Tax

More on Earning 9.62 Percent Tax-Deferred

But when it comes to investing, the U.S. Treasury Department has an inflation opportunity that’s downright amazing. You can buy bonds that pay 9.62 percent—tax-deferred—with no downside risk, and with no state or local income taxes when you cash them in.

If you buy now, you earn that 9.62 percent for six months, guaranteed. At the end of six months, the Treasury Department

  • adds the interest you earned to your principal, and
  • pays interest on your new principal balance at the new rate it will determine this year, on November 1.

Example. You buy $10,000 of Series I bonds on September 24. You earn 9.62 percent for six months for a total of $481 ($10,000 x 9.62 percent ÷ 2). On March 24, your principal balance is $10,481 ($10,000 + 481).

Let’s say Treasury sets the November 1 interest rate at 9 percent. During the six months from March 24 to September 24, 2023, you earn interest at 9 percent on $10,481. Now, at the end of a full year, you have $10,953 in your TreasuryDirect I bond account.

The big deal with an I bond is fourfold:

  • You can’t lose your principal (e.g., your $10,953 in the example above can’t go down).
  • Interest rates on I bonds track with the consumer price index inflation rate, which has been high.
  • You earn tax-deferred compound interest until you cash in.
  • The interest is exempt from state and local income taxes.

You have much to like with the Series I bond. And there’s little to dislike. Perhaps the biggest dislike is the $10,000 limit on I bond purchases, but you can use your business entities, trusts, gifts, and even your living trust to make purchases of I bonds and create a much higher limit than $10,000.

With the gifting strategy, you can have more than one gift box per donee, so you have opportunity there too.

The biggest deal with the I bond is that it carries no downside risk. It can’t go below its latest redemption value, and the interest rate can’t go below zero.

The one thing you need to pay attention to is the interest rate. It changes with inflation. The Fed wants to lower inflation to its target 2 percent. For most people, this means that the I bond could be a short-term investment—say, one to five years.

But think in the short term now. Where else can you earn 9.62 percent tax-deferred interest, risk-free?

If you would like to discuss I bonds, please call me on my direct line at 408-778-9651.

Tax-Free Conversion of a Partnership into an S Corporation

Let’s say you’re considering converting your partnership into an S corporation. The reason might be to reduce exposure for you and the other owners to Social Security and Medicare taxes, which come in the form of the self-employment tax for partners.

Specifically, each partner’s share of net partnership income is usually fully exposed to the self-employment tax. For 2022, the self-employment tax rate is a painful 15.3 percent on the first $147,000 of net self-employment income. On net self-employment income above $147,000, the self-employment tax rate drops to 2.9 percent.

For a shareholder-employee of an S corporation, the Social Security and Medicare taxes come in the form of the FICA tax. But for shareholder-employees, the FICA tax hits only amounts paid as salaries. Distributions of the remaining corporate cash flow are FICA-tax-free.

Whatever the reason for wanting to convert your partnership into an S corporation, here’s an explanation and a summary of the key federal income tax implications.

Good news: You can transfer the business assets, liabilities, and operations of your partnership to a C corporation by incorporating the partnership. This can potentially be a totally federal-income-tax-free transaction under Section 351 of our beloved Internal Revenue Code. Or it can be mostly tax-free.

Then you can turn the C corporation into an S corporation.

Section 351 treatment for the incorporation of a partnership is allowed when all the following requirements are met.

  1. One or more persons (which can include the partnership itself or its partners) transfer property (assets, which can include cash) to the corporation.
  2. The transfer is solely in exchange for stock of the corporation.
  3. The person or persons (the partnership itself or its partners) are in control of the corporation immediately following the transfer. Control means owning at least 80 percent of the stock.
  4. The transaction has a business purpose. The IRS created this additional requirement, but meeting it should not be a problem. For instance, incorporating to take advantage of the liability protection offered by the corporate form of doing business would be an acceptable purpose. So would providing for the orderly transfer of ownership of a business from one generation to the next.

The tax results when Section 351 applies are not elective. When you meet the Section 351 requirements, the tax results are what they are. One result is that there cannot be any taxable loss in a Section 351 incorporation.

If you would like to talk about converting your partnership to an S corporation, please call me on my direct line at 408-778-9651.

Cash In: Beat the Taxman with 11 Tax-Free Income Breaks

I was perusing the Internal Revenue Code (it’s one of the things I do) and started to think about the various sources of tax-free income.

Here are the 11 that jumped out at me:

  1. Roth IRAs
  2. Social Security benefits up to the taxable limits
  3. Tax-free IRA withdrawals (on top of tax-free Social Security)
  4. Home sale gains of up to $250,000 ($500,000 if married, filing jointly)
  5. Tax-free capital gains and dividends when you hit the sweet spot
  6. Capital gains sheltered with capital losses
  7. Stepped-up inherited assets
  8. Section 1031 real estate exchanges when held until death
  9. Qualified small business tax gains
  10. Section 529 college savings plans
  11. Coverdell Education Savings Accounts

When it comes to tax planning, tax-free tops the list.

If you would like to discuss tax-free income, please call me on my direct line at 408-778-9651.

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