Ever wondered how to reduce the amount of taxes you need to pay when selling your business? Or if it’s possible to eliminate taxes altogether? Here’s the guy who shows who how to do it. Dr. Bart Basi is the nation’s leading tax attorney and one of its best estate planning experts. He talks about ways to reduce your tax liabilities that no one else can touch, detailing how this depends on which state you are in and what kind of company you have. Dr. Basi also explains the best approach when coming up with succession plans, the role of brokers in this undertaking, as well as the right way to deal with double taxations. Listen. Take notes. Save thousands. Or millions.
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Get Uncle Sam Off Your Back When Selling Your Business With Dr. Bart Basi
How To Reduce, Even Eliminate, Your Tax Hit
We’re talking about getting deals done for folks looking to buy and sell outstanding businesses. After working with entrepreneurs and business owners all these years, one thing I’ve noticed is how many of them don’t have a good sense of the numbers when we’re talking about selling their business and what their walkaway numbers might be. Their accountants often give them general advice and thoughts about what the tax hit could be if they sell and take the profits.
Until someone like me gives them a real evaluation and estimates of what the sale price of the business might be, and then they take that to their accountant, what you get is that ‘Oh my God’ moment. That moment is not only terrible for these business owners who think, “I can’t afford to sell my business,” but it’s also a lousy moment for me, the business broker, who’s now getting told, “Sorry. We can’t sell your business right now.” It’s important to know how long-term capital gains and other tax issues will shape your plans for the future.
We thought, what better way to take a deep dive than with one of the best tax and legal minds in the country? Dr. Bart Basi is amazing. He’s a national speaker at dozens of conferences and events over the years simply because he is so good at it. He’s both a CPA and a tax attorney. He has a Bachelor’s and an MBA from Syracuse University. He took his Law degree from the University of Louisville, then a Doctorate in Economics and Accounting from Indiana University, and topped that off with post-graduate work at Stanford. He’s the author of five books and has won many awards over the years. He writes The Tax Report, which is a publication about tax and estate issues.
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He’s the Founder of The Center for Financial, Legal & Tax Planning in Illinois. You can go to his website at TaxPlanning.com and check them out. He talks to us about ways to reduce or even eliminate your taxes to Uncle Sam. He also tells us things you don’t hear anywhere else about new ways to sidestep taxes altogether, which is amazing. He also gets into structured installment sales, a great way to reduce and even eliminate the amounts you’ll pay to Uncle Sam, which is extremely relevant to a lot of business owners. Anyone who’s looking to sell in the next few years and doesn’t want to get killed on taxes needs to learn from Dr. Bart Basi. I hope you enjoy it.
Bart, I’m glad to have you here. I appreciate you taking the time. As a business broker, this topic is so important and it’s not understood even by some of your fellow accountants. They’re not able to keep up on a day-to-day basis as to what’s going on with tax law, tax changes and how to serve their clients best. We’ll get into some of that. Thanks for coming. I appreciate it.
My pleasure. I’m glad to be here and glad to help you and some of your readers.
We should start with a quick overview of how taxes work for the typical business seller and the owner who’s been working at this for years. I built my construction company from scratch. Let’s say I built it 25 years ago and I’ve got a buyer who’s offering me $1 million to buy my business. I’ve got eight employees, equipment and vehicles. My wife works part-time in the business in the accounting and bookkeeping function. Can you give us a little bit on the basics of how the IRS and the state will tax my business when that guy gives me $1 million?
When the buyer gives the seller $1 million, if the money goes directly to the seller, that creates one problem. If it goes through the business, that creates another problem. The method of operation or the entity structure is critical. In some cases, some of these people have never even incorporated. You mentioned a construction company. I spoke with an owner of a construction company in the State of Illinois and he likes his accountant so much. He’s selling his business and he’s retiring. It’s similar to your situation here, although his wife does not work in the business. Would you believe he’s never incorporated?
He’s got a $10 million to $12 million business, not just $1 million, and everything is on his personal income tax return, including all the real estate that he personally owns. He’s going to pay 40% type of taxes and when you include the state taxes depending on the state. He’s in Illinois. If you’re in California, it’s a totally different situation. By the way, I don’t know if you’re aware, but some states have no state tax. Tennessee’s legislature voted to eliminate their state income tax.
West Virginia is going to be doing the same thing soon.
It’s an overtime period with West Virginia. It’s amazing what’s going on in this country. To answer your question, it depends on how the structure is legally written. In Connecticut, a gentleman sold his business. He sued and went to court because he had to pay all these taxes. The judge says, “I know what you wanted to do. I understand what your intention was, but the legal documents do not say that. Therefore, you have to pay taxes because your thoughts and your objectives were not properly drafted in the legal documents. The legal document is drafted properly, but not from a tax standpoint.” To answer your question, it depends on how the company is structured, how the payment of $1 million is made, the entity itself, and the way in which the legal documents are drafted.
One of the 30,000-foot level pieces of advice I give to my clients when they ask the question, “How is this going to be taxed for me?” I typically tell them that you can guarantee that Uncle Sam wants some money if you put dollars in your pocket. If you defer that or you somehow don’t put dollars in your pocket, then they’re not going to ask for money right off the bat. Is that a fair statement, do you think?
To a great extent. One of the first things my firm does whenever we get involved with a client is we do what’s called a tax minimization analysis. We look at different scenarios like selling your stock, selling your assets, whether it’s a C corporation, Subchapter S, partnership, or incorporated. We take a view to say, “If this is the way the deal is structured, the deferred tax is your after-tax cash.” You mentioned deferral. Yes, there are some tax laws that you can defer taxes. There are also a couple of tax laws where no Federal taxes have to be paid at all.
Having said that, we also have to deal with state taxes, and the state revenue departments are looking at things totally different from the Federal Internal Revenue Service. Depending upon the state that you live in, where the business is located, it makes a big difference. I’m going to give you one quick example. A gentleman in North Carolina is selling his company and the buyers want to buy assets in that stock because they’re concerned about potential liability issues. Long story short, he has moved to the State of Florida. By moving to the State of Florida before he sells the company, the money he receives will escape all state income tax. We have this happening a lot. In California, they move over to a state that has no taxes. Nevada is a big state that we work with a lot in. A large publicly-held corporation moved its headquarters from California to Texas because Texas has no state income tax. Be aware that state income tax is totally a different approach than Federal income tax is.
I get a lot of clients who come to me and they’ve done their Google searches and they’re trying to educate themselves. They will tell me, “From what I read, there are three categories of capital gains rates. You can be either 0% or 15% or 20%. When that guy gives me $1 million for my business, should I plan on having to pay Uncle Sam 20% as a capital gain?”
While you’re correct, you’re not correct. Depending upon the income reported and the personal income tax return to the seller, the tax rate can be 18.8%, not 15%, and it can be 23.8%, not 20% because there is a 3.8% Medicare tax that’s added on top of all revenue generated from investments. If the income reported on the tax return, whether a single head of household, married, joint family and so forth, reaches a certain level, that level is not much. For married couples, it’s like $250,000 to $300,000. We’re not talking much. When you talk about 10%, 15% or 20%, be aware it could be 18.8% or 23.8%. In some cases, it’s even higher than that. That’s only Federal taxes that you and I are talking about.
On the state level, what does that picture look like? Take California, for instance. A lot of my clients are in California.
California has a high-income tax rate and it does not recognize capital gains. They’re taxed as regular income. In one large company in Southern California that we handled, in order to smooth out and lower the taxes, the buyer agreed to take over the company under a management agreement and pay a fee to the seller over a period of years so that the state taxes would be lowered and smooth it out instead of being hit all at once. There are several different ways and that worked extremely well. We’ve used that concept in other situations.
That’s a great one to know. Walk me through that scenario. It’s the same example. I’m a construction guy. If I don’t have a general manager, a family member or anyone I can hand the business to and an investor comes along and says, “I’ll buy your business,” what does that look like? I talked to this potential buyer as not buying my business, but what does that look like for him?
Let me explain. You got to be careful and I apologize. Terminology is extremely critical to me and it’s critical when you get into a court of law. You used the word investor. When these investors come in to buy companies, they usually do not want to run it on a day-to-day basis. The buyer has to have a good operating structure and people in place for investors to be interested in paying premium dollars for it. That’s important. Management agreements may or may not work in that case. They may if the internal operating structure is properly drafted prior to the sale because then they can use that as a management structure and operate it for 5 years, 7 years, 10 years or whatever the case may be. The seller can get a steady stream of income.
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Let me give you an example of how this works in one case when it wasn’t an investor. It was someone who knew the business. The person said, “I know the business and I know the operation so I’ll make sure I have my people in place.” They took over as a management company. What they’re doing is their fee for managing it is they will keep all the profits of the company. However, they will pay the owners a fee of let’s say $50,000, you can add as many zeros as you want, on a quarterly basis to the owners, which by the way, is then tax-deductible to the company. At the end of the year, the company shows no profit because the profit is transferred to the managers’ third-party company.
The people who own it, their accountant continues to file their tax return. They pay no income taxes because on their tax return for their company, it shows no profit, doesn’t it? In that particular case, over a ten-year time period, for a nominal amount, that entire company will be transferred to the management company. In the meantime, the management company is buying equipment to run the company and they get a full 100% deduction every year they buy the equipment. That will give you an example of how we use those management agreements.
Let’s review that. Under that scenario, the outgoing seller, the man who wanted to sell his business is taking income year after year, but at such a level that he’s not going to incur the same level of taxation that he would have if he took it as a lump sum. In that scenario, what does the change of ownership look like? Is that a change of ownership or is the outgoing seller retains ownership? What does that look like?
The outgoing seller retains ownership and the management company comes in. My company might be let’s say, Bart’s Construction Company. You come in and operate it. We say, “Ken’s Construction Company operating as Bart’s Construction Company.” We have both names there so that the people know. Gradually, you’re creating your own goodwill so that when the actual transfer has taken place in 5, 7, 10 or 12 years, it’s a smooth and seamless transaction. That’s not the only way of doing it. There are other ways of doing it. This is something that I ask all the time. When I get involved in a job, I sit down with the seller and we ask them, “What are you going to do with the money?” There are a couple of laws that affect them. Have you heard of the term Opportunity Zones?
That term has been extended in time periods so that if people want to sell their business and they can invest in an Opportunity Zone, there’s a possibility that they not only defer taxes but profits can be completely eliminated depending upon the time period involved. It’s a technical array. Opportunity Zones are something your people should look at. Another area that they should look at would be what we call a Structured Sale. I did one in the Washington DC area where the buyer wanted to pay X number of dollars and the seller wanted to receive Y number of dollars and they couldn’t seem to get together. The broker called me and said, “Bart, can you help?” I said, “Let’s see what we can do.” I talked to the buyer, “What are you going to do with the money?” He said, “I’m going to retire. I don’t want to work. I’m sensitive about my investments.” I said, “Would you be interested in investing in an insurance company and getting a return and annuity?” He said, “That would be fantastic.”
We worked out how much the seller wanted on a regular basis for 10 or 20 years or whatever the case may be. I then went to the buyer and I said, “How much do you want to pay for this company?” Once I found out how much cash the buyer was willing to pay, we then contacted an insurance company. I have no relationships with any insurance company so you understand how I work. I get agents calling me saying, “Bart, what commission do I owe you?” I said, “Nothing. The guy needed it and we did it.” In that case, we took the buyer’s money and found out that if we could buy an annuity policy, that would give the seller the amount of money he wanted or she wanted each year for X number of years.
Would you believe we could buy an annuity policy that the buyer paid for with the money that the buyer was willing to pay, which was less than the seller wanted, but then we could give the seller an income that he wanted over a period of years that he was comfortable with? We were able to solve the problem. In one case I did, we had a woman who owned a company and she wanted to transfer it. I said, “What do you want?” She’s like, “I just want some money. I want $50,000 a year.” We divide the $50,000 by twelve. We set up a program where she gets it and the buyer is happy because it’s costing him less than he thought it would cost him.
Would you believe she wants that income every month for twenty years? Here’s the key. Your readers have got to be careful. There can be no constructive receipt by the seller. That’s the key terms, constructive receipt. That means if the seller makes the decision to invest the money with let’s say an insurance company, the entire thing is taxable in one year. It’s got to be the buyer that buys the policy where the beneficiary of the annuity is going to be the seller.
The buyer must buy the policy and the seller is going to be the beneficiary.
Correct. I had one in New York State with a veterinarian who takes care of the dogs. The attorney that was working to try and sell his company did not understand the concept. I said, “You can’t do it because if you do it, you’re going to have a major problem on your hands because you represent the seller.” We hired another attorney that worked for the buyer. They became the intermediary, and the funds were transferred to this other second attorney representing the buyer and getting paid by the buyer. They invested the money and the veterinarian was able to get a steady stream of income for the rest of his life.
I do want to spend a little bit more time on this installment sale thing because it is something that comes up a lot in my conversations with folks and they are intrigued by it. Let’s use super simple numbers as we have been. Instead of taking $1 million as a check from somebody who’s going to buy your business, you come to an agreement where the buyer and seller are agreeing that the price is going to be $1 million for the sale. Instead of handing over any money at the time of sale, I’m going to take $100,000 for ten years from you in the form of an annuity. This is an annuity that the entire activity is such that it is now money that is being held by an insurance company. Like you, Bart, I have no stake in the game but I do know that these types of instruments, MetLife and Independent Life are the two big players in this game.
A lot of people also use US Treasury bonds. I had one guy in California who sold his business and he wanted a steady stream of income. I asked him casually, “Where would you invest your money?” He said, “There’s a stock brokerage firm in Miami, Florida.” I said, “You’re in California.” He says, “Yeah, but I like this guy and he knows how to invest money, so we talked to the buyer.” The buyer invested the money with the stock brokerage firm in Miami, Florida, and the seller got his money on a regular basis. You can use insurance companies, stockbrokers, treasury bonds with banks. There are all kinds of things. There are all types of installment basis, but it’s not an installment decision of the seller. It’s the installment decision of the buyer.
That’s an important distinction.
I can explain because the IRS or the state, especially if they find that the seller was involved in the decision process and the seller controls whoever is handling the funds, the entire amount is taxed immediately.
Let’s talk about that. I’m the broker for the seller and I come across a buyer who might be interested in this scenario. You’re going to have to advise me. Are there things I should be saying and not saying to guide them towards understanding how this process works, what steps they should take, and what I, as the broker, or what my client, as the seller, should or should not say? This has come up a couple of times in my life where the seller wanted this to take place, but they couldn’t convince the buyer to take the necessary action to get the ball rolling. It’s a tricky scenario where the buyer has to do a self-education process. Isn’t that the way it has to go?
Yeah, to a certain extent. The broker has got to be careful because they’re being paid by the seller, typically. In some states, they call themselves transactional brokers, which bothers a lot of people. It’s like real estate agents, “We don’t represent the seller and we don’t represent the buyer.” You signed a contract with the seller and you’re getting paid by the seller. You better say you represent the seller. Otherwise, you’re going to be held responsible. It’s a touchy issue of brokers. My firm does not do litigation, but we get involved in court cases as expert witnesses. I’m sorry to say that there’s been a couple of court cases where we’ve been asked to testify against business brokers.
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They got involved in the transaction from a financing standpoint where they’re not supposed to. You can talk to the buyer, but the buyers got to have their own counsel, or you’ve got to hire an independent third–party who advises the buyer on how the structure should be. You got to keep the buyer happy. Otherwise, they’ll walk away from the deal. You’ve got to make sure that the seller is happy or they are scared to sell. Keep this in mind. If you have a bank account and the bank account gives you interest on your account, at the end of the year, you receive a 1099 interest statement from the bank saying, “You earn $50 on your savings account.” You may not take that money out, but you could take it out if you wanted to.
Therefore, you have to pay taxes on that money even though it’s not in your pocket. That’s called Constructive Receipt. If the seller or the broker works with the insurance company, the state and the Federal Government could come back and say, “You’ve got a connection,” therefore, the decision not to receive the money. You’ve got to be sensitive to your position. I don’t want to say the brokers can’t participate, but I’m saying that it’s got to be careful. The buyers got to be educated. “If you want to buy this company, here’s what you have to do. Here’s where you have to pay the money. Talk to an insurance company.” You can suggest. There’s a difference between suggesting insurance companies or banks as opposed to recommending. You never want to recommend. That puts you at risk. You got to use the words, “I can suggest you can talk to this company, this guy and that guy.” If you can set up an annuity program, the seller will probably accept it.
Because you are so good at accounting issues and legal issues, is the dividing line that would keep me safe as a broker and my seller safe as an owner is if the buyer going through this installment sale process has his own representation and attorney? Is that a good enough divider?
It’s probably a good idea to not go far down the road with the buyer until he has some form of representation for that.
If you’re talking to the buyer, you want to make suggestions and make sure you use the word suggestion and not a recommendation. A suggestion says, “I can suggest anything I want.” People call me and say, “Bart, where should I invest in?” I’m not a registered investment advisor according to the United States government, but I can suggest what I do. I can suggest what I think might be good. It’s a suggestion. I’m not going to say, “You should do this. You should do A, B, C. You should invest in this real estate down the street.” That puts me at risk.
Let’s do a quick review. We’ve gone over two big bullet point strategic methods where someone cannot take all the cash in a transaction and get the money paid to them over time. One of them is a structured sale. The other one that you mentioned was the management agreement. What would you call that category? Does it have a term? I just call it a management agreement.
There are other ways. Keep in mind, if the client has formed a C corporation, there’s a special law in the United States that says, “The law in effect at the time you create the company, not when you sell it, will control the taxes you pay on the transaction.” Let’s assume you have a company that’s thinking of selling but they’re not sure they’re ready yet. They might be ready in 3 or 4 years or something, and they’re not a C corporation. You might suggest, and if they’re your client, you can recommend that they form a C corporation and keep the ownership for a minimum of five years. The Federal Law says, “If you create a C corporation in 2021 and you operate it for at least five years before you sell it, you will pay no income taxes on the profits at the time you sell it. If you’re married, the maximum amount of excluded profits being taxed is $10 million. If you’re not married at the time you sell it, the maximum amount is $5 million.”
If I’m an S Corp or an LLC and I transitioned this minute to a C corp, and I hold the business for five more years, and I want to sell it for $2 million in five years, I’m not going to pay a dime in taxes up to those amounts.
Let’s mix a couple of things. Let’s say that somebody comes along in two years and they want to buy your business. How can you sell your business in two years and still take advantage of not paying taxes on the profits? Let me tell you, I’m an old professor. We discussed the management agreement, didn’t we?
Suppose in 2 or 3 years, somebody comes along. You’re a business broker and your job is to sell companies and buy companies. You help the guy structure his entity properly. You keep marketing it if you can and someone comes along and they want to buy it. You say, “We can’t close the transaction until five years and one day, but we’ll give you a management agreement to run the companies if you’ll keep all the profits on it. You’ll pay the seller a few dollars each year, but we will sell you the company at the end of five years.” You see, I can mix apples and oranges.
It gets back to trust. The seller at that point says, “Can I trust a total stranger to commit to this kind of arrangement and last for five years?” It then becomes a trust issue.
Not just that, but you’ve got to also realize, typically in these situations, the seller is going to have some involvement in the company. The way we draft management agreements is that the buyer has not a tightrope. They’ve got the flexibility to change and increase the company and all this type of stuff, but it works because you’ve got the business sold and it could be 2 years, 1 year or 4 years. The idea is that under the income tax laws of the Federal Government now, it is advisable that people close down their Sub-S or partnership or whatever it could be and create a new C corporation.
There have been studies done on this since the law has been changed. There have been articles in the newspapers and magazines and Journal of Accountancy. There have been seminars given even by the different bar associations. I know I’ve done several programs myself for associations and for companies about it. It’s not just a Bart Basi idea. I don’t want to mislead you. A lot of people are concerned about double taxation. I wrote a report and it’s amazing. Double taxation exists with publicly held companies. It does not exist with private companies. It’s important for people to know.
I even educate accountants and they say, “Bart, there’s double taxation. We can’t do that.” I say, “Tell me something. Would you rather pay 37.5% taxes every year or would you rather pay 21% taxes every year?” A publicly held corporation like General Motors makes a profit. You are an investor, but you’re not an active investor. You’re a passive investor and you have nothing to do with running the company. You simply own stock. At the end of the year, General Motors makes a profit and they pay income taxes. It’s basic. You’re an investor and you live in California, and you want some dividends, so General Motors issued you some dividends. You have nothing to do with General Motors other than the fact that you bought some stock in the stock market. You will pay income taxes on the dividends, will you not? People call that double taxation.
Let’s switch gears. You have a private corporation, a construction company, and you want to operate it. I recommend that you operate it as a C corporation. You’re going to pay 21% tax and you’re not going to have the income transferred to your personal income tax return. You’re not going to be subject to personal audit with anything that happens with the company because there’s no relationship between you and the company other than the fact that you own the company and you work there. If the company makes a profit, it will pay taxes at 21%. That’s the tax rate that General Motors pays. You say, “Bart, how do I get money in the company?” You own the company, don’t you? You run the company. If you want to take money out, take it out as a bonus. The company gets a tax deduction. You saved 21% on your bonus. Your bonus is taxed on your personal return the same as if it was a Subchapter S corporation, but you’re not paying 35% or 37%. You’re paying a maximum of 14% because the company got a tax deduction of 21%. If you were a Subchapter S corporation, there’s no tax deduction.
In addition, capital gains do not apply to C corporations. The 3.8% capital gains do not apply to C corporations or medical expenses. The Subchapter S corporation and partnership are transferred to your personal income tax return. The corporation pays everything and nothing is transferred anywhere. You have Social Security taxes and you’re paying your salary. It’s paid by the company and it’s not shown on your personal income tax return where you can deduct 50%. You can’t deduct the other 50%. There are many benefits. I would not ever recommend anything to you or any of your clients or any brokers that come to me and help me if I don’t do it. As you introduced me, I am the Founder and the Senior Adviser to The Center for Financial, Legal & Tax Planning. Inc. in the United States. If I practice what I preach, the corporation is what kind of corporation?
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You are going to be a C corp man.
I have been a C corporation since 1978. I was interviewed by a movie producer for a movie. I’m not going into the details. By the time we ended, he said, “Are you telling me I’m not operating my business right?” I said, “You may not be.” I wonder how I get clients.
You look on the internet and you get advice and you even talk to your own accountant. You’ll always get the same thing, “That’s double taxation. You don’t want to be a C corp. You want to be an S corp or you want to be an LLC.” It’s like a mantra that’s out there that is not founded in reality.
If you’ve got a private company and your aunts, uncles, cousins and nephews own stock in your company and they have nothing to do with your company, and they want money and you give them a dividend, let them pay taxes. You’re operating as a public company. That’s not true. I can show you how you can get two tax deductions also with a C corporation. Let me use myself as an example. If you are a C corporation in your business and you own equipment. Your business has heavy equipment. Let’s say you’re a contracting firm. You’ve got trucks, backhoes or whatever the case may be. You got to even have a building. All that equipment should be in an LLC, a limited liability company, that should be a partnership or a Subchapter S corporation, not a C corporation. Here’s why. The operating company is a C corporation. The operating company needs to use the trucks and the equipment in the real estate, so it rents it from the LLC. Therefore, the C corporation gets a tax deduction for the rental expense.
In addition, item number two, money is taken out of the C corporation and put into the LLC, Subchapter S company, let’s say. No taxes are paid for transferring the money because the money being transferred is payment for the ability of the C corporation to take a tax deduction for its rental expense, renting the building or equipment. Item number three, the LLC must now report the cash they received as income, but the LLC owns the trucks and owns the real estate. Therefore, they get a second deduction because they can now take depreciation on all that stuff against the income and not pay taxes. There are two tax deeds. You can’t do that with a Sub S or a partnership. You can only do it with a C corporation if the equipment in real estate is owned by an LLC.
I’ve done a lot of deals with equipment-heavy businesses and I don’t know that I’ve ever seen somebody arrange it like that. Why haven’t more people done that?
Like my wife says, “If people know what to do, they wouldn’t need me.” I practice what I preach. It’s just some key things.
It does create more accounting complications. You’re now having multiple entities rather than one. I would presume that if you were taking 179 deductions on brand new purchase stuff, you’re still able to take that in that scenario.
If all this stuff is owned by the C corporation, you get one deduction, but you can’t transfer money out because of that deduction either. I’m showing you how you get an income tax deduction in the C corporation. You get an income tax deduction in the LLC for the same piece of equipment and you’re taking money out of the C corporation free of taxes. Just to let you know something, and we might be able to conclude on this point. It’s important to understand that not only am I a subcontractor with the IRS, but my son and I teach classes for the Internal Revenue Service for tax return preparers throughout the entire United States.
We wrote an examination that everyone was taking. In other words, if you want to file taxes in the United States and you want to be registered with the Internal Revenue Service, it’s a volunteer program. There’s no requirement that every tax return preparer for money has to be registered. Congress won’t require that. There are over 146,000 people all over the country. To be registered, you have to take eighteen hours of continuing education every year because the Tax Law changes and you have to pass an examination.
For example, during 2021, you have to take eighteen hours of continuing education, pass an examination in 2021, and then in 2022, you’re registered with the IRS to file tax returns for 2021. Roman and I teach those eighteen hours and we write an exam for the IRS. We’ve got to know the tax laws. As a result, we have been approved and the IRS audits our programs. They even audit me. I’ve got to be honest with you, the last two times I was audited, I was audited by former students of mine who worked for the IRS. Can you imagine?
I’m very careful. I will never tell you something that’s unethical or illegal. I’ve got too many licenses to lose and too much of a reputation in the United States, so I’m very careful about what to take. I’m telling you three things. Let’s review quickly. One, when a person wants to sell the company and someone values that company and tells them, “This is what you want. This is what you can get.” That’s step one. Step two is you got to do a tax minimization analysis to find out what you are going to keep after taxes. Step three, what are you going to do with the money? How are you going to invest in it? Do you want to turn around and invest in an annuity yourself or is there someone else, so we can save some taxes by doing it?
Installment sales are good. You’ve got to jump through hoops. Number four, are you set up properly to help you operate your business in the next few years if you don’t sell it right away? Number five, what are you going to do? Do you have a succession plan in your own structure or in your own family? Brokers can help so much in all of these areas, but these are five key areas that deal with that. As we talked about here, these are the basics. I refer to them as basics.
Before we let you go, I do want to let you talk about succession plans. People hear a succession plan and their eyes glaze over and they think, “How am I going to take time to do this? What does that look like?” All this kind of thing. They’re running day-to-day businesses and they’re putting out fires. They can’t sit down and write a succession plan. That’s going to be some 50-page god-awful thing.
It’s not that bad. Some of the largest corporations in the world have to spend time. I’ll give you two examples. You’re located in California. Toyota Corporation in the United States used to be headquartered in California. They’re now headquartered in Texas because Texas has no state income tax. That’s another matter. Stop and think of the dealers in Toyota Corporation around the United States. If they don’t have succession plans, a dealer dies. Who takes over the dealership? What is the succession plan? I work with Toyota Corporation. I said, “You got attorneys.” “Bart, they put up brushfires. They’re handling legal suits. They’re litigators.” We worked with 3M Corporation.” The same thing, they’ve got distributors all over the company. Purell Corporation, distributors all over the country. Insurance companies like American General Life Insurance Company. They’ve got insurance agents all over the country. If those agents or those distributors die and they don’t have a proper succession plan, these manufacturing firms and these large insurance companies lose market share. It is critical that every private company has it now.
What is the succession plan? It is called an executory contract, a contract that goes in-effect in the future. If I die, when I become 65 and I want to retire, not just want to retire, but it’s got to be a specific time or date in the future that occurs, a contingency plan. If I’m not able to run the company. There are three things. Do you have someone that you can prime to take over the situation or take over the business? It’s got to be in writing? Do you have other stockholders, buy-sell agreement? Do you have a friendly competitor that you work with that you could be a potential takeover for his company and he could be a potential takeover of your company? Is there a merger that the business broker should get involved in so that they can help someone? That’s a succession plan, a merger.
I’ll give you one quick example. There are so many I’ve gone through. John Deere Corporation in the State of Washington had individual dealers all over the state. Why? Years ago, they were farmers and they needed equipment. They started buying equipment and they were able to sell it to other farmers and they became a distributor. They hired me to consolidate a whole bunch of dealers. By consolidating them, we wrote up a nice couple of documents. We had to value each operation and write up a couple of documents so that each person who is running a dealership now is part of a large organization. They could sell their stock back to the dealership over a three-year time period and eventually, phase out and retire. It’s a fantastic succession plan.
Succession plans can be done with family members, employees, competitors or investors. It doesn’t have to be something that’s implemented now. It’s implemented in the future. It consists of valuing the business and setting up a format. It consists of watching how the stock is going to be transferred. It’s a team effort. It’s not done by one person. It’s done by working together with the owner and the owner’s family. I’m going up to see a dealer and I’m going to work with him and his wife and his family. He’s got four children and he’s getting ready to retire. We’re going to sit down across the table probably for 2 to 3 hours. We’re going to talk about what he plans to do when he retires and how he plans that. Does he have a team in place to take over the operation of the company? Does he need to sell it? What does he need to do to prepare it for sale? Does his spouse have a steady stream of income that may not be dependent on him?
I’ve done my own succession plan. Succession plans should be reviewed every three years and succession plans are also part of an estate plan. My wife and I have our own operation. We have set up our own succession plan. I recommend in this particular gentleman’s case once we finish everything that we sit down with his family. His children who are adults now understand that if something happens to dad or something happens to mom, what’s going to happen? If mom and dad want to retire, here’s what they’re going to do. They might travel. My wife has a philosophy that we should travel to California and Italy for two months. God bless her.
I say the same thing and it never happens.
My wife did go to Florence for an entire month with a friend of hers and went to school. It’s one of the best things. Don’t get me wrong. I was home working. She said next time, I’m going with her. I said, “I’ll take the time and come.” Be aware. Succession plan also deals with retirement programming and setting up funding for that. The brokers can find a fantastic operation there. That’s not done on a percentage basis. That’s done on a flat fee basis. It can generate substantial income to brokers that work let’s say with my firm or any other firm that it gets involved in. We do valuations and we’re authorized by the Labor Department, which is very important.
We do valuations with private companies. We do mergers and acquisitions. We work with brokers side by side. We’ve got some brokers that will call us on different items just for a second opinion and we provide that. We have a staff that works with setting it up. I’ve got a complete book with eighteen pages, and I’m not selling it, so don’t mislead me. It’s a series of questions that I’ve asked over the years when my staff says, “Dr. Basi, we got to put this in writing.” One of my attorneys has said, “If I can keep working for ten years, they can retire.” It’s a situation like that.
I talked to a gentleman who’s retired. He worked with the Federal Government. He says, “Bart, you don’t have to retire.” I said, “I retired twice, but I like what I’m doing.” He said, “Yours is more intelligence, brain-wise. Mine was physical work. I can’t lift 40 or 50 pounds anymore.” Depending upon the type of business, depending upon the type of involvement, every broker in the United States can assist in developing a succession estate plan that a business can continue. If you do it right, you’ve got a continuing client because every 3 to 5 years, typically businesses are resold.
This has been so great. I don’t see any reason why all the S corp and LLC and partnership ownership out there don’t go and become C corp. Is there any reason not to become a C corp?
There’s some reason. If a person’s making under $100,000 in profit and they need it to live on, then just stay as a Sub-S Corporation. It’s not worth transferring. Another thing is when people start up a business, a lot of times, there are losses because it’s the beginning business. The law says, “You can start up as a Subchapter S corporation, and then as you grow, you can convert to a C corporation.” Some small businesses do start a startup as Sub-S or partnerships. Remember what I said, if there’s equipment in real estate, that should not be in a C corporation. C corporation should be reserved for operating entities.
Those are investment vehicles that we do use partnerships and we use Subchapter S. My family has a lot of real estate in the United States. We have a partnership. It’s not mine. It’s been transferred to my wife, children, and grandchildren. Everyone participates in that, which is a good long-term passive investment. There’s one other subject we haven’t talked about and we’ll leave it for another blog or something, and that’s the use of a trust. It’s important both in transferring a business, buying a business, selling a business, preparing it for sale, and also succession planning and estate planning.
That is a different subject. You could spend an entire show just on that. They are important instruments. They are not recorded instruments, so they’re private documents. You’ve covered so much ground in however much time we’ve done this. Bart, I appreciate this.
I hope I’ve been of some help, not just to you but to all of your readers. If I can conclude by saying they can go to our website, www.TaxPlanning.com. It’s not just about our company, but we have blogs on there and we have articles we’ve written. They’re all free. You and your members can go there and take a look at them, read them, and download them if you want if they can help you. Our job is to help private companies in the United States be successful and be able to pass on to the next generation, which my father was unable to do.
It’s so important. You found your niche in life. You have done a great job. I was going to conclude by saying TaxPlanning.com is Bart’s site, as well as we want to drop your email address. It’s B-Basi@TaxPlanning.com in case anybody wants to reach out. Bart, I can’t thank you enough. We could do twenty of these and people would be learning a lot.
Keep in mind, let your people know that tax laws are changing, so they’ve got to stay current. They can’t use this three years from now. Possibly maybe not even six months from now. I wish you the best of luck. Thank you for taking your time to work with me to be able to assist not only you but all your readers. Good luck.
Thank you, Bart. Take care.
About Dr. Bart Basi
Dr. Bart Basi is quite amazing. He’s been a national speaker at dozens of conferences and events over the years, simply because he’s so good at it. He is both a CPA and a tax attorney.
He has a bachelor’s and MBA from Syracuse University…. took his law degree from the University of Louisville… then a Doctorate in Economics and Accounting from Indiana University… and topped that off with post-graduate work at Stanford.
He’s the author of five books. Won many awards over the years. He writes “The Tax Report”, a publication about tax and estate issues.