Infrastructure Bill Strips

I have been struggling for quite some time to understand why some organizations spend millions of dollars each year providing their employees with some kind of incentivizing benefit such as health care, pension benefits, health insurance, etc. Many companies still use tax advantaged plans, such as 403b plans, 401(k) plans, profit sharing plans, flexible spending accounts (FSA) and health savings accounts (HSAs) to provide employee benefits.

The latest contribution limits for the FSA and HAS plans are $2,600 and $3,400, respectively, in 2019. The combined total in 2019 of these accounts will be ,400. As far as I am concerned, these plans are ripe with red flags and should be avoided. Though the change is only for a year, the Labor Department has given the notice to businesses to begin the early removal of the credit.

The Code of Federal Regulations

When applying for an employer identification number, an employer is required to maintain records of all employees at all levels of their operation, including those who are not eligible for benefits under Title 38 of the Code of Federal Regulations, which is applicable to self-employed individuals. Once an employee is hired and the employee is working for the business, the employment ends. Therefore, if a startup business’s only employee is an entrepreneur who is not considered an eligible employee, the startup can no longer benefit from the credit.

The first calendar quarter after the change in law begins, new employees who are not eligible for the credit are not included in the annual requirement to maintain records of their employees. Small business owners were notified in September by the Department of Labor that they will begin to have their records reviewed by the agency in December, and that the early removal of the credit will take place during 2019. The estimated value of the tax credit for the average business is approximately $250,000 for an individual.

Why Congress Passed the American Jobs Act

According to the Bureau of Labor Statistics, approximately one-quarter of new businesses remain in the first five years. One reason for this is that it is difficult for companies to hire qualified employees for their company at the start. Another reason is that businesses are not able to convince qualified applicants to take a job that they are not guaranteed to make full-time. To boost worker morale, startup businesses try to pay well.

Small business startups are more likely to fail than established companies. Fifty-six percent of startup businesses that remain in business for less than five years fail, compared to 18 percent of companies that stay in business for 15 years or more. These stats are why Congress passed the American Jobs Act in 2012, that included the Employee Retention Tax Credit. This credit is intended to help boost employee morale, encourage employment and increase the average work week for employees. With the elimination of this credit, it is likely that startup businesses will continue to have a hard time attracting qualified employees.

This change in the law is expected to affect employees across the country, but especially those in startup businesses. Many of these employees may have moved to an area for job opportunities and plan to stay in their area, but it may not be as easy to find jobs with these new changes. CTC offers resources to help business owners understand the future of the employer identification number (EIN) law changes and how to prepare to comply.

The organization suggests that businesses that are not yet aware of the law change may benefit from reviewing current HR records for purposes of verifying their full-time employee workforce in the first fiscal year after the credit is changed to a phase-out. Businesses should prepare to assist employees who will be affected by the change. CTC has a dedicated guidance line available at 1-800-827-6277 for any business questions about the employer identification number law changes. It is also recommended that businesses review their EINs and Form W-2s to verify that employee withholding and estimated tax withholding are correct, as the IRS is likely to revise these returns.

The Reasons and Story Behind the Changes

If there is one thing that people don’t like, it is having to pay more for things they want. That means that going to work every day to earn their keep is something that people don’t like. Now it is not all that surprising when you consider the pay out ratio that pays from personal income taxes as an example. Here is what happens.

Americans work approximately 10 years to earn the full personal income tax liability for the year. The top marginal rate on taxable income is 39.6%. This is the tax rate that has been in effect since December 31, 1986. So, when you work 10 years and earn an income of $100,000, this is what your tax liability looks like.

  • Total Taxes $20,550
  • Income Tax $39,600

If you decide to retire, you will now need to work for 10 years to earn enough money to pay $40,000 back to the government. Since, your income is fixed, you will work to earn the same amount each year regardless of your age. The same must happen with a business that has no interest rate or fees attached to its capital and cash flow.

So, if a business is unable to obtain the credit for a full year of business operations, they are left to determine a different source of financing to continue operations. And, it could be a difficult and painful process, considering the business may have to scale back operation if there is not the cash flow to operate or refinance an existing debt or credit line.

What a business would need to do in order to continue operations is to re-capitalize through a term loan. This could mean a number of different things to the business. You might need employee retention credit and government assistance to be able to get the financing. Or, the company may need an additional employee to run the business and to increase their sales. Whatever the case may be, it seems the only reason the company would seek additional capital is to improve cash flow and to expand the business.

If this business is unable to raise additional funds and isn’t able to expand operations, they are left in a position where they must seek their employees back to work, or close their business. That could be either a very difficult decision or one that is the easiest one to make for a struggling business. It’s tough to sell something you can’t sell. And, it’s tough to close your doors when there is no money to close the doors.

But it’s Not as Tough as Most Think

In a perfect world, we would not have a 1 in 5 businesses failing in any given year. In the real world, there are a lot of reasons businesses fail. Maybe a recession came along, the company got in over their head in terms of debt or regulations changed or were made harder to operate.

So, what do we do when these companies fail? How does a business get their operations back on track to be able to re-capitalize and once again be able to operate? What options does this business have to save its business and allow them to turn a profit and survive?

The business will look at a few different options when faced with needing to reduce operating costs.

  1. They could reduce operating costs by reducing workforce.

There is nothing better for a business than to keep their staff and continue to employ them. This business would have to find a way to reduce their workforce and pay them less to make the business viable. If the company reduced its workforce to 30 employees, this would save the business $3,750,000 in payroll costs.

It’s estimated the average cost of a full-time employee is $45,000 per year. So, $450,000 would be deducted from the company’s payroll. However, we need to remember that this is a very conservative estimate. Because some employees may make more than that and some will receive fringe benefits, there could be an even bigger savings than this.

As stated before, there are a number of ways to reduce your operating costs. Perhaps you could reduce your full-time workforce by 20% and require that everyone work 40 hours. This would save the business $800,000 in full-time wages. Or, you could change your business’s business model so that it’s more likely you have cash on hand rather than having to pay bills each month.

Another option is to stop receiving any customers, which would mean having no customers to pay for your services. You’d then need to hire someone to serve as the salesperson to find new customers and convince them to use your services.

  • Some of your revenue can be used to pay off some of your debt.

In many cases, a business will still have debts they’ve accumulated. In order to fix the problem, the business may be in a position to take on some new debt. This could come in the form of a line of credit or a loan. However, it’s important to make sure that this new debt is something that ERC would be willing to service or even provide additional funding for. Otherwise, the company is in a worse position than they were before.

Typically, a business that has debt, like employees that haven’t been paid, will be on the hook to pay that debt. If the business is in debt and can’t pay that debt, it can lead to creditor’s handling the business’ assets through foreclosure or bankruptcy. This is usually a last resort, but it’s not unheard of. In some cases, it may be worth it for the business to borrow money from a bank or corporation to pay off its creditors.

  • Hiring people could be cheaper than before.

Another possible option for saving the business is to hire new people. Hiring new employees might result in more costs, but it could also save money in the long run. This is especially true when you look at how much the employee benefits are versus the total salary and benefits. A larger savings might be had if they were using contract labor to perform many of the tasks that were being done by full-time employees.

The next question that would need to be asked is “Do you think you could get away with paying the employees even less than what you currently pay them?” As we discussed before, an average full-time employee makes about $45,000 per year. If the business is paying full-time employees around $35,000, this business will save about $45,000. A 5% pay cut for the employees will save $45,000, and a 10% pay cut will save $50,000. Even better would be to lower the salary for each employee by 10%.

Assuming that the employees receive health insurance, and they’re not exempt from paying a portion of this cost, the result will be a savings of $75,000 for the business. In some cases, the employees may not have a high turnover rate. A five-year turnover rate of 10% is a very good indication that employees will be committed to the business and will be diligent in the production of the products or services being provided.

But sometimes, it’s not the employee turnover rate that will prevent a company from having a high turnover. It’s other employees who may have a job that they need to take care of, but don’t want to do it. It’s perfectly acceptable to hire someone that would normally only perform two or three tasks. The results are usually a much higher production output for the business, and most of the time, this leads to less overhead costs.

  • The business will need to stop doing unprofitable activities.

In many cases, the business will need to make the conscious choice to stop doing an activity that is unprofitable for the company. In this case, a decision would need to be made as to how much revenue the company needs to generate in order to break even on this unprofitable activity. What’s often seen as being more profitable, may end up being more costly to the company, especially if they don’t have a lot of products and services that are directly related to this unprofitable activity. If there’s no product or service that is directly related to the unprofitable activity, the business is better off discontinuing that unprofitable activity.

An example would be a professional services company that performs accounting services. This type of company will probably have some new revenue generating opportunities. But if the company is serving a specialized niche, it may be less worthwhile for the company to remain in this niche. By replacing the unprofitable business, you will end up with a much higher margin of return on each dollar that you invest.

The Takeaway

Unless you know a lot about the business or the industry in which it’s operating, the best course of action is probably to sell the business. But if the business still has some value, a business sale might not be the best option. Consider using it as a way to get rid of unprofitable activities. Don’t let unprofitable activities hinder the potential profits that are possible for your business. When you’re trying to decide whether to sell or keep the business, you’ll need to do a self-audit.

It’s very easy to let unprofitable activities creep back into the business when you think that you’ll be able to get away with it. It’s also very easy to look at the profits and think that there’s room for improvement. Before you make a final decision on the future of your business, take the time to think things through and to check for any unprofitable activities. If you do find any unprofitable activities, it’s worth it to talk to a business broker to find out what kind of services could be provided to the business to reduce the amount of these unprofitable activities.

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