Need some personal cash? Here's the right way to tap your company
If you thought it was hard finding money to put into your business, wait till you try taking some out. Tapping your company for personal cash isn't as simple as rustling around the petty cash drawer. Do it wrong, and you could hobble your company's growth. Or you might tick off your partner, who no doubt shares your joy about your daughter's coming wedding but isn't thrilled about sharing the bill. Worse still, you may incur the ire of the IRS.
The solution? Lay out a strategy for extracting cash on a continuing basis, before a big expense such as a wedding or college bill arises. That way, you'll have time to take advantage of some little-known but legal tactics for boosting your personal wealth.
First, though, you need to ask if it's economically sensible to take capital from your company. In many cases, says Mark Balasa, a Chicago financial planner, the answer is yes. "You shouldn't keep more money in your business than you need to run it well," he says. Of course, how much cash a company needs depends on its age, industry, and prospects. A business drained to its last dollar has trouble qualifying for loans and insurance, not to mention attracting buyers, notes accountant Thomas Geraghty of American Economic Planning Group Inc. in Watchung, N.J. And a new or fast-growing company may not be able to spare any cash if it's in a competitive field or is a big consumer of technology. The amount varies from industry to industry, but a rule of thumb says you ought to keep a dollar of cash on hand for every dollar of bills due within 90 days.
Once you're over that hurdle, you need to pick the right method. Goodness knows, there are plenty of wrong ones. Borrowing from your company, for instance, is no bargain, because Federal tax rules require you to pay close to market interest rates. And if you thought you could order your company to "forgive" your loan, forget it: The windfall can be taxed as personal income. Such tactics are hardly necessary when there are plenty of perfectly legal things an entrepreneur can do:
- Become Your Own Landlord. If you're renting office space, consider moving to a building you and your partners own. This creates a steady stream of income, and unlike other landlords, you don't have to worry about finding new tenants every few years. Best of all, rental payments escape payroll taxes if they aren't excessive.
Owning the building personally has two other major advantages. First, you can get cash for yourself by mortgaging the property. Second, property owned by a person gets better tax treatment than if it's owned by a company. If you own it, you don't pay taxes on the appreciation until you sell. But if your business is organized as an S corporation, a structure many entrepreneurs favor, the appreciation gets taxed the moment you liquidate the company -- even if you don't sell the property itself.
- Mix Business with Pleasure. Technically, your business can't pay for your personal expenses. In reality, it happens all the time, and you don't have to cross any moral or legal lines to do it.
Take Edward M. Stuart, a financial adviser at Bugen Stuart Korn & Cordara Inc. in Chatham, N.J. "When I have a business meeting in Florida, my wife comes along," he says. He uses frequent-flier miles piled up by business travel, there's no additional cost for the rental car or hotel, and last month, the World Center Marriott in Orlando let the couple stay another night at the cheap rate offered for conventions. "She got a break from work, went shopping, lay by the pool, and it was much more enjoyable for me to have her along," he says. Total savings: about $700. You can even extend a business trip over a weekend if it qualifies you for a reduced airfare, and deduct the additional meals, lodging, and expenses, says Ed Slott, a CPA in Rockville Centre, N.Y. "Saving money is a valid business purpose," he says.
- Boost Your Benefits. Pile on the company fringes. They're deductible to your business and nontaxable to the employee -- and you're an employee, too. That includes medical, life, disability, and long-term care insurance, plus plans that let you pay for uninsured medical and dependent care expenses in pretax dollars.
True, the law in most cases requires you to give the same benefits to the whole staff, which drives up the cost -- but not as much as you think. "When I wanted more disability insurance, I found I could get group coverage for myself and 15 employees cheaper than an individual policy," says Joel S. Isaacson, president of his own New York City financial-planning firm.
One hitch: If you own 2% or more of an S corporation, you're not eligible for "employee" benefits, notes Steven Kaye, president of American Economic Planning Group. But your spouse is eligible, if she or he is a bona fide employee, and if your spouse opts for family coverage, you'll be covered, too. Which brings up the next tactic:
- Do Some Family Planning. In practice, this means funneling money to your spouse and children. Start by getting your spouse on the payroll and into a defined-contribution pension plan, such as a 401(k). A little-noticed rule change in 1997 allows both spouses in a family-owned company to fully participate, potentially doubling your maximum annual contribution to $60,000. Ideally, you should leave the money to grow tax-deferred, but many plans allow you to borrow up to $50,000.
Next, give your kids nonvoting shares in your business. This provides them with income that's taxed at their presumably lower rate after age 14 to invest for college. And there's a built-in bonus: Normally, you'd be liable for gift taxes on any shares you give a kid in any one year that are worth more than $10,000. But as a minority interest in a closely held business, the shares can be discounted by 45%. That allows you to give each child almost $20,000 of stock annually, which should throw off a nice stream of income if your business is thriving. You can even hire the kids. Their earned income is always taxed at their rate -- and as wage earners, they can open Roth individual retirement accounts, which grow untaxed.
- Sell Out, But Stay Put. Selling is the ultimate way to get money out of your business. "You'll pay only 20 cents on the dollar in capital-gains tax," says Alan Weiner, senior tax partner of Holtz Rubenstein & Co. in Melville, N.Y. The obvious downside here is that you wouldn't control the company anymore. But you can get around that by creating an employee stock ownership plan to buy part of your company in cold cash. Just make sure you sell at least a 30% stake, says Jerry L. Lerman, a managing director at American Express Tax Services Group in New York. That way, the money you receive can be tax-deferred if you reinvest it within 12 months into securities of publicly traded U.S. operating companies, such as blue-chip stocks. You won't owe taxes until you sell the stocks.
But why sell? You can convert the shares to cash by borrowing against them, notes Lerman. And if you die owning the shares, your heirs pay no capital-gains tax, thanks to inheritance law. It's a classic case of having your money and spending it, too.
By Lynn Brenner in New York
This article was originally published online as part of the May 25, 1999 edition of Business Week's Frontier. To subscribe, please see our subscription policy.
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