How to Get a Jump on Tax Planning When You Are Hoping to Hit it Big …

or Already HaveBarbara Coats

Interview with CharlieOwner, Biotech Cures, Inc.

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Charlie’s Facts• Owns 500,000 shares• 50,000 shares non-qualified stock options

(exercise price = $0.10/share)• 100,000 shares unvested restricted stock • Today’s share price is $5• Buyout share price is $100• Pre-tax value today = $3.25 million• After the sale, pre-tax value = $65 million

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Charlie’s Goals• $10 million financial security for family• $10 million for new business in two

years• $2 million for scholarships• Fund college education for children• Gift to children if he has enough assets

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What if Charlie does no planning?

Ordinary Income

Capital Gain Total

Proceeds $15,000,000 $50,000,000 $65,000,000Tax Rate 47.95% 29.80%Tax $7,192,500 $14,900,000 $22,092,500After Tax Proceeds $7,807,500 $35,100,000 $42,907,500Profit as % of Gross 66.1%

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Entrepreneur’s Special Tax Break – Section 1202 Stock

• Requirements for qualified small business stock (QSBS)– C corporation– Acquired at original issue when corporation

had less than $50 million of assets– Company is an active business– Stock options do not qualify

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Entrepreneur’s Special Tax Break – Section 1202 Stock

Percent of Gain ExcludedAcquisition Date Exclusion

8/11/1993 to 2/17/2009 50%2/18/2009 to 9/27/2010 75%9/28/2010 to 1/1/2015 100%

After 1/1/2015 50%

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Entrepreneur’s Special Tax Break – Section 1202 Stock

Gain ExclusionValue of stock $ 50,000,000Less basis $ (1,000)Gain $ 49,999,000Ten times basis $ 10,000Maximum exclusion $ 10,000,000

Section 1202 gain $ 10,000,000

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Entrepreneur’s Special Tax Break – Section 1202 Stock

Tax on GainRegular capital gains tax rate 29.80%Capital gains rate with Section 1202 18.90%

Difference in tax rate 10.90%Section 1202 gain $10,000,000Tax savings $ 1,090,000

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Entrepreneur’s Special Tax Break – Section 1202 Stock

Beware of AMT GotchaExcluded gain $5,000,000AMT Preference 7%AMT Preference Item $ 350,000Not a problem for Charlie because of his high ordinary income!

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Charitable Giving – Wait as Long as Possible!

• Want donation as close to sale date as possible• Beware: Assignment of Income Issues• What if transaction falls through?• Choice of public charity, donor advised fund or

private foundation• Donor Advised Fund – deduction now; give later

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Charitable Gift of Stock - Limitations

Private Foundation

Public Charity

Amount deductible Cost Fair ValueAGI Limit 20% 30%Appraisal needed if over $5,000?

Yes Yes

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Charitable Gift of Stock – Double Tax Savings

DonationCapital Gain

Avoided Total

Scholarships $2,000,000 $2,000,000Tax rate 47.95% 29.80%Tax savings $ 959,000 $ 596,000 $1,555,000

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Stock Options Giftedto Trust for Children

• If planning in advance, use pre-transaction price for gift tax value

• Value stock options using Black–Scholes calculation

• Discounts for lack of marketability and minority interests

• Donor pays income tax on exercise of options

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Stock Options: Value of GiftStock price before transaction $

5.00Discounts for marketability and minority interest

$ (1.00)

Black-Scholes discount $ (0.10)Gift tax value $ 3.90Number of option shares 50,000Value of gift $195,000

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Gift Tax Saved by Charlie’s Family

Difference in option value “before” and “after”

$4,750,000

Income tax paid by Charlie $2,395,103Value of gifts by acting now $7,145,103Gift tax rate 40%Gift tax savings $2,858,041

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Summary of Charlie’s Tax Savings

Section 1202 stock $1,090,000Charitable savings $1,555,000Gift of options to trust $2,858,041Total tax savings $5,503,041

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Did Charlie Meet His Goals?• $10 million financial security for family• $10 million for new business in two

years• $2 million for scholarships• Fund college education for children• Gift to children if he has enough assets

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Interview with LauraCFO, Big Orange Hardware

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Laura’s Facts• Base salary is $500,000• Bonus up to $750,000• Must own Big Orange stock equal to four times base

salary • Big Orange stock = $10/share • Annual increase 12.5%, next 10 years

– Stock value $18/share in 2020– Stock value $36/share in 2025

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Laura’s Facts• Owns $3 million stock• Has $1million non-qualified stock options • Awarded 100,000 shares of restricted stock – 5-year

vesting• 2016 deferred compensation – guaranteed return of 9%• Big Orange 401(k) – $2 million of which $1.2 million is

Big Orange stock• Basis of stock in 401(k) is $200,000

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Laura’s Goals• Diversify some wealth into assets other than Big

Orange stock• Obtain advice about when to receive her 2016

deferred compensation• Develop strategy for her new restricted stock award• Retire to Florida in ten years• Provide for Children’s Healthcare in her estate plan• Save money on her 2015 taxes

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Options for Diversification of Stock

• Outright sale• SEC Rule 10b5-1 selling program• Exchange fund• Transfer to charitable remainder trust

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Charitable Remainder Trust: General Operation

• Laura contributes Big Orange stock to CRT• CRT sells Big Orange stock with no tax• Laura gets a charitable deduction today • CRT assets grow in a tax sheltered environment• Laura retains an income stream for life or a number of

years• Unitrust allows Laura’s income to increase as trust value

increases• At end of trust, remaining assets go to Children’s

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Charitable Remainder Trust With Net Income Make-up

• Trust pays Laura fixed percentage or trust income, whichever is less

• If income is less than fixed percent, deficiency can be made up in future

• Ideal for high earner who does not need current income

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Operation of Laura’s NIMCRUT

• Laura contributes $1 million of Big Orange stock to CRT

• CRT sells Big Orange stock and pays no capital gains tax

• Trust pays Laura lower of trust income or 8.2% of trust value

• Payout deficiency is made up in future years• Laura has $100,000 charitable deduction today• Laura retires and makes up payout deficiency as

resident of Florida26

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Results of Laura’s NIMCRUTAt age 65: Value if CRT (tax effected) Value if no CRT Extra

$2,590,467 1,403,026$1,187,441

Tax savings from charitable deduction 47,950

Total $1,235,391

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Non-qualified Deferred Compensation

• Defer for 10 years• Establish Florida residency before leave

company• Pension Protection Act of 1995– If Laura moves to a non-taxing jurisdiction,

payments cannot be taxed in states where Laura lived while working for Big Orange

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Non-qualified Deferred Compensation

• Potential disadvantages:– Unfunded promise to pay– Concerned about change in

management, ownership, or market downturn

– Not protected by ERISA

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Deferring Compensation – What is the Benefit?

Net WorthReceive compensation in Year 1 $480,240

Defer compensation until Year 10 $687,127

Percentage increase 43%

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Deferred Compensation – Source of Savings

Savings from 10 year deferral $135,866

Savings from move to Florida 71,021

Total increased net worth $206,887

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Section 83(b) Electionfor Restricted Stock

• Pay ordinary income tax on value of stock today

• All future appreciation taxed as capital gain

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Section 83(b) Electionfor Restricted Stock

• Make election within 30 days after grant date

• Potential disadvantages– If stock goes down, will pay more tax than

necessary– If leave company before stock vests, you

will pay tax on compensation never received 33

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Section 83(b) Election: Pay Tax Today

Ordinary income per share $ 10Shares of restricted stock 100,000Ordinary income $1,000,000Tax Rate 47.95%Income tax today $ 479,500

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Section 83(b) Election: Tax Saved in Year 5

Share appreciation from now to Year 5 $ 8Shares of restricted stock 100,000Capital gain income $800,000Tax rate difference (47.95% - 29.8%) 18.15%Tax savings from Section 83(b) election $145,200

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Georgia Film Credits• Purchase at 91 cents on dollar• Laura has $75,000 of Georgia tax a

year• Net return is 6%• Laura’s savings are $4,500

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Summary of Laura’s Tax Savings

Non-qualified deferred compensation

$ 206,887

Section 83(b) Election $ 145,200Charitable remainder trust $1,235,391

Georgia film credits $ 4,500Total Tax Savings $1,591,978

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Contact InformationBarbara M. Coats, CPAPrincipal

Windham Brannon3630 Peachtree Road NESuite 600Atlanta, Georgia 30326Main: 404.898.2000Direct: 678.510.2724Fax: 404.898.2010Email: bcoats@windhambrannon.com