Plan For Success

Does your business have a written business plan?  If it does, when was the last time you or anyone else referred to it?  When was the last time it was updated?  Has your business, or the climate in which it operates, changed since the original business plan was conceived?  I have been in the practice of public accounting for over thirty years, and in all that time I can recall only a handful of clients who had written business plans.

The process of writing or updating a business plan will help you to identify and deal with issues facing your business; short term and long term budgeting, customers, suppliers, products, personnel, marketing, competition, technology, succession, and legal issues, just to name a few.  It will force you to think about your short and long- term goals and how you hope to achieve them, and provide a way to measure your progress in meeting these goals.

The elements of a traditional business plan are a business description, an analysis of markets and competition, and marketing, operating, and financial plans.  The business plan will help communicate goals and ideas to investors, lenders, and employees.  If your management team and employees will be responsible for implementing the plan, they should have input in its formulation.   In our consulting engagements, we often find that the best ideas come from employees, who before being interviewed by us, have never been asked to share their ideas.  Also, it is much easier to get buy in and accountability from someone who participates in planning rather than having the plan thrust upon them.  Although it is a topic for another day, we are currently assisting a professional service firm client prepare financial projections.  Rather than projecting revenue based on an arbitrary estimate of billable hours, we asked each of the firm’s professionals to give us their commitment for 2011.  Not only does this help us more accurately project firm revenue, it introduces individual accountability, and an element of competition and peer pressure, which in this case is expected to result in additional revenue for the firm.

The business plan should begin with a mission statement, which clarifies what is most important to you, explain why your business exists, what it hopes to achieve, and the principles and beliefs will you employ along the way.

The market analysis section of the business plan should identify your target customers and your competition.  What are the characteristics of the market for your product and how has it changed since your business was started?  Identification of the profile of your target customers and why they might purchase your product or service will allow you to efficiently focus your efforts.  In analyzing your competition, you should evaluate their strengths and weaknesses compared with your own.

The operating plan addresses the internal operational structure, including management, production, technology, facilities, and staffing.  The plan should outline management responsibilities, production methods, the use of technology, and staffing needs.  For example, is any new technology available that will allow you to reduce labor costs?  Can any production methods be improved, resulting in greater efficiency and profitability?  These are just a few of the issues to be addressed in the operating section of the plan.

Although the financial plan may be the most difficult section to prepare, it is also one of the most important and useful tools in running a business.  The plan should be five years, prepared on a monthly basis for the next year, and an annual basis for the following four years.   Accurate projection of revenue and expense will tell you how much profit you can expect to earn for the year, and monthly comparison of actual and projected results will help monitor your progress.  Also, if you are falling short of goals, your will know about it immediately, while you can still do something about it, rather than after year-end, when it is too late.  If your company lacks the internal expertise to prepare a financial plan, your outside CPA firm will certainly be glad to assist you with this most important task.

A thoughtfully written business plan will be a most useful tool in contributing to the success of your business.  The insight gained in preparing and writing the plan will provide benefits that go far beyond the effort expended.  Spend the time now and prepare a 2011 business plan; you will be glad you did.

Can S Corp Shareholder Wages Be Unreasonably Low?

In a recent US Tax Court case, the Internal Revenue Service successfully recharacterized dividend distributions from an S corporation to its sole shareholder, employee, and director as wages.  In the case of David E. Watson 2010-1 U.S.T.C. 50,444 (May27, 2010), the Court held that the corporation structured the individual's salary and dividend payments in an effort to avoid employment taxes, with full knowledge that dividends paid were actually remuneration for services performed.

In this case, Mr. Watson, who is a CPA, was the sole shareholder and employee of this CPA firm, which operated as an S corporation.  During the year 2002, he received salary of $24,000 and dividends of $203,651.  In 2003, Mr. Watson received the same $24,000 salary, but received $221,577 of dividend payments from the corporation.  In February 2007, the Internal Revenue Service assessed approximately $48,500 in tax, penalties, and interest for the years 2002 and 2003.

Over the years, I have seen many S corporation shareholders save payroll taxes by using the same technique as Mr. Watson, generally with no problem.  Although I have read and heard about various IRS initiatives to identify S corps that pay unreasonably low wages to their stockholders, I have not seen the issue raised.  Now I have the feeling that the Watson case is a sign of things to come.  Perhaps if Mr. Watson had not been so aggressive in taking only $24,000 annual salary, which he admitted was insufficient to cover his basic living expenses, this would not be an issue.  However, with all the talk about taxing the "rich" this is certainly an easy way to do it.  After all, the people affected by this program are business owners, not employees.  The rich are such an easy target!

There is also a tax proposal before Congress that make earnings of professional service S corporations subject to self employment tax.  Even if this law is not enacted, the Watson case shows how the IRS can accomplish the same result.

What does this mean to you, the S corporation shareholder?  Take a look at your compensation structure, and be sure that your compensation is reasonable.  If it is low, document the reason.  Do you work part time?  Is the business unprofitable?  Are you reinvesting the profits in the business?  How do the amount of dividend distributions compare to shareholder compensation?  Think about these things and talk to your tax advisor today.  Don't wait until the IRS contacts you.

Time for a State Tax Checkup

Facing declining revenues and increasing budget shortfalls, many states have found a new way to raise significant money; through enforcement of existing tax laws.   From residency audits of individuals to collection of sales, income and payroll taxes from out of state businesses, if you are not complying with state tax laws, you are flirting with disaster.

In recent years, New York State has collected billions of tax dollars from people who maintained a residence in New York but claimed to be a resident of another state (often Florida).  If you maintain a residence in New York and enter the state more than 182 days, you are a New York resident, and subject to all its tax laws.  Maintaining a residence can be owning or renting, and entering the state can be going to work; you do not have to spend the night or even visit the residence.  If you do spend the night, it automatically counts as two days, the first is the day you go to sleep and the second is the day you wake up.  If you have a house anywhere in New York State work in Manhattan every day, you are a New York resident who is subject to New York State income tax, because you maintain living quarters and enter the state more than 182 days during the year.

There is also bad news for New Jersey people who claim residency in another state - the New York State Tax Commissioner who did all this good work has just started working for Governor Christie, so get ready for a lot of residency audits.  Do you spend the winter in Florida and keep your house in New Jersey, but claim to be a Florida resident?  If you do, must keep records and documentation to prove where you are each and every day of the year.

As bad as it may be for individuals, the potential ramifications are much worse for business.  Let's say you have a business in New Jersey, and your customers are all located in the state.  Your business sells something, say household appliances.  One day you get a call from someone in New York City who wants to buy a washing machine.  You sell him the washing machine, deliver it to his location, remove the old washing machine, and install the new one.  And by the way, since you are a New Jersey company and not registered for New York tax, you don't bother collecting New York Sales Tax.  He is so happy to save 8.8% sales tax, he tells all his friends, and before you know it you are making deliveries every week.  You also forget to tell your CPA about the New York sales.  Several years go by, and you get a notice from New York.  What taxes are you liable for?  New York State and City income taxes, payroll taxes, and sales taxes, and if your business is a partnership or LLC taxed as a partnership, the partners are liable for New York nonresident personal income tax as well.

In these situations, sales tax is often the biggest problem, the one that may put you out of business.  Even though you did not collect sales tax, you are still responsible for remitting it for all taxable sales.  With the addition of penalties and interest, the liability can be staggering.

One more thing that often suprises business owners is use tax.  If you purchase a taxable goods or services and the seller does not collect sales tax, you are required to voluntarily remit the tax to the State.  If you are audited by the State and the auditor identifies purchases on which you should have paid sales tax but did not, you will be required to pay the tax, plus penalties and interest.  The fact that the seller should have collected  tax but did not will not relieve you of this liability.

The consequences of noncompliance with State tax laws can be devastating to a business.   Now is the time to conduct a review of your business operations to identify and deal with State tax compliance issues.