Monthly Archives: September 2012

S-Corps and Taxation Considerations

An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election (you must first incorporate the business and then make the IRS election via Form 2553).  Many new business owners often contact us asking if this is a good form to conduct business under.  While there are advantages to operating as an S Corp, there are some things that one should consider prior to making the election.  Depending on your goals, one may find that it’s better to operate under another organizational structure.

Ownership Restrictions

Per IRS guidelines, S Corp owners (shareholders) must first meet the following criteria:

  • Number 100 or less
  • Must be US citizens/residents (cannot be non-resident aliens)
  • Cannot be C Corporations (C Corp), other S Corps, limited liability companies (LLCs), partnerships or certain trusts
  • Any shareholder who works for the company must pay him or herself “reasonable compensation.” Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages”

Benefits

Many small business owners elect S Corp status for two main reasons:

  • Avoid double taxation on distributions
  • Allow corporate losses to flow through to its owners (however there are 3 loss limitations discussed later)

Other typical advantages include:

  • Limited liability protection. Owners are not typically responsible for business debts and liabilities.
  • Easy transfer of ownership. Ownership is easily transferable through the sale of stock.
  • Unlimited life. When a corporation’s owner incurs a disabling illness or dies, the corporation does not cease to exist.

Pass Through Taxation

What makes the S Corp different from C Corp is that profits and losses pass through to your personal tax return. Consequently, the business is not taxed itself, only the shareholders are taxed.  The amount which is taxed is determined by the shareholders basis (i.e. their interest in the business).  What is unique about S Corp basis is that it fluctuates depending on several things including the company’s operational performance.

Additionally, since the tax liability lies with the shareholder and not the corporation, individuals have to make sure that they receive enough money from the corporation in the form of distributions in order to satisfy their tax obligation.  Non dividend distributions aren’t taxable to the extent the shareholder has adequate basis.

Importance of Basis

It is important that a shareholder know their stock AND debt basis at all times. As such, it is imperative that it be calculated every year.  If the corporation allocates a loss or deduction to the shareholder, in order to claim it the shareholder needs to demonstrate that they have enough stock or debt basis.  For example, if a person invests $10,000 in a company (i.e. stock basis) and the company then passes through a $18,000 loss to them in a single year, only $10,000 will be deductible in that year.  The remaining $8,000 becomes “suspended” until the shareholder has adequate basis in the future.

Loss Limitations

As mentioned above, losses are limited to the extent that an owner has basis.  However, there are in fact three limitations which could cause a loss to be nondeductible at any given time.  Each limitation must be met in the following order before a shareholder is allowed to claim a flow through loss:

  • Stock and Debt Basis Limitations
  • At Risk Limitations
  • Passive Activity Limitations

Calculating Stock Basis

A good way to think of stock basis is in terms of a checking account.  Basis essentially equals deposits and earnings less any withdrawals made.  Furthermore, similar to a bank account (with no overdraft protection) basis cannot go negative – that is more cannot come out than goes in.

  • Initial basis typically starts with the money a shareholder paid for the S Corp shares, property contributed to the corporation, carryover basis if gifted stock, stepped-up basis if inherited stock or basis of C Corp stock at the time the C Corp converts to an S Corp.
  • Subsequent basis is made via adjustments which are typically recorded at the end of the corporations tax year.  First they are increased by income items, then decreased by distributions and lastly decreased by deduction and loss items.  The order is important because if basis is positive before distributions but would be negative if all deduction items were subtracted (however, again, basis cannot be negative) then the excess loss would be suspended rather than the excess distribution being taxable.

Other Important Considerations

  • Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended loss or deduction items in excess of stock and/or debt basis are carried forward indefinitely until basis is increased in subsequent years or the shareholder disposes of their stock.
  • In determining current year allowable losses, current year loss and deduction items are combined with the suspended loss and deduction items carried over from the prior year, though the current year and suspended items should be separately stated on the Form 1040 Schedule E or other appropriate schedule on the return.
  • If the current year has different types of loss and deduction items, which exceed stock and/or debt basis, the allowable loss and deduction items must be allocated pro rata based on the size of the particular loss and deduction items.
  • If a shareholder sells their stock, suspended losses due to basis limitations are lost. Any gain on the sale of the stock does not increase the shareholder’s stock basis. A stock basis computation should be reviewed in the year stock is sold or disposed of.
  • A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder’s personal return. Stock held for longer than one year is a long-term capital gain (LTCG).

5 Ways To Grow Your Business

Market Share, or how much of the pie is coming through your door, is one thing that all businesses try to track.  If you listen to the big guys, they’re always tracking if share is up, if it’s down and just how they can go and get more of it.  Yet when the economy is down, many business folks and entrepreneurs alike will throw their hands up and say that “oh well, there’s nothing we can do to grow right now.”

Down markets present a host of opportunities for the savvy and innovative business person to grow their business.  Listed below are five ways that you can increase your share of the pie when times are tough.

Examine/Exploit Your Competitors Weaknesses.    When times are hard, companies will look to ease the bleeding so to speak.  This might mean reduced advertising, hiring and marketing.  If you look at where your competitors are failing and step in with better services or products, you might just see an increase in customers.  For example, when Restaurant A had to stop offering free fries with their meals, Restaurant B took it as an opportunity to market that their combos “still” had free fries.  The result? A few new customers during the lunch hour that use to frequent their competitor.

Get The Word Out.  While marketing/sales professionals tend to live the good life when the economy is up, their budgets are often the first to be slashed when times head south.  However, nothing happens in an organization until a sale is made and sales don’t happen without marketing.  Thus when times are down, if you still have adequate cash flow, don’t cut your marketing but instead continue spending on “smart” marketing.  What this means is that if you can highlight something you do that your competitors don’t – go for it!  What you don’t want to do is spend money where it won’t make a difference.  So, if for example you’re a landscaping company in Chicago, it probably doesn’t make sense to do a major ad campaign in December when it won’t lift your sales all that much (unless you offer snow removal of course).

Expand Product Offerings.  Expanding by leaps and bounds is never advisable when the market is tough.  However, businesses should be encouraged to look for add on, tuck in and complimentary products to help them grow.  We’re not talking about adding on a major product line, but something that enhances what you already do.  For example, a hot dog stand already attracts people who are looking for an inexpensive yet fast meal.  Why not keep a case or two of “veggie” or vegan brats in stock?  Many vegetarians don’t frequent this type of establishment alone but may wind up there when a friend or coworker does.  If they can make a purchase from you, why not make the sale?  It doesn’t cost you a ton to add the product, and you don’t even have to keep loads of inventory as the demand is probably pretty low.

Purchase A Failing Business. If you have deep pockets, a down economy is a good time to look for struggling competitors and help put them out of their misery.  The only word of caution is make sure you do a thorough analysis of their business (i.e. due diligence) before you do the deal.  Remember, there is a reason the business is struggling – just make sure that it’s something that you can fix or you will simply purchase a headache instead of increased profits.

Increase Volume.  Playing the price card (i.e. reducing prices) is one of the last things recommend when times get tough.  Not only do you lose money on the top end (e.g. sales) but you tend to lose it on the bottom line as well because of the inflexibility of certain fixed cost.  However, if you have a streamlined operation that has solid margins (think > 50%) then you could go for a volume play.  For example, if you can slightly reduce prices and keep yourself profitable, you may see an uptick in customers (volume).  If the profit generated by the volume increase outweighs the money you lost when you reduced prices, then it’s a smart move.  The goal would be to do this long enough where you increase your customer base and then gradually increase prices once the economy improves.  The end result would then be a bigger market share and increased revenue/profits when compared to your competitors.

The Power of Thought

Well, today there is a lot of controversy swirling in the media over some comments that presidential candidate and former Massachusetts Governor Mitt Romney made at a fundraising event.  In short, Mr. Romney said the following about those voters whom polls indicate will instead vote for President Barack Obama:

“There are 47 percent who are with him, who are dependent upon government, who believe that they are victims, who believe that government has a responsibility to care for them, who believe that they are entitled to health care, to food, to housing, to you name it.”

He then goes on to state that his role “is not to worry about those people. I’ll never convince them they should take personal responsibility and care for their lives.”

Now, we will not get into the details of politics in this post as that is personal opinion and everyone is entitled to their own viewpoint.  However, there is one thing that is clear in the last statement, the belief that you can influence change in your life.

At some time or another, each of us fall susceptible to the thinking that there is nothing we can do regarding a particular situation.  “I’ll never be smarter. I’ll never be a climber. I’ll never lose weight. I’ll never finish college. I’ll never be any good.”  Statements like the foregoing are views that we have of ourselves, however, they are not fact until we make them so.  Thus, here is the question at hand; how powerful is thought and can you think yourself into another situation?

Outlined below are six steps that we believe allow one to go from thought to change over the course of time.

Changed Thinking Transforms Your Beliefs.  Beliefs are nothing more than the perception one has of something based on past or historical experiences/information.  For most Americans, we believed that a fellow named Santa Claus brought us presents and cookies on Christmas for some time of our lives.  Then one day that changed.  Why?  Did the facts of receiving presents and cookies change? Nope, your thinking surrounding how they got there did.  This changed thinking then caused you to alter your beliefs and you no longer believed in Santa Claus.  With that said, thinking can yield changes in all your beliefs.  Being creative is when you think about your thinking, being innovative is when you begin to act on your ideas.

Altered Beliefs Modify Your Expectations.  What you believe in guides what you expect in life.  For the most part, all of us can take a look at a task or challenge and know whether or not we can succeed at it.  Thus, in belief lies power; the power to give us clear vision, outline our opportunities and make our visions reality.  In essence, our beliefs control just about everything we do in life.  If we believe we will fail, we often don’t begin the journey of attempting a feat and thus the result of failing materializes.  However, if we believe we can, while it is true that we may ultimately fail, we also move that much closer to ultimately succeeding.

Modified Expectations Give Way to A New Attitude.  “Blessed is the one who expects nothing, for he shall receive it” – Benjamin Franklin.  We’ll finish our analysis by looking at the story of a minister named Frank W. Gunsaulus who lived in the late 1800’s.  While going through college he observed many defects in the educational system, defects which he believed could be corrected if he were the head of a college.  He didn’t have the large sum of money necessary to start a school and could not make any real progress in attaining it for almost two years.  However, he set his mind on attempting to make a difference which impacted his belief and attitude that he would eventually find a way to open a college.

A New Attitude Transforms Your Behavior. One day while in his room thinking of ways to raise the money to carry out his plans, it dawned on Mr. Gunsaulus that he had done nothing but think. He finally resolved that the time had come to take action.  He still didn’t have a clear plan on just how he would raise the money, but he did do one thing, he called a newspaper and announced he would preach a sermon the following morning, entitled “What I would do if I had a million dollars.”  Had it not been for his “new” attitude, Mr. Gunsaulus probably would have forever been locked in thought.  William James was right when he said, “That which holds our attention determines our action.”

Transformed Behavior Revises Your Performance.  By spurring himself to action, Mr. Gunsaulus preached a sermon to a well attended church with all the heart and soul that he could muster.  He shared what he would do with a million dollars.  He described his plans for organizing a great educational institution where young people would learn to do practical things, and at the same time develop their minds.  Mr. Gunsaulus could have never gotten on that pulpit; many of us would rather stay in a routine than make changes.  Even when we know that the changes are going to be better for us, we often don’t make them because we feel uncomfortable or awkward about making that kind of a change.  However, Mr. Gunsaulus did give that sermon and the results were quite astounding.

Revised Performance Changes Your Life.  When Gunsaulus finished and sat down, a man arose from his seat and made his way toward the pulpit. He approached Mr. Gunsaulus with an extended hand and said, “Reverend, I liked your sermon. I believe you can do everything you said you would, if you had a million dollars. My name is Phillip D. Armour.”  Gunsaulus would eventually get the money he sought and became the first president of the Armour Institute of Technology (now IIT).  The performance that Gunsaulus exhibited in the end changed his reality, yet it all began with his thinking and beliefs.

While thinking yourself to a different place in life is not easy, instantaneous or at times even pleasurable, it is something that can be done.  The reality is that change makes a person feel alone, even if others are going through it. Yet it is easier to turn a failure into success than an excuse into a possibility.   A person can fail and turn around and understand their failure and then make it a success.  However, a person who makes excuses for everything may never truly succeed.  With that said, if you are thinking of doing something different in life, take the first step and think your way to a new place.  We’re confident you’ll be happy with the results!

The Benefits Of Mutual Funds

Mutual fund ownership by U.S. households has grown appreciably over the past three decades. Forty-four percent of all U.S. households owned mutual funds in 2011.  In 1980, this same figure was less than 6 percent.   Furthermore, approximately 89 percent of total mutual fund assets were owned by these same estimated 90 million individual investors.  So just what is it about mutual funds that make them such an attractive investment option?

Diversification.  Mutual funds invest in a broad spectrum of securities and debt instruments.  Thus, an investor can potentially limit their investment risk by reducing the effect of a decline in any single security.  For example, if you own 100 shares of XYZ stock and it all tanks, you lose your shirt.  However, if you own 100 shares of ABC mutual fund which is comprised of 5% XYZ stock, when the stock declines, your portfolio won’t feel the full brunt of it.  Another benefit of diversification is that one can gain ownership to more companies and industries with a lower overall purchase price when compared to purchasing outright individual shares.

Professional Management.  Most investors don’t have the time or wherewithal to perform the necessary research and continual analysis required to protect their investment.  By pooling the money of many investors, mutual funds are a way to receive full-time professional management that few investors would be able to otherwise afford.  These “fund managers” have teams of analyst and researchers who routinely update them and provide recommendations as to how the fund can achieve its goals.  Thus, by investing in mutual funds you can rest assured that someone is continually monitoring you investments performance and making the necessary adjustments when warranted.

Liquidity.  Buying and selling shares in a mutual fund is just as easy as it is to purchase shares of an individual stock.  Most people can either invest or divest of their holdings within the same business day.  This makes this vehicle extremely attractive for those who may need “relatively” quick access to their funds.

Convenience and Simplicity.  Instead of having to track down and purchase each individual share, you only have to keep track of one; that of the mutual fund itself.  Additionally, you will still receive the benefits of owning a diversified portfolio and a wide range of services including:

  • The ability to purchase or sale your shares via mail, telephone or internet
  • Minimal investment floors; allowing you to invest with as little as $50-$100 per month
  • The ability to schedule automatic investments/transfers into or out of the fund via your bank account