STRENGTH IN NUMBERS

A Time for Reflection and Reevaluation

BY MITCH KLINGHER

For some sectors of our economy, the pandemic has been a total disaster, but the corrugated and other paper-conversion businesses have been booming of late. Shipments are up 5% year over year, and paper has become extremely tight for the first time in many years. There has already been one price increase, and from what I hear, another one is looming in the not-too-distant future. While I could make the argument that, since mill operating rates are still on the low side and North America is still exporting a tremendous amount of paper at seemingly little or no profit levels, the “shortage” is somewhat artificial and should be short in duration, I will leave that one for another day.

The bottom line right now seems to be that the public is being forced to stay at home, and they are ordering more and more things via internet and telephone. Things that by and large need to be shipped in paper-based shipping containers, which has caused just about everyone in the paper-conversion business to be extremely busy. This dynamic has caused large integrated producers to send numerous orders to independent producers and larger independent producers to send numerous orders to smaller independent producers. Almost everyone is busy and must wait for paper and sheets, so on-time delivery percentages are decreasing, and many converters are running out of machine hours to sell, without running overtime or building additional shifts. No one knows if this is a temporary situation or if these trends will continue.

So, the operative question is what to do with all of this newfound success that is testing everyone’s productive capabilities. Is this just a passing fad, or is it the new normal? Is this a time to take on risk by buying new equipment, hiring new employees, looking for acquisitions, or entering new lines of business? Or should you hunker down, put some money in your pocket, and wait to see what happens? The answer to these questions is probably one that would require a team of social scientists—economists, sociologists, psychologists, and maybe a Ouija board—and the answer is likely to be slightly different for every one of you. What I see in my travels is that two of the most prevalent traits of the most profitable converters are a focus on speed and a focus on quality. Speed makes you competitive, and quality helps you maintain customers. Everyone can make a pretty square box with reasonably good printing, even

using a lot of the older equipment that is around. But in a world with the following factors, can you afford to stay competitive for long if you do nothing? • The e-commerce boom has likely accelerated due to the pandemic and will probably continue to grow as retail America continues to shrink. • Product distribution has become a pick and pack world filled with automatic case erectors that require very tight tolerances. • Graphics and other detailed printing of bar codes and other information, both on the inside and outside of a box, have become more prevalent. • Digital printing has become faster, wider, and much more available. • Robotic and other automated feeding and take-off equipment have dramatically reduced labor costs and waste. • Technological advances are allowing the best operators to go from initial quote to production and delivery in days, even for complicated orders.

All of this will depend on: • The strength of your balance sheet. • Evaluation of the niches that you are trying to exploit relative to your current capabilities. • Your tolerance for additional risk at this stage of your business life. • Analysis of your markets and competition.

For many of you, this newfound success can and should be used to upgrade your capabilities to ensure your long-term survival.

In addition to the aforementioned market-based factors, there has been a significant change in the federal government and how we expect it to view fiscal policy.

President Joe Biden has announced that he wishes to: • Raise marginal tax rates for corporations. • Raise marginal tax rates for highincome individuals. • Tax capital gains at ordinary income rates for individuals with taxable income over $1 million. • Lower the estate tax exemption back to $5 million dollars per person.

Although these figures are likely to change throughout the legislative process, it appears that he has the political clout to get this done. So, for many of you it is time to update your income and estate tax planning, and do it quickly. Here are a few things you need to consider: • Should I consider a transfer of wealth prior to the enactment of any reduction in the estate tax exemption? • What assets should I select to transfer? • How should I effectuate the transfer? • What estate tax level is likely to be exempt? • Are there any items of income that I can accelerate into 2020? • Are there any items of expense that I can defer into 2021?

The current federal estate tax exemption is $11.18 million dollars per person ($22.36 million per couple), although not all of the states have exemptions that high. Notwithstanding Biden’s stated desire to lower this to $5 million per person, it was always going to “sunset” back to around this level in 2027 unless Congress voted to extend the 2017 tax changes. So, for those of you who have potential estates over $10 million, you may have a limited amount of time to take advantage of the current $22.36 million exemption. This is a complex arena that cannot be comprehensively discussed within the confines of this BoxScore article. However, you need to think about transferring assets outside of your estate quickly. Assets that have the most potential for appreciation should be No.1 on your list of things to transfer, since the value in your estate may be much greater than their current value. In addition, assets with a fairly high tax basis should be considered for transfer, while it may make sense to leave assets with a comparatively low basis in your estate, as the basis in these assets will be stepped up to fair market value as they pass through your estate. There are myriad vehicles that can be used to minimize the value of what is being transferred and to make sure that effective control of the assets being transferred is still left in your hands, so you need to bring in a qualified expert. I also suggest you do it quickly, since the estate planners and business valuation firms are about to get very busy.

Since tax rates are likely going to be higher in 2021 than they were in 2020, you need to take a hard look at whether there are items of future income that you can accelerate into 2020 and whether there are potential current tax deductions that you can push into future years, such as charitable contributions. Since the effective rate of capital gains may be significantly higher in the future, you may want to recognize gains this year that you may have been able to take in future years, such as electing out of installment sale treatment on the sale of an asset that contains payments in future years.

Current trends in the business world and changes in government will serve to make the immediate future for converters both interesting and challenging. There will be many opportunities and some dangers, which serve to make this a time for reflection, reevaluation, and for many of you, decisive action.

Mitch Klingher is a partner at Klingher Nadler LLP. He can be reached at 201-731-3025 or mitch@ klinghernadler.com.