October 1991
Vol 14 No 12
Do you ever get the feeling that you‘re working in an ant hill full of faceless, nameless automatons, all of which go about their tasks mechanically? Have you ever pondered what makes you worth what you‘re paid? How your cost to your company compares to profits you earn them? Do you concern yourself as to exactly whether/how your efforts contribute to an end result – or how that result affects your employer for better or for worse? Do you see your employer laying off the wrong people to save money while retaining those others whose waste and inefficiency are the root of the problem? If you do, you‘ll relate to my own feelings. And you may be ready to BE YOUR OWN BOSS.
For 28 years, this was my week: Monday: UGH! Tuesday: 3 more days to go. Wednesday: half way home. Thursday: I need a 4 day week. Friday: At last. Saturday:Chores, family, fun. Sunday: Oh wow, tomorrow‘s Monday. I lived for the weekends, holidays, vacations and occasional natural disasters which permitted me to stay away from work. That isn‘t to say that I wasn‘t a good employee or that I didn‘t get promoted. I did enjoy a moderately successful career. But I think it says a lot about how much I disliked working for someone else. Eventually, I got out! Started my own business – in fact, several businesses – and prospered. You can too, if you really want to!
It‘s all a matter of attitude. What I didn‘t like about my 28 years as a salaried employee was not the work. Or the boss. Or the effort. On the contrary, it was a feeling that I could do so much more and be much more productive if I could work at WHAT I WAS GOOD AT, ON MY OWN AGENDA, AT A TIME WHEN I WOULD BE MOST PRODUCTIVE. For some reason or other, the sophisticated personnel evaluations and highly qualified supervisors I worked for never put me into a job which enabled me to use my highest talents and aptitudes. To say that I was frustrated would be an understatement. I was slowly going a little crazy. When I finally went into my own full time real estate business, it was as if I‘d been shot out of a cannon. I‘d never had so much fun in my life.
ENTREPRENEURSHIP STARTS WITH A DREAM . . .
You can‘t just ‘go into business for yourself‘ as a means of escaping gainful employment. Being your own boss implies that there‘s something you want to get done. Something you‘re sure you can do better, faster, more economically than anyone else. A brand new idea. A new approach. Something that the ‘big boys‘ either can‘t or won‘t do. Something your old boss prevented you from doing. You‘ve got to KNOW YOUR MARKET NICHE! Your competition! You‘ve got to have specific ideas about what, why, how, when, where, WHO you intend to do. Examples of people doing this are all around you.
Randy is a guy I know who‘s in the stock market. Even though he was making big bucks as a broker, as an employee, he felt about like I did. He had been involved in various training programs for several years, during which time, he discovered that most school districts lose revenue sharing money every time that a student drops out of class. Students drop out because they fall behind and don‘t want to appear to be stupid to classmates and peers.
So Randy approached the school district with a unique proposal. It had the potential of making everyone money. And it promised to reduce the growing social and economic problem of teen-age drop outs. Here‘s his proposition: He offered to open a private company to tutor drop-outs. Based upon lists the schools gave him, he proposed to contact drop-outs to enroll them in his private remedial clinic. He‘d give them special attention that the school system couldn‘t to catch them up their old classmates and re-enter them into the school system. All he wanted to be paid was 50% of all per capita funds received by the school district for each student he got to start back for as long as he remained in the system or until graduation. They took no risk. He was offering to provide a valuable service with considerable benefits both to the school district and community. This is a good case study of an approach to becoming your own boss. Let‘s dissect his approach.
WHAT? Randy‘s idea was to provide an intangible – EDUCATION – at low front-end cost. It would require minimal money and equipment. It would generate long term returns to his clients, his customers (the school system) and himself so long as graduates remained in school. His ‘product‘ had the potential for future growth. By using a corporate form of business organization, he could later sell stock for a gain.
WHY? Randy had a creative urge which he wanted to satisfy. He had under-used talents which he could employ productively and efficiently. American education is a national disaster. Everyone is seeking solutions. He‘d found a need which he could fill, for which there appeared to be a market with little competition.
HOW? First, he needed a CUSTOMER! He fired off letters to school boards, districts, news media, educational suppliers, state, local and federal politicians, administrators, teachers and teachers‘ unions, local employers in an effort to get supporters from as many segments of the public as possible. He volunteered to speak to civic groups, join educational panels, appear on local call-in radio shows, public affairs T.V. programs. In short, to do everything possible to call attention to the need and his solution via PUBLICITY rather than ADVERTISING.
WHEN? ‘There‘s a tide in the affairs of men, which taken at the flood, leads on to fortune.‘ Shakespeare wrote these lines for Julius Caesar, but they might just as well have been written for any entrepreneur. Timing is everything. Most entrepreneurs fail because they‘re under-financed. Or they‘re susceptible to family pressures that compete for time and money. I became my own boss because I was out of work and nobody would hire me! I had nothing to lose. I doubt that I‘d quit a perfectly good job with a steady income to do it. Neither did Randy. He retained his regular job, and started up his business as a side-line. His wife kept her job too. With 2 incomes, the new business had a source of replenish-able funding based on regular jobs. TIME was in shorter supply than MONEY at the start.
WHERE? The kitchen table and the garage have been the site of more ‘grand openings‘ than anywhere else. Until you begin to see your idea put into action and income begin to start coming in, COST CONTROL HAS TO BE YOUR MOST IMPORTANT OBJECTIVE!
The market may reject what you have to offer. You may need your money for supplies and outside contractors. So much for where YOU begin operations. Where you market your product depends upon what it is and where/who your customers are. You may have observed that newsletters are mailable. I can contact my customers and they can contact me by telephone. I live in my office, so can be available to customers across 10 time zones if they want to order something. In any direct mail business, access to a credit card Merchant Account is the key to telephone sales operations.
WHO? YOU! From my first paper route at age 11 up until now, I‘ve never had a business that failed to make money. And I‘ve had lots of them. I‘ve found 4 WORDS HOLD THE KEY TO SUCCESS: NO EMPLOYEES, NO INVENTORY! Of course, that means you’ll never own a big business. But I’d rather have a small business that makes money than a big business that loses it. Until you confront the complexities of myriad government regulations, tax reporting, personnel administration, overhead costs, labor relations that are associated with employees; you won‘t believe me. But ask anyone with a large staff how much time, money, effort and profit it consumes. When you need help, CONTRACT FOR IT! Employees and PARTNERS will both cost money!
SMALL BUSINESSES PAY THE LEAST TAXES . . .
For most readers, the $25,000 write off of active managers against all other types of income represents about the only tax deduction that doesn‘t represent actual outlay of cash. And that‘s only true if all our properties are precisely leveraged to the point at which income matches expenses, so that the deduction is solely for depreciation. Here‘s what I mean.
Suppose a $100,000 property is rented for $850 per month, $10,200 per year. Annual depreciation @ 27.5 years is $2910 on the $80,000 basis. Operating expenses and vacancies plus principal and interest payments must exactly equal $10,200 for the depreciation to be used to shelter taxes on non-passive income from other sources such as a job, investments, active businesses, paper, etc. Otherwise, it would be used to merely shelter income from rental real estate to the extent that expenses exceeded income, and only the remaining deductions could he used to shelter active and portfolio income. Remember, to take full advantage of the $25,000 you‘d need $687,493 in depreciable basis.
But let‘s take a look at the way a business pays taxes. Naturally, it gets the advantages of direct deductions of operating, marketing, research expenses against income. And it also gets to deduct expenses of 25% of medical insurance reimbursement, transportation between work sites. It can deduct $10,000 each year for personal property (with some exceptions such as vehicles and computers) used in the business. When a sole proprietor hires his kid under 18, he doesn‘t have to pay FICA. He can deduct the kids‘ wages from the business while keeping the money in the family. And each employed family member can deduct $2000 for his/her IRA contributions. When it has more business expense than income, it can use that to offset income from ANY SOURCE! And those losses can be carried back and applied against income for the previous 3 years to recover taxes paid then, or carried forward to shelter taxes in future years. Corporations are better yet!
Businesses can incur liability which can wipe out the personal assets of the owner. Properly structured, a corporation can insulate the owner from business risks. ‘S‘ corporations are simple to administrate. Because all profits and losses flow through to the owner, profits are effectively taxed at the owner‘s tax rate. This offers an interesting strategy when a person wants to engage in business that requires a license that he either doesn‘t have or can‘t qualify for. One person I know bought 100% of the stock of a real estate brokerage S corporation. The former owner stayed on to manage the business on a percentage basis as an independent contractor. All commission profits then passed through to the non-licensed owner just as if he‘d been licensed ‘C‘ corporations are a little more complex, but I prefer them for a couple of reasons. Because income DOESN‘T FLOW THROUGH, they can avoid state taxes under certain circumstances. They can be the center point for both asset protection and estate planning in combination with trusts. They can be set up with a fiscal year for accounting purposes which is different from a calendar year. They can offer an extensive package of deductible fringe benefits. At a level of about $150,000/year gross income, they are possibly the lowest taxed profit-making business entity in the United States today.
CORPORATIONS AND TRUSTS PROVIDE GREAT PLANNING COMBINATIONS . . .
Real estate Deeds, Mortgages, Options, leases and Deeds of Trust are normally recorded in the public records for all to see, along with the names of the parties. As you begin to acquire more property, it behooves you to concern yourself with privacy. Litigation is a process whereby people can extract property from other people by using the courts. It’s been estimated that 85% of all disputes are settled OUT OF COURT. This is the outcome of a form of legal blackmail whereby ANYONE can file a suit against anyone else at any time! Filing of a lawsuit can cloud title to property, damage credit ratings, kill business. The defendant agrees to settle because even TO WIN IN COURT COSTS MORE!
By taking title to property in the name of a TRUST, your name need not show in the public records at all. I prefer the Illinois Type Land Trust. For several years we‘ve published a booklet on this ($25). This type of trust has 100 years of legal and practical precedent in the United States, and its use can he traced hack into Roman times. Essentially, the property, lease, Option, Mortgage are owned by the Trust, held in the name of the Trustee (who can be you, but probably should be another party if you want to maintain privacy). If you‘ve bought the property, you‘d be the BENEFICIARY. And even though the trust property might be REALTY, your interest would be PERSONALTY.
Unless there‘s a specific prohibition in the law, you might live in one state and have each separate property held by a Trust/Trustee domiciled and administered under the laws of another state. Just to make things interesting, you might then name a ‘C‘ CORPORATION in a low/no taxed state as the Beneficiary. Let‘s see what you‘ve achieved.
Suppose I were a Tenant who slipped on the ice in front of your house. I dash for the nearest contingent fee lawyer to see if I can turn this into a quick profit. We both bolt for the courthouse to look you up in the public records. You‘re not there! You‘ve no visible assets! No problem, I‘ll sue the Trust who owns the property instead. But because the Trustee is out of state, I‘ll have to get another lawyer to file suit in that state. But the Trustee has no culpability. He‘s just the title holder. We‘ve got to go after the corporate Beneficiary. But its in yet another jurisdiction. Another law suit. More expense. The contingent fee lawyers know this is a no-fee proposition. And I‘m not mad enough to risk so much money when I could lose in court. Ergo, no suit!
Now, let‘s track the taxes. Since the Trust has no right to income, it all goes to the C corporation beneficiary in a state without any corporate taxation (Nevada). Because Passive Loss provisions of the code DO NOT APPLY TO C CORPORATIONS, all my rental losses can be written off against operating income without limit in the corporation before it is taxed on income. And corporate income tax rates weren‘t even touched in the last tax bill that raised taxes on mere voters. The first $50,000 AFTER DEDUCTIONS is only taxed at 15%. The effective rate of the first $100,000 NET INCOME is only about 22%.
O.K., O.K. so here we have this corporation with all this money, what good does that do us? How do we get it out? If we pay salary, the corporation can deduct it, but we‘ll have to pay FICA and taxes personally in our bracket. If we pay it out in dividends, the corporation will have already paid taxes, then we‘ll have to pay them again. But the corporation might rent from us, and deduct the rent. That would get cash out of the corporation while also adding to passive income which we could shelter with passive losses. There will be no FICA if everything is done at true market rates.
The corporation might also buy some property from us. In today‘s market, plenty of expensive property won‘t sell even at appraised values, but our corporation could buy it and hold it as an asset. Lee Iacocca reportedly got his employer to buy two such homes as a part of his negotiated salary. He‘s over 55 too, so he also probably took advantage of the $125,000 exemption on gain from the sale of a personal residence. I wonder how we might arrange a similar fate for our illiquid, expensive houses? Hmmmm.
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