Tag: small business

Taxes and Small Business

In our research for the upcoming Lunch and Learn, we discovered something quite interesting. I thought I would work through it here and try to figure out how to help small businesses plan effectively.

As part of the potential for tax reduction is an attempt to deal with flow-through entities; that is sole proprietorships, S Corporations and LLC’s. Currently, with flow-through entities, the tax on profits is paid by the owners. The problem becomes defining profits. Let’s look at 3 companies A, B and C.

Profits and Compensation

All 3 companies make $100,000 before owner compensation. A decides to pay herself $50,000 of wages, B decides not to pay any and C pays almost all in the form of wages. The tax consequences are remarkably different.

A B C
Taxable Income Before Owner Compensation      100,000      100,000      100,000
Owner Compensation        50,000              –        92,500
Company Payroll Taxes 8.0%          4,000              –          7,400
Taxable Income Passed Through        46,000      100,000            100
Income Tax for Owner
Wages        50,000              –        92,500
Taxable Income Passed Through        46,000      100,000            100
Taxable Income for Owner        96,000      100,000        92,600
Tax Liabilities 25.0%        24,000        25,000        23,150
Total Taxes Paid
Company Payroll Taxes          4,000              –          7,400
Owner Payroll Taxes          4,000              –          7,400
Income Taxes        24,000        25,000        23,150
Total Taxes        32,000        25,000        37,950
Taxes as a Percent of Income Before Comp 32.0% 25.0% 38.0%

The difference between the results is the payroll taxes which every employee pays and which every employer matches.  The problem is that the only statutory requirement is that “Compensation must be Reasonable”.   And this has been an audit headache as the term “Reasonable Compensation” is based upon the facts and circumstances of the particular taxpayer and Company.

This difference in the tax law has been around for decades and has been left to auditors and taxpayers to argue about the term “Reasonable Compensation”.    In this case, we have argued on all sides – that A’s and C’s compensation is reasonable and so is B’s.   Most professionals would worry about losing in B’s position but clearly any compensation less than the amount of taxable income before owner compensation is a win for the taxpayer by reducing employment taxes.

Given that there is already this disparity and given that Congress knows about it and has elected not to touch it yet should give us all pause for concern as Congress looks at passing a substantial rewrite of the tax law to both reduce rates as well as treat Business earnings with a different tax rate.

Deemed Wages

To address this issue Congress will need to figure out a way to address owner compensation. So far, in all the proposals they use a phrase “Deemed Wages” to account for owner compensation. Randy and I have debated this and we are of the opinion that what is likely to happen is that the IRS will publish a table of expected compensation for various businesses and the owner’s compensation should be close to that in order to be considered reasonable. If an owner wants to pay differently, there should be some written justification for the position, such as minutes to the board of directors or a memo from a meeting between the owners and their representatives.

Keep in mind though, that this is one areas where is almost no guidance as it hasn’t been touched before.

This change to how small business reflects taxable income will be major.  By addressing the disparity shown above, Congress will potentially eliminate an audit headache and improve compliance.  It may mean that some pay more and some pay less, but it could also help give taxpayers peace of mind by addressing the unknown of “Reasonable Compensation” and reducing the risk of money spent on litigating this issue.

 

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Pricing

Happy Tuesday.  On Sunday, we had brunch with some good friends Jordan and Whitney at Tommy O’s in downtown Vancouver.  Kubae and I split a delicious Kahlua Pork Quesadilla and had a great time with conversation about firing ranges and civil liberties.  We then spent the rest of the day driving around contemplating if it is time to move to another spot as we are fast approaching our 2 years in downtown.  How time flies when you are having a great time.

One of the things I think that worry small business owners is what price to charge.  And since most small business owners start their small business after leaving their employer, they typically follow the model they were taught there.  This works, but I think there may be a better way.

When I was working with VSource in the startup of Argentstratus, I decided to approach the pricing model differently.  Instead of first saying, “here is our price”, I suggested the sales team start by asking what the prospective buyers budget was for things like

  • Server replacement
  • Desktop PC replacement
  • Software updates
  • System security
  • Downtime for server maintenance
  • etc

The typical response was a blank – deer-in-the-headlights- stare because most small business owners don’t stop to think about those things.  Depending on their answer though, the sales team could help create a frame of reference for the costs of doing everything in-house versus outsourcing their entire IT.

This had two benefits: First we avoided having the investment discussion too soon and second we ensured that the prospective buyer understood what they were really purchasing.  In essence, we established the value of the offer and then provided a price which was dramatically lower than that value.

To be clear, there is no such thing as the right price.  What the small business faces are buyers with absolute maximum and minimums to their pricing decision.  Many start-ups are willing to pay legal counsel several thousands of dollars: Some will not pay a dime.  Established businesses are willing to pay a million dollars to buy out a competitor but won’t spend $100,000 on an advertising campaign.  Each party perceives the value differently but I honestly believe the main point of differentiation is how the investment is packaged to the buyer.

By the way, I intentionally use the word investment over “Price” or “Cost”.  For most of us, especially in the service industries, we are often considered a “Cost of Doing Business” – an expense.  I go out of my way to explain that using my services is an investment.  By paying my firm you get access to some of the best business, tax and accounting minds in the area.  By deliberately removing loaded words we can continue the conversation in ways that benefit all parties.  If I say your tax return is going to cost  you $1,800 you will try to shop me.  If I say that your investment in assistance in running, managing and reporting on your business is $1,800 and I will throw in a tax return for free… you see my point.

So some guidelines I have learned along the way when it comes to pricing.  Where I can remember the source I will give credit and if I do not actually remember the source I apologize in advance and if you can send me a message with the actual source I will update this post for that information.

  • Do not charge by the hours worked, but by the years it took to get you to this point. Harry Beckwith
  • Price high and offer amenities – it is easier to remove add-ons than raise prices
  • It is always easier to offer discounts than to raise prices
  • Determine what your customer can pay and then figure out if you can service the client profitably.
  • Offer tiers of service (Bronze, Silver, Gold or the like) with very clear differences between them so you can cater to a larger audience
  • Ask the prospective buyer their budget and try to hit it.  Jeffrey Gitomer
  • People hate to be sold but they love to buy.  Help them buy.  Jeffrey Gitomer
  • Your number one competitor is apathy, price accordingly.
  • Your costs are not your customers problem.

What these guidelines suggest is to be open and creative when it comes to pricing your solution.  You are offering a solution to someone’s problem so don’t be afraid to be creative about what they pay for their investment.  As a general rule, if you are looking for new or more business opportunities, look at how your competition is pricing and then do something different.  Make your pricing easy to understand and consistent for a set of prospective buyers.  Test your price and if you are getting 100% of prospects saying yes, realize your price may be too low.  If you are getting 100% saying no, your price is too high.

Somewhere in between is that sweet spot for that group.  You can find it.  If you are interested in thinking about ways to create new pricing models, try talking with your current accounting professional about ways to make your solution and pricing more effective.  If you are looking for a new accounting professional or would like a second opinion, feel free to contact me for a free no obligation consultation.

Have a great day and enjoy the challenge of charting a new course on pricing your solution.

Thoughts on change

Happy Friday.

Have you noticed that many people are afraid of change?  That somehow the way it was is good enough and so should be continued into the future unnecessary.  Or worse, because it didn’t work before it can’t work today.   While looking back at history is a decent guide to making a decision, it cannot be the only tool we use when deciding how we should do things today.  Or tomorrow.  Things are changing and small business has to get on top of this or suffer the consequences.

Last night Kubae and I had dinner with Wes and Dianne – good friends for many years.  We got onto the topic of change – technically we were discussing the Brexit and the Trump issue – and the things that both sides had in common.  Dianne pointed out that that the supporters of both movements lived in fear of the change that is happening.  Kubae then pointed out that it isn’t just the change but the pace of change that is possibly a driver.

The pace of change. I think they are onto something.

Look at the last 100 years. in 100 years we have gone from being essentially foot-mobile to autonomous vehicles.  We have gone from handwritten letters to text messages.  We have gone from biplanes to space shuttles. All this in 100 years.

Look at the last 50 years. We have gone from 3 major automobile manufacturers to 15. From leaded gasoline to electric and solar. From princess phones to Bluetooth.  From large global mass manufacturing to 3D printing of single pieces.  Amazing changes in my lifetime.

As an accountant, I am a trained historian.  Historians look at the past and try to make sense of it.  All accounting is really is ensuring that the business history (its transactions) are recorded clearly and concisely for future use.  History is useful but I have found that history alone is insufficient to help chart a course of action.

As a business developer, I am a futurist.  A futurist looks at today and asks how it might look tomorrow.  A futurist needs history to provide a starting point and trends that can help guess what tomorrow will look like.  Guessing about the future is fun, although it is often seen as science fiction or worse a waste of time.

And yet, a futurist is a planner.  Businesses must plan what their future is going to look like and then remain flexible enough to adapt to the unforeseen changes and also record things so that the historical reality can be compared to that future guess.

And this is the rub isn’t it?  I have often joked that I think most small business owners are frustrated accountants. They love the history of their business -how hard they’ve worked, how much money they’ve made.  But when asked what the future holds for their business, the response is typically, “same as last year but add 10%”.  That might have worked in 1960, but I don’t think this is going to hold true in 2020; and that is only 4 years away.

That’s right. four short years.  Are you asking yourself what your business is going to look like with

  • Drones doing delivery
  • cars that drive themselves
  • trucks that drive themselves
  • equipment that warns before it malfuctions
  • a printer that can make parts by adding and not subtracting raw materials
  • energy without being connected to the power grid
  • food grown locally instead of on large farms and trucked
  • and a million other things

This is the easily predicted future because most of this is here now.   What about the things we haven’t even dreamed of yet?  Are you positioning your business to be part of these changes or are you going to defiantly wave your buggy-whip until the end?

Typically, I would sign off by suggesting you have a conversation with your accountant, but not today.  Take someone two generations removed from you out to lunch and ask them these questions.  Find a good science fiction book and read about what their vision of the future looks like.  Let your mind explore the fascinating potential that your business has before it and start thinking about your future. Because it doesn’t have to be about fearing the change – it can be about embracing it.

Have a great weekend.

 

 

 

Thoughts on Marketing

Happy Wednesday.  You know, I am typically not much for working out in the evening – I prefer reading and drinking wine – but it does help me sleep much better.  Still a little sore from last night’s routine, but I slept like a rock!

Kubae and I were talking this morning about a restaurant that started and died a few blocks away.  It lasted about 2 months before the doors were closed.  she wondered what they might have been thinking and what lessons we could learn from this.

I think there are several important lessons for anyone starting a business in this story.

First, the old adage, “If you build it, they will come” is no longer valid.  I am not certain there ever was a time you could open business and customers would flock to your doors, but it definitely won’t work today.  Today, your potential customers have a huge array of choices so a small business owner must find a way to get to “top of mind”.  This means marketing.

Second, as I discussed in a prior post, the saying, “Location, location, location” is extremely important for certain types of small businesses, especially restaurants.  In this instance, this restaurant might have had the best Chinese cuisine in the Pacific Northwest.  It wouldn’t matter as it was sandwiched between two other restaurants and on a side street.

Third, whatever you think is the bare minimum you can spend to get the word out, triple it.  That’s right, plan on spending 3 times as much on marketing than you originally anticipated.  Your potential customers are bombarded with thousands of choices a day and your small business competes with those other messages.  Whether you choose to spend money or time, a conservative approach is to plan for more messaging.  A lot more.

Fourth, when in doubt, spend more on marketing.  A good friend of mine, Mike Leitch of VSource Systems, used to joke that the biggest problem he would like to see is having more work than he has time to do it.  With a growing business you can hire to handle the extra work; but if your business never gets going, you will be hard pressed to pay yourself.

Fifth, change your marketing channels.  The first thing you need to do is ask yourself how anyone is going to find out about you.  If you are a restaurant, you need to find out how to get listed on Yelp and Google Maps and any of the other dozen websites that cater to restaurant reviews.  If you are an accounting business you will need to find out how your potential customers look for new accountants.  And then, ask yourself, what other ways can I get the word out.  Experiment with channels, track their effectiveness and if after a few months it isn’t working, discard it for now and try something else.

Starting a business is risky.  If you are ready to take the plunge, then I strongly suggest you create a marketing plan to help you build excitement about your Company.  And if you are looking to expand your business, I strongly suggest you create a marketing plan to help you build excitement about your Company.  Getting more potential customers than you have time to work on is a great problem to have.

If starting a business is in your future, I encourage you to reach out to your accounting professional and create a business plan and budget to help you get through the first 3 years.  If you are looking for an accountant who can help you plan your startup or would like another opinion, feel free to contact me for  your free no obligation consultation and lets see what we can do to help make your dream come true.

Have an awesome Wednesday.