P&Q University Lesson 14- Business

By |  December 21, 2015

Whether the crushed-stone or sand-and-gravel operation is a start-up or a going venture, the business side plays a significant role in its success or failure. Finding an affordable location, equipment, employees and insurance all involve financial transactions with almost inevitable tax consequences.

Attracting – and retaining – qualified employees for example, means providing them with affordable compensation, fringe benefits and other “perks.” When it comes to offering benefits to employees, small-business owners don’t have the leverage that large companies do. Fortunately, survey after survey shows that it is not money alone that attracts new workers and keeps existing employees on the job. It is the benefits. And thanks to our unique tax laws, every smart aggregates business owner can not only afford to offer fringe benefits to their workers, they may even be able to benefit themselves.

Every employer is required to withhold state and federal income taxes as well as social security and Medicare taxes from employees’ wages. They are also required to pay a matching amount of social security and Medicare taxes for their employees and to pay state and federal unemployment tax.

One of the nastiest and most feared taxes currently imposed is the “Trust Fund Penalty Tax,” a whopping 100 percent penalty on payroll taxes withheld from a business’s employees, but not forwarded to the federal government. That’s right. The IRS has the authority to assess penalties on “responsible parties,” a label that often includes owners, shareholders, partners, members, managers and officers in an aggregates business.

Although the Department of Labor claims a whopping 30 percent of businesses “misclassify” employees, some pit and quarry operations don’t understand the “employee” or “independent contractor” labels. By misclassifying employees as independent contractors, employers circumvent fair labor standards, health and safety protections, and unemployment and workers’ compensation benefits.

Not too surprisingly, the IRS also takes a dim view of employees who masquerade as “independent contractors” whether accidentally or on purpose because they have a harder time collecting taxes from these individuals as opposed to someone with a payrole tax withheld.

Aggregates business owners and producers who may have hesitated or postponed making capital investments because of economic conditions might now want to review the current tax incentives that can substantially reduce the cost of equipment and other capital investments. And don’t forget that under our tax laws, crushed-stone and sand-and-gravel businesses have long been entitled to deduct a reasonable allowance for the exhaustion, wear and tear of equipment and property used in a trade or business, or for property held for the production of income.

For some aggregates businesses, purchasing needed equipment may not be an option because the initial cash outlay is too high. The question of whether to buy or to lease is an on-going one facing many of these operations.

Deciding the best strategy is a tough move for anyone and there is no one correct answer that fits every situation, nor every operation. Keep in mind, however, that new accounting rules may come into play that will require lease transactions to be included in the operation’s financial statements.

IGNORE “USE” TAX AT YOUR PERIL

Photo by Kevin Yanik

Industry trade shows offer a good opportunity for employee education. Photo by Kevin Yanik.

If an aggregates business makes a purchase within its so-called “home state,” sales tax is usually paid on the transaction. On equipment or business property purchased out-of-state or via the Internet, both businesses and individuals are supposed to pay a “use” tax on that item used, given away, stored or consumed in the home state.

The use tax is a type of excise tax levied by numerous state governments usually assessed at the same rate as the sales tax. Unfortunately, not all use taxes derive from sale transactions. A number of internal transactions may trigger use tax consequences. A good example is provided by equipment purchased under a manufacturing or mining exemption in one state that is later relocated across a state line — into a jurisdiction where the exemption no longer applies. In this case, the aggregates business must recognize the book value of equipment or machinery when it was relocated as the basis of the use tax due to the nonexempt state.

Despite all of the attention focused on income taxes, it is the bill for the tax on the property owned – or leased by – aggregates businesses that is the biggest expense and the most difficult to manage. According to the Council on State Taxation, a Washington, D.C. think-tank, American businesses shell out more on property taxes than for any other type of state or local taxes.

Every business, even many commercial tenants, pay a so-called “property tax” on the value of its property. While most property taxes are levied on real property (land and improvements to land), states are increasingly taxing personal property (such as noncommercial motor vehicles), as well.

Unlike most taxes, property taxes are computed by the local government and the taxpayer is usually told only how much to pay. However, lowering business property tax bills in any of the more than 14,000 taxing jurisdictions can be accomplished with a few simple strategies. Few business owners or producers are aware of how easy it is to check the computation of that property tax bill – as well as that of the underlying valuation – and correct all errors.

According to many experts, a basic business insurance package should consist of four fundamental types of coverage: general liability, workers’ compensation, auto and property/casualty – plus an additional layer of protection called an “umbrella” policy. However, selecting the right type of insurance for the aggregates business is only one factor every owner and producer should consider. Premiums amounts, claims payouts and the financial health of the insurance company also enter the equation.

Good times or bad, the hardest question to answer is what kind of funding should an aggregates business seek? Any quest for business funding should begin with an understanding of the various types of financing, where that funding may be found, and at what cost?

Generally, there are two basic ways to fund the business: debt financing or equity financing. With equity financing, capital is received in exchange for part ownership in the crushed-stone or sand-and-gravel business. With debt financing, capital is received in the form of a loan, which must be paid back.

BORROWING

For many small businesses, borrowing means a loan from the owner, partner or shareholder. However, whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated aggregates business, the tax law requires that a “fair-market” rate of interest must be included. If not, the IRS will step in and make adjustments to the below-market (interest) rate transaction in order to properly reflect “imputed” interest.

Is the type of “entity” that the aggregates business is operated as costing you money? Although many provisions apply to all business entities, some areas of the tax law specifically target each entity. Thus, choosing among the various entities can result in significant differences in federal income tax treatment.

Sole proprietors and those operating a crushed stone, sand or gravel operation as a pass-through entity pay only one tax on profits. Shareholders in an incorporated business pay taxes on the dividends received from the operation’s already-taxed profits – in essence, a double tax.

Naturally, there is also more to choosing the right structure for a business than taxes. The decision will also affect the amount of paperwork required for the business, the personal liability faced by the operation’s principals and, especially important in today’s economy, the operation’s ability to raise money.

Yet another major difference between a regular corporation and an S corporation is the ability of a corporation to raise money. A corporation can sell its stock, either common or preferred shares, in order to raise funds. S corporations, on the other hand, and despite being allowed to have up to 100 shareholders, can only issue one class of stock. Experts say this can hamper the operation’s ability to raise capital.

FINDING PROFESSIONAL HELP

Photo: iStock.com/lvsigns

Employee education can offer tax breaks for employers. Photo: iStock.com/lvsigns.

While most owners and producers know their business inside and out, in general and in detail, there are highly technical matters that are usually best handled by outside experts. Whether those professionals are lawyers, accountants, insurance agents or brokers, bankers, financing professionals, consultants or financial advisers to help manage or invest the profits from a successful operation, the strategies for finding them are similar.

The first step to finding the right professional requires an inventory of what the operation – and the operation’s owner, partners or shareholders – actually need in the way of services and advice and, most importantly, how much they can afford to pay for that advice or those services.

The best way to find any needed professional is to get a referral from business associates, the operation’s bankers or attorney. If more possibilities are needed, every state has professional associations such as those for certified public accountants (CPAs) or lawyers. State and local professional organizations may also help in the search for professional assistance as can many trade groups.

Community relations

Aggregate operations are frequently faced with opposition from community groups. Haul trucks – both off road and on road – are often part of the reason for this opposition. Community residents cite the dust that is kicked up by haul trucks; the repeated sound of trucks’ back-up alarms; the sound of revving engines; and the speed at which on-road trucks drive, as common reasons for discontent.

While truck manufacturers have gone the extra mile to ensure trucks operate with minimum noise, and most aggregates producers do their best to engage in safe driving practices, the truth is, many citizens do not support mining – period. In a larger sense, they do not recognize the dependence of society on aggregate. Direct personal use is very little, if any, and individuals may not recognize aggregate mining as a necessary land use, even though the need for the commodity is constant. Thus, zoning, regulations and competing land uses may restrict or preclude aggregate mining.

Now, and in the future, the rebuilding of deteriorated roads, highways, bridges, airports, seaports, waste disposal and treatment facilities, water and sewer systems, and private and public buildings require that enormous quantities of aggregate be mined or quarried.

Long-range planning is necessary to help ensure adequate economical supplies of high-quality aggregate while simultaneously protecting the public from the unwanted effects of mining.

To design guidelines or regulations for crushed stone or sand and gravel operations, it is necessary to predict what effects such operations may have on the surrounding communities and environment. Regulations should set minimum operational standards to control impacts such as noise, traffic, dust, pollution of streams and water supplies and erosion. The task for planners is to balance the needs of the operators with the public’s right to minimum nuisance resulting from the extraction.

Aggregate operators generally wish to be good neighbors and are willing to cooperate if cooperative efforts lead to a more smoothly operating facility. In fact, many innovative actions taken to decrease environmental impacts have been conceived and voluntarily implemented by aggregate operators.

Planning efforts help to limit public exposure to the impacts of aggregate mining and processing. Buffer zones, in particular, help mitigate impacts. Regulations or permits should set minimum standards for buffer-zone widths.

Buffer zones shield adjacent residents and land owners from mining operations and at the same time protect mining operations from intrusion or adjacent land-use conflicts. Berms, fences, screens, dense tree plantings or other barriers contribute to public safety and provide aesthetic controls that help to screen objectionable views. Newly exposed rock faces can be treated to match adjoining naturally weathered surfaces.

The impact of noise depends on adjacent land use. Noise can be mitigated through the use of buffer zones, berms and muffling equipment. Noise-generating equipment, such as haul trucks, loaders and the primary crusher, can be placed near the middle of the site, in pits below grade, in sound-insulated buildings or away from residential areas. Haul roads can be kept away from property lines, and the use of conveyor belts can minimize traffic within the site.

Truck traffic is one of the most serious problems associated with aggregate development. Some traffic can be mitigated at the site. Operators can be required to provide acceleration and deceleration strips on both sides of all entrances and exits to the operations. Paving and limiting the number of entrances and exits and wheel-washing procedures can minimize the amount of dirt deposited by trucks on adjacent highways.

The most serious problems associated with truck traffic – noise and safety problems – are on public rights-of-way. Conveyors constructed to carry aggregate under highways, reduced speed limits, restriction of routes for truck traffic and restriction of hours of operation all can help minimize traffic problems.

Dust can be reduced by minimizing the amount of area mined at any time, by planting vegetation or constructing other wind breaks, by using wet or chemical dust-suppression systems, and by enclosing dust-generating equipment in vacuum-equipped buildings. Erosion can be controlled through techniques such as settling ponds and revegetation.

Cooperative planning by developers, government and citizens is the key to successful protection and utilization of aggregate resources.

Employee education

Photo: iStock.com/Pattanaphong Khuankaew.

Photo: iStock.com/Pattanaphong Khuankaew.

One of the major assets for all aggregate producers is their employees. As is the case with most business assets, producers usually have quite a bit of money invested in hiring and training workers. Smart producers realize that improving a business asset can reap rewards that far exceed the cost of any improvements made to that asset.

When it comes to making smarter workers, everyone benefits thanks in large part to our tax laws. The pit or quarry operation prospers with smarter, better-trained employees – and a tax deduction if they foot the bill for employee education or training costs.

Smarter employees can often avoid a tax bill for the value of education provided by an employer and reap a tax deduction for their own educational expenses. Plus, they are often rewarded with higher pay, promotions or more opportunities. Regardless of whether an employer or the operation’s suppliers provide the education or training, both the worker and the business benefit.

BASIC SMARTS

At its most basic, an aggregate producer who trains a new worker or an existing worker for new duties incurs what our tax laws consider “ordinary and necessary” tax-deductible business expenses. It’s when expenditures are made for training or education by others, or outside the business, that the tax rules kick in.

It really doesn’t matter if an aggregate producer is self-employed, an employee of his or her own pit and quarry business, or simply an employee. Tax deductions and unique write-offs abound for anyone willing to look for them – or seek direction from an expert. In fact, under our tax rules, many educational and training expenses incurred by a business are both tax deductible by the business and, at the same time, tax-free to the recipients.

An aggregate producer may deduct the cost of “ordinary and necessary” expenses paid for employee education and training. Producers may also deduct the cost of education for the business owners if it can show that the education or training “maintains or improves skills required in the trade or business,” or that the education is required by law or regulations for maintaining a license to practice, status or job. For example, professionals in many fields routinely deduct costs for continuing education.

Of course, expenses incurred in meeting the minimum requirements of an individual’s present trade or business, or those that qualify them for a new trade or business, are not deductible. This is true even if the education maintains or improves skills required in the present employment.

THE EMPLOYER PAYS

An often-neglected provision of our tax law permits every aggregate producer to claim a tax deduction for expenditures made to educate or train employees. This is an ideal fringe benefit for any employee – even employee/owners of their own quarry or aggregate business. And, best of all, it is deductible by the business and tax-free to the recipient.

In general, an employer with an educational assistance plan can deduct up to $5,250 of educational assistance provided to an employee each year. Without an educational assistance plan, or if educational assistance exceeds the $5,250 threshold, the amounts qualify as a tax deduction if they are so-called working condition benefits. A working condition benefit is a service or property that would have been deductible as a personal business expense if an employee paid for it.

An educational assistance program is a separate written plan that provides educational assistance only to an aggregate operation’s employees. These expenses usually include the cost of books, equipment, fees, supplies and tuition. The cost of a course or other education involving sports, games or hobbies, is usually not included unless required as part of a degree program, or unless it has a reasonable relationship to the business.

Although the tax law requires an actual “plan,” the rules do not require an employer to fund the plan’s educational benefits. In fact, most businesses with a plan pay the educational benefits out of the operation’s general assets. Naturally, the benefits paid to participants cannot be conditional on them making contributions to the plan.

No educational assistance plan or program can discriminate in favor of owners, shareholders or highly compensated employees.

Generally, this applies to employees whose compensation was in the top 20 percent of all employees and above the current ceiling. Plus, the business must provide reasonable notice concerning the availability and terms of the plan to all eligible employees.

ASSISTING EDUCATION

With an IRS-approved educational plan, payments for educational expenses, even for graduate-level courses, are excludable from the gross income of the employee. What’s more, employees may be able to exclude as “working condition fringe benefits” any amounts that are not excludable under the basic plan. In addition, all payments made by a pit and quarry operation – or any business with a similar plan – are tax deductible as ordinary and necessary business expenses.

Despite the latitude given to aggregate producers and other businesses, there are restrictions placed on educational assistance plans. Educational assistance, to our lawmakers, does not include payments for tools or supplies that an employee gets to keep after completing the course or employee meals, lodging or transportation.

WORKER BASICS

An employee itemizing his or her personal deductions can claim a deduction for the expenses paid for work-related education. The deduction is the amount by which qualifying work-related education expenses, plus other job and certain miscellaneous expenses, is greater than the amount of the itemized personal deduction allowed in excess of the current floor on personal expenses. An itemized deduction reduces the amount of income subject to tax.

For the self-employed, expenses for qualifying work-related education are deducted directly from self-employment income. This reduces the amount of income subject to both income tax and self-employment tax.

Work-related education expenses may also qualify for additional tax benefits, such as a tax deduction for tuition and fees and the American opportunity and lifetime learning credits.

WORK-RELATED EDUCATION

An employee can often deduct the cost of qualifying work-related education as personal expenses. This is education that meets at least one of the following two tests:

1. Education required by an employer or by law in order to keep present salary, status or job. Of course, the required education must serve a bona fide business purpose for the employer.

2. Education that maintains or improves skills needed in the individual’s present work.

However, even if the education meets one or both of the above tests, it is not qualifying work-related education if it is needed to meet the minimum educational requirements in the individual’s present trade or business, or if it is part of a program of study that will qualify for a new trade or business.

Even better, an individual can deduct the costs of qualifying work-related education as a personal business expense even if the education could lead to a degree.

The fact that an individual is already employed does not mean the minimum requirements for qualification in that employment have been met. If new education requirements are established after an individual has met the minimum requirements, that individual will be treated as continuing to meet those qualification requirements. In other words, expenses incurred in meeting the new requirements will be tax deductible.

It should also be kept in mind that a change in duties is not a “new trade or business” if the new duties involve the same general work as that involved in the present employment. Thus, changing from driving a wheel loader to a tracked loader or from a mine manager to a plant superintendent does not result in a new trade or business. Also, a change in duties is not a change in trade or business.

EDUCATION PAYS

Training and education are important for every quarry and aggregate business in order to ensure the success and continued profitability of the operation. Those training and educational expenses, whether paid for by the producer, by a supplier or an equipment distributor, subsidized or sponsored by an industry group or association, can be considered fringe benefits because they are, for the most part, tax-free to the recipient.

Owners, producers and employees can enjoy an offsetting tax deduction for educational expenses that are not covered by the employer or business. Thus, everybody profits – especially the business that benefits from smarter, better-educated or trained employees. The aggregate producer can, of course, claim a tax deduction for educational expenses, all while providing the operation’s employees with a valuable, tax-free fringe benefit.

Regardless of who foots the bill for education, the rewards of smarter, better-trained employees are something every aggregate producer can reap. Crushed-stone and sand-and-gravel businesses, as well as their employees, can help to reduce the cost of that education with tax breaks. Education also makes an excellent fringe benefit every operation can employ to attract and retain employees.

Succession planning

Sooner or later, everyone thinks about retirement. For those who own a closely held or family aggregates business, retirement is more than just a matter of deciding not to go to work anymore. In addition to ensuring there will be enough money to retire, pit and quarry owners, shareholders and partners must decide what will happen to the business when they are no longer in control.

For many small crushed-stone and sand-and-gravel business owners, maintaining a positive cash flow and a stable balance sheet can be an ongoing battle. Retirement often seems like a distant speck on the horizon, let alone plans to hand over the business. To avoid “going to battle,” establishing a sound business succession plan is beneficial for most aggregates business owners — and can be absolutely necessary for some.

An effectively developed succession plan can involve:
■ Selling the business to provide a retirement nest egg.
■ Continuation of the aggregates business, with gradual changes in management and/or control, to ensure a source of retirement income.
■ Any combination thereof.

DEATH AND TAXES

At its most basic, a succession plan is a documented road map to be followed in the event of the owner, partner or shareholder’s death, disability or retirement. This plan can include a program for distributing the stock of the operation and other assets; retiring the operation’s debt; obtaining life insurance policies; buy-sell agreements among partners and heirs; dividing responsibilities among successors; and any other elements that affect the business or its assets.

The tax component of succession planning addresses the minimization of taxes upon death. Tax law changes under the American Taxpayer Relief Act of 2012 or ATRA, made the estate tax a permanent part of the tax code and the exemption amount automatically indexed for inflation. ATRA also increased the tax rate on estates in excess of the exemption amount from 35 percent to 40 percent.

Thus, in the 2013 tax year, the estate tax exclusion amount was $5.25 million and, thanks to inflation, was increased to $5.34 million for 2014. In 2014 up to $14,000 could be given to any number of persons in a single year without incurring a taxable gift ($28,000 for spouses “splitting” gifts).

One of the more important aspects of business succession planning is working out the financial pitfalls following the death of the business owner, answering questions like where the money would come from to pay taxes — or, if the business is a partnership, where the money would come from to buy out the deceased partner’s share.

INSURING THE TRANSFER

Life insurance often plays an important role in a business succession plan. For example, some aggregates business owners wait until death to transfer all or most of their business interests to one or more of their children. If the business owner has a taxable estate, life insurance can provide the children receiving the business the cash necessary for them to pay estate taxes. What’s more, the business owner can use life insurance to provide those children who are not involved in the business with equitable treatment.

Life insurance is also a popular way to provide the cash necessary for the business or the surviving owners to purchase a deceased owner’s interest, pursuant to the terms of a buy-sell agreement. In many instances, the cash surrender value in a life insurance policy can also be used tax-free (by surrendering to basis and borrowing the excess) to help pay for a lifetime purchase of a business owner’s interest.

Once a set dollar value has been determined, life insurance can be purchased on all of those involved in the business. Then, in the event that a partner passes on before ending his or her relationship with the other partners, the death benefit proceeds will be used to buy out the deceased partner’s share of the business and distribute it equally among the remaining partners.

There are two basic arrangements used for this. While both ultimately serve the same purpose, they are used in different situations.

■ Cross-purchase agreements are structured so that each partner buys and owns a policy on each of the other partners in the business. Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured; therefore, when one partner dies, the face value of each policy on the deceased partner is paid out to the remaining partners, who will then use the policy proceeds to buy the deceased partner’s share of the business at a previously agreed-upon price.

■ Entity-purchase agreements are much less complicated: The aggregates business itself purchases a single policy on each partner, and becomes both the policy owner and beneficiary. Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person’s share of the business accordingly. The cost of each policy is generally deductible for the business, and the business also “eats” all costs and underwrites the equity among partners.

GIVING IT AWAY

Photo by Kevin Yanik

Photo by Kevin Yanik

One key way to reduce estate taxes is to lower the value of assets that are in the estate. Gifting strategies can legitimately lower any owner, partner or shareholder’s tax liability. Fortunately, there are several ways to make gifts outright, and all serve to reduce the amount of the overall estate:

■ Annual gift tax exclusions — Currently, property valued at up to $14,000 per year per donee (person gifted) may be gifted without any gift tax consequence.
■ Other gift tax exclusions — Gifts for the purposes of the donee’s health or education are excluded from gift tax calculations. This is why parents can seemingly pay unlimited amounts for their children’s doctor appointments and, for some lucky ones, schooling expenses.
■ Lifetime gift tax exemptions — In 2014 giving lifetime gifts totaling up to $5.34 million before an estate, gift or generation-skipping taxes are imposed is possible.

Unfortunately, none of these gifting strategies directly benefit the aggregates operation. Other strategies for transferring the business do exist, however; strategies that frequently include retaining control.

FLIPPING FOR FLPS

By controlling the aggregates business through a “family limited partnership” (FLP) or a “family limited liability company” (FLLC), everyone can get the added benefit of gifting shares at considerable discounts. A FLP or FLLC can also assist in transferring a business interest to family members.

First, a partnership with both general and limited partnership interests is created. Then, the business is transferred to this partnership. A general partnership interest is retained for the owner, allowing continuation of control over the day-to-day operation of the business. Over time, the limited partnership interest is gifted to family members.

BUY-SELL AGREEMENTS

A buy-sell agreement, often called a “business prenup,” is a legal contract that prearranges the sale of a business interest between a seller and a willing buyer. A buy-sell agreement allows the seller to keep control of his or her interest until an event specified in the agreement occurs, such as the seller’s retirement, disability or death. Other events such as divorce can also be included as triggering events under a buy-sell agreement.

When the triggering event occurs, the buyer is obligated to buy the interest from the seller, or the seller’s estate, at its fair market value (FMV). The buyer can be a person, a group (such as co-owners) or the business itself. Price and sale terms are prearranged, which eliminates the need for a fire sale if the owner, partner or major shareholder becomes ill or dies.

SELLING TO EMPLOYEES

An employee stock ownership plan (ESOP) allows the owner of an incorporated crushed-stone or sand-and-gravel operation to sell his or her stock to the ESOP, and defer the capital gains tax. Ownership can be transferred to the operation’s employees over time, and the business can obtain income tax deductions for contributions to the plan.

An ESOP provides:
■ A market for the shares of owners who leave the business.
■ A strategy for rewarding and motivating employees.
■ The ability to benefit from available borrowing incentives.
■ The ability to acquire new assets using pretax dollars.

AN OUTRIGHT SALE

To keep the income rolling in without having to show up for work every day, succession planning might look at selling an owner, shareholder or partner’s interest in the aggregates business outright. When the business interest is sold, the seller receives cash (or assets that can be converted to cash) that can be used to maintain the seller’s lifestyle, or pay his or her estate taxes.

The time to sell is optional — now, at retirement, at death or anytime in between. As long as the sale is for the full FMV of the business, it is not subject to gift tax or estate tax. On the other hand, a sale that occurs before the seller’s death may be subject to capital gains tax.

LIQUIDITY STRATEGIES EQUAL CASH

So-called “liquidity” strategies permit a business owner to take cash out of the business in exchange for the transfer of assets to another individual. While liquidity options are most common with sales of a business to a third party, they can also be used when the assets are being transferred to family members or business insiders (such as partners).

A private annuity involves the sale of property in exchange for a promise to make payments for the rest of the seller’s life. Here, ownership of the business is transferred to family members, or another party (the buyer). The buyer, in turn, makes an unsecured promise to make periodic payments for the rest of the seller’s life (a single life annuity), or for the seller’s life and the life of a second person (a joint and survivor annuity).

A joint and survivor annuity provides payments until the death of the last survivor — in other words, payments continue as long as either the husband or wife is still alive. Again, because a private annuity is a sale and not a gift, assets can be removed from an estate without incurring gift tax or estate tax.

A self-canceling installment note (SCIN) permits the transfer of the business to a buyer in exchange for a promissory note. The buyer must make a series of payments to the seller under that note. A provision in the note states that upon the owner’s death, the remaining payments will be canceled. SCINs provide for a lifetime income stream, as well as the avoidance of gift tax and estate tax, in a manner similar to private annuities. Unlike private annuities, however, SCINs give a security interest in the transferred business.

STARTING THE PROCESS

The first step to succession planning involves clearly establishing the aggregate producer, shareholder or partner’s goals and objectives, as well as the operation’s current human and financial resources.

Consider the following:
■ How much control of the business do you want to maintain?
■ Is there someone capable of running the business once you step down?
■ Are there key employees who must be retained?
■ Are there sufficient assets to pay the estate tax, equalize the estate and keep the business?
■ How much money is needed to reach the owner’s financial goals?

While clarifying those goals and wishes is important, it’s not enough. The aggregates business owner also needs to communicate his or her vision with family, business partners and key employees.

Developing a succession plan is a multi-phase process, outlining in detail the who, what, when, why and how changes in ownership and management of the aggregates business are to be executed.

At a minimum, a good plan should help accomplish the following:
■ Transfer control according to the wishes of the operation’s owner, shareholder or partner.
■ Carry out the succession of the business in an orderly fashion.
■ Minimize the tax liability of all involved.
■ Provide economic well being after the owner, partner or shareholder steps aside.

Obviously, business owners seeking a smooth and equitable transition of their interests should seek competent, experienced advisors to assist them in this matter. But no matter how talented and earnest those professional advisors are, their limited specialties should never dictate the choices for the business or the owner, shareholder or partner’s family.

A tax lawyer can make compelling arguments for strategies that can minimize estate and gift taxes. Likewise, a certified public accountant (CPA) can be very convincing when suggesting strategies for controlling income taxes. And it is a similar story with financial planning and insurance professionals. But the fact remains: Tax planning should never control any business decisions. First, determine the result desired, and then let the professionals find the most tax-efficient way to achieve that result.

Finally, succession planning isn’t something that can be done once and forgotten. To be complete and effective, a succession plan must be continually revisited, reviewed and updated to reflect changes in the value of the aggregates operation, the market conditions, and the health of the owner, shareholder or partner — as well as the abilities and passion of the people to whom it will be passed.

Mergers and acquisitions

Photo: iStock.com/Cecilie_Arcurs.

Photo: iStock.com/Cecilie_Arcurs.

Surprisingly in today’s uneven and uncertain economic climate, two recent reports show that mergers and acquisitions (M&A) are on the upswing, with most of the action involving smaller deals (and a couple of very large ones such as Martin Marietta Materials’ purchase of Texas Industries and the Lafarge/Holcim union. Obviously, not every aggregate producer is in a position to buy, but weak earnings and declining market share create great buying opportunities for good managers.

For many small crushed-stone and sand-and-gravel business owners/operators, mergers are a way of cutting overhead costs, increasing efficiency, battling a larger competitor or acquiring a permit. M&As are often based on the belief that a profitable, better-managed business can get more out of the assets of an underperforming business than was possible under its current ownership.

Admittedly, most small aggregates businesses tend to grow “organically,” that is by slowly adding customers, employees, new services or products, equipment and physical space. Others grow by merging with or acquiring another operation – or by being acquired. In fact, an economic downturn often creates greater opportunities for buyers to take advantage of depressed business valuations, providing an opportune moment to do a deal.

Mergers and acquisitions typically take one of two forms: an “acquisition,” in which an aggregates business folds a new company into its existing operations (or vice versa, if the business is being acquired), or a “merger” where both businesses are typically dissolved and a new business entity formed or created.

A merger is a tool used by many businesses to expand operations, often aiming at an increase in long-term profitability. Usually, a merger occurs on a consensual basis where the owners/operators/management from the target business help those from the purchaser to ensure that the deal is beneficial and profitable for both parties.

Acquisitions can also happen through a so-called “hostile” takeover by purchasing the majority of outstanding shares of a business in the open market against the wishes of the target company’s management and/or directors. This approach is, however, rare among smaller, privately held businesses.

BUYING A GOING BUSINESS

In most cases, buying an existing business is less risky than starting from scratch. When a business is purchased or acquired, the target is usually already generating cash flow and profits. After all, the aggregates operation to be acquired usually has an established customer base and reputation as well as employees who are familiar with all aspects of the business.

On the downside, buying a business is often more costly than starting from scratch. Fortunately, even today it is often easier to get financing to buy an existing business than the funding necessary to start a new one. Bankers and investors generally are more comfortable dealing with a business that already has a proven track record.

PAYING FOR IT ALL

When it comes to financing, there are a number of strategies for financing mergers or acquisitions:

■  Use the seller’s assets. Finance companies, factors (companies that buy accounts receivable) and some investors will lend money based on purchase orders. Factors, finance companies and banks will lend money on receivables. Finance companies and banks often lend money on inventory. Equipment can also be sold and then leased back from equipment leasing companies.
■ Joint venture. Where an acquisition may be out of reach for one aggregates business, buying in conjunction with another party may make the acquisition affordable. To find a likely partner, ask the seller for a list of those who were interested in the business, but did not have enough money to buy.
■ Employee Stock Ownership Plans (ESOPs). ESOPs offer a way to get capital immediately by selling stock in the business to employees. By selling only non-voting shares of stock, control can be maintained. Imagine using an ESOP to acquire a business for as little as 10 percent of its purchase price.
■ Assume liabilities or decline receivables. Reduce the sales price by either assuming the business’s liabilities or having the seller retain the receivables.

ISSUES WITH TAX ISSUES

Unfortunately, buyers and sellers who fail to address the tax issues of a merger or acquisition risk leaving money on the table. Because of its significant impact on the bottom line of any M&A transaction, formulating the right tax-efficient strategy can play an important role in the success or failure of any deal.

While no two deals are the same, the start of every M&A transaction depends on whether it is taxable or tax-deferred.

In a tax-deferred transaction, the seller typically gets a substantial part, if not all, of its proceeds in the form of stock in the buyer’s business. Because the seller continues to hold an interest in the surviving business – without realizing a gain – there are no tax consequences until the stock is sold. This alternative often makes sense for sellers who do not need immediate liquidity provided, of course, they think the buyer’s shares are a good long-term investment.

REORGANIZATIONS

A so-called “qualified reorganization” is tax-free if it falls within the transactions outlined in the tax rules:

A Type A reorganization is a merger or consolidation under state or federal corporation laws.

■ A Type B reorganization is the acquisition by one corporation of the stock of another corporation in exchange solely for all, or part of its own or its parent’s voting stock. The acquiring corporation generally controls the other corporation after the acquisition.

■ A Type C reorganization involves the acquisition by one corporation of substantially all of the properties of another corporation, in exchange solely for all or a part of its own controlling parent’s voting stock, followed by the acquired corporation’s distribution of its property under a reorganization plan.

Type D reorganizations involve a transfer by an incorporated quarry or aggregates business of all or a part of its assets to another corporation where, immediately after the transfer, the transferor, or one or more of its shareholders is in control of the corporation to which the assets were transferred.

■ Type E reorganizations would be better labeled as a “recapitalization.”

■ A Type F reorganization is a mere change in identity, form or place of organization of one corporation.

■ Type G reorganizations refer to a transfer by a corporation in bankruptcy of all or part of its assets to another corporation on a tax-free basis.

TAXABLE BUT FLEXIBLE

In a taxable M&A transaction, where the government usually takes its cut in the first year, two of the most critical factors influencing the negotiations between the buyer and seller are:
■ What the buyer is purchasing – assets versus stock.
■ The legal structure of the seller.

In most M&A transactions, the buyer either purchases the seller’s assets (after which the seller becomes a shell and is liquidated) or acquires stock. From a tax standpoint, buyers benefit by assigning more of the purchase price to fast-depreciating assets such as inventory and equipment – while allocation of the purchase price to longer-term assets such as land, generally favors sellers.

In general, “S” corporations and limited liability companies (LLCs) are the most tax-efficient when a business is up for sale. Since the tax liability that a regular “C” corporation incurs on an asset sale is often subjected to the “double tax,” aggregate operations planning to go on the market should at least consider converting to “S” corporation status.

(An “S” corporation is a incorporated business whose shareholders have chosen to have all of the operation’s gains and losses passed on to them, to be reported on their individual tax returns. Thus, like an LLC, a partnership, the “S” corporation is a “pass-through” entity with all of the liability protections of a regular, ordinary, everyday corporation – sometimes referred to as a “C” corporation.)

TAXES AND MORE TAXES

There are other tax-related issues that will have to be addressed by both buyers and sellers. State and local governments, for example, assess income, sales, transfer and property taxes that vary considerably – particularly if one or both parties do business in multiple states. Above all, don’t forget that a merger or acquisition mainly for tax benefits is a no-no, easily and legitimately undone by the IRS.

Acquiring control of another business to evade or avoid income taxes by securing the benefits of a deduction, credit or other allowance also means the deduction, credit or other allowance may be lost.

The tax rules explicitly authorize the IRS to deny acquiring corporations, carryovers and other tax benefits including losses, acquired as part of the acquisition of another corporation.

Even if it is not a deal breaker, the tax aspects of an M&A transaction can be significant enough to make or break a deal. The right tax strategy can help sellers maximize their after-tax proceeds, while buyers can minimize their costs, and better position the new company emerging from the deal for success.

Now may be an excellent time for every well-managed aggregate company to think about acquiring another business for increased profits, lower costs or strategic growth. Still others are thinking about the many benefits of merging with another operation, perhaps even a competitor. Obviously, professional tax advice is almost always necessary.

Taking your company public

Management teams begin to ask themselves those questions as they approach the normal threshold for going public in terms of revenue and operating performance. Due to the expenses of going public, that threshold today generally suggests the company have at least $20 million annual revenue and at least $2 million in cash. The revenue number can be lower for mining companies with large reserves.

In order to properly attract the investing public, the company must also be operationally strong with robust prospects. The company should have a strong management team and a consistent history of double-digit growth that will continue into the foreseeable future.

Assuming the thresholds are met, a company’s management needs to weigh the pros and cons of going public.

PROS OF GOING PUBLIC

Today, there are many good reasons companies continue to go public. Chief among them is increased ability to raise capital. Mining companies often need capital to fund expansion, update equipment, pay for research and development, or even to pay off debt. Going public gives the company’s securities a “public” marketplace that far exceeds the size of private marketplaces. The company has greater access to capital markets as management now has the option of issuing additional stock through initial and secondary offerings. As the network of potential investors expands into the broad public arena, the likelihood of raising money expands.

Public companies often enjoy greater valuations and access to more favorable borrowing terms. The public company can offer its stock to the public at large, greatly increasing the pool of potential investors and generally leading to increased demand, which, in turn, yields a higher stock price and net worth. As banks use a company’s debt-to-equity ratio as an indicator of loan risk, the increased net worth should allow the public company to borrow money on more favorable terms.

Going public also makes the company’s stock a kind of currency, further increasing the company’s ability to fund operations and growth. A public company’s stock can be used to purchase other companies and services and be used to attract, retain and motivate key personnel.

Going public also provides an exit option to original investors. Normally the company’s stock becomes more liquid as the company goes public, offering original investors the opportunity to financially capture years of hard work by selling at least some of their stock. They may want or need to purchase a new car or home or at least diversify their investments to minimize portfolio risk.

Going public can actually help a company retain control when compared to raising capital through a venture capital firm. Often venture capital firms insist on a decision-making position, something typically avoided when going public.

Another reason to go public is that it can be an outward sign of credibility, achievement and prestige.

CONS OF GOING PUBLIC

The pros of going public are quite enticing, but are they enough to overcome the cons?

Being a public company is something akin to being in a fishbowl with the public looking in. Companies should be prepared to explain their decisions to shareholders. Companies will feel pressure to perform and increase share price from quarter to quarter. This can lead to short-term thinking and actions that are counterproductive to the long-reaching goals of the business.

Another con to going public is the large expenses involved. Depending on several variables, including the size of the offering and method of going public, expenses can exceed $1 million. Of course, proceeds raised during the go-public process can be used to pay for these costs. However, doing so will increase dilution.

Another form of dilution comes from selling shares to the public. When dilution occurs, original investors own a smaller percentage of the pie. They trade ownership percentage for the hope that selling shares yields a stronger company with increased prospects that essentially creates a much bigger pie for which their smaller percentage is worth more. While that’s the plan, companies that fail to deliver strong results can find their claim on the company to be worth less.

There are also ongoing costs and compliance burdens to consider. Complying with SEC disclosure and reporting requirements take time and money. In addition to running the business, management and accounting staff need to report each quarter, answer shareholder questions and prepare annual 10Ks and other filings. Management may find significant resources are diverted away from operations. Costs are also incurred by various third parties, including investor-relations firms, auditors, attorneys and filing agents. Third-party costs alone can exceed $300,000 per year, even for small companies.

HOW TO GO PUBLIC

Assuming the pros outweigh the cons for your mining business, the next step is to consider how to go public. While there are a number of ways to go public, two of the most common are IPOs and reverse mergers, each having their place.

IPO – An IPO (Initial Public Offering), as the name implies, is the first public sale of stock by a company. In an IPO, an investment bank guides the company through filing regulatory paperwork, helps authorities review the deal and underwrites and issues shares. A traditional IPO necessarily combines the go-public process with raising capital.

There are various benefits to going public through a conventional IPO. IPOs generally raise more money, usually $20 million or more. Also, IPOs can make it easier to create market support for a stock, as most companies start out trading on a major exchange. And IPOs are the ultimate outward sign of credibility and achievement; they buy a lot of prestige.

On the downside, conventional IPOs are typically the most lengthy and costly way to go public, often taking a year to complete and costing $1 million or more. And IPOs can be risky for companies because the deal depends on market conditions. If the market is off when it’s finally time to go public, often a year or more after starting the process, the underwriter may pull the offering.

Reverse merger – A reverse merger, also known as a reverse takeover (RTO) or reverse IPO, takes place when the shareholders of a private company purchase control of a public shell company and then merge it with the private company.

Prior to the reverse merger, the public company is called a “shell” because no active business resides within it; all that remains of the original business is its organizational structure. Today it’s common that the private company receives at least 95 percent of the shares of the shell.

The shell’s board of directors steps down and is replaced by the board of the private company. Assuming the shell is registered with the SEC, the private company avoids the time-consuming and expensive review by the SEC because that has already taken place with the original company. The net effect is that the formerly privately held company is transformed into a publicly held company.

A reverse merger can be an attractive strategic alternative to the IPO. Reverse mergers are less time-consuming and less costly than traditional IPOs. Reverse mergers can be accomplished in as little as 30 days. The price of shells varies widely today depending on its type and condition, where you get what you pay for. Today, a good, clean-reporting Over-the-Counter Bulletin Board (OTCBB) shell that’s at least 98 percent deliverable and comes with lots of original shareholders will probably cost in the $350,000 to $500,000 range. And some of the best shells have several hundred or even a thousand or more original shareholders, exceeding the minimum shareholder requirement to up-list to a major stock exchange such as the NASDAQ or AMEX.

In a reverse merger, the processes of going public and raising capital are separate. The two processes normally take place concurrently but can be separated if desired, avoiding the risk of market timing faced in an IPO. Reverse mergers are often chosen by companies raising between $5 million to $30 million.

On the downside, reverse mergers are viewed as less prestigious than an IPO. And you have to do your homework to make sure the shell you’re acquiring has good bookkeeping and is clean and not tainted by pending liabilities or lawsuits. Additionally, shells can come with angry shareholders who will dump their stock the first chance they get. However, finding a shell that has been a shell for the past 10 to 20 years can eliminate much of the risk of angry shareholders because shareholders will be delighted to finally merge with an operating company with strong prospects and potential share-price appreciation.

Operationally and financially strong, private aggregate companies with robust prospects have the ability to attract the investing public. For these companies, it makes sense to consider the pros and cons of going public and the method by which to do it.

If you’re considering going public, your next step is to find a good investment banker. Sit down and explain your business and goals with the banker, who will explain the various private and public options you have. He or she will offer his or her opinion on what fits your company best and leave you and your team to decide what course to take.


Sources

Contributors to this chapter include the following, in alphabetical order:

Mark E. Battersby
Freelance Writer
mebatt12@earthlink.net

John Hickey
Former President & CEO
Valley High Mining Co.


Lesson 14 Quiz

1. What is a “use” tax?

2. What is the difference between corporations and S corporations?

3. Besides by minimizing the amount of area mined at a time, planting vegetation and wind breaks and enclosing dust-generating equipment in vacuum-equipped buildings, what is a fourth way to minimize dust?

4. What is the definition of a succession plan?

5. What are two basic arrangements used for life insurance?

6. What do FLP and FLLC stand for?

7. What is it called when a shareholder of a private company purchases control of a public shell company and merges it with a private company?

8. Why are initial public offerings (IPOs) sometimes risky for companies?

 

Click here for the quiz answers.

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