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Most business owners spend a lifetime building their business. And when it comes to succession, they face the difficult decision of whether to sell, dissolve or transfer the business to family members (or a nonfamily successor).

Many complicated issues are involved, including how to divvy up business interests, allocate value and tackle complex tax issues. Thus, as you put together your succession plan, include not only your financial and legal advisors, but also a qualified valuation professional.

Various value factors

When drafting a succession plan, a valuation expert can help you put a number on various factors that will affect your company’s value. Just a few examples include:

Projected cash flows. According to both the market and income valuation approaches, future earnings determine value. To the extent that a business experiences decreasing, or increasing, demand and rising (or falling) prices, expected cash flows will be affected. Historical financial statements may require adjustments to reflect changes in future expectations.

Perceived risk. Greater risk results in higher discount rates (under the income approach) and lower pricing multiples (under the market approach), which translates into lower values (and vice versa). When selecting comparables, the transaction date is an important selection criterion a valuator considers.

Expected growth. Greater expected revenue growth contributes to value. In addition, there’s a high correlation between revenue growth and earnings (and thus, cash flow) growth.

Other determinants of discounts

In many cases, valuation discounts are applied to a company’s value. For example, decreased liquidity translates into higher marketability discounts, while increased liquidity reduces marketability discounts. Other factors that affect the magnitude of valuation discounts include:

• Type of assets held,
• Financial performance of the underlying assets,
• Portfolio diversification,
• Leverage,
• Owner rights and restrictions,
• Distribution history, and
• Personal characteristics of the general partners or managing members.

Discounts vary significantly, but can reach (or exceed) 40% of the entity’s net asset value, depending on the specifics of the situation.

For best results

An accurate and timely value estimate can facilitate the succession process and prevent costly and time-consuming conflicts. Please contact Tom Vereecke for more information.

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Some business owners make major decisions by relying on gut instinct. But investments made on a “hunch” often fall short of management’s expectations.

In the broadest sense, you’re really trying to answer a simple question: If my company buys a given asset, will the asset’s benefits be greater than its cost? The good news is that there are ways — using financial metrics — to obtain an answer.

Accounting payback

Perhaps the most common and basic way to evaluate investment decisions is with a calculation called “accounting payback.” For example, a piece of equipment that costs $100,000 and generates an additional gross margin of $25,000 per year has an accounting payback period of four years ($100,000 divided by $25,000).

But this oversimplified metric ignores a key ingredient in the decision-making process: the time value of money. And accounting payback can be harder to calculate when cash flows vary over time.

Better metrics

Discounted cash flow metrics solve these shortcomings. These are often applied by business appraisers. But they can help you evaluate investment decisions as well. Examples include:

Net present value (NPV). This measures how much value a capital investment adds to the business. To estimate NPV, a financial expert forecasts how much cash inflow and outflow an asset will generate over time. Then he or she discounts each period’s expected net cash flows to its current market value, using the company’s cost of capital or a rate commensurate with the asset’s risk. In general, assets that generate an NPV greater than zero are worth pursuing.

Internal rate of return (IRR). Here an expert estimates a single rate of return that summarizes the investment opportunity. Most companies have a predetermined “hurdle rate” that an investment must exceed to justify pursuing it. Often the hurdle rate equals the company’s overall cost of capital — but not always.

A mathematical approach

Like most companies, yours probably has limited funds and can’t pursue every investment opportunity that comes along. Using metrics improves the chances that you’ll not only make the right decisions, but that other stakeholders will buy into the move. Please contact our firm for help crunching the numbers and managing the decision-making process.

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Reimbursing employees for education expenses can both strengthen the capabilities of your staff and help you retain them. In addition, you and your employees may be able to save valuable tax dollars. But you have to follow IRS rules. Here are a couple of options for maximizing tax savings.

A fringe benefit

Qualifying reimbursements and direct payments of job-related education costs are excludable from employees’ wages as working condition fringe benefits. This means employees don’t have to pay tax on them. Plus, you can deduct these costs as employee education expenses (as opposed to wages), and you don’t have to withhold income tax or withhold or pay payroll taxes on them.

To qualify as a working condition fringe benefit, the education expenses must be ones that employees would be allowed to deduct as a business expense if they’d paid them directly and weren’t reimbursed. Basically, this means the education must relate to the employees’ current occupations and not qualify them for new jobs. There’s no ceiling on the amount employees can receive tax-free as a working condition fringe benefit.

An educational assistance program

Another approach is to establish a formal educational assistance program. The program can cover both job-related and non-job-related education. Reimbursements can include costs such as:

• Undergraduate or graduate-level tuition,
• Fees,
• Books, and
• Equipment and supplies.

Reimbursement of materials employees can keep after the courses end (except for textbooks) aren’t eligible.

You can annually exclude from the employee’s income and deduct up to $5,250 (or an unlimited amount if the education is job related) of eligible education reimbursements as an employee benefit expense. And you don’t have to withhold income tax or withhold or pay payroll taxes on these reimbursements.

To pass muster with the IRS, such a program must avoid discrimination in favor of highly compensated employees, their spouses and their dependents, and it can’t provide more than 5% of its total annual benefits to shareholders, owners and their dependents. In addition, you must provide reasonable notice about the program to all eligible employees that outlines the type and amount of assistance available.

Train and retain

If your company has employees who want to take their professional skill sets to the next level, don’t let them go to a competitor to get there. By reimbursing education costs as a fringe benefit or setting up an educational assistance program, you can keep your staff well trained and evolving toward the future and save taxes, too. Please contact us for more details.

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If you run a business “on the side” and derive most of your income from another source (whether from another business you own, employment or investments), you may face a peculiar risk: Under certain circumstances, this on-the-side business might not be a business at all in the eyes of the IRS. It may be a hobby.

The hobby loss rules

Generally, a taxpayer can deduct losses from profit-motivated activities, either from other income in the same tax year or by carrying the loss back to a previous tax year or forward to a future tax year. But, to ensure these pursuits are really businesses — and not mere hobbies intended primarily to offset other income — the IRS enforces what are commonly referred to as the “hobby loss” rules.

If you haven’t earned a profit from your business in three out of five consecutive years, including the current year, you’ll bear the burden of proof to show that the enterprise isn’t merely a hobby. But if this profit test can be met, the burden falls on the IRS. In either case, the agency looks at factors such as the following to determine whether the activity is a business or a hobby:

• Do you carry on the activity in a business-like manner?
• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you (or your advisors) have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

Dangers of reclassification
If your enterprise is reclassified as a hobby, you can’t use a loss from the activity to offset other income. You may still write off certain expenses related to the hobby, but only to the extent of income the hobby generates. If you’re concerned about the hobby loss rules, we can help you evaluate your situation.

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Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

April 18

•  If a calendar-year C corporation, file a 2016 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004), and pay any tax due. If the return isn’t extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.

•  If a calendar-year C corporation, pay the first installment of 2017 estimated income taxes.

May 1

• Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), and pay any tax due. (See exception below.)

May 10

• Report income tax withholding and FICA taxes for first quarter 2017 (Form 941), if you deposited on time and in full all of the associated taxes due.

June 15

• If a calendar-year C corporation, pay the second installment of 2017 estimated income taxes.

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