The reality of the new tax reality

If you filed your tax bill earlier this year, chances are it wasn’t pretty.

I polled a group of key advisors and asked if the new tax reality had sunk in with their business owner clients, and the overwhelming majority answered, “NO!”

The reality is, for many business owners and high-net-worth individuals; their tax bill was a shocker. In California, top wage earners are now experiencing a 51.9 percent federal-state income tax on earnings over $1 million*, the result of new tax levies imposed by California and Congress in 2012. Many other states aren’t far behind.

My CPA tells me that he’s looking at all options when helping business owners reduce their taxes.

For some, that’s increasing their contributions to qualified plans, HSAs and maximizing deductions. For others, that may be moving to another state. And for others, he pointed out that nonqualified (NQ) plans can have a meaningful impact on the business owners’ taxes.

So now’s a great time to talk to business owners and their CPAs about NQ plans.

So what’s to talk about? My two personal favorite NQ plans are 162 executive bonus plans and traditional deferred compensation plans. Both are tried and true and each takes a different approach to help solve the tax problem.

Executive bonus plans

Let’s start with executive bonus plans – in my opinion, one of the most under-promoted plans available.

If structured properly, they can work like a Roth IRA, so we’re taking after-tax dollars, growing them tax-deferred and, if funded properly, providing tax-free income in the future, often to supplement retirement. And since qualified plan distributions are 100% taxable, this is a great tax diversification strategy.

Contributions are currently deductible to the business, work with any corporate structure and there are special designs of these plans that can work for owners and key employees alike.

You’ll recall I mentioned ‘funding’, earlier. Since these plans typically use life insurance as a funding vehicle, you can pick a product – Universal Life, Indexed Universal Life or Variable Universal Life – which can match the risk tolerance of the participant.

Deferred compensation plans

My other favorite choice is the deferred compensation plan.

They work well for large institutional clients as well as closely held businesses.

These plans reduce current taxable income for participants, and contributions grow tax-deferred, so the taxes you’d otherwise use to pay the IRS start earning interest crediting immediately.

They work well for larger companies that want to offer a competitive pre-tax savings plan to key employees and are often used to supplement 401(k) plans when companies fail their 401(k) discrimination testing.

For closely held companies, we often see NQ deferred compensation plans structured as pre-tax savings or incentive plans to retain key employees. They’re a great way to incentivize key employees without giving up ownership of the company and can be tied to a succession plan.

We also see C Corp owners using them to help reduce their own taxes.

The bottom line – NQ plans can be a great tax strategy for your business-owner clients. These plans can meet a multitude of business planning needs, and they’re simple, easy and turnkey!

If you have questions, or want to learn more about how to incorporate our complete suite of nonqualified supplemental retirement plans into your tax planning strategy, drop me line, here. I will try to answer it in a future blog post.

 

Sherry Flint is Regional Vice President – Business Owner and Executive Solutions (BOES) sales team at the Principal Financial Group®.  She is a graduate of Northeastern University, Boston, MA and is the former President and Board of Directors member of NAIFA San Diego. With over 25 years of experience in the insurance industry she has worked with hundreds of advisors and their clients in the area of business planning and nonqualified plans. 

*Source: New York Times, “Two-Tax Rise Tests Wealthy in California,” February, 2013.

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal® are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

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