Installment Sales: A Viable Option for Transferring Assets

Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.


Giving Away vs. Selling

From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.

But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.

Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.

Advantages and Disadvantages

An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.

One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.

Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.

Simple Technique, Big Benefits

An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.

Bear in mind, however, that this simple technique isn’t right for everyone. We can review your situation and help you determine whether an installment sale is a wise move for you.

First Quarter 2019 Tax Deadlines

January 15

  • Individual taxpayers’ final 2018 estimated tax payment is due.

January 31

  • File 2018 Forms W-2 (“Wage and Tax Statement”) with the Social Security Administration and provide copies to your employees.
  • File 2018 Forms 1099-MISC (“Miscellaneous Income”) reporting nonemployee compensation payments in box 7 with the IRS and provide copies to recipients.
  • Most employers must file Form 941 (“Employer’s Quarterly Federal Tax Return”) to report Medicare, Social Security, and income taxes withheld in the fourth quarter of 2018. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 11 to file the return. Employers who have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944 (“Employer’s Annual Federal Tax Return”).
  • File Form 940 (“Employer’s Annual Federal Unemployment [FUTA] Tax Return”) for 2018. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it is more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 11 to file the return.
  • File Form 943 (“Employer’s Annual Federal Tax Return for Agricultural Employees”) to report Social Security, Medicare and withheld income taxes for 2018. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 11 to file the return.
  • File Form 945 (“Annual Return of Withheld Federal Income Tax”) for 2018 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on pensions, annuities, IRAs, etc. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 11 to file the return.

February 28

  • File 2018 Forms 1099-MISC with the IRS.

March 15

  • 2018 tax returns must be filed or extended for calendar-year partnerships and S corporations. If the return isn’t extended, this is also the last day for those types of entities to make 2018 contributions to pension and profit-sharing plans.

Laying the Groundwork for Your 2018 Tax Return

The Tax Cuts and Jobs Act (TCJA) made many changes to tax breaks for individuals. Let’s look at some specific areas to review as you lay the groundwork for filing your 2018 return.


Personal Exemptions

For 2018 through 2025, the TCJA suspends personal exemptions. This will substantially increase taxable income for large families. However, enhancements to the standard deduction and child credit, combined with lower tax rates, might mitigate this increase.

Standard Deduction

Taxpayers can choose to itemize certain deductions on Schedule A or take the standard deduction based on their filing status instead. Itemizing deductions when the total will be larger than the standard deduction saves tax, but it makes filing more complicated.

The TCJA nearly doubles the standard deduction for 2018 to $12,000 for singles and separate filers, $18,000 for heads of households, and $24,000 for joint filers. (These amounts will be adjusted for inflation for 2019 through 2025.)

For some taxpayers, the increased standard deduction could compensate for the elimination of the exemptions, and perhaps even provide some additional tax savings. But for those with many dependents or who itemize deductions, these changes might result in a higher tax bill — depending in part on the extent to which they can benefit from enhancements to the child credit.

Child Credit

Credits can be more powerful than exemptions and deductions because they reduce taxes dollar-for-dollar, rather than just reducing the amount of income subject to tax. For 2018 through 2025, the TCJA doubles the child credit to $2,000 per child under age 17.

The new law also makes the child credit available to more families than in the past. For 2018 through 2025, the credit doesn’t begin to phase out until adjusted gross income exceeds $400,000 for joint filers or $200,000 for all other filers, compared with the 2017 phaseout thresholds of $110,000 for joint filers, $75,000 for singles and heads of households, and $55,000 for marrieds filing separately. The TCJA also includes, for 2018 through 2025, a $500 tax credit for qualifying dependents other than qualifying children.

Assessing the Impact

Many factors will influence the impact of the TCJA on your tax liability for 2018 and beyond. For help assessing the impact on your situation, contact us.

Welcoming Some New Members of the CPA Club!

We are excited to share that two of our employees passed the CPA exam! Michael Kanallakan of Jerseyville and Alex Stoff of Highland are our newest CPAs.

Congratulations on this amazing milestone in your careers!

 

Social Security Administration Scam Calls

Our offices have received a few client calls this holiday season concerned about phone calls they recently received from someone claiming to be from the Social Security Administration (SSA). The “SSA” said they were calling to verify our client’s social security number and other personal information. Obtaining your social security number is a surefire way for scammers to create a world of problems for you. Your social security number is a key piece of information used to steal your identity. If you get a phone call from someone claiming to be from the SSA needing to verify your information, don’t give it out!

The SSA published this blog post about this malicious activity earlier this year, and it has some great advice on what to do if you receive one of these scam calls.

Is a PTO Contribution Arrangement Right for Your Business?

Many businesses find themselves short-staffed from Thanksgiving through December 31 as workers scramble to use, rather than lose, their remaining time off. Indeed, your workplace may resemble a ghost town if you limit how many vacation days employees can roll over to the new year. A paid time off (PTO) contribution arrangement may be the solution.

A PTO contribution program allows employees with unused vacation hours to elect to convert them to retirement plan contributions. If the plan has a 401(k) feature, it can treat these amounts as a pretax benefit, similar to normal employee deferrals. Alternatively, the plan can treat the amounts as employer profit sharing, converting excess PTO amounts to employer contributions.

A PTO contribution arrangement may be a better option than increasing the number of days employees can roll over. Larger rollover limits can result in employees building up large balances that create a significant liability on your books.

To offer a PTO contribution arrangement, simply amend your 401(k) plan. However, you must still follow the plan document’s eligibility, vesting, rollover, distribution and loan terms. Additional rules may apply. To learn more about PTO contribution arrangements, including their tax implications, please contact us.

Accelerating Your Property Tax Deduction

Smart timing of deductible expenses can reduce your tax liability, and poor timing can increase it unnecessarily. One deductible expense you may be able to control to your advantage is your property tax payment.

You can prepay (by December 31) property taxes that relate to 2018 (the taxes must be assessed in 2018) but that are due in 2019, and deduct the payment on your return for this year. But you generally can’t prepay property taxes that relate to 2019 (they must be assessed in 2019) and deduct the payment on this year’s return. Also beware of the dollar-amount limitation discussed below.

It’s important that we mention that Illinois is one of the few states that this would be allowed. Depending on how your state collects property taxes, this may not apply to you. Please contact us for specific questions.

A Big Decision

Accelerating deductible expenses such as property tax payments is typically beneficial. Prepaying your property tax may be especially advantageous if your tax rate under the Tax Cuts and Jobs Act (TCJA) is expected to decrease in the next year. Deductions save more tax when tax rates are higher.

But not every tax rate has dropped for the 2018 tax year under the TCJA — the very lowest rate, 10%, has been retained, as well as the 35% rate (though the income brackets for these rates have changed). So, some taxpayers may not save any more by prepaying. Also, taxpayers who expect to substantially increase their income next year, pushing them into a higher tax bracket, may benefit by not prepaying their property tax bill.

Another important point is that, under the TCJA, for tax years 2018 through 2025 the itemized deduction for all state and local taxes is limited to $10,000 ($5,000 for married filing separately).

More Considerations

Property tax isn’t deductible for purposes of the alternative minimum tax (AMT). So, if you’re subject to the AMT this year, a prepayment may hurt you because you’ll lose the benefit of the deduction. Before prepaying your property tax, make sure you aren’t at AMT risk for 2018.

Also, don’t forget that, for 2018 to 2025, the TCJA suspends personal itemized exemptions but roughly doubles the standard deduction amounts (for 2018) to $12,000 for singles and separate filers, $18,000 for heads of households, and $24,000 for joint filers. This may affect your decision on whether to prepay.

Specific Strategies

Not sure whether you should prepay your property tax bill or what other deductions you might be able to accelerate into 2018 (or should consider deferring to 2019)? Contact us. We can help you determine your optimal year-end tax planning strategies.

Use Capital Losses to Offset Capital Gains

When is a loss actually a gain? When that loss becomes an opportunity to lower tax liability, of course. Now’s a good time to begin your year-end tax planning and attempt to neutralize gains and losses by year end. To do so, it might make sense to sell investments at a loss in 2018 to offset capital gains that you’ve already realized this year.


Now and Later

A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. You can use capital losses to offset any capital gains you realize in that same tax year — even if one is short term and the other is long term.

When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately) and carry the remainder forward to future years until it’s used up.

Research and Replace

Years ago, investors realized it could be beneficial to sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses when an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.

Waiting 30 days to repurchase a security you’ve sold might be fine in some situations. But there may be times when you’d rather not be forced to sit on the sidelines for a month.

Fortunately, there’s an alternative. With a little research, you might be able to identify a security in the same sector you like just as well as, or better than, the old one. Your solution is now simple and straightforward: Simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. You maintain your position in that sector or industry and might even add to your portfolio a stock you believe has more potential or less risk.

If you bought shares of a security at different times, give some thought to which lot can be sold most advantageously. The IRS allows investors to choose among several methods of designating lots when selling securities, and those methods sometimes produce radically different results.

Good With the Bad

Investing always carries the risk that you will lose some or even all of your money. But you have to take the good with the bad. In terms of tax planning, you can turn investment losses into opportunities — and potentially end the year on a high note.

An Intrafamily Loan is Worth Careful Consideration

Lending money — rather than giving it — to loved ones is an idea worth considering. Perhaps you’re not ready to part with your wealth. For example, maybe you’re concerned about having enough money to fund your retirement or you feel that your children aren’t ready to handle the responsibility.

Intrafamily loans allow you to provide family members with financial support while hanging on to your nest egg and encouraging your children to be financially responsible.

How does it work?

The key to transferring wealth is the borrower’s ability to take advantage of investment opportunities that offer relatively high returns. In other words, after paying back the principal, the borrower essentially receives the “spread” between the investment returns and the loan interest — free of gift and estate taxes.

With this in mind, when you lend money to family members, it’s important to charge interest at the applicable federal rate (AFR) or higher. Otherwise you’ll trigger unintended income and gift tax consequences.

AFRs are published monthly and vary depending on whether the loan is:

  • Short-term (three years or less),
  • Mid-term (more than three years but not more than nine years) or
  • Long-term (more than nine years).

They also vary depending on how frequently interest is compounded.

Keep in mind that the loan balance is still included in your taxable estate. Even if you die before the loan is paid off, the borrower must repay the loan to your estate, though an intrafamily loan can be structured to provide that the loan will be forgiven if you die before it’s paid off.

What are the risks?

The biggest risk is that the invested funds will fail to outperform the AFR. If that happens, your child or other borrower will have to use his or her own funds to pay some or all of the interest — and, if he or she experiences a loss on the investment, even some of the principal. In other words, instead of transferring wealth to your child, your child will transfer wealth to you. As noted above, however, low AFRs minimize this risk.

There’s also a risk that the IRS will challenge the loan as a disguised gift, potentially triggering gift tax liability or using up some of your lifetime exemption. To avoid this result, you must treat the transaction as a legitimate loan. That means documenting the loan with a promissory note and adhering to its payment and enforcement terms. If, for example, your child is unable to make a payment, you should make a genuine effort to collect the funds from the child.

Who can help?

The intrafamily loan is just one of many tools available for transferring wealth to your loved ones in a tax-efficient manner. Contact us for help developing a strategy that reflects your financial situation and goals.

 

Sidebar: No-interest loans are a big no-no

When making an intrafamily loan, you must avoid the temptation to charge no interest or charge interest below the current applicable federal rate (AFR). If you do, you’ll be subject to income tax (with certain exceptions for smaller loans) on imputed interest — that is, the excess of the AFR over the interest you collect. In other words, you’ll be taxed on interest that you didn’t receive. In addition, the imputed interest will be treated as a taxable gift to the borrower.

400+ Attend Tax Seminars

We definitely packed the house this year for our Year-End Tax Planning & Tax Reform Update Seminars! The three events brought in nearly 500 attendees. Leader of our tax department and firm Principal Mike Fitzgerald shared some great information and we hope everyone found the presentation useful for year-end planning. Thank you to all those who joined us!