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Proper tax planning requires thorough analysis of an individual's complete financial and tax situation. While there are some general rules, effective tax planning is very specific and a unique plan should be tailored on an individual basis.
Taxpayers who wish to reap all the benefits of a Section 475 election may still do so by forming a new trading entity which can make the election by placing a statement with the required wording in its books and records within 2 months and 15 days of its inception.
Some ways to have both mark-to-market accounting benefits and capital gains rate advantages are:
- Elect MTM accounting in a new entity set up for trading activities and retain non-MTM securities identified as investment positions. This can be used as an effective planning tool in some cases to allow a taxpayer to utilize unused carry forward losses and have available the ability to have long term capital gains taxable at the preferential lowest capital gains rates
- Elect MTM accounting for your personal trading and set up an entity to trade assets that will utilize the advantages of favorable long term capital gains tax rates
- Elect MTM accounting for your trading account and segregate and identify other securities in a separate brokerage account which can have capital gains tax rate apply
- One spouse can be set up as a MTM trader while the other spouse with clearly segregated assets can be considered an investor
Section 419 Plans/VEBA
Generally speaking, a 419 Plan is a multiple-employer welfare benefit plan authorized under section 419A(f)(6) of the Internal Revenue Code. Sec. 419A(f)(6), exempts multiple employer funded welfare benefit plans from the strict funding limitations contained in IRC Sections 419 and 419A. While many people are familiar with VEBAs (Voluntary Employee Benefit Associations), 419 Plans are not governed by ERISA, thus making them much more flexible for use by Traders and Investors. These type of multiple employer trusts (MET's) have been used by large corporations, unions and association for over 50 years, yet they are just as beneficial for Traders.
419 Plans can be used to fund health, medical, severance and death benefits, although a practical strategy for Traders is through the implementation of a death benefit only plan. Section 419 Plans have a number of advantages for traders, perhaps the greatest of which is the ability to obtain an unlimited tax deduction. Whether you make $50,000 from trading or $5,000,000, you can avoid taxation through the use of these plans. Too good to be true you say - what's the catch? Simply this, through these plans Congress allows tremendous benefits but there is a cost - you must be willing to give up some ownership and some control for a short period of time.
Since 419 Plans are "employee benefit" Plans they must be established by bona fide employers. Thus they cannot be established by sole-proprietors. To be eligible your trading or investing activity must be conducted through a qualifying employer such as a corporation, partnership or limited liability company. This is a strategy designed for profitable traders, though it can also be used to protect non-trading income as well. Although there are several ways in which a Section 419 Plan can be structured for a trader, a typical scenario might be as follows:
Step 1. Trader's "company" makes $100,000 in capital gains. There are two options: (1) pay 40% tax and reinvest $60,000 into the trading account to trade on a taxable basis; (2) contribute $100,000 to a Section 419 Plan and receive a $100,000 tax deduction and avoid all taxes.
Step 2. Trader's company contributes $100,000 to a Section 419 trust, receives deduction and pays no taxes.
Step 3. Section 419 Trust purchases life insurance on Trader's life. While any type of life insurance is possible we suggest a variable whole life policy to take advantage of the ability to build up a cash value for the Trader's benefit.
Step 4. Of the $100,000 contribution from the trust to the insurance policy approximately $15,000 goes toward premium and about $85,000 goes toward front-end loaded cash value.
Step 5. The cash value in the policy is invested in mutual funds and all growth is tax free.
Step 6. When Trader needs access to the cash a loan can be obtained from the policy which is a non-taxable event.
The foregoing is an oversimplification of a fairly complex arrangement, however, as you can see the benefits can be tremendous.
The second greatest advantage of 419 Plans is the ability to pass on a great deal of your wealth to your heirs estate tax free and with tax-deductible dollars.
A brief summary of some of the benefits of Section 419 Plans are:
- Contributions are 100% tax deductible in the year contributed
- Growth is 100% tax deferred
- Allows an unlimited amount to be saved for retirement, childrens' education, etc
- May contribute as much or as little as you desire in any given year
- Contributions are protected from creditors
- Contributions are protected in the event of a divorce
- Contributions are excluded from your estate for estate tax purposes.
- May be passed to your heirs free of estate tax