Month: May 2017

Preface: The cost of a buy/sell agreement is miniscule compared to preventing the turmoil that can result among family members or owners when capital or equity interests are traded. Buy/sell agreements, plain and simple, make sense no matter your business. If you have a corporation, LLC or partnership – any business with more than one equity holder – you need a buy/sell agreement.

Why You Need a Buy/Sell Agreement for Your Business

Any business that has more than one equity holder needs a buy/sell agreement. A buy/sell agreement is a written contract that specifies the steps that will be taken if an equity holder wants to release his ownership.  The documented rules in a buy/sell agreement determine how values will be appraised and payment made during fragile business conditions. In addition, a buy/sell agreement can prevent other partners from selling to other individuals or competitors, such as anyone joint equity holders do not want to hold equity. Buy/sell agreements specify rules for a business entity or other owners to acquire another equity interests in specific in the event of an owner selling for retirement, death, disagreements, defaults, or incapacitation.  So you could say a buy/sell agreement is a “business will,” and prevents unfair treatment of all equity holders in delicate situations arising from the trade of of a business interest.

A buy/sell agreement is typically a legal document prepared with attorney oversight. The document contains a prearranged agreement for a sale of business interests. The agreement is not limited to 1) who can purchase a departing partner’s or shareholder’s equity interests, 2) the methodology or hybrid appraisal for determining value, or 3) events that will spark a buy/sell agreement.

In a corporation, a buy/sell may result in treasury shares, and necessitate terms for the trade value between the shareholder and the corporation. The cost of a buy/sell agreement is low compared to preventing the turmoil that can result among family members or owners when capital or equity interests are sold. Buy/sell agreements, plain and simple, make sense no matter your business. If you have a corporation, LLC or partnership, any business with more than one equity holder, you need a buy/sell agreement.

What do you need to know to talk your attorney and hold an intelligent conversation? First, you can have a redemption buy/sell agreement where your interest is traded to the business, so the other owners don’t need to pay out of their own checking account. Or, you can have a cross-purchase agreement where another equity holder has first right to purchase your interest. A cross-purchase agreement allows partners or shareholders to acquire your interest, or you to buy other equity interests.

Second, and more important, the nucleus of a buy/sell agreement ensures proper valuation of a business when there is an unanticipated pending sale of an interest. Valuation is key to a fair market sales price of an interest. Valuation of your business should occur every several years with a buy/sell agreement to ensure you have a documented benchmark history of the business value from say the basement to the peak.

At a minimum, you should value your business at the writing of a buy/sell agreement, as well as every time the buy/sell is updated. Your buy/sell should also should list specifically the method(s) the appraiser will use to calculate the business value in the marketplace, e.g. the income approach or say a market approach. Typically the most successful buy/sell valuations carefully avoid unnecessary hybrids, e.g. complex combinations of income, asset or market approaches.

In summary, A buy/sell agreement is a written document prepared with attorney oversight, that details the requirements and play rules for trades of a business interest in instances of ownership change. If you own a business interest with partners or shareholders, you need a buy/sell agreement. If you already have a buy/sell agreement, make sure it is updated when necessary. If you do not yet have a buy/sell agreement for your business, talk to your trusted advisor or CPA about obtaining one today.

 

Preface: Tax planning is an important and vital step to reducing the cost of business. But saving tax dollars isn’t the only prudent or advised consideration. Strategizing with your tax advisor to manage business costs, and plan tax advantaged operating and investing cash flows, with before and after tax dollars, will reward your business

Small Business Tax Reduction Strategies

Taxes are simply a cost of doing business. Yet, like all costs, you can manage them to your advantage. If you’ve read this far, you are an entrepreneur who appreciates the time it takes to plan the tax effect of your income. Maybe planning tax strategies is new to you. Whether it is or not, the strategies are similar year to year–deferring revenue, accelerating expenses, contributing to a retirement account, making charitable contributions, or maximizing depreciation expense. You would be wise to stick with only legal tax reduction strategies. Any other path is risky, may result in lowered business value, and is time-tested to be morally wrong. Other legal loopholes include domestic productions activities deductions for manufacturers or specific tax credits which apply to your industry.

Employee bonuses are a great strategy to reduce taxes and reinvest in your workforce. A well-compensated team will take satisfaction in their work and lessen hidden business liabilities such as employee inefficiencies. Reducing taxes can be done in many more ways.

Investing in marketing and advertising is another strategy for deferring a business tax liability. Advertising and marketing is one of the most efficient methods to defer taxes from one year to the next, or every year. An advertising campaign will help you develop your market position, and defer revenue to later periods. With the increased top line revenue from advertising, you can increase the value of your business over time, too.

Successful tax planning should line up with the business vision. For instance, does it make financial sense to purchase $150,000 of equipment solely to save on taxes? Will the new equipment reduce costs on manufacturing processes and provide a 7% IRR  in the future? Spending cash to purchase necessary equipment such as a truck, robotics, or office furniture, should result in plans for additional future cash flow, such as the development of office staff and plans for office overhead. Otherwise paying the tax at 40% still puts 60% net tax in your bank account for new working capital.

Keep in mind that debt is repaid with income, net of tax, except the interest expense.  So if you have a $150,000 line of credit, you will need to earn say $210,000 or more to repay that line of credit, without reducing working capital. Debt is leverage. If you have debt, you are better off to pay tax and resist spending excessively on fixed assets beyond what is required. With the excess cash you can accelerate the payment of debt, reduce business leverage, and increase equity (and value).

Retirement plans also defer taxes. SIMPLE-IRA’s or SEP-IRA’s are an easy way for business owners to contribute towards retirement and save on taxes. SIMPLE-IRA’s permit up to $12,500 to be contributed and SEP-IRA’s up to $53,000 for 2015. The characteristics of the IRA plans may or may not make them fit well with your business tax planning. If you’re interested, talk about it with your CPA or with a retirement advisor to decide what could work best for tax planning in your business.

Sometimes saving on taxes isn’t everything you need to think about. Are you in compliance with Obamacare? Are you in compliance with labor laws? Nondeductible penalties are an expensive way to learn about the crucial area of compliance. Are you selling your business? Businesses are often valued based on cash flow. The more net income, the more tax paid, often the more value at sale for the seller (you). Why? The business valuation is mostly based on cash flow and net income. This is to say the more tax paid (the higher the tax reported income on the tax return) the larger the gain at sale, because of the value multiple of earnings on the businesses net income.  Don’t worry. Sometimes there is an advantage to paying tax.

In summary, tax planning is important and vital to reducing the cost of business. But saving tax dollars isn’t the only consideration. Working with a tax advisor who can help you manage your business cash flows, with before and after tax dollars, will reward your business.

 

Preface: Charitable contributions require you need to be very careful and rely on professional help, to keep in compliance the IRS when giving more than say 25 dollars. The IRS is becoming increasingly aware of questionable practices and is cracking down on taxpayers who use them. If a charitable giving scheme sounds too good to be true, it probably is! 

Charitable Giving – Permissible Tax Benefits for Charitable Giving

You probably know that you can get an income tax deduction for a gift to a charity if you itemize your deductions. But there is a lot more to charitable giving. For example, you may be able to indirectly benefit a family member and a charity at the same time and still get a tax break. Or you may be able give appreciated property to a charity without being taxed on the appreciation. These benefits can be achieved, though, only if you meet various requirements including substantiation requirements, percentage limitations and other restrictions. We would like to take the opportunity to introduce you to some of these requirements and tax saving techniques.

 

First, let’s take a look at the basics: Your charitable contributions can help minimize your tax bill only if you itemize your deductions. Once you do, the amount of your savings varies depending on your tax bracket and will be greater for contributions that are also deductible for state and local income tax purposes. To get a current deduction, the charitable gift must be to a qualified organization and must not exceed certain percentage limitations.

 

You also need to substantiate your donations. Generally, a bank record or written communication from the charity indicating its name, the date of the contribution and the amount of the contribution is adequate. If these records are not kept for each donation made, no deduction is allowed. Remember, these rules apply no matter how small the donation. However, there are stricter requirements for donations of $250 or more and for donations of cars, trucks, boats, and aircraft. Additionally, appraisals are required for large gifts of property other than cash. Finally, donations of clothing and household gifts must be in good used condition or better to be deductible.

 

The amount of otherwise allowable itemized deductions is reduced for higher income taxpayers whose adjusted gross income exceeds certain threshold amounts. For 2017, the threshold amounts are $313,800 in the case of married taxpayers filing a joint return or a surviving spouse, $287,650 in the case of a head of household taxpayer, $261,500 in the case of an unmarried individual, and $156,900 in the case of married taxpayers filing separate returns. A taxpayer with AGI over the threshold amount must reduce their otherwise allowable itemized deductions by the lesser of: three percent of the amount of the taxpayer’s AGI in excess of the applicable threshold amount, as adjusted for inflation, or 80 percent of the itemized deductions otherwise allowable for the tax year.

 

Now a word about special gift-giving techniques: There are some strategies that can help minimize your tax liability. Making a gift to another individual outside of the umbrella of a charitable organization is one. For example, you can give up to $14,000 in 2017 tax-free to another individual or $28,000 for married couples making joint gifts. If larger gifts are made, use of a lifetime gift and estate tax exclusion, set at $5.49 million for 2017, might be considered. However, you need to be very careful and rely on professional help. There are a lot of scams and schemes that really push the envelope. The IRS is aware of these abusive practices and is cracking down on taxpayers who use them. If a scheme sounds too good to be true, it probably is!

 

There are other special charitable giving techniques beyond the usual gifts of cash. These include, among others, a bargain sale to a charity, a gift of a remainder interest in your residence and a transfer to a charity in exchange for an annuity.  

Please do not hesitate to contact us if you have any questions regarding the planning of charitable gift of money or property.

Preface: Tax groupings of business activities can solidify tax positions in certain instances. What is a grouping, and when may it may be applicable?

To Group or not to Group

Credits: Jacob Dietz, CPA — jdietz@saudercpa.com

Lancaster, PA

The IRS considers a business activity to be passive if the taxpayer does not “materially participate.” The full complexities and the details of passive activities are beyond the scope of this blog, but generally the IRS will not allow the deduction of passive losses unless there is offsetting passive income of an equal or greater amount, or the activity is entirely disposed.

There are exceptions, however. For an example of how the passive activity rules could work, let’s imagine John owns two businesses. Business A is a restaurant, and John works full-time in the restaurant. Business B is a bakery across the street from the restaurant, and the bakery provides the restaurant with food. John hired an able manager for the baker, so he hardly does any work in that business.

If the bakery and the restaurant are treated as separate activities, then John would be active in the restaurant but may be passive in the bakery. If the restaurant made money and the bakery lost money, then John might not be able to deduct the bakery’s loss until future years if he had no other passive income.

The IRS, however, does allow grouping of activities that form an “appropriate economic unit.” If the bakery and the restaurant had been grouped, then John’s work in the restaurant would count as material participation for the entire activity, thereby making the bakery’s loss nonpassive.

What constitutes an “appropriate economic unit?” There is some discretion in making this determination, but below are some factors from IRS Reg. 1.469-4 detailing some of the considerations.

“(i) Similarities and differences in types of trades or businesses;

(ii) The extent of common control;

(iii) The extent of common ownership;

(iv) Geographical location; and

(v) Interdependencies between or among the activities (for example, the extent to which the activities purchase or sell goods between or among themselves, involve products or services that are normally provided together, have the same customers, have the same employees, or are accounted for with a single set of books and records).”

These groupings are then permanent per the IRS regulations unless “a taxpayer’s original grouping was clearly inappropriate or a material change in the facts and circumstances has occurred that makes the original grouping clearly inappropriate.” If you are starting a new business, and you already have a business, then consult with your accountant regarding whether the businesses should be grouped. If you fail to group them now, and later try to group them, the IRS might disallow that grouping. There is an exception to the regrouping rule which allows taxpayers to regroup the first time the taxpayer is subject to the net investment income tax.

In Rev. Proc. 2010-13, the IRS lists disclosure requirements regarding tax groupings. If the original grouping was made before 1/25/2010, then no disclosure is required until a change is made. New groupings or regroupings after that date must be disclosed. If there is no disclosure, the IRS can generally treat them as separate activities. What if it is discovered that a grouping has not been disclosed? If the taxpayer discloses the grouping in the first year the omission is discovered, and all previous returns were consistent with that grouping, then the IRS considers it a timely disclosure.

If the IRS discovers the omission of the disclosure, then the taxpayer must have “reasonable cause” for omitting the disclosure. Contact our office if you think you may have some undisclosed groupings on your tax return which should be disclosed.

Even when the disclosure has already been made, the taxpayer may want to continue to disclose that grouping in each tax return. If done correctly, this may help inform the taxpayer and IRS and future accountants that there is a grouping in effect.

This blog is not tax advice. If you would like help walking through your options, please contact our office.