At the very least, update the financials in your business plan

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Every new company should launch with a business plan and keep it updated. Generally, such a plan will comprise six sections: executive summary, business description, industry and marketing analysis, management team description, implementation plan, and financials.

Now, ideally, you would comprehensively update each section every year. But if the size, shape and objectives of your company haven’t changed all that much, you may not need to make major revisions to the entire plan. However, at the very least, you should always review and revise your financials.

Explain your route

Lenders, investors and other interested parties understand that descriptions of a business or industry analysis may be subject to interpretation. But financials are a different matter — they need to add up (literally and figuratively) and contain realistic projections in today’s dollars.

For example, suppose a company with $10 million in sales in 2019 expects to double that figure over a three-year period. How will you get from Point A ($10 million in 2019) to Point B ($20 million in 2023)? Many roads may lead to the desired destination; your business plan must explain its route.

Let’s say your management team decides to double sales by hiring four new salespeople and acquiring the assets of a bankrupt competitor. These assumptions will drive the projected income statement, balance sheet and cash flow statement referenced in your business plan.

Justify assumptions

When projecting the income statement, you’ll need to make assumptions about variable and fixed costs. Direct materials are generally considered variable. Salaries and rent are usually fixed. But many fixed costs can be variable over the long term. Consider rent: Once a lease expires, you could relocate to a different facility to accommodate changes in size.

Balance sheet items — receivables, inventory, payables and so on — are generally expected to grow in tandem with revenues. The financials in your business plan must accurately and reasonably justify the assumptions you’re making about your minimum cash balance, as well as debt increases or decreases to keep the balance sheet balanced. And these amounts must be current.

From a lending perspective, your bank will be expected to fund any cash shortfalls that take place as the company grows. So, realistic cash flow projections in your business plan are particularly critical. The financials section should outline how much financing you’ll need, how you intend to use those funds and when you expect to repay the loan(s).

Keep it fresh

Your business plan needs to tell an accurate, objective story of your company — where it’s been, where it is right now and where it’s heading. Keep the whole thing as fresh as possible but pay special attention to the numbers. We can help you review your financials, arrive at reasonable assumptions, and express your objectives and projections clearly.

© 2019

2 valuable year-end tax-saving tools for your business

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At this time of year, many business owners ask if there’s anything they can do to save tax for the year. Under current tax law, there are two valuable depreciation-related tax breaks that may help your business reduce its 2019 tax liability. To benefit from these deductions, you must buy eligible machinery, equipment, furniture or other assets and place them into service by the end of the tax year. In other words, you can claim a full deduction for 2019 even if you acquire assets and place them in service during the last days of the year.

The Section 179 deduction

Under Section 179, you can deduct (or expense) up to 100% of the cost of qualifying assets in Year 1 instead of depreciating the cost over a number of years. For tax years beginning in 2019, the expensing limit is $1,020,000. The deduction begins to phase out on a dollar-for-dollar basis for 2019 when total asset acquisitions for the year exceed $2,550,000.

Sec. 179 expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It’s also available for:

  • Qualified improvement property (generally, any interior improvement to a building’s interior, but not for the internal structural framework, for enlarging a building, or for elevators or escalators),
  • Roofs, and
  • HVAC, fire protection, alarm, and security systems.

The Sec. 179 deduction amount and the ceiling limit are significantly higher than they were a few years ago. In 2017, for example, the deduction limit was $510,000, and it began to phase out when total asset acquisitions for the tax year exceeded $2.03 million.

The generous dollar ceiling that applies this year means that many small and medium sized businesses that make purchases will be able to currently deduct most, if not all, of their outlays for machinery, equipment and other assets. What’s more, the fact that the deduction isn’t prorated for the time that the asset is in service during the year makes it a valuable tool for year-end tax planning.

Bonus depreciation

Businesses can claim a 100% bonus first year depreciation deduction for machinery and equipment bought new or used (with some exceptions) if purchased and placed in service this year. The 100% deduction is also permitted without any proration based on the length of time that an asset is in service during the tax year.

Business vehicles

It’s important to note that Sec. 179 expensing and bonus depreciation may also be used for business vehicles. So buying one or more vehicles before December 31 may reduce your 2019 tax liability. But, depending on the type of vehicle, additional limits may apply.

Businesses should consider buying assets now that qualify for the liberalized depreciation deductions. Please contact us if you have questions about depreciation or other tax breaks.

© 2019

Thinking about converting from a C corporation to an S corporation?

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The right entity choice can make a difference in the tax bill you owe for your business. Although S corporations can provide substantial tax advantages over C corporations in some circumstances, there are plenty of potentially expensive tax problems that you should assess before making the decision to convert from a C corporation to an S corporation.

Here’s a quick rundown of four issues to consider:

LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

Passive income. S corporations that were formerly C corporations are subject to a special tax. That tax kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

Additional factors

These are only some of the factors to consider when a business switches from C to S status. For example, shareholder-employees of S corporations can’t get all of the tax-free fringe benefits that are available with a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors have to be taken into account in order to understand the implications of converting from C to S status.

Contact us. We can explain how these factors will affect your company’s situation and come up with strategies to minimize taxes.

© 2019

Deciding whether a merger or acquisition is the right move

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Merging with, or acquiring, another company is one of the best ways to grow rapidly. You might be able to significantly boost revenue, literally overnight, by acquiring another business. In contrast, achieving a comparable rate of growth organically — by increasing sales of existing products and services or adding new product and service lines — can take years.

There are, of course, multiple factors to consider before making such a move. But your primary evaluative objective is to weigh the potential advantages against the risks.

Does it make sense?

On the plus side, an acquisition might enable your company to expand into new geographic areas and new customer segments more quickly and easily. You can do this via a horizontal acquisition (acquiring another company that’s similar to yours) or a vertical acquisition (acquiring another company along your supply chain).

There are also some potential drawbacks to completing a merger or acquisition. It’s a costly process from both financial and time-commitment perspectives. In a worst-case scenario, an ill-advised merger or acquisition could spell doom for a business that overextends itself financially or overreaches its functional capabilities.

Thus, you should determine how much the transaction will cost and how it will be financed before beginning the M&A process. Also try to get an idea of how much time you and your key managers will have to spend on M&A-related tasks in the coming months — and how this could impact your existing operations.

You’ll also want to ensure that the cultures of the two merging businesses will be compatible. Mismatched corporate cultures have been the main cause of numerous failed mergers, including some high-profile megamergers. You’ll need to plan carefully for how two divergent cultures will be blended together.

Can you reduce the risks?

The best way to reduce the risk involved in buying another business is to perform solid due diligence on your acquisition target. Your objective should be to confirm claims made by the seller about the company’s financial condition, clients, contracts, employees and management team.

The most important step in M&A due diligence is a careful examination of the company’s financial statements — specifically, the income statement, cash flow statement and balance sheet. Also scrutinize the existing client base and client contracts (if any exist) because projected future earnings and cash flow will largely hinge on these.

Finally, try to get a good feel for the knowledge, skills and experience possessed by the company’s employees and key managers. In some circumstances, you might consider offering key executives ownership shares if they’ll commit to staying with the company for a certain length of time after the merger.

Who can help?

The decision to merge with another business or acquire another company is rarely an easy one. We can help you perform the financial analyses and project the tax implications of any prospective deal to bring the idea better into focus.

© 2019

Is it time to hire a CFO or controller?

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Many business owners reach a point where managing the financial side of the enterprise becomes overwhelming. Usually, this is a good thing — the company has grown to a point where simple bookkeeping and basic financial reporting just don’t cut it anymore.

If you can relate to the feeling, it may be time to add a CFO or controller. But you’ve got to first consider whether your payroll can take on this generally high-paying position and exactly what you’d get in return.

The broad role

A CFO or controller looks beyond day-to-day financial management to do more holistic, big-picture planning of financial and operational goals. He or she will take a seat at the executive table and serve as your go-to person for all matters related to your company’s finances and operations.

A CFO or controller goes far beyond merely compiling financial data. He or she provides an interpretation of the data to explain how financial decisions will impact all areas of your business. And this individual can plan capital acquisition strategies, so your company has access to financing, as needed, to meet working capital and operating expenses.

In addition, a CFO or controller will serve as the primary liaison between your company and its bank to ensure your financial statements meet requirements to help negotiate any loans. Analyzing possible merger, acquisition and other expansion opportunities also falls within a CFO’s or controller’s purview.

Specific responsibilities

A CFO or controller typically has a set of core responsibilities that link to the financial oversight of your operation. This includes making sure there are adequate internal controls to help safeguard the business from internal fraud and embezzlement.

The hire also should be able to implement improved cash management practices that will boost your cash flow and improve budgeting and cash forecasting. He or she should be able to perform ratio analysis and compare the financial performance of your business to benchmarks established by similar-size companies in the same geographic area. And a controller or CFO should analyze the tax and cash flow implications of different capital acquisition strategies — for example, leasing vs. buying equipment and real estate.

Major commitment

Make no mistake, hiring a full-time CFO or controller represents a major commitment in both time to the hiring process and dollars to your payroll. These financial executives typically command substantial high salaries and attractive benefits packages.

So, first make sure you have the financial resources to commit to this level of compensation. You may want to outsource the position. No matter which route you choose, our firm can help you assess the financial impact of the idea.

© 2019

5 ways to withdraw cash from your corporation while avoiding dividend treatment

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Do you want to withdraw cash from your closely held corporation at a low tax cost? The easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” But it’s not deductible by the corporation.

Different approaches

Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five ideas:

1. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.

2. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient. The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

3. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

4. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimize taxes

If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.

© 2019