In this episode Josh talks with Randy Fox from Two Hawks Consulting. They discuss philanthropic planning along with how to get out of your business and save yourself a bunch of taxes.

A third-generation entrepreneur, Randy is a founder of Two Hawks Consulting, LLC and EzCharitable, LLC, an online training resource for professional advisors who wish to expand their capabilities in philanthropic giving.

He is also currently the Editor in Chief of Planned Giving Design Center, a national newsletter for philanthropic advisors. Randy has recently been named the Distinguished Co-Honorary Chair 2017 Improving Financial Awareness & Financial Awareness Movement.

In today’s episode you will learn:

  • How to sell your business
  • What can you do that would help you reduce your tax burden when selling business
  • What is Charitable Remainder Trust
  • How Pooled Income Fund works
  • A lot of financial and tax advices

Transcript

Narrator:             Welcome to “Cracking the Cash Flow Code”, where you’ll learn what it takes to create enough cash to fill the four buckets of profit. You’ll learn what it takes to have enough cash for a great lifestyle, have enough cash for when an emergency strikes, fully fund a growth program and fund your retirement program.

When you do this, you’ll have a sale ready company that will allow you to keep or sell your business. This allows you to do what you want with your business, when you want in the way you want. In Cracking the Cash Flow code, we focus on the four areas of business that let you take your successful business and make it economically and personally sustainable.

Your host, Josh Patrick, is going to help us through finding great thought leaders as well as providing insights he’s learned through his 40 years of owning, running, planning,   and   thinking   about   what   it   takes   to   make   a   successful   business sustainable and allow you to be free of cash flow worries.

Josh:                      Hey, how are you today? This Josh Patrick here at Cracking the Cash Flow Code and today, my guest is Randy Fox from Two Hawks Consulting. I’ve known Randy, I don’t know for going on 17, 18 years now. I’ve always considered him one of the smartest people in the world when it comes to planning especially when it comes from planning to leave your business.

Randy, besides being a really smart guy and an extra imprint of your business, is also an extra philanthropic planning. He has merged philanthropic planning, otherwise known as charitable planning along with how to get out of your business and save yourself a bunch of taxes. We’re going to start our conversation there. We’ll see where it goes because with Randy and I always goes with places. So at any rate, let’s bring Randy on and we’ll start the conversation.

Hey, Randy, how are you today?

Randy:                  Pretty good, Josh. Good to be with you, as always.

Josh:                      Yes. I won’t make you talk among Neil Stevenson yet.

Randy:                  We’ll do that later.

Josh:                      Anyway, Neil Stevenson is an author. We could digress for 30 or 40 minutes on that, but we won’t. So Randy, tell me, I’m going to sell my business. I’m sitting there and looking at this gigantic tax bill for selling my business. I go to somebody like you and I say, “Hey, what can I do?” What would you suggest?

Randy:                  Well, again, what I would suggest is slowing down before you sell your business, and really doing a thorough analysis to understand all of the elements of the business sale. Are you selling your stock? Are you selling assets? What kind of stock if it’s stock? Or what kind of entity do you own? Is it an LLC? Is it an S corp? Is it a C Corp? Is it a partnership? Are you selling at all or you’re selling for cash?

Then what do you need to have happen for your lifestyle to be secure at the end of the day? One of the things that’s always been curious to me, Josh, is that business owners spend their whole life typically trying to pay as little tax as possible. Every business owner I’ve met, and I’m sure it might be true for you is the let’s call it aggressive on the income tax side on an annual basis.

A lot of their personal expenses end up on the business, which I never have a problem with, that’s fine. Then they sell their business and they pay all the money back because they take the offer they get and sign the papers without thinking about the interim step of, is there something I can do to pay less tax on the way out? Then I put more money for my family. That’s where I would start and and then I would say, “Let’s look at several things that might help reduce your tax head and still leave you with the type of money you need to live on for you and your family.”

Josh:                      My experience with business owners is with rare exceptions, the business is not going to get them to retirement by itself. So when it comes to how much money they need other business they need every last dollar they can possibly get. If that happens to be true, which is true with probably 99% of the businesses, what can they do that would help them reduce their tax burden? Let’s say they’re an S Corporation. They’re doing an asset sale because again, that’s how the vast majority of businesses are actually sold.

Randy:                  S Corps, what can they do? They could consider several types of charitable structures that are called split interest sales or split interest trusts, such as a charitable remainder trust, a pooled Income Fund. Those would be the two main ones, whereby they could donate a portion of their assets. After all, you say they need everything, every penny they can possibly get. That means if they pay tax, they’re losing some of those pennies.

Josh:                      That’s correct.

Randy:                  So if we can take some of those assets and donate them to a charitable remainder trust or a young pooled Income Fund, we get a charitable income tax deduction, and that’s a calculation that’s made based on the ages of the donors and the income beneficiaries. We can sell those assets without paying capital gains tax.

If you do the calculations right, you don’t only have to put everything in, maybe you put 20% in, maybe you put 30% in, what you do is to try to create a tax deduction that will help offset the sale of the assets outside of the charitable trust and save the tax on the sale of the assets inside the trust. It’s a two prong strategy, save taxes from an income tax deduction, save capital gains tax on the sale of low basis asset.

Josh:                      What if the assets are going into the charitable remainder trust are recaptured appreciated assets, which would be taxed at ordinary income, can they go in there?

Randy:                  Recapture depreciation is always a challenge, right? That’s one of the things we have to worry about. That just requires some extra planning, Josh. That probably is beyond where we want to talk about today.

Josh:                      So you’re saying that the only thing that really can go into a charitable trust and make sense are capital gains assets?

Randy:                  Now, a little basis as a matter of fact, just before I got on this podcast today, we dealt with a client at the end of the year who had already sold his business. By the way, that’s a whole separate conversation, but he’d already sold his business, had realized that he was going to be in for a big tax hit. We did some end of the year kind of tax mitigation planning and that included because it was so late in the year, the securities he bought were all short term assets.

Because of that, we contributed those short term assets, he will get a tax deduction at the basis of those assets, which is very similar to what they were worth at the time because you only own them a month or two. But interestingly enough, when you contribute short term gain property, your tax deduction is based on 50% of your AGI. The usable tax deduction is based on 50% of your AGI. You actually get a higher deduction, even though your cost may be lower.

Now, if you have something that’s fully depreciated, so your tax deduction will be lower, but you’ll still avoid the gain on the sale. Again, it’s a matter of just analyzing what the results would be doing that.

Josh:                      I just want to point out Randy to our listeners that that is a huge big deal. Because when it comes to the sale, at the end of the day, most business owners I know they’re not wild about paying capital gains taxes, but they look at that tax as relatively low. But when we get into that recaptured depreciated tax asset, the taxes on those states can be 40 or 50% because it’s ordinary income tax.

Randy:                  That’s right, Josh. Also listen, I for whatever reason, I deal with a lot of people that are in very high tax states. If you’re in California, a capital gains taxes are 37.1%, ordinary income taxes if you’re in a top bracket are 50%. All taxes high tax in California, and if you can save some of that and have 100% of your dollars working for your family, instead of 60% of the dollars working for your family, I think you’re ahead of the game.

Josh:                      So just to put this into perspective, here’s the difference. Let’s see I have a million dollars. I’m putting into this Trust. Let’s say just for fun that the payout from the Trust is 4%. So I’m going to get 4% of a million dollars, which is $40,000. If I don’t put it inside the trust, my payout would be a lot less because I’d be paying, say 40% in taxes, which leaves me $600,000. In the financial planning world says the most that you should ever payout is 4%. That’s $24,000. There are 340 and $24,000 and what I can actually spend a year is a huge number.

Randy:                  I couldn’t agree with you more. That’s why I really don’t understand of all the people I talked to that are helping business owners. They will never stop and take the time to hold the line and say, “Why don’t we look at some options before you sign the agreement, before you agree on the price, before you sign the letter of intent. And let’s see what we can do about the tax that you’re about to take.

Josh:                      I think that’s absolutely true now, but here’s the issue that I have dealt with investment bankers and Business Brokers for a zillion years as you have. I have a theory about that. I actually have two theories about that. One is they have no idea what’s even possible for business owners, nor do they especially care. Two, they have learned that anytime they introduce anything that has anything to do with any more complexity, the business owner often gets overwhelmed. He just decides not to sell the business.

Randy:                  Another way of saying that is they don’t want anything to slow down their sale and their commission check.

Josh:                      That’s correct.

Randy:                  That’s not polite way to say it, I think.

Josh:                      It’s the truth. I mean, it’s also the reason I think that if you’re going to sell your business, it’s always a good idea to have an intermediary who doesn’t get paid whether it sells or not.

Randy:                  I think that’s right, Josh, I’ve always taken the position. It’s my job to inform the client of their options to let them weigh the various options they have, and help them make the best decision for themselves and their families. Regardless of what the outcome is, if the best thing to do is not sell the business, or not transfer the business to the structure, at least they know that they have the opportunity to do it and decided against it.

Josh:                      Yes, absolutely. It comes down to, I assume that if you’re going to do this, you better have some charitable intent.

Randy:                  You always have to have charitable intent. Sellers who don’t have charitable intent will end up resenting the structure. In fact, there’s a fair amount of knowledge in the industry about you don’t want to talk to somebody who isn’t charitable. You can make them charitable. Now, I think charitable intent is often misunderstood by the planning community because we as advisors, talk about it improperly. Let me stop and say a couple of things. One is, that when you ask a business owner if they’re philanthropic, the word philanthropic rings of the Carnegie’s of the melons and the Rockefellers, right?

They go, “I’m not that guy. I just own this shop over here. That’s all I’ve ever done.” But if you really dig down and find out, you’ll find out that they’re on the elder Council of their church, and that there have been in the Rotary Club for 25 years. They sponsored a little league team so they’re charitable. They’ve always been charitable. What they think when you say, “Would you want to be charitable? Or have you thought about doing a bigger gift?” Is they think you’re going to take money away from their family and their kids.

That’s the last thing they want. We have to say, as advisors, you have as beneficiaries in your world, you have three choices. You have the government, you have charities of your choice, and you have your kids. And you Sir or ma’am, you get to pick two of those, which two would you like? We have to tell them that we’re taking money away from the government. We’re not taking the money away from their family.

Josh:                      The truth is, I mean, as you’ve mentioned, I would say that most business owners actually are quite charitable because they’ve support their community in a variety of ways. We have to help people understand and realize that they’ve been charitable. As we go up the economic scale, to more and more wealthy families, charity has multiple uses besides what’s good for the charity. There’s also some great uses for the family. Can you talk about that a little bit, Randy?

Randy:                  Well, that’s right. One of the things I mentioned earlier, we talked about the charitable remainder trust. In most cases, the charitable remainder trust serves one generation. Mom and dad or husband and wife, whoever the owner of the businesses will donate assets to a charitable remainder trust, they’ll get a tax deduction. They’ll get an income stream for life. We’ll save the capital gains tax. When they expire, that money goes to whatever charity that they name. On the other hand, coming back into vogue over the last five or six years,  I have to say that I’ve been at the tip of the spear of this old idea that’s becoming new again, is something called the young pooled Income Fund.

Pooled Income Funds have been around since 1969. They’re not new. If you look up Pooled Income Funds on the internet, they’re run by Harvard and Yale and Princeton and big hospital organizations and big church organization. When you give your money to Harvard’s pooled Income Fund, Harvard says, “We manage the money. When you die, all the money comes to Harvard.” That’s not very attractive to most individuals, unless they’re Harvard grads. Then, it’s not so attractive.

Josh:                      I’m not sure about that. Most Harvard grads I know they’re painted red.

Randy:                  Well, Harvard does a really good job of staying in touch with their grads.

Josh:                      They sure is.

Randy:                  One thing they do really well, but that’s a diversion here. Now, there are Pooled Income Funds and I am actually full disclosure on the board of one of them, a charity that does nothing but sponsor Pooled Income Funds. We’ve made those Pooled Income Funds donor facing and advisor facing so the end charity is whoever the donor wants, it can be 110 or 100 charities because the money just goes to a donor advised fund at the end of the day.

This facility allows any living individual to become an income beneficiary. So if we think about that, we have mom and dad, but we might have mom and dad and then children. We might even have mom and dad and then children and then grandchildren as income beneficiaries. So even if the family is hazily interested in charity, if the money doesn’t go to charity for 80 or 90 years, that changes the story a little bit, because that keeps the money in the family for 80 or 90 years.

Josh:                      Can I just take a step back because I think I’m learning something new here. So a Pooled Income Fund is I put my money into this pool, and the income can go to a non-charitable beneficiary for a period of years.

Randy:                  Non correct, the way a Pooled Income Fund works it’s very analogous to a charitable remainder trust. I put my money in the pooled Income Fund. I get a charitable income tax deduction based on the lives of the living income beneficiaries at the time of the gift. I sell my assets. I pay no capital gains tax, the Pooled Income Fund will pay me income for my life then when I pass away any of my surviving income beneficiaries. It’s like a charitable remainder trust on steroids to some extent, because we can make multi generational pooled income fund.

Josh:                      So it’s possible, and one of the complaints I hear about charitable remainder trust is it lasts for my lifetime. Let’s say it’s 25 years, I never get my money back. But if I have it, my children and potentially grandchildren, it runs for 80 years, what kind of percent of the base would be paid out?

Randy:                  Again, Pooled Income Funds only pay out income and that’s the tricky part. Again, the smart pool of income funds, the new pools income funds have a broad definition of what income is. So I can pay out, donors can receive all their interest, all their dividends, any rents that are received, any royalties that are received, a100% of the short term capital gains that are realized. The good funds will even pay out up to 50% of post gift realized long term capital gains.

I’m going to stop on that one for a second, Josh. So a post gift realized long term capital gain. What the heck is that? If I put in a million dollars, and I instructed to be invested at the end of the year today, it’s worth $1,100,000. I want my money manager to realize that game. So now I have $100,000 long term capital gain, while half of that long term capital gain is $50,000. I can get that paid off.

Josh:                      So if I dividends are of that million dollars and putting in our say 3% so that’s $30,000.

Randy:                  Right?

Josh:                      Or I invest in high yield bonds 6% that would be $60,000. Those high yield bonds have had a capital gain of 10%. On top of that, I could sell them at a year in one. So I get to $60,000 plus $50,000. I will get $110,000 out of that year. Is that correct?

Randy:                  Yes.

Josh:                      So what that means is you now have a really, really powerful methodology of managing investments as if it was an IRA, but you haven’t paid any taxes when the money went in, nor have you paid any money taxes on the growth in the money. They assume you’re paying ordinary income what comes out.

Randy:                  The income actually retains its character. So interest is taxes, interest dividends, or taxes dividends, when long term capital gains come out there taxes long term capital gains. So all income retains its character which means also that if you happen to invest in real estate inside the pooled income fund and it carries with it depreciation, the depreciation flows through to the income recipients. We should also circle back about what you said earlier.

Most of the funds I set up, when I do the calculations for families, I look at whether or not they can use the income tax deduction. The income tax deduction for a Pooled Income Fund because of the current way that they’re calculated is could be three or four or five times larger than it would be for a similar charitable remainder trust.

So when I look, I say, can the family ever use this charitable income tax deduction over the next six years? If they can’t, I say, “Well, why don’t we make the kids income beneficiaries after mom and dad?” Often when I do that, you can see the family gets to use the income tax deduction, but then you have another whole generation receiving income from that same pool of money. Then when you factor in grandkids, then you have another generation receiving income from that pool of money. The results are extremely powerful.

Josh:                      So really, I’m going to bet people listening right now their heads are absolutely spinning because you and I have spent years and years studying this sort of thing. For me, it’s easy to pick up what you’re talking about, because I’m aware of the general strategy we’re talking about. How many people like you exist in the world? How are they found?

Randy:                  That’s a great question. One of the big issues I have when I talk to legal professionals, accountants, other financial advisors or potential donors, their first question is, how come I’ve never heard of this before? My answer is, I don’t know why, but I always figure it’s my job to be educated about what’s going on in the world in which tools are working, at which points in history, and what’s happening in the planning world.

I always made it a point to stay as tuned in and educated as I possibly could. I don’t think there are very many other people doing Pooled Income Funds. I’ve kind of made it a mission to train as many people as I can. I have a dozen or 50 people that I’ve spoken with that actually kind of call me now and then and say, “I think I’ve got a client that might work for.” I certainly am trying to spread the word because I think it’s a huge opportunity.

Josh:                      Yeah, I think that this is something that as much as we like to say, “Oh, gee, this is something as good in the future, but may or may not be doing this.” The challenge here, I want our listeners to understand this as and if you want to do stuff that’s sophisticated and complicated, it’s complicated. The truth is, if you want to save a lot of taxes and you want to go down a road. By the way, this is not what we call made up stuff. I’m assuming there is really hard regulations behind this, that the IRS is not going to come in and attack you on. Not like 18,000 other strategies people come to me with.

Randy:                  This is black letter law, been in the code since 69. Everybody wants to go read Code Section 642-C5 and see all the stuff that says it’s there for you. One of the things I love to tell people, is paying taxes is very uncomplicated. It’s simple. You just write the check, you do nothing, and then you write a big check. If you want to reduce your taxes, you’re going to have to jump through a few hoops. Fortunately, there are people who know how to help you get through the hoops.

Josh:      This is really good advice. It’s a good session, Randy. Thanks so much. I appreciate it so just in closing, because we have to kind of end it up here. Charitable planning is something that you really need to be paying attention to, if you’re getting ready to sell your business. By the way, the earlier you start looking at this, I mean two or three years before you sell the business, the better chance you have of doing it because it is complicated.

Most business owners I know have learned that if they don’t understand something as complicated, they don’t do it because they’ve gotten burned in the past. I want you to take advantage of this stuff, which means you need to do your planning more than 10 minutes before you sell your business.

Randy:                  I could agree with you more, Josh. This is complex stuff. The charitable sections of the tax code are right up there with pension law in terms of their complexity. There are lots of rules and there are lots of rules you can inadvertently break. We have to be very cautious. The more time we have before something is contributed to a charitable vehicle and a deal I think, the happier we are— plan early, plan off.

If you’re getting your business position for sale out a couple of two or three years, the time to start thinking about how you’re going to plan is right now.

Josh:                      Cool. Randy, unfortunately we are at a time so if somebody wanted to find you. I hope everybody listening is thinking about selling their business does give you a call. How would they go about doing that?

Randy:                  Well, you can email me at randy@twohawksconsulting.com.

Josh:                      Is that T-w- o?

Randy:                  twohawksconsulting.com. My website is the same name twohawksconsulting.com. You can call me 7046984055. That number rings me everywhere I can ever get away from it. 7046984055 yes, it’s a North Carolina number and I’m in Chicago, but let’s not worry about that.

Josh:                      We’ll have that for another conversation. I have an offer for you too. Before you go about selling your business or thinking about selling your business, it might be a good idea to find out if you can afford to sell your business. So I have put this little thing together called The Four Boxes of Financial Independence.

I’ve been using it for years and years and years on a yellow panel. I meet with someone one on one. Now you can you do the same thing for about seven minutes. All you do is go to thecashflowcode.com, that’s one word, thecashflowcode.com. Click the big orange button that says start. It’ll take seven or eight minutes for you put some financial information and you’ll find out whether you’re on the road to financial freedom or you’re not.

I hope you do that. If you say I am, then you want to give Randy a call and find out what can we do to minimize taxes? And if you’re not, you might want to give me a call and say, what can I do to make sure I get to? Yes, on this particular question. Last thing you want to do is sell your business or leave your business and find out. Gee, I didn’t do it right, I have to go to work for somebody else. Thanks a lot for stopping by today.

This is Josh Patrick. We’re with Randy Fox. You’re at Cracking the Cash Flow Code. Thanks a lot for being here. I hope to see you back here really soon.

Narrator:             You’ve been listening to the “Cracking the Cash Flow Code” where we ask the question, “What would it take for your business to still be around a hundred years from now?” If you’ve liked what you’ve heard and want more information, please contact Josh Patrick at   802-846-1264   extension   102.   Or visit us on our website at www.sustainablebusiness.co.   Or you can send   Josh an email at jpatrick@stage2solution.com.   Thanks for listening and we hope to see you at Cracking the Cash Flow Code in the near future.

Topics: sustainable business podcast, Sustainable Business, selling business, exit planning, pooled income fund, reducing tax burden, financial advice, randy fox, tax advice, philanthropic planning, charitable remainder trust

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