Month: September 2020

Key Principles of Successful Partnerships

By Nevin Beiler, Attorney

We all know people who are partners in businesses. Maybe you are a partner in a business, or you work for a partnership. Maybe your experience with partnerships has been good, maybe it has been bad. In my work as an attorney I see it all—good, bad, and ugly.

Business partnerships play an important role in our families and communities. They represent jobs and income to owners and employees, and they provide products and services to the community. The success or failure of these partnerships can significantly impact not just our personal finances, but also our relationships and community connections. Success in business involves much more than the financial bottom line, and when we partner with others in business, this becomes very evident.

In this article I will share a few things I have learned and observed about what makes partnerships successful. The three key areas I will cover are Compatibility of the Partners, Defining Roles and Expectations, and Preventing and Resolving Conflict. But first, a quick story to provide context for my discussion of these areas.

Paul and Mark (names changed to protect privacy) were a father and son with a successful service business. Paul (the father) had started the business on his own, and Mark joined a few later just as the business was getting off the ground. They worked together for about 15 years, and the business eventually became very successful.

Unfortunately, Paul and Mark’s relationship started to get rocky. They had different ideas about how to manage the business. Paul was focused on things that increased customer satisfaction, but wasn’t as concerned about employee satisfaction. Mark would have liked to focus on employee satisfaction as much or more than customer satisfaction. Paul tended to be more frugal minded, while Mark was quicker to spend money.

Somewhere along the line Paul decided that he wanted to share profits 50/50 with his son Mark, so he gave him 50% of the business. Paul’s expectation was that he would still be considered the boss, but eventually Mark began to assume and expect that he and Paul had equal authority (as 50/50 owners).

Unfortunately, neither Paul nor Mark were natural communicators. Their failure to communicate regularly and maintain clear expectations began to create more and more conflict. The most difficult conflict arose when Mark, who was expecting to completely take over the business from Paul in one or two years, realized that Paul did not want to sell out for another three to five years. Mark felt that he could not continue with the way things were going for that long, so he ended up selling out of the business. This was not what either of them wanted, but Mark felt like he had no choice.

With this story in mind, let’s think about some principles that would have helped Paul and Mark be more successful at working together.

Compatibility of the Partners

For partners to work well together, they need to have at least some level of compatibility. This does not mean that they do everything the same way, or always think the same. It does mean, however, that they know each other well and are able to work together towards common goals.

The Purpose of the Partnership: The partners should agree on the purpose of the partnership. Why does it exist? What is it trying to accomplish? What are its core values? One obvious goal of a business is to financially support its owners, but the mission and purpose should be bigger than that. The bigger purpose might be to provide good jobs with a good work environment. Or to provide a needed product and service to the community. Or to generate financial resources to support Christian ministries. Core values might include things such as integrity and innovation. When partners have a shared sense of purpose for their business, it can help keep them headed in the same direction.

Complimentary Skills and Personalities: Different personalities can bring balance to a partnership. For example, one partner might be a visionary while the other is an implementer. The visionary can see opportunities and come up with ideas for how to grow and improve the business. The implementer is the person who is good at consistently getting things done and implementing ideas. These two types of people need each other to reach their full potential.

Ability to Communicate: Partners must be able to maintain open and healthy communication. Otherwise, it will probably be just a matter of time before serious conflict arises. Partners that are communicating regularly will probably still experience some conflict. But by maintaining open communication, it is more likely that they will be able to resolve conflict in healthy ways, which will make their business relationships stronger.

Paul and Mark may have had a vague sense of business purpose that they shared, but they also had different ideas about how important it was to care for customers vs. employees, which sometimes caused friction. Their personalities were somewhat complimentary, with Paul being more of a visionary type and Mark being more of an implementer. But where they really struggled was with a lack of communication. This allowed small conflicts to fester and grow larger, and resulted in unmet expectations that eventually caused Mark to leave the business.

One good way to get to know your partners (or your employees) and improve communication is by taking a DISC assessment (or another type of personality evaluation) together with your partners and/or employees. I have taken the DISC assessment myself, and I have heard good things from other business owners who have taken it. DISC stands for Dominance, Influence, Steadiness, and Conscientiousness. Taking this evaluation, and then reviewing it together with your partners (or employees), can teach you a lot about each other (and yourself!).

Defining Roles and Expectations

For a partnership to function effectively, each partner needs to understand both his (or her) authority and responsibilities.

Some partnerships have two equal partners (50/50), like Paul and Mark. Some have majority partners and minority partners (such as 70/20/10). Whatever the case, each partner should know the extent of his authority. This is usually determined primarily by the partnership agreement, which may state that all partners will act together to manage the partnership or that the partners must appoint a managing partner to manage the partnership. The partnership agreement should clarify what actions require approval by more than one of the partners (usually by a majority or unanimous vote of the partners).

When a partnership is managed by all the partners without clarity about who has what authority, things can get difficult. This is especially true when the partnership is 50/50, because any time the partners don’t agree they are essentially stuck until they compromise or one of them changes his mind. This was the difficulty Paul and Mark found themselves in. For this reason, it is generally wise to avoid 50/50 partnerships, unless the partners agree on a way to get unstuck when they don’t agree on a decision. It is best if this agreement is in writing, ideally in the partnership agreement.

In addition to clarifying how the partnership will be managed, the responsibilities of each partner should be clarified. Many partners have both management responsibilities and production responsibilities. Taking the time to write out a job description for each partner, especially each partner’s management responsibilities, can help avoid power struggles or frustration among the partners when things do not get done.

Preventing and Resolving Conflict

Business partners are likely to encounter conflict at some point. But the conflict they encounter does not need to be bad or harmful. A certain level of conflict can actually be healthy for a business—if it promotes good discussion and improvements in how the business is operated. When partners can share and discuss different perspectives, it often leads to better results than if everyone thinks the same way. But too much conflict, or conflict that is not properly handled, can be very harmful for a business.

We can reduce the amount of unhealthy conflict in our businesses by clarifying expectations. This requires regular and frequent communication. If Paul and Mark had done this, they might still be working together today.

Decide ahead of time what process you will use to resolve conflict. This might involve the assistance of a third party to help resolve the conflict, or even a committee that can give counsel or binding direction. I shared some recommendations about this in my article “The Importance of a Good Partnership Agreement,” which was published in the September 2018 edition of the PCBE. When we don’t know how to address conflict it is even more tempting to just avoid it, so it can be very helpful to have a conflict resolution plan in place before you need it. I suggest that you include this plan in your partnership agreement.

Avoiding conflict, perhaps in the hope it will go away on its own, is usually a big mistake. Just like in marriage and other close relationships, conflict that is ignored just gets bigger and creates wounds that go deeper. When we can confront and effectively deal with conflict, we can experience freedom. And we will develop deeper and more trusting relationships with our business partners when we can successfully work through difficult issues and disagreements. If you need help to do this, ask a trusted friend, business advisor, or church leader for help.

When you encounter conflict, whether at home or in your business, remember this important principle: “Seek first to understand, then to be understood.” This is a concept that Stephen Covey talks about in his book The Seven Habits of Highly Effective People. While it is natural to want to give our opinion when we are experiencing conflict, it usually works better if we approach the person with whom we are disagreeing with a willingness to first listen to them. There are two sides to every story, and hearing their side of the story can help us understand the full picture. Once we understand them, we can better share our side of the story, and they will probably be more willing to listen if they feel heard and understood.

Conclusion

Partnerships can be a great blessing, but they can also be a source of great difficulty. To a large extent, our words and actions will determine which we experience. Know your partners, clarify your roles, and communicate well.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, settling estates, and business formations & agreements. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com. This article was originally printed in the Plain Communities Business Exchange.

Disclaimer: This article is general in nature and is not intended to provide specific legal or tax advice. Please contact Nevin or another attorney licensed in your state to discuss your specific legal questions.

Preface: We are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly.” B. Franklin

Tax Planning for the 2020 Year

Credit: Donald J. Sauder, CPA | CVA

Tax planning time is never wasted, and this year that tax planning has a chance to be more pertinent than in recent years. With 2020 being a presidential election year and therefore, an increased variable for the 2021-year tax rates with a shift in Presidential legislation, getting your tax planning right for the 2020 tax year is pertinent. Income taxes are often one of the most substantial costs annual recurring costs for entrepreneurs and households alike.

The bottom line, this may again be perhaps the year to pay as much income tax as possible. Pay tax, buildup equity, and pay down debt. Then reserve deductions for the new year when tax rates have a material risk of shifting higher.

For the 2020 year, married filing joint tax payers are in a 10% rate up $19,750 in earnings, 12% up to $80,250, 22% to $171,050, 24% to $326,600, 32% to $414,700 with a maximum rate of 37%. Single tax filers are in a 10% bracket to $9,875 in taxable income, 12% to $40,125; 22% to $85,525; and 24% to $163,300, and 32% up to 207,350 with tax maximum rate of 37%.

For the 2020 tax year, decisive tax planning strategies could include accelerating taxable income recognition to capitalize on the lower Trump Legislation tax rates before any new Legislative changes could risk a shake-up in either capital gains, corporation rates, or ordinary tax rates. This could encompass converting traditional IRA’s to Roth IRA’s or taking larger distributions to shield capital from higher taxes on taxable distributions. Also pertinent is considering harvesting capital gains on investment assets to protect both investable capital or higher taxable gain rates. Or simply reshuffling your investment portfolio to increase lower future tax costs should the market continue to climb and a potential capital gain tax rate increase.

Step two in tax planning considerations for 2020 incorporate deferring tax deductions and expenses. The tax strategies could include deferring major capital expenditures on either equipment, accelerated build-outs, or vehicles for your business until January 1, 2021, to manage any variables on tax rates in the new year, and deferring one-time charitable donation pledges until 2021. Another significant tax variable is the risk in a possible change to the current transfer-friendly estate and gift tax exclusions. If you are planning substantial gifts of assets, you may want to talk with your tax advisor on the potential benefits of accelerating those gifts of assets in the 2020 year to avoid the risk of higher costs in the future from changes in tax laws.

Scheduling a meeting with an experienced estate attorney to plan your will to enable your executor or heirs to assign assets with highest the tax liabilities to charities if you’re planning to gift. Specifically, it doesn’t make sense to donate assets from your estate with lower tax implications and burden heirs with higher tax burdens assets, i.e., some retirement accounts. Besides, if you have a trust or plans to organize a trust to minimize estate taxes, you are advised to talk with your estate planning expert on the potential planning variables with a change in the tax laws.

The bright-line great news is that all the above tax factors and likelihoods should be known before early December on whether the Trump-friendly business tax legislation is intact per the November Presidential election results. Hence, a real possibility and probability continue that tax planning could again be straightforward and uncomplicated, perhaps for the 2020 year.

Once again, we remind readers that debt is paid with after-tax dollars. For example, if you borrow $100,000 for business or personal, you will pay it back with $100,000 plus the cost of taxes, i.e., say $130,000. Therefore, the lower tax rates decrease, the more affordable debt financing and repayment are obtained. This wind in the sails has powered the craft well in recent years, but this leverages words both ways; hence a word of caution should tax rates increase on income taxes.

In contrast to the sunny economic climate of 2019, according to Jeffery Gundlach, 24% of income in the US is now from the government. As this trend builds in government payments that gain more market share in the economy, taxpayers will eventually pick-up the expenses. Secondly, approximately Fifty+ million Americans have lost their jobs since the Covid-19 pandemic began, and over 50% of households in major cities are financially distressed. In contrast, one in five children doesn’t have enough to eat.

Summary: If you are concerned about tax planning for the 2020 year, firstly, you’re advised to quietly “ponder” optimal steps with the sunrise to manage 2020 tax attributes, and then speak with your trusted tax advisor.

This article is general in nature, and it does not contain legal or tax advice, nor is it to be construed as tax or legal advice.  Contact your trusted advisors to discuss your specific situation.

 

Preface: Tax shelters are financial vehicles individuals and corporations incorporate to minimize tax liabilities. Shelters range from employer-sponsored 401(k) programs to overseas bank accounts. The phrase “tax shelter” is often used as a pejorative phrase, but a “tax shelter” can be also be a uniquely legal way to permissibly reduce tax liabilities.

Managing Euroclydon Risks with Corporate “Tax Shelters”

This blog is posted to address corporate concerns regarding the IRS’s continuing campaign to identify and shut down abusive corporate tax shelters, many of which involve transfers of rights or property to foreign entities.

In recent years, offshore asset reporting has become one of the IRS’s primary areas of focus as it seeks to increase tax revenue. In 2010 Congress addressed the significant issue of international tax compliance, enacting the Foreign Account Tax Compliance Act (FATCA). FATCA imposes more stringent reporting requirements and, in many cases, increased tax liability on U.S. taxpayers—many of whom are corporations—with investments in offshore accounts. Since then, the Treasury Department and the IRS have issued new regulations to implement FATCA and its reporting and disclosure regime.

The IRS is cracking down on tax shelters in other ways as well. Many employees of publicly traded companies are taking advantage of the tax whistleblower provisions of the Tax Relief and Health Care Act of 2006, which often enable the IRS to provide a hefty reward to those who report tax evasion. Additionally, the Treasury Inspector General for Tax Administration has recommended that the IRS improve its audits of small corporations, meaning that corporations with assets of $10 million or less may begin to feel a squeeze from examiners in upcoming tax years.

Large Business & International

As part of its initiative to increase international corporate tax compliance, the IRS has reorganized its 600-employee Large and Mid-Size Division (LMSB) into the Large Business & International Division (LB&I). The IRS more than doubled the number of employees, many of them industry experts and practitioners, and made in-roads to improving employee education and skill sets. LB&I’s expanded purview includes LMSB’s original jurisdiction over corporations, S corporations, and partnerships with assets of $10 million or more and also the implementation of the FATCA provisions.

Annual Reporting for Reportable Transaction Disclosure

Any taxpayer, including an individual, trust, estate, partnership, S corporation, or other corporation, that participates in a reportable transaction and is required to file a federal tax return or information return must file Form 8886 disclosing the transaction. The IRS maintains a list of the abusive transactions which must be reviewed annually by the taxpayers. The taxpayer must attach a Form 8886 disclosure statement to each tax return reflecting participation in the reportable transaction. The taxpayer must also send a copy of the Form 8886 to the Office of Tax Shelter Analysis (OTSA).

Offshore Voluntary Disclosure Program

In 2011, the IRS relaunched its Offshore Voluntary Disclosure Program (OVDP), which rewards taxpayers who disclose unreported foreign accounts with a reduced penalty framework. The revived OVDP has no official end date but the IRS has cautioned that it may terminate the program at anytime.

FATCA

In addition to requiring certain U.S. taxpayers holding financial assets outside the United States to report them to the IRS, FATCA generally require foreign financial institutions to report certain information about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest. Non-compliant foreign financial institutions could be subject to a 30% withholding tax on all U.S. sourced payments.

The IRS has stressed its intent that FATCA be a reporting regime rather than a penalty regime, and that it is eager to work with industry professionals and experts into ease the law into implementation. Nevertheless, the effect of FATCA on corporate offshore tax shelters is meant to be severe on the numerous abusive tax shelters that take advantage of lower or non-existent corporate income tax rates abroad through the dubious transfer or licensing of assets.

Small Business/Self-Employed

IRS’s Small Business/Self-Employed division, which holds in its jurisdiction all small businesses with assets of less than $10 million, plans to be more proactive in its field audits this year, concentrating in particular on stopping line-item schemes such as inflated business deductions or false earned income credit claims. SB/SE is currently at work expanding the knowledge and skill set of its examiners, matching exams to those examiners with the greatest knowledge of the subject matter involved, and producing online materials that will better educated taxpayers on their responsibilities. For the long-term, the SB/SE may update the index by which it selects tax returns for audit so that exams are targeted to returns likely to contain underreported tax.

Other Initiatives

The whistleblower rules encourage individuals to report any tax abuses or corporate fraud through generous reward offers. In 2012, the IRS paid out its largest award, more than $100 million, to an individual who disclosed tax evasion by a foreign bank.

The IRS has also maintained its campaign against accounting and law firms that design or promote tax shelters. The “anything goes” attitude of past years ago is a long faded memory. And while the IRS has been enforcing the law, Congress is looking to close as many loopholes as possible to prevent tax evasion. IRS examiners are still directed to look for the checklist of characteristics common in abusive corporate tax shelters. These include:

• • • A reported transaction has no business purpose or economic substance other than to minimize taxes;
    • Investments made late in the tax year that indicate there may be deductions for prepaid expenses that are not allowable.
    • A large portion of the investment made in the first year indicates the transaction may have been entered into for tax purposes rather than economic motivation.
    • A loss exceeding a taxpayer’s investment indicates the possibility of a nonrecourse note.
    • If the burdens and benefits of ownership have not passed to the taxpayer, the parties have not intended for ownership of the property to pass at the time of the alleged sale.
    • A sales price that does not relate comparably to the fair market value of the property indicates the value of the property has been overstated.
    • If the estimated present value of all future income does not compare favorably with the present value of all the investment and associated costs of the shelter the economic reality of the investment may be questionable.

Some businesses are concerned that the IRS’s focus on tax shelters will mean increasing scrutiny of other aspects of their business operations as well. Others want to undertake internal protective audits to set up a strategy against IRS involvement before the IRS sends out audit letters.

If you would like a further analysis of how the IRS assault on tax shelters may affect you, directly or indirectly, please call your trusted tax advisor.

The Importance of a Good Partnership Agreement (Segment II of II)

Credit: Nevin Beiler, Attorney

Segment II of II Continued

What We Can Learn From This Story

Unfortunately, disagreements among business partners are far too common, even among family members and Bible-believing Christians. As a result, some people refuse to enter a business partnership with anyone as a matter of principle, because they don’t want to risk the conflict. I personally don’t think that partnerships should be off limits for everyone, but I appreciate the concern that people have about the risks of entering a partnership. If you are a partner in a business, let’s think about what we can learn from the above story so that your partnership does not have the same problems.

In our story, Jake and Henry (and their father) failed to adopt a partnership agreement that could have helped them resolve management conflicts and have a pre-established buyout plan. The right time to adopt a partnership agreement is early on in the life of a partnership, ideally at the same time the business is formed. This agreement should be reviewed and revised periodically, especially if there are major changes in ownership. It is much easier for partners to agree on management and buy/sell provisions early on before disagreements arise. And if you cannot agree on management terms or buy/sell terms when you are entering a partnership, stay out of the partnership.

A well-written partnership agreement should specify which partner has the final say in management decisions, either by naming a managing partner or by specifying how the voting rights will work. If the partners have equal management and voting rights (which is not advisable, but is not uncommon) the partnership agreement should specify a process of breaking a deadlock if the partners cannot agree on any given issue. This could involve giving a trusted business advisor the ability to break a deadlock on management decisions, or any other approach that the partners are comfortable with.

Another key aspect of a partnership agreement is how a partner can or must be bought out if a partner wants to leave the partnership, dies, becomes mentally incapacitated, or needs to be bought out for other reasons. In addition to specifying who has the rights to buy the ownership share of the departing partner, the partnership agreement can specify how the buyout price will be established and paid if the buyer and seller of the ownership interest cannot agree on a price and payment terms. Two common methods of setting a buyout price are (1) having the partners agree in writing to a valuation of the business on an annual basis, with that value being the buyout price for the following year, and (2) hiring an independent appraiser to value the business periodically or at the time of the buyout.

A third key aspect of a partnership agreement is a dispute resolution provision that gives the partners a good way to address disagreements as they arise instead of letting the disagreements pile up. Good communication is critical to the success of a partnership. Having a plan for communicating about and resolving disagreements can make the difference between the success or failure of a partnership.

For example, I often write partnership agreements that require partners to work with a third-party mediator to resolve disputes. This could be a professional mediator or a trusted business advisor or church leader that both partners are comfortable working with. Mediation involves the partners meeting (perhaps several times) with one or more mediators to help them discuss the problem and hopefully reach a voluntary agreement on what to do.

If the disagreement is not resolved in mediation, I generally recommend that the partnership agreement require the appointment of a three-man team of impartial business advisors or a church committee to give binding direction to the partners. This is an informal method of what is called “arbitration.” (Professional arbitration services are also available if necessary, but they tend to be more expensive and adversarial.) The partnership agreement should require each partner to follow the decision of the arbitrators.

There are other important things to include in a partnership agreement, but clear management provisions, comprehensive buy/sell provisions, and good dispute resolution provisions are the most important things that are sometimes missing from partnership agreements.

Working through all these issues can take some time. But it is time well spent. Even if a partnership never has a full-blown dispute between the partners, taking the time to prepare or update a customized partnership agreement is a very good way to communicate about, and clarify, the expectations of all the partners. And having clear expectations is a benefit to any business.

If Jake and Henry (or their father) had taken the time to set clear expectations and adopt a good partnership agreement for their business, they likely could have avoided a great deal of heartache and expense. Take the opportunity to learn from their story, and consider whether reviewing and updating your partnership agreement would make your business stronger. Also, if you find yourself in the midst of partnership conflict, don’t be afraid to ask for help, especially if you and your partner(s) are having trouble communicating. Open and honest communication is the salve that can heal a broken relationship.

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, estate administration, and business law. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.