Successful business owners and professionals often have maxed out the tax deductible and elective deferral contributions to their qualified retirement plans, such as profit sharing, 401k, or Simplified Employee Pension (SEP) type plans. Often, this prompts questions to their financial professional on whether there are plans that could provide additional supplemental retirement income. Is there a simple plan that can be offered selectively to SCorp, C Corp, or LLC shareholder-employees that can provide a special benefit plan just for the business owners on a tax-favored basis?
Yes. A non-qualified benefit that can be offered selectively, may provide a valuable retirement supplement to the business owner. For instance, the business owner may have reached the 2016 limit of $18,000 for contributions to the company 401k plan. Participants age 50 and over can increase their contribution limit to $24,000 by taking advantage of the $6,000 catch-up provision. What else can be done for this business owner without including employees in the plan?
The plan that could be attractive is known as a Section 162 Executive Bonus Plan which can be selectively provided to the business owner. The financial product that may provide the best accumulation vehicle for a supplementary retirement benefit is a specially designed life insurance product that takes advantage of the tax-favored benefits of life insurance found in the Internal Revenue Code (IRC).
199A is a new internal revenue code section that was introduced as part of TCJA. Starting with the 2018 tax year, 199A allows a 20% deduction on the Qualified Business Income (QBI) of owners of certain pass-through entities.2 The 199A deduction is by far the most complicated part of TCJA and the business owner’s tax advisors must always be whom the business owner
Most, if not all, of the provisions of TCJA for individuals (i.e. non-corporate) taxpayers expire on January 1, 2026. 199A is no different. That means that owners of pass-through entities that qualify for the deduction have it through the end of 2025.3
QBI is, in essence, the profits of the business that flow through to the business owners. It does not include wages or other income derived from other sources by the business owner. The determination of what is considered QBI is very complex and will vary by business. For example, for some S-Corporation owners, the QBI may be the K-1 or pass-through income that they receive from their business. For some LLC owners or partners in a partnership, all of the income generated by the business may be considered QBI. Business owners need to work with their CPAs and their tax advisors to determine how much, if any, of their income is considered QBI.
No, and this is where 199A gets really complex. If the business owner’s taxable income is under $ 315,000 * if they are married, or $ 157,500 * if they are single, they will get the 20% deduction on their QBI. It doesn’t matter where the income comes from (e.g wages, investments, other sources of income), it is the total taxable income that matters, not just the income derived by the business. Once they pass over that income threshold, then businesses are split into two categories: businesses that are a specified service trade or business (SSTB) and those that are not. For the 2018 tax-year, owners of SSTBs start to get phased out of the 199A deduction at that $ 315,000 * income limit (assuming they are married and filing jointly) and they are totally phased out at $ 415,000. * This means if their total taxable income is over $ 415,000, * their 199A deduction will be zero. The Non-SSTBs do not have this limitation, but once they pass the same income threshold ($ 315,000 * for a married filer in 2018) they have their own test that they must pass in order to get the deduction, called the wages and capital test. Their 199A deduction is the lesser of (1) 20% of QBI, or (2) the greater of: (a) 50% of the W-2 wages for the business, or (b) 25% of the W-2 wages plus 2.5% of the business’s unadjusted basis in all qualified property.4 I wasn’t lying when I said it is complex. Again, it will be imperative that business owners work with
their CPAs and tax advisors to determine what, if any, 199A deduction they are eligible for
An SSTB is any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. Essentially, businesses that you would traditionally think of as personal-services businesses are going to be considered SSTBs. The technical definition provided by the proposed 199A regulations is: (1) any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is
the reputation or skill of one or more of its employees or owners, and (2) any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).5 So, stepping back and looking at the technical definition of an SSTB, doctors, dentists, orthodontists, attorneys, CPAs, consultants, and financial planners would clearly be examples of SSTBs.
Their options are extremely limited. When 199A first became law, a number of legal practitioners had the idea that if you split up an SSTB business into several pieces, some of the business may be able to qualify for the 199A deduction while other pieces wouldn’t. The proposed regulations on 199A would seem to foil this idea for most pass-through businesses.6 Other legal practitioners had the idea that you could move ownership of an SSTB into a series of non-grantor trusts, each of which would have taxable income below $ 315,000 *, thus preserving the deduction.7 The proposed regulations also seem to have foiled this idea.
Without getting too complex, the only realistic option that many SSTB owners have to try to qualify for a 199A deduction is to reduce their taxable income. This could potentially be done at the personal level (e.g. charitable deduction), but would most likely be more successful at the business level. Owners of SSTBs that are just above the threshold where they are phased out of the 199A deduction may look for any business expense that they could find that is currently tax deductible. For some businesses, this may mean making additional capital expenditures. For others, it may mean increasing compensation for their employees. For many SSTB owners, the best option may be the implementation of a qualified plan, such as a split-funded defined benefit plan.
An SFDB plan is a type of defined benefit qualified retirement plan that is funded with traditional investments, such as mutual funds and life insurance (more on this later). Defined benefit plans, such as an SFDB plan, define the retirement benefit that is paid to the participant upon retirement. SFDB plans can provide the same maximum retirement benefit as other defined benefit plans. An SFDB plan, like other defined benefit plans, may provide a maximum lifetime annuity
payment of $ 220,000 a year8 starting at retirement or a specified age and continuing for the rest of the participant’s lifetime. Contributions to SFDB plans may be tax-deductible for the sponsoring business and the benefits are only taxed to the participants when distributions are made.9 An SFDB plan may be a good strategy for a small business owner with ten or fewer nonowner employees because of the small size of the business’s work force. Since the business
owner has to make the SFDB plan available to most, if not all, of the eligible employees to comply with the minimum coverage and minimum participation tests, providing the plan to a larger workforce would offset the tax-savings that would result from implementing an SFDB plan.
Living Benefits provide access to cash from a life
insurance policy that can be used while you are alive.
Living Benefits are also known as Accelerated Death
Benefits. Benefits are based on an insured incurring a
chronic, critical, or terminal illness as defined in the policy.
Refer to the policy contract for complete requirements.
Living Benefits and Accelerated Death Benefits are terms used interchangeably on a life insurance policy. Both offer access to funds that can be used for chronic, critical and terminal illnesses. When you choose to use your living benefits, you are accelerating your life insurance policy’s face amount so that you can use the funds while you are alive.
There are several factors that determine the amount of money you will receive. These factors include:
The face amount you choose to accelerate from your policy.
Your life expectancy as determined by the Company, which is based on age and overall medical condition (as impacted by the severity of your illness).
Accelerated benefit interest rate in effect (used to determine the present value of future benefits and premiums).
Any administrative fees assessed.
Here’s an example of an estimated Critical Illness Accelerated Death Benefit:
The benefit amounts shown below are estimates based on a Trendsetter LB 30 policy, with a face amount of $200,000. 90% of the $200,000, which is $180,000, was accelerated for this example. Benefits are based on the severity of illness and the impact on remaining life expectancy.
The longer you are expected to live, the lower the benefit you will receive. The shorter you are expected to live, the higher the benefit you will receive. The remaining amount of the face amount will be $20,000, which is the remaining amount after the maximum of 90% was accelerated from the face amount.