Barbara’s Blog

About 70% of Boomer-owned businesses are expected to change hands within the next 10 or so years, according to a 2006 article by Robert Avery of Cornell University.

Many of these owners have adult children or other relatives who work for them, and the owners may be thinking of ways to transition to retirement without a huge tax bill.

If you want your successors to own your business while you enjoy capital gains treatment for disposing of your ownership interest, follow tax rules scrupulously. Your successors can end up with 100% ownership of your corporation, you get the payout you want, and it won’t cost your successors a penny.

Here’s how the transaction should be set up:

• Assume you own 100% of your corporation (it doesn’t matter whether it’s a C or S corporation) and you have two adult children who work for you. You want them to own the business so you can retire to a nice community in a better climate and enjoy the fruits of your labor. You give some stock to each child; the amount is up to you. There’s no income tax when you give shares to your children. For federal gift tax purposes, you can give up to $13,000 worth of stock in 2012 with no tax (or $26,000 if you are married and your spouse consents to the gift).
• Now the corporation redeems all of your stock. If the corporation has sufficient cash, it can pay you the full redemption price. If not, the corporation can give you an installment note and pay you off over a fixed period (say five or 10 years).

Legal results: Following the redemption, your children own 100% of the corporation. You are no longer involved in the company (other than as a creditor if you are paid in installments).

Tax results: The redemption is treated as if you’d sold your stock to the corporation; this “sale” is taxed at the favorable capital gain rate (15% in 2012). If the corporation pays you out over time, then you report your gain over the period of the installments (unless your tax picture favors opting out of installment reporting so that you pick up all of the gain in the year of the redemption). Your children are not treated as having received a dividend from the corporation, even though they now own the entire business without any personal cash outlay.

Traps: This favorable redemption rule does not apply if you retain any interest in the business other than as a creditor (i.e., one who is owed money from the corporation). Caution is advised if you want to remain as a consultant or a board member; in some situations these positions can be considered a retained interest that prevents favorable redemption treatment. Doing the arrangement incorrectly can mean:

• You’re taxed on the proceeds as dividend income (which may not be taxed favorably after 2012 if you’re considered a high income taxpayer).

• Your children may be burdened with dividend income as well.

Because of the need to follow tax rules exactly, it is wise to work with a knowledgeable tax advisor who can help you structure the arrangement. You can also review this arrangement in a private letter ruling.

As an employer, you have to pay federal unemployment tax (FUTA) in addition to your state unemployment tax. The federal tax is figured on the first $7,000 of wages for each employee. The FUTA tax rate is 6%. This rate is reduced by a tax credit for state unemployment insurance.

The credit rate for state unemployment insurance normally is 5.4%. However, if states borrowed money from the federal government to pay their unemployment claims and have failed to repay the money, then employers in those states (called “credit reduction states”) have a reduced credit.

Technically states have until November 10 to repay their loans, but as it stands now, employers in 26 states are looking at additional FUTA taxes.

Employers in Indiana and South Carolina could have a credit of only 4.5% (a credit reduction of 0.9%), resulting in $63 additional FUTA tax for each employee

Employers in Alabama, Arkansas, California, Connecticut, Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Virginia, and Wisconsin could have a credit of only 4.8% (a credit reduction of 0.6%), resulting in $42 additional FUTA tax for each employee

Employers in Arizona, Colorado, Delaware, Kansas, and Vermont could have a credit of only 5.1% (a credit reduction of 0.3%), resulting in $21 additional FUTA tax for each employee

On a per-employee basis, the additional tax isn’t much. But the principle of the higher tax is significant. You — the employer — are penalized because your state has not been able to manage its finances well enough to avoid borrowing or repaying loans on time. It is likely you are based in a state with a high unemployment rate. And there’s nothing you can do about it (other than relocating).

The Department of Labor determines which states are credit reduction states; the IRS posts these states and the amount of the credit reduction late in the year. For 2011, for example, there were 21 credit reduction states, with credit reductions ranging from 0.3% to 0.9%.

I’ll be on the lookout for the final tally of credit reduction states for 2012.

Futurist Alvin Toffler coined the term “information overload” in the 1970s when he predicted the explosion of information. Little did he know then how much information we’d really be dealing with because of email, the Internet, cable TV, Kindle, social media, and other technological changes that make information more accessible. Bloomberg Businessweek reports that the average person receives 63,000 words of new information every day.

Just a decade ago I’d receive three print newspapers every morning. Now I have literally dozens of online editions to scan each day.  A decade ago, I’d receive a few dozen emails every day; now it’s hundreds. Add to this all the social media sites that require monitoring and all the books I receive weekly from publishers. I now have a bad case of information overload.

Even worse than my own information overload is the recognition that my publications are part of information overload for others. I’m competing with an ever-growing sea of information for my target audience’s attention. What can I do to make sure that my articles, newsletters, books, and daily ideas get read?

One great site I found to help with this problem is Infoengineering. It helps to manage information overload with tips and articles on the subject.

Even better, it had tips and tools to improve the chances of my material being read. My favorite tips and tools are found here:

• Clarity Rating Calculator to assess the clarity of my own writing. Just drop in some text and receive immediate feedback.
• Tips for improving email, along with a signature builder.

The bottom line is that every person has to find his or her own solution for handling information overload. You can learn to read faster (I took a course and it helped a little), limit the time spent online (I have difficulty with this one), or find ways to cope (my solution).

We all applaud our Olympians who have done us proud. Their countless hours of hard work and personal sacrifice have paid off in their athletic achievement. Winners have been rewarded with fame (their names are in the record books) as well as medals and cash prizes from the U.S. Olympic Committee (e.g., $25,000 for a gold medalist). Under federal tax law, prizes and awards are fully taxable. Now there is a bill entitled the Olympian Tax Elimination Act in Congress (proposed by a Republican Senator and supported by the Democrat President) that would exempt the winnings from income tax. Is this the right thing to do?

Tax law by pet project
One of the reasons why the tax law is so complex is that it’s a patchwork of special rules to serve certain causes, special interests, and objectives. Let’s become energy independent (the objective), so let’s give tax credits for energy-related activities. Let’s help the housing market (the objective), so let’s create a first-time homebuyer credit. Let’s support NASCAR racing (the special interest) with a faster depreciation recovery period for motorsport racing track facilities. It seems that special interests with sufficient lobbying funds can effectively buy tax breaks in many cases.

Special tax breaks for small businesses
So my special interest is small business. What’s in it for me? All of the so-called incentives for small businesses, such as the health insurance tax credit for small employers, could be viewed as gimmicks. They appear to support small business. They appear to provide special help for the small business sector. And they do cut taxes for those who qualify. But the reality is that the small business tax breaks provide inadequate tax savings to incentivize action.

The health insurance credit, for example, does not underwrite the cost of providing health coverage for employees. I have not met one small business owner who took any health insurance action based on the credit. What’s more, in many cases, the paperwork and audit exposure for using various tax breaks is more costly than the tax savings. So special tax breaks for small businesses are rather illusory.

Tax-free treatment for small business winnings?
Would anyone suggest that profits earned by small businesses should be tax free? Don’t small business owners put in countless hours of hard work and personal sacrifice on behalf of their companies? There are no record books or medals for small business owners who succeed. And there is no tax-free treatment for small business winnings.

Bottom line
The tax law should be (or try to become) more neutral in its treatment of earnings of individuals. The tax law should not be picking winners. I admire the Olympic athletes, but I can’t support enactment of a new tax break for them.

How big is small business? Is entrepreneurship on the ascendency?

There is much conflicting information in the media. Here are some of the facts from or based on government sources:

All businesses in the U.S.

The Joint Committee on Taxation’s report on choice of entity found that the “vast majority” of businesses in the U.S. are sole proprietorships, with more than 22.6 million non-farm sole proprietorships in 2009 out of 33.6 million total business returns.

There were:

• 1.7 million C corporations (some of which are mega-public companies)
• 1.9 million farms
• 3.1 million partnerships (which includes limited liability companies)
• 4.1 million S corporations

The number of pass-through entities (businesses structured so that profits and losses are taxed on owners’ personal returns) has nearly tripled since 1987.

Startups

The SBA says that from 2007 to 2010, the rate of startups declined by 12%. In 2008, the startup rate fell below 3% in a quarter (compared with the previous quarter) for the first since tracking began in the 1990s. The latest startup rate for which data is available is 2.7% in the second quarter of 2011.

A Kauffman Foundation report found that new firms (less than five years old) were 35% of all companies in 2010 as compared with 49% in 1982.

States with the best business climates:

• Small Business & Entrepreneurship Council Report found that South Dakota, Nevada, Texas, Wyoming, and South Carolina were the top five locations.
• The Tax Foundation Report found that Wyoming, South Dakota, Nevada, Alaska, and Florida were the top five locations.

Bankruptcies

It appears that bankruptcy filings in federal court are on the wane. According to court statistics, there were 13% fewer filings for the 12-month period ending March 31, 2012, as compared with the previous 12-month period.

Comment on the numbers

Like a Georges Seurat painting, statistics create the broad picture of the state of business today. However, each little dot in the picture is a unique entity on which an owner has pinned his or her hopes, dreams, and financial resources.

Anecdotal stories that I hear from entrepreneurs around the country continue to show three main themes: strong desires to start a business, continued struggles to keep a company going, and, unfortunately, failures (folding a company, selling out, or going into bankruptcy).  There’s no single statistic that can capture the state of small business today.