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Why You Should Pay Taxes Now

Posted By Jason Trujillo, Woodbury Financial, Friday, January 23, 2015

Why You Should Pay Taxes Now

Article originally appeared on on January 20, 2015.

Click here to read original post.

Shortly before the Great Recession, I was with an advisory team that counseled a business owner to pay $1.2 million in income taxes – taxes he could have deferred. Time has proven that we were right.

He had an $8 million gain from the sale of a commercial building, and was contemplating rolling over the gain in a tax-deferred, like-kind exchange. Instead, he paid the then top capital gain rate of 15 percent versus the 23.8 percent tax he would be facing today.

On $8 million, that’s a difference of more than $700,000.

Paying taxes now that could be deferred until later sounds like crazy talk. But sometimes the numbers show a demonstrable financial saving by paying taxes currently. The scenarios in which this logic prevails are many but can be summarized into the following six situations.

Pay tax on the seed, not on the harvest

A Roth IRA is a classic example. You pay tax on income currently and put the net into a Roth IRA account. If requirements are met, the Roth builds tax free and pays out tax free.

Cash value life insurance is another example. Using after-tax dollars, you can put premiums into a life insurance contract that builds cash values tax-deferred. The proceeds pay out tax-free either as a death benefit (personally, I don’t recommend this approach) or by the owner taking tax-free withdrawals of the cash value up to the tax basis and then switching to loans.

With both a Roth and life insurance, the tax strategy is to pay taxes on a small amount currently so as to avoid taxes in the future on a potentially high amount.

Get the clock running

Sometimes reporting a taxable transaction does not mean you actually pay a tax currently. Gift taxes are an example. An individual has a lifetime $5.43 million gift-tax exemption.

This means a lot can be given before an actual gift tax is incurred. Particularly where the gift involves an uncertain valuation, it may make sense to make and report the gift currently. For example, a business owner who is contemplating transferring a business interest to a family member might do well by making that gift now.

First, it takes the asset out of the business owner’s taxable estate without necessarily causing a current gift tax. Second, future income taxes on the asset won’t be attributable to the business owner. And finally, it starts the clock on the statute of limitations for tax purposes. If the IRS wants to challenge the valuation of the asset, they have a limited period in which to do so.

Better the enemy ye know

With many business transactions, the amount of gain that will be generated in the future is unknown. It may make sense to pay the tax now, when the gain is known. For example, there is a tax provision referred to as an 83(b) election.

Say the founder of a business grants stock to a key person but makes it subject to a vesting requirement. Normally, the key employee defers paying tax on that grant until it vests; however, an 83(b) election allows the employee to be taxed currently. If the key employee anticipates the stock will grow wildly, it may make sense to elect to pay the tax now, when the value is known.

A second example involves IRC 280G. This provision disallows a tax deduction for certain compensation payments made to “disqualified individuals” – such as officers, shareholders and highly compensated individuals – when the compensation is paid pursuant to a change in control. It also assesses an additional 20 percent excise tax on the amount of the payment that is an “excess parachute payment.”

This tax is designed to penalize certain compensation payments associated with taking a business public. One of the ways tax planners avoid this punitive tax is to anticipate the sale and make some compensation payments in earlier years.

This is a complex topic, but the point is that, in this situation, paying tax in advance may avoid confiscatory taxes in the future.

Change the character of the tax

Personally, I think this strategy is oversold, but it’s at least worth considering. Some advisors suggest that rather than putting large amounts of wages in tax-deferred qualified and nonqualified plans, it may be better to pay tax on the income currently and then invest the proceeds in capital gains properties.

The idea is that capital gains taxed at a top 23.8 percent rate is better than deferred ordinary income taxed at a top 39.6 percent rate. The good news is that this isn’t an all or nothing decision. The employee may just defer some wages.

Flow-through beats double taxation

This typically involves the decision as to whether the business should be taxed as a C Corp, an S Corp or an LLC.

There’s a reason the majority of businesses in the U.S. are taxed as flow-through entities. It avoids double taxation. A C Corp pays tax at the corporate level and then is taxed again when excess earnings are distributed as a dividend.

Flow-through entities (S Corps and LLCs) result in the owners paying tax on income as it is earned. With privately held companies, it is typically preferable to be taxed as a flow-through entity.

The overall tax paid may be lower, and it avoids money being trapped in the corporation when it’s time to liquidate or sell the business.

Tax rates may go up

Now that the 114th session of Congress is open for business, we’re all wondering what will happen with taxes. While it can be argued with both houses in Republican control, the session will tilt more toward tax relief, the current federal debt and infrastructure needs are a demand for additional government revenue.

If you feel tax rates will go up in the future, consider paying some taxes now. If you feel tax rates will go down or stay the same in the future, tax deferral techniques may be more attractive.

For most business owners I talk with, taxes are neither a political nor a moral issue. They are a cost of doing business. In some situations, the simple fact is that paying taxes currently will save taxes in the future.

Tags:  after-tax dollars  business owner  C Corp  cash value life insurance  Congress  double taxation  federal debt  flow-through entity  Forbes  gift tax  income taxes  IRS  key person  LLC  Principal Financial Group  Republican control  Roth IRA  S Corp  Steve Parrish  tax deferral  tax strategy 

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Seller Beware: Avoid These 6 'Gotchas' In Selling Your Business

Posted By Jason Trujillo, Woodbury Financial, Tuesday, October 28, 2014

Seller Beware: Avoid These 6 'Gotchas' In Selling Your Business

By Steve Parrish. This article originally appeared on on Monday, October 27, 2014. Click here to read.

I was working with the co-owners of a retail sporting goods shop when the topic came up about possibly selling their business to outsiders.

We discussed what a competing store in the area might want to know if they were to become a prospective buyer.

They’d probably want information on:

  • Financials (revenues, profits, loans, etc.)
  • Staff
  • Location
  • Leases of their stores
  • Existing inventory

I pointed out that if the buyer was a “big box” retailer instead, the scenario could be different. When a large company wants to swallow up a small operation, there’s a David-and-Goliath situation.

Big box retailers will bring in an army of MBAs who do these deals monthly, while the small retailer may be involved in the one and only deal of an entire career. These sales happen all the time, many successfully for both parties, but it’s important for small business owners to watch out for the “gotchas” in selling their business.

Although the following list isn’t exhaustive, it may give you a feel for some of the items to address when considering selling your business.

Gotcha No. 1: The intermediary

The intermediary is the deal maker.

For example, business brokers and investment bankers often serve as the go-between with the seller and the buyer of a business. In some cases however, it is difficult to separate the intermediary from the buyer.

Consider private equity firms.

Private equity firms put together the deal, but they do so on behalf of a hedge fund, institutional investor or other capital source. Consider who the intermediary is beholden to, how it gets paid and where its loyalties lay.

If you hire an investment banker, you’ll want to know if the firm is working on your behalf to shop for the best deal in the market or is working for a major buyer who is looking to pluck small operations off at the lowest possible price.

Further, the terms of the agreement the seller has with the intermediary are crucial:

  • Is theirs an exclusive listing, and for how long?
  • Will that listing affect the seller’s ability to sell to others … perhaps internally?
  • Are there upfront costs, or is the agreement purely a revenue share?

Gotcha No. 2: The valuation

Valuation is a range, not a value. And until a check is written, valuation is a slippery concept.

Some buyers will start with an inflated initial offer price as a way to entice the business owner to sell. The actual sales price, however, could be lower because of flaws alleged to have been discovered during the due diligence phase.

Or, the sale price may be high, but the terms of the sale have so many hooks, such as earn-outs and non-competes, that the true economic value of the deal to the seller is much lower.

And, in some cases, a low sale price is the result of a war of attrition.

The sales process drags on for so long that the seller accepts a lower price simply because it feels like it’s too late to turn back. The lesson for sellers is to not just focus on the price but to also understand the terms and the process for obtaining that amount.

Gotcha No. 3: The sales process

Most business sales take a number of months to complete.

The initial offer may be put together quickly, but there is usually a due diligence phase where the buyer gets to check out the business and its financials.

During this period, sellers can be challenged by the amount of personal and staff time it takes to support the review. Because of this distraction, it is not uncommon for sales and profits to suffer. It’s important to avoid having this predictable downturn reflect negatively in the final price used in the sale.

Create a game plan to wall off the sales process from day-to-day operations.

Gotcha No. 4: Internal obligations

An all-too-commonly forgotten issue in a business sale is the disposition of the company’s benefits and retirement plans.

Both buyer and seller must recognize that a qualified retirement plan involves long-term legal commitments to employees. The parties must be aware of controlled group issues and exercise caution when structuring the transaction.

For example, they should consider whether there will be one or two plans after the sale.

Likewise, they must study other benefit plans. Some nonqualified deferred compensation plans allow executives to receive a payout upon a “change in control.” Is there liquidity for such a distribution, and could that clause trigger an exodus of key personnel?

Gotcha No. 5: Provisions in the agreement

Especially when Goliath is buying David, it’s important to consider the impact of contractual provisions.

For example, earn-outs are a perfectly acceptable way for a buyer to protect itself against an unexpected loss of customers.

The seller, however, needs to understand:

  • How the earn-out works
  • Who does the measuring
  • What affect this may have on net proceeds

Similarly, most states still permit limited non-compete clauses as a way for buyers to protect against unfair competition from the seller.

Again, though, the seller needs to understand how this may affect his or her career aspirations for the future. Will the seller have to change professions, perhaps move?

Gotcha No. 6: Taxes

I saved one of the biggest issues for last.

So often a business sale is done in the vacuum of purely legal and financial issues. The seller fails to consider the after-tax effect of one sale structure versus another.

For example, selling the business for its assets rather than its stock can radically alter the tax outcomes for both parties. Or, a lump-sum sale provides peace of mind to the seller but also increases the tax bill.

A technical but not insubstantial issue is how goodwill is characterized. When the top ordinary income tax bracket is nearly 40 percent, while the top capital gain rate is half of that … tax characterization matters. Taxes need to be a strategic part of the deal, not simply the result.

The sale of your business can be a well-deserved payday. Just don’t let the gotchas involved in the sales process wreck the outcome.


Tags:  Business Brokers  Business Sale  Business Sale Tax  Business Valuation  Due Diligence  Forbes  Mom and Pop  Principal Financial Group  Private Equity  Small Business Owners  Steve Parrish 

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What's Not Keeping The Fastest Growing Companies Awake At Night

Posted By Jason Trujillo, Woodbury Financial, Tuesday, October 21, 2014

What's Not Keeping The Fastest Growing Companies Awake At Night by Steve Parrish. Article originally appeared on on October 17, 2014. Click here to read original article.

I’m in Arizona this week at a meeting where 1,500 business owners and key employees have gathered to:

  •  Share best practices
  • Learn from each other
  • Hear from nationally recognized experts

 These are businesses that have made the prestigious Inc. 500/5000list.

 And what have I learned?

 It’s my third time at the Inc. 500/5000 annual meeting, but there is always so much insight from this  impressive group.

 A colleague and I presented on the financial issues that are keeping business owners awake at night (taxes, retirement planning, employee benefits, etc.). My big takeaway from the discussion was the long list of business issues that are NOT keeping them awake at night.

 These are issues that are being addressed, neutralized or even leveraged.

 Optimism for the overall business environment

 As always, there is a lot of enthusiasm and confidence among Inc. 500/5000 attendees.

 These are entrepreneurs with fast-growing companies.

 Pessimism and insecurity would simply not work for this crowd. That being said, this is the most upbeat I’ve ever seen Inc. 5000 business owners. They are reporting a positive consumer market, good liquidity and a manageable economic environment.

 The elephant in the room

 In past years, the Affordable Care Act (ACA) had been the proverbial elephant in the room. Some disguised their concerns through a political rant, some procrastinated by taking a “wait-and-see” approach, and many simply chose to ignore the law.

 Despite all the bravado, however, I sensed the ACA was keeping them awake at night.

 This year there seemed to be a refreshing turn. Companies have come to accept the reality of the ACA’s existence and have started learning and adapting. These businesses are almost universally building healthcare planning into their strategic and tactical business planning.

 Incorporating the new law has caused some growing pains. One retailer I met with can’t find anyone who wants to provide his successful company health insurance, and his business – by default – is relegated to the federal exchange market.

 But the owner is simply accepting the challenge as a normal part of doing business, and he’s doing what he can to mitigate its effect on the company’s plans.


 Business owners I talked with are receiving unsolicited sales offers with high multiples of earnings. The buyers appear to have available financing and liquidity.

 These are fast-growing companies, of course, and the multiples being offered are dependent on the industry they’re in. Still, compared with three years ago, the merger and acquisition market has heated up significantly.

 Interestingly, notwithstanding these high multiples, there doesn’t seem to be much of a mood among owners to take the money and run. Many want to grow their companies organically and eventually sell their business interests to their other partners or employees.


 Fast-growing companies always seem to have a unique marketing spin, but there are some themes I noticed that apply to a number of marketing strategies.

  •  Retailers who entered the market by selling online are often seeking to additionally sell their products through brick-and-mortar retailers. I talked with both a snack company and a skin care company that sell through the Internet but have started to also sell their products through name-brand retailers in malls. They report that this gives them some credibility to advertise on the Web. They promote that they also sell their products at, say, Bed Bath & Beyond, GNC, etc.
  • Retailers that traditionally sell through their own stores or dealerships are increasingly finding success in selling online. Imagine an RV company that reports excellent sales through Web purchases. A family researches the product online, even buys online, and then comes to the shop to pick up their camper as part of their vacation.
  • Similarly, manufactures and retailers of big-ticket items like specialty vehicles report success in selling used products through the Web. They buy back products they’ve manufactured or sold, post it on the Web and sell it to a new buyer. Consumers are accustomed to eBay-style purchases, and they find peace of mind in buying a used product through the website of the original manufacturer.

 Key employees

 It was particularly encouraging to see that employers want to address recruiting and retaining key employees.

 Business owners recognize that key people are mobile and attuned to pay and benefit issues. The “keep my head down and keep my job” mentality is history among employees.

 Even more encouraging is that many of these owners want to avoid the mistakes of the past, where the solution was to try to mollify the key employee with stock options or restricted stock. A number of business owners are interested in unique and exciting employee benefits (voluntary service days off, weight loss programs, flex time) and goal driven incentive plans.

 They’ve come to realize pay and bonuses work as rewards but not necessarily as retention tools. More than one owner I talked with plans on selling their business soon yet still wants to install long-term incentive plans for key employees.

 In the end, I can only guess what business issues do or don’t keep these successful business owners awake at night, but I did see a lot more willingness to recognize potential problems as opportunities for the future rather than impediments to growth. No wonder they’re among the fastest-growing companies in the country.


Tags:  Affordable Care Act  Business Best Practices  business concerns  Business Learning  business planning  business worries  employee benefits  fast growing companies  Forbes  Inc. 500/5000  National Business Experts  Principal Financial Group  retirement planning  Steve Parrish  taxes 

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Business Growth Mantra

Posted By Jason Trujillo, Woodbury Financial, Thursday, October 9, 2014

A Business Growth Mantra: Take Big Actions; Make Little Mistakes

by Steve Parrish

Originally posted at 10/06/2014. Click here for original article.

“My life expectancy is 24 years. My money expectancy is about 15 years.” This is the opening line a new retiree makes to a financial advisor. The discussion, and a number of other financial dialogues between consumers and advisors, is showcased in this series of videos designed to encourage people to take action on their financial goals.

This past summer in Chicago, people were offered free taxi cab rides with an advisor during which they could essentially lay out their financial concerns while being driven to their requested destination. These video vignettes remind me of the popular Discovery Channel program “Cash Cab,” but in this case the test is financial honesty and the reward is useful financial advice.

Take Action
The challenge is not so much finding good advice; it’s acting on the advice given. Think about the individual who said he has a longer life expectancy than money expectancy. If he had taken that cab ride 10, 15 or 20 years ago, would there be a better match up today with his money and life expectancy? I’m guessing that “back when,” whether the advisor recommended he invest in 60 percent equities and 40 percent fixed securities, or vice versa, the resulting difference wouldn’t be all that big of an issue. As long as the individual had actually saved the recommended amount of money, his portfolio would be in far better shape than it is today.

I refer to this as the financial law of “little mistake, big mistake.” A person should consider which financial strategies entail the potential for a little mistake and which have the risk of being a big mistake.

1. An advisor suggests that a parent buy a particular life insurance policy. It turns out that the suggested policy is more expensive than another product released a few months later. I suppose purchasing the policy qualifies as a little mistake. However, had the parent decided to wait to buy life insurance coverage at a later date—and in the meantime becomes uninsurable or passes away —now that’s a big mistake.
2. An individual has money available to invest in equities. She uses dollar cost averaging to spread her entry into the market over 12 monthly installments. If it turns out the stock market had huge growth during those months, it could be argued she made a mistake. Why? She would have received a higher return on her investment had she participated in the stock market all at once. In the scheme of things, however, that’s a minor error. In comparison, not investing at all during those months would be a bigger mistake.


Taking Action in Business
You might contend that the “little mistake, big mistake” approach won’t work in the context of growing one’s business. The very nature of growing a business involves taking risks. I would counter that yes, business involves taking risks, but it also involves minimizing mistakes. When a successful business owner assesses a business growth opportunity, there is a natural balancing of the investment risk and the reward potential. For example, when an entrepreneur considers which expenses in a project will be variable and which will be fixed, that entrepreneur is in effect asking, “How can I limit my downside exposure; if it doesn’t pan out, can I limit this venture to being a little mistake by making some costs variable instead of fixed?”
Similar assessments go into the process of deciding whether to grow a business organically or through acquisitions. There are pluses and minuses to all these decisions. The trick to the decision-making process, however, is to keep the mistakes little, and the growth big.

Tags:  business decision-making  business development  business exposure  Business growth  business mistakes  business planning  business risk  financial planning  financial strategies  Forbes  INC 5000  Principal Financial Group  Steve Parrish 

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