Business finance concept – tax planning text in the notice board
When your next ship is visible on the horizon — a business you built or some asset you bought astutely long ago is now ready to sell — you need to think about how you will handle the tax associated with your winnings. Just for perspective, you should calculate how much the tax will be, and from there you can start thinking about ways and means to delay or even avoid the tax. I remember when my ship arrived – it was more of a PT boat than an aircraft carrier. It was the largest check I ever wrote. Circumstances opposed me being able to do anything about it.
My favorite technique
Rising interest rates have given rise to one technique that is no longer popular, the regulated installment sale (SIS). For what it’s worth, if I had another ship come in this is the tech I would likely use. I’ve discussed cash installment selling, which doesn’t actually work. There is a deferred sales fund that is still worth considering. Then you have things like opportunity area funds, 1031 disbursement, some sort of charitable surviving trust or if you’re a generous donation of your assets to a donor advice fund. Perhaps there are other secret sauces, of which I know nothing.
You should analyze these last techniques keeping in mind Riley’s second law for tax planning – Sometimes it is better to just pay the taxes. This requires a thought experiment. Let’s say you have the prospect of getting $1,000,000 from the buyer and your business or your advisor reporting the resulting profit will increase your tax liability by $200,000. This means when the dust settles, you’ll have $800,000 if you just pay the taxes.
Let’s say you sell that kind of thing that qualifies for a 1031 exchange. Someone suggests that you could defer the $200,000 tax indefinitely by exchanging it for a joint lease interest at a Walgreen’s in Chicago. It is a mistake to think of this possibility as a $200,000 win. The analysis you must make starts with thinking of yourself with $800,000 after tax. Are you seriously considering purchasing a co-leasing interest in a pharmacy? If not, as difficult as it may be to understand, there is a good argument that it is better to pay taxes. There may still be an option besides paying taxes, but for you the pharmacy is not.
Back to fashion
Regulated Installment Selling (SIS) is actually quite simple from a planning and execution perspective. Essentially, the buyer will pay the broker, most likely an insurance company instead of you. Then they pay you for the time. When I say it’s simple, I’m looking at it from your point of view and from your tax advisor’s point of view. There are some significant technical complications but you are relying on the tax expertise of a major insurance company. You still need to remember Fourth Riley tax planning law – Implementation isn’t everything, but it’s a lot.
What made this technology go out of style were the pathetically low interest rates. One of the main deferral points is to defer the amount to work for you. If you’re getting a little interest, it seems like there’s no point in it, but there can be a point, an income distribution can significantly lower your tax, and this can be important for taxpayers who have a once-in-a-lifetime type.
Consider Joe. Joe, who is in his late 60s and makes $36,000 a year in Social Security, owns a few acres of land he inherited from his grandfather that was of little value. Things change. Something happened. You make it. My creativity backs off. He can sell the land which will give him a profit of $800,000. Along with the same gains that would make his $30,600 Social Security taxable. There is AMT and NII. All in total taxes would be $165,022.
Let’s spread the gains over four years and assume unrealistically that there is no change in laws and rates. The tax would be $29,003 annually if the gain was distributed evenly. There is still some NII but no AMT. That’s a saving of nearly $50,000 in taxes, and spreading recognition of the gains over eight years would save nearly another $20,000. In a smaller transaction with a profit of $100,000, the $12,840 tax could be eliminated entirely by spreading the recognition of the gains over four years.
These savings aren’t exciting if that’s all you get from tying your money with the insurance company. And a few years ago this was close to everything you were getting. And remember, if your basis isn’t slim, you’re also crediting the sale proceeds tax-free. The only method I know of where you can invest only earnings is to invest in a Qualified Opportunity Area Fund.
Better prices
Rising interest rates change the game. Chad Etmoeller GCR Settlements LLC Encourage me to write about SIS in response to my articles on more shady tactics. He told me that on fixed rate deals now rates around 4.25% are available. The origin of the intelligence system is an extension of structured settlements in litigation. Personal injury payments are excluded from income. So instead of taking one payment that you invest for a taxable return, you take a series of payments that are completely exempt. What bothers me about structured litigation settlements is the ads you see for people selling their structured settlements probably at a deep discount. Given the way capital markets work, it’s hard not to believe that they might have been better off if they had a lump sum upfront.
Anyway, someone had a bright idea to apply the principle to premium sales. Plans allow deferral of not only gains but also return on investment. I must admit that I rely on the insurance company’s tax attorney for this aspect of the business plan. Mr. Ettmueller is very excited about the plans associated with the index. These allow you to delay up to forty years. Future payments can increase based on the performance of the index, but they can never decrease. I can see the appeal of these products. However, you really need to do the same type of analysis as you would with a drug store in Chicago. Is this something you would buy if you had your post-tax earnings on hand? It’s not like a relatively short-term structure that lowers the tax significantly while providing an acceptable short-term return.
heard from Timothy Space Private Client Focused Partner at Eisner Advisory Group LLC. He had a number of practical notes. Not everything you sell may qualify for installment sale processing. Dealer property and ordinary income property do not qualify. This can be a particularly complicating factor in business sales. State taxes can also get complicated very quickly especially if you sell property in a state where you don’t live or move there later. Finally, a taxpayer with more than $5 million in installment sale obligations due may have to pay interest on the tax-deferred. This can take a lot of the fun out of procrastination.
In conclusion, regulated installment selling deserves a place in your bag of tricks for dealing with liquidity events. Make sure you run good numbers and don’t let the tax tail wag the economic dog
other coverage
Dan Finn has Introduction to Structured Installment Sales Avoid capital gains taxes on real estate transactions or business purchases inCPA Journal.
“If planned properly, unlike many other options that focus mostly on tax deferrals, an organized installment sale can eliminate taxes on gains entirely, even if the gain is substantial.