Be an Ethical Entrepreneur, Marketer, and Business Builder

Owning a business MUST be part of your wealth generation strategy

April 1, 2010 by Leave a Comment

The reason for this is actually extremely simple and direct: Taxes

If you could consistently make 20% MONTHLY returns in the stock market you’d still benefit from a small business. Realistically, I can’t think of a single reason not to own a small business. Even if the business only employs you, there are tax advantages though there are certain advantages, such as healthcare, that are only possible with people working with you.

Keeping in mind that less than 12% of millionaires, according to The Millionaire Mind, are professionals (i.e. doctors, lawyers, engineers, etc.) and the vast majority create their riches through building a business, that’s actually beside the point. My point in this blog is simply that owning a brick and mortar business has many advantages that even your 1-man-show-no-employees-to-deal-with internet business can’t match. Let’s look at a few:

  1. Taxes
  2. Room to cutback
  3. Health Insurance
  4. Retirement Accounts

The quantity of tax advantages possible with a small business are for more numerous than a short blog can cover so I’ll touch on a few highlights:

  1. Pre-tax Expenses – Your gross pay is meaningless. Your net pay is all that matters and when your phone, internet, car, car insurance, business meals, and travel are all paid for by your business the savings are huge. As an example, if all of those pre-tax expenses add up to only $10,000 per year and you are in the 30% Federal Income bracket, have 5% state income tax and have to pay 15.3% in FICA (7.65% from the employee and 7.65% from the empoyer) you’d have to pay yourself over $20,000 in salary to afford the same expenses. If you own a business and those expenses only amount to $10,000/year you probably need a better accountant. Keep in mind you have to be honest about the use of those items. For instance, my company doesn’t pay for my entire cell phone bill because obviously I use the cell phone personally a portion of the time. The same is true for my vehicle allowance.
  2. Distributions – When you have a pass-thru entity you have to pay yourself a “reasonable” salary and the rest of the profit you can take as a distribution without paying any FICA tax (a savings of 15.3%).
  3. Racing – This is probably my favorite! In essence, if you like racing cars, motorcycles, airplanes, bicycles or have some other hobby and you don’t mind plastering your race vehicle with your business’ logo, then your vehicle and most of the expenses related to racing can be paid for pre-tax as a marketing expense for your business.
  4. Real Estate – If your business requires a building and you own the building in a separate entity (most likely an LLC), your business can rent the building from your other entity and the rent is passive income that isn’t subject to FICA (again saving you 15.3% over a salary). Obviously the rent has to be reasonable.

As you can see, just these few items can quickly add up to tens of thousands of dollars in tax savings even with a business grossing less than $500,000 per year. Obviously, the larger the business, the greater the savings.

By room to cutback, I simply mean that if you have a business that employs just you and sales drop, guess who the first one to get fired is? On the other hand, if you have a business with just a dozen employees and sales start dropping now you have a lot more room to cut payroll before you’re out of a job or taking a pay cut. As a small business owner, I know personally that cutting others before you cut your own pay is extremely difficult to do, but you can’t deny that, if necessary, you and your family have a bit of extra security.

As for health insurance, if you have a few employees (at least prior to the new Healthcare Reform Bill) there were health insurance advantages to being on a group plan such as your rate is primarily based on your age and not pre-existing conditions. I learned this first-hand as I couldn’t get insurance as an individual but had no problem getting on my business’ plan.

Since it’s your business, you get to structure your SEP-IRA or other retirement vehicles in any way that you want. Of course you have to make the accounts available to everyone on your team, however you have the ability to structure the accounts to best benefit you. This power can have a major impact on your overall tax bill today and into retirement, so don’t overlook it.

Finally, if you’re looking for what type of entity to create, I highly recommend an LLC filing as an S-corp. Also, make sure you have a GREAT accountant to take care of all of the details of these tax advantages and to make sure you’re doing everything legally and ethically.

To your tax-saving success, Bryan

Filed Under: General Business Tagged With: , , , , , , , , ,

A few more ways to get tax-free money from your business…

February 21, 2009 by Leave a Comment

As I’ve pointed out before, when dealing with customers, team members, suppliers and even the tax man I’m not at all a fan of doing anything “under-the-table” or unethical. So keeping that in mind, here are a few ways to get tax free money from your business.

  1. Credit Card Rebates – This would be the ever popular cashback, rewards, points, and travel credit cards. The IRS currently has no provisions for rebates of any kind so this can easily add hundreds (if not thousands) of dollars in cash, gifts, or travel expenses into your pocket tax-free. I personally have 3 rebate cards. One from American Express, one CapitalOne visa, and a Discover card. The rebates range from 1-5% and in about 8 months of random purchases (both personal and corporate) I accumulated over $500 in rebates. My personal preference is to receive cash rebates so I can spend the money wherever I want however I’m looking into travel rebates since I tend to travel a lot.
  2. Purchase Rebates – These are the rebates you find at large retailers where you buy a fax machine and can receive a $50 mail-in-rebate. Guess what? The total expense is deductible and when the rebate comes in the money is yours. Check with your accountant (cause I’m definitely not one).
  3. Marketing – This is one of my favorites. A few weeks ago I sat down with my accountant and asked about my business sponsoring a race car at the local track. Turns out it’s 100% deductible. The racecar (or motorcycle), repairs, gas to get there, parts, etc. etc. can all be written-off as marketing expenses. If you are always racing something like me, then you really shouldn’t let this tax-free racing budget pass you by. Of course your race vehicle needs to advertise your business.
  4. Personal Development/Training – My accountant just educated me on this one recently. Currently I have 2 businesses that are about 4 hours apart with a total territory that would take me about 12 hours to circle by driving. Add to that the possibility of another business about 4 hours away in a different direction and the benefits of flying become quite obvious. So I’m working on getting my personal pilot’s license so I can fly myself around for business and also a bit just for fun. Just like with a company car, you need to figure out how much of your time is truly business and how much is personal and allocate the proper amount of your flight instruction and flying lessons through your business. Of course that would be a direct, pre-tax, business expense.
  5. Gifts – Not sure if this varies by state or is just for federal however my accountant informed me that a performance based incentive of up to $400 can be awarded to all employees without claiming it as taxable income each year. This can be in the form of a gift or simply cash. Hopefully you’ve performed well enough in your business to earn such an award. 🙂

It seems like I’m learning new, creative, legitimate ways to benefit from owning a business on a weekly basis so as I learn more I’ll post them. If you have any great ways to lessen your tax burden legally please let me know!

To your success, Bryan

P.S. I’m not an accountant and everyone’s situation is different, so make sure you check with your accountant before starting any of this. 🙂

Filed Under: Business Accounting, Business Ethics Tagged With: , , , , ,

The ULTIMATE tax shelter?

October 8, 2008 by 2 Comments

It never quite made sense to me why when you’re applying for a mortgage they ask about your gross income. You know, your income before taxes. Who cares what your gross income is???  If you make $100,000 per year are single and rent an apartment you’ll probably pay your full federal tax of $22,110.75. Factor in your state income tax (let’s say it’s a conservative 3%) and your FICA (7.65%) and your take home is around $67,200. That’s a total of about 32% or about 1/3rd of your total income going to Uncle Sam. Kinda depressing isn’t it? (Did I forget to mention the sales tax on everything you purchase, too?)

Now let’s say you’ve done some homework and decided to buy (~$14,000 in interest and $2000 in property taxes) instead of rent. You even felt that it was a good idea to make a few charitable contributions (another $5000) and invested the maximum allowable amount ($4000) in an IRA and assume your state doesn’t allow any of those deductions.  Now your federal tax bill will be $14,423.75.  A savings of almost $8k in federal taxes alone.  Your take home after taxes jumps to ~$74,900. Keep in mind, that after your charitable contributions, property taxes, interest, and IRA your take-home that you can spend on sports cars and flat-screen TV’s will only be ~$50,000.  However, you now have a house that hopefully is appreciating and a retirement account so you’re ahead of the game. But let’s face it – you still don’t have tons of cash as compared to the total cash that you earned.

Now here’s the real exciting part. If you have a business that pays for your car, for your cell phone, and your internet access (pre-tax), since you work from home at times, you’re starting to get WAY ahead of the tax man. Add in some passive income from a rental property (since you won’t have to pay FICA on residual income) and your NET (after-tax) income just keeps climbing. If your business is filing as an S-corp, you take a “reasonable” salary, and take the rest out in distributions you again avoid the FICA taxes. Tax minimization is one of the greatest advantages of being an entrepreneur. In the scenario above, if you take out $50,000 in salary and pay the remaining $50,000 in distributions, your tax bill drops another $3825 (which is direct cash to your pocket).

Before I get into The Ultimate Tax Shelter, Jeff Schnepper in How to Pay Zero Taxes 2009 points out a few fun facts for us:

  • The average middle-American salary in 2005 would take about 107 days of 100% of income going to Uncle Sam to pay off his taxes! In 1930 it took only 57 seconds of work to pay your taxes.
  • On Average Americans spend more time working to pay their taxes than they spend working to pay for food and shelter combined (as an employee I KNOW that was the case for me).
  • In 2004, 42.5 million tax returns – one third of all filed – had no income tax liability because of the available deductions and credits
  • For the tax year of 1998 2,085,211 individual tax returns showed income of $200k or more. Of those, .07 percent or about 1,467 returns, showed no U.S. tax liability! By 2001 that number jumped to 2,959 returns! (This statistic is my personal favorite)

My point is you pay too much tax. However, as I always stress, you don’t need to cheat the tax man by doing anything unethical. You play by the book and educate yourself properly and you won’t have to. With that in mind, my accountant confirmed what How to Pay Zero Taxes 2009 recently taught me – an amazing tax shelter – resort rental properties.

Obviously as a rental property it has all of the advantages of passive income:

  1. No FICA (7.65% of wages)
  2. Potential for paper loss along with a positive or break-even cashflow for great tax deductions
  3. Appreciating real estate
  4. Minimal management (most resorts offer management companies)
  5. A vacation home to use when you want!

Without any of the draw-backs:

  1. NO Necessity of being an “Active Participant”
  2. NO Limitation of $25,000 of passive losses against active income
  3. NO Phase-out of all deductible losses starting at $100k and completely erasing all deductible losses by $150k

This scenario is because in any property where the average rental term is less than 7 days it’s considered a hotel/motel and the income (and loss) becomes active with no limitation on the loss. In other words, it becomes its own business with all the normal business perks. (Have your accountant reference Treasury Reg. 1.469-5T(f)(2)(ii) for more details.)

Let’s take it even a step farther. Once you start your vacation rental business, you decide it’s a pretty good business to be in and so would like to invest in more resort rental properties. Your spouse and you are both shareholders so you decide to take a trip to evaluate more properties. That tax-deductible trip can be to the local ski-resort, to Hawaii, or around the world. After all, you need to evaluate 50 businesses to find the right one, how many resort rental properties will you have to evaluate before you find a great one?

Unfortunately, in my experience, your accountant is rarely going to come up with great tax-savings ideas for you… The average accountant seems to be too busy with the “basics” and effort taking care of those monotonous details, to get real creative. I’m not real sure exactly why that is… At any rate, it’s your responsibility, not your accountant’s, to make sure you’re not paying too much tax!

Don’t ever forget that NO investment should be made solely for a tax deduction. That’s not only poor business planning, it’s actually illegal. You make your real estate investments based on the potential for appreciation and ultimately that the money you put in will be less than the cash you take out.

As an entrepreneur it’s important to build your team, educate yourself on technology, train yourself on marketing and a host of other things – but why do all that work while donating 107 of your hard-working days to the tax-man? It’s poor business and probably poor for your health considering the possible depression that it can induce.

To your NET success, Bryan

Filed Under: General Business Tagged With: , , , ,

Your business should be an LLC filing as an S-corp

October 2, 2008 by 9 Comments

*DISCLAIMER: I am a mechanical engineer. (Do I really need to say anything else to emphatically point out that I am not a lawyer or accountant advising you on legal or tax matters?)

So here’s the plan:

Buy the assets of a business, create an LLC that files taxes as an S-corp, and sell the LLC.

First a little background. You have a few options when forming a business entity:

  1. Sole-proprietorship – single owner as disregarded (pass-thru) entity
  2. Partnership – multiple owners as disregarded entity
  3. Sub-S C-corporation – up to 75 shareholders as disregarded entity
  4. C-corporation – unlimited shareholders with corporate tax on profits and capital gains on distributions
  5. LLC – unlimited members

However when filing your taxes you have to choose one of the top 4 OR an LLC (for legal purposes) filing as one of the top 4 (for tax purposes). So not including all of the types of partnerships (Limited, Family Limited, Master Limited etc. etc. etc.) or Trusts you have about 8 options when forming your business entity. Of those 8 basic options, the LLC filing as a Sub-S seems to be the best for our buy, build, and sell purposes.

Reasons why you want an LLC filing as an S-corporation:

  1. An LLC is the simplest legal entity requiring the least amount of corporate formalities.
  2. An S-corp is a pass-thru (disregarded) entity so all distributions pass-thru to the owner on his personal tax return and are only taxed on state and federal income (and in several states such as Texas, Tennessee, Nevada, and Wyoming there are no state income taxes).
  3. You only pay tax on your Net Profit in your P&L – not on the actual cash distributions.
  4. With Amortization, Depreciation, Interest on the loan you used to buy the business, and a Section 179 of your equipment expenses, you can have quite a lot of cash distributions with no paper income.

Taxes you won’t have to pay with your LLC filing as an S-corp:

  1. FICA – you only pay that on your “reasonable” salary, not on your distributions
  2. Self-Employment Tax – this is only necessary with a sole-proprietorship or a partnership
  3. Corporate Tax – currently around 34% on the profits of a C-corp plus another 15% capital gains on your distributions (is there any reason a small closely held business would be a C-corp???)

The reason you buy only the assets of a business is your depreciation and amortization schedules start all over again and with the numerous business valuation methods you can always come up with some “goodwill” to amortize. Keep in mind, that amortization is your best friend. It’s a non-cash accounting expense that can save you thousands in taxes. For a more in-depth analysis of Amortization and Depreciation check out my Business Valuation 2 – EBITDA can eat my shorts blog.

The reason you sell the shares of the S-corp is that you can provide vendor financing to the new owner and only pay capital gains little-by-little every month as the payments come in. However if you sell the assets out of the S-corp, you have to pay the entire capital gains up-front EVEN if you’re carrying a note for the new owner. This obviously is the worst part about an S-corp. I believe the only way around paying all of the capital gains up-front on an asset sale would be a Like-Kind exchange. This could be very tough if you’re selling a business to buy another one because it would have to be an extremely similar business and you’d have to meet all the strict deadlines for the transfer (usually less than 90 days). And of course if you’re carrying a note then you may not have the cash to buy that other business. Is there a better way?

Exceptions.

  1. If you’re never going to have any income (such as with a rental property or if you have a great accountant) you might as well file your LLC as a partnership or sole-proprietorship. Without income you won’t have to worry about taxes and when you go to sell, you can sell the assets, carry a note and still not have to worry about immediately paying for all of the capital gains. In other words it gives you a bit more flexibility when you go to sell.
  2. If you have multiple owners/shareholders and you don’t want the distributions to be evenly split along ownership percentage lines you can’t use an S-corp.
  3. If you’re going to buy, build, and sell very quickly (i.e. less than a year) you’re probably better off filing as an LLC sole-proprietor or partnership. I say this because if you can flip a business that quickly you’re probably able to grow it extremely rapidly and your biggest tax concern would be the capital gains on the sale. With the sole-proprietor or partnership you could be flexible and either sell the assets or LLC with vendor financing and not have to pay all of the capital gains up-front.

Unfortunately, I can’t claim that I learned all of this from a single book. As a matter of fact, it took about an hour with my accountant which will cost me about $55. Money well spent! 😉

To your success, Bryan

Filed Under: General Business Tagged With: , , , , , , ,

Why being ethical is always more profitable…

September 21, 2008 by 1 Comment

It’s amazing when you consult for businesses throughout North America – particularly when you’re intimately involved with their billing software – how many “questionable” things you learn.

I’ve seen:

  1. Paying people under the table.
  2. Canceling cash transactions in the computer and pocketing the money.
  3. Trade deals to avoid sales and other taxes.
  4. Running the expenses to remodel a home through the business.
  5. Paying salaries to family members who don’t even work in the business.
  6. Buying a company motorcycle.
  7. Paying country club memberships directly from the business.
  8. Writing off business trips and meals where business was never discussed.

And if your accountant approves of one or more of the above, get a new accountant because they’re not liable – you are. Those write-offs are only gonna be legit for as long as you can avoid an audit.

So why the overwhelming pressure to “cook-the-books”? The simple answer is, of course, taxes. When someone in America makes more than $100,000 per year about half of his income goes to the government so I can understand how people can get a bit bitter… However, there are a few reasons why not doing things “by the book” or why sneaking unethical transactions through your small business is a bad idea.

  1. It devalues the business when you go to sell. If you’re ever buying a business NEVER include cash deals that aren’t on the books as part of the value of the business no matter how well documented they are. I can create a fake spreadsheet in about an hour “documenting” the 3 years of over-the-counter cash transactions. If the business hasn’t paid taxes on it, then don’t include it. You have no way to verify. Additionally, when valuing a business based on Seller’s Discretionary Earnings or Cashflow you can only add back so many “owner perks” before the buyer is going to wonder if maybe a great deal of those perks might just be necessary for your type of business. You bet I would certainly use that to negotiate the purchase price down.
  2. It will catch up with you. And maybe the only way it’ll ever catch up with you is by you not being 100% comfortable every night knowing that the IRS will never find anything out of line. Business is a means to an end. That end being more freedom – particularly of your time.  But if that free time is haunted in the back of your mind with, “How do I conceal X if I get audited” then how can you completely enjoy it? CFO magazine from July/August 2008 had an article titled Don’t Mess With the IRS – Tougher Enforcement has Companies Rethinking Tax Strategies. It makes the point that the IRS is better funded, has better legal talent, and for the first time ever, actually wants to take people to court because they’re so confident in their new abilities to win. And they’re making waves. CFO points out that in 2002 corporate tax penalties amounted to $335 million while in 2007 they totaled $939 million. Nearly a three-fold increase in 5 years. Don’t be naive and think “well those big sheister corporations deserve to pay all that money but they’ll never worry about my small business.” You don’t have a full staffed legal team for them to even fight. It’s just a matter of time before small and medium business’ start feeling the repercussions of the “New IRS”.
  3. There are legit ways to minimize taxes. However they can be a bit challenging and finding a good accountant is even more work…

Don’t get me wrong. It makes me physically ill to think of how many thousands of my dollars are going to wasteful government spending and redistribution of the wealth programs…  If it gets bad enough, then I’ll move to another country that’s more tax friendly (more on that later) however for now, the possibility at the American Dream and making millions in America is still alive and well so I’m going to pay my fair taxes and make sure my business’ are legit. With that in mind, here are a few legal tax minimization ideas you may want to consider:

  1. Rental Real Estate – You can deduct up to $25,000 in losses from passive income against active income if you’re an “active participant” in that real estate and you don’t make more than $100,000 per year. It gets more complicated from there…
  2. Equipment Leasing – Leasing equipment from one business to another business, or from your person to your business is a great way to get money to your pocket with minimal taxes. More importantly it’s a great way to shield your business from the liability that having employees driving vehicles would present. In other words, if company A owns your trucks and leases them to your primary company B and someone sues the company that owns the trucks because they were in an accident, all they could take would be the trucks… Not the rest of your business. Admittedly its a bit more complicated then that, but you get the idea.
  3. Multiple Business Entities – If you have a pass-thru entity such as an S-Corp or LLC, you don’t pay any Self-Employment tax or FICA. In essence, any distributions that you take out of those businesses saves you 15.3% on FICA taxes right off the top. You must, however, pay yourself a reasonable salary. You can’t take all of your income in distributions. Also, all corporate expenses (i.e. forming your business entity) plus the formalities necessary to keep it up and running are deductible expenses. Depending on your type of business you could also incorporate in a state without state income taxes such as Nevada, Wyoming, Texas, or Tennessee.
  4. Personal Loans – Loaning your business money and then taking a reasonable interest rate against that loan is a form of passive income. It’s not taxed the same way as active income (no FICA, I believe).
  5. Like-kind-exchanges – If you buy and then sell a business, you can defer your tax indefinitely by buying another business with your capital gains. The same is true for similar real estate transactions. Obviously if you can’t completely and legitimately eliminate the tax, your next best option is to defer it for as long as possible.

The list can go on-and-on. Granted, as in all my business dealings, I err on the side of creativity which is why I would never setup any of these programs without my accountant’s and lawyer’s blessing.

Simply put, according to The Millionaire Mind, “Being honest with all people” is the number one trait millionaire’s attribute to success – dealing with the IRS requires that same level of honesty.

For a few more resources on legitimate ways to minimize your exposure while improving your marginal tax rate, check out How to Pay Zero Taxes 2009 (How to Pay Zero Taxes) and The Corporation Manual.

Oh yeah, and don’t forget the purchase of those books can be deductible. 😉

To your success, Bryan

Filed Under: Business Books, Business Ethics Tagged With: , , , , ,