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Saving a Money-Losing Business

Sep 9, 2016 10:50:16 AM
Author: Scott Hanson

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Caller Dave is a good businessman with a big problem: What should he do with a business that helps people, but loses money?

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Scott: Let's talk with Dave. Dave, you're with Hanson McClain.

Dave: Hey, good afternoon, guys. Thanks for taking my call. Love your show.

Scott: Thank you.

Dave: I'm a self-employed businessman, and have been for 20 years. My company's doing well, I'm making pretty good money. My wife has a similar business. She's a franchisee in a franchise for babysitting. She's losing her tail. My company has to keep her going every month, put in, paying some of the bills for her and that sort of thing. My question is, the IRS is killing me, because my company's doing well, and I can't...you know, I have to figure a way to write off the expenses that I pay for her onto my business. Is there some way that I can take profits against my company and then subtract her losses, because I'm paying for them?

Scott: How many years has she had losses in her business?

Dave: Oh, probably, she's had that business 25 years, and she's probably been losing ever since the economy went down in '08, '09, and '10, so eight or nine years.

Pat: Okay, what type of...

Scott: And has your CPA told you it's a hobby, and so you would not able to deduct it?

Dave: He's told me to close it down.

Scott: Yeah, I know, but...

Pat: So, what is your business?

Dave: I'm a manufacturer's representative. I represent 14 different clients in the semiconductor and medical market, selling industrial products and things like that.

Pat: You're an independent multi-lines rep, right?

Dave: There you go. You got it.

Scott: Perfect.

Pat: So, why haven't you closed the business?

Dave: Because she doesn't want to. She has seven franchises from Long Beach up here to San Francisco. The people, her franchisees are nice people. She feels like they sort of depend on her to have some income, even though it's not much income, it's some. And she pays all the insurance and everything else, so they don't...

Scott: And how much do you lose on that each year? What's the loss?

Dave: Oh, probably $20,000 a year.

Scott: And you're making a decent income in your...Why can’t they be formed into a single business?

Scott: They can't, because they're too dissimilar. It would still be the same issue.

Pat: And why, and Scott, you would know better than I, why can't he wash those losses against the gains?

Scott: It's the hobby rule.

Pat: But it's obviously not a hobby.

Scott: Well that's what my question is to you. Because she'd made money for so many other years, are you able to take the loss?

Dave: Well, when we bought the franchise 25 years ago. We bought a single franchise, and then we bought the entire franchise. We had one unit, and we bought all of them. And initially, for the first four or five years, she was making money, doing okay. It's just been since the downturn, nobody wants a babysitter, anymore.

Pat: But why isn't she taking the loss? That's what we don't understand. It's not a hobby...

Scott: On the taxes.

Pat: ...on the taxes, so that you shouldn't be paying...

Dave: She does. I mean, she's showing the loss, but I'm the guy that's footing the bill out of my business, so I'm trying to figure out a way to get it, to write it off on my multi-line rep business.

Scott: Yeah, so you're not going be able to do that. So the issue is, so, from an income tax standpoint, you're able to wash it out, but you still have FICA taxes that you're getting stuck with, on your business.

Dave: Yeah. Right. I'd still have to play by the rules, as for the Fed and the state tax this year, that's exactly right.

Pat: And you're a sole proprietor? S Corp? LLC? What are you?

Dave: I'm a California C Corp.

Pat: C Corp? Wait, wait. Slow down. Slow, slow, slow, Dave. You're a C corporation?

Scott: Not an S Corp?

Dave: No, I'm a C Corp.

Scott: Why?

Pat: Why?

Dave: Well, because when I started the business, I didn't know what the hell I was doing.

Scott: Well, that's fair. That's how most of us start businesses.

Dave: It was a small business. My accountant at the time said, "Go C corporation." I did. Now my accountants tell me I need to switch. In fact, we're planning to switch. I have a new accountant.

Pat: Good.

Dave: We're planning to switch to an S corporation at the end of this year. He says I have to wait till year end, we'll convert it over, then as of 2017, I'll be legal.

Scott: Okay. And so what are your...

Pat: Wait, Scott. How new is this new accountant? How new to you?

Dave: Less than a year.

Pat: Okay. So I feel better about this conversation already, because I didn't want to come straight out and say, “you should shop for a new accountant." You figured that out yourself. And then when you threw out that you were a C corporation, we both scratched our heads.

Scott: Particularly the kind of business you're in.

Pat: I scratched the hair on my head, Scott just scratched his head, with this concept of a C corporation. So you've got a good accountant now, it sounds like.

Dave: Yeah.

Pat: You're going to be able to take these losses against your income.

Scott: And then, as far as the loss...I mean, at some point in time, you have to go back to the other franchisees and change the economics.

Pat: You have to change the structure.

Dave: Change the terms. What I've told my wife is they have to start paying their fair share of insurance. She insures all franchises.

Scott: Well, it doesn't make sense. She can't operate at a loss forever, that's not fair to her, either.

Dave: Yeah.

Scott: Nor to you.

Dave: Or me.

Pat: Yeah, and she works. She puts time and energy in this, and she's losing $20,000. You're not seeing a way that you could make this better. You didn't say, "Okay, we're going to plan, we're going to get profitable in two years."

Dave: Yeah.

Pat: Or you wouldn't be calling us asking how I could take the losses in the future. So, go to your accountant with the problem, and say, "Help us. Give us suggestions. Give us 12 things that we should do next year to make this thing profitable," and see what the accountant says. So, appreciate the call, Dave.

Scott: Yeah, good luck, Dave.