCTs - now you don't. However, there are still plenty of ways to invest in a tax-efficient way.

The most obvious for any stock market investor is of course the ISA. You can put £7,200 this year, unless you're over 50, in which case you can invest £10,200 - next year, that goes up to £10,200 for everyone. Over time, you can build a fairly significant ISA portfolio.

An ISA will give you several advantages. No CGT. No income tax on dividends (though you still pay 20% through the tax credit which can't be reclaimed). And no need to fill in anything about it on your tax form. While the income tax break isn't significant unless you're paying higher rate tax, the CGT tax break can be very useful. You can take profits on your positions without having to worry about whether you're going to incur CGT. A £100,000 portfolio might only generate £4,000 in dividends a year - but you're much more likely to incur over the £9,200 capital gains tax threshold of profits.

Now you can also gain efficiencies by investing in a SIPP (or indeed any other pension scheme). The tax benefit here is up front - you can claim your contributions as an allowance against your income tax liability. I won't go into it in detail now, but subject to the lifetime and annual limits this can be an efficient way to invest.

VCTs are another useful break. These are investment trusts which invest in smaller companies and comply with various stringent regulations; you can invest up to £200,000 a year (rather a lot more than with an ISA!) and you can get 30% tax relief on that. To get the up-front tax relief you have to subscribe to a new VCT issue. But there are also advantages to buying second-hand shares, since all VCT dividends and capital gains are tax free. So if you have a large enough portfolio to be paying CGT most years and can't shelter all of it in an ISA, if you ask me, VCTs make good sense as an investment.

What's wrong with VCTs? Plenty. They invest in smaller companies so can be high risk. And they are often very illiquid, so really not suitable if you're going to need the money. I don't like to call it 'investment', but for more active investors wanting to make some of their capital gains tax free, spread betting has its attractions. The Inland Revenue says it's not investing, it's gambling - so there is no tax payable on your winnings. If, of course, you have any.

The tax man will inevitably take some of what you earn - and rightly so! But its worth doing your research and using your tax allowances and tax-free savings schemes to the full. That way, you can minimise what you're giving to the government - and do so, I hasten to add, completely legitimately!

1031 Exchange Info Guide 101

A smart tax saving tool that is gaining popularity among the real estate investors by enabling them to defer the entire capital gains tax is 1031 Exchange. Established in 1990 by the Internal Revenue Code Section 1.1031, it gives them an opportunity to defer their capital gain taxes on the sale of a property by re-investing the proceeds into "like kind" of property. However, one needs to have complete knowledge of the terms and conditions that apply for 1031 Exchange, and how it works.

Some very basic things that one should understand about 1031 Exchange are that only business and investment property qualify for the tax deferral under Section 1031. Also, the properties involved in the transactions should be of "like kind". The term "like kind' has often been misinterpreted to mean that if someone is selling an office of 1200 sq. ft. he should invest the money he gets from its sale to buy an office of 1200 sq. ft. only. However, this is not the case and this term has a very broad meaning. It actually encompasses any real estate held for productive use in a business or for investment. For personal property to qualify it must be depreciable and part of the daily operations of a trade or business, for instance automobiles, office equipment and furniture, machinery, computers, billboards, franchise licenses, and the like. 1031 Exchange does not cover cash, stock in trade or other property held primarily for sale, such as, stocks, bonds, notes or other securities or evidences of indebtedness, partnership interests, and certificates of trust or beneficial interests.

The real property to which the rules of 1031 Exchange apply includes raw land, single family homes, hotels, multi-family dwellings, factory and office buildings, shopping centers, farmland, and so on. Also, all the proceeds gained from the sale of a property should be transferred through a qualified intermediary and not by someone who is the beneficiary, so that no one can use this money for his own financial gain. To defer the capital gains tax, the proceeds should be re-invested in like kind of property, which should be of equal or greater value and equity than the exchanged property. Moreover, the time period allowed for the re-investment should be adhered to. After selling the property to be exchanged, a replacement property must be identified within 45 days and the exchange must be completed within 180 days.

Deferring all capital gains taxes is not the only benefit that one gains from 1031 Exchange. It also has some hidden benefits, such as, the provision for re-investing in another property can significantly add to one's assets. Moreover, as the property assets appreciate in value one can easily upgrade to a property of higher value with the additional cash flow. 1031 Exchange also provides the flexibility to exchange the rental properties that have appreciated in value in hot markets and re-invest into lesser-known areas that are expected to appreciate in value and become the next sizzling markets in the approaching years.

Buy and Sell Options to Minimize Taxes

One faces a little difficulty when it comes to planning taxes at the end of the year. But one has to face the fact and the earlier one act the lower will be the tax bill. This proves to be true when one has stocks which have had appreciable gains throughout the year.

In spite of the instability in the stock market some investors make nice gains throughout the year. If the time is good enough to sell a part of the stocks that have been appreciated then it would be beneficial to lock such gains. What one needs to keep in mind is that the market may not persistently be volatile so it is better to make some gains before the market crashes because of uncertainties.

One can buy and sell stock options to minimize taxes. Unfortunately an investor will have to pay capital gain taxes for selling stocks with gains. Larger the capital gains larger will be the capital gains tax, even though capital gains tax is lower than other regular taxes. For example a 10% tax on the $ 10,000 gain would mean paying $1000 in tax.

But one can think of strategies to minimize taxes. If one tries to balance capital gains with capital losses one can ward off taxes. Since there is no limit on the sum of losses this can be used to balance capital gains. For example if you have made $ 10,000 gains and $ 10,000 losses in that particular year. The capital losses will counterbalance the gains and you will not have to report the capital gains made for that year on tax returns.

So the strategy of buying and selling stock options is the best way to minimize taxes. So if you have stock that you wish to sell and make gains keep a track of the losses too that you have made. This way, your capital losses will come in use while counterbalancing capital gains.

So the best way to make up for the losses is by equalizing it against gains. So look out for the stocks that you wish to sell and take the best advantage of taxes. Buying and selling stock options minimize taxes and balance ordinary income. Buying and selling stock options minimize taxes by counterbalancing capital gains. Buying and selling stock options not only minimizes taxes helps to lock the gains in your favor. So assess your portfolio to check whether you would prefer unloading your losses.

Will I Lose The Capital Gains Exclusion If I Gift My Home Through An LLC

Question: Dear Mr. Pancheri, I read your great article "Gifting Real Estate Under the Annual Gift Tax Exclusion." In this article you explain that an LLC can be used to accomplish this. I am considering an LLC as a method to gift my house to my son. I have two questions:

- Is there any change in the basis when membership units are transferred (that is, can I take advantage of the Capital Gains exclusion)?
Question: Dear Mr. Pancheri, I read your great article "Gifting Real Estate Under the Annual Gift Tax E
-Can property taxes continue to be used as an income tax deduction when property is in an LLC?

I appreciate your help. Thanks. E.R.

Answer: Dear E.R. - You ask some very good questions that need to be addressed before you start giving away your home, whether through an LLC or otherwise.

First, let's step back a bit and consider the consequences of selling your home outright to a third party rather than gifting it to your son. Under §121 of the Internal Revenue Code, you can exclude up to $250,000 of gain realized from the sale or exchange of your personal residence if you owned and used the property as your personal residence for at least two years during the five-year period ending on the date of the sale or exchange. This can be an important tax benefit if you meet the requirements and your personal residence has appreciated considerably in value. For example, if you purchased your home for $300,000 and then sold it for $550,000, your gain of $250,000 would normally be subject to a tax of around $37,500. However, under I.R.C. §121, this tax is avoided on the sale of a personal residence.

If you give your house to your son instead of selling it to a third party, the tax consequences are different. By gifting it to your son, you will avoid the capital gains tax. That's because a gift is not a sale or exchange of the property. In that case, your son would step into your shoes and assume your tax basis (i.e., $300,000 from our hypothetical above). If he later sells your home, he would pay a capital gains tax on the difference between the sales price and his $300,000 basis. Of course, if he meets the requirements of I.R.C. §121, he would be able to avoid the capital gains tax on the first $250,000 ($500,000 if he's married) of appreciated value as well.

Now let's consider the estate-tax benefits of gifting your home to your son rather than selling it. Let's assume that your overall estate is currently valued at more than $2 million ($4 million if you're married). In that case, if you simply deeded your home over to your son, you would pay no income taxes or gift taxes on the transfer. However, to eliminate the gift tax, you would have to use a portion of your unified credit against the gift and estate tax.

So, what's the benefit of gifting your home to your son now instead of giving it to him upon your death? By giving it to him now, you avoid the estate tax on the value of the appreciation of your home from the time of the gift to the date of your death. That could be significant in view of rapidly increasing property values. For example, if your home increases in value from $550,000 to $1 million from now until you die, then you will have avoided the estate tax on $450,000 - a tax of approximately $207,000 under current estate tax laws.

But, wouldn't it be better if you could eliminate the estate tax on the entire value of your home - not just the future appreciation? In my article, entitled "Gifting Real Estate Under the Annual Gift Tax Exclusion," I discussed the use of an LLC to do just that, by bringing the entire gift under the annual gift tax exclusion (currently $12,000 per year per recipient). That would not only avoid the estate tax on the appreciation in value, it would also exempt the current value from the estate tax simply because you wouldn't have to use any of your unified credit in the process. In our hypothetical, the net estate tax savings wouldn't be just $207,000 (the tax on the appreciated value), it would be roughly $460,000 (the tax on the $1 million date-of-death value.

The technique is quite simple. In order to give your home away in increments that are valued at less than the annual gift tax exclusion (currently $12,000 per year), you would transfer your home to an LLC in exchange for 100% of the membership units. It's important that you create enough membership units in the LLC so that the value of each unit is somewhat less than the amount of the annual gift tax exclusion. Then you can give your son one membership unit each year without having to pay a gift tax or use any of your unified credit against gift or estate taxes. Over a period of time, your house will be transferred entirely to your son without any gift or estate taxes. Of course, the article also discussed ways to accelerate this whole process by having your spouse elect to join in on the gift, and by making gifts to your son's spouse and/or children.

Now that we've put all this into perspective, let's tackle your specific questions. You asked, first, whether there is any change in the basis when membership units in the LLC are transferred to your son and/or others? Under current income tax laws, if you transfer your home to an LLC in exchange for 100% of the membership units, no gain or loss is recognized. The value of your membership units is assumed to be equal to the value of the property transferred (i.e., your home, in this case), and your tax basis in the membership units is deemed to be equal to your tax basis in your home immediately prior to the transfer. In our hypothetical, the value of your home was assumed to be $550,000 and your tax basis was assumed to be $300,000. Following the transfer, the value of your membership interests in the LLC is assumed to be $550,000 and your tax basis in the membership units is assumed to be $300,000. If you received more than one membership unit in the LLC at the time of the transfer (which you should in order to bring the value of each unit to less than $12,000), then your tax basis in each membership unit would be equal to your basis in the property transferred divided by the number of membership units you received. Assuming you received 47 membership units following the transfer, your tax basis in each unit would be $6,383.

If you then starting gifting membership units to your son, each membership unit that your son received would carry a tax basis equal to your tax basis in that unit (i.e., $6,383 in our hypothetical). If your son later sold one or more of his membership units, then he would incur a capital gains tax on the difference between the sale price and his tax basis of $6,383.

You also asked whether you could take advantage of the Capital Gains exclusion under I.R.C. §121 if you transferred your home to an LLC. The IRS has generally treated single member LLCs as disregarded entities, which means that if you transfer your home to an LLC and take back all the membership units, you'll still be eligible for the capital gains exclusion if the LLC then sells the home.

However, if you transfer one or more membership units to another person (i.e., your son) while the LLC still owns the home, then the LLC will be converted from a disregarded entity to a partnership for tax purposes. In that case, it appears that you will lose the capital gains exclusion if the LLC then sells the home while you still own some of the membership units. In that case, the LLC would have to file a partnership tax return, and the net profits would then be taxed to you and your son in proportion to your membership interests.

Incidentally, any real estate taxes paid by the LLC would be fully deductible for tax purposes. If you're the sole member, then the tax deduction would be claimed on Schedule A of your Form 1040. If you're not the sole member, then the taxes paid would reduce the net profits on the LLC's partnership return, and the resulting taxable gain reportable by you would be reduced accordingly.

While the loss of the Capital Gains exclusion may seem to be a deal breaker, it really shouldn't be. If your estate is large enough to be subject to a federal estate tax, then the estate tax savings will far out weigh any loss of the capital gains tax exclusion. Moreover, if your son owns the house and lives in it for two years, he will be able to use the exclusion himself. In that case, you won't have lost the exclusion, you'll just have shifted it to your son.

Landlord Tax and Property Management Software

'Provision for tax liabilities' is a phrase that sends a shudder through the heart and soul of any businessman and businesswoman and without doubt the thought of calculating capital gains tax liabilities can fill even the hardiest and seasoned commercial landlord with feelings of horror and dread. This is because calculating capital gains tax can be complicated and the rules can change in the United Kingdom from budget to budget. The figures involved can be big and the consequences of getting the calculation wrong can be very costly indeed. As with many aspects of business management today ready access to accurate figures can be the difference between being in control of the business or the business cash flow and tax liabilities being out of control.

Over recent years good software which can calculate capital gains tax liabilities has been introduced onto the market. A good package used wisely and kept updated will put the landlord in control of this vital aspect of the property business. It is a very powerful piece of software kit that will allow complicated tax calculations to be completed in a matter of seconds. All the landlord has to do is enter the data. Before you invest in a product do your research and make sure that you invest in a product that is suitable for your type of property business and which, as well as being up to date, can deal effectively with calculations relating to previous tax years.

A good capital gains tax calculator should have the following features such as;

It should provide ready access to the information that a landlord needs to calculate. It should also have tools to calculate savings or provide some saving guide.

The total amount of capital gain, any tax reliefs and allowances etc should also be mentioned.

Easily comprehensible tool should allow landlord to calculate his tax liabilities.