As a business owner, never forget that the whole point of starting a business is enhancing your personal wealth. Turning a business into a wealth builder requires concerted, systematic effort.
These are the five most critical challenges that business owners face. These can represent opportunities if properly addressed on a timely basis.
What strategies can help keep my taxes as low as the law allows?
There is a wide range of tax planning opportunities that come with business ownership to help you and your business keep more of what is earned:
- Business Entity: Effective tax management starts with the firm’s business structure. At a C corporation, earnings are taxed at the corporate level and then a second time when you receive them. An S corporation can pass along earnings to shareholders without getting them taxed at the corporate level. The earnings must be divided up according to the owners’ shares. A limited liability company (LLC) also has a pass-through feature but can split the earnings disproportionately.
So an S-corp could allow operating losses to pass to the owners, thereby providing personal tax benefits. In other situations, a C-corp may protect owners by not distributing income that could otherwise increase their personal taxes. An LLC may offer some advantages of each. Periodically review your structure in light of current and anticipated business performance over the foreseeable future.
- Tax-Advantaged Benefits: There is a wide range of options that may provide tax benefits to the owner as well as employees. These include health and welfare trusts, individual pension plans, retirement compensation arrangements, holding companies, charitable donations and estate freezes (you transfer assets to the company and it issues stock to your beneficiaries at a nominal cost, thus limiting their tax liability).
- Tax-Deductible Payments to Owners: It can be advantageous for you to purchase an asset personally, then lease it to your business – perhaps equipment or real estate. This allows the business to deduct the payment from its tax return. But it also allows you to limit your taxes on the rental payments by deducting depreciation on what you lease out, any interest you owe on it and other expenses.
Effective tax management requires continual effort. Strategies need to adjust as your goals and financial situation changes.
How can I protect my business and personal assets against liability?
Especially in this litigious age, protecting business and personal assets against a liability claim is critical to financial success. A starting point lies in the liability protection found in a business entity. While this may not protect the business itself, it may protect your personal assets. Beyond that, it is important to:
- Periodically review the basic corporate documents such as articles of incorporation, bylaws, meeting minutes and state filings, to assure they are in good order and properly maintained.
- Make sure employees are not given the appearance of greater authority than you intend them to have. Their job titles should be consistent with their function, with appropriate checks and balances that a prudent business person would take to assure employees are acting within the scope of their authority.
- Review capitalization levels to make sure that excess cash or unrelated assets are not being left in the firm unnecessarily.
- General and professional liability insurance could protect against allegations of negligent activities or failure to use reasonable care.
How can I protect my business against the death, disability or departure of one or more key people?
Because small businesses are so dependent on one or a few key employees, their inability to perform can result in tremendous lost revenue. A multitude of planning tools is available, such as:
- Key person life and disability insurance: Provides the business with cash compensation to help replace such a costly loss.
- Buy-sell agreements: Can provide contracts to compensate families and provide for smooth ownership transition if you die unexpectedly.
- Split dollar life insurance: Adds tax-advantaged savings features to the benefits the business might receive, should one of its key personnel die unexpectedly. Premiums and death benefits are split between the employer and the employees.
How can I convert my business into planned retirement income?
With all businesses, especially service-oriented ones, it is important to shift from one that supports the owner’s lifestyle – operating according to his or her schedule, income and tax benefit needs – to an equity-based model. With the first kind, the value is based on the owner, and typically diminishes or vanishes when he or she retires or dies.
By contrast, an equity-based organization is designed for the long-term. It benefits both the owner and the owner’s family in the future. Keys to turning your business into an equity-based entity include:
- Staff: Surround yourself with people capable of creating the product or service. You should not be the only one to drive the operation. The staff can handle routine matters, especially those that involve customer contact. Your involvement as the owner remains, but with employees handling the day-to-day operations, you can focus on higher-level issues like new business development and strategic planning.
- Procedures: Your business must deliver a consistently high quality product or service without your direct involvement. Develop clear procedures and guidelines that staff can follow without the owner’s constant oversight and direction.
- Retention: Select one to three key employees who can operate the business in your absence. They should take pride in the business’ success, and have effective incentives to thrive personally from it. Bonuses based on performance and results, or giving them a piece of the business over time is often helpful in retaining good employees.
When it comes time for you to step down, you might transfer ownership to a family member or employee, become a co-owner, or allow a third party to take the reins. For succession to happen smoothly, a business has to be function independently, as a separate entity from its owner. Depending on tax circumstances, you can sell your business for a lump sum, a payment over time, an on-going interest in the entity or some combination of these.
Which qualified retirement plan is best for my situation?
Several factors need to be considered, including:
- Variability of business revenues and income: Generally, greater tax benefits are available if you contribute more to your plan. The downside, of course, is that in lean years it could be difficult to maintain those higher contributions. Carefully weigh these factors and be flexible.
- Owner or employee emphasis: The Employee Retirement Income Security Act (ERISA) specifies minimum plan participation requirements for rank and file employees. These rules have some flexibility that allows owners to receive a relatively greater proportion of dollars contributed. This is especially so if the firm is willing to match employee contributions, or if the key employees are have a significantly older than the others.
- Retention: Ensure that the dedicated staff built through the years is sufficiently compensated and not tempted to look for jobs elsewhere. Also, provide them with an incentive to begin saving for their future. This is especially important since many workers are not saving enough to live comfortably after retirement.
Every owner will one day leave the business. The question is, will you leave on your own terms or will it be dictated by health or financial circumstances? When it is properly planned, it can bring you financial independence, and has the added benefit of leaving the business a healthy, viable entity that can flourish long after you move on.
You need to look at your situation carefully to determine which strategies are best for your business. A qualified financial advisor can help develop a clear picture of a business’s value and then integrate that information your personal financial situation to help both succeed.
Uncertainty over the economy and financial markets has many people concerned about their financial futures. For friends, relatives and colleagues who may find this information helpful, please feel free to share with them. Remember, for those who could benefit we offer a complimentary “Second Opinion” that can provide an objective financial review. Keep us in mind for those who may be seeking a wealth advisory practice like ours—one that delivers services according to the needs and perspectives of its clients.
Note: Any information contained herein is not a complete summary or statement of all available data necessary. It is important to check with your tax professional and attorney.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Wells Fargo Advisors Financial Network LLC (WFAFN) does not provide tax or legal advice. We strongly recommend an advanced tax and estate planning expert be contacted for further information. Any opinions are those of Mitchell Kauffman and not necessarily those of WFAFN. The information has been obtained from sources considered to be reliable, but Wells Fargo Advisors Financial Network does not guarantee that the foregoing material is accurate or complete. Prior to making a financial decision, please consult with your financial advisor about your individual situation.
Mitchell Kauffman provides wealth management services to corporate executives, business owners, professionals, independent women, and the affluent. He is one of only five financial advisors from across the U.S. named the industry’s most qualified Financial Advisor through Research magazine’s Hall of Fame in 2010.
Inductees into the Advisor Hall of Fame have passed a rigorous screening, served a minimum of 15 years in the industry, acquired substantial assets under management, demonstrate superior client service, and have earned recognition from their peers and the broader community.
Kauffman’s articles have appeared in national publications, and he is often quoted in the media. He is an Instructor of Financial Planning and Investment Management at the University of California at Santa Barbara.
For more information, visit www.kwmwealthadvisory.com or call (866) 467-8981. Investment products and services are offered through Wells Fargo Advisors Financial Network LLC (WFAFN), Member SIPC. KWM Wealth Advisory is a separate entity from WFAFN.