Janathan Allen Was recently featured in an important publication by IR Global, a “multi-disciplinary professional services network that provides legal, accountancy and financial advice to companies and individuals around the world.”
The Article “The wisdom of transactional planning: protect your assets and reduce tax exposure” features an interview with Janathan Allen on a variety of important concepts surround transactional planning:
The wisdom of transactional planning: protect your assets and reduce tax exposure
What is “transactional planning”? How can an individual, married couple, business or entity structure the way they hold and transact assets and financial wealth in a manner that reduces risk, while increasing the protections surrounding those assets? Can you reduce taxation associated with those holdings and associated transactions?
Transactional planning is a process of structuring investments, business and real estate transactions in a manner which preserves and protects underlying assets while reducing associated risk and exposure to taxation. Allen Barron begins the process of transactional planning with a complimentary consultation with our clients to discuss their goals and objectives, current strategies, the challenges they’ve encountered and their present exposure to state, federal and international taxation.
“Our clients approach us with a burning issue, a challenge they’re facing,” notes Allen Barron’s founder Janathan Allen. “It’s always interesting to help our clients discover the smoke of the challenge in front of them is actually a symptom of a smoldering fire at a deeper level. We will absolutely manage the issues at hand, but the genuine solution lies in the resolution of that underlying challenge.”
The primary goals of transactional planning and the client
From an asset and investment point of view, the primary goals are almost always:
• Protect the assets and minimize risk surrounding how those assets are held as well as associated transactions
• Reduce taxation
The same goals apply to any well-conceived estate plan, a single closely-held business or a constellation of international corporate interests.
Transactional planning begins with a conversation. What motivates our client? What are their goals and plans for their present and future life? How are those plans currently structured and what assets do they contain? What is the fair market value and/or income created or produced by those assets?
The next step is to ascertain how those assets are held. Perhaps the client owns real estate which has been placed into a Limited Liability Company (LLC). Perhaps they own their own company, or several companies. What financial assets and accounts are in place and how are those accounts structured? Is everything local, or are there interests in several states or outside of the United States?
How should assets be held?
If two of the primary goals are to protect existing and future assets and minimize associated risks, the central question to evaluate is, “How should these assets be held?” Corporate entities such as an LLC or S or C Corporation exist to literally separate the individual owners and their personal assets from those held in the entity. Each entity protects the assets held by the company while reducing exposure to contingent liabilities associated with those assets for the owner of the entity. The nature of an individual asset or group of assets and the transactions associated with each determine how each asset should be held.
How, when and where is income realized?
How is income generated, when is income realized and where (geographically) is it coming from? How, when and where should income be realized? These powerful questions are an essential step in the transactional planning process. There are three types of income in a transactional plan: investment income, active income and passive income. Investment income is generated by profitable sales of investment assets such as stocks or real estate as well as dividends. Active income relates to duties, services or tasks based upon a specific time frame such as a salary, tips, commission, fees or allowances. Passive income relates to earnings from rents, an LLC or other entity in which the client isn’t actively involved. Each type of income is taxed in a different manner.
“An effective transactional plan is a sophisticated integration of legal strategies, tax expertise and supporting accounting structures.”
PIGs and PALs
A conversation about transactional planning often includes a discussion on PIGs and PALs. Recent changes to the tax code provided the opportunity to reduce tax exposure by reclassifying the nature of some income and the tax liabilities associated with that income. Passive Income Generators (PIGs) are fully taxed. Passive Activity Losses (PALs) can be utilized to offset income from PIGs or shelter passive income from taxation in a manner which is not available with other forms of income or investment.
One objective of a transactional plan is to minimize tax. This might be a reason for creating a new entity or structure of entities within a transactional plan. For example, LLCs can hold active income or passive income. Part of the transactional plan may include varying LLCs based upon the type of income each generates and offsetting specific types of income and losses (PIGs and PALs for example) to get as close to zero as possible.
Pass-through entities such as an LLC or S Corporation operate on a calendar year. A C Corporation, however, can set its fiscal year to be independent of the calendar year. Consider the impact of a year-end pass-through in an LLC or S Corporation. It’s the end of December and any remaining earnings in the LLC or S Corporation must be passed as income to the owner(s). If that occurs in December of 2022, the taxes on those earnings would be paid and reported on tax returns in April of 2023. In this same example, a C Corporation with a year-end of March 31 would allow the owner to defer the realization of that same income until January 2, 2023, thereby deferring the tax impact of that event for an entire year!
The wisdom of transactional planning
Generally speaking, an effective transactional plan is a sophisticated integration of legal strategies, tax expertise and supporting accounting structures. Legal entities provide additional protection for assets and reduce exposure to risk. A transactional plan should provide the ability to accelerate or defer income or losses into periods that provide the greatest tax advantage. The same is true geographically. Those with international assets, investments, corporate ownership and/or income are prudent to develop transactional plans which provide the opportunity to structure the realization of income in the most favorable tax jurisdiction possible.
The process of transactional planning begins with a thorough analysis of existing portfolios, income, losses, entities and transactions. The integration of legal, tax and accounting skill and expertise is required to answer the questions of how assets should be held, as well as how, when and where income is realized. A well-crafted transactional plan protects your assets, minimizes risk and reduces taxation to facilitate the accomplishment of your life’s goals and plans.