It’s an old saying but one that may be wiser today than ever: “East is east, and west is west; and never the twain shall meet.”
Suppose you’re Jack and Judy West, co-owners of Everett’s East Widgets. If the East account balance is too low to fund a business expense, you might be tempted to pay from your West personal account.
What business owner hasn’t done this, especially start-ups?
More importantly, how can you prevent the headaches of doing it? And how can you untangle business and personal assets to transfer a business within the family?
Mixing personal and business finances may be tempting, but it’s a bad idea. It attracts IRS attention, confuses your tax consultant and often shields you from knowing how East Widgets is really faring. It can jeopardize applications for either business or personal loans, such as home mortgage modifications or home equity loans.
Start by using separate accounts: a business checking account or credit card for business expenses, and personal accounts or cards for personal expenses. It seems obvious, but avoid the temptation to deposit money from a personal loan into your business account. And deposit only checks written to your business into your business account.
Incorporate or document the business as separate from you, with its own legal existence, tax ID number, books and records.
Many banks offer multiple types of business checking accounts, even for start-up organizations. Use your Social Security number and the account could be titled in your name DBA (“doing business as”) your company name. The DBA structure, however, precludes the tax and limited liability benefits of structures such as incorporations, or various partnerships, including LLCs.
Pay your salary from the business account into your personal account, setting your salary according to what works best for your business type.
A typical family business comprises 65 to 90 percent of your estate and is subject to taxes. Given that, business succession plans and estate plans can help reduce those taxes — and insurance is vital.
Many businesses don’t implement succession plans, and many don’t survive as a result. A business succession plan outlines how a family-owned business will continue and is essential enough to merit the professional counsel and expertise of accountants, attorneys, bankers, business brokers, investment bankers and insurance experts.
Family-owned companies represent retirement savings for business owners, so owners must consider drawing funds from a business for retirement, typically through deferred compensation and consulting agreements or by selling the business. You can also use the business to minimize estate taxes.
Compensation is generally subject to ordinary income tax rates as high as 35 percent, far higher than the 15 percent rate on long-term gains from sale proceeds. How these tax issues play out depends on such factors as whether the business is an S-corporation, a C-corporation and/or an LLC. But reducing the value of a business will generally reduce the value of the business owner’s estate and therefore the taxes on it.
So if you’re Jack and Judy West, co-owners of East Widgets, each of you can give tax-free gifts, within limits, to your heirs, your heirs’ spouses and their children. This can remove significant value from an estate — and remember, the estate includes the value of East Widgets. If you wanted to sell East Widgets within your family, you can also reduce its value through discounts that compensate for lack of marketability, minority interest or lack of control; you can achieve this by dividing stock ownership.
You can also reduce the value of East Widgets through nonqualified deferred compensation to yourselves, leasing such assets as real estate or equipment (which increase productivity as well as operating expenses), indemnification fees, licensing and royalty fees (for intellectual property such as patents or copyrights), and Subchapter S dividends.
To keep your family-owned business in your family, develop a comprehensive business succession plan with professionals experienced in business transfer transactions.
As family-owned businesses begin to change hands in huge numbers with the retirement of baby boomer entrepreneurs, business succession planning has never been more important than now.
Eddy Roddy, CFP, is a private banking relationship manager at KeyBank; 360-527-4474, Eddy_Roddy@KeyBank.com.
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