As we start 2021, change is once again on the horizon. Fortunately, Elevate CPA Group is here to help with five potential Biden tax law changes impacting RIA firms.

The transition to the Biden administration shines a spotlight on potential regulatory and tax policy changes that could go into effect as early as this year. Of course, nothing has happened yet, and it’s possible nothing could happen at all. Nevertheless, it’s important to be prepared for these five potential changes so you can act quickly if needed—and help your clients to do the same.

1. Removal of preferential rates for qualified dividends and long-term capital gains for taxpayers with income over $1 million

Under Biden, we could see qualified dividends and long-term capital gains taxed as ordinary income. Given the Senate deadlock, it’s hard to say whether Congress will actually implement this change. Even so, consider accelerating any planned sales for diversification (i.e., to remedy concentrated positions), capital raises, or other reasons to take advantage of current rates. That said, don’t let the tax tail wag the dog.

2. Increased top ordinary income tax rates from 37% to 39.6% at the $400,000+ income level

To the extent that your client will receive income in 2021 and has control over the timing, the earlier they receive it, the better. Consider accelerating wages for S corporation owners, guaranteed payments for LLC/partnership owners, and wages for C corporation owners to avoid having these be subject to a potential tax rate hike. This is not the year to wait until the last minute.

3. New limitation on tax deductions for charitable contributions

Similar to the two situations mentioned above: If you or your clients are planning a charitable gift in 2021 or 2022, consider making it as early as possible. Also, consider accelerating 2022 planned giving into 2021.

4. Expansion of Social Security wage base to more than $400,000 of earned income

This presents a significant incentive for converting from an LLC to an S corporation. Doing so can help to avoid self-employment tax on flow-through earnings, thereby mitigating the impact of this change. Business owners have only until March 15 to make an entity change election for 2021 without triggering late election rules. The time to act is now.

5. Decreased unified tax credit for gift and estate taxes and the elimination of the step-up basis at death

These potential changes could greatly limit the amount individuals can gift to other parties tax-free. For high-net-worth individuals, it’s important to establish a contingency plan for quickly executing a gifting plan if needed. Keep in mind documents related to gifts and trusts take time to execute. Having the documents and plan ready to execute should be a high priority for all high-net-worth individuals.

The bottom line: Be prepared—and make sure your clients are, too.

Although you don’t need to act now, you do need to have a plan—one that can be executed quickly if needed. Elevate CPA Group can help. We provide tax support to RIA firms and can help you provide value to your clients in planning for tax law changes, too. If you’re concerned about how these potential changes could impact you or your clients, contact us today.

Property for Services Series: Part 5 of 5

As we have discussed previously in our Property for Services Series, when property is received in exchange for services, it is taxable as compensation to the service provider. One of the most common situations we encounter is when our clients hold options to purchase stock of their employer. It is important for stock options holders to plan and to understand their options’ tax consequences and timing.

Options are not considered property for Section 83 purposes as long as they do not have a “readily ascertainable fair market value.” As a general statement, most employers will issue options that do not have a readily ascertainable value, but it is essential to understand a company risks an 83 issue if the options are issued with a strike price lower than the fair market value of the stock at the date of grant. Most companies use options to incentives an employee to contribute to increasing the value of the employer. For employees, this provides some significant advantages:

• A risk-free investment in the employer while the options remain unexercised; and
• Delayed taxation until the options are exercised.

The positives are often forgotten when it comes time to exercise the options and recognizing the tax consequences of the options.

The following equation measures compensation at exercise:

Number of Options Exercised x (FMV – Strike Price)

There are two types of compensatory options, with very different tax treatments.

1. Incentive Stock Options (ISOs)

Incentive Stock Options (“ISOs”) have favorable but confusing tax treatment. For our RIA clients, the essential points to understand are:

• There is no REGULAR tax income when exercised.
• Alternative Minimum Tax (“AMT”) may be due and depends heavily on the employee’s tax
  situation and AMT income based on the above equation.
• The employee can ultimately receive long term capital gain on the difference between the
  ultimate sale price of the stock and the strike price if the stock is held
  • One year and one day from date of exercise; and
  • Two years and one day from the date of the option grant.
  • If not held for this period, the income is ordinary income.

The significant consideration with ISOs is when the employee exercises the stock option, owes the strike price, AMT tax, and wants to hold the stock long enough to get long term capital gains. Consideration needs to be given to the risks associated with a decline in stock value post-exercise. The gamble is converting a risk-free investment to putting funds at risk to gain a tax advantage. You and the client’s tax advisor should work closely to analyze and understand the risks of the exercise and hold strategy, including the applicability of Section 83(i) is beyond this blog’s scope.

2. Non-Qualified Stock Options (NSOs or NQSOs)

Non-Qualified Stock Options (NSOs or NQSOs) are not as tax favored as or complicated as ISOs. Very simply, at the date of exercise, there is compensation income based on the equation above. From a planning perspective, NSOs should always be exercised and sold on the same day. There is no reason to hold the stock as that converts a risk-free investment to an at-risk investment.

Not all clients have a tax advisor that can help analyze the tax consequences of holding and exercising options. Elevate CPA Group provides our RIA clients with a fractional tax department providing a competitive advantage over competitors. If you have questions about property for services taxation, give us a call.

Property for Services Series: Part 4 of 5

Why is IRS Section 83, property transferred in connection with the performance of services, so important for our RIA clients? It is a central issue when selling your RIA firm and succession planning. Succession planning is like estate planning—something business owners know is important, but don’t usually address. Succession planning is important for principals of RIA firms to recognize the value built in the firm. Often the firm is the largest asset the principal owns. Recognizing the value for the principal is crucial to long term financial security.

In general, Elevate CPA Group encounters two types of transactions in succession planning:

• an arm’s length transaction with a third-party buyer, or
• a sale to key employees.

When the succession planning involves a sale to employees, Section 83 is something to think about. Some questions to consider are:

1. Is the fair market value properly determined? Does it include appropriate and allowable discounts and is the key employee paying the fair market value?
2. Are terms in shareholder agreement, buy/sell agreement or operating agreement unintentionally placing a substantial risk of forfeiture that may cause a delay in taxation?
3. Are options or profits interest being used to transfer ownership?
4. Are the shares, whether bought for full market value or not, subject to vesting?

Elevate CPA Group is uniquely qualified to help RIA firms navigate succession issues. We help our clients build value, develop a successful succession strategy, understand and minimize tax issues, value the firm, educate successors and provide a strong relationship to help guide the firm to continued success.

Selling the firm you have built over years is an important part of an RIA firm’s lifecycle. Elevate CPA Group are here to help you make the process successful. If you are planning on selling your firm someday, make sure you have reliable expertise to make the process as simple as possible. If you have questions about property for services taxation, give us a call.

Property for Services Series: Part 3 of 5

We know from Property for Services Part 1 and Part 2 that property received for services are taxable to the service provider and deductible for the business paying the service provider. We also learned about the timing of the income and how to change that timing using an 83(b) election. The next big question is, “How much is taxable?”

Section 83(a) has a simple formula. The taxable amount is “the fair market value of such property over the amount paid for such property.” In simple mathematical terms:

Fair Market Value – Amount Paid = Compensation for Services

For most clients, property for services is most prevalent in equity compensation with their employer. The fair market value of the stock is either established as a publically traded security or determined by the employer’s appropriate leadership. In almost all cases, it is not a number the service provider independently determines.

The employer must determine the value as if the substantial risk of forfeiture is not present. If we consider the timing rules of the income, this makes sense if our timing is either:

1. When the substantial risk of forfeiture no longer exists, or
2. At grant with an 83(b) election ignoring the substantial risk of forfeiture.

In both scenarios, the taxation is at a time when the substantial risk of forfeiture has lifted or deemed to no longer exist.

A client will only make an 83(b) election if the client believes the value of the stock will increase during the vesting period and they intend to fulfill the vesting requirements. What happens if an 83(b) election is made and then vesting conditions are not met? The client will forfeit some or all of the stock. Unfortunately, no deduction (loss) is allowed under section 83(b)(1)(B). This limitation is only for the compensation for services income. The client will only get a loss for any amount paid for the property.

Knowing how much is taxable is useful not only to your client, but also to you as their financial professional. Elevate CPA Group works with RIA firms to help increase the value of their business. If you have questions about property for services taxation, give us a call.

Property for Services Series: Part 2 of 5

When does property become taxable? As we discussed in Property for Services Part 1, when a service provider receives property in exchange for services, for example equity in a company, that receipt of property is taxable to the employee and deductible for the employer. In Part 2, we will examine how Elevate CPA Group can assist you with your succession planning and stock options property taxes.

The most important and common scenario we encounter is succession planning for our RIA clients and advising employees on receipt of stock or options from their employer.

In most scenarios, when an employee receives options whether Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NQSOs/NSOs) it is not a taxable event under IRS Section 83. The taxable event occurs when the option is exercised.

Some employees receive equity in a company instead of options. The timing of the taxability of this transaction is dependent on when the securities are transferable or are not subject to a substantial risk of forfeiture.

Transferable is not a practical consideration, but a technical one. A security is deemed transferrable if the employee is not subject to a substantial risk of forfeiture. A security may be subject to a buy/sell agreement, a right of first refusal or limited market, but none of these are transferability issues. The simple question is if the security is transferred, can the buyer (transferee) have the stock taken away due to a substantial risk of forfeiture.

The most common substantial risk of forfeiture is vesting. The general rule on taxation is the value of the property is determined on the date the substantial risk of forfeiture lapses, or as the employee meets the service requirements. For example, if an employee receives 100 shares of employer stock that vests 50% each year, 50 shares are taxable at the one-year anniversary of the grant and 50 shares are taxable on the second anniversary of the grant.

An 83(b) election simply changes the timing of the income recognition. The 83(b) election accelerates the timing of the taxation to the date of grant ignoring the vesting schedule or other substantial risk of forfeiture. I will discuss some of the considerations on whether to make the elections in the next blog. The most important takeaway to understand is an 83(b) election has very strict timing rules as it MUST be made no later than 30 days after the date of grant. The 83(b) election also has strict requirements on information it must include and where it must be sent. The specific rules are outside the scope of this blog, but we encourage you to urge your client to carefully and timely complete the 83(b) election if so required.

If you would like help explaining the tax liabilities to your client, let us know. Elevate CPA Group focuses solely on the RIA community. We pride ourselves on helping RIA clients streamline and increase the value of their business by not only providing a full range of services including fractional CFO, but also having the expertise to help you bring sophisticated tax planning to your best client relationships. If you have questions about property for services taxation, give us a call.