What an owner of a corporation pays themselves in wages should be reasonable. Tax audit risk differs between the corporate taxes structures your corporation elects. S Corporations should have higher vs. lower tax compensation. For instance an S Corporation that pays an owner $25,000, with tax profits of $100,000 post officer salaries, has an unreasonable compensation audit risk. Why? Because compensation is subject to payroll tax, but distributions are not. Some tax advisors may suggest that an S corporation shareholder pay themselves the lowest salary possible, and distribute the major of earnings through the accumulated adjustment account (AAA). AAA is a tax term for taxed S-Corporation retained earnings that can be distributed without any additional taxes. In an audit, the IRS can reclassify AAA distributions to wages and assess appropriate payroll taxes. A costly audit adjustment, not to mention the penalties that can be involved. Here’s how.   Let’s say Ron owns 100% of 555 corporation stock, and 555 is an S-Corporation, and is the only employee. If 555 produces $150,000 of taxable earnings, net a $30,000 W-2 payment to Ron, the FICA tax combined with Ron and 555 will be $4,590. Let’s say Ron’s intrinsic value to the corporation is $85,000. This would result in $95,000 of taxable corporate earnings, net the $85,000 W-2. The additional $55,000 of taxable W-2 wages would result in $8,415 of additional FICA tax. So with a “managed” W-2, Ron can give himself a bonus of $8,000 a year. This is the IRS audit risk. Let’s say Ron follows this policy for 3 years, of paying himself only $30,000 on his W-2, and distributing the additional $55,000 as AAA distributions. If the IRS audits 555, he is subject to a $24,000+ FICA tax expense adjustment; plus penalties. What if Ron pays himself reasonable compensation…

Business valuation is a complex field with multiple aspects in the determination of a business interest’s value. Whether you’re selling a business, buying a business interest, involved in court actions or estate planning, or filing gift taxes, a business valuator can assist you in achieving a realistic and fair valuation.   There are two types of business valuations – a full valuation and calculation of value.   A full valuation begins when a client and valuation analyst determine the valuation approach with an engagement letter outlining the extent of the valuation with a full report according to the professional standards of the business valuations. For a CPA certified in business valuation this would be the standards set by the American Institute of Certified Public Accountants (AICPA). Individual appraisal organizations have their own set of professional standards. A full AICPA valuation includes an estimate in value according to Statements on Standards for Valuation Services No. 1 with a valuation methodology appropriate for the circumstances, prescribed by the valuator. Then the valuator publishes a conclusion of value report. A full valuation report could exceed 45 pages with defensible proofs for the value determination on the business.   A calculation of value is limited in scope and nature and does not include any methodology considerations beyond those agreed to between the valuator and client. So a calculation of value could overlook important characteristics in valuing your business accurately, such as the optimal methodology, or specific value progenitors, i.e. a strategic sale. With a calculation of value neither is a detailed value report prepared that provides more depth on valuation numerics. A calculation of value is performed with only an agreement between the valuator and client on the methodology and procedures to performed on the business interest; a calculation of the business value according to the…

As an employer, you understand the various responsibilities of hiring, retaining, and managing your workforce. The human resource responsibilities can require more time than many business owners should allocate. Professional employer organizations are co-employer organizations that perform the human resource function for businesses; an outsourcing of the human resource responsibility.   Professional employer organizations rules differ from state to state, but the commonality stays the same. There are more than 800 professional employer organizations in the United States, with more than two million employees participating.   With a professional employer organization your business has no responsibility for payroll filings, benefit packages, and tax reporting – 941’s or W-2’s. Professional employer organization gain economies of scale when shopping for benefits packages and can often obtain better rates than a small or mid-size employer. Professional employer organizations also keep your business in compliance with federal workplace legislation too.   Some states recognize professional employer organizations as co-employers, assuming the responsibilities for legal rights and duties of employees at the employees working location. These states also make your business responsible for any unpaid payroll taxes not funded to the IRS. So if you retain a professional employer organization, make sure you do your due diligence. Request their audited financial statement to assess the financial strength of the organization; and interview management to gain the level of trust necessary for a good outsourcing relationship.   Specifically, professional employer organizations handle only the human resource function – payroll, tax and workplace compliance, record keeping – the client company is still in charge of managing employee responsibilities, on-site supervision, and tools for employees, i.e. the employees are outsourced for human resource management only. Professional employees permit your business to have a professional human resources department even if you are only a small business. You will pay a premium on…

If you are thinking of selling your business, be proactive, and not myopic in planning that sale. Sell-side due diligence is a reverse due diligence where you retain accountants or third-party advisors to perform proactive due diligence on your business, gearing it up for sale. These due diligence experts scrutinize your business for deal breakers and increase value. Investing in sell-side due diligence most often pays off for every seller.   First, sell-side due diligence helps identify problems and provide an opportunity to resolve those problems well in advance of presenting your business to an acquirer. Let’s say for instance that you have multi-state tax nexus, requiring your business to file tax returns in various states from activities in those tax jurisdictions. If you have not filed taxes in various states you have nexus in these jurisdictions, this potential liability could reduce value. Sales tax liabilities could be another risk. Or, let’s say you have a warranty liability on a new product, sell-side due diligence will help you identify and resolve these potential problems well in advance of gearing-up your business for sale. If you don’t correct these value reducers before taking your business to market, you could potentially break a deal, or lose value at the negotiation table. Your sell-side due diligence team will create options to resolve these value reducers before they are brought to your attention from the buy-side due diligence team.   Secondly, what surprises do you need to avoid. How polished are your internal financials for the years that will be scrutinized? How meticulous is your accounting software? What operations risk does your business have, or personnel resource concentrations? Will your businesses greatest intangible, your experienced employees, stay if you sell the business? Do you need an accountant to fine tune your internal financials or…

Monitoring your financial statements should be a frequent practice for any entrepreneur. Financials show not only your businesses current financial coordinates, but its projected future. Working with your CFO or accountant/advisor to monitor financial progress can help you better plan for continued success in your enterprise.   Here a several key numbers a CFO or accountant/advisor look for when they review your financials.   Cash Flow. Healthy cash flow is imperative in any business. Cash flow stability or increases in cash indicate the business operations vibrancy. If you are always drawing on lines of credit to finance payroll or purchase inventory, understand you are taking risk on your balance sheet. Yet, positive cash flow must be balanced with other factors to properly assess a businesses financial health. Cash can increase simply from reduction in inventory, or collection on accounts receivables or increases in accounts payable or customer deposits.   Changes in liabilities. Significant increases in liabilities are future payments required from the business. The lower your liabilities, the healthier your balance sheet will be. Liabilities will increase with draws on lines of credit, loans to build to the business, or ballooning accounts payable. Customer deposits are also liabilities and require resources to fulfill the cash deposits already received. Simply, you want to know if liabilities are appropriately trending lower.   Analytics. Financial ratios are also helpful in assessing financial conditions. The current ratio of your business is simply current assets to current liabilities. This ratio measures the businesses ability to pay liabilities over the next year. The current ratio assesses the current solvency of the financials. For example if business has $800,000 of current assets and $400,000 of current liabilities, its current ratio is a healthy two.   Gross profit margins are vital to monitor in manufacturing or construction businesses….

Board of Directors and Board of Advisors   While every public company has a formal board of directors elected by the corporation’s shareholders, many private companies lack a formal board of directors governing organizational decision making. A board of director’s work for the company and shareholders overseeing the major strategic decisions, e.g. managing the CEO, approving major financings and acquisitions, and most importantly providing gravitas fiduciary management and furthering the best interests of shareholders.   If your business already has a board of directors you understand a board of director’s value, but if not, why should your company have a board of directors? Most closely held corporations shy from forming a formal board of directors because 1) they want sole control of management decisions 2) it makes decision making burdensome 3) it is an additional expense. These can be valid arguments, but should be weighted against the advantages.   A board of directors 1) establishes accountability to individual and collective shareholders 2) provides valuable balanced and objective advice and guidance to corporate management 3) is a hallmark of integral corporate management to customers, employees, and vendors.   Uncompromising fiduciary responsibility is integral to a board of directors. Fiduciary responsibility requires competent, unbiased, equitable decision signatures. Governing directors should be independent from the corporate organization. A group of directors should be small enough to manage, i.e. 5-10 members, but large enough to contain diversity that provides insight into management areas where internal resources have a short longitudinal knowledge ribbon, i.e. directors should have more than a depth of specific technical expertise; directors should comprise a diversity of talent and knowledge.   Yet, directors should all have something in common: the values of the organizational culture. Directors, with the CEO, set the corporate tone, and it is vital that they share common…

So you gained $25,000 in your investment portfolio? Do you know what your tax liability will be? Tax deferred and taxable investment accounts have different tax rates on investment gains. For instance, a taxable investment account (money you invest from discretionary income in a brokerage account such as Fidelity) will be taxed in the year the gain occurs. Let’s say you invest $20,000 of savings in a Fidelity account and double your money over the duration of years. In the sale year of the stocks, bonds or other securities, or as trades occur, the gains will be taxable at the current capital gain tax rates.  The gain is the difference between cost basis and sale price.     Taxable investment accounts   Capital gain tax rates vary from taxpayer to taxpayer, depending on the adjusted gross income at time of filing. Typically, this rate will be 15%.  Yet there are instances where the rate will be higher or lower. For tax payers in the 10% or 15% ordinary income tax bracket, capital gain rates will be zero. Sales of 1202 qualified small business stock, sales of collectibles (coins, art) are taxed at 28%, and portions of unrecaptured section 1250 property (rental real estate) will be taxed at 25%. Capital losses on sales of investments are limited to $3,000 per year to the extent they exceed capital gains. For taxpayers with adjusted gross incomes exceeding certain levels qualifying them for net investment income tax (NIIT), an additional 3.8% tax applies. If a tax payer is in the 39.6% tax bracket for years 2013 and later, a 20% capital gains tax rate applies.   If you earn $50,000 of W-2 wages, married filing jointly, and have $10,000 of capital gains on sale of stock, your tax on the capital gain will be…

Strategy and Plans   Count how often you ask why? That is strategy. Count how often you ask how, where, who, and when? That is planning. More than 50% of the Fortune 500 companies from the 1980’s have retired ticker symbols. Companies that invested thousands of hours with brilliant groups in elegant, in-depth planning were replaced by technologically innovative businesses. Empirically, plans with impeccable depth, logic, and financial sophistication are shown to reduce shareholder value. Let’s analyze the why.   Pro-forma financials, graphs, and in-depth detail on when, how, where, and who a business will sell its products or service, while not to be diminished, are most often uninspiring and mundane. For the majority, plans include reliance on others. If those you count on to implement your plan are not inspired and thrilled with understanding the why of your plan, your business may be like 60% to 75% of business mergers, a reduction in your business’s value instead of an increase after five years of implementation.   The business landscape is competitive and often plans rely on constants, e.g. inflation has been 4% over the past 30 years, oil has powered transportation for more than a century. These constants can change. You need to strategize.   Why is important, but strategy is more than questioning. Business strategy DNA is observing, evaluating, positioning, and acting. Observation Observe your business environment, your customers and clients preferences and purchases. Economics and innovation play a significant role in success of management and shareholder value. Observe the industry leaders. If you are an industry leader in your locale, you want to observe industry leaders in other market sectors. Often the best ideas are adapted from different industries to your specific market.   Evaluate Form an idea of the value and merit of adapting and modifying…

Welcome to Donald Sauder, CPA. A blog for entrepreneurs interested in understanding the multifarious tax and accounting matters pertinent to your business and related topics.