|Copyright:||(c) 2011 National Underwriter Company dba Summit Business Media|
Business owners have just two years to take advantage of the 2010 Tax Reform Act. Here are some key income and employment tax planning strategies involving life insurance that can be adopted now to help lower the upcoming tax bite.
The 2010 Tax Reform Act (TRA) was a boon to sonic, an irritant to others and a surprise to many, lor the life insurance business, the new tax reform act opens a great number of sales opportunities in the business market.
Life insurance has long been an important product IV)I” business owners. It has helped owners’ families after tragedies, upheld promises made in buysell agreements, served as a valuable benefit to retain employees and worked as a source of indemnification when key employees were lost. The TRA has simply increased the importance and opportunities of life insurance in business planning.
This article focuses on the income tax provisions of the TRA and how they affect and enhance the opportunities for life insurance sales in the business market. The second of this two-part series. which will appear in the Max issue of Life Insurance Sellino, will focus on the estate and gift tax provisions of the IRA and how they affect business owners in particular.
A few TRA basics
Three overall TRA recommendations apply for advisors who work with life insurance in the business market:
* Learn the law. Contrary to popular assumption, the TRA does not simply extend Bush-era tax cuts for two years. There are significant opportunities and challenges with income, employment and transfer taxes. And timing is an issue when leveraging these lax provisions.
* Life insurance is a key product today, in the era of personal responsibility. The controversy that preceded and followed enactment of the TRA makes it clear the government is struggling. The herculean challenges facing
* The unclear future of taxes (income, employment and estate) make it all the more important to address known tax opportunities now. The TRA not only extends certain existing provisions, but also sunsets many of them. There are *”limited-time only” pro isions. particularly for businesses, that offer one-time opportunities. In an environment where taxes are likely to rise, the business owner needs to leverage these provisions while the) still exist.
Consider some of the key income and employment lax opportunities for life insurance sales to businesses and business owners. These opportunities are not specified in the law; they are simply results and outcomes of the lax provisions. For example, the fact thai lower income tax rates only extend for two years also means that, for two years, it may make sense to bonus premiums from the company to the individual.
Below is a list of income and employment lax planning strategies for business owners and their business. The advisor who brings these opportunities to light is the advisor who can offer life insurance as a way to leverage the provisions ol the TRA.
TRA and income, employment tax strategies
The increase is a result of both expiring Bush-era tax provisions and scheduled health care law tax provisions taking effect in 2013. The table shows how the combined income and employment lax rates for lop income earners w ill include massive increases in tax year 2013. almost tripling in size in one case.
* During the next two years, transfer capital from the business to the owner. While tax rates are comparatively low, an effective strategy is to move excess business capital to personal ownership, pay the taxes and secure the money in a tax-advantaged account going forward. Life insurance can be a key element in this strategy. The business would bonus premiums dollars out of the company to the owner for a policy on the owner’s life. This could be either in the form of compensation to the owner as an employee or, depending on the company’s tax structure, as a dividend. The money placed in the life insurance policy will be after-tax and individually owned. A high cash-value life insurance policy can be an excellent repository for some of this capital because it is a self-completing contract. It pays whether the owner dies too soon or lives too long. It typically has guarantees, and it diversifies the owner’s assets. The capital is no longer tied up in the business and is instead a personally owned, tax-advantaged contract.
* Reward and incent key employees by paying for their personal life insurance premiums. The executive bonus has been a popular benefit technique in the last several years, particularly for flow-through companies such as
* Use a nonqualified deferred compensation plan as a way to retain key employees concerned with high taxes. On the flip side, there’s the technique of deferring taxes by deferring both the deduction and the recognition of income taxes. The company would set up a nonqualified deferred compensation plan for key employees. The employer would use corporate-owned life insurance to informally fund the obligation on a tax-advantaged basis and then take the tax deduction when the tax bracket is potentially higher.
For the executive, the nonqualified plan offers the opportunity to defer taxation until a time when the money is actually needed for retirement. For the business owner, the plan offers a way to retain and reward employees while delaying tax deductions to a time when they may be more valuable. Not only does the deduction occur when the business owner is being taxed at a higher rate. but also when many of the smallbusiness tax-savings provisions are scheduled to have expired.
* Create and fund a buy-sell agreement. Federal income and employment tax law has been, and remains, unpredictable. For example, while employment taxes (FICA) are being reduced for 2011. top taxpayers will experience a significant increase in employment taxes in 2013, an increased
* Set up a plan to indemnify the company for the loss of a key employee. As the economy begins to recover, business owners have come to realize the importance of the employees who helped the business weather the storm. Business owners are concerned that they may lose these employees, not only because of death or disability, but also because of competition. Life insurance represents a key funding tool to help avoid or mitigate these losses. Key person life insurance is a tax-advantaged way for a company to indemnify itself for the unexpected loss of a key employee. If the life insurance has cash values, it further represents a potential source of capital to fulfill golden handcuff programs for keeping key employees.
The TRA has many favorable income and employment tax provisions, particularly for small businesses. But. because of its temporary nature, it also represents a cash-flow threat to these businesses in later years, when the tax provisions sunset. Life insurance is an important tax-advantaged product that can help the business owner leverage the tax advantages of the TRA and lessen its sting. The next article will examine how the estate and gift tax provisions of the TRA affect businesses. their owners and the owner’s wealth. We will also consider opportunities for business owners to preserve and continue their businesses and their wealth through effective life insurance planning.
“The advisor who brings these opportunities to light is the advisor who can offer life insurance as a way to leverage the provisions of the TRA.”
“While tax rates are comparatively low, an effective strategy is to move excess business capital to personal ownership, pay the taxes and secure the money in a tax-advantaged account going forward. Life insurance can be a key element in this strategy”