Keeping records of important paperwork is a necessary evil, especially when preparing to do both personal and business taxes. But it doesn’t have to be a necessary headache. Let’s narrow down which documents you should hang on to versus ones you can throw away for good.

Unless you’re a manager in an accounting or finance firm, working capital may be a foreign term to you. With today’s ever-shifting economy, it’s important to understand the benefits and complications that arise from managing working capital.

By implementing sound principles of saving and investing, average people – with average salaries and expenses – can build wealth. For most people wondering how to build wealth, it may be a lot like cooking stew in a crock pot. Two ingredients are required: discipline and time.

• Time harnesses the power of compound interest. Simply put, compound interest is the money gained by leaving your dollars invested. It’s interest earned on the interest. Say, for example, you put $1,000 in an investment earning 5% annually. After the first year, your account balance will have grown to $1,050. Leave your money invested, and by the end of the following year you’ll have $1,102.50. You make more money the second year because you also earn interest ($2.50) on the first year’s interest ($50).
• The sooner you start investing, the less you’ll need to save. Take, for example, two fellows named Tom and Jerry. Both are 18 years old. Tom paid attention in accounting class and started saving $100 a month. For ten years he contributed to a relatively conservative mutual fund that earned 7% annually. At age 28, Tom lost motivation and stopped saving.

Jerry, on the other hand, was a party animal. For the first ten years after high school, he spent every penny he earned. But at age 28, he got discipline. He started saving $100 each month, the same amount Tom had been saving for ten years.

By age 65, who comes out ahead? Tom is the clear winner with about $230,000; Jerry places second with $210,000. Consider that Tom saved $100 a month for ten years ($12,000) and Jerry saved the same monthly amount for 37 years ($44,400). Why did Tom end up with more money? Because his funds were invested longer. The power of compounding amplified his investment. (By the way, had Tom invested $250 a month from age 18 to 65, he’d have over a million dollars by age 65.)

Are you wondering how to build wealth? Cray Kaiser can help you with tax and financial planning strategies. Contact us today!

Estate tax planning looks much different than it did in the past. In prior years, estate planning often focused on minimizing taxpayer’s estates as exemptions were low and federal estate tax rates were as high as 77%. Today, the top marginal federal estate rate is 40%. The American Taxpayer Relief Act of 2012 (ATRA) made permanent the generous $5,000,000 federal transfer tax exemption, which is indexed yearly for inflation. This means an individual can die with $5,430,000 in assets and owe no federal estate tax. ATRA also made “portability” permanent. Portability permits a married couple to fully utilize both a taxpayer and a spouse’s combined exemption ($10,860,000 in 2015) by letting the surviving spouse claim any unused portion of the deceased spouse’s exemption as long as an estate tax return is filed. With these permanent changes, the Tax Policy Center projects that only .14% of adult deaths will result in federal estate tax.

At the same time, federal income tax rates are at higher levels – top rates are 39.6% for ordinary income items, 20% for capital gain items, plus the potential of an additional net investment income tax of 3.8%. Given the changing tax environment, one must now carefully consider the estate and income tax rate differentials when putting together an estate plan.

An important concept to understand when discussing estate and income tax planning is the “step-up” in basis. When a person dies their heirs receive a step-up in the tax basis of most inherited assets. The new tax basis is equal to the fair market value of the assets held by the decedent at the date of death. For example, if the decedent owned 1,000 shares of stock that they purchased for $10,000 in 1983 but was worth $100,000 when they died in 2015, the basis to the heirs is stepped up to $100,000. (Note that the decedent would also be subject to estate tax on the $100,000, if applicable). When the heirs sell the stock a few months later they will likely recognize little gain or loss, as compared to the $90,000 gain the decedent would have realized if they sold the stock right before they died. If the decedent were to have given the stock to the heir before he died, the heir would have to take on the basis of the donor, resulting in a $90,000 gain to the heir.

Planning for achieving the maximum step-up in basis of family assets at death has become more important than ever especially considering that most estates will not be subject to estate tax. It would make sense to hold onto highly appreciated assets, such as stock and fully depreciated real estate investments in order to obtain the basis step-up. An important item to note – step-up does NOT apply to many retirement accounts, such as IRA’s and 401(k)’s.

State estate tax considerations are just as important. For example, Illinois has an income tax rate of 3.75%. The estate tax rate is 8-16%; however, there is a lower estate tax exemption than the federal exemption – $4,000,000. Therefore, individuals with assets more than $4,000,000 and less than $5,430,000 will be subject to Illinois estate tax yet not to federal estate tax. As the estate tax rate will be less than the combined federal and state income tax rate in such a case, it would make sense for Illinois decedents in this asset range to maximize the value of their estates and minimize their income tax.

For married couples who will be comfortably below the $10,860,000 combined estate exemption amount, it would be wise to revisit existing trust agreements. Assets in a typical bypass trust (a staple in estate planning pre-ATRA) will not get a step-up in basis at the death of the second spouse. However, if you live in Illinois a bypass trust may make sense since Illinois does not honor portability. In addition, unless trust income is always distributed, the tax on the trust can be dramatic, as trusts reach the highest tax rate at $12,300 of income. While trusts may offer creditor protection and can offer protection in the event of a divorce of an heir, these benefits should be weighed with the potential tax consequences.

With the large federal estate tax exemption, the permanence of portability and the increase in income tax rates all brought about by ATRA, it is important to revisit your estate plan in light of income tax considerations. If you would like to discuss your estate plan, or have any questions on the information presented, please contact our office.

Changes to the federal income tax code can prompt you to review the legal structure of your business. The 2018 TCJA lowered the corporate tax rate to 21% while barely adjusting the highest individual rate to 37%. At the most basic level, businesses are taxed as either stand-alone or pass-through entities, and a significant difference between corporate and individual tax rates is reason for a new assessment.

If you’re debating between operating as a C corporation or an S corporation, here are three tax aspects to consider.

1.) Income taxes. A difference you’re probably aware of between the two types of corporations is the way earnings are taxed. C corporations are stand-alone entities and pay federal income tax at the corporate level, based on business earnings. If the corporation has a loss, the loss offsets business income in past or future years.

S corporation earnings and losses are passed through to you, as a shareholder. Earnings are taxed on your individual income tax return at your personal tax rate. This is true even if you receive no cash from the business. Losses can offset other types of income such as wages, portfolio, or retirement income.

2.) Ownership. Tax rules limit the number and type of shareholders who can own an interest in your S corporation. For example, an S corporation can have no more than 100 shareholders, and they must all be U.S. citizens or residents. In addition, your S corporation can issue only one class of stock, meaning all shareholders have the same liquidation and distribution rights. When you form a C corporation, foreign owners can hold stock in your business. You can also issue stock with different ownership privileges, such as preferred stock, which grants priority in receiving corporate dividends.

3.) Dividends and distributions. In general, when corporate income is distributed to you as a shareholder, the distribution is a dividend. Whether your corporation is formed as a C corporation or an S corporation, the business gets no deduction.

However, as a C corporation shareholder, you’re required to include income distributions on your personal tax return. In effect, distributions are taxed twice, once on the corporate return and once on your return.

When you own stock in an S corporation, distributions can be considered a return of the money you invested in the business (and has already been taxed at your personal level). The distinction means you may not owe income tax, assuming you have basis in the corporation.

Many tax and nontax reasons will affect your choice of the best type of structure for your business. Please call our office for a complete evaluation.

One of the greatest perks of owning a small business is flexibility. You can set your own hours and salary. You can plot the firm’s trajectory without consulting your boss, upper management, or even corporate policy. But that same flexibility may become a curse if handled unwisely. A small business owner without discipline and a well-thought-out strategy may fall into serious financial trouble. Employees in larger firms often rely on the human resources department to establish pay scales, retirement plans, and health insurance policies. In a small company, all those choices – and many more – fall to the owner, including decisions about personal compensation.

How to Set Your Salary

While there’s not a one-size-fits-all formula for determining how much to pay yourself as a business owner, here are three factors to consider:

Personal expenses. Tracking your business and personal expenses separately makes it easier to track the firm’s cash flow, and lets you know how much salary you can realistically draw without hurting profitability.

Start with your household budget, then determine how much you’re willing to draw from personal savings to keep your household afloat as the company grows. For a start-up company, owner compensation may be minimal. Beware, however, of going too long without paying yourself a reasonable salary. Be sure to document that you’re in business to make a profit; otherwise the IRS may view your perpetually unprofitable business as a hobby – a sham enterprise aimed at avoiding taxes.

The market. If you were working for someone else, what would they pay for your skills and knowledge? Start by answering that question; then discuss salary levels with small business groups and colleagues in your geographic area and industry. Check out the Department of Labor and Small Business Administration websites. In the early stages of your business, you probably won’t draw a salary that’s commensurate with the higher range of salaries, but at least you’ll learn what’s reasonable.

Affordability. Review and continually update your firm’s cash flow projections to determine the salary level you can reasonably sustain while keeping the business profitable. As the company grows, that level can be adjusted upward.

If you’re not sure how to set your salary, please contact Cray Kaiser today. We’re here to help!