Getting Bigger Thinking by Smaller Businesses Guest Columnist Bruce Weide Most small business owners bust their guts taking personal financial risks to build a business, until finally one day they pass that make or break point of profitability. And just as their hard-earned rewards are due to come to them (i.e. ever increasing profitability margins), now they have to worry about the IRS taking it all back? Is that just the way it is? It’s not true that you can’t keep your profits in the corporation without being subject to “double-taxation.” It’s also not true that a Qualified Retirement Plan is the only way to get pre-tax income out of a corporation. Can you honestly envision Bill Gates’ CPA telling him, “Well Bill, you’ve hit your $50,000 limit on pre-tax income in your Profit Sharing Plan this year. You’ll just have to bite the bullet on the other $100 million.” Now, I may not personally know what Mr. Gates’ specific strategies are, but I can bet how long that sort of a CPA would last in his lion’s den. The problem we generally see with too many small business owners is that the concept of retirement planning is dreadfully confused with strategies for wealth retention. So they think of their Qualified Retirement Plan as the only wealth retention strategy available to them. It’s apples and oranges. And with all due respect, many CPAs and financial advisers often don’t get it either. If you happen to find yourself in the same muddle, the crucial turning point for you will come that day when your business arrives at a stage of robust profitability. What’s “robust” is relative to your goals. For some small companies with only a handful of employees, that may be your first million in profits. For some mid-size companies it could be $100 million or more. The test is this Has your attention shifted in any way from building profitability to the taxes that will be due either corporately or personally? If yes, then it’s time to think beyond 401Ks. Wealth retention strategies break into two broad approaches. 1) How to draft profits from the corporation to the shareholder by tax-advantaged means, or 2) Keeping retained profits in the corporation without subjecting them to naked exposure to corporate taxation. Tax-advantaged profits Let’s say that you are a sole shareholder with a corporation seeing $1 million in profits and your standard of living requires only about $250,000 for you to live on. You have maxed your 401K contributions at $13,000. Or worse yet, you can’t take $13,000 because with your employees only rarely participating in the plan you have become “top heavy” and your plan administrator has just informed you that you have to take some of that $13,000 back out. For such a case there is a plan model available today that will allow a.) $1 million of contributions annually (maybe more), b.) Can be set up on a discriminatory basis, where you are not obligated to fund for your employees, c.) Contributions are roughly 75 percent tax deductible (meaning a $1 million contribution reduces your tax liability down to $250,000) d.) Contributions are placed into a variety of investment options e.) Withdrawals of principal or gain may escape income tax and capital gains taxes if properly structured and can be taken before age 59 & #733; without penalty. Sound too good to be true? If it doesn’t, then think this through again. This literally means that you could potentially take out hundreds of thousands of dollars per year and report ZERO on your income tax return for those years, from funds which caused a substantial tax reduction when they were contributed. Retaining profits In an S Corporation remember that the IRS comes to the individual shareholders to pay taxes on the corporate profits. (Known as a flow-through corporation. LLC’s are similar.) Now what would happen if a non-taxable trust owned your S Corporation shares? There is in fact a way to do this so that the S Corporation profits can’t be taxed and, contrary to what you might think, you do not lose control of your corporation one iota. Furthermore, that trust has a fiduciary responsibility to increase the value of its holdings. So it can take those untaxed profits and invest in things that will return gains for its beneficiaries, such as equipment for your company, real estate, a new factory, or even buying out a competitor, all with pre-tax dollars. Let’s say you’re 61 years old, and the only real retirement savings you have are the potential proceeds in selling your $5 million business. Well, typically this means finding a buyer who wants to haggle down the price with you. Then, if your basis on the stock has been entirely depreciated over the years, get ready to pay $1 million in capital gains taxes on the sale. Now, if I told you there was a way to 1.) Sell all or part of your stock to a ready-made market, 2.) Get a premium price not a discount 3.) Avoid capital gains taxes on the sale 4.) Secure the funding for the purchase of the stock on a tax-deductible basis (interest and principal are tax-deductible) would you be interested? The two biggest obstacles in getting someone graduated from retirement plans to wealth retention strategies are 1.) There may be a bit of new vocabulary for you to get up to speed on and you have to be willing to study up on it. If you don’t like learning new things, then you could opt instead to pay unnecessary taxes as you may have been doing 2.) Some people just more comfortable operating with fixed ideas they’ve been given from some unquestionable authority. We’ve often heard the reaction, “I don’t know how to do this, and neither do any of my friends or advisers. Therefore can’t be done.” Obviously, No. 2 will prevent progress in No. 1 above. On the other hand, don’t allow me to give you tax, legal, or investment advice either. I am laying information only for general illustration purposes here. When you have someone who can help you with these types of strategies, it is crucially important to get full support documentation and side-check it with advisers who don’t have fixed ideas themselves. Bruce Weide is the author of “Getting Rid of Taxes in Business and Retirement,” and CEO of TAX-FREE Benefit Specialists and Insurance Services. Headquarter in La Crescenta, he can be reached at (818) 896-5958 or at [email protected].
