Time is getting shorter every year. When a client reviews their financial and business plans with me, we discuss not only what will happen next year but what we expect to happen five or 10 years down the road. The steps you take to further your financial and business goals in 2012 should be part of your game plan to get you to your five- or 10-year goals. As the economy has worsened, I have noticed that clients tend to forget these long-term goals. Focusing on the here and now is a natural human reaction to uncertain times; unfortunately, this reaction can hurt you if you lose sight of your long-term goals.
How a wholesale business owner forecasts their personal finances depends entirely on their business. The strength and cash flow of your business will govern how you will take income from that business. There are also many nonfinancial issues that have a direct financial impact on a business owner. With that in mind, I have set out below a series of issues to consider in making your plans for 2012.
Goal Planning: As a business owner, when you look ahead to plan your personal finances, you will need to look beyond 2012; the first question to ask yourself each year is “where am I going?” Are your five- and 10-year goals the same as they were last year? When was the last time you even considered your long-term goals? Your primary long-term goal should be how you will exit your business; this goal will determine how you will build your business. Primary exits are the sale of the business, liquidation of the business, devolving the business to children or partners or maintaining the business purely as an income platform. Each of these goals requires different strategies. Make sure you understand them, and that your team of trusted advisers understands them. A year-end meeting with your attorney, accountant, insurance broker and any other adviser you use is a good way to keep everyone focused on the end goal.
The Corporate Form: Your company is where your equity lies — for many, their equity in their company is what they intend to use for retirement. You mine the equity from your company by selling it or its assets. Make sure that the vessel that holds your equity is sound; the corporate form does not take much time to maintain, but failure to do so can be catastrophic. Make sure that you have complied with the corporate form requirements of your business entity and that you plan to meet those requirements in 2012. Subchapter S corporations are particularly good vehicles for selling your equity but are also particularly susceptible to inadvertent destruction. Failure to maintain the corporate form can result in hidden tax liabilities (such as becoming subject to the double taxation of a Subchapter C corporation), or the failure of the corporate form to protect you personally against lawsuits. This failure can cost you more than any ill-advised investment strategy for 2012; do not brush it off as a ‘mere technicality.’ The problem with corporate form errors is that you cannot easily fix them in subsequent years; their cost grows exponentially. If you intend to sell your business, expect potential buyers to scrutinize your corporate formalities as part of their due diligence. No buyer will be interested in a corporation that risks tax or liability problems because you failed to observe the formalities; this will lead to a more difficult time finding a buyer, and a lower sale price.
Financing: It is no secret that financing is hard to obtain these days. If you need financing and are eligible for a Small Business Administration loan, you may want to move as quickly as possible. The SBA budget is unsure right now but likely to see a cut next year.
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Taxation: Here is where I can give you some nuts and bolts advice for the immediate future; this advice comes with a strong caveat — make sure you discuss these issues with your accountant and never, ever, prepare your tax returns on your own.
If your company is an S corporation, make sure that you are taking a ‘reasonable’ salary by industry standards. Failure to do so can lead to significant tax liability for you. Do not take more than a reasonable salary; however, you may be able to reduce your employment tax liability by taking only the legally required ‘reasonable’ salary with all other compensation in the form of distributions that are not subject to employment taxes.
The Tax Relief Act of 2010 provided tax relief to business, but many provisions expire at the end of 2011, and higher tax rates will reappear in 2012. Make sure you take advantage of all of the act's benefits for this tax year; do not depend on them to be available in 2012. Accelerate expenses (within legal limits) to reduce tax liability, especially if you are not confident that you can accurately forecast revenues for 2012. You will also be able to take advantage of “bonus depreciation” that is only available through 2011 - 100 percent of certain qualified asset purchases. Only 50 percent of those purchases will be available for bonus depreciation in 2012.
Accelerated depreciation for new equipment and software is increased and expanded to some real property. For the 2011 tax year, you may write off up to $500,000 of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property (although these write-offs are phased out once they exceed $2 million).
The 15 percent capital gains tax rate applies only through 2012 and may increase significantly thereafter. There is likely to be a public and brutal fight over the capital gains rate on Capitol Hill; there is no predicting how that will end. Therefore, selling stock and capital assets before the end of 2012 may be a very good idea.
Taking advantage of the tax breaks that are available to you in 2011 has future benefits as well; a reduced tax burden this year may allow you to reduce estimated tax payments you must pay through 2012. Furthermore, a reduction in taxable income may allow you to take advantage of certain deductions that are unavailable with a higher income.
Fix Problems: You may have some nagging issues that you have been ignoring: for example, corporate form issues, tax matters or improper employee income tax withholding. Fix these; do it now. The roller-coaster economy that we are in will require all of your attention — you do not have time to be losing sleep over problems you can fix or have your attorney or accountant fix for you. I have found that a good rule of thumb is that every year you allow a legal problem to linger, it will require 25 percent more in costs to resolve it. An interest rate of 25 percent is usurious; don't be caught in that cycle.
Particular hot-button issues for 2012 are owner-employee payments and independent contractor classifications. Make sure that you correct all errors in payments to owner-employees before the end of the tax year. This is especially true if you have any “deferred compensation” — that is, compensation that you have a right to now but will be paid in a subsequent year. Changes to the regulations under Section 409A of the Internal Revenue Code institute a 20 percent penalty of such deferred compensation. It sounds arcane, but it applies to bonuses, severance pay, change in control payments (which many owners will receive upon sale of a business) and other compensation that you may receive. Few understand the new rules, and many business owners and their advisers are unaware of these changes. Make sure your team reviews compensation packages for 409A issues.
Correct any improper classifications of employees as independent contractors. The IRS is focusing heavily on the improper classification of employees, especially in “pass-through entities” such as limited liability companies and S corporations. Many business owners have hired independent contractors due to the uncertainties of the economy and the need for transient work. Unfortunately, you cannot merely label a worker, even at a high level, an independent contractor. That worker must meet a multipart balancing test to merit that label; incorrect classification can lead to serious problems with the IRS, your state department of revenue, unemployment compensation, workers' compensation, overtime and wage issues and employee benefits issues. The cost of an improper classification that saves your company $15,000 a year can easily rise to $75,000 if you do not self-correct the problem. Expect IRS investigators to be particularly dogged on this issue, and expect an unemployment or workers' compensation challenge from your workforce on it.
Conclusion: Our uncertain economy is a time of great opportunity — this is the goal that you should keep in mind at all costs. If you are able to focus on your business and the opportunities presented now, and cut away the problems that will impede your progress, you will have maximized your potential for success.
Christopher Ezold is a partner at The Ezold Law Firm, P.C., a Philadelphia-based boutique law firm focusing on business, employment and health care law. Ezold acts as outside general counsel to his business clients, providing advice on a wide range of matters and litigation. He has a L.L.M. in Taxation from the Villanova University School of Law, serves as General Counsel to the Main Line Chamber of Commerce and is the chair of the Board of Directors of the Magellan Leadership Group. Ezold is licensed to practice law in Pennsylvania and New Jersey.