Assume your company has a cost basis of $100,000 and a sale price of $2 million. If you sold it outright, you would wind up paying about 35% in taxes on a capital gain of $1.9 million. That would leave an after-tax profit of $1,235,000 -- which might yield an annual income of $93,000 (assuming a 7% after-tax rate on $1,235,000, plus the untaxed $100,000). If at age 55 you had instead set up a charitable remainder trust, the full $2-million sale price could have been invested; assuming the same 7% after-tax rate, you would receive annual payouts of $140,000. You'd also receive an immediate tax deduction of about $400,000 for your contribution, which is the government's calculation of the value of the discounted $2-million contribution. At the end of the trust's life, the remaining funds would pass on to the charity.
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PERSONAL PORTFOLIO
* Insurance. For business owners and their executives, using an insurance trust to avoid estate taxes on the payouts from life-insurance policies is a simple personal tax-saving technique.
Here's how to do it: set up a trust whose purpose is to own all existing and future insurance policies on your life. As long as the trust owns the policies, the proceeds to your beneficiaries will be free -- that's right, absolutely free -- of estate taxes that now can run as high as 55%.
One potential problem: if the insured person dies within three years of transferring ownership of existing policies to the trust, the law says that policy proceeds must be taxed as part of the overall estate. Of course, your beneficiaries are no worse off than if the transfer hadn't taken place. One strategy to avoid possible transfer problems is to make an outright gift of funds to the trust, which then purchases its own insurance policies.
* Charitable Donations. Finally, a one-shot tax break that's too sweet to ignore came out of 1990's tax legislation. During tax year 1991 those who make charitable donations of artwork and other "appreciated tangible personal property" won't be socked with hefty penalties under the Alternative Minimum Tax (AMT) law. If you are a collector, the enticement speaks for itself. Since the AMT "preference" charge can be quite hefty for an art collection that rose in value during the go-go '80s, it's worth accelerating planned donations.
TAX TIPS
Some advice from managers who are experienced in weighing tax matters against the other financial needs of growing companies:
* Start tax planning early. "Since this is my second start-up, I'm trying to avoid some of the mistakes I made the first time around," says Mark Klein, chief executive of Channel Computing Inc., a software developer in Newmarket, N.H. "I learned along the way that tax savings can help pay for corporate growth, so with Channel I went out and hired my tax accountant and started tax planning before I even hired any full-time employees." Recently, Klein decided to purchase -- rather than lease -- new, expanded office space because he calculated that tax subsidies helped tip the balance to make it more profitable to buy.
* Keep detailed tax records. M. C. "Mac" McConnell, whose Fort Lauderdale, Fla., company, The Artful Framer Gallery, has grown from $175,000 in sales to $625,000 over the last four years, keeps meticulous records of all expenditures. "My computer software forces me to categorize every check I write and every deposit I receive, so there's absolutely no guessing -- or missed opportunity -- when it comes to figuring out my taxes."
Ann Blakeley, president and CEO of Earth Resources Corp., a hazardous-waste-management firm, agrees. "Since we do a lot of research and development, the R&D tax credit really adds up for us. So I tell my people that they've got to keep the same kind of accurate, detailed records -- complete with full documentation and very precise time and cost breakdowns -- that they would keep for any project where we were billing a customer."
* Document top-level tax decisions. John C. Heenan, the chief financial officer of Physical Acoustics Corp., in Lawrenceville, N.J., must juggle the needs of four foreign subsidiaries with the tax considerations of a U.S. parent. "I've found it helpful in dealing with the IRS to keep detailed minutes of meetings in which board members or key executives authorize decisions about tax-related matters like charges to foreign subsidiaries or how we'll make use of our net operating losses. It's better to prepare the records in advance than to have to scramble around for documentation if the company gets audited."
* Don't let taxes run the company. Although tax savings can definitely add up, it's essential for managers to remember that those savings are only one factor in a business decision. "It feels as if I've spent $5 trillion on accountants, only to come down to one basic conclusion," emphasizes Richard Novak, owner of N.H.S. Inc., in Soquel, Calif., which sold $23 million worth of skateboards and snowboards last year. "If you earn $100 in profit on the sale of skateboards, you'll eventually have to pay $40 or so in taxes. Rather than coming up with some kind of crazy, time-consuming tax scheme that just puts off the inevitable, I'd rather pay my taxes and put that $60 to work in ways that will generate more sales for the company."
IS YOUR ACCOUNTANT SAVVY?
Sophisticated tax strategies require expert advice
It's not uncommon for young companies to outgrow their accountants. But how can you tell if that's the case? Here are the types of questions you might ask -- and some red flags to watch out for.
