SELL YOUR COMPANY OR OTHER ASSETS

AND PAY NO TAX!

By: Richard M. Colombik, JD, CPA

Richard M. Colombik & Associates, P.C.

Retirement time. Your company, investment real estate or other business has matured, time to cash out and sell. It has taken a long time, and since you have held your shares for greater than one year, the gain qualifies for long term capital gain taxation, currently at a 15% federal income tax rate!

Yet, 15% of a $1,000,000 gain is $150,000. With a $2,000,000 gain it is $300,000. That is still a lot of funds that could be used for retirement.

Is there a way you can still sell the company and legally not pay any taxes today and still not run afoul of the Internal Revenue Service?

You spoke with you accountant and your attorney, but they are telling you how great it is that you are cashing out and capital gain rates are low, so why not pay the tax?

But if you pay $150,000 of tax, on a $1,000,000 gain, you have less money to invest, than if you did not have to pay the tax. The investment return on $150,000 at a municipal bond rate, now about 4% is $6,000 a year. 10 years of investment return, without compounding interest on $150,000, is $60,000. Do you want to give away $60,000?

Of course not, and here is how to save the money and sell the assets. (This works for any type of business, real estate, and any type of asset)

A well established, IRS approved technique, that is in the Internal Revenue Code, case law, revenue rulings and treasury regulations is available. It is a version of a conventional insurance product, an annuity, and it is normally done privately, not through a commercial firm. Hence, it is called a Private Annuity.

You could have a spouse, a child or other interested party set up a company, corporation, Limited Liability Company or other entity that would provide you an annuity contract.

Let’s address what an annuity is and how it works.

First, most people are familiar with an insurance product called an annuity. An annuity is a contract, generally with an insurance company, where you provide the company a sum of money. The insurance company agrees to make payments back to you over a set time frame. You would decide when the payments to you, would start and how the long the time period the payments would continue for. You would also decide if the payments would be measured by your life span, or by the life of an another, such as your spouse.

You would first select a starting date for the annuity payments to begin. If the payments begin immediatley this type of annuity is called an immediate annuity. The payments however, could began at any point in time you agree to, such as in five years, ten years, next week, or next month.

Second you would select how long the payments would continue for. If you want the payments to continue for your life, the term is referred to as a life annuity. If you selected the measuring period for payments to be you and a spouse, the term is referred to as a joint life annuity. You could also select a specific time period, or a term certain, such as ten years, twenty years or whatever term of years you require.

Each variable as to the starting date, the amount of time the annuity will be paid for, a certain term, versus a life time, a guaranteed return versus a variable term all will affect the amount of each payment you receive.

Annuities are approved within IRC §72. It allows a person to transfer property to another and receive back a stream of payments. Each payment that you receive from the annuity company will contain two or sometimes three components. The components are:

return of principal, (your cost basis)

capital gain, (depending on the property transferred) and

interest or investment income.

Now that you know this exists, why does this device allow your to incur no immediate income tax?

What makes this work is two factors:

1. The creation of an annuity usually is not a taxable event.

2. Every payment of the annuity has a fixed fractional component that consists of your taxable gain, a portion that is your return of capital, and a portion that is ordinary income.

Let’s apply this to your hypothetical sale of company stock.

You transfer $1,000,000 of stock, which cost you $10,000 (for example), for a $1,000,000 annuity. At this point, have a promise to have money paid to you, but you have not received any money. The company or party your transferred your shares to, “the annuity company”, now owes you a $1,000,000 annuity. Therefore the annuity company’s cost basis in your shares is $1,000,000, the amount they owe you.

The annuity company, now sells your shares to the seller that you have previously negotiated with to buy your shares for $1,000,000. The annuity company, not you personally, sells the shares for $1,000,000. as the annuity company has a $1,000,000 basis, the amount it owes you. The annuity company has no taxable gain as it sold the stock for the same amount it agreed to pay you for such shares, $1,000,000.

You would have no taxable gain, as the annuity company has not yet paid you for the stock! Hence, the sale occurred, no tax has been paid and $1,000,000 will be invested, with the principal and earnings available to make annuity payments to you!

In a conventional annuity, you would make a transfer of cash to an insurance company in exchange for the insurance company’s promise to pay you back the funds, with earnings in the future, the annuity. With a business sale, you would transfer your company shares to a private annuity company, possibly owned or controlled by younger generation family members, in exchange for the annuity company’s promise to pay you back the funds with earnings in the future. The promise and annuity contract, would be similar whether the transfer is to a publicly held insurance company or a private annuity company. But, with a private annuity company, not only income tax savings can accrue, but with the proper structure, estate tax savings can occur as well! Also, a commercial annuity company will not generally accept closely held corporate stock as a vehicle to fund an annuity.

A few words of caution:

1. The annuity must be properly written,

2. The interest rate, fair market value, must be per IRS tables,

3. The transfer of shares and control must be actually made, and

4. You can not control the annuity company.

If you follow the appropriate steps, have the transaction drafted by a tax law firm familiar with how the structure operates, you can accomplish many goals, save tax to boot, and not have the IRS looking over your shoulder!

Tax Planning is not dead, but the IRS is trying to make it hard to find available vehicles, but also the firms that are able to navigate their way through the murky waters of the Internal Revenue Code!