Entrepreneurs' Relief - Will You Actually Qualify?

Entrepreneurs' Relief was introduced following the abolition of the Capital Gains Tax taper relief scheme in April 2008.

At the time, the government was intent on imposing an 18% flat rate on all capital gains, whether business or non-business assets.

However, after a period of lobbying from business, the government backtracked (or actually listened?) on their original decision.

Quite rightly, business pointed out that the new 18% rate was an 80% increase over the old 10% rate that applied to business assets that had been held for a certain number of years.

Entrepreneurs' Relief was introduced with a 10% flat rate on all qualifying business gains up to £1m. Following the March 2010 budget, the lifetime allowance doubled to £2m (and increased to £5m by George Osborne in the Emergency Budget on June 22, 2010 - the exact implementation date is yet to be announced).

The relief can be claimed any number of times up to the limit and a business disposal can apply to the whole business or only part of it.

In order to qualify for Entrepreneurs' Relief, you must satisfy certain criteria:

the business must meet the definition of a trading company, that is it must not undertake "to a substantial extent activities other than trading activities"
this is referred to as the "20%" test; 20% is a measure of the maximum non-trading activities that can be ignored for the purposes of Entrepreneurs' Relief
the shareholding must be in the individual's "personal company". In other words, you must hold at least 5% of the ordinary share capital (which will entitle you to 5% of the voting rights)
you must be an officer or employee of the company

One possible trap that could lead to an individual losing the relief is if they hold too much cash in the company.

For example, let's say that at the time of winding up/selling the business the value of the company's net assets is £3m. At the time the company ceases to trade, it is holding £750,000. There is one owner holding 100% of the ordinary shares carrying all the voting rights.

Only £120,000 of this amount was earmarked for business purposes. The surplus £630,000 in cash amounts to 21% of the company's net assets, assuming net assets have remained broadly the same.

As this example fails the "20% test", it is likely that the conditions have not been met to qualify for the relief.

The Capital Gains calculation would be (assuming the shares were originally acquired for a nominal amount):

2010/11 gains - £3m

Annual Exemption - £10,100

Taxable Gain - £2,989,900

CGT - £538,182 (18%)

Effective Tax Rate - 17.94%

Net Proceeds - £2,461,818

One Possible Solution

One idea is for the company to contribute to a pension scheme on behalf of the 100% shareholder (the owner).

For example, if the company contributes £100,000 to a pension scheme more than a year before the cessation of trade, the situation looks like:

as long as it receives 28% corporation tax relief on the pension contribution, its net assets will reduce by £72,000 (£100,000 x 28% = £28,000. £100,000 - £28,000 = £72,000)
corporation tax relief is available provided the contributions are made "wholly and exclusively" for the purposes of the business
the effect of the pension contribution is that the company's net assets will reduce by £72,000, to £2,928,000
the result is that the company's level of surplus cash would reduce to £558,000 (£630,000 - £72,000), which is below 20% of its net assets (£558,000 / £2,928,000 x 100% = 19.06%)
as long as this remains the case for at least one year before the date the company ceases trading, Entrepreneurs' Relief will be available

Let's have a look at the calculation now:

2010/11 gains - £2,928,000

Entrepreneurs' Relief (4/9 x £2,928,000) - £1,301,333

Gain after relief - £1,626,667

Annual Exemption - £10,100

Taxable Gain - £1,616,657

CGT - £290,982 (18%)

Effective Tax Rate - 9.94%

Net Proceeds - £2,637,018

For this example, I have assumed that the business owner's relevant income is below £130,000 for the current and previous two tax years. This is to ensure the company is not restricted by the amount of pension it can make for the owner because of the temporary anti-forestalling measures that apply in respect of contributions to pension schemes for high earners.

The Financial Tips Bottom Line

Entrepreneurs' Relief is a valuable benefit that could save you a sizable amount of tax, providing that you qualify. The pension contribution option may be worth considering, however make sure you speak to your professional advisers before taking any action.

ACTION POINT

If you are within a few years of contemplating the sale of your business, speak to your accountant now to ensure that your affairs are structured in such a way that you are likely to qualify in full for Entrepreneurs' Relief.

Federal Income Taxes - Top 10 Things To Like About The Tax Relief Act Of 2010

President Obama just signed into law the Tax Relief Act of 2010. The full name of this legislation is the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. But for purposes of this article, let's just call it the Tax Relief Act.

There are plenty of good things in this bill. Here are some of the highlights:

1. Personal income tax rates will remain the same for the next two years. If this bill had not been passed, individual tax rates would have increased on January 1, 2011 to 15, 28, 31, 36 and 39.6 percent. Instead, they will remain at the levels of 10, 15, 25, 28, 33, and 35 percent for 2011 and 2012.

2. Maximum capital gains tax rates will also remain unchanged for 2011 and 2012. The maximum rate of 15 percent (zero percent for folks in the 10 and 15 percent tax brackets) stays in effect instead of increasing to 20 percent (10 percent for those in the 15 percent bracket).

3. Maximum dividend tax rates also stay the same for the next two years - 15 percent rather than ordinary income tax rates.

4. The child tax credit of $1,000 is extended for the next two years, rather than returning to $500 per qualifying child.

5. The American Opportunity Tax Credit (a credit to offset qualified higher education expenses) remains in effect for 2011 and 2012.

6. Employers can continue to provide tax-free educational assistance to their employees up to $5,250 per year in 2011 and 2012.

7. Several tax breaks that had expired on December 31, 2009 have been extended for 2011 and 2012. These include the teacher's classroom expense deduction, the higher education expense deduction, and the state/local sales tax deduction.

8. The deduction for qualified mortgage insurance premiums has been extended for 2011.

9. The dependent care credit remains as is for the next two years.

10. Social Security taxes have been reduced by 2 percent for 2011. This reduction applies to both employees and the self-employed.

Of course, there's at least one thing to dislike about this bill - all these provisions are temporary. A few exist for only one year (2011). Most of them will expire at the end of 2012, and so in two years, we get to watch Congress and the President have yet another debate on what to do about tax rules that change repeatedly because our politicians created them that way. So enjoy these tax breaks while they last.

Entrepreneurs' Relief - Another Company Formation Advantage

There are many benefits of carrying out a company formation to run your new business. For those businesses with a great idea and the potential to grow their company into a large empire worth millions, there are many things to consider. Capital gains tax is one of them. For any business the future can be an exciting prospect.

You'll put blood, sweat and tears into your business and watch it grow. In the future, you want to make the most of all your efforts, without letting the taxman take a large slice. Luckily, with the current state of the economy, the government has noticed the importance of small business to the financial stability of the Country and as a result are keen to encourage growth. One of the measures they have put in place to do this is Entrepreneurs' Relief.

What is Entrepreneurs' Relief?

The Entrepreneurs' Relief scheme was originally started back in 2008 with the intention of giving some tax relief to SME's with regards to capital gains tax. An individual is given a lifetime limit (previously £1million - now raised to £2million under the new budget) under which they are given relief from capital gains tax.

What is Capital Gains tax?

Tax is charged at a rate of 18% on any capital gain made by an individual in the course of running or disposing of a business. "Capital gain" is defined by HMRC as "...the amount by which the disposal value of a chargeable asset exceeds its acquisition value." In layman's terms this means if when selling an asset you make more money than you actually paid for it, then you will be liable to pay tax on that profit at the current rate (18%).

How does Entrepreneurs' Relief help?

The Entrepreneurs' Relief scheme means that any individual making a capital gain, will not have to pay the full tax rate (18%) but instead will only be required to pay a lesser rate up to their lifetime limit. As long as they satisfy the necessary criteria.

The capital gains and capital losses must be balanced to come up with a net figure. That figure is then subject to relief, calculated thusly:

This 'net gain' is...reduced by 4⁄9 and the reduced figure is chargeable at the rate of Capital Gains Tax - 18% for 2009-10 but at an effective rate of 10%.

To clarify 4/9 is roughly 44%. So if you had a capital gain of £100,000, then you would find 44% of this figure (100,000 x 0.44 = 44,000) and that figure is then taxable at the standard capital gains tax rate, rather than the entire amount. You can see that this is quite beneficial for entrepreneurs as it provides substantial tax relief. With relief, you pay £7,920 tax on a £100,000 gain, without it you would pay £18,000! When you consider that Entrepreneurs Relief is now set to a lifetime limit of £2million you can see the Government are making a substantial subsidy for business people.

What are the qualifying criteria?

There are certain specific qualifying criteria which need to be satisfied in order to benefit from Entrepreneurs' Relief. Firstly the gain must have been made on assets used in/by the business or assets owned by the relevant person but used by the business. The claim must be submitted within a year of the disposal and apply to:

- Disposal of whole business - which the individual owned.
- Ceased business - assets sold 3 years after business ceased trading (?)
- Sale of shares of your personal company*
- Associated disposal - basically disposal from a partnership

*personal company is defined as a company in which a person holds at least 5% of the ordinary share capital (and the voting rights that go with it).

Getting there

If you've got a great idea and can see it being worth a lot in the future, then you'll need to be aware of things like this. Carry out a company formation with a formation agent and make sure you have the most tax efficient company possible. These are the first important steps to making the most of your business idea.

Tax Increase Or Tax Relief: It Is Your Choice

Pondering today's current economy and the likelihood that capital gains and income tax rates will increase next year ignites fear and confusion for countless numbers of Americans. For many taxpayers, the future appears to be downright frightful, resulting in a new wave of terror that strikes their hearts. They may even take an impaired view and see only one result when they read the letters I...R... and S. Have you ever noticed that the words "The" and "IRS" when coupled together spells "THEIRS!"?

The reality, though, is that those who view the current circumstances from this perspective are only victimizing themselves. The trick in maintaining sanity during this time of economic and tax upheaval is to forget about what you cannot control and focus on those things you can. The fact is you can manage your taxes and most likely win out in the end.

Solving Tax Problems and Gaining Greater Benefit

To illustrate, concerns about capital gains and other taxes may be troublesome. You may have owned an apartment building for several years and now would like to sell, relax and enjoy the equity and income benefits your hard work has earned you. Your CPA, however, has reported that you would be obligated to pay substantial capital gains taxes if you sold your property. What do many property owners do when they get this news? Unfortunately, they do nothing, except remind themselves of what their accountant told them: "Nothing can be done but to pay the taxes." Right? WRONG!

Before you list your property for sale, it is important for you to learn what tax planning alternatives are available to meet your specific needs. If you search them out, you will discover that tax law does offer some pretty great solutions. You may, for example, be able to defer the taxes for up to 30 years or eliminate them entirely. If your mortgage to be paid off is greater than what your basis is for the property, you'll learn that the taxes for "debt relief" can be solved. And at close of escrow, you may find that it is possible to enjoy greater income than what you had by owning the property you sold. But you will never know unless you take charge of your circumstances and learn your options. You must become proactive and find out the right solutions for you. Here is what one real estate investor experienced:

Troubled about her real estate portfolio valued at $800,000, this 54-year old lady wanted to sell the properties, replace the income she received from the real estate and reduce her income taxes. She was stunned to learn, however, that, according to her CPA, she would be obligated to pay more than $200,000 in capital gains and other taxes if she sold her properties and little, if anything, could be done to lower her income taxes. Discouraged, she mentioned her concerns to a friend who suggested that she seek a second opinion diagnosis of her circumstances by a qualified tax planning advisor. She did this and was delighted to discover that her financial condition was far different that what her CPA had thought:

1. Rather than paying $200,000 in taxes when she sold her properties, she would pay no taxes at all.

2. Her income would significantly increase above what she was receiving by owning the properties.

3. Instead of paying excessive income taxes, she would receive an immediate refund of taxes that she unknowingly overpaid; and,

4. She discovered other tax-saving opportunities that she could take advantage of about which her CPA was unfamiliar.

How could her CPA be so wrong? As is true of many accountants, he was never trained in the discipline of tax planning. In fact, according to CPAs with whom I have spoken, candidates for the Certified Public Accountant designation are not required to take tax planning courses to earn this title--and most do not bother doing so. Consequently, although they can become very skilled in identifying tax problems, few of these professionals acquire the experience and know how to solve them. They can be viewed as being "financial historians" who take what a client has done after-the-fact, filter that information through the required tax codes and generate, hopefully, an accurate tax return. This is great accounting but it is not tax planning. You are always better served when you meld together the advice of a trained tax planning professional with that of your CPA or accountant.

If you want to find the most appropriate resolution to your tax concerns, it is essential that you first learn what your true tax problem is and then search out the most viable options available to eliminate, defer or reduce the taxes for the year of sale. After you identify potential solutions and understand how each can be tailored to your specific circumstances to meet your objectives, the last step before implementation is to validate them under tax law through independent tax and legal authority. Following this approach will prepare you to be better informed on how best to approach the sale of your property and maximize your profit and income at close of escrow. Once this is done, you can confidently move forward to sell and then enjoy the benefits of the plan you implemented.

Finding effective tax remedies can be more easily achieved by following the advice of an experienced tax planning specialist who will guide you through a simple step-by-step process that works. Your tax-planning advisor facilitates the tax solutions; tax attorneys and your CPA or accountant jointly validate the solution you choose and its structure; and your real estate professional guides the sale of the property. It is a synergistic team effort that is focused on benefiting you in the most effective ways possible.

Whatever the new tax laws might be, we all should prepare ourselves to take full advantage of them. How? By plotting out a common-sense approach to tax planning through which we can:

1. Gain the foresight needed to confidently pay less in personal income taxes; and,

2. Significantly reduce, defer or eliminate the capital gains, depreciation recapture and other potential taxes you would otherwise be obligated to pay when you sell your appreciated real estate or other assets.

Here is the Good News

Taxes can dramatically cut away at any chance for you to successfully meet your financial goals and objectives. It makes no difference how old you are, if you are working or now retired. If you earn enough money or want to sell appreciated assets such as real estate, you will probably be obligated to pay taxes. The good news is you have choices.

We have all learned from childhood that it is prudent to get a second opinion if we are diagnosed with a serious illness. Wouldn't you agree that paying more in taxes than you are legally required is a serious threat to your financial health? If you have appreciated real estate or other assets that you would like to sell but are concerned about paying taxes, doesn't it make sense for you to learn what options are available to you to solve them? If you do, you will find out that you, too, have choices that can help achieve your dreams in spite of a wavering economy and changing tax law.