Week 1 - Discussion 2

We commonly judge the acceleration capabilities of autontobiles by measuring how many

seconds it takes to get from zero to 60 mph. That's great for cars, but how would you lil're to see your taxes go from zero to 60%? You can get dangerously close. 'fhe culprit is capital gains.

'fhe f-ederal tax rate on long-term capital gains fbr a married filing jointly can be as low as 0% when taxable income is under $72,500. In contrast, a high income taxpayer with a short-term capital gain can see that gain subjected to a top marginal f'ederal tax bracket of 39.6'h, prlus thr: Medicare Surtax of 3.8%. If located in a state with a high .stale income tax, such as Neu' Yorh; and. then you add in a city income tax, such as New York City, that taxpayer's marginal tax rate

approaches 60%.

My point? Capital gains are not something you factor in afier deciding your business stnategy ... they are something that should be part o/'your business strategy from the very beginning.

Consider these planning opporlunities and how they are aflected by capital gains issues.

1. Selling your partnership interest: Somctimes a partner will sell a partnership interest without lactoring in the tax in-rplications oI"'hot assets." IRC 751 providcs that upon the sale of a parlnership interest, the selling paftner must dctcrminc which items if sold directly by the partncrship - would gencrate ordinary incomc.

'fhese itcms, com'monl)'

referrcd to as "hot asscts." include accounts reccivables, invcntory and ccrtaitl depreciable assets. A sale of a partner's interest that holds thesc assets may con"zert long

term capital gain into ordinary income. 2. Selling your business for its assets: Imaginc a purchaser offers you a premiurnr if you

agree to structurc the deal as an assct sale rather than a stock sale. Sounds good until 1'ou look at thc details. A seller is usually cntitlcd to pay taxes at thc lower capital gains rate with a stock salc. lf-an asset salc involves a corporation, the seller may incur double taxation bccause thc corporation will pay tax on thc gain liom thc sale ol-thc asset ancl then pay tax when the proceeds are distributcd to the selling owner. Keep in mind thal.

corporations don't have a long-term capital gain tax rate.

3. Stock options and stock grants: When designing inccntive stock plans, how you structure them al-fects how much tax the executive incurs. Qualified stock options havc

the advantage of long-term capital gains treatment, but may bc subject to altemative minimum tax. Nonqualiflcd stock options arc sub.jcct to ordinary income. When the

restriction on restricted stock lapses, the exccutivc is subject to ordinary incomc even i1-

this is an inopportune time for the executive's tax planning. Bad tax results can cast a pall

on slock incentives. 4. Business owner's personal tax: Whether long-term or short-term, a capital galLn is

factored into the dreaded 3.8% Medicare Suftax. The question is whether it is on top of a 20Yolongterm capital gain rate or a39.60/o rate for short-term capital gains. Further, timing is crucial because the 3.8% tax only applies when the taxpayer has exceeded a

threshold for modified adjusted gross income ($250,000 for married taxpayers). The

nature and timing of a business sale can greatly affect the business owner's overall rate of personal taxes.

5. Business owner's estate plan: One of the bigger recent changes in business owner elstate planning has occurred because of the federal estate tax. A manied couple can now pass

on as much as $10.680,000 without incurring the 40o/o federal estate tax. Now that the

estate tax applies to fewer business owners, planners are focusing more on inconle taxes'

If a business owner passes on a business at death, the income tax basis "steps up" to date

of death value. The iamily can essentially sell the business free of capital gains. If,

instead, the business owner gifts the business to the family during his/her lif'etime, the

income tax basis carries over. A sale could then trigger a sizeable capital gain. Ilecause

many business owners can now avoid both income anel estate taxes, estate plans are be'ing

reviewed and reviscd.

Learning more

Delegation is great; abdication is not. It may be useful to lcarn more about capital gains and how

this tax regime can affect your business decisions. Even if you have a great "tax person," you rlan

only benefit by being acquainted with concepts such as capital assets. holding periods a.nd tax

basis. your awareneis lcads to better questions fbr your tax advisor, which in turn leads to better

tax-informed business strategies. The value of the tax advice you receive is augmented by the

lime and trust youconfer o.rlou, advisors. Time allows your advisors to work with capiital gains

income in a way that leverages holding periods and tax years. Trust allows your advisors to

un<lerstand the ;'big picture'; {br your plans and where oapital gains fit into the se plans.

'fhe more

candid the information, the morc your advisors can takc a holistic look at your goals.

With goorl tux plunning you can deccleruta lhe rulc yttu poy on capilal guins' Puying u rale

closei to zerrs is bettei thbn paying close lo 60'%,. Who krunt,s, maybe you can save erutugh on

capital gains to affbrd u car lhul does greal going.fiom zero to 60!