Sauder & Stoltzfus Blog

Key Principles of Successful Partnerships

By Nevin Beiler, Attorney

We all know people who are partners in businesses. Maybe you are a partner in a business, or you work for a partnership. Maybe your experience with partnerships has been good, maybe it has been bad. In my work as an attorney I see it all—good, bad, and ugly.

Business partnerships play an important role in our families and communities. They represent jobs and income to owners and employees, and they provide products and services to the community. The success or failure of these partnerships can significantly impact not just our personal finances, but also our relationships and community connections. Success in business involves much more than the financial bottom line, and when we partner with others in business, this becomes very evident.

In this article I will share a few things I have learned and observed about what makes partnerships successful. The three key areas I will cover are Compatibility of the Partners, Defining Roles and Expectations, and Preventing and Resolving Conflict. But first, a quick story to provide context for my discussion of these areas.

Paul and Mark (names changed to protect privacy) were a father and son with a successful service business. Paul (the father) had started the business on his own, and Mark joined a few later just as the business was getting off the ground. They worked together for about 15 years, and the business eventually became very successful.

Unfortunately, Paul and Mark’s relationship started to get rocky. They had different ideas about how to manage the business. Paul was focused on things that increased customer satisfaction, but wasn’t as concerned about employee satisfaction. Mark would have liked to focus on employee satisfaction as much or more than customer satisfaction. Paul tended to be more frugal minded, while Mark was quicker to spend money.

Somewhere along the line Paul decided that he wanted to share profits 50/50 with his son Mark, so he gave him 50% of the business. Paul’s expectation was that he would still be considered the boss, but eventually Mark began to assume and expect that he and Paul had equal authority (as 50/50 owners).

Unfortunately, neither Paul nor Mark were natural communicators. Their failure to communicate regularly and maintain clear expectations began to create more and more conflict. The most difficult conflict arose when Mark, who was expecting to completely take over the business from Paul in one or two years, realized that Paul did not want to sell out for another three to five years. Mark felt that he could not continue with the way things were going for that long, so he ended up selling out of the business. This was not what either of them wanted, but Mark felt like he had no choice.

With this story in mind, let’s think about some principles that would have helped Paul and Mark be more successful at working together.

Compatibility of the Partners

For partners to work well together, they need to have at least some level of compatibility. This does not mean that they do everything the same way, or always think the same. It does mean, however, that they know each other well and are able to work together towards common goals.

The Purpose of the Partnership: The partners should agree on the purpose of the partnership. Why does it exist? What is it trying to accomplish? What are its core values? One obvious goal of a business is to financially support its owners, but the mission and purpose should be bigger than that. The bigger purpose might be to provide good jobs with a good work environment. Or to provide a needed product and service to the community. Or to generate financial resources to support Christian ministries. Core values might include things such as integrity and innovation. When partners have a shared sense of purpose for their business, it can help keep them headed in the same direction.

Complimentary Skills and Personalities: Different personalities can bring balance to a partnership. For example, one partner might be a visionary while the other is an implementer. The visionary can see opportunities and come up with ideas for how to grow and improve the business. The implementer is the person who is good at consistently getting things done and implementing ideas. These two types of people need each other to reach their full potential.

Ability to Communicate: Partners must be able to maintain open and healthy communication. Otherwise, it will probably be just a matter of time before serious conflict arises. Partners that are communicating regularly will probably still experience some conflict. But by maintaining open communication, it is more likely that they will be able to resolve conflict in healthy ways, which will make their business relationships stronger.

Paul and Mark may have had a vague sense of business purpose that they shared, but they also had different ideas about how important it was to care for customers vs. employees, which sometimes caused friction. Their personalities were somewhat complimentary, with Paul being more of a visionary type and Mark being more of an implementer. But where they really struggled was with a lack of communication. This allowed small conflicts to fester and grow larger, and resulted in unmet expectations that eventually caused Mark to leave the business.

One good way to get to know your partners (or your employees) and improve communication is by taking a DISC assessment (or another type of personality evaluation) together with your partners and/or employees. I have taken the DISC assessment myself, and I have heard good things from other business owners who have taken it. DISC stands for Dominance, Influence, Steadiness, and Conscientiousness. Taking this evaluation, and then reviewing it together with your partners (or employees), can teach you a lot about each other (and yourself!).

Defining Roles and Expectations

For a partnership to function effectively, each partner needs to understand both his (or her) authority and responsibilities.

Some partnerships have two equal partners (50/50), like Paul and Mark. Some have majority partners and minority partners (such as 70/20/10). Whatever the case, each partner should know the extent of his authority. This is usually determined primarily by the partnership agreement, which may state that all partners will act together to manage the partnership or that the partners must appoint a managing partner to manage the partnership. The partnership agreement should clarify what actions require approval by more than one of the partners (usually by a majority or unanimous vote of the partners).

When a partnership is managed by all the partners without clarity about who has what authority, things can get difficult. This is especially true when the partnership is 50/50, because any time the partners don’t agree they are essentially stuck until they compromise or one of them changes his mind. This was the difficulty Paul and Mark found themselves in. For this reason, it is generally wise to avoid 50/50 partnerships, unless the partners agree on a way to get unstuck when they don’t agree on a decision. It is best if this agreement is in writing, ideally in the partnership agreement.

In addition to clarifying how the partnership will be managed, the responsibilities of each partner should be clarified. Many partners have both management responsibilities and production responsibilities. Taking the time to write out a job description for each partner, especially each partner’s management responsibilities, can help avoid power struggles or frustration among the partners when things do not get done.

Preventing and Resolving Conflict

Business partners are likely to encounter conflict at some point. But the conflict they encounter does not need to be bad or harmful. A certain level of conflict can actually be healthy for a business—if it promotes good discussion and improvements in how the business is operated. When partners can share and discuss different perspectives, it often leads to better results than if everyone thinks the same way. But too much conflict, or conflict that is not properly handled, can be very harmful for a business.

We can reduce the amount of unhealthy conflict in our businesses by clarifying expectations. This requires regular and frequent communication. If Paul and Mark had done this, they might still be working together today.

Decide ahead of time what process you will use to resolve conflict. This might involve the assistance of a third party to help resolve the conflict, or even a committee that can give counsel or binding direction. I shared some recommendations about this in my article “The Importance of a Good Partnership Agreement,” which was published in the September 2018 edition of the PCBE. When we don’t know how to address conflict it is even more tempting to just avoid it, so it can be very helpful to have a conflict resolution plan in place before you need it. I suggest that you include this plan in your partnership agreement.

Avoiding conflict, perhaps in the hope it will go away on its own, is usually a big mistake. Just like in marriage and other close relationships, conflict that is ignored just gets bigger and creates wounds that go deeper. When we can confront and effectively deal with conflict, we can experience freedom. And we will develop deeper and more trusting relationships with our business partners when we can successfully work through difficult issues and disagreements. If you need help to do this, ask a trusted friend, business advisor, or church leader for help.

When you encounter conflict, whether at home or in your business, remember this important principle: “Seek first to understand, then to be understood.” This is a concept that Stephen Covey talks about in his book The Seven Habits of Highly Effective People. While it is natural to want to give our opinion when we are experiencing conflict, it usually works better if we approach the person with whom we are disagreeing with a willingness to first listen to them. There are two sides to every story, and hearing their side of the story can help us understand the full picture. Once we understand them, we can better share our side of the story, and they will probably be more willing to listen if they feel heard and understood.

Conclusion

Partnerships can be a great blessing, but they can also be a source of great difficulty. To a large extent, our words and actions will determine which we experience. Know your partners, clarify your roles, and communicate well.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, settling estates, and business formations & agreements. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com. This article was originally printed in the Plain Communities Business Exchange.

Disclaimer: This article is general in nature and is not intended to provide specific legal or tax advice. Please contact Nevin or another attorney licensed in your state to discuss your specific legal questions.

Preface: We are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly.” B. Franklin

Tax Planning for the 2020 Year

Credit: Donald J. Sauder, CPA | CVA

Tax planning time is never wasted, and this year that tax planning has a chance to be more pertinent than in recent years. With 2020 being a presidential election year and therefore, an increased variable for the 2021-year tax rates with a shift in Presidential legislation, getting your tax planning right for the 2020 tax year is pertinent. Income taxes are often one of the most substantial costs annual recurring costs for entrepreneurs and households alike.

The bottom line, this may again be perhaps the year to pay as much income tax as possible. Pay tax, buildup equity, and pay down debt. Then reserve deductions for the new year when tax rates have a material risk of shifting higher.

For the 2020 year, married filing joint tax payers are in a 10% rate up $19,750 in earnings, 12% up to $80,250, 22% to $171,050, 24% to $326,600, 32% to $414,700 with a maximum rate of 37%. Single tax filers are in a 10% bracket to $9,875 in taxable income, 12% to $40,125; 22% to $85,525; and 24% to $163,300, and 32% up to 207,350 with tax maximum rate of 37%.

For the 2020 tax year, decisive tax planning strategies could include accelerating taxable income recognition to capitalize on the lower Trump Legislation tax rates before any new Legislative changes could risk a shake-up in either capital gains, corporation rates, or ordinary tax rates. This could encompass converting traditional IRA’s to Roth IRA’s or taking larger distributions to shield capital from higher taxes on taxable distributions. Also pertinent is considering harvesting capital gains on investment assets to protect both investable capital or higher taxable gain rates. Or simply reshuffling your investment portfolio to increase lower future tax costs should the market continue to climb and a potential capital gain tax rate increase.

Step two in tax planning considerations for 2020 incorporate deferring tax deductions and expenses. The tax strategies could include deferring major capital expenditures on either equipment, accelerated build-outs, or vehicles for your business until January 1, 2021, to manage any variables on tax rates in the new year, and deferring one-time charitable donation pledges until 2021. Another significant tax variable is the risk in a possible change to the current transfer-friendly estate and gift tax exclusions. If you are planning substantial gifts of assets, you may want to talk with your tax advisor on the potential benefits of accelerating those gifts of assets in the 2020 year to avoid the risk of higher costs in the future from changes in tax laws.

Scheduling a meeting with an experienced estate attorney to plan your will to enable your executor or heirs to assign assets with highest the tax liabilities to charities if you’re planning to gift. Specifically, it doesn’t make sense to donate assets from your estate with lower tax implications and burden heirs with higher tax burdens assets, i.e., some retirement accounts. Besides, if you have a trust or plans to organize a trust to minimize estate taxes, you are advised to talk with your estate planning expert on the potential planning variables with a change in the tax laws.

The bright-line great news is that all the above tax factors and likelihoods should be known before early December on whether the Trump-friendly business tax legislation is intact per the November Presidential election results. Hence, a real possibility and probability continue that tax planning could again be straightforward and uncomplicated, perhaps for the 2020 year.

Once again, we remind readers that debt is paid with after-tax dollars. For example, if you borrow $100,000 for business or personal, you will pay it back with $100,000 plus the cost of taxes, i.e., say $130,000. Therefore, the lower tax rates decrease, the more affordable debt financing and repayment are obtained. This wind in the sails has powered the craft well in recent years, but this leverages words both ways; hence a word of caution should tax rates increase on income taxes.

In contrast to the sunny economic climate of 2019, according to Jeffery Gundlach, 24% of income in the US is now from the government. As this trend builds in government payments that gain more market share in the economy, taxpayers will eventually pick-up the expenses. Secondly, approximately Fifty+ million Americans have lost their jobs since the Covid-19 pandemic began, and over 50% of households in major cities are financially distressed. In contrast, one in five children doesn’t have enough to eat.

Summary: If you are concerned about tax planning for the 2020 year, firstly, you’re advised to quietly “ponder” optimal steps with the sunrise to manage 2020 tax attributes, and then speak with your trusted tax advisor.

This article is general in nature, and it does not contain legal or tax advice, nor is it to be construed as tax or legal advice.  Contact your trusted advisors to discuss your specific situation.

 

Preface: Tax shelters are financial vehicles individuals and corporations incorporate to minimize tax liabilities. Shelters range from employer-sponsored 401(k) programs to overseas bank accounts. The phrase “tax shelter” is often used as a pejorative phrase, but a “tax shelter” can be also be a uniquely legal way to permissibly reduce tax liabilities.

Managing Euroclydon Risks with Corporate “Tax Shelters”

This blog is posted to address corporate concerns regarding the IRS’s continuing campaign to identify and shut down abusive corporate tax shelters, many of which involve transfers of rights or property to foreign entities.

In recent years, offshore asset reporting has become one of the IRS’s primary areas of focus as it seeks to increase tax revenue. In 2010 Congress addressed the significant issue of international tax compliance, enacting the Foreign Account Tax Compliance Act (FATCA). FATCA imposes more stringent reporting requirements and, in many cases, increased tax liability on U.S. taxpayers—many of whom are corporations—with investments in offshore accounts. Since then, the Treasury Department and the IRS have issued new regulations to implement FATCA and its reporting and disclosure regime.

The IRS is cracking down on tax shelters in other ways as well. Many employees of publicly traded companies are taking advantage of the tax whistleblower provisions of the Tax Relief and Health Care Act of 2006, which often enable the IRS to provide a hefty reward to those who report tax evasion. Additionally, the Treasury Inspector General for Tax Administration has recommended that the IRS improve its audits of small corporations, meaning that corporations with assets of $10 million or less may begin to feel a squeeze from examiners in upcoming tax years.

Large Business & International

As part of its initiative to increase international corporate tax compliance, the IRS has reorganized its 600-employee Large and Mid-Size Division (LMSB) into the Large Business & International Division (LB&I). The IRS more than doubled the number of employees, many of them industry experts and practitioners, and made in-roads to improving employee education and skill sets. LB&I’s expanded purview includes LMSB’s original jurisdiction over corporations, S corporations, and partnerships with assets of $10 million or more and also the implementation of the FATCA provisions.

Annual Reporting for Reportable Transaction Disclosure

Any taxpayer, including an individual, trust, estate, partnership, S corporation, or other corporation, that participates in a reportable transaction and is required to file a federal tax return or information return must file Form 8886 disclosing the transaction. The IRS maintains a list of the abusive transactions which must be reviewed annually by the taxpayers. The taxpayer must attach a Form 8886 disclosure statement to each tax return reflecting participation in the reportable transaction. The taxpayer must also send a copy of the Form 8886 to the Office of Tax Shelter Analysis (OTSA).

Offshore Voluntary Disclosure Program

In 2011, the IRS relaunched its Offshore Voluntary Disclosure Program (OVDP), which rewards taxpayers who disclose unreported foreign accounts with a reduced penalty framework. The revived OVDP has no official end date but the IRS has cautioned that it may terminate the program at anytime.

FATCA

In addition to requiring certain U.S. taxpayers holding financial assets outside the United States to report them to the IRS, FATCA generally require foreign financial institutions to report certain information about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest. Non-compliant foreign financial institutions could be subject to a 30% withholding tax on all U.S. sourced payments.

The IRS has stressed its intent that FATCA be a reporting regime rather than a penalty regime, and that it is eager to work with industry professionals and experts into ease the law into implementation. Nevertheless, the effect of FATCA on corporate offshore tax shelters is meant to be severe on the numerous abusive tax shelters that take advantage of lower or non-existent corporate income tax rates abroad through the dubious transfer or licensing of assets.

Small Business/Self-Employed

IRS’s Small Business/Self-Employed division, which holds in its jurisdiction all small businesses with assets of less than $10 million, plans to be more proactive in its field audits this year, concentrating in particular on stopping line-item schemes such as inflated business deductions or false earned income credit claims. SB/SE is currently at work expanding the knowledge and skill set of its examiners, matching exams to those examiners with the greatest knowledge of the subject matter involved, and producing online materials that will better educated taxpayers on their responsibilities. For the long-term, the SB/SE may update the index by which it selects tax returns for audit so that exams are targeted to returns likely to contain underreported tax.

Other Initiatives

The whistleblower rules encourage individuals to report any tax abuses or corporate fraud through generous reward offers. In 2012, the IRS paid out its largest award, more than $100 million, to an individual who disclosed tax evasion by a foreign bank.

The IRS has also maintained its campaign against accounting and law firms that design or promote tax shelters. The “anything goes” attitude of past years ago is a long faded memory. And while the IRS has been enforcing the law, Congress is looking to close as many loopholes as possible to prevent tax evasion. IRS examiners are still directed to look for the checklist of characteristics common in abusive corporate tax shelters. These include:

• • • A reported transaction has no business purpose or economic substance other than to minimize taxes;
    • Investments made late in the tax year that indicate there may be deductions for prepaid expenses that are not allowable.
    • A large portion of the investment made in the first year indicates the transaction may have been entered into for tax purposes rather than economic motivation.
    • A loss exceeding a taxpayer’s investment indicates the possibility of a nonrecourse note.
    • If the burdens and benefits of ownership have not passed to the taxpayer, the parties have not intended for ownership of the property to pass at the time of the alleged sale.
    • A sales price that does not relate comparably to the fair market value of the property indicates the value of the property has been overstated.
    • If the estimated present value of all future income does not compare favorably with the present value of all the investment and associated costs of the shelter the economic reality of the investment may be questionable.

Some businesses are concerned that the IRS’s focus on tax shelters will mean increasing scrutiny of other aspects of their business operations as well. Others want to undertake internal protective audits to set up a strategy against IRS involvement before the IRS sends out audit letters.

If you would like a further analysis of how the IRS assault on tax shelters may affect you, directly or indirectly, please call your trusted tax advisor.

The Importance of a Good Partnership Agreement (Segment II of II)

Credit: Nevin Beiler, Attorney

Segment II of II Continued

What We Can Learn From This Story

Unfortunately, disagreements among business partners are far too common, even among family members and Bible-believing Christians. As a result, some people refuse to enter a business partnership with anyone as a matter of principle, because they don’t want to risk the conflict. I personally don’t think that partnerships should be off limits for everyone, but I appreciate the concern that people have about the risks of entering a partnership. If you are a partner in a business, let’s think about what we can learn from the above story so that your partnership does not have the same problems.

In our story, Jake and Henry (and their father) failed to adopt a partnership agreement that could have helped them resolve management conflicts and have a pre-established buyout plan. The right time to adopt a partnership agreement is early on in the life of a partnership, ideally at the same time the business is formed. This agreement should be reviewed and revised periodically, especially if there are major changes in ownership. It is much easier for partners to agree on management and buy/sell provisions early on before disagreements arise. And if you cannot agree on management terms or buy/sell terms when you are entering a partnership, stay out of the partnership.

A well-written partnership agreement should specify which partner has the final say in management decisions, either by naming a managing partner or by specifying how the voting rights will work. If the partners have equal management and voting rights (which is not advisable, but is not uncommon) the partnership agreement should specify a process of breaking a deadlock if the partners cannot agree on any given issue. This could involve giving a trusted business advisor the ability to break a deadlock on management decisions, or any other approach that the partners are comfortable with.

Another key aspect of a partnership agreement is how a partner can or must be bought out if a partner wants to leave the partnership, dies, becomes mentally incapacitated, or needs to be bought out for other reasons. In addition to specifying who has the rights to buy the ownership share of the departing partner, the partnership agreement can specify how the buyout price will be established and paid if the buyer and seller of the ownership interest cannot agree on a price and payment terms. Two common methods of setting a buyout price are (1) having the partners agree in writing to a valuation of the business on an annual basis, with that value being the buyout price for the following year, and (2) hiring an independent appraiser to value the business periodically or at the time of the buyout.

A third key aspect of a partnership agreement is a dispute resolution provision that gives the partners a good way to address disagreements as they arise instead of letting the disagreements pile up. Good communication is critical to the success of a partnership. Having a plan for communicating about and resolving disagreements can make the difference between the success or failure of a partnership.

For example, I often write partnership agreements that require partners to work with a third-party mediator to resolve disputes. This could be a professional mediator or a trusted business advisor or church leader that both partners are comfortable working with. Mediation involves the partners meeting (perhaps several times) with one or more mediators to help them discuss the problem and hopefully reach a voluntary agreement on what to do.

If the disagreement is not resolved in mediation, I generally recommend that the partnership agreement require the appointment of a three-man team of impartial business advisors or a church committee to give binding direction to the partners. This is an informal method of what is called “arbitration.” (Professional arbitration services are also available if necessary, but they tend to be more expensive and adversarial.) The partnership agreement should require each partner to follow the decision of the arbitrators.

There are other important things to include in a partnership agreement, but clear management provisions, comprehensive buy/sell provisions, and good dispute resolution provisions are the most important things that are sometimes missing from partnership agreements.

Working through all these issues can take some time. But it is time well spent. Even if a partnership never has a full-blown dispute between the partners, taking the time to prepare or update a customized partnership agreement is a very good way to communicate about, and clarify, the expectations of all the partners. And having clear expectations is a benefit to any business.

If Jake and Henry (or their father) had taken the time to set clear expectations and adopt a good partnership agreement for their business, they likely could have avoided a great deal of heartache and expense. Take the opportunity to learn from their story, and consider whether reviewing and updating your partnership agreement would make your business stronger. Also, if you find yourself in the midst of partnership conflict, don’t be afraid to ask for help, especially if you and your partner(s) are having trouble communicating. Open and honest communication is the salve that can heal a broken relationship.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, estate administration, and business law. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.

The Importance of a Good Partnership Agreement (Segment I of II)

Credit: Nevin Beiler, Attorney

In this article I will tell you about two business partners, who I will call Jake and Henry. The specific facts of this story are fictional, but the issues that are illustrated are ones that many partnerships have faced.

Jake and Henry were brothers. Jake was twelve years older than Henry, and when Jake finished school he started helping his father with the family hardware store. When Henry finished school, he also starting working full-time at the store.

When Jake turned 25 his father let him buy 10% of the business at a discounted price, and when Henry turned 25 he had the same option. When their father’s health declined to a point that he no longer could work at the store he offered to let Jake and Henry buy him out completely, again at a discounted price. This resulted in them being 50/50 owners with equal management rights. Jake would have rather purchased a larger share of the business, but he decided not to raise a fuss.

Jake and Henry’s working relationship slowly deteriorated over time. They had very different personalities, and they struggled to see eye to eye on many issues. Jake had a more careful and frugal personality, while Henry was more aggressive and liked to spend money to try to grow the business. Because they were 50/50 owners, and they had no partnership agreement stating who was in charge, they frequently disagreed about how to handle things. Their level of communication kept decreasing until they were hardly talking at all.

Eventually, things came to a point where they could no longer ignore their differences. This was mainly due to their lack of communication, but also partly due to the fact that some of Jake’s sons were interested in buying a share of the hardware store. Several of them had been working for the store for a while, and Jake wanted to give them a chance to become owners like his dad did for him. But neither Jake nor Henry wanted to sell any of their ownership shares because doing so would mean that the other brother would have more ownership percentage, and therefore more control over the business.

The bad feelings were beginning to make for strained interactions at family gatherings, and sometimes also between the uncles and their nephews during the workday. Henry finally decided that he could not continue on in the business because he didn’t see any way his family and Jake’s family would be able to work well together.

Henry offered that Jake could buy out his share of the store. Henry said that he could start his own separate hardware store in a different location that would not compete significantly with the existing store. Jake didn’t mind the idea of buying out Henry, or that Henry wanted to start another store in another location. This agreement was a great start!

But when they started talking about the buyout price for the store, their ability to agree abruptly ended. Each brother had vastly different opinions about what was a fair buyout price, based on what they had each paid for their shares of the store and the amount of years they had each invested in working there. Jake thought that because he had worked there longer than Henry and helped their father build up the business in its early years, he should get a significantly discounted price. Henry thought that because he was willing to sell out and let Jake have the business, he should get at least close to full price. They were not trying to be unfair to each other, they just had different ideas of what was fair, and their lack of communication prevented them from fully understanding the perspective of the other.

To complicate matters further, the eight-acre parcel of land on which the store was located was located in a rapidly-developing commercial area and had risen in value dramatically. It would have perhaps made financial sense for the existing business to sell the property for a high price and move to another location, but Jake was reluctant to sell the original business location as it had been in the family for many years and it was located just a short walk from his home.

After several months of fruitless and sometime tense negotiations, they both realized that they were not going to be able to resolve their disagreement on their own. Fortunately, they both knew that it was wrong to take their dispute to court. Based on the advice of their church leaders, they were both willing to work with a trained Christian mediator to help resolve their dispute. But even with the mediator’s assistance, the road to reaching an agreement was not easy. It required many meetings and long discussions, but in the end they were able to reach a resolution.

To be continued…. 

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, estate administration, and business law. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.

Why Private Student Loan Borrowers Should Refinance Right Now

Preface: Sales of personal residences have specific tax attributes with provisions for exclusions for taxable gains when a residence sales price exceeds the property basis. Tracking basis on your residence before the sale, and tax planning appropriately can lead to a good crop on harvest.  

2020 Transaction Planning: Sale of Main Residence

When selling your main home, you may qualify to exclude from your taxable income all or part of any gain from the sale. Your main home is generally the one in which you live most of the time.

Ownership and Use Tests

To claim the Section 121 sale of home exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

• • • • Owned the home for at least two years (the ownership test)
      • Lived in the home as your main home for at least two years (the use test)

Gains and Losses

If you have a gain from the sale of your main home, i.e. your sales price exceed your basis in the property, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a married filing joint return). You cannot deduct a loss from the sale of a main home.

Reporting the Sale Transaction

If you receive an informational income-reporting document such as Form 1099-S, Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable with tax Section 121. Additionally, you must report the sale of the home if you can’t exclude all of your capital gain from income.

More Than One Home

If you have more than one home, you can exclude gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

Example One. You own and live in a house in town. You also own a vacation house in the mountains, which you use periodically during year. The house in town is your main home; the vacation house in the mountains is not.

Example Two. You own a house in specific municipal jurisdiction, but you live in another house that you rent in that jurisdiction. The rented house is your main home for tax purposes and a Section 121 exclusion.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.

Example. On February 1, 2014, Amy bought a house. She moved in on that date and lived in it until May 31, 2015, when she moved out of the house and put it up for rent. The house was rented from June 1, 2015, to March 31, 2017. Amy moved back into the house on April 1, 2017 and lived there until she sold it on January 31, 2019. During the 5-year period ending on the date of the sale (February 1, 2014 – January 31, 2019), Amy owned and lived in the house for more than 2 years.

Amy can exclude gain up to $250,000. However, she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house.

Sale Home on Installment Sale Method

If you sold your home under a contract that provides for all or part of the selling price to be paid in a later year, you made an installment sale. If you have an installment sale, you may report the sale under the installment method unless you elect out. Even if you use the installment method to defer some of the gain, the Section 121 exclusion of gain remains available on the main home.

If you have any questions related to the sale of your main home or vacation home, please call our office. We’re happy to discuss your options.

Preface: Some would say that deducting tax losses from one business activity to offset income from another activity would be a great tax strategy. Not so fast, say the tax courts!

Passive Activity Loss Rules

Credit: Benuel B. Glick, EA

Do you own a business (or shares in a business) with minimal or no participation? Perhaps you own, or are considering to purchase, real estate or some other asset to lease out. If so, you may want to familiarize yourself with passive activity loss rules for strategic business and tax planning.

What is Considered a Passive Activity?
In IRC section 469(c), passive activity is defined as any activity which involves the conduct of any trade or business, and in which the taxpayer does not materially participate. Section 469(c)(2) also says except as otherwise provided, the term “passive activity” includes any rental activity.

Why is This Part of the Tax Code?
Prior to 1986, a taxpayer could usually deduct losses in full from rental activities and businesses regardless of his or her participation. This gave rise to a significant number of tax shelters that allowed taxpayers to deduct non-economic losses against wages and investment income, thus the Tax Reform Act of 1986 added IRC 469 to the package. Section 469 limits the taxpayer’s ability to deduct losses from passive activities.

Passive or Non-Passive Activity?
A trade or business activity is not a passive activity if you “materially participated” in the activity during the tax year. According to IRS Publication 925, you materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. There are other requirements for rental properties.

• • • • You participated in the activity for more than 500 hours.

• • • • Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.

• • • • You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.

• • • • The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests….

• • • • You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.

• • • • The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.

Based on all the facts and circumstances you participated in the activity on a regular, continuous, and substantial basis during the year.

There are a few additional stipulations to the above list but in general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Do not treat the work you do in connection with an activity as participation in the activity if both the work isn’t work that’s customarily done by the owner of that type of activity and, one of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules.

Passive Activity Income and Loss
Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity. It is noteworthy that investment income, e.g. stocks, bonds, interest from financial institutions etc., is not classified as passive income.

Passive activity loss is the amount, if any, by which the aggregate losses from all passive activities for the taxable year, exceed the aggregate income from all passive activities for such year.

Active Participation for Real Estate
If you or your spouse actively participated in a passive rental real estate activity, provided you’re not a limited partner or less than 10% partner without regard to limited partners, there is a special provision that allows you to deduct up to $25,000 of loss against your non-passive activity income. This special allowance is an exception to the general rule disallowing the passive activity loss. Additionally, there is a phase-out rule based on your filing status and MAGI that limits or disallows this special allowance.

Not to be confused with material participation, the IRS says that you may be treated as actively participating if you make management decisions in a significant and genuine sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Activity Groupings
To add to the Section 469 complexities, it has a provision for “grouping” activities if they form an “appropriate economic unit.” This essentially says that if business A is appropriately connected to business B economically, you can elect to group these activities. This could potentially offset otherwise passive activity gains with non-passive losses. Unless the original election is obviously inappropriate, this election is permanent and should be considered carefully prior to making the election.

Conclusion
While Section 469 provides rules for passive activity losses, there are some strategies that can be employed by the prudent entrepreneur to efficiently maximize his or her business’s resources. One consideration might be grouping appropriate economic units. Yet another might be materially participating in the correct enterprise.

The Unknown Unknowns: Preparing for the Future of Business During a Covid-19 Pandemic 

Credit: Donald J. Sauder, CPA | CVA

Written in 1742, one overlooked masterpiece from the most underrated century of English verse, Thomas Gray’s poem “Ode on a Distant Prospect of Eton College” concludes “And happiness too swiftly flies. Thought would destroy their paradise. No more, where ignorance is bliss, ‘Tis folly to be wise.”

The business world has changed since 1742, and so has the North American continent. Yet those timeless words still resonate today as a masterpiece. With the Covid-19 pandemic rapidly shifting reflections on both the macroeconomic and microeconomic landscape of business, entrepreneurs are increasingly likely to be entering an era where the business unknown unknowns are more evident than ever before. While ignorance is bliss, ignorance also has risk.

In recent decades, with a firm reliance and trust in the management of the US economy and economic policymakers, entrepreneurs have had an unparalleled opportunity to develop enterprises. The sunny business climate of past years has provided the best of resilient opportunities for enterprising entrepreneurs.

Approaching the new planning horizons of the Covid-19 business climate realistically, when we consider the reality that now we have a new classification of enterprises – essential and non-essential businesses, it should raise awareness that these quick shifts in trends and the business climate are likely not simply temporary. Today, for some businesses classified as many non-essential companies, strategic planning is merely a viable survival plan.

Too many businesses with aggressive growth strategies often fail to appreciate that business growth requires capital and access to capital financing; ultimately, growth involves a corresponding amount of cash. Companies that have continued to aggressively gain market share with the simple assumption that funding will always be available whenever needed should cautiously consider shifts in regulated lending practices and credit policies amidst a Covid-19 pandemic. Bottom line: Don’t pursue business growth if your financing funds are not assured.

Easy financing access in prior years has been a plain and straightforward vehicle that can transport any entrepreneur farther than they planned to go on the highway of commerce. The assumption, all risks are financeable in some fashion, is a truism until it isn’t. Perhaps you’ve never considered the fact your bank could get in financial trouble?

History tells us that companies confront financial trouble more often from a lack of cash flow than a lack of net income. This is no more apparent than when inventory is sold, and payment collection on contracts or accounts receivable is deferred because your customers are under financial duress. Increasing risk is supply chain disruption with just-in-time inventory margins, and the supply chain unexpectedly tightens. Too often, business owners are overly optimistic or unrealistic about real underlying micro and macroeconomic trends, hazards, and tensions, leading to unnecessary risks.

It would seem to be a reasonable expectation for many individuals, that Covid-19 pandemic business risks will perhaps last beyond the 2020 business year. For this cause, having a plan and cash equivalent reserves to continue to comfortably cashflow term debt and fixed expenses among variables in cashflows, is most prudent.

Envisioning what these Covid-19 business changes will look like in say even six months, would be folly for us to prognosticate with any credit as an expert. Plainly, we don’t know what we don’t know, and we don’t know what the unknowns are. On the contrary, considering possible business climate change and pandemic scenarios is advised.

The foreknowledge of the right business decisions in 2020 will only be known after the fact, and many necessary business decisions will be made with less than complete and perfect information. The words “Welcome to business speculation” should bring a degree of realistic awareness to current Covid-19 pandemic risk(s). Business leadership today must be increasingly decisive, and not be influenced by fear and concern.

If you’re a business leader and you’re fearful today or have more risk than you can handle or have prepared for, you know what you need to do. Begin immediately downsizing your enterprise risks. If you need help with this task, retain a trusted advisor. You are now aware that you exceeded your comfort zone of feeling appropriately equipped to navigate an economic storm. If you lack the necessary confidence both for yourself and those who look to you for business leadership, the voyage is unadvisable with your charted course. Do you see the lighthouse keepers? (More importantly, can you discern like a certain Apostle when you should be in the harbor?)

Many business industries are solely dependent on credit market access. In real estate, most buy | sell transactions, and more substantial construction activity is associated with loan financing. The real estate’s current and future value is pillared on the assumption that someone else will be able to access credit to purchase the property when the owner desires to sell.

The domino effect of the credit market reliance is the chief concern we need to consider for business strategy developing Covid-19 business plans. Instability in financial markets, and therefore credit markets, are a trusted forerunner of microeconomic business crisis developments.

When interest rates are near zero, it signals a leading indicator of the future value of that money. When interest rates are negative, banks will also be less likely to lend if they don’t pass on the additional costs to those customers who borrow. Correspondingly, the price to access credit can increase. It is not unrealistic to suppose fees can be placed on lines of credit and other financing sources. What would it look like to have to pay your bank a 1% or 2% fee simply to keep your business line of credit from being closed (without any amount drawn on financing)?

Restructuring balance sheets should be of top priority for businesses that want to avoid a potential risk of insolvency when counting the costs of a possibly longer-term planning horizon than expectation from a Covid-19 business climate. This includes downsizing inventory to pay off debt(s) and increasing equity either with additional capital or strategic downsize planning of the balance sheet. Paying off debt is the objective. When financing insolvency, financing experts will tell you that the last dollar of financing is the most expensive and may be too costly in business recovery.

Planning horizons should include all possible scenarios your team can think of with regards to risk including such things as a business shutdown or an off-line team. Events could occur for any number of reasons. Additionally, suppose government resources become strained and for peaceful discussion purposes a possible insolvency of local municipalities. In those instances, judges could rule that the property owners will make up the deficit in revenues. From a microeconomic perspective, when a homeowner’s association faces revenue deficits, who pays? (The appraiser thought those condos were worth $1.0m apiece, and now listed at $75,000 because costs rose to $5,000 per month payable to the HOA?) Or say real estate taxes doubled for any number of reasons, what would that do to local household budgets and, therefore, your customer’s discretionary revenue?

We are in a season when there are no perfect business decisions, and knowing the right choice is impossible to discern when complete information is absent until after the fact.

A business chief risk officer is increasingly vital to enterprise successes in a Covid-19 pandemic. If your business omits a meeting to assess Covid-19 business risk(s) regularly, you’re unprepared for the unknown unknows ahead. You should quickly be more diligent before it is too late. At a minimum, you should meet to examine and discuss pressures among other industries, resolutions, precautions, and plans to resolve potential tensions if they should reach your trade or enterprise.

Develop a list of the ten best events that could happen to your business, both during and absent a Covid-19 pandemic. Also, develop a list of the ten worse events that could occur, i.e., shutdowns, cashflow interruptions, or supply chain breaks.

After you successfully outline these twenty events, and develop workable and implementable solutions, you’ll be further prepared and ready for the future Covid-19 pandemic business unknown unknowns that may be encountered ahead.

 

Preface: Eight bills linked together comprise the pending HEALS Act legislation as a counter proposal to the HEROES Act, as additional Covid-19 relief measures are negotiated in Congress.

The HEALS Act: A Boots on Sand Covid-19 Safeguard

Credit: Donald J. Sauder, CPA | CVA

Staring this week’s Senate discussions, Republican Senators unveiled the next steps to safeguard the US economy from the possible risks of sinking sands amidst the coronavirus impact with a new bill – the Health, Economic Assistance, Liability Protection and Schools Act (HEALS). The new coronavirus relief provisions outlined in this pending legislation could bring $1.0 Trillion of additional economic relief funding.

The bills package includes a buffet of economic legislation including $306.0 billion in emergency appropriation from the SAFE TO WORK act introduced from Senator John Cornyn (R-Texas), the Safely Back To Work and Back to School Act from Lamar Alexander (R-Tennessee), the American Workers, Families, and Employers Assistance Act from Chuck Grassley (R-Iowa), the Continuing Small Business Recovery and Paycheck Protection Program Act from Marco Rubio (R-Florida) and Susan Collins (R-Maine), the Time to Rescue United States Trusts Act from Mitt Romney (R-Utah) and Restoring Critical Supply Chains and Intellectual Property Act from Lindsey Graham (R – South Carolina).

Relief Funds

First and foremost, the HEALS Act includes a second round of taxpayer stimulus checks like the CARES Act. This would provide qualifying taxpayers with $1,200 of relief funds for whatever spending purposes they so choose, with phase-outs on funds above $99,000 for individuals and $198,000 for couples. The Treasury announced these stimulus checks could arrive as early as August to qualifying taxpayers.

Secondly, economic relief with extra unemployment benefits proposed at $200 per week, as an extension to the original CARES Act $600 per week additional UC benefit that expired July 31. The federal supplement would not exceed 70% of previous wages when combined with both state and federal assistance, to incentivize workers to look for gainful employment.

The SAFE TO WORK Act proposal is designed to offer employers more durable protection from lawsuits brought from workplace coronavirus compliance risks. The Act would provide a guard to employers from personal injury lawsuits from coronavirus workplace risks. It would also place a ceiling on any awards, as long as employers did not demonstrate willful misconduct.

Update on PPP Loans

The famous Paycheck Protection Program would be extended to December 31, 2020, for bolstering treasuries of the forty-plus percent of small businesses that are concerned with making payroll without the aid of a PPP subsidy. The second round on these financings on the forgivable PPP loans would be limited to business with 300 or fewer employees with special funding channeled to micro-businesses with ten or fewer employees to ensure small business loan equality. Also, legislation is pending on automatic loan forgiveness on PPP loans below $150,000. The forgiveness features of the PPP loans are in a continued state of fluctuation, and borrowers should be patient as the trends are continuing towards reducing fears of inability or hassle to obtain forgiveness on PPP loans below $2.0 Million.

Also, a Long-Term Recovery Sector Loan facility would provide guaranteed long-term low-interest loans for working capital to businesses that equal up to two times annual revenues, with a $10.0 million ceiling. Maturity dates on these loans would be up to twenty years, with 1% interest rates. Eligible businesses would include 500 fewer employees that have seen declines in revenues of 50% or more in the first or second quarter of 2020 compared to 2019.

School Funding

School funding features in the HEALS Act provide for $105.0 Billion to education, with $70.0 billion allocated to grade schools and $29.0 for colleges and universities. The emergency funding would offer scholarships to parents to send children to private schools and funding for private schools based on certain stipulations and student numbers.

The bill proposed from Tim Scott (R-South Carolina) would provide a tax deduction of 100% for business meals to give relief to support America’s restaurant workers.

Summary

While the HEALS Act is pending, the significance of the additional relief package, if approved, will bring a new wave of economic relief awaiting a tide to turn on the Covid-19 tribulations.

This article is general in nature, and it does not contain legal advice.  Contact your advisors to discuss your specific situation