Business Owners
Becoming a successful entrepreneur has overtaken home ownership as defining the American Dream, thanks to the recent collapse of the real estate market and the made-for-Hollywood stories of folks like Steve Jobs or Mark Zuckerberg.
As you well know, fame is the least of the attractions in owning a business. More compelling to the tens of thousands of individuals starting a small business every year is the allure of being master of one’s own professional success.
But as exhilarating as it is be the Boss, there are also significant risks to going out on your own. Unfortunately, the failure rate of small business is high, with only 20 percent of new businesses surviving for five years. Another depressing statistic: fewer than 40 percent of solo self-employeds make more than $25,000 a year.
The old saying “No one plans to fail, but many fail to plan” has special applicability to the new business owner. Starting up can be deceptively simple: Facebook was launched with just an innovative idea, a laptop, and a dorm room. But from the very outset, business owners need to be aware that even the most basic business model entails considerable financial planning complexity. At the same time, this complexity creates opportunities to reap unique financial benefits.
What we do for Business Owners
Comprehensive financial planning for an individual or couple generally involves tax planning, risk management, investment planning, retirement planning and gift and estate planning. So, for each of these areas, let’s consider how business ownership takes this planning to another level.
- Tax Planning: The legal structure chosen for the business – sole proprietorship, partnership, limited liability company (LLC), or a corporation – will determine how the business profits are taxed. As a sole proprietor or single owner of an LLC, your business income is treated the same as your personal income, making tax compliance considerably simpler. Add partners or additional LLC members, and while again the business income flows through to the individual return, it is possible to split the taxable income (and losses) of the business in ways that can benefit multiple owners. S-corporation status can allow business owners to take some distributions of income without paying self-employment taxes, whereas C-corporation status entails separate taxation at the business level, at different rates from what the business owner pays on his personal return. To the extent that individuals and C-corporations have different marginal rates at different brackets of income, it is possible to coordinate the taxation of business and personal income in a way that provides the greatest benefit to both the business and its owner.
- Risk Management: Most individuals need to plan for the financial risk of early death, disability, illness and infirmity, and liability or loss related to property ownership. Once an individual owns a business, however, the risks multiply to include: interruption of the business due to a disaster; death or disability of a person key to the success of the business; loss of business property; and lawsuits resulting from negligence or defective products. This last risk can be addressed in part by the legal structure of the business, but the others require specialized insurance coverages over and beyond what the owner holds for himself and his family. If the business has employees, worker’s compensation in the event of a job-related injury becomes necessary as well.
- Retirement Planning: It’s not uncommon for business owners to assume they will never retire. After all, they’re presumably doing what they love, so why not continue indefinitely? Alternatively, they may see the business as the only retirement plan necessary – as a source of capital that will fund their retirement needs. Thinking along these lines is generally a mistake; if anything, a business owner may need more retirement planning rather than less, to prepare for the time when he no longer can or wishes to work, and/or the business cannot fully provide for his financial needs. The good news is that business ownership affords all sorts of tax-advantaged ways to save for retirement, and the ability to put aside amounts considerably larger than what is permissible to non-business owners.
- Investment Planning: Most small businesses are self-financed by their owners, which results in the business becoming the owner’s major or only investment. Even when the owner has extra capital to make other investments, he may still prefer to put his money back into his business, where he feels he has the most control over his returns. Prudent planning nevertheless must be focused on diversification. Asset classes and investments must be carefully selected for the owner’s personal portfolio to offset the concentrated risk he is taking with the business.
- Estate Planning: If a small business grows and becomes a valuable asset, simple wills or family trusts set up for personal affairs may no longer suffice for the transfer of the business. More sophisticated financial planning techniques will be necessary to ensure business continuity after death, reduce any estate taxes assessed for the business, and to provide liquidity to heirs to pay those taxes. A reorganization of the business might be advisable to create different types of ownership for family members, and to make full use of IRS-sanctioned discounts in valuing the business for purposes of gift and estate taxes. Insurance trusts and charitable trusts also can also play an important role in the efficient transfer of small business.
One point should be clear when it comes to financial planning for the small business owner: the do-it-yourself drive that helped you start your business will not serve you well when it comes to managing the many financial issues created by that business. This is where professional expertise often becomes necessary.
Exercise your privileges as Boss and delegate these issues to qualified tax and financial planning professionals. Their advice can make all the difference in improving your chances of business success.
*All videos were created by an independent third party. Demars Financial Group LLC, is not held liable for the content found in any video, does not offer tax advice or insurance planning. Insurance products are offered through Ted Demars and David Demars as independent agents.
