Fix Your Finances

Determine which areas could use some adjustment

Wherever your small business lies on the business lifecycle, it may be time for a Financial Tune-Up. Like the name implies, a financial tune-up is a fresh look at how well your small business is working for you, the owner. Here’s a short list of things to consider.

Type of business entity

Many small businesses start out as unincorporated sole proprietorships. The advantages are ease of formation and simplicity of operation. The disadvantages are exposure of personal assets to business liabilities and reporting net business earnings on your personal income tax return. If your business has grown since you started out, it may make sense to consider a operating under a different business form. Some types of business entities popular with small business owners—limited liability companies, S corporations, and regular C corporations—protect the individual business owner’s personal assets from claims of business contractual and tort creditor. Furthermore, some of these other business forms offer tax advantages to small business owners that are not available to sole proprietors.

For example, unincorporated sole proprietors pay self-employment taxes of 15.3 percent on net income up to $106,800 (2009). By comparison, an S corporation owner/employee is subject to employment tax withholding on his or her compensation. However, net earnings over and above a reasonable salary are included in income, but are not subject to employment taxes.

Retirement Plan

When is the last time you considered whether your employer-sponsored retirement plan was the best plan for you? Or, if you don’t have an employer-sponsored retirement plan, when is the last time you evaluated the benefits of starting a plan? The landscape for employer-sponsored retirement plans has changed considerably over the past few years and you may be missing out on a great opportunity for both you and your employees. One change has been an increase in the maximum allowable contribution for employer-sponsored defined contribution plans such as profit-sharing plans and Simplified Employee Pensions (SEPs).

Did you know that in 2009, your business can deduct the lesser of 25 percent of your salary (20 percent of net earnings for an unincorporated individual) or $49,000? If your business sponsored a 401(k) plan, you and your employees could put away as much as $16,500 pre-tax from salary in 2009, and up to $5,500 more if the participant will be age 50 or older in 2005.

Health Insurance Plan

Rising health insurance costs remain a major concern for many small business owners, but there are new options on the scene that lower costs through tax incentives. The newest and perhaps most promising is the Health Savings Account that were part of the massive Medicare changes legislated by Congress in December of 2003. With an HSA, employees—and their employers, if they choose—contribute pre-tax dollars to an account earmarked for out-of-pocket health expenses. In addition to not paying tax on contributions, participants also pay no tax on earnings that accumulate in the HSA. Moreover, money not withdrawn to pay for medical care is carried over to the next year and continues growing tax-deferred. And, provided money in the account is used for health-related expenses or to pay health insurance premiums, the participant pays no tax when withdrawals are made. Single participants can contribute up to $3,000 pre-tax, while married couples can contribute up to $5,950 for a family plan. And for participants over age 55, there is a catch-up provision of $1,000. Here is the only catch—not everyone is eligible for a Health Savings Account. To qualify, you can only be covered by a high-deductible medical insurance policy, either through your employer or one you purchase yourself as a self-employed person. “High-deductible” means the policy must not pay benefits until you have accumulated at least $1,150 worth of out-of-pocket medical expenses that year. The family deductible must be at least $2,300.

Life and Disability Insurance

Small businesses often find it challenging to attract and retain human resources. Employee benefits offerings such as life and disability income insurance are often necessary to compete with the “big boys.” Group plans provide affordable coverage without the need for individual underwriting. These coverages can be offered as an employee benefit paid for solely by the employer, an employer-sponsored plan paid for by the employee, or a combination plan. Furthermore, employer-paid premiums are generally deductible and are excludible from employee income (only the cost of the first $50,000 of group life insurance is tax-free to the employee). If you haven’t considered these plans recently, you’ll find that the market has changed significantly. An emphasis on rehabilitation and returning disabled employees to work has helped keep group disability income premiums in check. And, group life plans with supplemental individual coverage are commonly used to meet the needs of highly compensated executives and owners.

Key-Person Insurance

Small businesses routinely insure their premises, equipment, and inventory. Less common is the business that insures its most valuable assets, its key employees. If you haven’t increased the amount of existing key person life and disability coverage to keep pace with increasing profits and business lines of credit or to reflect the addition of new key employees, there’s no better time to do so than now. As employees age and/or become health-impaired insurance becomes more expensive or outright unavailable. When it comes to acquiring key person insurance, the sooner you act the better.

Business Succession Planning

When business owners think about wealth transfer, they usually think about the transfer of their business or its value. Typically, businesses have only three options available to them at the death of an owner. These include the following:

  • Sale of the business to an outsider

  • Retention of the business for family members or other surviving owners

  • Liquidation of the business

Liquidation of the business is typically what happens in the absence of a business succession plan. Lacking a plan, the owner’s executor is forced to sell business assets piecemeal. This results in loss of “going concern” value—the “goodwill” of a successful business due to its customer, supplier, and lender relationships.

This means that business succession planning usually comes down to the decision to sell or retain the business. The decision is not an easy one. If your business has experienced growth, if you’ve brought a family member into the business, or if you are approaching retirement, it makes sense to revisit your business succession plan.

A tune-up can be as painless as an oil change and lube job, or it can uncover some major work. But the benefit of a tune-up is that it puts you in control and minimizes the chance of getting stranded on a lonely road at night. A financial tune-up offers the same benefit—it prevents you from getting stranded without adequate retirement benefits, attractive employee benefits, or an up-to-date business succession plan.

This article provides general information for the subject matter covered. It is not intended to render legal or tax advice. An individual’s particular circumstances should be discussed with a personal tax or legal advisor. The Prudential Insurance Company of America, 751 Broad Street, Newark, NJ 07102-3777

Provided courtesy of Cornerstone Financial Partners, LLC. For more information, contact Richard L. McDonald, Tim Thornberry, ChFC or John Winters, MBA, CLTC, who offer investment advisory services through Prudential Financial Planning Services, a division of Pruco Securities, LLC. They can be reached at 770-730-6100. Cornerstone Financial Partners, LLC is not affiliated with Pruco. Other products and services may be offered through a non-Pruco entity.

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