Rule Number 1: Don’t Cash a Paycheck
I was on a panel of four other accountants at this luncheon where I had ten minutes to explain why converting to a C Corporation could be beneficial and double taxation never comes into play. It was a hard sell during these precious minutes, but the speech went over nicely. That was, until this business broker decides to put his two cents in.
Now business brokers sell businesses and take a 10 percent commission. They are famous for low balling the price of a business, in order to make the deal close faster, and for them to get their commission.
This particular business broker chimes in at the end of the presentation and states that if these people who convert to C Corporations sell their businesses, they will face double taxation. Now, I am of Irish decent, and have the temper. Five years ago, I would have gone up one side and down the other on this guy, but I didn’t. Keep in mind that he isn’t an accountant, and making a crass statement like he did, not to mention an ignorant one, made my blood boil.
If you are an S Corporation, partnership, or sole proprietorship, know that when you sell your business you sell the assets. In 24 years, I have had my battles with business brokers. They use an equation called “owner’s benefit” to come up with the listing price of a business. Owner’s benefit is basically expenses that the owner has taken for their benefit. Expenses include depreciation, amortization, meals, travel and auto. That also covers service businesses that are sold by multiples of gross receipts.
After the luncheon is over, I make my way to the business broker and ask him a simple question. I ask him if he has ever heard of IRC Section 1202 stock. I explain that, in a C Corporation, the stock commences with the shareholder who holds it for five years, and that when they sell it, they don’t have to pay capital gains tax on the first $10 million. He retorts that the new owner has to take on the liability and that no one will take on another company’s liability. I respond that it happens all of the time, and the seller just idemnifies the seller of all liabilities, including contingent liabilities. He states that the Securities and Exchange Commission (SEC) won’t let him sell stock. I then tell him that he should recluse himself from the sale then.
Do you literally think that this guy will turn down a commission by sending away a client who may have a potential tax liability because this client converted to a C Corporation? He is simply cashing a paycheck. He will never use the knowledge that I gave him.
Some accountants are guilty of this as well. You have a limited liability company (LLC) that you converted to an S Corporation. The S Corporation’s tax return costs more than the client is receiving in savings. When I see this, I ask the client when they will make money, in five years, do they see making a lot of money, etc. The answer is usually no. I explain to them that unless they net $15,000, then there is no point in being an S Corporation.
At $15,000, as a disregarded entity, the taxpayer will pay $2,295 in self-employment tax. A corporate return is less than that. In good conscious, I can’t charge a client more than what they are saving in taxes. I realize that I am cutting my throat here, but I just can’t do it any other way.
I have a client that I picked up recently. He is a chiropractor and his business is an S Corporartion. In 2015, he owed $68,000 in taxes. His accountant did nothing to fix the problem, she just gave him estimated tax payments totaling $78,000. His 2016 return showed a refund of $49,000, which the tax preparer APPLIED to 2017. That still doesn’t fix the problem, and the government gets to hold onto $49,000 to boot. She was paid $2,000 for the corporate and personal return.
Then he meets me, and I give him a scenario in which I can save him $50,000 just by changing around what he does. He is happy. I charge a fee for accounting work, then a retainer for tax planning, and then the returns are extra.
About a week later, he begins to complain about my fees. I then make an appointment with him and show him his prior returns. With tax planning, if we don’t save you double what we charge, you get your money back. He finally gets it, and we are fine.
The point that I am making is that I have food to put on the table, just like everyone else. However, I’m not going to cheat a client to do so.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...