A Dry Cleaner’s Tax Guide (Part 1)

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(Photo: ©iStockphoto/Martin McCarthy)

Mark E. Battersby |

Creative tax and financing strategies to promote growth, keep more profits

ARDMORE, Pa. — Interest rates remain close to their historical lows but financing for many drycleaning businesses continues to be elusive. One problem: lower interest rates have translated into lenders and investors being more selective. However, if a bank won't lend the drycleaning business money, there are now lots of other options.

Any quest for funding must begin with an understanding of the various types of financing, where that funding may be found, and at what cost. What type of funding can best help your drycleaning operation’s growth plans become a reality?

DO-IT-YOURSELF

A surprising number of businesses today have funds available after paying all of their bills—including taxes. One use for those unused profits is to distribute earnings in the form of cash dividends. Seldom, however, are all earnings paid out as dividends. Usually, a portion is kept to finance future growth.

Unfortunately, growing any drycleaning operation with internally generated funds can be a difficult process to plan for and implement. The main consideration, obviously, is whether the business has sufficient internal cash flow to pay for growth or expansion outlays.

For many dry cleaners, borrowing can mean a loan from the operation’s owner. U.S. tax laws create a number of obstacles that must be overcome in order to avoid the penalties and corresponding higher tax bills that result when IRS auditors restructure loans that don’t meet their criteria.

Whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated business, our tax laws require a fair-market interest be included. If not, the IRS can step in and make adjustments to the below-market interest rate transaction in order to properly reflect “imputed” interest. How large the tax impact depends on the effect of added interest income to the lender and the bite of an offsetting interest expense deduction felt by the borrower.

FUNDING LOCALLY

One of the best sources of assistance—and, in many cases, funding for growing drycleaning operations—are the many state, regional and local economic development agencies. There are nearly 12,000 U.S. economic development groups whose purpose is to provide economic growth and development in the areas they serve. They generally encourage new or expanding businesses to locate in their area—or to remain in the area.

Even those who are aware of public funding often have misconceptions about who will and will not qualify. Many of these programs are looking for businesses with proven track records. The state, regional and local agencies are willing to help them expand their sales, which in turn will help expand the tax base as well as increase employment.

While not always the source for direct growth financing, a state’s office or agency of economic development can be a guide to sources for regional and local funding programs.

ALTERNATIVE FUNDING

An important form of alternative financing is so-called “asset-based” lending. In general, commercial finance companies are often willing to lend funds to businesses that cannot, for various reasons, secure credit from a bank. The credit is secured by the assets of the drycleaning business, such as receivables, equipment and sometimes real estate.

Admittedly, while asset-based lenders usually advance capital more quickly and more readily than banks, they charge more for the higher risk. The loans are generally offered on a revolving line of credit basis, allowing the drycleaning business to draw on a line of credit as needed over a fixed time period.

CROWDFUNDING AND STOCK SALES

The Securities and Exchange Commission recently approved new rules that will allow drycleaning businesses—even start-ups—to more easily raise money from investors using newer technologies such as online “crowdfunding” sites. Crowdfunding allows those seeking money to post details of their project online and, hopefully, money comes flowing in. Today, by advertising on websites, called “funding portals,” those needing funds can reach out directly to investors.

Although large-scale crowdfunding was not previously permitted under federal securities regulations, today investors can receive equity (i.e. a “share” of ownership in the business) or bonds (i.e. providing a small loan to the business), depending on what the dry cleaner chooses to offer.

Still on the subject of stock sales as a source of growth funds, an extra incentive is now available to individuals who invest in small businesses. Investors in qualified Small Business Stock can exclude 50% of the gain that results when the stock is eventually sold.

Check back tomorrow for the conclusion!

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an attorney or tax adviser for advice regarding your particular situation.

About the author

Mark E. Battersby

Freelance Writer

Mark E. Battersby is a freelance writer specializing in finance and tax topics. He is based in Ardmore, Pa.

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