Businesses introduce several unique characteristics for planning purposes. Each business includes several factors:
– Business value and appreciation
– Spendable cash flow
– Taxable income
There are several ways to account for business values in TOTAL. The most straightforward method is capturing the net value impact of the business as detailed in this post.
Current Business Value
Enter the net business value in the asset input section, with the group as [Other/Business] and the type as [Equity/Other]. Uncheck the [Available for Withdrawal] box (Check if Used for Retirement in the desktop edition.) This means the business value will only be included in the current year net worth report, but it also means the program will not draw down from the business automatically. This allows you to capture the income in the future if the business is to be sold (see business sale below).
For example, a client with a current business with a net value of $500k entry for Net Worth purposes:
For business income, you will want to capture the income for the client’s cash flow purposes and tax purposes.
An example of a client with gross business income of $300,000, operating expenses of $100,000 and depreciation of $75,000 is shown below.
Cash Flow – determine the spendable cash flow from the business.
– Gross business income
– Less debt payments
– Less cash expenses
– Equals cash flow income
Enter this annual amount in the [Tax Details] tab of the Taxes Section (Tax Data tab in the desktop edition) data entry under [Other Taxable Income/(Loss)] category for the [Cash Flow] column. This is the amount of income that will be displayed on the Cash Flow reports.
Taxable Income – determine the taxable income that will be reported.
– Gross business income
– Less any deductible expenses
– Less any depreciation on the business assets
Enter this annual amount in the [Tax Details] data entry under [Other Taxable Income/(Loss)] category for the Tax Report column. If they have a loss for tax purposes, enter this as a negative amount. This is the amount of income that will be displayed on the tax reports.
Golden Years includes a detailed annual cash flow and tax projections, so enter any changes to the income for cash flow and tax purposes by using age-change events. Be sure to include a stop age by entering the age the business income is expected to stop and zero for the dollar amounts.
For the example client, the cash flow income is $200k, which is the gross income of $300k less operating expenses of $100k. The taxable income is $125k, which is the gross income of $300k less operating expenses of $100k and depreciation expenses of $75k.
The tax and cash flow reports in Easy Money are for the current year only due to its goal-based methodology focusing on savings prior to retirement rather than cash flow income and expenses. The entry made on tax data will only impact those current year projections. If the business income continues into retirement, the income should be entered using [Other Income] tab within the [Income] section of the data entry.
Business Sale Proceeds
Like business income, capturing sales proceeds needs to account for the net sale income and associated taxes. You will need to have an assumed sale proceed and approximate tax information for the business sale. The best way to capture the sale varies between Easy Money and Golden Years projections due to the underlying goal vs cash flow methodologies.
For example, a client is selling a business at age 65 for an expected value of $750k. The net income is assumed to be $675k after transaction fees and other expenses. For taxation purposes, the sale will result in a net of $300k of long-term capital gain income and $100k of ordinary income.
Capture the After Tax Net Income:
Use the [Other Income] tab in the [Income] section of the data entry to capture the assumed after-tax net income from the sale of the business, making sure to leave the [Taxable %] at 0. If the business will experience growth between now and the time is it received, you may enter the future income amount, or allow the program to increase it by entering an appreciation rate beginning in the current year. Enter a stop age in the next line of the age change table to make sure the income doesn’t continue past the year of sale. The income from the sale will be considered a surplus to be reinvested into retirement capital.
For the example, enter the client age of 65 and the net sales income of $600k. This is the net income from the sale of $675k less taxes of $75k. Taxes include $45k assuming a 15% capital gain rate for the $300k of capital gain income and an additional $30k for assuming a 30% ordinary rate on the $100k of ordinary income.
Golden Years completes a detailed annual tax analysis, so it’s best to capture the taxable income rather than simply entering the after-tax amount used for Easy Money.
1. Capture the Pre-Tax Income for Cash Flow Income:
Use the [Other Income] tab in the [Income] section to include the pre-tax proceeds for the age of sale. Set the [Taxable %] to 0 (step 2 captures the taxable income). Enter a stop age in the next line of the age change table to make sure the income doesn’t continue past the year of sale. Alternatively, you can capture the income using the [Tax Details] data entry under [Other Taxable Income/(Loss)] category for the [Cash Flow] column like for regular business income. Make sure to enter a stop age the year after the sale.
2. Capture the Net Taxable Income for the Tax Expense:
Use the [Tax Details] tab to enter the net capital gain income and ordinary income resulting from the business sale. Use the age change table to enter the taxable income under the Tax Report column only, breaking apart long-term capital gain income and ordinary income. Enter the net amount of capital gain income under the “Schedule D Capital Gain/Loss” category for the [Tax Report] column. Enter any ordinary taxable income under [Other Taxable Income/(Loss)] for the [Tax Report] column. Enter a stop age in the next line of the age change table to make sure the taxable income doesn’t continue past the year of sale.
In 2018 the [Tax Details] section was enhanced to allow for an increase rate for each item. With this you can now enter values in today’s dollars and use an increase rate to model the appreciation. Be careful if there are existing items with increase rates to work back and make sure the values at the time of the business sale match as desired.
For the example, the pre-tax business sale income is $675k and the sale results in a net of $300k of long-term capital gain income and $100k of ordinary income shown entered in TOTAL below. The cash flow income is entered using the [Other Taxable Income] category under [Tax Details] rather than [Other Income] in this example.
The cash flow amount will be an income source and taxes due will be part of annual expenses on the Cash Flow Illustration.