How Can a Captive Insurance Company Benefit Your Business?

Business owners are generally more concerned with day to day business matters and may not realize some of the opportunities that may arise from solving problems. You may be concerned about the loss of key employees, vendors or major clients, legal expenses, or a myriad other concerns.  All of these can result in a catastrophic loss if they occur and are the types of items that can keep you up at night.  When dealing with all of this it isn’t often that a single solution can be found to solve multiple problems facing business owners, but there is such a solution available in the tax law.

One potential solution is known as a Captive Insurance Company (CIC).

The key difference with the insurance to be discussed here and insurance you obtain from your local insurance carrier is you own the insurance company. The Internal Revenue Code Section 831(b) effectively allows a business to claim a deduction of up to $2,200,000 in a calendar year and have that premium go to an insurance company that is owned by the business owner. The added benefit of the self owned insurance company is you do not pay any tax on the receipt of the insurance premium. Yes, you read that correctly, you deduct the premium from one company you own and exclude the income in another company you own.

So how can a Captive Insurance Company help your business?

Specifically, there are risks in your business that are uninsured or under insured. First you will need to determine the risks, the actuarial cost of the risk and determine a premium that an operating company will pay to the Captive Insurance Company. The operating company pays the premium to the Captive Insurance Company to cover those risks that are needed. It is important to note that the risks must be real, as an example you could not insure your local business facility against a tidal wave because no such risk of a tidal wave exists in upstate New York. As long as the annual premium paid to the Captive Insurance Company is under $2,200,000 the CIC will pay no tax on the receipt of the premiums. The Captive Insurance Company has certain obligations and liquidity needs to pay any claims that arise but it is also allowed to invest its assets. The income from its earnings is taxable.

What is this worth to you and your company?

Assume after doing the analysis we determine a premium for the series of risks is $1,000,000. Your company pays and deducts the $1,000,000 business income thereby reducing your taxes. If you had not deducted the $1,000,000 then your business would have an additional $1,000,000 of income. Therefore, you would be in the highest tax bracket for Federal purposes which is 39.6% (not including the effective rate increase from various phase outs) or an effective rate as high as 43.592% after taking into account the effective costs of phaseouts plus New York Taxes of anywhere from 6.85% to even 8.82%. These make an effective combined tax rate with federal and NYS taxes of 50% or greater. That $1,000,000 deduction results in a savings of $500,000. Remember that your CIC does NOT pay tax on the $1,000,000 of revenue as illustrated n the example. At this point you have saved $500,000 or more in tax. Furthermore you have protected yourself against claims and liabilities which, up to this point, have not been covered.

As you fast forward a few years and insure your risks, pay claims from your CIC as claims arise and after a few years the company has sufficient reserves on hand to pay claims. At this point the Captive Insurance Company can distribute the funds as long as it does not jeopardize its reserves. These distributions would be taxable to the individual owners at the long term capital gains rate as a qualifying dividend. Currently the qualifying dividend rate ranges from 0% to 20% plus the 3.8% ACA tax. So the tax cost of receiving the dividend in current law may be 23.8% for a qualifying dividend (exclusive of effective tax costs of phaseouts) or 24.592% with effective costs of phaseouts plus the NYS rate of anywhere from 6.85% to even 8.82%. Therefore the tax paid on receiving the qualifying dividend is approximately 30%. A business can deduct the premium in one year, save taxes at perhaps at rates of 50% or higher and then several years later receive earnings back from the CIC and pay taxes at a rate of closer to 30%. This is a 20 percentage point benefit to the owner.

The CIC needs to be properly structured, designed for risk transfer, and managed as an insurance company to be acceptable. The CIC may be owned by the owners of the operating company or may be owned by others as well. CICs have expenses separate from the current operating company to maintain and operate on an annual basis. It is safe to assume the operating costs of the CIC can be $50,000 to $70,000 annually but if you have saved $500,000 in taxes you are still ahead $430,000, this I argue is an expense well worth having.

Hedley & Co Certified Public Accountants can help you determine if the Captive Insurance Company is right for you and help you protect your business, solve the problems that concern you and even save money.

Estimated Tax Payments

Estimated Tax Payments — AN OVERVIEW

Are you on track for making your estimated tax payments for the 2017 tax year?

Here is what you need to know.

HOW MUCH DO I HAVE TO PAY?

Whether it’s through payroll withholding, quarterly payments, or a combination, the IRS requires taxpayers to pay a certain amount of income tax during the year. The total amount you’re required to pay depends on your adjusted gross income (AGI) for the previous year. For 2017, your “required annual payment” is the smaller of:

  • 90% of the tax that will be shown on your 2017 return or
  • 100% of the tax shown on your 2016 return (110% if your AGI exceeded $150,000 in 2016 or $75,000 if you are married filing separately).

WHEN ARE ESTIMATED TAX PAYMENTS DUE?

For calendar-year taxpayers paying their estimated taxes in installments, payments are generally due on the 15th of April, June, September, and January of the following year. Each of the four installments generally should equal at least 25% of your required annual payment. If you receive income unevenly (because you have a seasonal business, for example), you may be able to vary your payment amounts and still avoid a penalty by using the “annualized income” method.

WHAT HAPPENS IF I MISS AN ESTIMATED TAX PAYMENT?

If you do not pay your estimated tax by the due date, the IRS may assess a penalty equal to the product of the IRS interest rate on deficiencies times the amount of the underpayment for the period of the underpayment.*

If you discover that you’ve been underestimating your taxes, you may be able to resolve the problem by requesting an increase in withholding from your or your spouse’s paychecks for the remainder of the year. Or, if you are taking taxable distributions from an individual retirement account, 401(k), or other retirement plan, you could increase the withholding from year-end distributions. With either alternative, the IRS will apply the withheld tax pro rata over the tax year to reduce prior underpayments of estimated tax.

* You won’t owe an underpayment penalty if the tax shown on your 2017 return — reduced by withholding taxes paid during the year — is less than $1,000.

Need help?  Contact Hedley & Co for your tax planning needs.

Can You Avoid Early Withdrawal Penalties from your Retirement Account?

How can you avoid Early Withdrawal Penalties?

If you’re saving for retirement in a qualified plan sponsored by your employer, such as a 401(k), or in a traditional individual retirement account (IRA), you need to remember that the IRS generally imposes a 10% penalty on any withdrawals you make before you turn age 59½.* This penalty is in addition to any income taxes due on the withdrawal. However, there are several exceptions that may apply.**

DISABILITY OR DEATH

Both qualified retirement plans and IRAs allow penalty-free distributions in cases of disability or death. “Disability” generally means that the individual is unable to engage in any “substantial gainful activity.”

UNREIMBURSED MEDICAL BILLS

Withdrawals from an IRA or a qualified retirement plan to pay deductible medical expenses that exceed 10% of adjusted gross income may avoid early withdrawal penalties. The withdrawal must occur in the same year the expenses are paid.

HEALTH INSURANCE PREMIUMS

You can make penalty-free withdrawals from an IRA to pay health insurance premiums if you have received unemployment compensation for at least 12 weeks (or could have except for being self-employed).

FIRST-TIME HOMEBUYER EXPENSES

You can withdraw up to a maximum of $10,000 penalty free from your IRA to buy, build, or rebuild a principal residence for an eligible first-time homebuyer. (The buyer can be yourself, your spouse, or any child or grandchild of you or your spouse, provided the buyer and his/her spouse have not owned another principal residence for at least two years.) This is a lifetime limit.

HIGHER EDUCATION EXPENSES

You may make penalty-free withdrawals from your IRA to pay qualified higher education expenses for you, your spouse, or any children or grandchildren of you or your spouse.

EQUAL PAYMENTS

Withdrawals from an IRA or qualified retirement plan that are part of a series of substantially equal periodic payments over your lifetime or the lifetimes of you and the designated beneficiary may be penalty free. (Requirements apply.)

* A 10% penalty may also apply to taxable distributions taken from a Roth IRA prior to the owner turning 59½, but a different set of rules applies.

** The list presented is not all-inclusive

tuition tax credits

Tuition Tax Credits

Education Tuition Tax Credits

College expenses are on the rise. The College Board reports that the average cost of a college education, including room and board, has risen faster than the inflation rate in recent years, topping $20,000 for public four-year institutions and $45,000 for private colleges for the 2016-2017 academic year.*

For many Americans, this burden may be alleviated through the use of education tax credits. There are two types — the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Both require that qualified education expenses be incurred by you, your spouse, or a dependent, and credits may not be combined for any one student for a single tax year.

AMERICAN OPPORTUNITY TAX CREDIT

The AOTC provides a dollar-for-dollar tax reduction of up to $2,500 of the cost of tuition, books, and other required course material for up to four tax years. Specifically, the tuition tax credits is allowed for 100% of the first $2,000 of qualifying expenses, plus 25% of the next $2,000 (for each qualifying student). Should the credit exceed the amount of tax you owe, you may be eligible for a refund of 40% of the credit or $1,000, whichever is less.

You may generally claim the full AOTC if your modified adjusted gross income (MAGI) for the tax year is under $80,000 ($160,000 if married filing jointly). However, the credit starts to phase out once MAGI exceeds those levels and is no longer available once MAGI reaches $90,000 ($180,000 if married filing jointly).

LIFETIME LEARNING CREDIT

The LLC is a tuition tax credit of up to $2,000 per tax return for tuition and fees, calculated as 20% of the first $10,000 of expenses. In contrast to rules under the AOTC, qualified expenses for the LLC do not include academic supplies, and no portion of the credit is refundable. However, the LLC is available for an unlimited number of years, and it does not require the student to be enrolled in a degree program.

You may receive the full credit if your MAGI is less than $56,000 ($112,000 if filing jointly). The amount of the LLC phases out when MAGI falls between $56,000 and $66,000 ($112,000 and $132,000 if married filing jointly) and is not available when MAGI exceeds these upper limits.

* The College Board, Tuition and Fees and Room and Board Over Time (Public school costs are based on in-state rates.)

We can help you take advantage of the tax credits you are allowed with our tax preparation service. 

CDFA Certified Divorce Financial Analyst

Why Use a CDFA in your Divorce?

A Certified Divorce Financial Analyst (CDFA) Can Help

The process of a divorce can last a year or more. A Certified Divorce Financial Analyst (CDFA) can explain all the financial aspects of your decisions and help you to make smart choices throughout the process.

A CDFA works with you and your attorney to forecast the long-term impact of the divorce settlement. This includes tax liabilities, long term and deferred savings, retirement and college savings plans.

What is the real cost of your divorce?

A CDFA can assist you on planning a budget and help you adjust to the cost of your new living arrangements. Life insurance, health insurance and cost of living increases need to be considered when agreeing on a financial settlement.

There are a lot of misconceptions around the divorce process. A CDFA can help cut through the financial lingo and bring greater understanding to your situation. A CDFA can also help you build a realistic, stable financial budget for both the long and short term

A CDFA will help you take stock of your current financial situation, including:

  • The current balance in all bank accounts
  • The value of any brokerage accounts
  • The value of investments, including any IRAs
  • Your residence(s)
  • Your autos
  • Your valuable antiques, jewelry, luxury items, collections, and furnishings
  • Examine copies of the past two or three years’ tax returns
  • Make sure you know the exact amounts of salary and other income earned by both yourself and your spouse
  • Examine papers relating to insurance-life, health, auto, and homeowner’s-and pension or other retirement benefits
  • List all debts you both owe, separately or jointly. Include auto loans, mortgage, credit card debt, and any other liabilities.

This will help you to make smart decisions regarding how debts incurred during the marriage are to be paid off and obtain preliminary information for the eventual division of property. Assessing the above is critical in planning a secure financial future.

Contact our office – we have the areas only Certified Divorce Financial Analyst who is also a CPA.  A true asset to your post-divorce financial planning process.

Best Practices for Running a Family Business

How hard can it be to run a family business? It should be easy since presumably all the key people are on the same page and they all share the same goals. Unfortunately, that’s not always the case. Running a family business is anything but easy when what’s good for the business is different from what’s good for the family.

COMMUNICATE CLEARLY AND OFTEN
There are two controlling forces in a family business — the family and the business. Successful family businesses find an effective way of separating the two so that family problems don’t spill over into the business and vice versa. Keeping the lines of communication open on all levels and holding regular business meetings to address and resolve business issues will help establish the necessary boundaries.

FOCUS ON PROFESSIONALISM
Professionalism is another best practice for family businesses. Standardizing operations and procedures and establishing policies can help your family business be successful. If you have nonfamily employees, pay particular attention to personnel issues (such as hiring and promoting on merit and paying market-based salaries). Allowing “special” benefits for family members can be a real morale killer. Providing equal benefits and establishing a family code of conduct will show you’re committed to leveling the playing field.

PAY ATTENTION TO FINANCES
One big reason family businesses sink is poor financial management. All businesses can benefit from establishing proper accounting procedures. Having accurate data allows you to generate monthly statements and keep tabs on your current financial situation. You can also spot trends as they develop and be proactive instead of reactive.

PLAN AHEAD
The odds of a family-run business making it to the next generation are generally low. You can boost the likelihood of beating the odds if you make succession planning a top priority. Just don’t wait until the last minute.

spending plan

Create a Spending Plan & Get a Handle on Your Finances

Create a Spending Plan

Does it seem as if your paycheck is here one minute and gone the next? If your money disappears before you know it, you might need a way to keep better track of your spending. A budget — or spending plan — can help you take control of your finances to make sure that you’re spending wisely.

FOLLOW THE TRAIL

The first step is to find out where your money is going. And the only way to do that is to keep track of everything you spend, including cash purchases. Ideally, you’ll be able to gather spending data for three months (although one month may be more realistic). There are software programs and mobile apps that can help simplify the process.

Add up how much you’re spending in specific categories during a one-month period, and use those figures to project your future expenses. To improve accuracy, add up any and all irregular expenses (insurance premiums, taxes, etc.), divide the total by 12, and include that amount as a monthly expense. Obviously, spending projections should not exceed your income.

PRIORITIZE YOUR EXPENSES

Household expenses generally fall into two main categories. Non-negotiable expenses are the expenses you must pay, such as your mortgage or rent, utilities, phone service, and insurance. Groceries and any personal or student loans also fall into this category.

Negotiable or discretionary expenses are for things you want but don’t necessarily need, such as premium cable service, dinners out, and pricey vacations. If your cash flow is negative, reducing discretionary expenses will help you get from red to black.

MAKE SAVINGS AN ITEM

Your budget should include “savings” as an expense category. Direct the money into an emergency fund, a retirement savings account, a college savings account (if applicable), etc. Your budget should also reflect your priorities. You don’t necessarily have to give up expensive splurges, as long as you can fit them into your spending plan.

It will probably take some tweaking to finalize a workable spending plan, but it is well worth the time and effort.

business-borrowing-loan

Business Borrowing

Like most business owners, you probably have high hopes for your company’s future. You want to expand, to add employees, and, perhaps, to open up other locations. You know that to turn these hopes into reality, you’ll need financing. But you also know that obtaining a small business loan is never a slam dunk.

How you approach the process of securing business financing can determine whether you get the money you need. Here are some ideas that may help make a difference.

FIND THE IDEAL MATCH
Not all banks lend to small businesses. And not all of those that do lend to small businesses lend to all small businesses. The ideal match for you is a banker who’s familiar with your industry and can discuss potential risks and make informed decisions.

LAY THE GROUNDWORK CAREFULLY
If you walk in off the street and ask for a loan, you may not be successful. If possible, build a relationship with a potential lender. If your plans call for borrowing a substantial amount in a few years, you can establish your creditworthiness ahead of time by setting up a line of credit or taking out a small loan.

SUBMIT YOUR BUSINESS PLAN
Regardless of whether you have a relationship with a prospective lender, you’ll need to submit a business plan along with your loan application. Be prepared to answer questions about the assumptions you’ve used to create your plan. You might want to take things one step further by projecting how your plan might play out in three different scenarios: best case, most likely, and worst case.

Another proactive planning move is to line up some secondary repayment sources (business or personal collateral, for example) ahead of time. It shows the lender that you acknowledge the risk your loan represents and that you already have a backup plan.

PROVIDE FINANCIAL INFORMATION
Potential lenders will want to verify your background and confirm that you have the necessary experience. They will also require extensive financial information, including both your personal and business credit histories. Be prepared to provide personal and business financial statements as well as cash flow projections for a year (or more, depending on what the lender requires).

spending plan

Smart Business Strategies for a Seasonal Business

Spring may still be weeks away, but if your business is seasonal — and your season is summer — it’s time to start getting things organized. The more you can do before opening day, the easier it will be to stay cool when business and the weather heat up.

GET YOUR FINANCES IN ORDER
Operating a seasonal business means having to squeeze a year’s worth of business into a few months and then make your earnings last the entire year. You have to resist the temptation to overspend when cash is plentiful. So, before you start scrubbing walls or unpacking boxes, make sure your business finances are in order.

Go over last year’s budget carefully to see what changes may be necessary. Run some financial projections. Then check your progress frequently during the season to make sure you’re on track.

REVISIT AND RETHINK YOUR MARKETING PLANS
Give some thought as to how you plan to market your business. If you’re adding new product lines or services for the coming season, there may be new markets you can tap. Think about tweaking your website to give it a fresher look. If your client base is mobile friendly but your website isn’t, it may be time to upgrade.

START HIRING EARLY
If you’re hoping to rehire some of last season’s newer workers, the sooner you get in touch with them, the better. Once you know how many vacancies you have to fill, you can even start advertising and interviewing.

FOCUS ON THE DETAILS
This is a great time to take care of any needed repairs and to put on that fresh coat of paint. You also have time to search for deals and compare prices, which could result in substantial savings. Shop for items you regularly keep in stock and any equipment you need to buy or replace.

Before you know it, summer will be here.

The Home-Sale Gain Tax Exclusion

A Big TAX BREAK
Who doesn’t love a tax break? The reality is that for many taxpayers, there aren’t too many tax breaks they can take. However, if you’re thinking the time is right to put your house on the market and it has appreciated in value, you may be eligible for one of the most valuable tax breaks of all — the home-sale gain tax exclusion.

THE NUTS AND BOLTS
Here’s how it works: If you make a profit when you sell your principal residence, all or part of your gain may be tax free. Eligible individual filers may exclude up to $250,000 of gain from their income; married couples filing jointly may exclude up to $500,000 of gain.

USE AND OWNERSHIP TESTS
In general, this tax break is available only once every two years. To qualify, you generally must have owned and used the home as your principal residence for at least two years (a total of 24 full months or 730 days) during the five-year period ending on the date of the sale. The ownership and use periods don’t necessarily have to coincide.

Only one spouse must pass the ownership test, although neither spouse may have excluded gain from a previous home sale during the two-year period ending on the sale date. As for the use test, both spouses must pass it.

REDUCED EXCLUSION MAY BE AVAILABLE
If you have to sell your home because of a change in employment, you move for health reasons, or there are other qualifying “unforeseen circumstances,” you might qualify for a reduced exclusion. The amount of the reduced exclusion is based on the portion of the two-year use and ownership periods you satisfy.

 

The general information provided in this publication is not intended to be nor should it be treated as tax, legal, investment, accounting, or other professional advice. Before making any decision or taking any action, you should consult a qualified professional advisor who has been provided with all pertinent facts relevant to your particular situation.   Content courtesy of Client Line Newsletter