Divorcing business owners need to pay attention to tax implications

tax consequences of settling your divorce

If you’re getting a divorce, you know it’s a highly stressful time. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets, and your marital property will include all or part of it.

Transferring property tax-free

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that, under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:

A year after the date the marriage ends, or
Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

Future tax implications

Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid adverse tax consequences

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Your tax advisor can help you minimize the adverse tax consequences of settling your divorce under today’s laws.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Be vigilant about your business credit score

business credit score

As an individual, you’ve no doubt been urged to regularly check your credit score. Most people nowadays know that, with a subpar personal credit score, they’ll have trouble buying a home or car, or just getting a reasonable-rate credit card.

But how about your business credit score? It’s important for much the same reason — you’ll have difficulty obtaining financing or procuring the assets you need to operate competitively without a solid score. So, you’ve got to be vigilant about it.

Algorithms and data

Business credit scores come from various reporting agencies, such as Experian, Equifax and Dun & Bradstreet. Each agency has its own algorithm for calculating credit scores. Like personal credit scores, higher business credit scores equate with lower risk (and vice versa).

Credit agencies track your business by its employer identification number (EIN). They compile data from your EIN, including the company’s address, phone number, owners’ names and industry classification code. Agencies may also search the Internet and public records for bankruptcies, judgments and tax liens. Suppliers, landlords, leasing companies and other creditors may also report payment experiences with the company to credit agencies.

Important factors

Timely bill payment is the biggest factor affecting your business credit score. But other important ones include:

Level of success. Higher net worth or annual revenues generally increase your credit score.

Structure. Corporations and limited liability companies tend to receive higher scores than sole proprietorships and partnerships because these entities’ financial identities are separate from those of their owners.

Industry. Some agencies keep track of the percentage of companies under the company’s industry classification code that have filed for bankruptcy. Participation in high-risk industries tends to lower a business credit score.

Track record. Credit agencies also look at the length and frequency of your company’s credit history. Once you establish credit, your business should periodically borrow additional money and then repay it on time to avoid the risk of being downgraded.

Best practices

Business credit scores help lenders decide whether to approve your loan request, as well as the loan’s interest rate, duration and other terms. Unfortunately, some small businesses and start-ups may have little to no credit history.

Build your company’s credit history by applying for a company credit card and paying the balance off each month. Also put utilities and leases in your company’s name, so the business is on the radar of the credit reporting agencies.

Sometimes, credit agencies base their ratings on incomplete, false or outdated information. Monitor your credit score regularly and note any downgrades. In some cases, the agency may be willing to change your score if you contact them and successfully prove that a rating is inaccurate.

Central role

Maintaining a healthy business credit score should play a central role in how you manage your company’s finances. Contact us for help in using credit to help maintain your cash flow and build the bottom line.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

5 ways to give your sales staff the support they really need

supporting your sales team

“I could sell water to a whale.”

Indeed, most salespeople possess an abundance of confidence. One could say it’s a prerequisite for the job. Because of their remarkable self-assurance, sales staffers might appear to be largely autonomous. Hand them something to sell, tell them a bit about it and let them do their thing — right?

Not necessarily. The sales department needs support just like any other part of a company. And we’re not just talking about office supplies and working phone lines. Here are five ways that your business can give its sales staff the support they really need:

1. Show them the data.

Virtually every aspect of business is driven by analytics these days, but sales has been all about the data for decades. To keep up with the competition, provide your sales team with the most cutting-edge metrics. The right ones vary depending on your industry and customer base, but consider analytics such as lead conversion rate and quote-to-close.

2. Invest in sales training and upskilling.

If you don’t train salespeople properly, they’ll face an uphill climb to success and may not stick around to get there with you. (This is often partly why sales staffs tend to have high turnover.) Once a salesperson is trained, offer continuing education — now commonly referred to as “upskilling” — to continue to enhance his or her talents.

3. Effectively evaluate employee performance.

For sales staff, annual job reviews can boil down to a numbers game whereby it was either a good year or a bad one. Make sure your performance evaluations for salespeople are as comprehensive and productive as they are for any other type of employee. Sales goals should obviously play a role, but look for other professional development objectives as well.

4. Promote positivity, ethics and high morale.

Sales is often a frustrating grind. It’s not uncommon for sales staff members to fall prey to negativity. This can manifest itself in various ways: bad interactions with customers, plummeting morale and, in worst cases, even unethical or fraudulent activities. Urge your supervisors to interact regularly with salespeople to combat pessimism and find ways to keep spirits high.

5. Regularly re-evaluate your compensation model.

Finding the right way to compensate sales staff has challenged, if not perplexed, companies for years. Some businesses opt for commission only, others provide a salary plus commission. There are additional options as well, such as profit margin plans that compensate salespeople based on how well the company is doing.

If your compensation model is working well, you may not want to rock the boat. But re-evaluate its efficacy at least annually and don’t hesitate to explore other approaches. Our firm can help you analyze the numbers related to compensation as well as the metrics you’re using to track and assess sales.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Could your business benefit from the tax credit for family and medical leave?

paid family and medical leave

The Tax Cuts and Jobs Act created a new federal tax credit for employers that provide qualified paid family and medical leave to their employees. It’s subject to numerous rules and restrictions, and the credit is only available for two tax years — those beginning between January 1, 2018, and December 31, 2019. However, it may be worthwhile for some businesses.

The value of the credit

An eligible employer can claim a credit equal to 12.5% of wages paid to qualifying employees who are on family and medical leave, if the leave payments are at least 50% of the normal wages paid to them. For each 1% increase over 50%, the credit rate increases by 0.25%, up to a maximum credit rate of 25%.

An eligible employee is one who’s worked for your company for at least one year, with compensation for the preceding year not exceeding 60% of the threshold for highly compensated employees for that year. For 2019, the threshold for highly compensated employees is $125,000 (up from $120,000 for 2018). That means a qualifying employee’s 2019 compensation can’t exceed $72,000 (60% × $120,000).

Employers that claim the family and medical leave credit must reduce their deductions for wages and salaries by the amount of the credit.

Qualifying leave

For purposes of the credit, family and medical leave is defined as time off taken by a qualified employee for these reasons:

  • The birth, adoption or fostering of a child (and to care for the child),
  • To care for a spouse, child or parent with a serious health condition,
  • If the employee has a serious health condition,
  • Any qualifying need due to an employee’s spouse, child or parent being on covered active duty in the Armed Forces (or being notified of an impending call or order to covered active duty), and
  • To care for a spouse, child, parent or next of kin who’s a covered veteran or member of the Armed Forces.

Employer-provided vacation, personal, medical or sick leave (other than leave defined above) isn’t eligible.

When a policy must be established

The general rule is that, to claim the credit for your company’s first tax year that begins after December 31, 2017, your written family and medical leave policy must be in place before the paid leave for which the credit will be claimed is taken.

However, under a favorable transition rule for the first tax year beginning after December 31, 2017, your company’s written leave policy (or an amendment to an existing policy) is considered to be in place as of the effective date of the policy (or amendment) rather than the later adoption date.

Attractive perk

The new family and medical leave credit could be an attractive perk for your company’s employees. However, it can be expensive because it must be provided to all qualifying full-time employees. Consult with us if you have questions or want more information.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

When are LLC members subject to self-employment tax?

LLC members

Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.

SE tax background

Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.

General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.

(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)

LLC uncertainty

Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

Review your situation

The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.

Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.