As you know by now, we are huge fans of cash balance plans. But we do get involved in other tax structures from time to time.
This post will briefly discuss other structures available to some of our clients. Each client situation is unique, so discuss and review these strategies with your CPA and tax attorney.
Not only do these structures save on income tax, but many of them offer estate tax benefits and asset protection as well.
Below is a list of these strategies. We’ll briefly discuss the structures and offer a few tips.
Table of contents
- C-Corporation for Fringe Benefits & Lower Tax Bracket
- 1202 C-Corporation for Intellectual Property
- Restricted Property Trust
- R&D Tax Credits
- Insurance Company Owned by Roth IRA or Roth 401(k)
- Money Purchase Plan + 401h
- Section 105 Medical Reimbursement Plan
- Sell Business (or Appreciated Assets) to a Family Endowment Plan
- S-Corporation ESOP
- Tax Strategies for Small Business Owners
C-Corporation for Fringe Benefits & Lower Tax Bracket
Consider adding a C-corporation that is managed within your family. This can allow you to take advantage of certain fringe benefits that are not available with a typical S-Corporation structure.
Here are a couple of advantages:
- Owner/employees receive tax-free fringe benefits, like medical expense reimbursement, daycare, college, and educational funding.
- Any remaining taxable income is shifted to the 21% tax bracket.
Your S-Corporation would make a tax-deductible management fee payment to the C-corporation. Then the C-Corporation would hire employees who could take advantage of the tax-free fringe benefits.
1202 C-Corporation for Intellectual Property
A little-known part of the tax code allows certain shareholders to exclude qualifying capital gains from taxation. Silicon Valley companies have been using this strategy for years.
Specifically, owners of qualified small business stock that has been owned for at least five years can exclude capital gains of up to $10 million upon the stock sale and up to 100% of capital gains in some situations.
The 1202 corporation holds intellectual property, and your operating entity pays the entity a tax-deductible IP licensing fee for the use of the IP. When the practice is sold, this income stream can then be capitalized for valuation.
Restricted Property Trust
An RPT is an excellent option for business owners who also need life insurance. They get to deduct 70% of the payment and receive tax-free income in retirement.
It works a little like a deferred compensation plan. But you have a minimum annual contribution of $50,000, and you must commit to it for a minimum of five years.
R&D Tax Credits
You may think that R&D tax credits are only available for IT companies. But I have some good news. The tax credit is available to almost any company in any industry that incurs certain costs in the development of new or improved processes or products.
We have seen R&D tax credits work in physician offices and other service related businesses. They can be used to offset the costs relating to research and experimentation for the following:
Insurance Company Owned by Roth IRA or Roth 401(k)
With this structure, the business pays an annual insurance premium to the insurance company. It is generally less than 10% of the gross revenues or up to $2.3 million. Assuming a claim is not filed, the funds are a surplus to the insurance company.
The insurance company can then invest the surplus. Once the insurance company is no longer needed, you can liquidate it down to the self-directed Roth IRA. At age 59 ½, you are able to take the money out tax-free.
Money Purchase Plan + 401h
This is another retirement strategy. It won’t give you the highest contribution, but this plan might do the trick if you want significant contributions and tax-deductible medical.
The benefit of this approach is based on the combination of three specific plans:
- Money Purchase Plan
- 401(h) Account
- 401(k) Plan with Profit Sharing
The money purchase plan acts like a profit-sharing plan but with mandatory contributions. It is technically a “pension” plan and can be combined with other retirement plans.
Many people know what a Health Savings Account (HSA) is. But very few people have even heard of a 401(h) account.
A 401(h) is a medical expense account added to a pension plan. Section 401(h) of the IRS Code allows a pension plan to provide payment of medical expense benefits for retired employees.
Section 105 Medical Reimbursement Plan
These plans allow for tax-free medical reimbursements. The company is able to deduct these reimbursements directly on their tax return.
A section 105 plan can work with the C-Corp fringe benefit structure above. But it also works excellent with sole proprietors.
A sole proprietor must legitimately employ a spouse involved in the business. The employed spouse is treated as any other employee, with the business owner offering medical benefits as part of the employee’s compensation package. A spouse doesn’t need to work for the company with a C-Corporation.
Sell Business (or Appreciated Assets) to a Family Endowment Plan
This strategy allows you to make tax-deductible contributions. In addition, the money grows tax-free, and any long-term distributions are tax-free. The funds are also outside of the client’s taxable estate.
You have the ability to control the investment decisions and retain a 100% voting interest. You would establish a donor-advised fund (DAF), which owns the non-voting interest. You control the donor-advised fund.
This approach can help with IRA utilization, pension structuring, stock option sales, and the tax-free sale of real estate.
Here’s a look at how the structure works. You contribute your business goodwill or non-hard assets to the family endowment plan. In return, you receive a 100% voting share, and the non-voting share goes to the donor-advised fund. After the sale, 99% of the resulting capital gain from the asset sale is attributed to the donor-advised fund, a tax-exempt entity.
At the end of the day, you get a charitable tax deduction equal to the fair value of the non-voting interest in the DAF. This is limited to 30% of your adjusted gross income. But it can be carried over for up to five years.
But no matter the gain, it’s not subject to capital gains tax because it is in the DAF. Those funds are available to reinvest in essentially any vehicle.
With an employee stock ownership plan (ESOP), you pay a management fee to the S corporation. This is typically a reasonable amount, up to 30% of gross revenue. The funds going into the S corporation are tax-deductible, and the employee stock ownership plan owns it.
You will likely be considered a highly compensated employee (HCE). If the structure is a partnership, there could be many HCEs. But you can retain 70% of the net economic impact of the ESOP, and the non-highly compensated employees (NHCEs) would get allocated 30%.
You can use the funds for investments, operating needs, or future acquisitions.
If you sell the sales outright to the ESOP at some point, the resulting capital gains are deferred as long as you sell over 30% of the business and roll over the funds into qualified replacement securities. These could be privately or publicly traded stocks or bonds.
Tax Strategies for Small Business Owners
As a successful business owner, you have various tax planning options at your disposal. Hopefully, you will consider these above strategies and see if they can work for you in your situation.