Make a List…
In order to create any type of plan, you first need to look at the end objective in mind, and then reverse engineer the result, until you have specific basic steps and key processes lined out.
For our purposes of goal setting and game planning, we want to look at what would it take for our business to last at least 3 generations.
- REVOCABLE TRUST: For the business to pass seamlessly (succession plan), in addition to tax shelter advantages, I would recommend the business owner consult with a business attorney that is familiar with estate planning strategies – to see if a revocable trust is going to be appropriate. There are numerous advantages to this type of planning, since the corporation/LLC would be owned by the trust, creating an additional layer of separation between yourself and the business (on paper – you still are able to operate and make changes to the function of the trust). This also has, as mentioned, tax shelter benefits as well, since the trust does not pay taxes in the same way. Something to also discuss with your tax professional when choosing the entity type you are using for your business.
- OWNERSHIP OF PHYSICAL PROPERTY AND FINANCIAL ASSETS: Keep in mind, that because the trust owns the business, and the business should own ALL of your physical property, such as real estate, vehicles, equipment, supplies, etc., the salary you pay to yourself is thus minimized to necessary living expenses. Effectively, the trust will be able to purchase anything that you require, so keeping “income” under a certain amount with current tax laws will therefore allow you to pay little to no income tax. The business will also own all the necessary bank accounts.
- Be sure to have a business valuation done preferably each year, so that you are fully aware of the cost factors which are being addressed in this goal setting and game planning process. You can’t do these things, if you don’t know how much they are worth.
- Your business will provide you “bonuses” in the form of Whole Life Insurance. Section 162 of the IRS tax code allows businesses to offer this incentive, which we will take advantage of, giving the business a profit margin reduction (lowering tax exposure), providing a tax write off, and the insurance policy will then be generating tax free cash value which you may borrow from for necessary expenses. This cash value does not show as income, so it is another tax-sheltered strategy.
Each of your business’ employees will also have Whole Life policies written on them, as “key person” Strategies.
These life insurance policies will be owned by the business entity, although the insured is the key employee.
There is a monetary value to each employee, and as such, the loss of key employees could create severe trouble for the business, not to mention the cost of coaching and training a new employee.
This policy covers the event of death to the employee, as well as providing yet another profit reduction per each employee.
As before, the cash value account is available to be used for the business, and because of this, it is much like taking money from one pocket and putting it into the other…
For newer businesses, due to cost factors, it may be necessary to begin with a term policy as opposed to a whole life policy.
This satisfies the financial burden to the business needing to pay the family of your key employee, but also the costs associated with bringing in a replacement employee – in the event of death, however it should be noted that the cash value benefits mentioned above will not be available to a term policy.
If this choice is the one that you decide to use for your business, then you should ensure that the term policy is not only with a reputable company, but is also convertible into a whole life policy later – when the company assets are more available, to take full advantage of the cash value benefits.
- Another “key person” strategy you will want to include is a disability policy on each employee, which is owned by the business entity. What this means is, if your key employee is either too injured to work, or develops an illness preventing them from being able to continue working, the business will have a strategy to not only allow their salary to continue – but also allow the business to hire a new employee to fill the vacancy left open by the disabled key employee. Note that there is not a cash value account with this policy, but it enables you to have it pay for their disability leave (rather than the business paying) while your business pays their replacement to work instead. This a nice incentive for employees to continue working loyally for your company, which in turn is going to foster better employee retention.
- Now this is a reminder to what we covered in the tips above: The business entity is paying for ALL these strategies, and if the entity formation is an S Corp, the business will also be writing them off under Section 162 of the IRS Code.
- Offering an FSA as well as an HSA to each employee will also create employee loyalty, as they are able to pretax some of their income into these respective accounts to pay for personal needs with tax free money. There are powerful incentives for employees to utilize these plans in coordination with working with a financial planner, so that they are able to best leverage all other financial strategies in place to benefit their family’s long-term financial success. Encouraging your employees to do this will also foster a lower level of financial stress among your workforce – which in turn is going to aid in employee retention and employee loyalty.
- Offering a Roth 401k is another good incentive for your employees, and either may or may not be matched by your company (depending on your financial situation). It incentivizes your employees to save for their future, which will create happier and less stressed employees. This means more productivity as well as loyalty.
- It is essential for all the prior tips to be effective, that you are reducing unnecessary expenses in your business. As you set this goal for the year, be specific about how you will reduce business costs — using more technology, reducing debt, or changing up your operations — in order to make it stick.
- CREATE A NEW PRODUCT: Creating a product is a critical decision stage, because having the wrong product in the wrong market area is in fact the number one cause for business failure. Be sure and do adequate market research to ensure that your current product(s) and any new ones you wish to bring to the table, are going to be appropriate for whom and where you are selling.
- NEVER SPEND OLD MONEY, ONLY SPEND THE NEW MONEY: Consider a business operating expense loan to cover production expenses, rather than trying to conduct business strictly from the bank account. By following the above strategies regarding reducing your profit numbers, the remaining profits should be invested rather than spent. The invested money will be drawing a higher percent than what the business operating expense loan is charging, so it is better to pay for the loan using dividends from the investment, than to just spend the profits with no returns gained. For example, if $50,000 profit is invested and drawing 7% interest, and a business loan of $50,000 is charging 3% interest, then your business will be netting 4% gains by having the profits invested, and is still able to function and scale up through the use of the business loan. This is like taking money from one pocket and putting it into the other pocket with friends!
This is a principle I call “Never spend old money – Only spend new money”. Your “old money” is what you invest.
It draws interest “new money” which covers the debt of a loan “new money”, which keeps the business running. Additional profits “old money” is reinvested to draw even more interest “new money”, which will cover more loans or section 162 WL policies as described above, which generate tax free cash “new money”, and so on…
The more you leverage, the more you have available to work with, which allows even more leveraging!
- NOW TAKE ACTION. It’s up to you.!
Please note that this article is not offering legal or tax advise, rather, is offering strategies which should be properly planned out with legal council, CPA for the tax strategies and proper entity formation, as well as working with your financial planner to implement these strategies correctly for your business. Our advisers are available to assist with getting this process put into place, and have the necessary legal and tax partners to take your business to the next level of success and longevity. Schedule your no obligation consult today at: http://cal.jsnow.us
