If I Were You!


My day job has kept me from writing in the last two weeks so I hope to add a few timely posts with year end approaching so quickly. I wanted to outline in this post some of the things that I would consider as part of my year end tax planning and tax planning arsenal going into 2014 if I were you.

Medical Expense Reimbursement Plan (MER)
Everyone one of you has out of pocket medical expenses that you probably can’t deduct on your personal tax return. This problem has only increased in recent years with higher deductibles on most plans. Why? For starters, maybe you don’t itemize deductions on Schedule A on Form 1040. The only way to deduct these expenses might be a MERP. The more obvious reason might be that your medical expenses don’t exceed the threshold of 7.5 of Adjusted Gross Income (AGI) threshold. At the same time, these deductions are a preference item for AMT purposes and might throw you into a higher tax bracket. Retirees with large out of pocket medical expenses can easily adopt this strategy.

You may say “Who cares?”. If you are in a 40 percent tax bracket – federal and state – and have $10,000 of out of pocket medical expenses (including Junior’s braces so that he does not have a smile like Mr. Ed), you will need to earn $14,000 to net the $10,000 after-taxes. The savings are $4,000 in my example. Some people can afford to throw this type of money away but even the people that can, don’t like to.

If you are a W-2 employee working for the Man (your Company), here is what you need to do? Create a company or LLC. If if is an LLC, make your spouse an employee of the LLC who only works for benefits. The technical reason is that tax law would limit the ability of a more than 2 percent shareholder, member in a LLC or partner in a partnership from directly participating as an employee in certain benefit arrangements. Take it on faith for now that I am not a tax fiction writer.

If you are a sole proprietor, on a consultant with a LLC and with or without employees or making money or not, you should implement the MERP strategy without hesitation. The Plan will allow you to deduct out of pocket medical expenses of every type – co-pays, co-insurance, deductibles, etc. It is my impression that every taxpayer has this problem.

The MERP allows the business to deduct the out of pocket expenses – 100 percent. The MERP payments are not subject to employment taxation. Lastly, the reimbursements are not taxable to you individually.

How to set the MERP? First, call me. Second, set up a new LLC if you don’t have an existing business. Third, complete the documentation to set up the MERP. Not to worry, I have those documents. Simple and low cost to set up and operate. I can do all of these things for you at a nominal fee.

Family Defined Benefit Plan

If you have investment income taxed as ordinary income – short term capital gain, interest or partnership income, you can easily convert this income in to a format that can become a contribution into a new defined benefit plan. Here is an example. Joe has a job in corporate America and has W-2 income. He has discretionary investment income of 100k taxed at ordinary rates. Joe’s combined federal and state marginal tax bracket is 45 percent. Joe and his wife are both 50.

Joe and his wife create a family investment LLC. It could be the same one that you set up for the MERP. Joe pays his wife a salary of 25,000 from the LLC. Joe takes a management fee of $25,000. The LLC adopts a 401(k), profit sharing
and cash balanced defined benefit plan with a medical savings account. Joe’s wife is able to contribute $23,000 in to the 401(k) Plan – the regular contribution of $17,500 with a catch up provision of $5,500. The LLC is also able to contribute an additional $1,500 into a profit sharing plan. The company is able to contribute $28,000 into a cash balance defined benefit plan for a retirement payout equal to percent of her highest three year’s salary average. The LLC is also able contribute an additional $9,250 into the Medical Savings Account. The total contributions for Joe’s wife are $61,740.

Joe participates in the 401(k) of his company. He can continue to contribute up to a level that maximizes his employer’s match and contribute the balance into the LLC 401(k) plan. The LLC can make a profit sharing, cash balance defined benefit and medical savings account contribution. These contributions not counting the 401(k) are approximately are $38, 740. The combined contributions for Joe and his wife are $100,740 sheltering the entire amount of investment income.

The contributions are fully tax deductible. The investment earnings are tax-deferred until distribution. These plans are self-directed meaning, you get to manage the investments for better or worse. At retirement, Joe and his wife can take a retirement annuity or rollover to their IRAs.

Charitable LLC

You have high taxable income and really don’t have any other practical outlet for tax planning purposes. You work for a Company, and have a business with too many employees etc. The idea here is to create an investment LLC. Capitalize the LLC with cash and marketable securities. Contribute a 99 percent non voting LLC interest in the LLC to a Donor Advised Fund (DAF). The DAF is a charitable foundation administered on your behalf by a 501(c)(3) charity for your benefit and the charities that you sponsor. You retain a controlling interest and continue to control the LLC and LLC assets.

You retain a management fee for the performance of your duties as managing member. As managing member, you decide how much and when too distribute cash or dividends to the DAF. In my example, you receive a deduction up to 50 percent of AGI for the charitable contribution. In my example, 99 percent of the investment income of the LLC will be tax-free. You opt to defer your management fee because The Man is paying you so much. The operating agreement allows the managing member to borrow from the LLC on an arms-lenght basis, i.e. commercial terms.

In summary, similar to a pension plan, you receive a deduction that can be up to 50 percent of your AGI. You create a long-term legacy for your favorite charities through the DAF. You control the distributions to the DAF. Virtually all of the investment income is tax-free.The LLC assets are protected from your personal creditors. Lastly, you retain full management and investment control over the assets. If that weren’t enough, you can add the MERP and Family Defined Benefit Plan in subsequent years.


I know that I should have told you about these things a month ago. I did!!! It is not too late to implement these strategies for 2013 but you need to move quickly. Call me at (860) 404-9401 or send me an email at Grnowotny@aol.com if you have any questions on these strategies.

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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