The saying goes “Too many chefs spoil the broth”. I saw that concept play out twice this month with the tax liabilities of two small businesses. These otherwise successful entrepreneurs used too many financial advisers without designating one of them as the chief financial officer in charge. The results were nearly disastrous.
Potential disaster #1: S-corp cash distribution
I spent the entire day yesterday checking a tax return of an S corporation with one owner. The business had been successful enough to build up over $1 million in the business checking account. An investment adviser saw the idle cash and recommended that the money be moved to a retirement plan. The problem was that the tax accountant was not consulted prior to the implementation of the plan. The business had no tax basis so the entire transaction was taxable. Without intensive corrective action, the owner would have been surprised by an IRS bill of well over $400,000!
Fortunately the bright CPA adviser came up with a plan that stands a good chance of fixing the problem by restoring basis in the company. My job was to check the current year tax return to be sure that there was nothing that would otherwise trigger an audit. Accountants know that once a tax audit is opened for one minor issue it often expands to explore more significant questions that are not related to the original issue. We believe the corrective strategy will be effective but there is always a degree of risk in an exam. The immediate goal is to make sure that no trivial issue triggers an exam.
Potential disaster #2: Wage tax confusion
An employer with a used one firm for tax return preparation, another for bookkeeping and a third company to handle payroll. In addition, he occasionally took financial advice from other associates and would occasionally announce to his accountants “I heard that it would be better if we…” overriding the advice of his own advisers. The accountants were subject to the whim of the unknown advisers.
The payroll processing account was not arranged and supervised by either of the other accountants. Companies like PayChex, ADP and others have their own sales representatives who are not trained accountants and are not aware of the bigger picture of the small business tax and financial situation. When a sales representative sets up the payroll account directly with the employer, the professional adviser does not have input or control of the process. In this case the tax preparer took payroll data from the bookkeeper who never reconciled the employer’s books with the payroll company report. Other financial service companies use the same business model. They gladly accept referrals from accountants but would just as soon sell a product or service without any other adviser’s approval.
It was only a matter of time until a government agency (federal audit is possible but state and city auditors are more aggressive) tax reconciliation audit inevitably found some discrepancies. IRS reports that 4 out of 10 employers eventually face some type of wage tax penalty. I wonder how many of these are triggered by lack of coordination between the payroll processor and the tax accountant. In this case, any payroll tax errors will need to be corrected and the accountant will focus on relieving tax penalties. Going forward, all of these should be coordinated.
The problem: a team with no captain
Small businesses grow through a cafeteria-style selection of service providers without considering the interaction between them. It is not unusual for a business owner to use a trusted attorney who handled personal issues, an investment adviser who made a good presentation, an employee benefits broker who offered the lowest rate, and a CPA. The trouble is that none of them are charged with the responsibility of overall financial success of the firm.
The simple solution is to select one accountant as the primary business adviser and give your primary adviser authorization to select (or at least nominate) and manage the others who will be on your financial team. Primary advisers recognize that they are not experts in every aspect of financial management. Today’s financial advisers are accustomed to working together through online networks and should be well versed in this team approach business model. A small business specializes in recruiting the right team and having these specialists work together to achieve the best overall performance.