By Judy L. Mina, Owner, HR Now!
We are all trying our best to run our businesses and stay on top of the myriad of legal challenges we’re faced with on a day-to-day basis, one of which is dealing with our employees. Unfortunately, as layoffs and reductions in staff continue to be on the rise, legal challenges are sure to follow.
As you are most likely aware, an estimated two-thirds of the nation's non-residential construction companies are planning to cut their payrolls, according to new employment and business forecast figures released recently by the Associated General Contractors of America. When said and done, those layoffs are forecast to result in a 30 percent decline in the number of people working on construction projects. And that’s just one industry.
Former employees from major U.S. banking institutions and Wall Street giants are seeking help from the federal government and employment lawyers. Employees who feel they have been discriminated against by their employers must file a claim with the federal government. In 2008 there was a 15% jump in federal claims and legal experts predict those numbers to skyrocket. With job layoffs in the hundreds of thousands and executives remaining employed, employees are asking the civil justice system to help maintain their workers’ rights.
Former employees for Lehman Brothers claim they were not given the required 60 days notice, under federal law, before being laid off. The Worker Adjustment and Retraining Notification Act, known as the Warn Act, was enacted into law in 1989, requiring an employer give workers 60 days’ notice before letting them go. After a recent layoff at Dell Computer, affected employees from Dell are suing the computer giant alleging age and sex discrimination.
President Obama recently signed legislation last Thursday to overturn a Supreme Court’s decision against a former Goodyear Tire and Rubber company worker. Lilly Ledbetter sued Goodyear citing she worked for the company for years while being paid significantly less than her fellow male employees. The U.S. Supreme Court ruled in 2007 against her sex discrimination lawsuit stating she needed to bring her claim within 180 days of Goodyears’ initial decision to pay her less than her male colleagues. This reversal by President Obama may give way to a renewal of workers’ rights in America.
The sad truth is that once a layoff occurs, some people will seek out any retribution they can find and if the company did not conduct the “RIF” (reduction in force) correctly they may leave themselves exposed to possible claims by the affected employees. In some cases the employees are not waiting to be affected by a reduction, they are seeking ways to “protect their rights” preemptively.
There are a number of ways in which past, present and prospective employees can involve the employer in employment disputes. These can run from serious sexual harassment situations costing millions to smaller frivolous claims. While accurate statistics are hard to determine, it is believed that the average EPL claim now settles for approximately $450,000. Frivolous claims rarely settle for less than $10,000 including legal fees.
Employers have been facing rapidly increasing liability for employment related claims. From sexual harassment to discrimination in hiring, employers are now legally responsible for a broader range of employment related acts. This change has resulted in an environment of rapidly increasing employment claims. Many small to medium sized businesses do not yet appreciate the significant employment exposure facing them. Employment litigation has increased by 400% in the last 10 years as a growing number of employees sue their employers for sexual harassment, discrimination and wrongful termination.
With the odds against us, as business owners how can we be expected to keep up on all of the ever-changing laws and regulations when it comes to dealing with our employees? The workshop “Top 10 Reasons Employers Get Sued” is designed with you – the business owner in mind (May 5th at the offices of SingerLewak, 2050 Main Street, 7th Floor, Irvine...4PM to 6PM). We will go in depth on the following topics and have an open forum for you to ask questions and receive your answers during the workshop.
The best way to make sure your company’s actions don’t become one of the top 10 things employers do to get sued is to become an informed employer. The best way to stay on top of the most up to date information regarding dealing with your employees is to have a solid strategy and a third-party that specializes in the information.
Here are some the topics we will cover in the workshop:
· Overall policy development – do’s and don’ts
· Having a “use-it-or-lose-it” policy which means employees lose accrued vacation days if the employee doesn’t take the days by a specific deadline.
· Failing to provide a final paycheck within the legal time limits, regardless of what company issued property the employee still holds, can be a costly and time-consuming mistake.
· An employer is not shielded from a lawsuit simply because the employee has returned to work for a period of time after a workers’ compensation injury.
· Wage and hour laws place many restrictions on the number of hours an employee may work each day and week without overtime pay.
· Training employees on such topics as sexual harassment, discrimination, safety and wage and hour laws.
· Certain employees are exempt from overtime requirements and can be paid a straight salary no matter how many hours a week they work. How to classify them?
· For each workday an employer doesn’t give an employee a required meal break, the employer owes the employee one additional hour of pay.
· An employee who signs a non-compete agreement is consenting not to work for one of your competitors for a certain period of time after leaving your company. While this practice is legal in many other states, California law specifically prohibits non-compete agreements.
· The consequences for misclassifying an employee as an independent contractor can be significant tax, wage and benefits liabilities, as well as massive fines that may be imposed by state and federal agencies.
To adapt a quote from the well-known 18th-century literary critic Samuel Johnson, the road to being sued by an employee is oft paved with good intentions. Whether it's agreeing to an employee's seemingly reasonable scheduling request, simplifying the payroll, or just saving a little money, an employer's good intentions easily can lead to lawsuits.
Our intention in providing you this information is to give you awareness of the possibility and tools to avoid the pitfalls.
Thursday, April 16, 2009
Tuesday, March 31, 2009
Job Sharing and CA Work Sharing Unemployment Insurance Program
Job sharing programs have been around for many years. This type of work arrangement, where usually two people share one full time equivalent employment time slot, typically a 40 to 60 hour commitment, has come to my attention a few times in the last month or so. I was careful not to frame it as sharing one job as it is not necessary for it to be a share of a “job” or position. It merely means the sharing, by two or more individuals, of one employment slot (think of it as a labor budget item) that generally equates to one full time salary and related benefits.
The challenging economic environment we face is the driver causing this work arrangement to be discussed with more frequency lately. There are a few concepts I’d like to address…one being “job sharing” which I’ll discuss first. The other is California’s “Work Sharing Unemployment Insurance Program” which I will address later in this article. The main difference between the two is that the latter provides for unemployment benefits for the portion of the full time position being cut back by the employer (e.g. cutting back from a 5 day work week to 4 days to save payroll costs).
I don’t think job sharing is generally a viable option in the field. My interest in researching this topic was driven by a desire to help contractors keep their office personnel intact through this down cycle and to expand the possibilities for office personnel, and their employers, even in the good times! If the contractor could divide office responsibilities that normally take 40 hours or so per week to accomplish into two (or more) pieces, this could provide for many benefits for all parties concerned including work/life balance and retention of income for employees and reduced business costs (including
I see job sharing as a potential win-win for both employer and employees. There are many reasons job sharing can make sense including offering a better work/life balance for employees. It can also help to keep more people employed and also possibly get the best from everyone in achieving common objectives required of a given position. Other benefits for employers include:
1) Each employee may be better rested, focused and better managers of their time improving efficiencies
2) The division of responsibilities could allow for leveraging each job sharer’s strengths while mitigating any weaknesses
3) Happier employees as they can tend to their personal lives more easily
4) Less time off for dentist appointments and the like as they can do on their personal time easier during the week
5) If there is a short term surge in work in the office, the existing human resources are more easily expandable as hours can be ramped up to cover those spikes in work
6) Can reduce overtime costs as fewer workers will work greater than 40 hours per week
An often cited downside to job sharing programs is the potential loss of benefits. Many employers use a 32 hour per week minimum required to qualify for employee benefits such as health insurance, 401(k), etc. There are many ways to approach this issue although, as always, it is important to be careful how you as an employer deal with these issues as unintended consequences could result (setting unwanted precedents, etc.). A policy should be established and followed for job sharing programs including employee benefits issues. Sometimes an employee may have a benefit deemed important to him or her through another family member (health insurance being an obvious example) so the issue is mitigated. If one of your job share employees who is in the job share arrangement waives the benefits, perhaps consider allotting those benefits to the job sharer who does not. Again, be very careful as circumstances could change (what if the spouse who is providing the health insurance suddenly gets laid off?). As with everything, consult with experts in order to better understand and comply with all the laws and regulations.
Consider holding an office staff meeting and discuss the possibility of a job sharing program. You may be surprised at your employees’ willingness, for a number of reasons, to be part of such a program. There seems to be a fear on the part of employees actually desiring this type of arrangement to ask for it. Chances are very good that your company has never had such a program in place. You may have never even considered it and/or think it may not a workable arrangement. The environment and office culture may be prohibitive factors for any of your employees to ask for such an arrangement. Some of them may want more time with their children, or grandchildren, or other personal reasons. If you, driven perhaps by today’s current economic climate, raise the issue during a staff meeting, you may find that you have a few people willing to get involved in the arrangement providing benefits to you, as the employer, you never realized were possible.
Another viable option to consider is California’s “Work Sharing Unemployment Insurance Program” which needs to be applied for. These “work sharing plans” are approved for a six month period. Although this program appears to market itself as a solution for short term market downturns, I have heard that consecutive six month plans have been approved for employers. The way the program basically works is by pro rating unemployment benefits for workers in the program to mitigate the lost income from reduced hours. In order for a plan to be approved by California, the employer must apply this program to “at least 10% of it’s regular work force or a unit of the work force” with at least 2 employees participating in the program. The example provided by the Employment Development Department (EDD) is that of an employee reduced from 5 days down to 4 days. The employee would be eligible to receive 20% of his or her unemployment benefits. At the same time, the employer should understand that there will be an impact on the company’s unemployment reserve account which could impact the unemployment insurance tax rate in the future. The net result is still positive for the employer both financially in terms of reduced payroll costs and intangible positives in terms of retention and morale while avoiding the costs of re-hiring, re-training, etc. when business improves.
I recommend consulting with a Human Resources professional as well as a labor law attorney to ensure compliance with all rules and regulations. SingerLewak will be conducting a seminar for business owners addressing various HR issues on May 5, 2009 at 4PM in our Irvine office. The workshop will be led by an HR specialist as well as a labor law attorney. I have asked that these arrangements be included in the discussion. Contact me if you would like more information.
Useful Links
For more on the CA Program http://www.edd.cahwnet.gov/pdf_pub_ctr/de8714bb.pdf
For the CA Program Application
www.edd.ca.gov/pdf_pub_ctr/de8686.pdf
Sunday, March 15, 2009
State of the Construction Industry - A Surety Broker's Perspective
By Michael Strahan CCIFP
KPS Insurance Services
As most of us have experienced over the past year the financial crisis has had a significant impact on the construction industry. With what seems like the demise of residential construction, a significant slowdown in commercial construction, and state budget issues impacting public works construction, the industry is facing significant challenges that we have not seen in some time.
As a result of the financial crisis and the impacts on construction, we have seen a change in the makeup of bid lists. Larger construction firms, even some national firms, have been bidding on work that in the past would have been considered too small to pursue. This could be due to the fact commercial project pipelines have been drying up and large firms are finding gaps in backlog. Conversely, we have seen smaller construction firms trying to bid projects that are probably larger than they would generally consider routine. Some of these firms are trying to elevate away from heavy competition. And lastly we have seen significant numbers of residential firms that never pursue public works projects coming over and bidding as well. As a result we have heard of pre-bid meetings having in excess of one hundred firms attending and it is not unusual to get bid results with more than thirty bidders.
We have also seen a significant change in the make-up of backlogs. Generally speaking, most backlog reports have become much more concentrated. We rarely see firms with large backlog reports of work in various stages of completion. It is not unusual to now see a construction company’s backlog being made up mostly of four or five projects. This naturally has led to a concentration of risk and a lower months in backlog ratio. Months in backlog measures how many months of work a firm has on hand at any one time based on historical, average monthly revenues recognized. One bad job today can have a much larger impact than what was historically the case.
Sadly, the surety industry is also to blame for part of the current competition problem. With so many construction firms coming to the public work environment they need to secure bonds. While some of these firms are financially strong and have had prevailing wage experience in the past, many do not come with prior experience or the financial strength to learn the hard way. Many of these firms need to be reviewed more stringently for credit than they are currently being evaluated. As a result, some of these construction firms are hurting the overall marketplace by taking work too cheaply. They will likely encounter financial hardships at some point in time if they are securing multiple jobs near or possibly below cost. Meanwhile, responsible bidders are not getting work which is also impacting their ability to run operations normally.
In addition, it is understood the stimulus package will include changes to the small business administration bond guarantee program. This change will increase bond guarantee limits on projects from two million dollars up to five million dollars. While this is a noble cause to help small businesses, it will also cause an increase in competition on larger projects by less qualified firms.
With increased competition for less work, profit margins have been decreasing. Naturally with a decrease in margins the overhead coverage ratio has also been decreasing. The overhead coverage ratio measures how many months of general and administrative costs are being covered by existing work on hand. All in all construction firms these days are more exposed to potential financial hardships due to concentrations of risk, lower margins, and simply less work to cover fixed costs.
With all the changes in the construction industry, it is inevitable that certain things will occur. We have already seen an increase in filings of stop notice and liens. It seems as if the ability to secure change orders, whether a general to owner or subcontractor to general, is becoming more difficult to secure. Payments appear to have also slowed, again whether from owner to general or general to subcontractor.
We will have construction failures most likely by the second half of 2009, definitely during the first half of 2010. In concurrence with construction failures, the surety industry will also begin to have an increased frequency in losses. While these are not good things the overall result may be somewhat healthy. Hopefully the strong construction firms survive and market competition starts to return to a healthier balance. The surety industry, with an increase in losses, should also tighten underwriting standards. This should further help limit bidders on jobs to more qualified firms.
A complete wildcard at this point in time is how and when the pending stimulus package will impact the construction industry. Conceivably when the federal government passes the stimulus package and states get assistance with budget deficits via government loans, more construction opportunities should present themselves. With the infrastructure spending the federal government wants to support, other construction related opportunities tied to green and alternative energy construction, and hopefully the ability to sell local municipal bonds again the number of opportunities should increase. This again will hopefully lead to less competition on projects as more work will be on the street to be bid.
While the times are clearly tough right now we do see some light at the end of the tunnel. We are hopeful more work will hit the streets in the near future. Coupled with less competition due to construction failures, surety industry tightening underwriting standards, and with a hopeful return of the real estate market, we can get back to a more traditional list of bidders and profit margins in the very near term.
Fact -
States are facing a great fiscal crisis. At least 46 states faced or are facing shortfalls in their budgets for this and/or next year, and severe fiscal problems are highly likely to continue into the following year as well. Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total more than $350 billion.
For more information please visit www.cbpp.org
KPS Insurance Services
As most of us have experienced over the past year the financial crisis has had a significant impact on the construction industry. With what seems like the demise of residential construction, a significant slowdown in commercial construction, and state budget issues impacting public works construction, the industry is facing significant challenges that we have not seen in some time.
As a result of the financial crisis and the impacts on construction, we have seen a change in the makeup of bid lists. Larger construction firms, even some national firms, have been bidding on work that in the past would have been considered too small to pursue. This could be due to the fact commercial project pipelines have been drying up and large firms are finding gaps in backlog. Conversely, we have seen smaller construction firms trying to bid projects that are probably larger than they would generally consider routine. Some of these firms are trying to elevate away from heavy competition. And lastly we have seen significant numbers of residential firms that never pursue public works projects coming over and bidding as well. As a result we have heard of pre-bid meetings having in excess of one hundred firms attending and it is not unusual to get bid results with more than thirty bidders.
We have also seen a significant change in the make-up of backlogs. Generally speaking, most backlog reports have become much more concentrated. We rarely see firms with large backlog reports of work in various stages of completion. It is not unusual to now see a construction company’s backlog being made up mostly of four or five projects. This naturally has led to a concentration of risk and a lower months in backlog ratio. Months in backlog measures how many months of work a firm has on hand at any one time based on historical, average monthly revenues recognized. One bad job today can have a much larger impact than what was historically the case.
Sadly, the surety industry is also to blame for part of the current competition problem. With so many construction firms coming to the public work environment they need to secure bonds. While some of these firms are financially strong and have had prevailing wage experience in the past, many do not come with prior experience or the financial strength to learn the hard way. Many of these firms need to be reviewed more stringently for credit than they are currently being evaluated. As a result, some of these construction firms are hurting the overall marketplace by taking work too cheaply. They will likely encounter financial hardships at some point in time if they are securing multiple jobs near or possibly below cost. Meanwhile, responsible bidders are not getting work which is also impacting their ability to run operations normally.
In addition, it is understood the stimulus package will include changes to the small business administration bond guarantee program. This change will increase bond guarantee limits on projects from two million dollars up to five million dollars. While this is a noble cause to help small businesses, it will also cause an increase in competition on larger projects by less qualified firms.
With increased competition for less work, profit margins have been decreasing. Naturally with a decrease in margins the overhead coverage ratio has also been decreasing. The overhead coverage ratio measures how many months of general and administrative costs are being covered by existing work on hand. All in all construction firms these days are more exposed to potential financial hardships due to concentrations of risk, lower margins, and simply less work to cover fixed costs.
With all the changes in the construction industry, it is inevitable that certain things will occur. We have already seen an increase in filings of stop notice and liens. It seems as if the ability to secure change orders, whether a general to owner or subcontractor to general, is becoming more difficult to secure. Payments appear to have also slowed, again whether from owner to general or general to subcontractor.
We will have construction failures most likely by the second half of 2009, definitely during the first half of 2010. In concurrence with construction failures, the surety industry will also begin to have an increased frequency in losses. While these are not good things the overall result may be somewhat healthy. Hopefully the strong construction firms survive and market competition starts to return to a healthier balance. The surety industry, with an increase in losses, should also tighten underwriting standards. This should further help limit bidders on jobs to more qualified firms.
A complete wildcard at this point in time is how and when the pending stimulus package will impact the construction industry. Conceivably when the federal government passes the stimulus package and states get assistance with budget deficits via government loans, more construction opportunities should present themselves. With the infrastructure spending the federal government wants to support, other construction related opportunities tied to green and alternative energy construction, and hopefully the ability to sell local municipal bonds again the number of opportunities should increase. This again will hopefully lead to less competition on projects as more work will be on the street to be bid.
While the times are clearly tough right now we do see some light at the end of the tunnel. We are hopeful more work will hit the streets in the near future. Coupled with less competition due to construction failures, surety industry tightening underwriting standards, and with a hopeful return of the real estate market, we can get back to a more traditional list of bidders and profit margins in the very near term.
Fact -
States are facing a great fiscal crisis. At least 46 states faced or are facing shortfalls in their budgets for this and/or next year, and severe fiscal problems are highly likely to continue into the following year as well. Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total more than $350 billion.
For more information please visit www.cbpp.org
Monday, February 16, 2009
Estate Planning Considerations for Business Owners
In addition to owners of construction businesses, many of you on this distribution list are professional service providers. You work in surety bond companies, insurance and surety brokerages, banks, law firms, CPA firms, etc. and all provide valuable services to your clients. One of our main objectives, as service providers, is to have a positive impact on the lives of our clients and their businesses. One of the areas of greatest import in the coming years to many of our clients will be addressing wealth transfer and succession planning. Although few of us on this distribution list are expert in this area, it is well within our sphere of influence to help facilitate this process for business owners in order to help them achieve their personal and professional goals. We all know the demographic landscape in our business community and the world around us. The first part of the Baby Boomer generation is nearing retirement. As our objectives are to help business owners achieve their most important goals, we should gain an understanding of some of the more basic estate planning tools as they relate to the transfer of business ownership. This article will address some of the more basic concepts, in more basic terms, in order to provide a general framework of some of the more utilized estate planning tools to transfer ownership, and wealth, from one generation to another. Keep in mind that estate tax rates historically (pre George W. Bush) approximate 55% if you have significant assets to pass on to your heirs. These tax levels return after December 31, 2010 unless Congress makes changes. The planning you do will result in significant tax savings for your heirs when you consider this level of tax rate.
Intentionally Defective Grantor Trusts (IDGT)
There are a variety of ways to transfer ownership and wealth from one generation to the next. I will offer a summary explanation of a few of these powerful tools. The first is the use of Intentionally Defective Grantor Trusts (IDGT). The feature that makes this trust “defective” is that it is considered incomplete for income tax purposes. That is to say the owner (grantor) will still continue to pay income taxes on the earnings of the company. One of the strongest features of the IDGT is the ability to transfer assets at a locked in, discounted valuation. There is a presumption that our client’s business will continue to increase in value over time. The ability to remove an asset from the business owner’s personal balance sheet (his or her stock in ABC Construction Company) at a locked in (as of the transfer date), discounted valuation today will result in a significantly reduced taxable estate at date of death. I’ve used the term “discounted” a few times. The discounts exist due to the fact that the shares sold to the trust are non-voting shares and therefore a lack of control factor is present making those shares less valuable. Before selling shares to the trust, an attorney will restructure the stock such that there are both voting and non voting shares. An example would be for the owner to retain the one “voting” share of stock while selling 99 “non-voting” shares to the trust. Although 99% of the shares have been sold, the one voting share retained by the business owner allows him or her to retain control of the company. A discount will be applied to the non voting shares for lack of control. An additional discount will be applied due to lack of marketability (you can’t sell these shares in your E-Trade account for example). A conservative approach would be to suggest that these discounts represent a combined 30% reduction in the valuation of the shares. This discount percentage is supportable, but you must have a qualified business valuation performed to determine fair market value as of the date of sale or transfer. The valuation should be performed by a reputable, properly credentialed valuation firm to ensure a proper fair market value is derived and can stand up to any potential scrutiny. Another benefit of the IDGT is that in moving this asset, the stock of the company, off of the personal balance sheet of the owner, is no longer available to be attached by the claims of the grantor’s creditors. The asset protection offered by this strategy is also a great benefit.
Grantor Retained Annuity Trusts (GRAT)
Another possible strategy is to first install a Grantor Retained Annuity Trust (GRAT) with an IDGT as the beneficiary of that trust. There could be circumstances, such as the current interest rate environment (due to the present value discounting calculations), where this makes good sense to consider. The GRAT is established with a set term in years. The stock, as explained above regarding voting/non-voting shares, is placed into the GRAT and tax is paid by the grantor at this time. The GRAT pays an annuity over the term each year to the grantor based on the valuation of the company. At the end of the GRAT term, the stock is transferred into the IDGT whose beneficiaries may be the owner’s children. One of the drawbacks to this structure is that if the grantor passes away during the GRAT term, the asset will become part of the taxable estate of the owner and all the planning becomes irrelevant.
Qualified Personal Residence Trusts (QPRT)
Qualified Personal Residence Trusts (QPRT) are also a very commonly used planning tool, allowing you to again remove one of your more significant assets from your personal balance sheet – your personal residence. There are some choices that can be made in structuring a QPRT including the term of the trust (at which expiration the asset becomes the property of the beneficiaries), whether the entire asset, or just a portion, will be contributed to the trust, etc. The concept again is to lock in a value of an asset at the date of sale or transfer and also gain the benefit of discounting either through valuation discounts as discussed above and/or the present value of the asset at date of transfer relative to the value at the end of the trust term (which is the case with a QPRT). The future appreciation of the home is excluded from your estate, which is an extremely valuable proposition for you and your family.
CONCLUSION
Succession planning often achieves maximum results with the best and greatest number of options available when done many years in advance of the targeted retirement date. Start gaining an education regarding the available tools and options now and you’ll get the maximum results when you are ready to execute your plan. The use of these tools can create very positive financial results for your family over time. It is obviously important to connect with the right estate planning firm (which you can easily do by talking with your business partners and getting a strong referral). Please be sure to communicate, during the planning process and not after you’ve finalized your planning, with your bond agent (and thereby your bond company), your bank, CPA and any other business partner whom it makes sense to notify and/or include in the process. Planning in a vacuum without the inclusion of your integral business partners often times leads to unintended consequences.
Intentionally Defective Grantor Trusts (IDGT)
There are a variety of ways to transfer ownership and wealth from one generation to the next. I will offer a summary explanation of a few of these powerful tools. The first is the use of Intentionally Defective Grantor Trusts (IDGT). The feature that makes this trust “defective” is that it is considered incomplete for income tax purposes. That is to say the owner (grantor) will still continue to pay income taxes on the earnings of the company. One of the strongest features of the IDGT is the ability to transfer assets at a locked in, discounted valuation. There is a presumption that our client’s business will continue to increase in value over time. The ability to remove an asset from the business owner’s personal balance sheet (his or her stock in ABC Construction Company) at a locked in (as of the transfer date), discounted valuation today will result in a significantly reduced taxable estate at date of death. I’ve used the term “discounted” a few times. The discounts exist due to the fact that the shares sold to the trust are non-voting shares and therefore a lack of control factor is present making those shares less valuable. Before selling shares to the trust, an attorney will restructure the stock such that there are both voting and non voting shares. An example would be for the owner to retain the one “voting” share of stock while selling 99 “non-voting” shares to the trust. Although 99% of the shares have been sold, the one voting share retained by the business owner allows him or her to retain control of the company. A discount will be applied to the non voting shares for lack of control. An additional discount will be applied due to lack of marketability (you can’t sell these shares in your E-Trade account for example). A conservative approach would be to suggest that these discounts represent a combined 30% reduction in the valuation of the shares. This discount percentage is supportable, but you must have a qualified business valuation performed to determine fair market value as of the date of sale or transfer. The valuation should be performed by a reputable, properly credentialed valuation firm to ensure a proper fair market value is derived and can stand up to any potential scrutiny. Another benefit of the IDGT is that in moving this asset, the stock of the company, off of the personal balance sheet of the owner, is no longer available to be attached by the claims of the grantor’s creditors. The asset protection offered by this strategy is also a great benefit.
Grantor Retained Annuity Trusts (GRAT)
Another possible strategy is to first install a Grantor Retained Annuity Trust (GRAT) with an IDGT as the beneficiary of that trust. There could be circumstances, such as the current interest rate environment (due to the present value discounting calculations), where this makes good sense to consider. The GRAT is established with a set term in years. The stock, as explained above regarding voting/non-voting shares, is placed into the GRAT and tax is paid by the grantor at this time. The GRAT pays an annuity over the term each year to the grantor based on the valuation of the company. At the end of the GRAT term, the stock is transferred into the IDGT whose beneficiaries may be the owner’s children. One of the drawbacks to this structure is that if the grantor passes away during the GRAT term, the asset will become part of the taxable estate of the owner and all the planning becomes irrelevant.
Qualified Personal Residence Trusts (QPRT)
Qualified Personal Residence Trusts (QPRT) are also a very commonly used planning tool, allowing you to again remove one of your more significant assets from your personal balance sheet – your personal residence. There are some choices that can be made in structuring a QPRT including the term of the trust (at which expiration the asset becomes the property of the beneficiaries), whether the entire asset, or just a portion, will be contributed to the trust, etc. The concept again is to lock in a value of an asset at the date of sale or transfer and also gain the benefit of discounting either through valuation discounts as discussed above and/or the present value of the asset at date of transfer relative to the value at the end of the trust term (which is the case with a QPRT). The future appreciation of the home is excluded from your estate, which is an extremely valuable proposition for you and your family.
CONCLUSION
Succession planning often achieves maximum results with the best and greatest number of options available when done many years in advance of the targeted retirement date. Start gaining an education regarding the available tools and options now and you’ll get the maximum results when you are ready to execute your plan. The use of these tools can create very positive financial results for your family over time. It is obviously important to connect with the right estate planning firm (which you can easily do by talking with your business partners and getting a strong referral). Please be sure to communicate, during the planning process and not after you’ve finalized your planning, with your bond agent (and thereby your bond company), your bank, CPA and any other business partner whom it makes sense to notify and/or include in the process. Planning in a vacuum without the inclusion of your integral business partners often times leads to unintended consequences.
Monday, January 12, 2009
S Corporations - A Summary Discussion
One of the concepts least understood by many business owners, and even others in the business community, are “S” Corporations. Although I’ll cover a few of the issues surrounding this entity type, my main goal here is to highlight why, in the vast majority of cases, it makes sense to be treated as an S Corporation for tax purposes. It’s a decision that all business owners should have already addressed or should be addressing. Over the years I’ve met business owners who have said that no one in their trusted advisor circle ever raised the issue for consideration. That’s truly a shame but it’s never too late to consider whether making the election to be treated as an S Corporation for tax purposes makes sense. I do not plan on getting into the details of who can qualify for “S” status as most contractors will be able to do so. Further, it always makes sense to consult with the company’s advisors to decide whether “S” status makes sense as certain circumstances may be present (unused NOL carry forwards as one example) whereby it would make sense to retain the C Corporation status.
The S Corporation is a tax concept, it does not affect the liability protection afforded by being incorporated or the accounting and reporting for the business (aside for accounting for income taxes). I’ve often been asked whether liability protection is diminished and I always give this same answer along with the suggestion that they speak with their corporate legal counsel to gain additional peace of mind. As “S” status is a tax concept, it affects how tax is assessed and who is responsible for the payment of tax. An S Corporation is not an income tax paying entity. The shareholders are responsible for paying the income tax to the government. The income tax is calculated, and reported, on the shareholders personal tax returns. The money to satisfy the tax obligation usually comes from the S Corporation itself in the form of a distribution. As the S Corporation is not an income tax paying entity, any deferred income taxes (including those arising from the use of a tax exempt method such as cash or completed contract basis) will not be the responsibility of the S Corporation and therefore not recorded on the corporate balance sheet as a liability. Most CPA firms will provide a footnote in S Corporation financial reports stating what the amount of the estimated personal deferred income tax liability is for the shareholders resulting from the S Corporation. One quick way to calculate this deferred tax amount is to, as long as the balance sheet in the tax return is reported on the tax exempt method (e.g. cash basis), take the difference between percentage of completion based retained earnings in the financial report and retained earnings reported in the tax return and multiply the difference by 40%. That should provide a reasonable estimate of the deferred tax liability to be paid by the shareholders in the future.
Perhaps the greatest reason for electing “S” status is the planning for the exit strategy; the liquidation event. Let me take you through an example that will illustrate the issue. In the first example let’s say that a contractor can sell her business for $5MM dollars. She owns the company, a C Corporation in this case, and the proposed buyout is an asset purchase (the prospective buyers do not want to purchase the stock as they want no part of any contingent liabilities, construction defect issues, etc.) The assets that are being purchased are owned by the C Corporation (Jane owns the stock of the C Corporation, not the assets themselves). The C Corporation sells the assets for $5MM and since the tax basis for the assets being purchased is nominal, we’ll assume that it’s all taxable gain. The full $5MM is taxed inside the C Corporation at 40% (Fed and CA combined) therefore the tax liability is $2MM. The remaining $3MM in cash is distributed out to Jane in the form of compensation and is taxable to her, again at 40% combined tax rates. The liability on the $3MM she takes out is therefore $1.2MM leaving her with roughly $1.8MM on the $5MM sale. That doesn’t seem like a great result.
Let’s go through the same example but this time with Jane having elected S Corporation at the time she started her business. The prospective buyers again are only interested in purchasing the assets of the corporation for $5MM. Since the S Corporation is not an income tax paying entity, no income taxes will be due by the corporation. In California however, S Corporations must pay a 1.5% franchise tax based on taxable income, so Jane’s S Corporation will owe $75,000 to the state of California on the company’s $5MM gain on the asset sale (again assuming nominal tax basis in the assets). Let’s set the $75K liability aside until the end of our example to keep the math easier. Jane wants to retire on this transaction so she pulls the $5MM out of the S Corporation and again, at the personal combined tax rate of 40%, the tax liability is $2MM with $3MM remaining. When we consider the $75K CA franchise tax discussed above, the net take home for Jane is $2,925,000. The difference between the take home for Jane owning a C Corporation ($1.8MM) and an S Corporation ($2.925MM) is over $1MM! Stated another way, the effective tax rate after the double taxation as a C Corporation is approximately 64% while the tax rate for the S Corporation transaction is approximately 42%. The difference is significant and can actually affect whether a transaction is actually done. Owners don’t care as much what they could sell their company (or its assets) for, they care much more about what they can take home after taxes. Owning an S Corporation will generally provide for a maximization of the “take home” amount and provide a greater likelihood a transaction can be structured to a seller’s liking.
As I write this, there is not a meaningful difference in the top tax rates for corporations versus individuals. Many years ago the top tax rates for corporations were significantly less than those for individuals, making the decision to be treated as an S Corporation a more challenging one. Time will tell if a divergence in those rates will affect whether “S” status makes sense. For now I’d suggest in the vast majority of cases, operating as an S corporation is the best entity choice for contractors.
The S Corporation is a tax concept, it does not affect the liability protection afforded by being incorporated or the accounting and reporting for the business (aside for accounting for income taxes). I’ve often been asked whether liability protection is diminished and I always give this same answer along with the suggestion that they speak with their corporate legal counsel to gain additional peace of mind. As “S” status is a tax concept, it affects how tax is assessed and who is responsible for the payment of tax. An S Corporation is not an income tax paying entity. The shareholders are responsible for paying the income tax to the government. The income tax is calculated, and reported, on the shareholders personal tax returns. The money to satisfy the tax obligation usually comes from the S Corporation itself in the form of a distribution. As the S Corporation is not an income tax paying entity, any deferred income taxes (including those arising from the use of a tax exempt method such as cash or completed contract basis) will not be the responsibility of the S Corporation and therefore not recorded on the corporate balance sheet as a liability. Most CPA firms will provide a footnote in S Corporation financial reports stating what the amount of the estimated personal deferred income tax liability is for the shareholders resulting from the S Corporation. One quick way to calculate this deferred tax amount is to, as long as the balance sheet in the tax return is reported on the tax exempt method (e.g. cash basis), take the difference between percentage of completion based retained earnings in the financial report and retained earnings reported in the tax return and multiply the difference by 40%. That should provide a reasonable estimate of the deferred tax liability to be paid by the shareholders in the future.
Perhaps the greatest reason for electing “S” status is the planning for the exit strategy; the liquidation event. Let me take you through an example that will illustrate the issue. In the first example let’s say that a contractor can sell her business for $5MM dollars. She owns the company, a C Corporation in this case, and the proposed buyout is an asset purchase (the prospective buyers do not want to purchase the stock as they want no part of any contingent liabilities, construction defect issues, etc.) The assets that are being purchased are owned by the C Corporation (Jane owns the stock of the C Corporation, not the assets themselves). The C Corporation sells the assets for $5MM and since the tax basis for the assets being purchased is nominal, we’ll assume that it’s all taxable gain. The full $5MM is taxed inside the C Corporation at 40% (Fed and CA combined) therefore the tax liability is $2MM. The remaining $3MM in cash is distributed out to Jane in the form of compensation and is taxable to her, again at 40% combined tax rates. The liability on the $3MM she takes out is therefore $1.2MM leaving her with roughly $1.8MM on the $5MM sale. That doesn’t seem like a great result.
Let’s go through the same example but this time with Jane having elected S Corporation at the time she started her business. The prospective buyers again are only interested in purchasing the assets of the corporation for $5MM. Since the S Corporation is not an income tax paying entity, no income taxes will be due by the corporation. In California however, S Corporations must pay a 1.5% franchise tax based on taxable income, so Jane’s S Corporation will owe $75,000 to the state of California on the company’s $5MM gain on the asset sale (again assuming nominal tax basis in the assets). Let’s set the $75K liability aside until the end of our example to keep the math easier. Jane wants to retire on this transaction so she pulls the $5MM out of the S Corporation and again, at the personal combined tax rate of 40%, the tax liability is $2MM with $3MM remaining. When we consider the $75K CA franchise tax discussed above, the net take home for Jane is $2,925,000. The difference between the take home for Jane owning a C Corporation ($1.8MM) and an S Corporation ($2.925MM) is over $1MM! Stated another way, the effective tax rate after the double taxation as a C Corporation is approximately 64% while the tax rate for the S Corporation transaction is approximately 42%. The difference is significant and can actually affect whether a transaction is actually done. Owners don’t care as much what they could sell their company (or its assets) for, they care much more about what they can take home after taxes. Owning an S Corporation will generally provide for a maximization of the “take home” amount and provide a greater likelihood a transaction can be structured to a seller’s liking.
As I write this, there is not a meaningful difference in the top tax rates for corporations versus individuals. Many years ago the top tax rates for corporations were significantly less than those for individuals, making the decision to be treated as an S Corporation a more challenging one. Time will tell if a divergence in those rates will affect whether “S” status makes sense. For now I’d suggest in the vast majority of cases, operating as an S corporation is the best entity choice for contractors.
Sunday, December 14, 2008
What Happens if Joe the Contractor Gets Hit by the Proverbial Truck?
Many contractors are owned and operated by one key individual, the owner. Further, usually the vast majority of the owner’s net worth is tied up in the stock of the company he or she owns. It is imperative, for many reasons some of which I’ll outline here, for every contractor to have an operational succession plan in place to ensure fluid continuity of the business operations.
Let’s say for example that Jane Contractor employs 150 people between the field and the office. On average, for every employee I would suggest that another 1.5 people are dependent/affected by that employee’s livelihood within Jane Contractor’s company. Some employees are married, some aren’t, some have kids, while others don’t. So I’m suggesting that, including the employee, for each person employed perhaps 2.5 total people are affected by the success of Jane Contractor’s business. That’s a total of 375 people dependent on whether Jane Contractor has a plan in place to ensure the continuity of business whether Jane, the primary driver of success in the company, shows up to work or not. There are many business reasons to have an operational succession plan, but perhaps none more important than the financial security of all of the construction companies employees and their dependents. Most, if not all, of the owners I know are great and compassionate people and this issue might be the highest priority. The knowledge that their own families, their employees and the families of their employees, will be able to have a secure financial future should something happen to the “Top Dog” should be a primary driver in the desire to develop an operational succession plan.
Management should prepare an operational succession plan to also serve as an “insurance policy” which can be shown to creditors. Surety companies and banks are generally two very interested parties wishing to ensure that a construction company can perform on its backlog without total reliance on the Owner/President being involved. I’ve witnessed countless times where a bond company requests a succession plan document only to be met with either lack of a meaningful response, “we’ll get it to you”, “it’s in process”, etc. One main concept that usually occurs to me is that the bond company, bank, etc. are only asking for items the contractor should want to have for his/her own purposes in managing the company and ensuring its success more than anyone else! The bond company is not asking for this document to be a pain in the neck, they just wants reasonable assurance (a written plan) that management has a strategy for performing on its backlog in case of unforeseen circumstances. The bond company’s goals are not inconsistent with what the contractor should want/need for him or herself. If Joe Contractor asks a bond company to vouch for him and his construction company that he has the necessary components in his business (relevant experience, capital, personnel, capacity, etc.) to successfully perform the work, Joe Contractor should ensure he has all the pieces in place to back up that promise to perform on the backlog including a contingency plan in case he isn’t able to show up to work for whatever reason.
Another benefit to the creation of an Operational Succession Plan is that it requires the contractor to think about his or her replacements, as well as replacements for them as they vacate their positions. Further, it calls for cross training those individuals now and actually provides for the beginnings of a natural (not getting hit by a truck, etc.) succession plan. Many contractors think about how to get into the business and build the business, but few think about how they will get out of it. For many contractors a viable exit is to sell to the next level of management. Often times that structure necessitates the owner to take back a note (debt) from the new ownership. The chances that the debt will be successfully paid on schedule (or ahead of schedule) are greatly tied to the success of the ongoing business. The new owners/management will fare much better if they are properly trained and groomed for the roles. By having an operational succession plan in place “in case of emergency” you are also building your future possible exit strategy. It is not lost on me that some may think you could be training your future competition, however I am a firm believer that if you create a fair, fun and successful work environment and treat your employees well you will not face that scenario. As long as those future stars have the knowledge that “your” business will someday be “their” business or in the event of sale or other windfall they will share equitably, they most likely will not leave.
CONCLUSION
It is clear for many reasons the creation of an Operational Succession Plan is an important, fluid document which should be updated as circumstances warrant. There are many important reasons to have the document in place as discussed above. It may seem a daunting task to create such a plan. If you need help getting started we have created a template you can use (and our clients have successfully done so) as a solid starting point, just email me for your copy. I encourage all owners of construction companies to create an operational succession plan to help ensure a bright future for themselves, their employees and all their families. It could be a key component in the perpetuation of the business they worked so hard to start and build.
Choosing Best Fit Accounting Software
By Steve Antill, Foundation Software, Inc.
When contractors decide they need new accounting software, the Internet is usually the first place they begin their search. But do a Google search on “construction accounting software” and hundreds of options will appear—accounting software that does estimating; accounting systems that do estimating, accounting, and project management; and project management systems that do estimating and accounting. The construction software industry has reached a point where many vendors are trying to be everything to everyone.
Theoretically, this is ideal. After all, who wouldn’t want a onestop shop for all technology tools? Realistically, though, every construction business is unique, and an all-in-one product may not be flexible enough. An estimating module built into an accounting system, for example, may not work for a specialty trade contractor since the estimating tool is too general. The real question is: When looking to replace an accounting system because it is too generic to meet the
required needs, why consider an all-in-one system that was not designed with the specific business or trade in mind?
Preparation Is Key
So what is the best advice for new technology shoppers? Before taking any other steps, the company should develop a plan and stick to it. The best plans, by the way, are those that include input from all employees who will use the software or who may require information from the system. When shopping for new accounting software, contractors need to prioritize their wish lists. The “must-have” list includes features and functions the company cannot do without. Depending on the company, this list may include American Institute of Architects (AIA) billings, work in process (WIP) reports, certified payrolls, customizable report writers, and so on. Beyond must-have items, shoppers should identify items they could live without and, finally, those they simply do not need.
Implementation
Companies often overlook functionality when shopping for construction accounting solutions. For example, why purchase an accounting system that includes a built-in, canned estimating module if the estimating module is too generic and may never get implemented? Wouldn’t it make more sense to buy an industry-specific, third-party estimating software product that will integrate with the new accounting system, so the contractor can benefit from the best of both worlds? On top of needing to be prepared for a conversion, companies need to make sure the feature sets of the new system will work for them. Wowed by cool, yet impractical features. Failure to plan. Unrealistic expectations. These are just some of the reasons companies end up with a construction accounting application that offers them limited benefits. Overbuying is something companies often regret, and yet it happens because they get in over their heads and fail to focus on their true needs. It all comes down to one basic purchasing principle: Don’t get sidetracked. Buy only what is really needed and what can realistically be used and implemented.
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