Moving for Tax Breaks

In recent years, high-tax states began to suspect a tax-dodging trend as more taxpayers changed residences while still maintaining ties to their former home states. As a result, these states have been more aggressive with their residency audits. Increasingly, states are challenging former residents who attempt to change their domicile to another state.

Although the rules vary among states, generally speaking, most states define a “resident” as an individual who is in the state for other than a temporary or transitory purpose. States consider a person’s “domicile” to be the place of his or her permanent home to which he or she intends to return to whenever absent from the state for a period of time. Most claim the right to tax an individual’s income if they are believed to be a resident and domiciled in that state.

  • Location of employment
  • Location of business relationships and transactions
  • Serving on the board of directors for a business or charity
  • Residence—whether a person’s former residence was sold, rented, or retained, and whether he or she rented or purchased real property in the new state
  • The amount of time spent in the state versus amount of time spent outside the state (183-day rule)
  • Where the taxpayer is registered to vote
  • Location of the school a family’s child attends
  • Memberships in country clubs and social organizations
  • Where charges are incurred, location of bank accounts, investments, and ATM withdrawals
  • Freeway fast-lane pass charges
  • Records of airline frequent-flier miles
  • Jurisdiction issuing a driver’s license, vehicle registration, professional license, or union membership
  • Church attendance and membership
  • Location of doctors, dentists, accountants, and attorneys
  • Official mailing address and where mail is received

Each state also has specific rules that can trigger audits. Three major red flags are 1.) a significant increase in taxable income in the year of residency change; 2.) a spouse with a different state of residency; and 3.) filing a resident state return in the first year after a move and then filing a non-resident state return the next year.

Taxpayers have the burden of proving which states they spend time in during the year. If you live elsewhere but travel on a regular and frequent basis to another state, it is a good idea to maintain a diary that clearly indicates the dates you are in a specific state, accompanied by supporting records such as transportation tickets and receipts.

Just as establishing as many ties as possible to the new state can be helpful when a change of domicile is desired, it’s also helpful to try and sever ties to the old domicile. When domicile challenges arise, they almost always revolve around the old state being unwilling to give up its status as “domicile,” rather than an issue of the new state refusing to accept that status.

Unfortunately, there’s no single bright-line test that can be used to “prove” a change in domicile, because it’s based on a determination of “intent” that simply isn’t always clear. But the good news is that there is a long list of “dos” and “don’ts” that individuals can follow to help give themselves the best opportunity at proving a bona fide change that can result in lower income taxes, lower real estate taxes, enhanced creditor protection, and other valuable benefits.

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

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Pre-Transaction Considerations

In any industry, preparing for a liquidity event requires a great deal of strategic vision and technical expertise. The earlier you start mapping out your vision for what you want to achieve financially and understanding your resources, the more flexibility and leverage you have in shaping the outcome. For those that are in the pre-transaction phase, or have secured first or second round funding, there are specific items to consider:

 

Work Optional Lifestyle

Determine your “numbers” and think about where you want your wealth to go: work to articulate your desired lifestyle post-liquidity event and then determine the amount of wealth needed to achieve that vision. Whatever your goals— retiring early, buying a vacation home, spending more time traveling, or funding your children’s college education— you need to quantify the cost of those goals and then determine the present value of the assets needed to fund this lifestyle. Essentially, all of your wealth will end up in one of four buckets: funding your lifestyle, transferring wealth to your children and other loved ones, supporting charities or paying taxes.

 

What if Scenarios

Test your assumptions (scenario planning): perhaps the biggest variable in planning for a liquidity event is the valuation of your equity. To help you understand the range of potential outcomes, we recommend that you have your advisors run calculations to show how much after-tax wealth you would receive under best-case, base-case, and worst-case valuations.

 

Compensation Packages

Understand your executive compensation package: technology entrepreneurs and executives often receive multiple forms of compensation, including traditional equity, stock options, restricted stock, employee stock purchase plans, deferred compensation, and life insurance. Each of these forms of compensation has a unique set of tax consequences, downside risk and upside potential when it comes to generating liquidity.

 

Gifting

Take advantage of valuation discounts: one of the most powerful pre-transaction planning strategies has to do with the fact that your equity likely will have a lower valuation before the transaction than the valuation used for the transaction. By transferring equity to children or other loved ones before the transaction valuation has been determined, the subsequent appreciation occurs outside of your estate, increasing the amount that you can transfer to loved ones without incurring estate tax. Many business owners choose to make these transfers through a grantor retained annuity trust (GRAT). Transferring shares to take advantage of the valuation discount, however, isn’t without risk. If the transaction valuation ends up being higher than you anticipated, then you may end up transferring more wealth than you intended. Conversely, if the transaction valuation ends up being significantly lower than you anticipated, this may mean that you didn’t retain enough wealth to fund your lifestyle goals.

 

Health Coverage

When selling a business or going through a certain liquidity event, you may lose health insurance coverage. Finding coverage on your own can be stressful, but there are considerations to be aware of such as where to find a plan, what to look for in a plan and costs and coverage associated with each plan. For a good summary of considerations, you can read our health care whitepaper here.

 

 

Important Disclaimer:

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

10b5-1 Planning for Corporate Executives

Along with running a successful company and answering to shareholders, corporate executives of public companies have something else to worry about — their significant equity positions in their own companies, and generally complex compensation packages. Used properly, a 10b5-1 plan is a tool that can help executives strategically plan and execute concentrated equity position sales.

 

What It Is and Why You Need It

Rule 10b5-1 was established by the Securities Exchange Commission (SEC) for insiders of publicly traded corporations to sell their stock at predetermined dates and prices. If properly designed and implemented, a 10b5-1 trading plan can provide a corporate executive with an affirmative defense against insider trading as well as an opportunity to sell their stock during periods they would normally be restricted (blackout periods). These plans, available from the custodian where the stock is housed, can provide a great way for executives to diversify their holdings in a flexible manner consistent with their financial objectives.

Though 10b5-1 plans are flexible for the executive — they can be cancelled at any time — the plans can only be initiated while the executive is in an open window and is not in possession of non-public, i.e. inside, information. The plans must specify the amount, prices, and date of the shares to be sold.

 

Important Plan Elements

There are important elements and dates that need to be outlined in a plan:

  • Plans should be in place at least one year after adoption date and should not exceed two years. These plans can be cancelled at any time but canceling and replacing a plan should be avoided if possible.
  • The adoption date is the date the executive and the issuer sign the plan. New 10b5-1 plans need to be adopted while the executive is in an open window and is not in possession of nonpublic information.
  • The effective date is the date the first trade is initiated.
  • The termination date is typically no longer than 2 years from the adoption date. Insider trading restrictions set forth by both the SEC and individual companies have become more stringent and arduous for executives that receive a significant portion of their compensation in the form of restricted stock or stock options.

 

Trends

We’ve noticed the following trends that savvy companies and executives institute:

  • Cooling periods mandate a length of time during which trading is prohibited after a plan is adopted. Plans typically have a cooling period between the adoption date and the effective date. A normal cooling period is 30-90 days for a new plan. If an executive is cancelling and replacing a plan, this generally involves waiting at least 90 days from the date of cancellation, and generally involves a new cooling period after adoption. This could lead to 6 months of blocked trading.
  • Although executives can sell in an open window, it is preferable to only use the 10b5-1 plan for officers and directors to sell stock. It should also be the exclusive defense against insider trading.
  • Some companies establish plans concurrent with their initial public offering (IPO), when all information is publicly disclosed. This provides the executive with extra protection against insider trading because the cooling period needs to exceed the underwriter lock up (greater than 6 months). The longer the cooling period, the less likely it is for shareholders to make the claim that an executive has acted on inside information

Establishing a plan concurrent with an IPO is particularly important for companies with constantly evolving non-public information, such as certain life science companies involved in drug trials. In situations like this, executives might have limited windows for selling stock absent of a 10b5-1 plan.

It is important to ensure that the brokerage account registration that the stock will go into matches the title stock being sold. For instance, individual accounts need to be established for shares resulting from RSUs and options because they are in individual form when issued. This also ensures that the form 4 and 144 will match.

Because of more rigid insider trading policies, 10b5-1 plans have become a common practice for corporate executives who work with an advisory firm. 10b5-1 planning, under the umbrella of financial planning, has emerged as a way to help executives be more strategic in their planning, protect themselves against insider trading and diversify their wealth. Since the plans can be complex, most executives receive guidance from the investment advisory firm with which they work.

 

Important Disclaimers

This blog is powered by Callan Capital, LLC. The information contained in this blog is provided for general informational purposes, and should not be construed as investment advice. Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Callan Capital, LLC endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.

Callan Capital, LLC may from time to time publish content in this blog and/or on this site that has been created by affiliated or unaffiliated contributors. These contributors may include Callan Capital, LLC employees, other financial advisors, third-party authors, or other parties. Unless otherwise noted, the content of such posts does not necessarily represent the actual views or opinions of Callan Capital, LLC or any of its officers, directors, or employees. The opinions expressed by guest bloggers and/or blog interviewees are strictly their own and do not necessarily represent those of Callan Capital, LLC.

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors.  For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

Year End Planning

As 2018 comes to a close, we are actively discussing the following year end planning items with our clients. Year-end tax planning must take into account each taxpayer’s unique situation and goals. Please consult with your tax adviser to devise a tax-saving plan that most effectively meets your needs and takes into account the latest tax rules.

Required Minimum Distributions (RMDs)

For those over 70 ½, you are required to take a required minimum distribution from your retirement account. If you are a client of Callan Capital, we are processing your distribution and it will be complete in early November. If you would like to take your distribution before November, please let us know.

Charitable Strategies

Donating to charity can be a fantastic tax-savings strategy since you are in control of when and how much you give.  Consider a charitable IRA rollover, which allows clients over 70 ½ to donate up to $100,000 per year to a charity directly from their IRA and avoid paying taxes on the distribution. The charity benefits from the donation and the individual satisfies their RMD.

Clients who would like to donate to charity and expect to be in a lower tax bracket next year may want to consider contributing future charitable gifts through a Donor Advised Fund (DAF). A DAF is a philanthropic vehicle established for donors who want to make a charitable contribution and receive an immediate tax benefit. A donor contributes to the fund as frequently as they want and then grants to their charity of choice when they are ready.

Gifting to Non-Charitable Entities

The IRS allows each person to give $15,000 to each non-charitable beneficiary such as non-spouse family members every year.  This annual limit does not accrue into future years if it’s not utilized.  In addition to the annual exclusion, individuals can give up to $11.18 million (married couples can give $22.36 million) over a lifetime before owing gift taxes.  For gifts to 529 plans, the IRS allows 5 years of annual gifting to be accelerated for a total of $75,000 upfront ($150,000 for a married couple).

 

Disclaimer: Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. For more information, please refer to our most recent Form ADV Part 2A which may be found at www.adviserinfo.sec.gov.

The tax information provided in this document is for general informational purposes only—it is not meant to be used, and cannot be used, by individuals to avoid federal, state or local tax penalties. Taxation varies depending on an individual’s circumstances, tax status and transaction type; the general information provided in this guide does not cover every situation—for complete information on your personal tax situation, you should always consult with a qualified tax advisor.

Tools for Finding a Health Insurance Plan – For You and Your Family

If you have lost health insurance coverage due to early retirement, selling your business or because of a change in family circumstances, finding coverage on your own can be stressful. There are many considerations when looking for a health care plan—this guide will help you navigate through the health care marketplace and help you find the best plan for your needs.

When to Look for a Plan

First, it’s important to note that unless you qualify for a Special Enrollment period, you will have to sign up during the Open Enrollment Period each year. Most states have open enrollment from November 15th through December 15th, the year before coverage begins. You may be eligible to enroll during a Special Enrollment Period if you lost coverage due to leaving your employer, selling your business, divorce, moving to a new area or other major changes in circumstances. Generally, you have 60 days from the date of the qualifying event to choose a new plan. If you miss this window, you may have to wait until open enrollment at the end of the year.

Where to Find a Plan

Anyone can find a health care plan on the Healthcare Marketplace at https://www.healthcare.gov/. Each state has their own marketplace established under the Affordable Care Act (ACA). People with lower incomes may be eligible for a subsidy for marketplace plans, but plans are available to anyone at full price. The marketplace allows you to compare and contrast available plans in your area side-by-side. You may also buy a policy through an individual provider or health care broker, however, these plans may not meet the minimum requirements of the ACA.

Different Types of Plans

When choosing a plan, it’s important to know how different types of plans are defined. There are four major types of health insurance plans—HMO, PPO, EPO and POS. HMOs and POS plans require you to choose a Primary Care Physician that is in that health care plan’s network of providers. You are generally required to obtain a referral from that Primary Care Physician before you can see a specialist. Many people want the freedom to see a specialist without first having to see their primary physician, but these plans tend to have lower costs overall. The main difference between a HMO and a POS plan is that a POS plan allows you to see doctors who are out-of-network at an additional cost, whereas an HMO requires you to stay in-network, except in the case of emergency care. A PPO and an EPO are similar in that you do not need to have a referral to see a specialist, you can see a specialist directly. These plans are typically more expensive than an HMO or POS plan. An EPO requires you stay in-network, except for emergency care, whereas a PPO will allow you to see providers out of your network at an additional cost.

Costs Associated with Each Plan

When comparing plans, look for a Summary of Benefits. The summary of benefits will display the various costs and coverages associated with each plan. Your health care costs will consist of several parts—your premium, deductible, copayments, coinsurance and out-of-pocket costs.

Your premium is the amount you pay every month to have the insurance plan.

Your deductible is the amount you must pay for your own health care before your health insurance will begin to pay towards your health care costs. Some plans have a $0 deductible and kick in immediately. Other plans have a high deductible, such as $4,000, where you would have to spend $4,000 towards your health care before your insurance will pay. The deducible resets every year.

Your copayment is a flat charge you have to pay for different types of services you use. For example, you may have to pay $45 every time you see your doctor.

Your coinsurance is usually a percentage of larger health care services that you share with your insurance. If you have a knee surgery and your coinsurance is 30%, you pay 30% of the total cost of that health care service and your health insurance pays the other 70%.

Your out-of-pocket expense is the amount you pay towards your health care that is covered under your insurance but that your insurance does not pay for (not including premiums). Many plans have an Out-of-Pocket Maximum, where they cap the amount you would have to pay each year out of your own pocket.

Here’s an example of how all these costs work together:

Let’s say you need shoulder surgery on January 1 that costs of $40,000. You have a plan with the following benefits:

Deductible: $2,000

Coinsurance: 20%

Out-of-pocket maximum: $5,000

First you need to meet your annual deductible. You pay the first $2,000 of covered medical expenses (your deductible). Next, your coinsurance of 20% on the rest of the costs ($38,000) comes to $7,600.

Your total costs would be $9,600 (deductible plus coinsurance). But, you have an out-of-pocket maximum of $5,000. Your insurance company pays all covered costs above $5,000 — for this surgery and any covered care you get for the rest of the plan year. You end up paying $5,000 for this surgery (maxing out your out-of-pocket expenses and paying your deductible for the year) and your insurance pays the remaining $35,000.

In-Network and Out-of-Network

If you choose a plan like a PPO or a POS, that allows you to go “out-of-network”, there are a few more points to consider. Providers that are “in-network” are providers that accept your insurance’s negotiated rate for services, so your costs are predictable. When you go “out-of-network” to see a provider, that provider does not have negotiated rates with your insurance plan, and most often, will charge more than in-network providers. You will end up paying any amount that doctor charges above what your insurance covers. If you choose a plan that does not cover out-of-network providers such as an HMO or EPO, you pay for 100% of any out-of-network charges.

If you have a doctor you would like to keep working with, find out if he or she is in-network with the plans you are considering. Don’t take the word of the insurance company, providers change what insurance plans they work with and your insurance may not have the most up-to-date information. Instead, call your doctor and ask: “Will you accept this plan next year?”

Important Reminders

Plan costs and plan coverage have an inverse relationship. Plans with higher costs generally cover more and plans with lower costs will cover less. However, just like car insurance, if you don’t make a lot of claims on your insurance, choosing a plan with higher deductibles and lower premiums can make sense.

A plan that pays more of your medical costs, but has higher monthly premiums, is better if:

  • You see a doctor frequently
  • You often need emergency care
  • You have expensive prescriptions
  • You plan to have a baby or you have small children

A plan with high out-of-pocket costs and low monthly premiums, is better if:

  • You can’t afford the higher monthly premiums for a plan with lower out-of-pocket costs
  • You are in good health and rarely see a doctor

Make sure you shop around and compare plans. When choosing a plan, you should look at the whole plan: the type of plan, the deductibles, coinsurance, out-of-pocket maximums, which doctors are in-network and the plan premiums.

 

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

Tuning out the Noise

For investors, it’s easy to feel overwhelmed by the unrelenting stream of news about markets. News headlines that are presented as impactful to your financial well-being can evoke strong emotional responses from even the most experienced investors. Headlines from the “lost decade” (the stock market years of 1999-2009) can help illustrate several periods that may have led market participants to question their approach.

  • May 1999: Dow Jones Industrial Average Closes Above 11,000 for the First Time
  • March 2000: Nasdaq Stock Exchange Index Reaches an All-Time High of 5,048
  • April 2000: In Less Than a Month, Nearly a Trillion Dollars of Stock Value Evaporates
  • October 2002: Nasdaq Hits a Bear-Market Low of 1,114
  • September 2005: Home Prices Post Record Gains
  • September 2008: Lehman Files for Bankruptcy, Merrill Is Sold

While these events are now a decade or more behind us, they can still serve as an important reminder for investors today. For many, feelings of elation or despair can accompany headlines like these. We should remember that markets can be volatile and recognize that, in the moment, doing nothing may feel paralyzing. Throughout these ups and downs, however, if one had hypothetically invested $1,000,000 in US stocks in May 1999 and stayed invested, that investment would be worth approximately $2,800,000 today.[1]

When faced with short-term noise, it is easy to lose sight of the potential long-term benefits of staying invested. While no one has a crystal ball, including financial advisors, adopting a long-term perspective can help change how investors view market volatility and help them look beyond the headlines.

The Value of a Trusted Advisor

Part of being able to avoid giving in to emotion during periods of uncertainty is having an appropriate asset allocation that is aligned with an investor’s willingness and ability to bear risk. It also helps to remember that if returns were guaranteed, you would not expect to earn a premium. Creating a portfolio that investors are comfortable with, understanding that uncertainty is a part of investing and sticking to a plan may ultimately lead to a better investment experience.

However, as with many aspects of life, we can all benefit from assistance in reaching our goals. The best athletes in the world work closely with a coach to increase their odds of winning, and many successful professionals rely on the support of a mentor or career coach to help them manage the obstacles that arise during a career. Why? They understand that the wisdom of an experienced professional, combined with the discipline to forge ahead during challenging times, can keep them on the right track. The right financial advisor can play this vital role for an investor. A financial advisor can provide the expertise, perspective, and encouragement to keep you focused on your destination and in your seat when it matters most. Having a strong relationship with an advisor can help you be better prepared to live your life through the ups and downs of the market. That’s the value of discipline, perspective, and calm.

 

 Important Disclaimers

Past performance does not guarantee future results. Diversification does not guarantee investment returns and does not eliminate the risk of loss.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

For more information regarding Callan Capital, please refer to our most recent Form ADV Part 2A which may be found at adviserinfo.sec.gov.

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities-based financing, residential and commercial financing and cash management services.

The views expressed are those of Callan Capital, LLC. They are subject to change at any time. This thought piece expresses the views of Callan Capital as of August 2018 and such views are subject to change without notice.

The Standard & Poor’s 500 Index – S&P 500 is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value. The S&P 500 is a market value or market-capitalization-weighted index and one of the most common benchmarks for the broader U.S. equity markets. Other common U.S. stock market benchmarks include the Dow Jones Industrial Average or Dow 30 and the Russell 2000 Index, which represents the small-cap index.

Nasdaq is a global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks. Nasdaq was created by the National Association of Securities Dealers (NASD) to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971. The term “Nasdaq” is also used to refer to the Nasdaq Composite, an index of more than 3,000 stocks listed on the Nasdaq exchange that includes the world’s foremost technology and biotech giants such as Apple, Google, Microsoft, Oracle, Amazon, Intel and Amgen.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq. The DJIA was invented by Charles Dow in 1896.

[1]. As measured by the S&P 500 Index, May 1999–March 2018. A hypothetical dollar invested on May 1, 1999, and tracking the S&P 500 Index, would have grown to $2.84 on March 31, 2018. However, performance of a hypothetical investment does not reflect transaction costs, taxes, or returns that any investor actually attained and may not reflect the true costs, including management fees, of an actual portfolio. Changes in any assumption may have a material impact on the hypothetical returns presented. It is not possible to invest directly in an index.

Why You (Still) Need an Estate Plan

Estate Planning Changes

In 2018, the current administration signed a new tax legislation into law, which includes a higher estate, gift and generation-skipping transfer tax exemption of $11.18 million per individual. These new lifetime exclusion amounts might make some married couples, who have a taxable estate lower than $22.36 million, question whether they still need an estate plan.

First, let’s discuss what has changed for 2018. In 2017, the Federal Estate Tax Exemption amount was $5.49 million for an individual or $10.98 million for a married couple. This means a married couple could leave their children a $10.98 million-dollar estate without paying a federal estate tax on that amount. However, if the second spouse to die passes away with an estate in excess of $10.98 million, that estate would be subject to a 40% estate tax on every dollar over $10.98 million dollars (CA & TX do not have state level estate or inheritance taxes but some states have one or both). The new Tax Cuts and Jobs Act that came into effect this year increased the Federal Estate Tax Exemption to $11.18 million for an individual and $22.36 million for a married couple. With this massive increase in the federal exemption amount, very few married couples would need to pay a federal estate tax upon the death of the second spouse. All of that said, there are significant non-tax reasons for married couples to have an estate plan.

 

Not only About Taxes

Aside from helping minimize the 40% estate tax on estates over $22.36 million dollars, an estate plan can accomplish many other goals, such as avoiding a public (estate appraisal and inventory), lengthy (six months to two years) and expensive (probate fees averaging 5% of the total estate value) probate process in states like California. Even in Texas where the probate process is private (affidavit may be filed in lieu of an inventory), efficient (six months to one year) and inexpensive (attorney fees and nominal court costs), there simply remains no better form of asset protection than an irrevocable trust. Most estate plans are written so that upon the death of the second spouse, the family’s assets will be held in an irrevocable (i.e. can no longer be modified or terminated) trust for the benefit of children (and/or other beneficiaries), thereby insulating the trust assets from the reach of creditors and possible future divorcing spouses. Tax savings, control over asset destination and the opportunity for charitable giving all result in peace of mind.

Depending on a family’s net worth, certain estate planning techniques may be more or less relevant than they were before the new tax law changes. Many affluent families implemented a Credit Shelter Trust (also known as an A/B Trust) to take advantage of the then current estate tax laws. In 2011, portability was enacted which allows the surviving spouse to use any remaining portion of the deceased spouse’s Federal Estate Tax Exemption for their own estate. For many couples, this negated the need for the traditional A/B Trust, but for affluent families, the A/B Trust remained a good planning tool to freeze future asset appreciation out of the surviving spouse’s estate. With the recent tax law changes, it is critical that you and your family evaluate your current estate plan to ensure it is still meeting your needs. Traditional Credit Shelter Trusts were very valuable when the estate tax exemption was much lower. The original intention of this trust was to allow couples to reduce their estate tax burden by creating and funding an irrevocable trust upon the first spouse’s passing. Generally, this irrevocable trust was funded with the estate tax limit for the year in which the first spouse passes. This allowed for the deceased spouse’s estate to take advantage of the full exclusion amount and for that amount to grow outside of the surviving spouse’s estate.

Credit Shelter trusts, however, are not without disadvantages. Primarily, the amount placed into the irrevocable credit shelter trust do not receive a second step up in basis when the surviving spouse passes away. Also, in a Credit Shelter Trust, the surviving spouse might receive income from trust but not have direct access to the principal (which is why the trust was not included in his/her estate). Since this trust is not included in his/her estate, the value of that trust is not eligible for a step-up when that surviving spouse passes away (this is the trade-off). Furthermore, these types of trusts can contain provisions that make funding mandatory. Therefore, under the new tax laws, this irrevocable trust could end up being funded unnecessarily since the exclusion amount is now double what it was when the estate plan was originally written. This could limit the surviving spouse’s access to funds needlessly while creating the extra burden of managing an irrevocable trust.

A Disclaimer Trust may be an alternative worth considering in this new estate tax environment. This trust allows the surviving spouse to elect to create and fund a credit shelter trust upon the first spouse’s passing, but does not make it mandatory. The major downside associated with a Disclaimer Trust is that the surviving spouse must affirmatively elect to create the Credit Shelter Trust within a 9-month window. If they fail to do so, a potential tax planning opportunity may be missed. Furthermore, a Disclaimer Trust puts the control in the surviving spouse’s hands, which means this might not be a good alternative for guaranteeing that assets pass to children from a prior marriage. This underlines the point that estate planning is often driven by a myriad of non-estate tax reasons such as probate avoidance, incapacity protection, providing for the next generation in an asset protection structure and keeping the surviving spouse from giving the decedent’s share to a new spouse or someone besides who the decedent intended.

Estate planning is influenced by constantly changing legislation, which means it is important for individuals and families to review their estate plans on a regular basis. Even the most recent tax law changes are already scheduled to change, with the new tax law sunsetting at the end of 2025. In 2026, the estate tax will revert to its previous exemption base amount of $5 million, indexed for inflation annually. Therefore, even if you do not require complex estate planning today due to the unlimited marital deduction, portability (the which allows the surviving spouse to transfer the unused exemption of a deceased spouse to themselves) and the $22.36 million in total exemptions for a married couple, it does not mean you will not require it in the future. For families with significant assets, you should consider the opportunity to utilize the current exemption in order to remove assets from your estate today as well as the $15,000 annual gift tax exclusion and various income tax planning opportunities under the new tax laws.

Again, proper and regular estate planning is not only about estate taxes. It can accomplish many other goals such as avoiding probate, giving you control of where your assets go after you pass, creating privacy for you and your family, divorce protection and increasing your peace of mind. Even if your taxable estate is not over the new threshold, it’s an important time to revisit your estate plan with your trusted advisors and make sure that it still accomplishes your family’s unique goals.

Disclaimer:
Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

Planning for Education Expenses

Expenses, tuition hikes and the rising cost of an education are commonly heard phrases when planning for education expenses. Planning and saving can be daunting, since education related expenses are rising faster than inflation and other non-education related expenses. The 10-year historical inflation rate for education related costs is approximately 5%1, while the 10-year average rate of inflation for non-education related expenses is much lower. To avoid a feeling of helplessness when it comes to such a critical stage of your child’s life, pre-planning is key. What is the best way to save for your child?

  • Early – start now, your money needs time to grow. As your investments appreciate, they will compound, which means your appreciation will appreciate too.
  • Set aside a consist amount of money that you want to save for your child on an annual or monthly basis. For example, if you decide on $6,000 per year, you can do this all at once, or save $500 per month. The key is to choose a method that works for you and that you can stick with.
  • Tax-free. 529 plans and Coverdell ESA accounts are wonderful ways to save for your children and allow you to take the money out free of taxes, as long as it’s used for qualified education costs.

529 Plans

Over the past few years, 529 plans have become the premier method of saving for college. The plans allow for tax-free growth, significant contribution limits and do not impose income limitations. Additionally, with the recent change in tax legislation, 529 funds are now eligible to be used federally tax free for up to $10,000 a year per child in qualified tuition expenses for K-12 education.

These plans are now the gold standard for college savings. They allow a much larger contribution amount than a Coverdell ESA (discussed below). The aggregate plan limit depends upon the state plan you choose but ranges from $235,000-$520,000. There are no age restrictions and some states offer additional tax incentives. Like Coverdell ESAs, if the funds are used for qualified education expenses, they will come out of the account tax-free. Unlike Coverdell ESAs, 529 plans do not have modified adjusted gross income limitations in order to participate. In addition, the fees/expenses and investment choices are reasonable in most cases.

There are 2 types of 529 plans – prepaid tuition plans and college savings plans. Prepaid tuition plans lock in the tuition at the state plan’s state school, allowing you to pay for future years of college at today’s costs. Since the inflation rate of education expenses is so high, this is essentially matching your investment rate of return with the rate of inflation for education expenses. Not all states offer prepaid tuition plans and most have residency requirements. The drawback to this type of plan is that your child is limited to colleges included in that specific plan, however, the funds can usually be transferred or refunded in case your child chooses a different school but fees may apply.

College savings plans, on the other hand, do not lock in the tuition but give the beneficiary the option to use the funds at any institution. In a 529 college savings plan, contributions are allocated to specific investments selected by the account owner. The accounts value then depends upon the growth of the investments held in the account.  Typically, these plans only allow the plan beneficiary to change investment allocation twice a year. However, age-based allocations have become popular. They become increasingly more conservative as the child reaches college age. This type of allocation avoids the need to make ongoing investment modifications.

529 Plan Quick Facts

Contribution Limits:

  • Contributions of up to $15,000 per year may be made to a 529 college savings plan by an individual without triggering the need to file a gift tax return. This amount matches the annual gift tax exclusion for 2018, which is indexed periodically for inflation.
  • Contributors may choose to make accelerated gifts lumping 5 years of gifts into one year (under IRC Section 529(c)(2)(B)), allowing a contribution of up to $75,000 per individual to a 529 plan beneficiary in a single year, prohibiting additional gifts to the account over the next 5 years.

Qualified Expenses:

  • Contributions may be withdrawn tax-free when used for qualified higher education expenses, including tuition, room and board, fees, books, supplies, and equipment, including computers. Contributions up to $10,000 per child per year may also be withdrawn federally tax-free when used for K-12 tuition payments. Certain states may still charge tax on distributions used for K-12 tuition expenses.

State Tax Benefits:

  • Some states offer resident participants of their plan an incentive to choose their plan by giving a state tax deduction for a portion of the contribution amount (up to a set limit). Please note that this only applies to in-state participants, and California does not offer such incentive tax benefit.

Maximum Age:

  • There is no maximum age for contributions, and there is no maximum age for funds to remain inside the plan as well. Funds that do not end up being needed for a beneficiary can be used for another beneficiary who is a family member of the original beneficiary. For example, if the beneficiary does not go to college, the funds in the account can still be used by another family member. If the funds are not ultimately used for eligible educational expenses, then any growth in the account is taxed as ordinary income and is subject to a 10% penalty.

Financial Aid:

  • For purposes of the FAFSA, funds in a 529 plan are treated as an asset of the parents, regardless of whether they are owned by the parent or the child. If the child is not a dependent, however, then the account will be treated as an asset of the child. If the 529 plan is owned by a grandparent, it is not included in the financial aid evaluation, however, distributions from the plan count as income of the beneficiary for purposes of the Free Application for Federal Student Aid (FAFSA).

Coverdell ESAs

Another option to 529 plans are Coverdell accounts, but their implementation is much more limited.

A Coverdell ESA (previously known as an Education IRA) allows you to contribute up to $2,000 per year per beneficiary as long as your modified adjusted gross income does not exceed $95-110K for single filers or $190-220K for married filing joint filers. The $2,000 limit is phased out and then capped for people within these income brackets.

The advantage to Coverdell ESAs is that the funds can also be used for grades K-12.  The funds will be tax-free if used for qualified education purposes. The disadvantage is that the funds have to be made for a child under the age of 18 and used by the age of 30. In addition, you can make this contribution until April 15th for the following calendar year.

Conclusion

The first thing to keep in mind when saving for your child’s college education is to take some pressure off yourself and do the best that you can – paying for some of their college bill would be better than none of it. With tuition costs rising faster than inflation and faster than our paychecks, it is imperative to know the facts and plan early. The 529 and Coverdell plans addressed above provide excellent options. You can get your money to work for you (and your children) and take advantage of the tax benefits that are available.

 

Footnotes

1The College Board® https://www.collegeboard.org/

Disclaimers

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov

Qualified Small Business Stock Exemption

As an entrepreneur and business owner, you’ve put a lot of time as well as your heart and soul into building your company. You also likely have much of your net worth tied up in the business. In fact, for many business owners their equity in the business represents the bulk of their net worth.

This means that enhancing the after-tax value from the business should be a central part of your liquidity planning and wealth management strategy. We emphasize after-tax because together federal, state, and local income taxes can in some cases erode about half of the owner’s proceeds.

There are many techniques that can be used to minimize the tax impact for business owners. One of the most powerful is the exemption for certain types of small business stock. In some cases, small business stock can be sold with little or no tax implications. Under Section 1202 of the tax code, qualified small business stock (QSBS) qualifies for significant tax breaks and can provide an excellent planning vehicle for the right business.

 

The current rules

The rules related to QSBS have evolved over time. The current rules have been in place since 2013, but keep in mind that Congress can—and has—changed the rules several times.

Here are some of the most important features of this potential tax break for business owners and shareholders:[1][2]

  • The excludable gain from gross income is the greater of $10 million or 10 times the adjusted basis the shareholder has in the investment.
  • The stock must have been issued by a U.S-based C corp. Other types of entities, including S-corps and LLCs, aren’t eligible. The stock must have been acquired via an original offering by the corporation, not as the result of a sale from a shareholder after this time.
  • The corporation’s assets at all times on or after August 9, 1993 and before the issuance cannot exceed $50m. The gross assets immediately after the issuance must not exceed $50 million.
  • The corporation must have been an active, operating company at all times during its existence. Holding companies aren’t eligible. The intent of the rules is to offer this tax break to companies engaged in a business, generally with assets and employees.
  • Service businesses like a CPA firm, law firm or a financial advisor are excluded. Businesses engaging in farming, mining, hospitality, restaurants and similar industries are also excluded. This generally restricts the tax break to companies involved in manufacturing, distribution, retailing, technology and wholesaling.
  • As part of the sale transaction, both the corporation and the selling shareholder will need to provide certain types of documentation for the transaction. This will include things like cost basis and other documentation to ensure the restrictions of Section 1202 have been met.
  • The transaction must involve some sort of payment. This can be either cash or services provided in exchange for the stock. The exemption would not apply, for example, if the stock is gifted to another person.
  • The acquisition date of the stock being sold matters.
    • For stock acquired after September 27, 2010, if it is held for at least five years the entire gain is excluded from the seller’s gross income. There are no alternative minimum tax (AMT) implications either. If the stock is held for less than five years, the gain would be subject to capital gains taxes; if held for less than one year, the gain would be taxed as ordinary income.
    • For stock acquired between February 8, 2009, and September 27, 2010, if it is held for at least five years, 75 percent of the gain would be excluded from gross income. AMT would apply on 7 percent of the amount of the gain.
    • For stock acquired on or after August 11, 1993, but before February 8, 2009, if that is held for at least five years, 50 percent of the gain would be excluded from gross income. AMT would apply on 7 percent of the amount of the gain.
  • Note: The above applies only to Federal taxes, some (but not all) states have related tax breaks for this type of transaction.

 

Why acquisition date is so vital

To illustrate how a QSBS transaction might work—and why the timing of when the stock was acquired is so important—let’s look at a hypothetical example. We’ll assume that the stock is sold on March 1, 2018, for a gain of $5 million and that all of the other QSBS qualifications listed above are met.

The table below shows how the tax treatment would vary depending on when the stock was acquired.

 

Date stock acquired Tax treatment
October 1, 2017 No exemption, gain is taxed at ordinary income tax rates
October 1, 2014 No exemption, gain is taxed at capital gains rate
September 28, 2010 Gain is fully exempt from gross income and no tax is due
February 9, 2009 75 percent of the gain is exempt from gross income; 25 percent is taxed at capital gains rates; 7 percent would be subject to the AMT
January 1, 1995 50 percent of the gain is exempt from gross income; 50 percent is taxed at capital gains rates; 7 percent would be subject to the AMT

 

 How we can help

If you’re an owner or executive of a relatively small C corp., you should take the QSBS rules into account as you move forward in developing your wealth management strategy. While the QSBS exemption probably wouldn’t affect your decision of whether to sell the stock, knowing about this exemption and whether you qualify can significantly influence what you could achieve with the after-tax proceeds from a liquidity event.

 At Callan Capital, we have extensive experience guiding business owners through all aspects of their wealth management and liquidity planning. By taking the QSBS rules and other potential benefits of business ownership into account, we develop a customized plan for maximizing the after-tax proceeds generated by a liquidity event and turning that wealth into an enduring legacy for you and your family. Our team prides itself in coordinating the expertise of all of your advisors to ensure the best possible outcome.

If you have questions about how the QSBS exemption or other rules related to executive compensation could affect your wealth management strategy, please give us a call to discuss your situation..

 

 

Important Disclaimers: Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. For more information, please refer to our most recent Form ADV Part 2A which may be found at www.adviserinfo.sec.gov. The tax information provided in this document is for general informational purposes only—it is not meant to be used, and cannot be used, by individuals to avoid federal, state or local tax penalties. Taxation varies depending on an individual’s circumstances, tax status and transaction type; the general information provided in this guide does not cover every situation—for complete information on your personal tax situation, you should always consult with a qualified tax advisor.

 

[1] U.S. Small Business Administration. https://www.sba.gov/blogs/qualified-small-business-stock-what-it-and-how-use-it

[2] https://www.law.cornell.edu/uscode/text/26/1202