Year End Tax Planning – It’s Never Too Late!

We live in exciting times (an understatement)! Among other things, all of us are poised for such major changes to the tax system. It seems inevitable.  At a minimum, without an extension of the Bush tax cuts, high income earners will face a federal tax increase of 3.6 percent. On top of that, ObamaCare carries with it a Medicare tax of 3.8 percent for top income earners which becomes effective in 2013. All of this before any tax change!

All kinds of rumors have flourished over the last several weeks about significant tax changes in the estate and gift tax system. All of that is well and goos, but your tax year ends in a month and you are faced with two realities – (1) You have done well and you need to write a big check to Uncle Sam or (2) Uncle Sam is holding already alot of your money through estimated tax payments or withholding tax and you would like to get some of that money back.

As all of us are staring Year End in the face.  The question that you may be asking yourself is “What can be done” at this late stage. I would like to focus on a few strategies over the course of the next several weeks that might create an avenue for holding on to your money. In these times, you need to hold on to your money!

This Post will provide an initial overview to three strategies that you might consider.

(1) Strategy # 1- Charitable Limited Liability Company (LLC)

This is a strategy that can work for any taxpayer – self employed or statutory employee with only W2 income. This charitable tax planning strategy works very well for the reluctant philanthropist. The reluctant philanthropist is someone who genuinely would like to help a charity but not necessarily right now  because he does not think that he can afford to give a subtantial gift to charity.

The tax law allows an individual to take a tax deduction for contributions to a public charity. The Charitable LLC involves the creation of a LLC by the individual taxpayer. The LLC is managed by a Manager (the taxpayer).  The business purpose for the LLC is the consolidation and management of family investment assets. This is a legitimate business purpose under federal tax law and state law. The taxpayer capitalizes the LLC with cash and/or marketable securities or any other capital asset. The taxpayer retains a one percent managing member interest and makes a tax deductible contribution to a Public Charity – a IRC Sec 501(c)(3) organization or a Donor Advised Fund which is a form of public foundation – of a 99 percent interest in the LLC.

The taxpayer is able to take a deduction on Schedule A of the Form 1040 up to 50 percent of adjusted gross income (AGI). Any excess unsued deduction may be carried forward for an additional five tax years. The charitable deduction is not a preference item for Alternative Minimum Tax (AMT) purposes.

The Charitable LLC has many benefits- (1) the taxpayer is able to maintain control of the LLC assets through retention of the Managing Member interest (2) The Manager is able to take a reasonable management fee for management of the LLC or defer this fee until a later period (3) The Manager is able to control the investment management of the underlying LLC assets. (4) The Manager is able to have full discretion over when and how much to distribute to the Public Charity. Distributions to the charity  should be regular and consistent.(5) The Manager may make arms-length loans as Manager of the LLC. (6) The Charitable LLC income is 99 percent income taxc free. (7) 99 percent of the Charitable LLC assets are outside of the taxpayer’s estate for tax purposes. (8) The Charitable LLC also exempts 99 percent of the assets from creditors. (9) the taxpayer may perpetuate this arrangement for multiple generations.

At the end of the day, it is all charity. Either you allow Uncle Sam through the public welfare system to determine how to allocate your tax dollars, or you can retain the control over which public charity; how much to distribute and when to distribute. The choice is your’s!

2. Strategy #2 – Family Defined Benefit Plan

An Employer’s contributions to a qualifed retirement plan are tax deductible. The type of retirment plan that allows for the largest tax deductible contributions is the defined benefit plan. Unless you work for the federal or state and municipal government, you are not likely to have this type of pension plan which provides for a guaranteed retirement benefit. It is a great deal and has always been a great deal. Specifically, a fully insured defined benefit plan authorized under IRC Sec 412(e)(3) is what we are focused on here. It provides by far the largest contributions while providing guaranteed retirement benefit. The funding vehicles for the Plan are life insurance company annuity and life insurance contracts. This type of plan can work well for you if you have self-employment income or a company with only a few employees.

The Family Defined Benefit Plan is designed to provide an opportunity for either the self-employed individual or statutory employee with W2 income. It is a creative planning application of the defined benefit plan. The technique outlined here requires investment income separate and apart from earned income. The Plan calls for the creation of a Family Limited Liability Company that is formed to consolidate and manage family investment income. It is a valid business purposes for both federal and state law purposes. The income to the LLC is the family investment income.

The LLC forms a new qualified retirement plan for the LLC. The taxpayer takes a salary or guaranteed payment from the Family LLC which becomes the basis for the LLC’s contribution into the newly formed Fully Insured Defined Benefit Plan for the taxpayer. The LLC may also add a 401(k) plan as well as a profit sharing plan on top of the defined benefit plan. This technique allows the retiree or W2 employee to create a business (Family LLC) and form a retirement plan separate and apart from the taxpayer’s Employer.

The pension rules are very complex and technical. Each situation must be separately evaluated. Nevertheless, the Family Defined Benefit Plan allows the taxpayer to make very substantial tax deductible contributions and defer taxable income while providing for a guarantedd retirement benefit. These benefits should mean something in a time when many people have lost 40-60 percent of their portfolio and 401(k)s.

Two quick examples to drive the point home. Husband (68) and wife (age 65) with $3 million dollars of rental income and no retirement plan, form a Family LLC and each take a salary/guaranteed payment of $245k. The conbined tax deductible contribution for the couple is $1.5 million with annuity and life insurance contracts issued by a top life insurer. Each with a guaranteed retirement benefit of $195k per year beginning in five years. A second example. An American Ex-Pat (age 51) living and working in London with his own business is able to make a tax dedutible contribution into a Plan of $400,000. He is able to add a 401(k) and contribute and additional $22,000. On top of that, he is able to add a profit sharing plan with a contribution equal to six percent of $245,000 or $14, 700.

3. Strategy 3- Closley Held Insurance Company aka Captiver Insurance Company

Tax laws not only favor the taxation of insurance products but also favor the taxation of small property and casualty life insurers. A captive insurance company is a licensed insurer that primarily insures risks of a parent and sister company. The captive typically insures customized low risks that are non-catostrophic. These risks may under-insured or excluded from the business’ existing property and casualty coverage.

The Captive is set up by the business owner. The business owner or a family trust may own the shares of the captive. Premium payments to the captive are income tax deductible by the business. Small property and casualty insurers pay little or no taxes on premium income. The business owner is able to manage the captive using a captive management company that for a fee manages all facets of the formation and operation of the captive. the captive may be set up domestically in a state like Delaware, Nevada or South Carolina or offshore in jurisdiction such as the British Virgin Islands – Cayman Islands, St. Lucia, Nevis.

The business owner is simultaneuously able to manage business risks while controlling costs and claims. At the same time, the business owner is able to accumulate assets inside of the captive in a tax deferred manner. The business owner may receive compensation from the captive inthe form of a salary,director’s fee or dividends. The  sale or liquidation of the captive will be treated as a long term capital gain for tax purposes.


I have provided a brief outline of a few techniques that can reduce your tax exposure in 2011. It is not too late and time is of the essence. These techniques have a lot of intricacies and will be the subject of many posts on this blog between now and the end of the year – 12/31/11. Stay tuned!!!


About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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