Some of the feedback from firms around incorporation is:
“If I was starting our in practice now, I’d do it in a heartbeat.”
“It all seems a bit too hard and time consuming.”
“I really don’t understand the benefits of incorporating.”
“It’s seems too expensive from a stamp duty and maybe a payroll tax perspective, but I’m concerned about capital gains tax.”
Here are some facts:
- You only need to transfer Goodwill and Fixtures & Fittings to the Incorporated Legal Practice (ILP), not WIP and debtors. This keeps the stamp duty cost down;
- The ILP provides a layer of asset protection;
- ILP simplifies partner entry and exit as it is only shares that are bought and sold, not partnership assets;
- If you are eligible for the small business CGT concessions, which most partners in partnerships or sole practitioners are, depending on the value of your net assets, CGT can either be completely eliminated or significantly deferred to ultimately exit from the business. Even better, with correct shareholding structured, you can maintain your access to the small business CGT concessions into the future;
- With appropriate asset structuring and funding in place, debt can be restructured into the ILP to provide personal debt relief and repaid from after tax profits of 70% with interest being tax deductible;
- By utilising correct shareholding structures, you can spread your share of business profits over your family members, including non-working spouse, children over 18 and even cap your tax at 30% in a corporate beneficiary;
- You will receive fully franked income as dividends. If the ultimate recipient has a tax rate higher than 30%, you only pay the top up. If the tax rate is less than 30%, you get the difference back from the ATO;
- If you are on the precipice of payroll tax, with the way that the payroll tax calculations work, by including directors’ salaries in the equation, the payroll tax is not significant. On a payroll of $1.2m, the Queensland Payroll Tax liability is $11,875, i.e. less than 1% of total payroll.
Here’s a scenario:
A two partner firm with Goodwill of $750,000, WIP of $350,000, Debtors of $300,000, Fixtures & Fittings of $50,000, a wages bill of $700,000 and a profit before partners salaries of $450,000. The practice has bank debt of $200,000. They operate their practice as a partnership of individuals and have a service trust which has a profit of $50,000 (minimal benefit these days due to the ATO’s view on service trusts and mark-ups). One partner is 46 and the other is 54. The younger partner has 2 children over 18 at university and a spouse who earns $50,000 per annum from other employment. The older partner is in a second marriage with a non-working spouse and 3 young children, and needs to continue working for quite some time yet. Both partners meet the small business CGT basic requirements for applying the concessions.
The firm is considering succession and is looking to restructure on 1 July 2011 into an ILP with the shareholders being 2 discretionary trusts.
By restructuring to an ILP the following is achieved:
- The bank funds the purchase of the Goodwill and Fixtures & Fittings for $800,000 which provides the partners with $300,000 each in cash to apply towards their own use after paying off the $200,000 practice debt. This cash could be used to reduce home loan debt, purchase another investment asset, or put into super.
- No capital gains tax is paid or payable by the partners. The younger partner will need to contribute $93,750 to his super fund in 2 years time after the sale to the ILP. Alternatively, he could pay the CGT at his marginal tax rates on 15 May 2015 (that right, 2015). This contribution will be tax-free on the way in and out of super. No contributions are required by the older partner.
- In year one, the partners bill their old firm WIP and collect all old firm debtors. The tax is already paid on the debtors and the WIP is taxable when billed. Profits in the ILP are reduced while WIP accumulates until it is billed. Any profits are taxed at 30% in the ILP.
- When the franked dividends are paid out, and $150,000 wages paid to each director, assuming the same level of before tax profits as the old firm, the tax positions for each partners’ family compared to under the old firm structure is:
- 46 year old: $64,300 after restructure, $78,175 before restructure;
- 54 year old: $72,150 after restructure, $81,400 before restructure;
- If the profit is retained in the ILP for debt reduction or working capital, it is only taxed at 30% instead of 46.5% to the principals.
- Due to the way that the PAYG Instalment systems works, the ILP will not have to start remitting tax to the ATO until the first quarter after the first income tax return is lodged for the company. If the ILP commenced business on 1 July 2011, then the first tax return would not be required to be lodged until 31 March 2013. The 2011/12 tax would be payable at this time, and the first instalment for the 2012/13 year would be payable in July 2013. The ILP will need to retain cash to meet its 2012 and 2013 tax liabilities.
From a costs perspective, the stamp duty on the transfer is $29,025, once off, but the other savings are annual.
So, what’s your action plan:
- Assess what the overall impact is for you to restructure, not just the immediate cost. There can be personal significant benefits;
- Think of it like an investment, a 10% tax saving per annum via correct structuring is the same as receiving and after tax 10% income return on your investment each year. Find me an investment that can provide this year on year;
- Seek advice from someone who understands the rules and opportunities from both the business and personal perspective.
For every law firm I offer a free Incorporated Legal Practice Restructure Review. We will meet and discuss the opportunities, costs and benefits of incorporating your business, and discuss strategies that you can implement to determine if an ILP is of benefit to you. This is provided to you free of charge. Email me at email@example.com to unlock the benefits an ILP, free of charge and obligation free.
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