Welcome back to our 3-part blog series where we discuss 12 Deadly Sins that could potentially kill profit and lifelong success for auto shops. Read on for Sins 5 – 8. If you missed last week’s blog, click here.
You Think Tax Planning Starts and Ends on April 15th
Too many times we get new clients after they have received the dreaded April 14th surprise from their old accountant: “You owe a big tax bill and you need to pay it ASAP.” Unexpected expenditures are the main killer to any small business, and unexpected taxes are the worst because the government always gets their money. We are known to be pretty aggressive in our tax positions because at the end of the day, we have the same objective as you: Pay the least amount of tax legally possible utilizing any avenues that keep more money in your pocket and lead to your long-term success. However, there is only so much that we can do after the year is over. All our monthly clients know how much tax they are going to owe by fall time. We do a full tax estimate that incorporates their payroll, their business, and any deductions for the year so that we have a complete picture. Once we know how much they are going to owe (or get back) we talk about tax planning, tax minimization, and possibly budgeting for the upcoming balance due. Some very successful businesses are going to owe tax, and there is no way to get around that. However, if you know that you are going to owe a $20k tax bill in 6 months, you will make very different decisions on how you run your business and your personal life. Tax planning needs to be done proactively, not retroactively.
You Aren’t Planning Your Own Retirement
“My business is my retirement.” This is a statement that we hear far too often from shop owners. In reality, your business is probably worth much less than you would like, and it will not provide sufficient cash on its own to fund your retirement. Shops are sold based on money available to the owner and a multiple of 2.5-3 times your average annual take home amount. This means that if you were to strip down the business and take all the cash out that is possible, the value of your business is worth 3 times this amount on the high end. You know what your business makes – do you think that you could live through retirement off 3 times that number? Probably not. The single best deduction that a business owner can take is contributing to a retirement account. It is a 100% deductible expense by contributing, and it is tax deferred while the asset grows to your full retirement age. We are known to be aggressive in our tax planning and interpretations, but I will not talk about any sort of creative deductions until your retirement contribution is maxed out for the year. There is nothing else out there that you can get a full deduction for putting money in your own pocket.
You Aren’t Paying Yourself Proper Rent
In a perfect world, the real estate that your business uses is owned outside of your operating entity and ideally it is owned by a separate LLC. We won’t get into the deeper reasons of this structure right now, but the short answer is it provides legal protection in case something goes wrong. However, by owning the real estate outside of the operating entity, you will need to pay yourself rent so that you can cover the cost of the mortgage, taxes, etc. Most shops that are setup like this and have a mortgage on the property “pay themselves” by classifying the mortgage payments as rental expense on the business, and rental income on their rental. Some shops that don’t have a mortgage are paying themselves little to no rent at all since the real estate doesn’t require cash to operate because the shop is shouldering the burden of expenses. What we need to do is strip out the related party idea and find out what is fair market value for the real estate. In other words, what would you charge someone else if they were renting this space from you? By doing this we are setting your business up to be self-sufficient. Let’s look at an example: You pay yourself $2,000/month in rent and you decide to sell your shop. The shop is profitable, but not overly profitable. It is making a decent return. The new buyer does not have the cash to purchase the real estate but instead wants to rent from you until he can get the capital needed to purchase the building. Are you going to charge them the same amount that you have been paying? If you are at fair market value, then you are fine. However, if fair market value is $5,000/month then that is more likely the amount you would propose. Is the $3,000/month extra expenses going to be sustainable for the shop for the new owner? No one knows because you do not have a track record to prove that the shop can handle this. On the other hand, if you had been paying yourself fair market value rent for the last 3 years you have deliverable results that you can show the new buyer that it can be done, and it can be done while still remaining profitable. You need to set your business up to make a profit while at the same time set your business up to sell.
You Aren’t Paying Yourself Correct Wages
One of the benefits of being self-employed is that you determine how much you are going to make on payroll. Just starting out in your shop, you were probably the last person to get paid. As the years go on you increase your salary because the business is growing and becoming more successful. However, as the wages increase, so do your payroll taxes, which means less money in your pocket. If you go the other direction and try to work the system by paying yourself little to no wages, you are saving payroll taxes, but you are putting yourself in a bad situation for multiple reasons. If you pay yourself low to no wages, you are putting yourself at risk with the IRS because you are not paying yourself “fair and reasonable” wages for your services. You are also not contributing enough to social security, so your future benefits are being diminished. If you are paying yourself too high of wages, you are throwing money away because you are paying excess payroll taxes that could be in your pocket and not Uncle Sam’s. The happy medium is right in the middle and for most shop owners, we find that to be around $60,000 – $65,000/ year. There are some more intricacies involved in this and you can read more about it here: How Much Should I Pay Myself?
Stay tuned next week for our final 4 Deadly Sins potentially hurting your shop!