A cash cushion, a tax rate that crept up, and four specialists who worked from one plan to bring it down.
AT A GLANCE
The clients: Raymond, 57, and Cheryl, 55, owners of a food distribution company with 41 employees, who joined their accounting firm in the spring
The gap: $2.7M of investments inside the operating company, cutting next year's small business limit from $500,000 to $190,000
The fix: a $900,000 working reserve, year-end loss harvesting, and the $1.8M surplus moved into corporate-owned insurance over about six years, subject to insurability, policy costs, and a long-term funding commitment. A holding company would not have worked
The illustrated result: passive income fell below the $50,000 threshold and the full small business limit applied the following year, an estimated $37,000 less corporate tax for that year in this hypothetical scenario. Future results depend on passive income levels, tax rules, and the owners' circumstances, and savings may vary
The team: the accounting firm's tax team and WealthCo's planning, investment, and risk specialists
Most business owners have a pile of cash inside the company that they call a safety net. Few have checked what that pile is doing to their tax rate. The people and numbers here are illustrative, but the situation is one we see often.
The figures below show how the rules could apply in one hypothetical case. They are not a prediction of results for any other company.
Raymond, 57, and Cheryl, 55, own a food distribution company with 41 employees and about $12.4 million in revenue. Over 26 years, profits Raymond did not need had built up inside the operating company as a $2.7 million investment portfolio. They joined their accounting firm in the spring, after their previous accountant retired.
THE GAP
When the accounting firm introduced Raymond and Cheryl to the team at WealthCo in November for the year-end review, the two teams were able to jointly identify the problem and show Raymond and Cheryl what they found.
The tax team saw $112,000 of investment income, enough to cut next year's small business limit from $500,000 to $190,000. WealthCo's planning team saw that the company needed about $900,000 of the $2.7 million it was holding. The other $1.8 million was surplus.
A holding company was the first idea on the table. The tax team explained why it would not help: companies under common control are associated, so they share the limit and their passive income is added together.
“I thought those investments were helping the company. Nobody had told me they were raising its tax rate.”
— Raymond (illustrative)
WHAT CHANGED
The accounting firm's tax team quantified the lost small business limit and ruled out a holding company, because associated companies share the limit and their passive income
WealthCo's planning team set the working reserve at $900,000 and identified the other $1.8 million as surplus
Before December 31, WealthCo's investment team realized about $50,000 of losses on positions already under water, trimming passive income to $87,000 and the estimated extra tax for the next year from about $37,000 to about $22,000
WealthCo's risk team designed a corporate-owned permanent life insurance policy on Raymond and Cheryl, to be funded with the surplus over about six years, subject to both being insurable. Income earned inside a policy that meets the exempt test is generally not counted as passive income, but the policy carries premiums and costs, a long-term funding commitment, and limits on how much can be deposited each year
WealthCo's investment team repositioned the taxable portfolio for less current income and staged the changes so the sales did not push the number back up
WHAT TO WEIGH BEFORE USING INSURANCE
Corporate-owned permanent life insurance is not the right fit for every company, and it was one part of a broader plan here. Before choosing it, owners should weigh:
Cost: premiums and policy charges reduce the amount that would otherwise stay invested in the company.
Long-term commitment: this plan relies on deposits of about $300,000 a year for about six years. Reducing or stopping deposits can change the outcome.
Insurability: coverage depends on medical and financial underwriting. A policy may cost more than expected or may not be available.
Surrender charges and access: surrender charges may apply, and access to the policy's cash value is limited in the early years.
Policy performance: cash value growth depends on how the policy performs and on its terms, and may be lower than illustrated.
Exempt-test limits: tax rules cap how much can be deposited while the policy keeps its exempt status, which limits how much surplus can move into it and how quickly.
A licensed insurance advisor should review whether a policy fits the company and the family before any decision is made.
THE OUTCOME
The reduced limit still applied for the first year, because it is set by the prior year's passive income, but in this scenario the year-end moves were estimated to cut that year's extra tax from about $37,000 to about $22,000.
By the end of that first year, passive income was about $46,000, below the $50,000 passive income threshold, so the full $500,000 small business deduction applied the year after. In this illustration, that is an estimated $37,000 less corporate tax for that year on the profits the company keeps. The figure is specific to this hypothetical scenario; actual savings may be higher or lower and can change from year to year.
Staying under the threshold is not automatic. It depends on future investment returns, how the company grows, changes to tax rules, and the owners' circumstances, so the plan needs to be reviewed every year.
The tax, planning, investment, and insurance pieces were built from one plan with the accountant in the room. Because each piece depends on the others, the team reviews them together at each year-end to check whether passive income is still on track as the company grows.
THE TAKEAWAY
Each specialist held a different piece. The accountant knew the rule and why a holding company would not help. The planner knew how much the company really needed. The risk team knew how insurance could keep part of the surplus out of the number, and what it would cost. The investment team knew how to manage the timing. Together they built a plan designed to be reviewed and adjusted each year as the company and the rules change.
Bring your accountant and your advisor to the same table
If your company holds a cushion of cash or investments, this is your chance to see what it costs and what it could be doing instead. Book a coordination review and we will sit down with your accountant and your advisors so every piece is built from the same page.
Important information: This case study is an illustrative scenario prepared for educational purposes only. It does not depict a real client or engagement, and all names, figures, and outcomes shown are hypothetical. Nothing in this piece is tax, legal, accounting, insurance, or investment advice. Tax rules change and outcomes depend on individual circumstances. Please speak with your own qualified advisors. Tax savings shown are estimates for this hypothetical scenario only and are not guaranteed; actual results depend on future passive income, tax rules, and individual circumstances. Life insurance involves premiums and costs, underwriting, and a long-term funding commitment, and the tax treatment of policy proceeds depends on factors such as the policy's adjusted cost basis and the tax rules in effect at the time.
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