Does your business have multiple owners? If so, you need a buy-sell agreement. This type of binding contract determines how (and at what price) ownership shares of a privately held business will change hands should an owner depart. There are also potential tax consequences to consider.

Unique Challenges

Unlike public companies, private ones have no ready or established market on which to sell ownership shares. This can create difficult circumstances for businesses when something unexpected happens. Say an owner suddenly dies. The owner’s shares may pass on to heirs, but how much are those shares worth and to whom can the heirs sell them? A buy-sell agreement will remove uncertainty by stipulating that remaining owners will buy the ownership interest at a price determined by the stated valuation method. Plus, the agreement will help to
prevent an unfamiliar and perhaps unwanted owner from suddenly joining the business.

Setting Parameters

A buy-sell agreement sets up parameters for the transfer of ownership interests following any of a number of “triggering events,” such as an owner’s:

• Death,
• Long-term disability,
• Loss of professional license,
• Retirement,
• Bankruptcy, or
• Divorce.

The agreement will also specify a valuation method for appraising the departing owner’s interest at the appropriate time. In choosing a method, you and your fellow owners should carefully define buyout terms and specify the financial data to be used in the agreement. For example, a sound buy-sell agreement will spell out a required end-date for the financial statements that must be used to appraise business interests following a triggering event. Some also mandate a particular level of assurance (compilation, review or audit) regarding those financial statements.

Different Approaches

In most cases business owners don’t have the cash readily available to buy out a departing owner. So most buy-sell agreements include insurance policies to fund the agreement. This is where different types of agreements come into play. Under a cross-purchase agreement, each owner buys life or disability insurance (or both) on each of the other owners. Should one owner die or become incapacitated, the other owners collect on their policies and use the proceeds to buy the deceased or incapacitated owner’s shares.

Another type is a redemption agreement. Here, the company (not each owner) buys the insurance policies and acquires the deceased or incapacitated owner’s shares. This approach can help businesses with a lot of owners, because fewer policies are needed. In some cases, a company will create a hybrid buy-sell agreement that combines aspects of the cross-purchase and redemption approaches. These agreements may stipulate that the business gets the first opportunity to redeem ownership shares. And, if the company is unable to buy the shares, the remaining owners are then responsible for buying the departing owner’s interests. Alternatively, the owners may have the first opportunity to redeem the shares.

Tax Consequences

The life insurance used to fund buy-sell agreement can also have undesirable tax consequences without proper planning. Life insurance proceeds generally are excluded from the beneficiary’s taxable income, whether the beneficiary is a corporation, another shareholder or a separate entity. An exception is the transfer-for-value rule, under which proceeds will be taxable if an existing policy was acquired for value by someone other than the insured or a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder.

This issue often arises when structuring or changing a buy-sell agreement using existing insurance policies. It’s important to structure the agreement so that the transfer-for-value rule won’t have an impact; otherwise, the amount of after-tax insurance proceeds will be reduced.

This issue often arises when structuring or changing a buy-sell agreement using existing insurance policies. It’s important to structure the agreement so that the transfer-for-value rule won’t have an impact; otherwise, the amount of after-tax insurance proceeds will be reduced.

You may be able to manage this problem by revising your buy-sell as a cross-purchase agreement. Under this approach, owners will buy additional shares themselves, increasing their basis. But there are downsides. If owners are required to buy a departing owner’s shares but the company redeems the shares instead, the IRS may characterize the purchase as a taxable dividend. Your business may be able to mitigate this risk by crafting a hybrid agreement that names the corporation as a party to the transaction and allows the remaining owners to buy back the stock without requiring them to do so.

Complex but Important

Buy-sell agreements can help closely held businesses ensure a smooth transition when an owner leaves the business. But they also require careful planning to be effective, including properly addressing potential tax issues.

One of the most important questions you face when changing jobs is what to do with the money in your 401(k) plan. Making the wrong move could cost you thousands of dollars or more in taxes, penalties and lower returns.

Consequences of Cashing Out

Let’s say you work five years at your current job. For most of those years, you’ve had the company take a set percentage of your pretax salary and put it into your employer’s plan. Now that you’re leaving, what should you do?

The first rule of thumb is to leave it alone. Resist the temptation to cash out. The worst thing you can do when leaving a job is to withdraw the money and put it in your bank account. Here’s why:

If you decide to have your distribution paid to you, the plan administrator will withhold 20 percent of your total for federal income taxes. So if you had $100,000 in your account, you’re already down to $80,000.

Furthermore, if you’re younger than 59 1/2, you’ll generally face a 10 percent penalty for early withdrawal come tax time. Now you’re down another 10 percent from the top line to $70,000.

There is an exception to the 10 percent early withdrawal tax penalty for 401(k) plans if you separate from service during or after the year you reach age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan). IRAs, SEPs, SIMPLE IRAs, and SARSEPs do not qualify for the exception.

In addition, because distributions are taxed as ordinary income, at the end of the year, you’ll have to pay the difference between your tax bracket and the 20 percent already taken out. For example, if you’re in the 32 percent tax bracket, you’ll still owe 12 percent, or $12,000, which lowers the amount of your cash distribution to $58,000. (If your tax bracket is less than 20%, you may qualify for a refund, depending on your overall tax liability for the year compared to what was withheld or paid in estimated taxes for the year.)

But that’s not all. You also have to pay any applicable state and local taxes. Between taxes and penalties, you could end up with little over half of what you saved, short-changing your retirement savings significantly. Finally, you will miss out on any future tax-deferred growth those assets would have produced had they remained in the retirement plan.

What Are the Alternatives?

If your new job offers a retirement plan, the easiest course of action is to roll your account into the new plan. A “rollover” is relatively painless to do. Contact the 401(k) plan administrator at your previous job, who should have all the necessary forms.

The best way to roll funds over from an old 401(k) plan to a new one is to use a direct transfer. With the direct transfer, you never receive a check, you avoid all the taxes and penalties mentioned above, and your savings will continue to grow tax-deferred.

Many employers require that you work a minimum length of time before you can participate in their 401(k) plan. If that is the case with your new employer, one solution is to keep your money in your former employer’s 401(k) plan until you are eligible for the new one. Then you can roll it over into the new plan. Most plans let former employees leave assets in their old plan for several months or longer.

If you’re not happy with the fund choices your new employer offers, you might opt for a rollover IRA instead of your company’s plan. You can then choose from hundreds of funds and have more control over your money. But again, to avoid the withholding hassle, use direct rollovers.

60-Day Rollover Period

If you have your former employer make the distribution check out to you, the Internal Revenue Service considers this a cash distribution. The check you get will have 20 percent taken out automatically from your vested amount for federal income tax.

But don’t panic. You have 60 days to roll over the lump sum (including the 20 percent) to your new employer’s plan or into a rollover IRA. Then you won’t owe the additional taxes or the 10 percent early withdrawal penalty and, depending on your overall tax liability for the year, you might receive a refund of some or all of the 20% withheld. But keep in mind that in your rollover you will have to make up for the withheld 20% with funds from another source. Otherwise, the withheld amount will be treated as a distribution and subject to any applicable taxes and penalties.

Leave It Alone

If your vested account balance in your 401(k) is more than $5,000, you can usually leave it with your former employer’s retirement plan. Your balance will keep growing tax-deferred.

However, if you can’t leave the money in your former employer’s 401(k) and your new job doesn’t have a 401(k), your best bet is a direct rollover into an IRA. The same applies if you’ve decided to go into business for yourself. You can still continue to enjoy tax-deferred growth.

Questions about IRA rollovers? Help is just a phone call away.

By law, U.S. citizens and resident aliens living abroad must file a U.S. income tax return and report any worldwide income. Some key tax benefits, such as the foreign earned income exclusion, are only available to those who file U.S. returns. As such, if you are living or working outside the United States and Puerto Rico, you generally must file and pay your tax the same way as people living in the U.S. This includes people with dual citizenship. Here’s what taxpayers need to know about reporting foreign income:

Reporting Worldwide Income

Federal law also requires U.S. citizens and resident aliens to report any worldwide income, including income from foreign trusts and foreign bank and securities accounts. In most cases, affected taxpayers need to file Schedule B (Form 1040), Interest and Ordinary Dividends, with their tax returns. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.

Some taxpayers may need to file additional forms with the Treasury Department:

Form 8938. Generally, U.S. citizens, resident aliens, and certain nonresident aliens must report specified foreign financial assets on Form 8938, Statement of Specified Foreign Financial Assets if the aggregate value of those assets exceeds certain thresholds. FATCA (Form 8938) is submitted on the tax due date (including extensions, if any) of your income tax return.

FBAR. Taxpayers with foreign accounts whose aggregate value exceeded $10,000 at any time during 2022 (or in 2023 for next year’s filing returns) must file a Treasury Department FinCEN Form 114 (formerly TD F 90-22.1), Report of Foreign Bank and Financial Accounts (“FBAR”). FBAR is not a tax form but is due to the Treasury Department by April 18, 2023, and must be filed electronically through the BSA E-Filing System website. It may be extended to October 16.

Foreign Earned Income Exclusion

Many Americans who live and work abroad qualify for the foreign earned income exclusion when they file their tax return. This means taxpayers who qualify will not pay taxes on up to $112,000 of their wages and other foreign earned income they received in 2022 ($120,000 in 2023).

Credits and Deductions

Taxpayers may also be able to take either a credit or a deduction for income taxes paid to a foreign country. This benefit reduces the taxes these taxpayers pay in situations where both the U.S. and another country tax the same income.

An income tax filing requirement applies even if a taxpayer qualifies for tax benefits such as the Foreign Earned Income Exclusion or the Foreign Tax Credit, which reduce or eliminate U.S. tax liability. These tax benefits are available only if an eligible taxpayer files a U.S. income tax return.

Automatic Extension

U.S. citizens and resident aliens whose tax home and abode are outside the U.S. and Puerto Rico on April 18, 2023, qualify for an automatic two-month extension (until June 15) to file their 2022 federal income tax returns. The extension of time to file also applies to those serving in the military outside the U.S. Taxpayers must attach a statement to their returns explaining why they qualify for the extension.

Additional Extension of Time to File

U.S. citizens and resident aliens living abroad may be granted a filing extension of up to six months (October 16, 2023) by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return prior to the due date of the tax return (April 18, 2023). However, a taxpayer filing an extension must pay any tax due by the original date or be subject to late payment penalties and interest.

If you’re a taxpayer or resident alien living abroad that needs help with tax filing issues, IRS notices, and tax bills, or have questions about foreign earned income and offshore financial assets in a bank or brokerage account, don’t hesitate to call.