The current corporate tax rate is 21%.
While this number is lower than it was in past years, it’s still a hefty percentage!
Taxes are an inevitable component of corporate life. But that doesn’t mean business owners don’t have options for minimizing the taxes they pay each year.
Eligible business owners can, for example, make use of a restricted property trust (RPT) to reduce tax on total annual income. An RPT trust helps business owners grow assets and save on taxes.
What is an RPT trust, and is it right for your business? Keep reading for insight into this little-known means of reducing corporate taxes.
What is a Restricted Property Trust?
A restricted property trust (RPT) gives businesses a chance to grow their assets and reduce their taxable income.
Businesses make annual, 100% tax-deductible contributions to an RPT trust.
The growth of these contributions is tax-deferred. This basically means that the plan’s cash accumulation is tax-free until it is withdrawn. Once RPT contributions are withdrawn, they are taxed–but at a much lower rate than expected.
The result? Businesses can deduct all of their RPT contributions, pay zero tax on contributions, and front a much smaller tax bill on distributions.
Plus, RPT plans are designed for the “exclusive” personal benefit of all shareholders. This sets them apart from Qualified plans, such as 401(k)s.
How It Works
Restricted property trust may sound too good to be true. But how does it work?
Once a corporation sets up an RPT trust, participants contribute a minimum of $50,000 a year for five years. To be a participant, you have to be a shareholder of some kind in the corporation. This includes employees and business owners.
Employers can deduct 100% of these pre-tax contributions. Because the minimum yearly contribution is $50,000, that’s a significant tax deduction! Plus, a corporation can contribute more than $50,000 a year if it has the assets.
Participants (non-employers) do have to claim part of their contributions as taxable income. But they only have to specify 30% of their contributions as such.
This equates to a tax rate of approximately 15%, which is substantially lower than individual income tax rates.
What happens to all of those annual contributions? With an RPT plan, contributions accumulate, but they are not taxed.
This is because the trust owns a life insurance policy that allows tax-deferred growth. Tax-deferred does not mean tax-free. It simply means that, for the time being, participants don’t have to pay tax on the plan’s cash value appreciation.
Keep in mind that RPT plans are in increments of five years, so participants enjoy tax deferral for a significant time period.
Reduced Tax Distribution
When the restricted property trust plan is over, an employer can distribute funds accordingly. Everything an employer deducted before this will now be taxed.
However, here’s the good news: the 30% that participants paid tax on earlier is tax-free income. Because contributions grow, participants can get 45-50% more than what they initially contributed.
Funds in an RPT are only accessible at the end of a five-year term of contributions.
Who is Eligible for an RPT?
Restricted property trust is designed to benefit highly taxed corporations. Its primary function, after all, is to help mitigate corporate tax burdens.
Here are a few other eligibility requirements for setting up an RPT.
Corporate Entities Only
All corporate entities can establish restricted property trust. This includes LLCs, C Corporations, S Corporations, and most Partnerships.
However, sole proprietorships cannot set up an RPT plan. Once again, this has to do with the fact that corporations often face the highest tax rates.
Only shareholders or partners in a corporate entity can actually be involved in an RPT plan (make contributions and receive distributions).
A restricted property trust doesn’t play by the same rules as qualified plans, such as 401(k) plans. For this reason, there are fewer restrictions on the number of participants and individual contribution amounts.
Capacity to Make Annual Contributions
To be eligible for an RPT plan, corporations have to contribute at least $50,000 each year for five years. Of course, corporations can contribute more than this sum.
In fact, shareholders get to decide the maximum value of their annual contribution. This value has to be “reasonable.”
$50,000 is a lot, especially for smaller corporations! For this reason, RPTs are ideal only for corporate business owners with such high assets.
You can extend your RPT plan after the first five years of funding. Extensions happen in five-year increments.
A Word About Substantial Risk of Forfeiture
Of course, there is a risk in establishing a restricted property trust. The Internal Revenue Service (IRS) wants to make sure that businesses can commit to five-year periods of contributions, after all.
The IRS calls the risk of RPT plans “substantial risk of forfeiture.” This basically means that businesses have to make the minimum $50,000 contribution to their trust every year for five years.
If they can’t, they immediately surrender all funds that they’ve contributed. The IRS will at least donate these funds to a charity, which business owners choose when setting up the trust.
For this reason, only corporations who feel 100% confident in their ability to make these contributions should establish an RPT.
How Do I Set One Up?
Are you thinking about establishing a restricted property tax for your corporation? If so, there are a few things to keep in mind.
First, corporations should make absolutely sure that they meet all eligibility requirements. That five-year contribution term and the “substantial risk of forfeiture” exist for a reason.
Second, be sure to establish your trust with the right provider. We strongly recommend scheduling a consultation with a licensed company prior to making any decision.
Visit this site for more information.
Final Thoughts: Reducing Tax on Total Annual Income
If used appropriately, restricted property trusts can ease corporate tax burdens. It can also be a great strategy for high-income businesses looking for tax-easy ways of managing their assets.
Are you looking for other ways to reduce tax on your total annual income? You may want to begin by avoiding these common business tax penalties.