Strategic Planning: Patience can lead to significant savings
Holding real property in a corporation is a bad idea — especially a C corporation. When it’s time to sell the property the gains taxes can be upwards of 35 percent, and any shareholder receiving proceeds from the sale will be liable for further taxes at dividend rates of up to nearly 24 percent. In other words, it’s not a good deal.
Falco Sult recently acquired a new client who wished to sell its manufacturing business and keep the real property in which it was housed. Unfortunately, the entire operation was tied up in a C corporation.
We came up with a four step plan to transform the business into an S corporation and distribute the property to their common stockholder, allowing him to sell the manufacturing business and keep the property in a favorable designation. This included a comprehensive approach of converting their year-end date from fiscal to calendar, clearing their preferred stock to be S corporation-compliant, and minimizing the built-in gains (BIG) recognition for the required five-year period.
It’s a complex strategy that will take five years to implement, but the client wins — both by avoiding an enormous tax penalty and achieving their long-term business goals.
Tax Planning: Structuring income can yield big rewards
Big changes require a disciplined approach and a solid game plan. From selling a business to allocating a bonus, understanding the tax laws and nuances of every transaction type is the key to minimizing penalties and maximizing payoff. At Falco Sult, we are experts in helping our clients make the most of every financial opportunity.
For example: A client was due to receive a substantial settlement award from a past employer, and our job was to provide an analysis to help them plan for the following year’s tax bill. After performing several different analyses, we suggested that the payout be negotiated to occur over a two-year period instead. Because of our knowledge of various limitations and phase-outs, the staggered disbursement saved our client almost $240,000 in taxes.
Accounting Services: Finding a better way to eliminate frustration
While it’s true that no accounting issue is too large for us to tackle at Falco Sult, there are times when our clients are surprised how manageable their problems turn out to be in the hands of an expert. The same way a simple oil change can seem like a monumental task to someone who has never taken a peek under the hood, some accounting problems often appear much larger in the eyes of an individual or business owner than they really are.
We were recently contacted by a client whose accounting system was overwhelmed by old adjustments that were creating problems in their balance sheet and preventing them from reconciling their accounts. They said they were afraid they would “mess something up” if they tried to fix it, but were frustrated every time they tried to pay a bill or reconcile the account. We had them send us the file and were able to quickly relieve the account of the old, uncleared checks, take care of the bills and bring everything to a current, manageable state. With a simple phone call they were able to solve a problem that had plagued them for months and get back to what they do best – running their business.
Business Valuation: Ownership Lite could help with succession planning
A client needed a strategy to reward and retain key employees. As the sole owner of a privately held S Corporation, they wanted to foster a sense of ownership within the company without the voting complications and potential tax consequences of creating additional owners. Our suggestion was to implement a phantom stock plan that would address their needs while avoiding the inherent risks of adding shareholders.
Their phantom stock plan designates select employees to receive cash at a future time, contingent upon their continued employment. Since the value of their compensation is based on the long-term success of the company, it fosters an ownership mentality and drives performance. Also, phantom stock is non-taxable until the benefit is paid, treated like ordinary income on their W-2 and becomes a deduction for the company. When the business is sold, the value of the employees’ phantom stock can be worth the same amount as the equivalent percentage of actual stock in the company.
After hearing about the unique benefits of phantom stock, our client was excited to move forward. With our guidance and a little legal help, that company now has a long-term, mutually beneficial way to retain and reward its top talent.
Mergers and Acquisitions: There are many ways to maximize your cash
At Falco Sult, we assist many clients with selling their business and the process can vary from transaction to transaction, depending on the client’s circumstances. When you sell your business, it is rarely about the gross sales price and all about what you net after tax from the sale. Part of our job is helping you determine what you need in total cash for your future and how it will be affected by the net cash received from the sale.
We had a professional service provider, a doctor, who wanted to retire and sell his business. The problem for him was that his company was formed as a C corporation and thus did not provide him capital gains benefits if he just sold his business outright. In fact, he would have been double taxed on the sale and subsequent liquidation of his company at very high tax rates at the corporate and personal level. One way to normally get around it is to sell the stock of the corporation and not the assets. This would have given him very favorable tax treatment, but the buyer did not want to purchase the stock due to potential liability issues. Needless to say, the client was stressed about the additional taxes and how it would impact his retirement.
So, in this situation, we were able to use an approach that allowed us to all split the sale up into two transactions. Basically, we sold the hard assets of the corporation as a normal asset sale in the company, and since those assets were not significant in value, his tax liability was minimal. The remainder of the sale, the Goodwill portion, was sold outside of the company. We considered it to be owned by him personally due to his relationships with the clients and his knowledge, and thus had a separate “goodwill purchase agreement” with him personally and the buyer. By using the separate agreement, we were able to reduce his tax rate from ordinary income rates to capital gains rates and avoid double taxation outside of the C corporation. This equated to hundreds of thousands of dollars in tax savings that went start to his bank account.
While this situation may not work for everyone and their circumstances, it shows how we try and work outside the box to find ways to accomplish the greater goals for our clients using creative structuring within the limits of the tax code.
Estate Planning: Planning your final resting spot
No one likes to think about when they pass away, and especially when and where, but believe it or not, there are planning opportunities you should consider around these topics. Not too long ago, we had this specific conversation with a client and it helped them with some estate planning.
A client and his spouse came into see us about some retirement planning. Both are in their late sixties, had a substantial estate and wanted to revisit some of their estate planning options that they had developed back in their fifties. Always a good idea to periodically revisit your plans because your circumstances can change as you get older.
In their case, they were trying to decide on where they ultimately wanted to retire. He had finally sold his business and the wanted to get serious about moving to a different state. They had adult children living in a few different states and they were also looking at possible desert locations. They were struggling with the decision, because all the options looked inviting. As we talked them through the options, we highlighted one issue that most people don’t normally think about; State estate tax liabilities. For many years, the estate laws in many states paralleled the laws at the federal level, so it was much easier to understand the consequences of taxes at the state level. When the federal estate laws changed, for the better for most, it meant that the states saw a potential decrease in the revenue they receive for state taxes. With the economy in a downturn at the time and the states projecting a loss in revenues, many states decided to have their own limits on estate taxes that didn’t parallel the federal limits.
We discussed the various differences in the federal and states laws with our clients and what the tax impact would be if they passed in the various states they were looking at for retirement. Once we opened their eyes to the pitfalls, it made the decision much easier because the tax savings alone would allow them to afford more home and opportunities to gift monies to their grandkids college funds.
Consulting: Recruiting and hiring Smart
As your business grows, your needs may change — especially when it comes to accounting. While an entrepreneurial, do-it-yourself mindset is great for getting a fledgling operation off the ground, it can eventually leave you stretched too thin and overwhelmed. We help our clients solve their financial problems in many ways, and in some cases it means connecting them with the talented staff they need to continue growing with confidence.
One of our long-term clients was in such a bind. Though he had personally handled his company’s day-to-day accounting since day one, rapid growth to nearly 30 retail locations had put him under enormous stress. He either needed to clone himself or hire additional help.
Because of our involvement in his company’s various monthly and quarterly reporting for years, we were already a trusted resource for financial consultation and advice. After discussing his situation in detail, we were enlisted to connect him with the right candidate. Our extensive recruiting expertise, deep industry knowledge and a close familiarity with our clients’ needs puts us in a unique position to match the right people with the right place.
After a search involving numerous resumes, detailed personality and technical testing and countless interviews, we selected our candidate. After a single interview our client offered her the position she has held ever since. Our client still expresses to us his gratitude for quickly finding the best fit for his company and freeing his time and energy.
Whether it’s for a CFO, controller, accountant or bookkeeper, our ability to rigorously gauge a candidate’s abilities and potential within the context of the clients’ needs is a powerful resource for a small business and part of the Falco Sult commitment to providing long-term value.
Mergers & Acquisitions: The art and science of the deal
The ideal business sale is a win-win arrangement for both the buyer and seller. Because the two types of business-sale structures tend to benefit one or the other, it’s easy for conflict to arise. Buyers tend to prefer an asset sale so fixed assets can be revalued for a faster tax write-off and sellers often prefer a stock sale for 100 percent capital gains treatment.
In a recent unique case involving the sale of a medical billing company, a win-win looked difficult to achieve. Both parties prefered an asset sale for the sake of revaluing the assets for tax depreciation purposes, but a stock sale preventing the loss of existing state licenses and insurance company certifications made the most sense overall.
Fortunately, our knowledge of IRS code enabled us to utilize a provision allowing a stock sale to be treated as an asset sale and give us the best of both worlds. By instigating a stock sale we solved the licensing issue by transferring the stock to the buyer — but not the assets — while simultaneously treating the transaction as an asset sale to allow the buyer to revalue the assets for depreciation purposes and attain a future tax advantage.
At Falco Sult we believe every transaction should be a win-win. With the industry knowledge and expertise to find intelligent and creative solutions, we work to ensure the most beneficial outcome for all parties involved.
Building Value in your Business
We work heavily with printing firms, and one of the most frequent questions that seems to come up with every one of them is: “How do I increase the value of my business so that when I retire, I can get the maximum return?” For most private business owners, their business is a major element of their “retirement plan.” So, this is a very important and serious question.
The answer to this, like the answer to most difficult questions, is complicated. But ultimately businesses are only worth what a buyer believes they can produce for them after a purchase. So while many different things may come into play, at the heart of this discussion is really this simple question. Will the dollars I get back from the company give me a reasonable return on the amount that I will have to pay, including debt that I will have to assume? This really has three parts; what is the cash flow I can expect, what is the “right” rate of return I should demand given the risk, and what is my price?
We have to remind clients that the first question, what is the cash flow, is critical, and it’s going to be looked at based on what you have shown on your statements or tax returns. When a client asks, how do I avoid paying taxes, the simple answer is, don’t show profits…it’s also the wrong approach; however, if you ever plan on selling. Your profit and cash flow history are going to be what a buyer looks at to answer the first part of the above question…the less you make, the less your company is worth.
The second question, what return do I need, is much trickier. But it really has to do with seeing a buyer as someone making an investment. If they see that an investment has a high risk, then they are going to require a higher return on their investment, and if the return has to be higher, given whatever cash flows are expected, then the price a buyer is willing to pay is going to be lower. However, understanding how to reduce risk is always challenging. But some of the actions that will reduce risk for any business, and increase value, are a solid management team that is not based on owners, a strong position in the market you serve, lack of reliance on a few major customers, a good workforce, a stable profit history, and a lack of excessive amounts of debt. Like any investment, anything that contributes to a more stable future for a business will mean that risk is lower.
Finally, price has to be seen in relationship to return and risk, and price includes any debt that is assumed by a buyer. So if you are coming close to the time you hope to sell, it’s probably not the right time to make significant investments in new equipment or capabilities that require you to borrow. It’s also important that you understand that what you need to finance your retirement has nothing to do with what you can sell your business for. Ultimately, your business is going to be priced in the marketplace for buyers and sellers of businesses, and while you can set a goal, you should realize that what will determine the eventual price are returns a buyer expects to get, and the “riskiness” of your business.
So any plan to increase value in your business needs to be based on increasing returns, and reducing risk. If you are planning to sell within a relatively short time period, five years or less, make sure these are a part of your planning and decision process.