| Spring 2005 |
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INFOLETTER
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Partner's Perspective |
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Strategies for a Graceful Exit
By Richard C. Fedorovich, CPA, Managing Partner
It was hard starting your business, and it won't be easy to leave. To ensure
a smooth transition, develop an exit strategy early, and communicate it clearly.
Work with clear, clean information by assembling the functional reports you
need to manage your departure. And do what it takes to keep your best people.
The value you're transferring isn't warehouse space or a manufacturing line, but
a going concern that promises future earnings—whether the next owner is your
granddaughter or a Fortune 500 giant.
Sell? Or Transfer Ownership?
How will you leave your business? There are two broad answers, and they
dictate different moves. One is to sell your business on the open market. The
other is to transfer ownership to a chosen party—family members or trusted
employees.
Either way, one early step will pay off: pull together a business advisory
counsel—a team of professional specialists to help you weigh options and make
decisions objectively. An attorney, an estate planner, an accountant and an
insurance expert, for example, can ensure that you cover all bases to fulfill
all your aims. Consider other business owners that you may know who have worked
through similar situations as candidates as well.
Maximize Value to Sell on the Market
If your goal is to sell, the first step is to identify the market for your
business. Your local competitors, companies in related lines or national firms
looking for a presence in your area may be interested.
To get the best price for your company, present it in its best light. Start
with a full professional valuation, identify improvements that will produce
returns, and target your spending accordingly.
Transferring Your Business to Heirs or Employees
The aim here is to transfer your ownership in such a way as to favor the new
owner—heirs or others—and also guard your own interests.
A venture in a second company owned by your successor, financed at a low
interest rate, can provide profits with which the successor can buy stock in the
primary company. Or recapitalize with voting and nonvoting stock—the latter is
typically valued lower, and your successor can start with it to buy the
company's stock. An S corporation presents special opportunities in this regard.
If a business is structured as an LLC, the owner can give a profits
interest—with no gift or income tax consequences—to a designated person. Another
vehicle is "phantom stock," and its value grows with that of the company. When
chosen employees receive it in a nonqualified plan, their equity grows as they
produce value.
One method of internal transfer—an employee stock ownership plan, or ESOP—can
be an effective alternative to an open-market sale. The plan can be structured
to enable you to realize fair market value, and still benefit your employees
with significant tax advantages. (If you are selling a "C" corporation to an
ESOP, there may be significant tax advantages to you as well.)
Succession and Disengagement
The first priority here must be protecting the owner's assets. Don't be so
focused on reducing estate taxes, for example, that you undermine the value at
stake in a buy-sell agreement.
Many business owners have few assets outside their companies. If you plan to
sell on terms, or depend upon the company's deferred compensation programs,
focus on building the infrastructure and culture by which the company can
continue profitably without you. That includes conserving sufficient cash—not
letting the business become so cash-strapped that it can't pay its obligations
to retired owners.
Another consideration, more laden with emotion, is how much influence the
owner wants to retain. Sooner or later you'll have to face it: you can either
retire, or hang around and risk impeding the progress of the next generation
instead of setting them up for future success. Setting a firm date is a first
step to move this process along: announce it, and set the company on course.
Take into account, of course, how long you'll be needed during the transition.
What about succession? The founders worked 60 hours a week, and maybe their
kids did, too. But the old shop floor holds less interest for the third
generation—for some, none at all. Objective business decisions must distinguish
between the benefits you want to bestow upon your heirs and the degree of
control over the company you wish to give any of them.
In any case, it's not always smart to bring Junior straight in from college.
Instead, you might let him or her make their way in the world. That way, when
they come on board a few years later, they'll have a baseline of business savvy,
and they'll bring added value in with them.
Exiting gracefully—and profitably—is an art and a science. Our firm can help
you put together a team of the right accounting, valuation, estate planning,
legal and insurance experts that's best for you. Having successfully completed
our own generational transition, we are extremely well positioned to help you
with your succession plan. Please feel free to call or email me at
rickf@bobermarkey.com, or your
Partner/ Manager contact at Bober, Markey, Fedorovich & Company, to discuss this
further. BMF&C
Automatic Cash-Out
Distributions—A New Rule for Retirement Plans
By Cindy H. Mitchell, Tax Supervisor
 For
the last several years, when a plan participant terminated
his/her employment, the account balance in his retirement
account could be distributed to him without his consent, if the
vested balance in his account was less than $5,000. This
mandatory lump-sum "cash out" distribution was for the benefit
of the plan sponsor so as not to incur additional expense in
tracking small account balances of former employees.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)
changed the default option for mandatory qualified plan distributions. Even
though the new rule was introduced in 2001, the effective date was left open so
the IRS could issue guidance on this new procedure. In October 2004, the
Department of Labor finalized guidance providing safe harbor for automatic
rollover of cash-out distributions, and in February 2005 the IRS issued Notice
2005-5 providing additional guidance. Therefore, beginning March 28, 2005, this
new rule will go into effect.
The new rule states that if the vested balance in a former participant's
account is $1,000 or less, a mandatory cash-out distribution can still be made
by sending a check to the former participant with the mandatory 20 percent
withholding. However, if the vested balance is more than $1,000 but less than or
equal to $5,000, the plan sponsor must now roll over the participant's vested
balance to an individual retirement account for the participant if no election
is made to receive a lump sum distribution. The mandatory distribution must be
invested in products designed to preserve principal and provide a reasonable
rate of return. To obtain relief under the safe harbor, plan administrators must
satisfy several other conditions.
All plans that offer a mandatory cash-out feature must be amended to comply
with these new rules by the end of the first plan year ending on or after March
28, 2005. Thus, calendar year plans must be amended by December 31, 2005. Fiscal
year plans ending in March must be amended by March 31, 2005. Plan sponsors have
several amendment options. They can either amend their plans to comply with
these new rollover provisions, they could reduce the cash-out limit to $1,000,
or eliminate the mandatory cash-out all together.
If I can help you better understand this change in the distribution rules and
their implications to your plan, please call or email me at
cindym@bobermarkey.com.
BMF&C
What You Should Know About
Health Savings Accounts
By Mary Taylor, CPA, MT, Senior Manager—Taxation
Services
 It's
no big surprise that the ever-rising cost of providing health insurance
to employees is the number one concern of small business owners in the
United States, according to a recent study conducted by the National
Federation of Independent Business (NFIB) Research Foundation. In fact,
rising healthcare costs have been the top-ranked small business problem
for nearly two decades.
For perhaps the first time since healthcare costs began their relentless
climb, there is now a legitimate health insurance option that may make it easier
for small businesses to offer coverage to their employees. Health Savings
Accounts, or HSAs, were established as part of the Medicare prescription drug
bill that was enacted late last year. They have been available to 250 million
non-elderly Americans since January 1, 2004.
HSAs replaced Medical Savings Accounts (MSAs), which were created in 1996 for
small businesses and the self-employed. Due to various restrictions, though,
MSAs have not been widely adopted. The most cumbersome of these restrictions was
a "use it or lose it" provision in which unused funds had to be forfeited at the
end of each year.
Employers seem to be embracing the concept of HSAs as they have learned more
about them during the past year. In one recent survey, three-quarters of
employers said they expect to offer HSAs to their employees by 2006.
How Do HSAs Work?
An HSA must be established in conjunction with a high-deductible health plan
(HDHP), which is a separate insurance policy with a minimum deductible of $1,000
for an individual or $2,000 for a family. (Families may choose policies with
higher deductibles in order to save on premiums.) For 2004, the maximum
out-of-pocket expense for allowed costs is $5,000 for individuals and $10,000
for families.
Once the HDHP is in place, individuals may contribute to their HSAs each year
an amount up to their deductible. For 2004, maximum contributions are $2,600 for
individuals and $5,150 for families. (Individuals between ages 55 and 65 can
contribute an extra $500 this year.) Employers can also contribute to their
employees' HSAs. Employer contributions are excluded from employees' income.
A typical scenario might look something like this: An individual would cover
the first amount of medical expenses from his or her HSA funds. If these funds
are exhausted before the deductible is reached, remaining expenses up to the
deductible would have to be covered by the individual out of pocket. Once the
deductible is met, the HDHP would cover all remaining costs.
Tax Benefits of HSAs
All HSA contributions made by employees are tax-deductible and can earn
interest or be invested in stocks or mutual funds, where earnings grow tax-free
(similar to 401(k)s and IRAs). Because HSA balances belong to the individuals
and follow them from job to job, a young, healthy person could conceivably
accumulate hundreds of thousands of dollars over a lifetime to pay for medical
expenses during retirement.
HSA funds can be withdrawn tax-free at any age to pay for qualified medical
expenses, including deductibles, co-payments and many charges that may not be
covered by standard health plans, such as over-the-counter drugs and vision and
dental care. Unused HSA funds at death may be passed on to a spouse or other
heirs, just like unused IRA or 401(k) funds.
Beginning at age 65, HSA funds can be used to pay the employee's share of
retiree medical insurance premiums or Medicare premiums, or they can be
withdrawn for non-medical purposes. However, funds withdrawn for non-medical
purposes beginning at age 65 will be subject to tax, and the same non-medical
withdrawals prior to age 65 are subject to tax and a 10 percent early
distribution penalty.
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Leveling the Playing Field
The tax treatment of HSAs helps create a more level playing field for
small businesses and individuals when it comes to paying for health care.
Here's why:
Every dollar employers spend on health insurance for their employees
avoids both income and payroll taxes. As a result, the government is
effectively covering almost half the cost of health insurance for the
average middle-income employee. Before HSAs, however, if employers
contributed money directly into savings accounts for employees to use to pay
their healthcare expenses, or if employees self-insured themselves, the
government took away almost half of every dollar in taxes.
This system heavily subsidized the use of third-party insurance while
penalizing individual self-insurance, thus encouraging the use of
third-party bureaucracies even when it made more sense for individuals to
manage expenses themselves. Now, employer and employee contributions to HSAs
enjoy the same tax benefits that were formerly available only when employers
paid health insurance premiums.
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HSA Eligibility Requirements
To participate in an HSA, an individual:
- Must be covered by an HDHP.
- May not be covered by any other health insurance plan (specific injury,
accident, disability, dental, vision and long-term care insurance are not
considered other health insurance plans).
- May not be eligible for Medicare.
- Cannot be claimed as a dependent on another person's tax return.
Dozens of companies (primarily insurance companies and banks) now offer HDHPs
and HSAs. A great online resource for locating a plan provider is
hsainsider.com, a Web site maintained by the HSA Coalition in Washington, D.C.
New competitors are entering the HSA market almost every day, notes the site,
and offerings vary widely in price and benefits. Whether you are an employer
searching for a plan to offer in the workplace or an individual looking to start
a plan for yourself and your family, you really have to do your homework.
Clearly, health insurance is a critical issue in our nation today. While
everyone may not agree on the best fix, most people do agree that our current
system of providing health coverage will not survive indefinitely without some
changes. Health Savings Accounts may be a first step toward a future system in
which individuals are truly healthcare consumers—with greater control over
delivery of their health care and how their healthcare dollars are spent.
If you are considering setting up an HSA for your company or for yourself,
please call or email me at
maryt@bobermarkey.com. We can help you choose the plan that will best suit
the specific needs of your company, employees and family. BMF&C
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In this feature of InfoLetter, each quarter we provide a profile of
one of our professionals who is available to work with our clients and
friends.
Michael J. Moldvay, CPA
Manager—Assurance & Advisory Service |
Mike's experience includes providing traditional audit, review and
compilation services to clients in a variety of industries including
manufacturing, retail, distribution, and non-profits. Mike also has significant
experience in the area of employee benefit plan audits, especially defined
contribution plans.
Mike graduated cum laude from The University of Akron's Honors Program in
1995 with a Bachelor of Science Degree in Accounting. While at the University,
he was a member in the business honor society, Beta Gamma Sigma, and the
accounting honor society, Beta Alpha Psi.
Mike is a member of the Board of Governors of the Tuscora Park Health &
Wellness Foundation, for which he serves as Treasurer, and a former member of
the Board of Trustees of Choices Community Social Center. Further, Mike is a
Director and Treasurer of the Akron/Canton Regional Foodbank and a member of
Torchbearers, a group of young professionals seeking to identify and groom the
region's future leaders. Additionally, Mike is a member of the American
Institute of Certified Public Accountants and the Ohio Society of Certified
Public Accountants
"During the audit process, we get the opportunity to gain an understanding of
our client's business beyond the numbers. This allows our team to provide more
than just a set of financial statements or a tax return. It is using this
understanding of a client's business to provide the services of a trusted
advisor that provides the greatest satisfaction to me and, more importantly, the
most value to our clients." BMF&C
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