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From the Desk of:

John D. Pivirotto
Calif. Insurance License #0699308

Financial Concepts

Burlingame, CA 
(650) 348-1880
(650)348-0255 Fax


Helping Build & Protect Your Future

Investment Advisor Representative
Securities and Advisory Services
offered through
Lincoln Financial Securities Corporation
Member SIPC

Cafeteria Plans 
Provide Tax Savings and Flexibility

Section 125 “cafeteria plans” can help business owners and employees lower their tax bills. Under Section 125 of the Internal Revenue Code, workers are permitted to withhold a portion of their pre-tax salaries to pay for premium contributions to employer-sponsored insurance plans and to cover qualifying unreimbursed medical and dependent care expenses. Because Section 125 benefits are not subject to FICA or income taxes, cafeteria plans can help employees lower their taxable income, while reducing the payroll and workers’ compensation tax liabilities of their employers. 

What’s on the Menu? 
As the name suggests, employees who participate in a cafeteria plan are invited to choose from a menu of employer-sponsored benefits. In some cases, both the employer and the participating employees share in benefit costs. The company’s contribution may consist of an annual benefits allowance that employees can use to pay for benefits or take as salary. This system provides flexibility for workers, while helping employers gain greater control over their benefits expenditures. 

The most basic cafeteria plan feature is the premium only plan (POP). Also known as premium conversion plans, POPs allow employees to withhold part of their pre-tax salary to fund their premium contributions to employer-sponsored insurance plans, including medical, dental, disability, accident, and group term life insurance. A POP is easy to set up and administer, and it does not require the employer to offer any new benefits.

 Flexible Spending Accounts 
A cafeteria plan may also include a flexible spending account (FSA), which provides employees with the opportunity to pay for dependent care and/or unreimbursed medical expenses using pre-tax dollars. To take advantage of the FSA option, an employee must estimate before the start of each tax year how much he or she will spend on medical or dependent care expenses, and commit to having a set amount withheld from each pay period to help cover these expenses. The agreed-upon sum is deducted from the employee’s paycheck before taxation and deposited in the individual’s FSA. Employees pay for qualifying expenses out of pocket and then submit a claim to the plan administrator for reimbursement. Unless an unanticipated change in family status occurs, employees are not permitted to change or cancel a Section 125 agreement during the tax year. 

While nearly all taxpayers incur some health care costs not covered by insurance, most find that their unreimbursed medical expenses do not exceed the 7.5% of adjusted income floor that would allow them to qualify for a federal income tax deduction. But, by contributing to a medical FSA, employees get a tax break on these miscellaneous health care and dental expenses, which may include deductibles and co-payments, prescriptions, over-the-counter drugs, and orthodontia. The maximum amount that may be contributed to a medical FSA is $5,000 a year. 

The dependent care FSA allows employees who pay for childcare or eldercare services to save money up-front, rather than waiting to claim a deduction or credit on their tax returns. Heads of household and married couples are permitted to withhold up to $5,000 annually of their pre-tax earnings to pay for dependent care services that enable them to work, look for work, or attend school full time. Qualified dependent care expenses generally Cafeteria Plans Provide Tax Savings and Flexibility (continued from page one) include care for a child under the age of 13, as well as in-home or daycare services for a spouse or adult dependent incapable of self-care. Individual employees should, however, calculate whether they and their families would save more by paying for dependent care expenses through an FSA or by claiming the child and dependent care tax credit. 

The biggest drawback associated with FSAs is the “use-it-or-lose-it” deadline imposed by the IRS. This rule stipulates that employees forfeit any funds left in their individual FSAs at the end of the year. The remaining balance is retained by the employer to offset administrative costs and to help pay for future benefits. This rule was modified in 2005 to permit cafeteria plan sponsors to extend the deadline for using the funds for up to 2½ months after the end of the year. There is also a grace period of 90 to 120 days during which employees may submit claims for expenses incurred during the coverage period. 

Most business owners find that Section 125 cafeteria plans are simple to set up and administer. Because cafeteria plans encourage workers to take an active role in managing their benefits, companies can use these plans to increase awareness among workers of the value of their employer-provided benefits. 

Business Survival Planning for the Sole Proprietor
 One question frequently asked by a sole business owner is, “What will happen to my business when I die?” To answer this question, you will need special expertise to deal with the issues of a closely held business in your estate. The planning concerns generally involve three areas: administration of your business during the estate settlement period; continuation of your business after your estate has been settled; and the important subject of taxes and related estate settlement costs. In general, there are three forms of business organizations: sole proprietorship, partnership, or a corporation. This article will discuss the possible advantages and disadvantages, as well as planning opportunities, of the sole proprietorship. 

The Pros and Cons . . . 
Simplicity is one of the major advantages of the sole proprietorship business form. No completed articles of incorporation need to be prepared, and there are very little administrative costs associated with starting the business. However, if the business is conducted in a name other than that of the owner, most states require that the name of the business and owner be filed as a matter of public record. 

Another major advantage of the sole proprietorship form is the flexibility and freedom of action enjoyed by the owner. There are no associates to consult. Unlike a corporation, the owner’s activities are not limited by statutes, corporate charters, or bylaws. A final advantage is that the owner is entitled to all profits.

 However, there is a distinct disadvantage to a sole proprietorship as a business organization when trying to continue the business after the death of the owner. In the absence of specific arrangements to the contrary, the business ends and the business assets and liabilities become the assets and liabilities of the estate. A majority of states have enacted statutes that authorize the executor or administrator to continue the business temporarily, in order to avoid loss to the heirs. However, application must be made to the court for continuing the operation of the business. Anyone who does so without authority may be liable for any losses or expenses, even though acting in good faith. 

Planning: Provide for the Future
 If a sole proprietor does not want to change the form of business ownership, but does want to retain the business, the planning concerns involving the administration of the business during the estate settlement period, and the continuation of the business after the estate has been settled, need to be addressed. The proprietor’s will must give the executor certain powers during the period of estate administration, such as 1) the power to retain the business interest indefinitely; 2) the power to do everything possible to operate the business successfully; 3) the power to re-organize the business, incorporate it, or merge it with another business; and 4) the power to borrow money, if necessary, to help the estate meet its need for liquidity.

 In addition to these discretionary powers, the will should also include a provision that relieves the executor of personal liability where duties are exercised in good faith. Another way to help minimize some potential problems is having the assets and accounts of the proprietorship in a trust with the trustee granted authority to continue the business during the applicable period. 

Regardless of the form of business organization, there will be a need for adequate cash to pay funeral and administration expenses, personal and business debts, and possible estate taxes. It is important to remember that directions in the will permitting continuation of the business will not be allowed to interfere with the right of existing creditors and tax collectors to receive their money when the proprietor dies. 

The easiest, most common and sensible way to deal with the need for cash is through the purchase of life insurance. There are no other assets the sole proprietor can purchase that can produce virtually instant liquidity to pay these cash needs, provide income for family members, and protect the continuation of the business. This is why qualified legal and financial professionals first suggest the purchase of life insurance to help fund these cash needs at the time of death. The insurance may be owned by an irrevocable trust to avoid the insurance proceeds from being taxed in the business owner’s estate. 

As a sole proprietor, ensuring the continuation of your business may be of prime importance to you. Availing yourself of the professional guidance of your financial advisor, attorney, and accountant can help assure you that, indeed, your business will live on. 

ESOPs—Giving Employees a Stake in the Company 
Profit-sharing plans have long been popular with employees because of the opportunity they provide to share in the profitability of a growing company. Many business owners look beyond shared profitability to shared ownership through employee stock ownership plans (ESOPs).

 ESOPs are essentially “defined contribution” benefit plans. However, unlike most defined contribution plans, ESOPs invest primarily in the sponsoring company’s stock. This can help motivate workers to do their best, since they have an ownership stake in the company and may directly benefit from an increase in the value of the company’s stock. On the other hand, the level of benefits paid to plan participants is not guaranteed, and employer contributions to the ESOP can vary

How They Work 
The amount of employer and (in rare cases) employee contributions, along with company profitability and administrative expenses of the plan, determines the level of benefits participants receive. Employer contributions are allocated to individual employee accounts according to a specified formula. These contributions are tax deductible to the employer within certain limits. 

To qualify for deductions, an ESOP must be in writing, and the sponsoring employer must establish a trust for employer contributions. Furthermore, the plan must have fiduciaries who are responsible for setting up and maintaining separate employee accounts. When properly established and maintained, the trust incurs no current income tax liability, and plan participants are not taxed on ESOP income until distributions are received. Taxation is based upon increases in the value of the stock. 

Although the antidiscrimination rules of the Employee Retirement Income Security Act of 1974 (ERISA, as amended) apply, limited groups of employees can be excluded from ESOP participation. Furthermore, participants can be required to satisfy a minimum period of participation before their interests in trust assets become vested (in other words, nonforfeitable). The ESOP vesting schedule must specify the percentage of assets each participant will earn upon completion of periods of service or plan participation, and the vested portion of the participant’s assets must be distributed as outlined in the trust document. 

A Viable Option 
While ESOPs may not be for all companies, the wide range of ESOP applications to fill company needs makes them a viable option for many. ESOPs are often preferable to alternative forms of employee stock ownership (for example, stock purchase or stock option plans) due to the preferential tax treatment they receive. 

To promote the concept of employee stock ownership, Congress has granted a number of tax incentives to employers adopting ESOPs, including deductible ESOP contributions and dividends, tax deferrals on distributions to employees, tax-advantaged rollovers for owners selling stock to employees, and estate tax advantages.

 When considering ESOPs, business owners must thoroughly analyze the potential drawbacks. Special attention must be given to the dilution of stock value and ownership control. With these issues addressed, and protective measures taken, ESOPs can offer a viable means of giving employees a stake in the success of the company. 
Copyright 2009 Liberty Publish- ing, Inc., Beverly, MA. The opinions and recommendations expressed herein are solely those of Liberty Publishing, Inc., and in no way represent advice, opin ions, or recommendations of the Financial Planning Association, its affiliates or members. CFPTM and CERTIFIED FINANCIAL PLANNERTMare federally registered service marks of the Cer- tified Financial PlannerBoard of Standards (CFP Board). This summary does not constitute legal and/or tax advice and should only be relied upon when coordinated with a qualified legal and/or tax advisor. Febuary, 2009.
Current tax law is subject to interpretation and legislative change. Tax results and the appropriateness of any product for any specific taxpayer may vary depending on the particular set of facts and circumstances. The information contained in this newsletter is not intended as tax, legal, or financial advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek such advice from your professional advisors. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Written and published by Liberty Publishing, Inc. Copyright © 2009 Liberty Publishing, Inc.
Planning Strategies
*Disclosure – Securities and Advisory services offered through representatives of Lincoln Financial Securities Corporation, member FINRA & SIPC. FINRA Branch Office: 233 Bloomfield Road, Burlingame, CA 94010. 
This is not an offer to sell securities, which may be done only after proper delivery of a prospectus and client suitability is reviewed and determined. Information relating to securities is intended for use by individuals residing in California, Oregon and Colorado only. Advisory Services are offered to residents of the state of California only. Lincoln Financial Securities Corporation is not affiliated with Financial Concepts. Financial Concepts offer insurance & financial services to residents in California and Oregon. Variable & Group insurance products offered through LFS Marketing and Insurance Sales Corporation; fixed insurance products offered through Financial Concepts Insurance & Financial Services.
John Pivirotto’s California Insurance License #: 0699308
Financial Concepts’ California Insurance License #: 0786047