Welcome to the Thought & Action podcast hosted by Erik Flegal. The Thought for the Day is “What are you going to do when taxes go up?” We don’t have any confirmation exactly on how it’s going to look yet, but the Biden administration is likely going to raise taxes. The thought is what are you going to do, but the action is to take some of this information and get your team together to come up with a plan that can help you navigate whatever these changes may be, and come up with a favorable tax situation for yourself.
Today we are joined by Jonathan Gopman, Anchorman Partner, specializing in the area of tax, trusts, and estates. He’s going to discuss Tax Mitigation, and what you need to do, from a tax perspective, surrounding the upcoming potential Biden tax increases.
The Categories of People
- You’re selling all or part of your business, taking some of the risks off the table.
You’re facing a large capital gains tax, looking at the Biden Green Book, there’s potential for it to be retroactive to the title that was announced much earlier this year. If you close your transaction now, before the end of the year, you’re still going to get hit with the higher rates, assuming a tax legislation passes. Capital gains right now are taxed to about a 20% rate. That change, to anything over a million dollars, in gain, crunched into one year, would be subject to tax at ordinary rates, plus the Obamacare tax, the tax on net investment income of 3.8% added to that. It’s a pretty hefty tax bite, and it can drastically change the mergers and acquisitions market.
- You have an active business and you don’t want to sell it, it delivers a substantial amount of profits and it’ll continue to be running well. But you’re still subject to very high tax rates, both at the state and federal levels.
Some people say they have little risk tolerance, some people say their risk tolerance is much higher. There are certain transactions that there is little to no risk because of the way the transaction works, and you still get a very good tax result. Then we have other types of transactions where the risk is higher, it doesn’t mean that the transaction doesn’t work, it just means that the service is likely to disagree with an interpretation of a provision in the Internal Revenue Code, that gets you to that tax result. In that situation, we’ll always recommend that a client gets what’s called a Tax Opinion from a qualified law firm such as Anchorman, or another law firm in the area. Typically, if Anchorman is doing the transaction, it is recommended to get an independent law firm to opine on the transaction, so you don’t have a law firm that’s assisting the client, nibbling a transaction, writing that same opinion letter.
You have to understand the risks and higher-risk transactions you owe. That’s why you always want to use an opinion letter because that wipes out the potential for penalties. When you have a qualified opinion letter, you then understand the process of how to settle that type of case. If you don’t want to take it, you’re risk-averse, you don’t want to go to court and end up with a final judgment, which could take several years, creating possible uncertainty and anxiety. There are a number of these transactions that don’t carry risk, tax credit deals, for instance, that we tend to see particularly in the green energy area right now, certain land credit deals, carry no risk, because that’s black and white. It’s a question of finding the volume of those deals, the inventory of those deals, which is the difficult thing to do. That’s where we come in, we have that inventory available to us. Anchorman can help you take advantage of those tax credits, and we can structure how you hold the one that holds those investments because that investment produces the tax credit to that actual asset.
You’re concerned about something being picked up on audit, incurring the cost of an audit, and incurring the potential cost of a tax court trial. That’s why it’s important to understand that risk, how it works and what your financial outlay may be if you have to deal with an audit, and if you don’t get through the audit favorably how you deal with that going on to Tax Court, either argue with the service and Tax Court, or paying the tax and filing for a tax refund in a federal court case outside of Tax Court, this can get rather expensive. If the service is deemed to take a specious position, they may end up paying your attorneys fees, but more often than not, that’s not going to be the case. For example, we were using captives for several years, and we still have a lot of good captives, most of which have not been audited, but there’s a tremendous amount of cases out there right now involving captives. There’s more audit risk because there are more reporting requirements that come in. We found alternatives that don’t require the reporting, you can get the same type of insurance coverage that you get through captives and you get the same beneficial tax, you actually can get better beneficial tax results, or tax benefits from certain transactions that tend to mirror what a captive may look like, but produce significantly better tax results.
What You Can Do to Mitigate the Tax Burden If Anything at All
With those types of people, we’ll work with 5-10 planning strategies at any one time, one where there is very low risk and others where they’re high risk. But in most of these situations that we know, we’re creating a beneficial tax environment that has a serious impact on the initial transaction you’re doing, or in many cases, a long-lasting impact year after year, putting our clients in a very favorable tax environment. What Anchorman will caution people is, not every planning strategy is right for you, you have to understand not only the initial tax consequences but the tax consequences on a go-forward basis. That being said, we like to look for strategies that are just extremely flexible, provide you with the ability to use your capital in any way you want, and provide you with very favorable tax benefits.
- Charitable Gifts
If you’re earning a large amount of income from your business or you’re selling your business, a low-risk strategy is to consider making charitable gifts in that year. Any type of charitable planning, if it’s done the right way, can be at a very low-risk level to get the most bang for your buck, when you’re in high income, or years where you have income bunched together. Whether you set up your private foundation, which is a private family charity, this is governed by certain rules, and you can’t abuse this situation or lawyers will get into significant trouble. You also have gifts to Donor Advised funds, direct gifts to a public charity, then there are split-interest trusts, where you get a deduction for a gift going into the trust that you retain an income stream for up to 20 years and/or your life (or your joint lives, if you’re married). After that term is done, whatever is left in that trust goes to charity.
- Solar Tax Credit Deals
This is where you take the money you otherwise would have paid Uncle Sam in tax, and you invest them into a solar tax credit deal. A more complex strategy, but one that would be referred to as very low risk. There’s a lot of very good deals out there, done with reputable and prominent developers in the business, and a lot of them have high-quality ones, usually available in June or July. If you’re interested in doing this, this is the time to be doing it, otherwise, you’re going to be looking to deal with offset income for next year. But if you invest money in the deal, you get a tax credit between 24-30% of your investment. The tax law provides a 24% tax credit, but there are some grandfathered deals these developers or promoters have that you can still get into. You can use that to offset your current year tax liability, whether it be operating income or whether it be capital gains, and you take some or all of that credit and apply it towards last year’s tax income to get a tax refund, which can also get you bonus depreciation on the remainder of the investment. You get the write-off in year one. Now certain states have different rules, and that’s at the federal level, you need to check to see if your state coordinates with the federal tax system, or whether you have to take the bonus depreciation a little differently, but the numbers usually work out great. Instead of paying Uncle Sam the money, you invest in the solar tax credit deal, you now have an asset, you’ve saved your tax liability, and you also get a return on that. Most of these solar deals are on a per million dollar basis return of about 4%. For example, you put down $8 million and get a check for $320,000 a year on that. Many of these promoters on your deals allow between 50 to 65% of your capital, at very favorable rates. You can use these to offset business income, or to offset capital gains on the sale of a company, regardless of the tax rate.
- Mixing and Matching Structural and Transactional Strategies
When customizing strategies you have to understand how these work, how they restrict the capital, or how it doesn’t, and it is important to understand the cost of getting involved. In all of these situations, the cost of getting involved is minuscule in comparison to the tax savings.
- Private Placement Life Insurance Policy
This is traditional insurance, with tax-free build-up, and you can pull out tax-free gains inside of the policy if you either draw down on your basis or take a loan against the policy. You could have millions upon hundreds of millions of dollars cash value inside of the policy if it’s administered as a left policy, and you have closely held businesses that are operated inside those policies, to be able to have the right type of situation, and the right type company, but that’s a possibility. You can also sell assets from inside of closely-held assets from inside of the policy, and eliminate the gain on that sale.
- Enterprise Risk Insurance
What Anchorman does is we have a licensed insurance company that sells these products, enabling you to take advantage of it, you have better long term tax results of the economics here for people getting into this, or businesses getting into it. This is a type of insurance policy that anyone in a business should have, they should have these types of protections. We have a way of designing that, where the deduction going in, you get tax free build-up of your capital, inside of the structure, and the release of funds from what we call risk pool, and in the insurance policy, because you have to have a certain amount of risk in a risk pool for at least a year. We have a way of withdrawing the capital from that structure without ever paying tax using private placement, life insurance and an insurance dedicated fund that we created to plug into that. It’s very creative to deal with active business income, and mitigating risk, the annual tax bite.
Investments are just a tool, and the legal and tax strategies that Anchorman can help implement, are the tools to help people create, maintain, and keep their wealth that they’re building.
One thing that if anybody’s listening I think needs to come away with is, you need a team that’s talking to each other, you can’t do this in a vacuum. You need an attorney, an investment person, whether it’s an insurance or wealth advisor, but everybody needs to be talking because these things are creative, but they need to be massaged a little bit so that it all works fluidly together and works well. Thank you to Jonathan for laying those basics out and it goes into a lot more detail.