Richard Scenario

Story:

Richard (63) is an orthodontist who lives in Illinois. He has built his orthodontist practice to the point that he has multiple locations around Chicago. Richard has 5 locations and an average of 10 employees at each location. He has decided that it is time to retire and sell his practice. Richard and his financial planner have discussed selling the practice for a few years. They have estimated that selling the practice could take eight to ten months, and with the recent appraisal coming back at $4,200,000 for the practice, Richard is ready to start the process. Richard is aware that there will be a 20% federal capital gains tax, 5% state tax, and 4% net investment income tax. Richard’s financial planner has some positive news. There is a way for Richard to sell the business that allows him to defer the capital gains tax liability permanently. 

Situation:

Richard decides to participate in a capital gains deferral strategy. He can sell his business and defer the $1,218,000 in capital gains taxes he would otherwise pay with a traditional business sale structure. Richard sells his orthodontics practice to an intermediary trust for $4,200,000. The trust gives Richard a promissory note for the $4,200,000. This promissory note outlines a structured payment plan that allows him to keep the sale’s principal in the trust.

Result:

The trust captures the total principal amount of the sale, and Richard has avoided a tax liability of $1,218,000. Richard knows that the trust will earn between 2% – 5%, and his distribution will be $84,000 – $210,000 annually. Between the distributions and the other investments Richard has made, he believes he can avoid taking a distribution from the trust’s principal for many years, if ever. If Richard never receives a distribution from the trust’s principal, he will not have to pay capital gains tax on the principal. However, if Richard eventually does need to have the principal distributed to him, he will only have to pay taxes on what is being distributed from the trust.