Flow, taxes, and protecting our assets.
For most of us, these are probably some of
the biggest concerns that
we have for our business.
It really boils
down to earning an
honest living, and
being able to keep
more of what you
When looking for ways to maximize
your cash flow and yet protect it from the
government and predatory creditors, probably
the last place any one would think of
would be our good friends at the government.
However, one little known ruling
issued by the Department of Labor (the
government agency in charge of pension
plans) could very well hold the secret to
In the DOL's ruling, the agency said
that under certain conditions, a retirement
plan could factor a business' accounts
Wait! What's that? One more time: A
business' retirement plan could actually
factor the same business' accounts receivables.
Now, your business can actually have
access to more cash to help it through
tight times. Not only that, this process
will also lower your business' taxable
income. Finally, if you ever are hit with a
lawsuit, you can sleep better at night
knowing that your accounts receivables,
probably one of the greatest assets of your
business, are protected from those lawsuits.
How it works:
First, you need to make sure that you
have a retirement plan for your business.
This is crucial because retirement plans,
be it a SEP, SIMPLE, 401k, or even an
IRA, are probably the greatest personal
tax havens allowable in this country. So
long as you operate them correctly, the
IRS is nice enough to not tax the investments
inside your retirement plan. Not
only that, but in many cases the federal
government says that the assets you build
inside your retirement plan are exempt
from the claims of creditors. Tax-free
growth and iron clad asset protection
not a bad combination. In fact, it's a
Next, you need to have a fair-market
appraisal on the value of your accounts
receivables. This is where some folks are
really in for a shock. Most business people
think that they don't need an appraisal
of their receivables; after all, if the clients
owe $10,000 then the receivables should
be worth $10,000. Right? But it isn't that
While you may very well be in love
with your clients, a banker or financier
isn't going to feel the same about them.
In fact, more than likely, they are going to
believe that not all of your clients are
going to pay what they owe. This means
that if you were to sell your accounts
receivables to the banker, they aren't going
to give you 100 cents on the dollar.
Instead they may only pay you 90 cents
for every dollar owed, or maybe even as
low as 80 cents on the dollar for your
receivables. Now the banker, not you,
receives the payments from your clients.
Understandably this is the reason most
business owners don't sell their accounts
receivables due to the large discount
bankers are going to insist upon. A better
solution is to sell your receivables to your
own business' pension plan.
A simple example:
Let's say that you sell widgets and that
you have an average profit margin of 20
percent. Your annual gross sales are
$600,000 (for sake of example, let's say
$50,000 a month, all of it purchased on
credit); you would end up being taxed on
the $120,000 profit.
After hearing about the government
ruling, you decide you would like to have
your company's retirement plan purchase
the accounts receivables generated. First,
you offer the receivables to your friendly
banker, and offer to purchase your receivables
for 90 cents on the dollar. (This is
your fair market appraisal of your receivables.)
However, you decline their generous
offer and instead offer the receivables
to your pension plan.
Your pension plan now pays your business
90 cents on the dollar, $45,000, for
your current receivables. Your business has
just received a cash infusion and you've
lowered your taxable income.When the
receivables are paid in full, $50,000 to
your retirement plan the $5,000.00 profit
is not subject to taxes.
This is a great investment for your
pension. Remember, the pension plan is
buying $50,000 of receivables each month
for $45,000 (90 cents on the dollar) and
when all receivables are paid in full, at the
end of the year, your initial investment of
$45,000 will have grown to $105,000
(Initial investment of $45,000 plus the
$60,000 of earnings from the $5,000 each
month profit on the receivables purchased)
inside your retirement fund for
the year. At the same time, your taxable
income is going to drop from $120,000 to
$60,000 because you've reduced your gross
receivables by that amount. It's like taking
your profit before taxes!
In addition to a great return on investment,
your pension is going to have to file
a UCC-1 naming the receivables as collateral.
So now they are also protected from
Of course, details of the ruling make
the example a bit simplistic, but the basics
are there. You can lower your taxes,
increase your cash flow, and protect your
The ruling by the DOL has a number
of specific requirements such as: you can't
use more than half of your pension assets
to buy the receivables, the business has to
guarantee the receivables, a third party has
to administer the program, and the receivables
have to be properly collateralized.
Still, the bottom line is that in this
particular situation, if you are willing to
meet the terms of the ruling, you could
dramatically lower your taxes, increase
your company's cash flow, and protect
yourself from lawsuits. This is one of
those fabled situations where the laws are
actually written in your favor.
Tim Berry is chief executive officer of
The Tax Academy in Reno.