Most of Michigan’s primary income is W-2, from an employer. Some are sole practitioners and work independently on a 10-99, and others own organizations that employee others. Sometimes the sole-practitioner, and usually the business owner, is also building an asset that can be sold for a profit. All three methods of earning an income are unique and not suited for everyone as their primary source.
Padding our wealth with different wealth
I’m a big believer in the powerful word ALSO. I encourage business owners to also build wealth outside of their business, and for employees to also build options outside of their job. The advantages of having self employment income are vast, and can be viewed as part of one’s overall "investment" strategy. Not only does it keep open the possibility of prosperity, but there are also many practical benefits.
Here are a couple of examples, starting with the employee. I recently met with Steve who is working for a big three supplier experiencing heavy layoffs. So far he is safe. Steve is quite good at building websites, and has been for a number of years, for free. Besides the fact that he isn’t making any money, unfortunately his skill isn’t structured as a business for tax reasons. Most of the equipment, overhead and meetings with his pro-bono clients would be considered a business expense if he operated as such. Some of the equipment helps him on his day job, and is written off as an un-reimbursed business expense on his tax return. But that is subject to a 2% restriction of AGI (meaning that if he made $100,000, then he could only begin writing off expenses that exceed $2,000). However, if he had a legitimate business (pursuing paying customers) then he might be able to benefit with greater realized deductions. Not to mention making extra income.
As it turns out, he actually does have potential clients who want to pay him to build websites. If he gets laid off, will the income be enough to support his family? Probably not entirely - but it helps. And who knows, the experience may open other doors. The great news is that it gives him options - another source of income, some nice tax advantages and another diversified way of building wealth.
For the current business owner, building wealth outside of your business isn’t just an option, it’s critical. Norm McKee, a CPA in Rochester has been performing a record number of business bankruptcies. Unfortunately too much wealth was wrapped up inside the business. When times are good it’s easy to think that it will always be good, and we spend our money freely. Then when times are bad we are just scraping by, and have no money to save. Many business owners have their wealth tied up in their business, and they believe that someday they will sell, and get all that wealth out. Sometimes it happens just that way. But other times it doesn’t. Many sell within, to existing employees or family members. People don’t often have the funds to pay for the business with one check, so they put down a modest payment, and then finance the rest. Sometimes they are not able to secure financing with a bank, so they finance with the original owner. For some it works, but for others things get tough, and the new owners are not as successful. The business fails leaving the original owner still wanting for the rest of their payment.
So business ownership can be used on a small scale to supplement income, or large scale to create value, I don’t believe it is a stand alone method of building wealth. I also recommend using various retirement plans (401k, 403b, 457, Simple, SEP), Roth IRA’s, real estate (not just your house), bonds, cd’s and other accounts. When calculating your retirement number, decide how much of that number might be driven by the sale of the business, and how much wealth needs to be raised elsewhere. It’s also wise to calculate what things might look like if the business isn’t sold at all. Are you protecting your outside assets and would they be sufficient to provide you a decent lifestyle?
For most of this week I’ve been talking about building wealth. I know that when times are tough it’s sometimes difficult to imagine excess. So for my final blog tomorrow, I’ll be giving you ideas of how to save money.