Let’s start a business

Judging from the local classifieds, it seems like a lot of folks who have lost their jobs have decided to start their own businesses. After all, they have years of experience in their industry developing strong and valuable skills. No doubt, some will discover they've always had a successful entrepreneur waiting to get out, but based on the returns I’ve done for clients who “oh by the way, I started a business last year,” I’m concerned that many more will discover that running a business requires a broad skill set that employment doesn’t always develop.

Planning: Many small businesses don’t create a business plan until they’re looking for investors. There’s an adage that “not planning to succeed means you’re planning to fail.” You many not need a formal, written plan, but you probably shouldn’t start a business without being able to answer the following:

What services or products will you offer? For how much? And how much will it cost to produce? It probably seems silly to think that someone would try to make money by providing something at less than their own cost, but it happens. Some new business owners just don’t have the cost/benefit mindset. And even with the right mindset, a new business owner, without a history to draw on, may not anticipate all the costs of a project (mileage seems to get overlooked a lot). Without good record keeping, they may not even realize that they’re losing money until they pull the numbers together for their first year's taxes. And often, (and I dare you to find someone who hasn’t done this at least once:-), they underestimate how much time (or other costs) a project will demand.

While not all franchises and multi-level marketing plans are scams, in general, they tend to emphasize the huge amount of potential revenues (not net income after costs) compared to the “modest” start up costs. This is probably not the best predictor of how much money you’ll be putting in the bank.

Marketing: Once you’ve developed a product or service that you can provide at a profit, you still need to get people to buy it. A marketing plan should answer the following:

Who will you offer your services or product to? Why will someone want to buy it from you? Are you offering something that no one else does? If so, how will you reach and convince people that they need a new product or service? How much will it cost to do so? If you’ll be competing with other business, what makes you special and more appealing than them? Also, research how your industry is doing in this economy – is anyone buying?

Doing it all: Unlike many large companies, small business owners don’t have coworkers to help (or dump stuff on – you know it happens). There’s no production, maintenance, sales, accounting, or delivery staff to handle the aspects of running a business that you aren’t the best at (or just plain don’t like), until you hire them.

Until then, guess who will have to answer the phone, fix the computer, track down the missing delivery, calm the disgruntled customer, write the copy for your new ad, and balance your checkbook. If you don’t have the skills to do any of these things, guess who will find (and pay for) a company to do it for you?

Time management: If you spend all day tracking down a delivery, you won’t get any other work done. Will you be better off paying someone to write your newsletter while you make sales calls or doing it yourself? Until you have staff that can handle crises for you, if you want to take a holiday or vacation (or a long lunch), bring your cell or plan to shut your doors until you get back.
Compliance: Larger companies have people who keep their licenses current (and know which ones they need). Ideally they have people who keep them current on their payroll, sales, property, and income tax filings. It’s up to you to learn the regulations that apply to your business and comply with them (or find someone who can). Fines for failing to obtain a required license can be hefty, and few late payments will cost you more than blowing a tax deadline.

BTW, it’s my understanding (I’m not an attorney) that failing to comply with certain regulations (doing construction contracts over $500 without a general contractors’ license or failing to register a foreign corporation doing business in California are the first two I think of) can cost you your standing to sue. Without standing to sue, you could be denied access to the courts to go after a client who doesn’t pay - or defend yourself against a lawsuit.

After you have a plan, you may find the following steps helpful for your new business:

1) Create a budget, calculate your startup costs, double or triple them, and find the funds. Make sure you have enough funds to cover operational expenses (leases, inventory, etc.) until the business is paying for itself. The last thing you want is to close your doors after investing your time and energy because you run out of cash. I’ve seen it happen – a local boutique recently came and went that had budgeted enough to lease the space and buy inventory, but didn’t have enough left for advertising. Also figure out how you will cover your personal living expenses until your business is making a profit (in some industries, that can be well over a year).

2) Find out what licenses or registration you will need and figure out how to get them (if you don’t have them already). You may find you need:
* A business license from your city, county, and/or state
* A resellers permit (for sales tax)
* A home occupancy permit (if you plan to work from home)
* Occupational licenses, like a commercial drivers license, brokers or contractors license, etc.

3) Cover your assets. Depending on your industry and personal financial situation, you may want to form an entity like a corporation or LLC. There is a lot of information available on the web about the asset protection and tax implications of various entity types, but an attorney and/or tax advisor can advise you about how they will affect your personal situation. You can also consider different types of insurance available to protect your assets from claims and damages.

4) Sell your product or service. Create the tools you will use to let potential clients find and appreciate you (website, flyers, brochures, business cards, print or other media advertising).

5) Provide your product or service. It’s generally cheaper to keep a client than to find one. Once you find clients, make sure you provide products and services that will keep them coming back (unless you’re selling something like funeral services J) and recommending you to their family and friends.

6) Get paid, pay your bills, and keep good records of both. The importance of the first is obvious, but a lot of small business owners hate doing collections – I think because they hate getting collection calls, so they don’t want to be the one making them. The second one, buy keeping your vendors happy and building good credit, will help you have everything you need available when you need it to take care of your clients. The last one will give you good information about how your business is really doing (and can pay off big come tax time).

7) Repeat steps 4-6.

Tax Strategies that Don’t Work

‘Tis the season for talking about taxes. I thought I’d repeat some tax strategies that don’t avoid taxes, they evade them (the first is legal, a great American pastime, and one of the things I love about what I do; the second can lead to penalties, interest, and if you try hard enough, jail).

Before we get started, I’d like to address a common misconception – money doesn’t always equal income. Some sources of money (the principal part of loan payments, for example) aren’t income. Some sources of income (debt forgiveness, for example) don’t show up as money coming in. One of the more common ways that this misconception plays out is with my clients who insist that their dividends aren’t taxable because they were reinvested rather than paid out.

As a rule of thumb, any transaction that increases your assets (net of liabilities) is probably income. Principal repaid on loans isn’t income because the money coming in is offset by the decrease in the amount owed to you (an asset). Cancellation of debt is income because it decreases a liability (increasing your assets net of liabilities). Dividends are income because (barring our recent stock market insanity) they increase the stock that you own (another asset)*.

Also, not all income is taxable. Certain types of income (gifts, for example) are exempted from taxation. The IRS’s take is that if it’s income, and it doesn’t meet any criteria to be excluded from income, it’s taxable.

Cash:
Some businesses will offer hefty discounts if they are paid in cash instead of checks or credit cards. Some of these discounts may reflect lower processing cost for cash versions payments like credit cards. But I suspect that at least some of these businesses are offering discounts because they don’t intend to report or pay income tax on payments received in cash. Because cash that isn’t deposited doesn’t show up on their bank statements, they assume that they won’t get caught. The IRS can and does do life-style audits – comparing what they calculate you must spend to maintain your lifestyle to all sources of income (including nontaxable) that you report.

Bartering:
I’ve heard bartering suggested as a way to avoid taxes. Unless otherwise excepted, the fair market value of goods and services you receive in exchange for your services (or goods) is taxable income. While bartering won’t increase your bank account or cash assets, it does increase other assets (the ones that you receive) or provide you with services that you would otherwise have to pay for, which would decrease your bank account or cash.

Tax Free Internet:
It’s generally true that if you buy from an out of state company, they won’t collect sales tax (unless they are also operating in your state). What is not true is that purchases over the internet are exempt from tax. California, like many states, has a requirement to report and pay use tax (equal to the sales tax) on purchases that would be subject to sales tax if made from a California vendor. Since I’ve received mailings for the past two years from the state reminding me to ask my clients about use tax, use tax made it to the first page of this January Franchise Tax Board’s Tax News, and California recently concluded a use tax amnesty program, I expect this to be an audit focus in coming years.

Nevada Corporations:
Many Californian’s like the idea of forming a corporation across the border in Nevada to take advantage of the fact that Nevada has no state income tax. No doubt, one of the reasons that Nevada doesn’t have a state income tax is to encourage businesses to operate in Nevada. However, even if you’re incorporated in Nevada, California can still tax you on the income that you make in California (and the California Franchise Tax Board has an entire department dedicated to making that happen).

You may have heard that Nevada (like some offshore jurisdictions) allow “bearer” shares (stock certificates) – where the owner of the stock on the certificate is listed as “bearer” (basically, it’s owned by whomever holds the certificates), and the owner is not recorded on the company books. This is sometimes promoted as a way to hide assets, hide from lawsuits, or hide from controlled group taxation. Hiding is nothing more than a way of trying not to get caught. Bearer shares have been around for a long time, and the IRS is halfway decent at catching folks who don’t want to be caught.

Another downside is the nonneglible possibility of ownership being lost by misplacing a piece of paper (and passing the piece of paper, because it’s worth part of a company, can quickly trigger some hefty gift tax implications). BTW, on June 18, 2007 the Nevada passed a law requiring that companies maintain a “record of a beneficial ownership[that must be] available on request by the Secretary of State during the course of a legitimate criminal investigation).

This is the first few bogus strategies that came to mind, and I make no claim that this is a comprehensive (or even prioritized) list. There are lots more (check out the IRS’ Dirty Dozen for some leading contenders). The truth is, in taxes, like investments, mortgages, and plastic surgery, if it sounds too good to be true, it probably is.

* Most taxpayers cannot recognize their losses in the stock market until they sell the stocks, and selling the stock and they buying it back within 30 days will subject you to wash sale rules, where the losses are suspended (you generally can’t take them until you sell the replacement stock). Taxpayers who qualify (not many do, but some bonafide daytraders may) to and make the mark to market election can generally recognize losses based on the fair market value of equities at year, and are exempt from the wash sale rules.

Business Provisions of The American Recovery and Reinvestment Act of 2009

First, a little backwards thinking. I know you’ve heard a lot about how tax cuts stimulate spending. I suspect you’ve heard little or nothing about how taxes, in and of themselves, encourage businesses to spend money. For example, a sole proprietor in the 25% tax bracket, in a high income state like California can expect an approximate 50% discount, via the tax deduction, for anything they spend on qualified business expenses. Yes, the expenses have to be reasonable or necessary, but knowing that you will get almost half of it back at tax time (or sooner, if you adjust your estimated tax payments), can make a new computer (or a new employee) much more appealing (and doable).

Speaking of estimated taxes:
Individuals with an adjusted gross income under $500,000, who can certify that at least 50% of their income reported the previous year was from a small business are now required to pay estimated tax payments based on 90% of the previous years taxes (rather than 100%). As always, if your 2009 taxable income is looking lower than 2008, you can still base your estimated taxes on your projected 2009 taxes instead of your 2008 actual taxes.

Speaking of new employees:
Disabled veterans and “disconnected youth” have been added to the classes of employees that may qualify their employers for the Work Opportunity Tax Credit.

Speaking of new computers (or other tangible assets):
Generally, the expense of fixed assets (assets expected to have a life of one year or more), is claimed over the lifetime of the asset via depreciation, rather than in the year they are purchased and/or put into service. The 2008 Economic Stimulus Act brought back bonus depreciation, allowing businesses to deduct 50% of the cost of new assets in the year of purchase, and then deduct the balance via depreciation over the first and remaining years of the assets expected life.

The 2009 Act extends bonus depreciation through 2010. The act also increased the amount that can be expensed (claimed) in the year of purchase under section 179, and the amount of depreciation that can be claimed for vehicles was also increased. The act also extended the opportunity for qualifying businesses can also take accumulated AMT and business credits in lieu of bonus depreciation through 2010.

And yes, there’s more. The 2009 act also has provisions that allow qualifying business to:
Recognizing cancellation of debt over 5 years
Carry net operating losses back 5 years
Shorten the S-corp built-in gain period

And more – as always, contact us if you have questions about how any provision of this act will affect your tax situation.

Other Tax Provisions - American Recovery and Reinvestment Act of 2009

I’ve talked about folks who buy a car or get (or have) a job seeing tax advantages from this act. What else can you do to take advantage of the new tax laws?

Get a job (and have kids):
Two earned income based credits for taxpayers with qualifying children – the additional child tax credit and the earned income credit, were both expanded. The wage base to qualify for the additional child tax credit was decreased from $8,500 to $3,000, and additional earned income credit is available to taxpayers with three or more qualifying children.

Lose a job :-(
The first $2,400 of unemployment benefits are now excluding from federal income tax. Also, individuals who are involuntarily separated between September 1, 2008 and January 1 2010 can maintain their insurance while paying only 35% of the COBRA coverage (the employer is required to pay the balance, but can take it as a credit against federal payroll taxes and withholding).

Buy a house:
The 2008 stimulus package included a “credit” of up to $7,500 for first time howebuyers (it’s actually a loan). The ARRA increases that to $8,000 and eliminates repayment (after living in the home for 36 months) for homes purchased from January 1, 2009-November 30, 2009 by qualifying taxpayers.

If you bought a house on or after April 9, 2008 and before January 1, 2009 you may still qualify for the 2008 credit.

Go to college (or send your kids):
The HOPE credit got a new name (the “American Opportunity Tax Credit”) and some nice enhancements. The maximum credit was increased from $1,800 to $2,500 for 2009 and 2010. Also students in all four years of college (instead of only those with freshman or sophomore standing) now qualify, and course materials are now qualifying expenses. It’s not all easy street, however, the Treasury Department has been charged with exploring the feasibility of requiring community service to qualify for the education credits.

Withdrawals from Qualified Tuition Plans are now excludable from income if used to pay for computers and computer technology (including internet access) as well as previously qualified educational expenses. The computers have to be used by the student (but not exclusively).

Take the A Train (or Van Pool):
The amount of transportation fringe benefits excludable from income was increased from $120 to $230 per month.

AMT Patch:
Check out our 2007 newsletter (click on AMT Relief) for a more complete explanation of how the alternative minimum tax works, and why it gets “patched” every year. This year, the exemption amount will increase to $46,700 for most taxpayers ($70,950 for married taxpayers filing jointly)

Making Work Pay "Stimulus Payments" American Recovery and Reinvestment Act of 2009

I’ve been getting calls and emails from clients who want to know when their stimulus check will arrive (and if they will ever get their California Refund).

Here’s how the 2009 “Making Work Pay” provision works:

It’s only available to U.S. Citizens or Resident Aliens. Those who are claimed as a dependent on another’s tax return do not qualify.

In 2009 and 2010, there will be a credit for 6.2% of earned income for up to $400 per taxpayer. 6.2% just happens to be the amount of social security withheld from most wages. Like the 2008 stimulus payment, this credit will phase out at $75,000 in modified adjusted gross income* ($150,000 for taxpayers filing jointly). Unlike the 2008 stimulus payment, checks will not be issued to pay the credit in advance.

Instead, qualified employees should see their federal income tax withholding reduced based on the new credit, increasing their net paycheck. I believe the thinking is that taxpayers are less likely to save an extra $13 a week (or so), than a lump sum check for $400. The IRS released new withholding tables yesterday that they would like employers to start using as soon as possible, but no later than April 1st.

When you file your 2009 return next year, the credit should offset the decrease in your withholding, and barring any other changes, your refund or balance due should be about the same as this year.

The Economic Recovery Payment or “making having worked pay”:

There will also be a $250 payment for many retired (and disabled) taxpayers. This payment will be made, not by the IRS, but by the Social Security Administration (to social security, including SSI recipients), Department of Veterans Affairs (for disabled veterans), and Railroad Retirement Board (for railroad retirement beneficiaries). Social Security has a special section on their website. Unlike the 2008 stimulus payment, no action is required to receive these payments if you qualify.

Retirees from the Civil Service or state governments who worked at a time when their wages were not subject to social security will qualify for a refundable $250 credit, but you will have to file a return to qualify.

* Total income subject to tax, less certain adjustments like IRA contributions, but not decreased by foreign earned income exclusions.

Sources:
CCH “Tax Legislation Update”
DHHCS ‘How the Economic StimulusPlan Affects Individuals with Disabilities”
FedSmith.com “$250 Tax Credit of Payment for Federal Retirees”
IRS “Tax Provisions in the American Recovery and Reinvestment Act of 2009

Sales Tax Deduction for Vehicle Purchases - American Recovery and Reinvestment Act of 2009

While other provisions of this legislation will affect significantly more people, the new vehicle sales tax credit is of particular interest to me - my **** recently experienced a sudden and unexpected transmission failure – guess what I’ve been shopping for?

From THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009 – FEBRUARY 12, 2009 - FULL SUMMARY OF PROVISIONS FROM SENATE FINANCE, HOUSE WAYS & MEANS COMMITTEES”

"Sales Tax Deduction for Vehicle Purchases. The bill provides all taxpayers with a deduction for State and local sales and excise taxes paid on the purchase of new cars, light truck, recreational vehicles, and motorcycles through 2009. This deduction is subject to a phase-out for taxpayers with adjusted gross income in excess of $125,000 ($250,000 in the case of a joint return). This proposal is estimated to cost $1.684 billion over 10 years."

Here’s a quick history:

The American Jobs Creation Act of 2004 allowed taxpayers to elect to claim either sales taxes or income taxes paid as an itemized deduction (but not both). Since most taxpayers would find keeping receipts and adding up the total sales tax paid for the entire year slightly burdensome, the IRS created pub 600, which calculated a sales tax deduction based on income, state sales tax rates, and exemptions claimed (an additional deduction could be claimed based on local sales tax). Taxpayers who purchased certain “big ticket items” like cars could add the sales tax on that purchase to the amounts from the tables.

Who does this benefit?

Taxpayers who itemize: The largest itemized deduction I generally see are property taxes and interest paid on a primary residence – most of my clients who own a home itemize while most of those who don’t own a home see a greater tax advantage from taking the standard deduction. If you aready have enough expenses to benefit from itemizing, any additional itemized deductions are gravy.

Taxpayers who pay little or no state income tax: taxpayers in states with a relatively high state income tax generally see more tax advantage from claiming the state income tax than the sales tax deduction (of course, taxpayers who live in states with no state income tax will get a larger deduction from the sales tax).

Taxpayers who purchased a qualifying “big ticket” item like a car: The additional sales tax deduction plus the amount from pub 600 may exceed their deductible income tax that year, even when the income tax is generally higher.

Taxpayers who shop a lot and keep all their receipts :-): I had a few clients who actually did so although they tended to get a larger deduction with the pub 600 amounts.

So what’s changed?

The new legislation allows taxpayers to claim qualifying sales tax on a new vehicle purchase without itemizing. For example Roger A. Vehicle is single, has no dependents, rents his home, and generally doesn’t have enough expenses to itemize. Of his $50,000 a year income, at 2009 rates and brackets, he would usually pay taxes of approximately $6,350. However, on February 18th, 2009 he purchases a new truck for $30,000 paying $2,325 in sales tax. On his 2009 return, he deducts $2,325 from his adjusted gross income, and without any other changes, lowers his taxes to approximately $5,769 – a savings of $581. Under the old rules, even with the purchase of a new vehicle, Roger wouldn’t have had enough expenses to itemize and wouldn’t have seen any tax benefit from his purchase.

Who does this benefit?

Taxpayers who don’t itemize: If Roger itemized, he could have taken the sales tax as an itemized deduction. However, if his income taxes paid were more than the pub 600 amount for the general sales tax deduction, he would effectively lose the difference (e.g. if he could deduct approximately $2,967 in sales tax with the new car ($642 from pub 600 plus $2,325 from the car), and $2,410 in income tax without it, the sales tax on the new car would only be reducing his tax by approximately $140, instead of $580)

Taxpayers who are in a higher tax bracket: Roger is in the 25% tax bracket, which means his taxes are reduced about 25% of the sales tax paid. If Roger were making $43,000, he would be in the 15% tax bracket and his tax savings would be approximately $349.

Taxpayers who purchase new cars: the legislation provides for a deduction on sales tax paid on new vehicles. Also, don’t run out and buy a Hummer yet - the deduction is limited to vehicle purchases of up to $49,500

How Fast Can You Get Your Income Tax Refund?

As refund loans are more heavily marketed, I’m waiting for an ad that shows someone walking into a tax office on December 31st with their dog and walking out with a check in their hand and another in the dog’s mouth. If you have a refund coming, who wouldn’t want it as soon as possible? BTW, the absolute fastest way to get your refund appears at the end.

Let’s start with the free ways to accelerate your refund (some tax preparers still charge for efiling and direct deposit - my company doesn’t) – starting the clock ticking from the time you have everything you need to file:

1) Efile, if possible*: The IRS will acknowledge electronically filed returns within 48 hours (I generally get acknowledgements the next day). With snail mail, your return probably hasn’t even arrived at the IRS by then (let alone been open and processed).
2) Direct Deposit: The IRS efile refund Cycle Chart show direct deposits sent between 8 and 14 days after the return is efiled (it can take a day or two to move through the ACH system). Paper Checks are scheduled to be mailed between 15 and 21 days after the return is efiled, and it will take at least a day or two for it to move through the U.S. Postal System. Of course, the IRS cannot guarantee a specific date – it’s not all bad, though, some of my clients tell me their deposit came in ahead of schedule!

Anything faster is some form of a loan – a rather expensive one (see How Much Does an Refund Anticipation Loan Cost).

Cost of a Refund Anticipation Loan (generally received within 1-2 days): $62-102 (2007 figures) – remember this is a 1-2 week loan..

Cost of an Instant Refund Anticipation Loan (received when you’re filing your return): fees above plus $25-55 (2007 figures) for a 1-2 day loan.

Cost of a “paystub” loan based on your anticipated refund (can be received prior to receiving you W-2s, etc, and filing your return): The cost depends on how long the loan is open – for a 1 month loan (between receiving proceeds and filing and paying back the balance), the annual percentage rate can be as high as 177%. Some loans require that your refund be paid directly to the line of credit (which the tax preparer will do, for a fee). According to 2006 data, the due date for the loans (Mid February) may force taxpayers to apply for a traditional Refund Anticipation Loan to pay back the paystub loan on time (one lender appears to require a bank product, with additional fees, in all cases).

Like any financial product, the various bank products based on your refund have both costs and benefits. Not only are the costs of these products extremely high, but in many cases, the extent of them is not readily apparent. They are also extremely complex, and your tax preparer, even with the best of intentions, may not themselves be aware of the full implication of some of these products, let alone able to advise you of them.

The Fastest Way to Get Your Refund

Your refund (or balance due) is the difference between what you paid in throughout the year, and what you actually owe for the year. Which means that if you are receiving a refund, you have given the IRS more money than you were required to throughout the year.

The fastest way to get your “refund” is to carefully plan your withholding and estimated payments so that you have the use of that money through out the year, rather than loaning it to the government, interest free, and then waiting for them to send it back. And I know an excellent tax preparer who can help you do just that :-).

* Many, but not all taxpayers will be able to e-file