Estate planning pitfalls exist if a significant portion of your wealth is concentrated in a single stock
Estate planning and investment risk management go hand in hand. After all, an estate plan is effective only if you have some wealth to transfer to the next generation. One of the most effective strategies for reducing your investment risk is to diversify your holdings.
However, it’s not unusual for affluent people to end up with a significant portion of their wealth concentrated in one stock. There are several ways this can happen, including the exercise of stock options, participation in equity-based compensation programs, or receipt of stock in a merger or acquisition.
Ease risk by diversifying
To reduce your investment risk, the simplest option is to sell some or most of the stock and reinvest in a more diversified portfolio. But this may not be preferable if you don’t want to pay the resulting capital gains taxes. Or it may not be an option if there are legal restrictions on the amount you can sell and the timing of a sale. And in some cases, you may simply wish to hold on to the stock.
To soften the tax hit, consider selling the stock gradually over time to spread out the capital gains. Or, if you’re charitably inclined, contribute the stock to a charitable remainder trust (CRT). The trust can sell the stock tax-free, reinvest the proceeds in more diversified investments, and provide you with a current tax deduction and a regular income stream. (Be aware that CRT payouts are taxable — usually a combination of ordinary income, capital gain and tax-free amounts.)
Ease risk without selling the stock
What if you don’t want to sell the stock? You have a few options, including:
- Using a hedging technique, such as purchasing put options to sell your shares at a set price.
- Buying other securities to rebalance your portfolio. Consider borrowing the funds you need, using the concentrated stock as collateral.
- Investing in a stock protection fund. These funds allow investors who own concentrated stock positions in different industries to pool their risks, essentially insuring their holdings against catastrophic loss.
Contact us to learn about additional asset-protection strategies so that you can preserve the greatest amount of your wealth for your heirs.
© 2021 Covenant CPA
There’s a harsh tax penalty that you could be at risk for paying personally if you own or manage a business with employees. It’s called the “Trust Fund Recovery Penalty” and it applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages.
Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is aggressive in enforcing the penalty.
The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a wide range of people involved in a business.
Here are some answers to questions about the penalty so you can safely avoid it.
What actions are penalized? The Trust Fund Recovery Penalty applies to any willful failure to collect, or truthfully account for, and pay over Social Security and income taxes required to be withheld from employees’ wages.
Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation’s officers, directors and shareholders under a duty to collect and pay the tax as well as a partnership’s partners, or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under some circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.
According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to pay them but instead make payments to creditors and others, you become a responsible person.
Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken entirely on his or her own after the penalty is paid. It isn’t part of the IRS collection process.
What’s considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due the government is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to take care of the job yourself can be treated as the willful element.
Never borrow from taxes
Under no circumstances should you fail to withhold taxes or “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions about making tax payments.
© 2021 Covenant CPA
Bad faith denials of claims by insurers are illegal, but some dishonest companies or agents attempt them anyway. It’s possible that just when you have the greatest need, you’ll find yourself out in the cold. Unfortunately, there aren’t a lot of great legal remedies. So it’s critical to avoid bad and fraudulent insurance in the first place.
An insurance policy is a contract. The insured agrees to pay premiums and take reasonable steps to prevent injury or damage, and the insurer agrees to settle legitimate claims according to the policy’s terms. Not only is it good business practice for insurers to cover legitimate claims, but it’s illegal for them to deny them.
There may be times when you and your insurer disagree about what’s covered or what constitutes a reasonable delay or amount in settlement. But errors in judgment and offers of compromise don’t necessarily equal bad faith. Bad faith arises when the insurer sacrifices its insured customers’ interests to enhance its own bottom line — and that can involve fraud.
Bad faith practices
Outright denial of legitimate claims is only one bad faith practice that indicates fraudulent insurance practices. Shady operators may also unreasonably delay investigating a claim or attempt to settle a claim for less than the amount specified by your policy.
Another bad faith tactic is to slow down the claim process by requiring multiple, duplicative proof of loss forms. Or an insurer might fail to settle one portion of a claim to induce you to accept a lesser settlement under another section of the policy. In many cases, fraudulent insurers misrepresent policy provisions related to claims.
Trouble with arbitration
When a claim is denied, one way to avoid legal action is arbitration. But a bad faith insurer might threaten to appeal arbitration awards to pressure you to settle for less than the awarded arbitration amount.
Defending against such practices can be difficult. One problem is that there’s no federal — only state — regulation of the insurance industry. Penalties imposed by states typically aren’t stiff enough to deter fraudulent practices, and they generally do nothing to compensate claimants who were wrongfully denied.
It’s important, therefore, to deal with only reputable insurance companies. Before you buy, check with industry rating services such as A.M. Best or your state’s department of insurance. Ask advisors and colleagues for their recommendations as well. And if you have a claim, be sure to file it promptly and document all correspondence and communication relating to it.
Adequate insurance coverage is a cornerstone of an effective risk management plan. If you’re not sure you have the right insurance by a trustworthy carrier, contact us for help.
© 2021 Covenant CPA
As counterintuitive as it may seem, law firms aren’t immune to criminal activity. Because some firms place enormous pressure on attorneys to produce billable work, they may be particularly vulnerable to fraud. Your firm needs to know what to look for and how to protect itself from potential schemes perpetrated by partners, associates and support staff.
Hold everyone to high standards
A firm’s accounting department — payroll and accounts payable and receivable — is where fraud often occurs. But even trusted partners should adhere to your firm’s internal controls and fraud-prevention processes.
All prospective employees, regardless of level, need to complete an employment application with written authorization permitting your firm to verify information provided. Then, call references and conduct background checks (or hire a service to do it). These checks search criminal and court records, pull applicants’ credit reports and driving records, and verify their Social Security numbers.
Protect with oversight
The design of financial documents can help protect your firm’s financial transactions from fraud. For example, use prenumbered payment vouchers that a designated partner must approve. This is effective because the designated partner knows what the transactions are and how they pertain to your firm’s clients.
A designated partner should also open all bank statements. Even if the partner doesn’t review every item individually, employees will get the message that transactions will be verified. Someone outside your firm’s accounting department, such as your CPA, might review transactions as they’re processed and financial statements at the close of accounting cycle reconciliations.
To prevent fraudsters from manipulating financial records, ensure that accounting and billing systems are accessible only to those partners, managers and accounting staffers who need to use them. Change difficult passwords frequently and keep your firm’s cybersecurity software current.
Some smaller firms assign the same person to open mail, make bank deposits, record book entries and reconcile monthly bank statements. In this environment, fraud is not only possible — it’s likely. It’s critical that your firm distribute these tasks to two or more people. If this is impossible, consider outsourcing at least some accounting functions.
Firms of all size — and, in fact, professional service firms in general — need to be especially wary of expense report fraud. A manager should review all expense submissions before they go to accounting for payment. Require backup documentation and an explanation of how expenses relate to client or firm business.
In the collegial environment of the typical law firm, partners and employees are more likely to be influenced by their peers. Make sure you’ve built a highly ethical culture in which everyone works to deter fraud and is committed to reporting behavior that violates policies. Contact us for help developing effective internal controls or if you suspect fraudulent activity in your firm.
© 2021 Covenant CPA
The premium tax credit (PTC) is a refundable credit that helps individuals and families pay for insurance obtained from a Health Insurance Marketplace (commonly known as an “Exchange”). A provision of the Affordable Care Act (ACA) created the credit.
The American Rescue Plan Act (ARPA), signed into law in March 2021, made several significant enhancements to the PTC. Although these changes expand access to the credit for individuals and families, they could increase the risk of some businesses incurring an ACA penalty.
More eligible people
Under pre-ARPA law, individuals with household income above 400% of the federal poverty line (FPL) were ineligible for the PTC. Under ARPA, for 2021 and 2022, the PTC is available to taxpayers with household incomes that exceed 400% of the FPL. This change will increase the number of PTC-eligible people.
For example, a 45-year-old single person earning $58,000 in 2021 (450% of FPL) would have been ineligible for the PTC under pre-ARPA law. Under ARPA, that individual is eligible for a PTC of about $1,250.
Lower income cap
The PTC is calculated on a sliding scale based on household income, expressed as a percentage of the FPL. The amount of the credit is limited to the excess of the premiums for the applicable benchmark plan over the taxpayer’s required share of those premiums. The required share comes from a table divided into income tiers.
Because the required share is less under the new tables for 2021 and 2022 than it otherwise would have been, the PTC will be greater. Under pre-ARPA law, a taxpayer might have had to spend as much as 9.83% of household income in 2021 on health insurance premiums. Under ARPA, that amount is capped at 8.5% for 2021 and 2022.
More penalty exposure
As mentioned, the expanded PTC will help individuals and families obtain coverage through a Health Insurance Marketplace. However, because applicable large employers (ALEs) potentially face shared responsibility penalties if full-time employees receive PTCs, expanded eligibility could increase penalty exposure for ALEs that don’t offer affordable, minimum-value coverage to all full-time employees as mandated under the ACA.
An employer’s size, for ACA purposes, is determined in any given year by its number of employees in the previous year. Generally, if your company had 50 or more full-time or full-time equivalent employees on average during the previous year, you’ll be considered an ALE for the current calendar year. A full-time employee is someone employed on average at least 30 hours of service per week.
Assess your risk
If your business is an ALE, be sure you’re aware of this development when designing or revising your employer-provided health care benefits. Should you decide to add staff this year, keep an eye on the tipping point of when you could become an ALE. Our firm can further explain the ARPA’s premium tax credit provisions and help you determine whether you qualify as an ALE — or may soon will.
© 2021 Covenant CPA
Many startup companies require access to large sums of investment capital to take on well-established competitors. The need to raise such funding may encourage a startup’s founder to paint an overly optimistic picture of the business and exaggerate its ability to succeed. In some extreme circumstances, founders may resort to deception to convince investors to back their ventures. That’s fraud.
Silicon Valley warning
A medical testing startup provides a cautionary tale of what can happen when an aggressive entrepreneur plays fast and loose with the truth. Based on the extravagant claims of the Silicon Valley company’s founder, the startup raised more than $700 million and secured a $10 billion valuation. When evidence emerged that it couldn’t conduct extensive medical tests on tiny amounts of blood as it had claimed, the company collapsed.
Its founder has denied allegations that she made false claims. She and the startup’s former president currently are defending themselves against criminal charges leveled by the U.S. Attorney’s Office (a trial is scheduled for this spring). The founder has already settled a lawsuit alleging fraud filed by the Securities and Exchange Commission.
Getting adequate information
So how can you avoid fraudulent investments? The simple answer is that you must investigate any claims that sound too good to be true and closely scrutinize new investment opportunities — and the entrepreneurs behind them.
The founder of the medical testing company deflected requests for information about its inner workings. She often cited the need to protect intellectual property. Protecting proprietary information is a valid concern. But before investors inject capital into a project, they need to have an intimate understanding of the company and its products and services. If a startup refuses to provide adequate information, you’re better off walking away.
The startup also lacked an audited set of financial statements. This is another glaring red flag that investors should have heeded. According to MarketWatch, none of its investors requested access to the company’s financial statements.
In addition to developing a detailed understanding of a company’s operations, set aside time to conduct background checks on its founders and key executives. A founder’s so-called stellar business track record may not jive with public records that show a history of failed ventures. Or you may find that a programming “prodigy” enjoys little respect or confidence in the tech community. Ask direct questions of the business’s owner to resolve issues.
Reduce your risk
Startups have a strong incentive to provide potential investors with overly optimistic financials and hyperbolic growth claims. Most startup founders aren’t involved in promulgating fraud. Nevertheless, you should work with experienced financial advisors when investing in a new company.
© 2021 Covenant CPA