How to keep retired business owners (and their cash) in Michigan

Rob Fowler

 

LANSING — The scenario: A small-business owner in Michigan, close to but not necessarily at retirement age, meets with a financial adviser to consider selling the company. He decides to move to Florida — in part for the climate and in part because the Sunshine State has no income tax — and buy a condo with the tax savings.

Rob Fowler calls them cashed-out entrepreneurs.

And he says he has seen it happen three times up close over eight years, involving former members of the board of the Small Business Association of Michigan, of which he is president and CEO.

“They sold their business, which is always a happy thing,” Fowler said. “What’s unhappy about it is out of Michigan goes the combination of their money — born and raised here — (and) their experience. And, you know, lots and lots of cashed-out entrepreneurs invest in other businesses, but not if they’re not around to watch their investment.”

The issue, he said, is the “low-hanging fruit” confronting his association’s board as it looks deeper at ways to increase entrepreneurship — and their success — in the state. The group is studying state policy areas to develop recommendations on ways Michigan leaders could remove barriers to starting a business: from access to capital, to access to markets, to recruiting talent.

The problem is particularly acute in Michigan, a state that has lost a net 18,000 businesses since 2006. The starkest drops were in the rural northern Lower Peninsula, as Bridge Magazine reported last month, based on data from the U.S. Bureau of Labor Statistics. Only three counties — Livingston, Midland and Missaukee — had net business gains.

Wayne County’s 29,982 businesses are 9.2 percent fewer than in 2006. Oakland and Macomb counties lost 4.2 percent and 4.8 percent of their businesses, respectively, over the same decade.

To Fowler, the issue is of losing business owners’ wealth and expertise that could otherwise help to mentor and support startups.

Sen. Wayne Schmidt, R-Traverse City, introduced a bill intended to encourage owners who sell their businesses to reinvest the proceeds in new Michigan ventures. He said he hopes it will get a hearing when the Legislature reconvenes this fall.

“It is a long-term (effort) just trying to figure out how do you keep capital in here and how do you keep young entrepreneurs, that next generation,” Schmidt said. “One of my goals was initially just to get it out there so that there is discussion.”

The legislation, though, might not be the simple fix proponents hope, several accountants whose firms do business in Southeast Michigan told Bridge and Crain’s.

Among other things, the bill as drafted could have unintended consequences, not least that it might not serve as enough of an incentive to encourage business owners to stay in Michigan. At least one accountant said younger entrepreneurs actually could benefit most from the deduction, particularly if they have a hot startup that takes off while they’re in their 30s and suddenly have cash to invest in another company.

And, they noted, many business buyers purchase the company’s assets, rather than stock, because assets are depreciable; a provision in the federal Internal Revenue Code also allows buyers in some business transactions to purchase the stock in a company but treat it as an asset for tax purposes.

In either case, the seller must pay state income tax on the portion of income from the deal that belongs to the state, regardless of whether the seller lives in a state without an income tax requirement. For instance, if a business did a quarter of its sales to Michigan customers, 25 percent of the seller’s gains from the sale of the business would be owed to Michigan.

“My personal feeling is that it probably isn’t going to change those individuals’ (minds) that are selling their businesses, from the simple standpoint that when they’re looking to sell their business they’re looking to cash in their chips and then diversify themselves,” said Dennis LaPorte, a partner in the tax group of UHY LLP in Sterling Heights. “I would think that the majority of it would be a moot point.”

Studying solutions

Each year, the state’s small-business association ranks Michigan nationally on a variety of metrics, from private sector research and development to commercialization of university technology.

The declining rate of startup companies in Michigan got Fowler’s attention, too. He convened an internal task force to consider why Michigan might be losing entrepreneurs to other places, and how public policy could be improved to help them stay.

That could mean addressing something as intangible as cultural norms that discourage people from starting businesses, to advocating for walkability or mass transit if that’s what could help Michigan attract new talent, to pursuing state programs or finding people with expertise to pull research out of universities and turn it into products.

The organization could be ready to present its recommendations this fall, with plans to develop a policy platform that could be shared with candidates for governor in 2018, Fowler said.

The issue of cashed-out entrepreneurs is just one thread.

Many small-business owners fund their retirement accounts with income from selling their business, he said. Could there be a way to incentivize them to stay in Michigan when they do retire?

“That’s exactly the person you want to stay and actively re-engage with other companies, invest and mentor and maybe even start a new one,” Fowler said. “That wealth, if reinvested in some way, we could certainly think about treating that differently. I think we’d start again with the proposition that it’s bad policy to run wealth away by putting it at a disadvantage.”

Several accountants, though, said many of their business clients aren’t necessarily interested in reinvesting in a business when they retire; rather, they’re interested in taking their retirement savings and looking for the highest return with the least amount of risk.

“If they were changing their residency to Florida, I think they would do it potentially to save tax, but (mostly) because they were already planning to move,” said Michael Mayette, a principal with Rehmann in Troy. “The discussion about Florida residency comes up a lot, and generally it comes up because somebody’s already bought a place or moved there or has thought about it for other non-tax reasons.”

Becoming a Florida resident requires establishing a permanent home in the state, including filing a declaration of domicile, earning a homestead tax exemption, registering to vote in the state, registering children for school or providing “the date non-Florida residency was terminated,” according to the Florida Department of Revenue. The department’s guidelines say that simply obtaining a Florida driver’s license only proves intent to become a permanent resident.

Jeffrey Miller, M.D., who owns Novi-based vein clinic Miller Vein, said at 53, he doesn’t intend to retire soon. But he said as he gets closer to retirement, if his financial adviser and attorney handling his estate planning suggest he had a financial incentive to move out of the state, “I would definitely consider moving.”

The concept of an income tax deduction for business sale income makes sense, said Miller, a Small Business Association of Michigan board member who owns the chain of five clinics across Southeast Michigan. He said he expects his roughly $5 million company to see growth between 12 percent and 15 percent this year.

Yet Miller said he believes more business owners might contemplate staying in Michigan, especially younger ones, if they could exempt their sale proceeds without the requirement they be reinvested — though he understands why the language was included.

Accountants say proving that a resident has left Michigan is one of the most important — and the most complicated — pieces of the process.

“It’s not only about abandoning your current state of residency. It also requires establishing yourself in another state,” said Curtis Ruppal, a Grand Rapids-based partner in the state and local tax group for Plante Moran, which has multiple offices in metro Detroit.

If Michigan business owners still have personal and professional connections in Michigan, including maintaining a second home, “have you really abandoned Michigan as your primary residence?” Ruppal said.

Tax tangle

Residency, ultimately, might be irrelevant when it comes to cashing in on a business sale today, several financial advisers said.

That’s because the owner of a small business incorporated in Michigan as an S-corporation, in particular, will have to pay income taxes on any business income that can be sourced to the state of Michigan based on how much work the company did in the state — even nonresidents, said Richard Spengler, Grand Rapids-based senior director of the multistate tax consulting group for BDO USA LLP, which has an office in Troy.

Schmidt’s bill might be trying to fix a perceived problem, Spengler said, though he added that he isn’t sure the perceived problem actually exists because so many business transactions are done as asset sales. As drafted, Senate Bill 893 raises questions in its wording, including how to define a business owner reinvesting in another business or doing business in Michigan, Spengler said.

“Irrespective of what they’re trying to accomplish, whether that’s right or wrong, there are flaws in the legislation itself” due to holes in the language, he said. “I would say it’s not clear what they’re even intending, because it’s so sparse that it could apply to lots of situations.”

Sue Tellier, owner of Grand Rapids-based government sales firm JetCo Solutions, said that while she isn’t looking at selling today, she and her husband will want to know as they get close to retirement that they have financial incentives to stay in Michigan. Tellier said she does not envision herself retiring to anywhere but Michigan.

“Anything we can do to keep entrepreneurial spirits in Michigan is a positive thing,” said Tellier, an SBAM board member whose firm helps clients obtain government contracts through such services as proposal management and writing responses to requests for proposals. “As those of us who are business owners right now look at retirement (and) look at selling our companies — look at the next phase of our professional lives — the more options we have, the better.”

Ruppal, of Plante Moran, said he foresees the bill as written could have a broader impact than its authors hoped, in that there is nothing in the language that he believes could prevent a business owner from moving to another state and investing the proceeds of a sale into an equity fund that has just 5 percent of its portfolio activity in Michigan. More corporate income than intended could wind up tax-exempt, he added.

“Let’s put it this way: I think the way the language is worded, there would be some creative tax positions,” he said.

Schmidt said he intentionally left out definitions that clarify the size or value of companies allowed to benefit from the income tax deduction in order to start debate on the issue. The language ideally would be refined during committee hearings with input from interested groups, he said.

He added that he intends the primary beneficiaries to be smaller businesses, perhaps up to $30 million in value.

“That’s kind of my vision for it, but again, we didn’t put parameters (on it). It’s still a work in progress,” he said. “It might turn out that maybe, all things considered with other changes that we’ve made, this isn’t the best route. I’m willing to do (or) try anything, or look at it, to make sure that that kind of money stays in Michigan.”