The power of utilizing the Qualified Small Business Stock (QSBS) exemption cannot be overstated when it comes to strategic tax planning and wealth accumulation. By harnessing the QSBS exemption, investors have the opportunity to significantly reduce, and in some cases entirely eliminate, their capital gains tax liability.  With proper estate planning, you can multiply these benefits many times over.

What is Qualified Small Business Stock? QSBS refers to a specific tax incentive provided under Section 1202 of the Internal Revenue Code in the United States. QSBS is designed to encourage investment in small businesses by offering significant tax benefits to investors who hold eligible stock in qualified small businesses.

Key Requirements for QSBS:

1. Definition of Qualified Small Business: To be eligible for QSBS benefits, the issuing corporation must be a “qualified small business” at the time the stock is issued.  A qualified small business typically meets the following criteria:

• It is a domestic C corporation (not an S corporation or LLC).
• Its gross assets do not exceed $50 million both before and immediately after the stock issuance.
• It must be engaged in an active business, with specific exclusion for certain types of businesses, such as service-based businesses.

2. Holding Period Requirement: To qualify for the tax benefits associated with QSBS, investors must hold the stock for at least five years.

If you happen to meet these requirements, the primary benefit of QSBS is the potential exclusion of a percentage of the capital gains realized upon the sale of the qualified stock. This exclusion percentage is 100% of the qualified gain if you acquired the stock after September 27, 2010.  If you acquired it before then, it will be either 50% or 75% depending on acquisition date.

The easiest way to understand the potential benefits of QSBS is by running through an example.

Scenario: Suppose you invested in QSBS by purchasing stock in a qualified small business that meets the QSBS criteria. After holding this investment for more than five years, you decide to sell the QSBS shares, resulting in a capital gain of $10 million with 100% exclusion.

Without QSBS: If you were subject to the long-term capital gains tax rate of 20% without the QSBS exclusion, you would owe $2 million in federal capital gains tax ($10 million x 20%).

With QSBS: In this hypothetical scenario with a 100% QSBS exclusion, you can exclude the entire $10 million capital gain from federal capital gains tax. This means you would owe zero federal capital gains tax on the $10 million gain. (You may still owe state income tax)

As you can see, in the scenario above, you could potentially save up to $2mm in capital gains tax by utilizing the QSBS exemption. 

Powering up through QSBS Trust Planning: Duplicating the benefits of the Qualified Small Business Stock (QSBS) exclusion through trusts for family members can be a complex but effective tax planning strategy. The idea is to leverage the QSBS exclusion for multiple family members while complying with relevant tax rules and regulations. Here’s how this can work:

1. Multiple Trust for Multiple Family Members:
   • Establish separate trusts for each family member you wish to benefit from QSBS. These trusts should be irrevocable trusts, such as grantor-retained annuity trusts (GRATs) or intentionally defective grantor trusts (IDGTs), depending on your goals.
2. Transfer QSBS into each trust:
   • Transfer QSBS shares into each trust. These shares should meet the QSBS criteria, including the five-year holding requirement.
   • A valuation of the shares will be required and you could also get the added benefit of a valuation discount upon transfer to the trust.
3. QSBS Exclusion for each trust:
   • If each trust qualifies for the QSBS exclusion, each trust may be eligible to exclude a portion or all of the capital gains from federal capital gains tax when the QSBS shares are sold.
4. Unique Terms for each trust:
   • Each trust can have its terms and beneficiaries. This flexibility allows you to tailor the trusts to your specific objectives, such as providing for different family members or generations.
5. Compliance with tax rules:
   • Ensure that each trust complies with all relevant tax rules and regulations. This may involve careful structuring of the trusts, annual reporting, and adherence to IRS guidelines.
   • It’s crucial to work closely with tax professionals and legal advisors experienced in trust planning and QSBS to navigate the complexities and ensure compliance with tax laws.

Benefits: By duplicating the QSBS benefit across multiple family member trusts, you can potentially achieve several advantages:

1. Maximize QSBS Exclusions: You can utilize the QSBS exclusion for each trust, potentially allowing multiple family members to exclude significant capital gains from federal capital gains tax.
2. Wealth Transfer: This strategy can serve as a means of transferring wealth to multiple family members efficiently, allowing for a significant legacy or financial support.
3. Estate Planning: Trusts can be a valuable component of your estate planning, enabling you to structure the distribution of assets according to your wishes and minimize estate tax liability.
4. Tailored Planning: Each trust can be customized to the specific needs and goals of the family members it benefits.

It’s important to note that trust planning, especially involving tax-advantaged strategies like QSBS, can be intricate and should be approached with care. Tax laws and regulations may change over time, so it’s essential to stay informed and adapt your plan as needed. Consulting with professionals is critical to ensuring that your trust planning aligns with current laws and meets your family’s objectives.

Waldron Private Wealth (“Company”) is an SEC registered investment adviser with its principal place of business in the Commonwealth of Pennsylvania. Company may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. For information about the Firm’s registration status and business operations, please consult Waldron’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov.

This material is for informational purposes only and is not intended to be an offer, recommendation or solicitation to purchase or sell any security or product or to employ a specific investment strategy. Due to various factors, including changing market conditions, aforementioned information may no longer be reflective of current position(s) and/or recommendation(s). Moreover, no client or prospective client should assume that any such discussion serves as the receipt of, or a substitute for, personalized advice from Company, or from any other investment professional. Investing involves risk, including the potential loss of money invested. Past performance does not guarantee future results. Asset allocation and diversification do not guarantee a profit or protect against loss. Company is neither an attorney nor an accountant, and no portion of the web site content should be interpreted as legal, accounting or tax advice. 

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If the CARES Act did not add enough planning complexity to 2020, we now have a change in leadership at the presidential level.  With the recent election pegging Joe Biden as the next President, it is important to take a look at his legislative proposals and determine if there are any areas in which individuals should review their situation and make proactive moves.  While nothing is certain, especially with the Republicans holding the Senate, we recommend you review the following situations before the end of the year:

Taking additional income in 2020 

If you are at the top tax bracket, Biden has recommended increasing the tax bracket to 39.6% for those making over $400k.  If you are in that situation, and you have control over timing of your income, you may want to consider moving some to this year. 

Also, if your income is over $1MM, Biden has proposed increasing capital gains to the top tax bracket which could be 39.6%.  With the additional NIIT, that would be a total rate of 43.4%.  It may make sense to realize some or all of your investment gains now. 

Utilizing your lifetime gifting exemption 

Each individual currently can gift up to $11.58MM, or $23.16MM per couple without paying gift tax or future inheritance tax.  Biden has proposed lowering it to $3.5MM per individual and increasing the tax rate 5%.  If you are currently in an estate tax situation, you may want to consider utilizing the extra exemption now as the IRS has promised not to claw it back if legislation changes. 

Hold off on your renewable energy investments and electric vehicle purchase 

Biden has proposed many different tax credits to expand tax deductions for things like energy technology upgrades and smart metering.  He also is looking to restore the full electric-vehicle tax credit.  If you are in the market for any of the above, consider holding off until next year when you may get additional tax savings. 

Bonus: Consider using cash instead of securities to donate to charity 

If you are charitably inclined and were considering donating to charity this year, you may want to consider doing it via cash instead of low basis securities.  The CARES Act increased the amount you can give to charities and receive a deduction for in 2020.  The limit has been raised to 100% of your AGI.  Each individual’s situation is different, so please discuss with your tax professional before making this decision. 

As with all tax legislation, everyone’s position is unique, so please discuss with your trusted advisor to determine if any of these moves might make sense for you. Always consult with your tax preparer how these items apply to your personal situation. 

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Buying a house is one of the biggest purchases a person will make in their lifetime.

While most people will have no choice but to take out a standard mortgage, there are people in financial situations that allow more flexibility. If an individual has accumulated a substantial amount of liquid assets, or comes from a wealthy family, they could consider paying for a property with cash. Another popular trend is loaning a family member money to help them purchase a house. This is often referred to as an intra-family mortgage or loan. To find out if an intra-family mortgage might make sense for you and your family, here are 5 questions to ask:

1. Does a family member have liquid assets available for the loan, and are they willing to help?
For an intra-family mortgage to work, a family member must have the assets available to loan out. If the assets aren’t available, or the tax consequences of making the necessary funds available are too high, this would also make an intra-family mortgage a non-starter.

2. What type of loan repayment should be structured?
Intra-family mortgages are great because of the flexibility they allow for the repayment terms. The participants can determine the length of the loan, how much principal and interest will make up each payment or if it will be interest-only with a balloon payment at the end, among many other options. When determining the repayment schedule, primary considerations should include the amount of payment you can afford, how long you expect to own the house and current interest rates.

3. At what rate should the loan be set?
One of the largest benefits of an intra-family mortgage is that the loan can be made at a rate below what you could get from a bank. An intra-family loan interest rate should be based on the Applicable Federal Rates (AFR). This is a rate that the IRS updates monthly and is the lowest interest rate one can charge on this type of loan without running afoul of the IRS. There are short, mid and long-term AFR rates, and the rate you lock in when the loan is made should match the rate of the appropriate tier. Any rate set below AFR has tax consequences that should be discussed with your accountant.

4. Will you register the loan as a mortgage or keep it as a standard loan?
A true intra-family mortgage will be properly documented and registered like any other mortgage; this includes drafting a promissory note and filing a Deed of Trust in the proper jurisdiction. This will allow you to deduct the interest on your tax return if you use itemized deductions. If you do not register the loan as a mortgage, you will not get the tax benefits that you would otherwise receive.

5. Are both parties able to follow the correct reporting procedures?
An intra-family mortgage is only as good as the family’s ability to follow the rules. Interest income the lender receives must be reported on their personal tax return. The loaner will have the ability to forgive the payments annually, but it is important that the mortgage payments are paid throughout the year so that the loan is not viewed as a gift.

An intra-family mortgage can be a great solution when looking to help a family member purchase a house, but the details should be well thought through to determine if it makes sense in your family’s situation. It is also important to coordinate with your attorney, financial advisor and accountant before deciding on which approach you should take, as the key to success is ensuring all of the rules are followed appropriately.

If you have any questions about how an intra-family loan could be implemented in your family’s situation, please contact me or anyone in our planning department.

Accepting a new position and changing companies is not an easy task. 

There are many things you must consider, including the new company’s culture, pay, benefits, and location, to name a few.  When you are a highly compensated professional or corporate executive, there are additional considerations which warrant your attention. In my experience assisting corporate executives with the evaluation of potential career changes, I have identified 5 key mistakes to avoid:

1. Not confirming non-compete status: One of the biggest risks in switching companies is not being aware of the details in your non-compete agreement. Reviewing your non-compete should be the first thing you do before even entertaining a role at another company. Have an attorney look over your non-compete, to give you a better idea of the types of roles you could accept that would be allowed, as well as the actions to avoid if you do make the switch. Depending on your non-compete, you may be allowed to compete in the industry, but you may owe compensation back to your current company if you join a competing firm. Understanding the details of your existing non-compete is essential to making a smooth transition to your next opportunity.

2. Forgetting to negotiate to “make whole” during compensation discussions: Most executive compensation packages include a number of election choices. These can include stock options, restricted stock units, and pensions, among others. Many of these types of compensation must vest before you get ownership of them. When switching jobs, you must consider all of the unvested positions that you are losing. When negotiating terms for a new position, it is important to know what you are giving up by leaving your current firm and to discuss a way that your new company can compensate you for those lost benefits. This can be accomplished in a number of ways, including a one-time bonus, or providing additional benefits equal in value to what you are giving up.

3. Ignoring current compensation and benefit decisions: There are certain types of compensation that you must make decisions on when leaving a company. Vested stock options may be required to be exercised within a certain time period or risk forfeiture. You must make decisions about what you are going to do with your pension, 401k, supplemental savings plan and so on. Common options are leaving them at the old company, rolling them into other plans, or taking lump sum distributions. It is important to know your options and to plan around them before announcing your move.

4. Leaving unused vacation days: This is an often-forgotten benefit that many people leave on the table. Some companies may pay out unused vacation days, but for the ones that don’t, you may want to consider taking a vacation before announcing your departure.

5. Ignoring tax opportunities to lower your bill: In the year that you switch jobs, chances are you will be in a higher tax bracket due to the many benefits exercising and paying out. Because of this, you may want to investigate planning strategies that help to lower your tax liability. Making a charitable contribution to help offset the taxes is one of the more common strategies. There are many ways to do this, but one of the more popular options is putting money into a donor advised fund so that you have more control over the timing of the distributions.

When you are preparing to make a move to a new company, make sure that you avoid these 5 mistakes by doing your research and constructing your plan ahead of the move.

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Intergenerational wealth transfers create both opportunities and risks, especially for those inheriting a large sum.

And with the boomer heirs now standing on the precipice of the largest wealth transfer in history, understanding the finer points of inherited wealth is more important than ever.

Inheriting an IRA, for example, has spurred a number of questions from our clients: What options do I have for taking distributions? What are the tax implications? How do I determine the right strategy based on my long term goals? To make evaluating the options simpler, we’ve put together a few guidelines for both spouse and non-spouse beneficiaries to consider when incorporating an IRA into their retirement plans.

Spouse inheritors – Traditional IRA

When one inherits an IRA, the first priority should be to understand the potential tax implications and to avoid any unnecessary penalties. While spouses have the option to roll their inherited IRA into an existing IRA, all inheritors must eventually pay income taxes on traditional IRA distributions. One option open to spouse and non-spouse inheritors is a lump sum distribution. A lump sum distribution involves a payout taken immediately after inheriting an IRA, which will not incur a 10% early withdrawal penalty. The distribution will, however, incur income taxes, and the beneficiary may move to a higher tax bracket as a result of the distribution. Depending on the beneficiary’s age, financial situation and immediate needs, a lump sum distribution may be a preferred option as you will be able to access the funds right away. For spouses over the age of 59½, rolling over an inherited IRA might make more sense, as they will gain control over the distributions, so long as they are above the required minimum distribution (RMD), and the associated taxes.

For beneficiaries who prefer to forego an immediate payout in favor of investing their inherited IRA, they should first identify their goals, and then incorporate their new portfolio into their overall financial plan. Choosing conservative investments, like corporate bonds, may be appropriate for someone who needs their money in the short term. If RMDs are small, and the money will not be needed for a while, a diversified portfolio that includes a mix of equities, alternatives and fixed income may make more sense.

Non-spouse inheritors – Traditional IRA

Non-spouse beneficiaries do not have the option of rolling their inherited IRA into an existing IRA, and must begin withdrawing assets immediately. These distributions will be considered part of the beneficiary’s annual income, and could bump them into a higher tax bracket. Conversely, those who do not realize that they need to take distributions immediately may end up paying a 50% tax penalty on the amount taken below the RMD.

Distributions

Spouse and non-spouse beneficiaries of inherited IRAs may can choose to take distributions as an RMD over the course of their lifetime (life expectancy method), over a five year period, or as a lump sum. The life expectancy option means a RMD will be set each year based upon the beneficiary’s age, and the RMD must be made each year to avoid paying a penalty of 50% on the amount taken below the RMD. The five year option allows the beneficiary more flexibility in that all funds are available for withdrawal throughout the five years, there are no RMDs nor is there an early withdrawal penalty. After five years, any remaining funds in the account will need to be distributed. A lump sum provides access to the assets immediately and sidesteps the 10% penalty for early withdrawals. For most situations, the life expectancy option will be the most beneficial distribution method as the funds that remain in the IRA are afforded a lifetime of tax free growth, prior to distribution.

Roth IRA difference

When inheriting a Roth IRA, the beneficiary will not pay income tax on their distributions nor will distributions be counted as taxable income when determining the beneficiary’s tax bracket. However, if the life expectancy method is the distribution elected, distributions below the RMD will still be subject to the 50% penalty.

People typically make two mistakes when inheriting IRAs: They either forget to take the RMDs, or, with traditional IRAs, they will take a lump sum distribution in a high-income year. The first mistake brings a 50% penalty tax on the amount below the RMD not withdrawn. The second mistake may cause the entire amount to be taxed at a higher rate than necessary. Of course, there are many other aspects to integrating an inherited IRA into your financial plans which we did not address here, as each individual’s specific circumstances and goals will have a unique impact on their immediate and long terms strategies.

For individuals inheriting an IRA, understanding your options as well as the requirements and potential liabilities of those options is essential to making an informed election, and to maximizing your potential benefits. A trusted financial advisor with extensive tax planning and estate planning experience can be a tremendous asset during this process.

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Over the years, I’ve traveled the crowded skies quite a bit for work, and have picked up a few lessons and tips which have made business travel a lot simpler. 

1. I highly recommend getting a Global Entry (international + domestic flights) or TSA Pre-Check (domestic flights) membership. Global Entry is a U.S. Customs and Border Protection program that allows pre-screened travelers at major US and many international airports to pass through security via a vastly expedited process. Members enter an exclusive, and much shorter, security line (Pre-Check line), and are allowed to go through the screening process with their jacket and shoes on, and are not required to remove their laptop or liquid bags, with the express purpose of moving them through security as efficiently as possible. Global Entry members also enjoy the benefit of skipping the customs line when re-entering the US on international flights, instead they use a Global Entry kiosk, where they simply scan their passport and complete a customs declaration. The application fee for Global Entry is $100 and includes a TSA Pre-Check membership; TSA Pre-Check membership by itself is $85. Global Entry and TSA Pre-Check memberships are both valid for 5 years once approved. If you travel often as a family, I would suggest getting a membership for each family member, including children, as privileges are non-transferable. The application process is relatively painless and the price over five years is negligible. And the reality is that after skipping the security line for the first time, you will already be ahead.

2. Pre-made technology bag – Have you ever gone on a trip and realized that you forgot your charging cable, just as your phone goes dead? To prevent this, I always keep a “tech bag” pre-packed for my next trip, which includes a charging cable, headphones and a power station. When I’m packing for my trip, I just drop the tech bag in my carry-on, and never have to worry.

2a. Bonus Tip – Same idea works with toiletries. Have your toothpaste, toothbrush, Q-tips and other standard personal items pre-packed in a toiletry bag and store that in your carry-on too. No need to leave it to chance.

3. Don’t check your bags – With the allowance of a “personal item bag” to accompany your carry-on luggage, you should rarely, if ever, need to check a bag. By keeping your bags with you, the risk of losing something important in transit is eliminated, not to mention the time savings of skipping baggage claim.

4. Use the airline app – All major airlines now have an app you can use to check-in to your flight, produce a digital boarding pass on your smartphone, and provide updated status reports on your flight. There is no longer a need to take the time to print out your pass (and risk losing it) or log into your desktop at home to check in.

Hopefully the next time you travel, you can use some of these tips to help you have a simplified, and less stressful trip.

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Your child has just turned 21, and it is time to celebrate.

Your family and friends have come together for dinner, a birthday toast, and to deliver a few choice presents to mark the occasion. However, lurking in the background is another “gift” that some parents may have forgotten about – the UTMA account which they established years ago has just converted to a traditional investment account, and sole ownership has transferred to their child.

From the child’s perspective, they are most likely  attending college, with no stable source of income, and possibly no knowledge of the UTMA’s existence. The value of these accounts usually range from tens of thousands to hundreds of thousands in investment assets, and when confronted by these numbers, children may be astonished to realize that this money is now in their sole possession. For many, the realization can be quite intimidating.

From the parents’ perspective, there are often fears that come with transferring wealth to their children. These concerns typically fall along the lines of: “Will they blow the money on unwise purchases?”, “Will they be less incentivized to work when they come Into possession of these assets”, “Will they be prepared to manage the account?”But for some parents, funding a UTMA account is a way to address these concerns, while providing their child invaluable experience in managing their their own money.

The transfer of UTMA ownership from parent to child occurs automatically on either the child’s 18th or 21st birthday, depending on the state, but for the child to take ownership of the account, paperwork must be signed by both parties. This presents an opportunity to hold an open dialogue about the assets – what they are, where they came from, and what they were Intended for. Whether the funds were set aside for school expenses, to assist with housing or for any other purpose, the stage is set for parents to discuss what the purpose and value of money is with their child, including their perspective on responsibility and long term goals. The conversation will be extremely beneficial for the child as well, who will likely be learning about asset management, risk tolerance and cash flow, in real terms, for the first time.

An additional, crucial facet of the financial education yielded by the transfer of control of the UTMA account, is budgeting, as the child will now be in a position to manage and pay many, if not all of their own bills. With assets now in their direct control, the child can develop a skill set that will prove invaluable when they graduate college, and for the rest of their life.

The UTMA transition from parent to child comes with concerns on both sides, but if handled head on, through open and honest conversation, many positive outcomes can be expected on both sides.

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