Do you know how much your RIA firm is worth? Many firm owners don’t think about their firm’s value every day, or even every year. Often, the question comes up only ahead of a sale or owner transition. But knowing your firm’s value is critical for more than these occasions. For starters, doing so can enable you to unlock powerful opportunities for growth. And this is where a fractional CFO who has expertise in business valuations can help.
What is a Fractional CFO?
Simply put, a fractional CFO is like having a virtual CFO for your business. Instead of keeping a full-time CFO on your payroll, you hire a CPA firm to provide outsourced CFO services. There are many reasons why an RIA firm might want to consider a fractional CFO. The one we’re focusing on today is the ability to track the valuation of your firm.
Why is it Important to Know the Value of Your Firm?
If you’re like most RIA firm owners, your firm is one of your largest assets. Now, what do you tell your clients about their largest assets? If you don’t know how much your firm is worth, you’re likely going against your own advice!
The thing is, it’s important to conduct a valuation of your firm at least once a year. Doing so is critical to understanding how you can increase your firm’s value and how your day-to-day decisions could affect it. A fractional CFO can easily provide you with a valuation as part of their CFO advisory services.
Allow me to explain…
Fractional CFO: Looking Beyond the Numbers
When it comes to your firm’s value, its revenue stream is only the tip of the iceberg. A fractional CFO will dig into your RIA firm’s revenue stream to determine exactly what makes up your revenue, such as the demographics of your client base. To give you a true value, a fractional CFO will normalize certain expenses and make sure they’re in line with market value. These could include officer compensation or even rent. With these insights, your fractional CFO can advise you on how to best grow your business and adjust your expenses or compensation if needed.
Rules of Thumb Matter
Your fractional CFO uses certain rules of thumb to help you better understand your firm’s value. This might involve walking you through your firm’s revenue per employee, average wage per employee, or discretionary earnings. With an understanding of your revenue stream, your fractional CFO can apply rules of thumb that account for the factors that make your firm uniquely valuable.
Outsourced CFO Services Grow Your Firm
By assessing your firm’s value each year and advising you on ways to increase it, a fractional CFO can be your secret weapon for growth. Comparing your firm’s value year over year can also help you see if you need to cut expenses or change the composition of your client roster. To explore how a fractional CFO could benefit your RIA firm, contact us today.
The transition to the Biden administration shines a spotlight on potential regulatory and tax policy changes that could go into effect as early as this year. Of course, nothing has happened yet, and it’s possible nothing could happen at all. Nevertheless, it’s important to be prepared for these five potential changes so you can act quickly if needed—and help your clients to do the same.
1. Removal of preferential rates for qualified dividends and long-term capital gains for taxpayers with income over $1 million
Under Biden, we could see qualified dividends and long-term capital gains taxed as ordinary income. Given the Senate deadlock, it’s hard to say whether Congress will actually implement this change. Even so, consider accelerating any planned sales for diversification (i.e., to remedy concentrated positions), capital raises, or other reasons to take advantage of current rates. That said, don’t let the tax tail wag the dog.
2. Increased top ordinary income tax rates from 37% to 39.6% at the $400,000+ income level
To the extent that your client will receive income in 2021 and has control over the timing, the earlier they receive it, the better. Consider accelerating wages for S corporation owners, guaranteed payments for LLC/partnership owners, and wages for C corporation owners to avoid having these be subject to a potential tax rate hike. This is not the year to wait until the last minute.
3. New limitation on tax deductions for charitable contributions
Similar to the two situations mentioned above: If you or your clients are planning a charitable gift in 2021 or 2022, consider making it as early as possible. Also, consider accelerating 2022 planned giving into 2021.
4. Expansion of Social Security wage base to more than $400,000 of earned income
This presents a significant incentive for converting from an LLC to an S corporation. Doing so can help to avoid self-employment tax on flow-through earnings, thereby mitigating the impact of this change. Business owners have only until March 15 to make an entity change election for 2021 without triggering late election rules. The time to act is now.
5. Decreased unified tax credit for gift and estate taxes and the elimination of the step-up basis at death
These potential changes could greatly limit the amount individuals can gift to other parties tax-free. For high-net-worth individuals, it’s important to establish a contingency plan for quickly executing a gifting plan if needed. Keep in mind documents related to gifts and trusts take time to execute. Having the documents and plan ready to execute should be a high priority for all high-net-worth individuals.
The bottom line: Be prepared—and make sure your clients are, too.
Although you don’t need to act now, you do need to have a plan—one that can be executed quickly if needed. Elevate CPA Group can help. We provide tax support to RIA firms and can help you provide value to your clients in planning for tax law changes, too. If you’re concerned about how these potential changes could impact you or your clients, contact us today.
Every decision has consequences. The decisions you make as a new RIA firm owner can have consequences for years to come, and many are likely to be tax-related. If you’re just now starting out on your own, it’s important to understand the tax implications of certain actions. To help you better understand and potentially minimize your tax liability for today and tomorrow, here are Elevate CPA Group’s top six tax considerations for new RIA firms.
1. Your Choice of Entity
Most RIA firms will choose an LLC or an S corporation as their entity type. I could go down a rabbit hole comparing the two—each has its pros and cons—but it’s critical to know that the entity you choose should fit your business plan and ownership structure. There are no hard-and-fast rules to follow. Before you set up your RIA firm’s entity, talk to your attorney and tax advisor to determine the most appropriate and tax-advantageous type for you.
Keep in mind: You’ll need to secure the proper agreements between you and the entity, and then ensure these are followed. For instance, in many cases a broker-dealer will pay you individually. How do you assign this income to the entity? These agreements, as you might imagine, have tax implications, too.
2. Your Payroll (Don’t Try This at Home)
Payroll is complicated. Not only do you have to worry about paying your employees, but you also have to worry about payroll tax filings. Getting these wrong can lead to steep penalties.
This is why I highly recommend working with a third-party payroll provider, even if you have only one employee. Most third-party payroll providers will indemnify you against late filings and payments. You’ll save time while essentially buying yourself an insurance policy.
3. Your Retirement Plan
When you’re evaluating retirement plans, be sure to consider out-of-pocket and after-tax costs, which employees should be covered, and what kind of flexibility the plan offers. Pay attention to non-discrimination rules, too, as these can substantially increase the cost of your plan if you don’t follow them.
To secure the right plan for your firm, consider working with a third-party administrator. This person can model retirement plan choices based on your business and, eventually, administer the plan for you. Similar to a payroll provider, a third-party administrator makes sure you’re providing the right disclosures and annual filings so that you stay in compliance.
4. Your Working Capital
In order to get tax basis (i.e., the value of your RIA firm, used to measure a gain or loss), an owner has to loan or contribute money to the entity. How you go about making a contribution or a loan can affect your ability to benefit from losses in the early years of your business. Consider consulting with your tax advisor to ensure you’re getting it right.
5. Your Books and Records
Be sure to keep your books and records clean. Failing to do so can imperil the limited liability afforded by your entity. What’s more, don’t muddy the waters between business and personal.
Pay all business expenses through your business accounts, and all personal expenses through your personal accounts. The more you co-mingle funds, the more time-consuming and riskier an IRS audit becomes.
Simply put, keeping your accounts clean and separated can go a long way toward avoiding hassles in the future.
6. Your Time
Your time is valuable when you’re growing a business. It’s also hard to come by. Working closely with knowledgeable professionals can help you properly address the items listed above without losing focus on your business.
At Elevate CPA Group, we’ve helped RIAs become independent and make the right decisions for their newly-formed firms. We’ve seen the long-term benefits of properly considering tax implications as well as the pitfalls of ignoring them. Our fractional CFO services help newer RIA firms focus on high-value items, like servicing and acquiring clients.
Ready to Grow with Confidence?
Let Elevate provide you with the information and advice you need to maximize the value of your business. Contact us today.
Property for Services Series: Part 5 of 5
As we have discussed previously in our Property for Services Series, when property is received in exchange for services, it is taxable as compensation to the service provider. One of the most common situations we encounter is when our clients hold options to purchase stock of their employer. It is important for stock options holders to plan and to understand their options’ tax consequences and timing.
Options are not considered property for Section 83 purposes as long as they do not have a “readily ascertainable fair market value.” As a general statement, most employers will issue options that do not have a readily ascertainable value, but it is essential to understand a company risks an 83 issue if the options are issued with a strike price lower than the fair market value of the stock at the date of grant. Most companies use options to incentives an employee to contribute to increasing the value of the employer. For employees, this provides some significant advantages:
- A risk-free investment in the employer while the options remain unexercised; and
- Delayed taxation until the options are exercised.
The positives are often forgotten when it comes time to exercise the options and recognizing the tax consequences of the options.
The following equation measures compensation at exercise:
Number of Options Exercised x (FMV – Strike Price)
There are two types of compensatory options, with very different tax treatments.
1. Incentive Stock Options (ISOs)
Incentive Stock Options (“ISOs”) have favorable but confusing tax treatment. For our RIA clients, the essential points to understand are:
- There is no REGULAR tax income when exercised.
- Alternative Minimum Tax (“AMT”) may be due and depends heavily on the employee’s tax
situation and AMT income based on the above equation.
- The employee can ultimately receive long term capital gain on the difference between the
ultimate sale price of the stock and the strike price if the stock is held
- One year and one day from date of exercise; and
- Two years and one day from the date of the option grant.
- If not held for this period, the income is ordinary income.
The significant consideration with ISOs is when the employee exercises the stock option, owes the strike price, AMT tax, and wants to hold the stock long enough to get long term capital gains. Consideration needs to be given to the risks associated with a decline in stock value post-exercise. The gamble is converting a risk-free investment to putting funds at risk to gain a tax advantage. You and the client’s tax advisor should work closely to analyze and understand the risks of the exercise and hold strategy, including the applicability of Section 83(i) is beyond this blog’s scope.
2. Non-Qualified Stock Options (NSOs or NQSOs)
Non-Qualified Stock Options (NSOs or NQSOs) are not as tax favored as or complicated as ISOs. Very simply, at the date of exercise, there is compensation income based on the equation above. From a planning perspective, NSOs should always be exercised and sold on the same day. There is no reason to hold the stock as that converts a risk-free investment to an at-risk investment.
Not all clients have a tax advisor that can help analyze the tax consequences of holding and exercising options. Elevate CPA Group provides our RIA clients with a fractional tax department providing a competitive advantage over competitors. If you have questions about property for services taxation, give us a call.