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Shelly

CPA | Principal

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With the incoming new administration comes changes in tax law. The news media has been sharing bits and pieces of the potential changes, which vary by day and speaker. One expected modification, as espoused by the GOP, is the repeal of the federal estate and gift tax. While this may be welcome news to many voters, it is only a part of the estate tax planning equation. We need to remember that the state of Washington itself imposes one of the highest state estate tax rates in the country.

Yes, the Washington estate tax is slated to continue, regardless of potential changes to the federal law.

The exemption limit in Washington, before estate taxes are owed, is surprisingly low at $2,079,000 per person. Even if the new administration is successful in changing the federal estate tax, it is very unlikely that state lawmakers will change their own estate tax. For that reason, we urge individuals and families to take note of the low state exemption limits and high marginal rates. They should also make sure their estate plans are up-to-date and address the current, and potential, interplay of both the federal estate tax and the current state estate taxes.

As mentioned above, the Washington estate tax rates are very high in comparison to other states, ranging from 10% to 20% after the allowable exemption limitation. For an individual who is dying with a taxable estate of $5,000,000, the estate tax would be almost $380,000. Further, with the high home values in the Seattle metropolitan area, the recent recovery in the equity markets and related impact to IRA’s, and the plethora of Initial Public Offerings, many Washington residents will create $5,000,000 estates during their lifetimes. For individuals with estates over $9,000,000, the state marginal tax rate alone is a very material 20%. With the combination of the low exemption and the quickly escalating rates, Washington estate tax is something for which you will want to plan.

But have no fear; there are several planning techniques to reduce exposure to Washington estate tax, including lifetime gifting or perhaps even switching state residence. With the proposed repeal of the federal estate and gift tax, which again is no sure bet, and use of proper state estate tax planning, many residents may indeed benefit from the ability to transfer higher financial value to the next generation.

Please feel free to contact your Clark Nuber representative, Elizabeth Nesmith or Jeff Pannell, 425-454-4919, to discuss how planning might be beneficial for your personal situation.

© Clark Nuber PS and Developing News, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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Barriers to Entry

Often, business people think of barriers to entry as the legal protections offered by patents or trademarks. These intellectual property barriers can allow companies to recover significant up-front costs of R&D and effectively block competition. They can also be enormously important to the overall value of a business. However, barriers to entry can take on several other forms, and business owners need to understand the value that these protections can provide their company. Some may be hidden in plain sight. Examples of Barriers Key relationships with suppliers or customers, even informal relationships, can serve as effective barriers for keeping potential competitors from entering a market. Companies build these relationships over time through providing superior service. That service then leads to implicit trust and mutual respect, effectively keeping competitors out of the picture. Exclusive agreements between manufacturers and distributors or retailers can also serve to bar outsiders from entering a market. Such agreements are normally won through promises of minimum orders, specific territories, and sales/service support requirements. Sometimes large manufacturers enjoy economies of scale through having large production runs, a highly trained workforce, or operational efficiencies that effectively prevent new entrants to the market. These assets can be some of the most significant barriers for competitors to overcome. They are also often the catalysts for new inventions or technology that disrupt the market. Cost advantages outside of economies of scale can also provide an effective barrier. For example, proximity to sources of raw materials, labor, or inexpensive power can give one company an advantage over another through providing products at a lower cost. Capital is also a potentially significant barrier. New products that are intended to compete with existing products may be incredibly expensive to develop. Within the pharmaceutical industry, for example, few companies are willing to invest capital on unproven technologies, thereby giving the market leader a tacit advantage. What can I do? The barriers to entry are not always clear or tangible to every business. However, simply being aware of whether or not your business has clear advantages over the competition can help your company understand which barriers exist and how best to be a strong competitor. Start developing legal protections by looking at your contracts and employment agreements, or by documenting these agreements. Next, consider elements outside the business, such as complimentary products or technology that could add an element of exclusivity to your offering. This list includes just a few of the strategies businesses have developed to stay ahead of their competitors. Companies that have taken advantage of market forces or government-sponsored means to stave off competitors generally enjoy a profit and value advantage. At a minimum, business owners need to understand this important element of business value and how it applies to their business. © 2016 Clark Nuber PS All Rights Reserved

Year-End Tax Planning After the Election

Both the House GOP blueprint and President-Elect Trump have emphasized tax reform as a major goal. Tax reform involves both tax simplification and reduction of the marginal tax rates for C corporations, individuals, and even income from pass thru entities (Partnerships, LLC’s and S Corporations) are common themes. For individuals in the top marginal 2016 federal tax brackets (potentially as high as 44% **) the economic value of deductions taken in December of 2016 versus 2017 could be significant. Typical items that can be accelerated, such as payment of real estate taxes, sales tax, state and local estimated tax payments, and charitable contributions, might be worth 10% more on the dollar by paying in December versus next year. Conversely, deferring until 2017 gains recognized on the sale of stocks or other property, or, just deferring income in general might be beneficial. Conferring with your investment advisor to accelerate and harvest any portfolio loss positions could potentially result in more after-tax savings. High level views considered by both the House and President Elect Trump include:
  • Simplified Individual tax brackets of 12%, 25%, and 33%
  • Elimination or limits on the amount of allowed charitable deductions
  • Repeal of the 3.8% Net Investment Income Tax embedded in the Affordable Care Act on certain income, gains, and pass thru entity income.
  • Reduction of long term capital gain tax rate from 20% to 15%
  • Exclusion up to 50% from tax for certain investment income, interest dividends, and capital gains
  • Repeal of federal estate and gift tax (although Washington State Estate Tax would still continue to apply)
  • Reduction of C corporation top tax rate from 35% to 25% or lower, and, a limit on pass thru entity income to owners to 25% or lower
  • Repeal of itemized deductions for taxes (sales tax, state and foreign income taxes) and two versions of the GOP plan allow only mortgage interest and charitable contributions as itemized deductions
  • Significant increase in the individual standard deduction making itemized deductions less attractive to taxpayers ($15,000 for individuals and $30,000 for couples under President Trump’s plan)
  • President-Elect Trump’s plan further puts a $100,000 cap for singles and $200,000 for couples on total itemized deductions.
Of course, each individual or business must decide whether to implement specific year-end strategies based on the context of their unique situation. Accordingly, it could be extremely beneficial to have a conversation with your CPA now about how the potential changes might impact you. Please feel free to contact Clark Nuber or Skip Smith, (425) 454-4919, to discuss how planning might be beneficial. ** 39.6% Top Marginal Rate, plus 3.8% Net Investment Income Tax Rates, plus deduction phase outs approximate 44%. © 2016 Clark Nuber PS All Rights Reserved

Customer Diversification Strategies to Increase Business Value

Over-dependence on one customer, or a small handful of customers, can leave a business vulnerable to sudden downturns, or spikes in revenue and volume, that are difficult to manage. Companies with concentration on a single customer, such as aerospace suppliers to Boeing or consultant/contractors to large software and web enterprises like Microsoft and Amazon, often experience considerable pricing pressure and consequential lower profit margins. Employees in companies with high customer concentration are often reluctant to challenge the increasing demands of a large customer. As a result, small concessions can be made over time – such as free shipping or services that can erode the profit margins even further. When customers know they are holding your company’s oxygen bottle, they often ask for, and receive, significant price concessions. Finally, the enterprise value of a firm significantly diminishes when it has too much customer concentration. This is because potential buyers rightfully perceive the business as a riskier choice than a company with good customer diversification. So what do you do if you have a concentrated customer base and your company relies on one or two customers for a large percentage of your revenue? Here are 10 things you can do to get started on the path towards better customer diversification: 1. Customer diversification has to be part of your strategic plan. Go through a strategic planning exercise to identify a handful of key initiatives that, if properly implemented, will diversify the company’s customer base. During this process, identify the products or services that your company will sell to new customers as standardized offerings and build a business plan around those services. This should include an operations plan, a sales/marketing program, and a budget to support the plan. 2. Evaluate, and possibly upgrade, your sales team. A good sales team, with experienced producers and a qualified manager who knows your industry, is essential to gaining new customers. The sales team will need a specific plan to target new clients and may require training or skill development. You may also need to bring on new personnel to achieve your goals. 3. Look at your sales incentives. If your current sales team is heavily incentivized based on sales from your existing customer base, you should re-design the sales commission plan. The new plan should encourage and reward team members who gain new business, and de-emphasize managing the existing businesses. This is particularly important for the person who heads up the sales team, as they can often assume the role of key account manager for the largest client. As a result, they can be reluctant to move from that position, unless their incentives encourage them to do so. 4. Marketing is important for reaching a wider audience and finding new customers. Many companies with a concentrated customer base have devoted little effort or investment in marketing. A marketing agency or consultant may be helpful for providing specific guidance regarding cost-effective ways to target new clients. A marketing coordinator with good web skills is often a cost effective option, although a good agency can provide a marketing strategy and plan. The company’s website is critical in the marketing effort and should be reviewed and updated as a first step. 5. Develop a plan for new customer on-boarding. If much of the company’s resources have been devoted to a few existing longtime clients, bringing on new customers may strain existing resources. It is important to have an operational plan that serves and creates a great experience for your new customer, while allowing current operations to continue running as planned. 6. Additional production or service capacity may be required. An analysis of current capabilities and the firm’s ability to increase capacity should be conducted. Can the company add a second shift to boost capacity?  Is a large capital investment required? Are more people needed? These are some of the important questions to have answers for as the sales and marketing effort to gain new business gets underway. 7. An acquisition can offer a fast path to customer diversification, particularly the acquisition of a direct competitor. Conducting a search for a suitable acquisition candidate, with customer diversification as a key criterion for evaluation, is a valid strategy. This is often a very good way to secure large enterprise customers with complex supplier specification processes, for which the acquired company has already met the requirements. 8. Pricing is an area that sometimes does not receive enough attention. Companies with severe customer concentration are sometimes out of touch with market pricing for their products or services. Conduct a detailed pricing study to determine competitive pricing levels and decide if purchasing products or services in bundles makes sense in your market segment. You may be surprised that market prices may be higher than the prices currently offered to the major customer. 9. Measure your efforts and results. The management team should be accountable for their efforts to diversify the company’s revenue. Tracking progress, celebrating wins, and analyzing losses, should be incorporated into the company’s management discussions and meetings. 10. Finally, executives should keep in mind that tending to the existing customer base still requires considerable attention. Diversification efforts should not be at the expense of current customers. It is critical for your company to continue paying attention to, and growing, the established customer base. This enables you to maintain revenue, profit, and cash flow during the diversification effort. Customer concentration is a relatively easy trap to fall in to. In fact, some companies actually start out that way. Addressing the issue with a focused strategy while making appropriate investments in marketing programs, sales people, and production capacity, will allow your company to diversifying its customer base and reduce its concentration risk. © 2016 Clark Nuber PS All Rights Reserved

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