Taxes

This Will Kill the Economy Long-Term

There are many factors that can help an economy to grow, including productivity gains, wage growth, sound governmental policies, healthy banking systems, etc. A lack of all of these items will hurt economic growth, and there is one more often overlooked item that can and will devastate an economy over the long haul.

It’s probably not what you think, but I’ll give you a hint: think Japan. What is a major issue that is facing Japan? Low birth rates and a disproportionate amount of older persons compared to younger persons. Why does this matter?

Minimum: Statistically, a country needs approximately 2.1 births to have a stable population. If you want to bury yourself in statistics, then you can read reports from the U.N. or The World Bank. Although there are lower mortality rates than in the past, fewer births will mean a declining population and a disproportionate amount of older persons. By the way, the world’s population is expected to stabilize and/or decline by the end of this century.

Disproportion of elderly: In Japan, the population of elderly persons is much higher than in the U.S. Unfortunately, with lower birth rates there are less younger people able to physically take care of the elderly and also financially. Systems like social security will not be able to continue in a healthy fashion if there are not enough younger people available to contribute towards the system.

Basic math: If there are less people available to purchase services and products then economic growth will stagnate or decline. This can be offset somewhat by productivity gains and wage increases to an extent. Also, there will not be enough candidates to fill employment opportunities at businesses, which will stifle growth further.  More people = growing economy.

Myths?: I believe it started back in the 1960’s with doomsday scenarios of overpopulation and a strain on the resources of the planet. It really hasn’t panned out, but there have also been other modern inventions and policies that have stifled population growth. There is one statistic that I’ve heard that states the entire world’s population can fit in the State of Texas comfortably. Even if this statistic is way off and it would take the entire United States, then that would leave the rest of the world wide open.

Solutions: There are a few solutions to address this problem. One is immigration from countries or regions with high birth rates, such as Africa to countries with low birth rates, such as Japan. This would take changes to immigration policies enacted by governments.  The other solution is to encourage families to have more children and not to wait too long to do so. What is the worst that can happen – you may need to buy a massive van to drive your family around?!

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Who Will Come Out Ahead When Filing Their Returns This Season?

Who will benefit the most from the tax law changes this year? The biggest winners will be:

Corporations: With reduced corporate tax rates of 21% versus the previous 35%, most corporations will come out ahead. Although corporations that have income of less than approximately $75,000 may not benefit.

Business owners: Business owners that operate sole-proprietorships, s-corporations, and partnerships that will benefit from the section 199A deduction, which generally is a deduction of 20% of your business income. However, there are limitations based upon the type of business such as healthcare providers, wages paid, income, etc.

Large families: With a child tax credit of $2,000 per child, families with many children will benefit from this credit. However, there are no exemptions this year which offset the benefit of the credit, and there is a phase-out of the credit if your income is greater than $200,000 or $400,000 if filing jointly.

Higher income households: Since the tax brackets have all been lowered and mostly expanded as your income increases, then the more money you make the more you will benefit. The highest individual tax bracket is 37% versus a high of 39.6% previously.

On second thought, who will be available to process all of the returns at the IRS?

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Paid Sick Leave in NJ? What You Need to Know

Another change in New Jersey that affects both employers and employees in the state is paid sick leave, which was effective starting October 29, 2018. Here are the details:

Number of sick days: The New Jersey Earned Sick Leave Law allows employees to accrue 1 hour of sick leave for every 30 hours worked, up to a maximum of 40 hours each year. An employee is eligible to use the earned sick days beginning 120 days after commencing employment.

Permitted usage of sick leave: Sick days can be used for diagnosis, care, treatment or recovery from an employee’s mental or physical illness or for the needs of a family member. The time can even be used by an employee in connection with their child to attend a school-related conference, meeting, or function.

Alternatives: An employer is in compliance if they offer paid time off, including personal days, vacation days, etc. that can be used as sick days, as long as they are accrued at the same or greater rate.

Carry forward: The employer shall not be required to permit the employee to accrue or use in any benefit year, or carry forward from one benefit year to the next, more than 40 hours of earned sick leave.

The interesting aspect of this law is that as an employee-owner, you have to include yourself. When do owners take a sick day?!

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Are there Alternatives to Traditional Health Insurance?

My last post titled, “Did You Know that NJ Now Requires All Residents to Have Health Insurance?” gave a few exceptions to the new New Jersey mandate that requires all New Jersey residents to have health insurance. One of the exceptions to the mandate is health care cost sharing, which almost no one has ever heard of. It may be a good fit for you or maybe not, but here are some details regarding health care cost sharing to help you decide.

Examples of health care cost sharing ministries: Solidarity Healthshare (my family and I are currently members), United Refuah, and Christian Healthcare Ministries

What is health care cost sharing: This is taken from Solidarity Healthshare’s website https://www.solidarityhealthshare.org/ :

“Health care sharing ministries provide a way to pay for health care costs that is different than traditional health insurance.

As a member of a health sharing ministry, you pay a Monthly Share Amount. This monthly share is then used to pay for the health care needs of other members. When you have a health care need and if you have met your Annual Unshared Amount, other members will pay for your health care needs.

Members also agree to a common set of beliefs that help determine which medical costs the community will share towards. With Solidarity HealthShare, guidelines on the medical expenses that members share towards are primarily guided by the moral teachings of the Catholic Church. These beliefs help define what is and is not eligible for sharing.”

What is the cost: For Solidarity, the monthly cost to join ranges from $149 for a single person under 30 years of age to $449 for a family under age 65. The amount that each member is responsible for before their costs are eligible for sharing is between $500 for a single person to $1,500 for a family. Each health care cost sharing ministry encourages and supports healthy behaviors and lifestyles and encourages you to be in charge of your own health care. This is what enables the ministries to be so cost effective.

What’s covered/not covered: All three healthcare sharing ministries seem to be very transparent about what expenses they cover and do not cover. Their websites list medical expenses that are covered, which is very comprehensive.  Items that are generally not covered are:  pre-existing conditions may be limited, dental, vision, and other expenses that are outlined as not eligible for sharing. Each health care cost sharing ministry has difference guidelines.

Caveats: Unfortunately, the cost of your monthly membership is not tax deductible. Additionally, you want to make sure that you thoroughly review what is covered and what is not covered according your situation and needs. Also, it seems that health care cost sharing makes most sense for individuals that are not covered with health insurance by their employers, such as self-employed individuals.

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Did You Know that NJ Now Requires All Residents to Have Health Insurance?

Starting this year, New Jersey is requiring all residents to have health insurance. Even though the Federal government has gone in the opposite direction, there are a handful of states that have their own mandates or are considering a mandate. What are some of the requirements, exceptions, and penalties regarding this new law?

Requirements: The law requires you to have minimum essential health coverage or qualify for an exemption of coverage. If you do not have coverage or qualify for an exemption, then you will incur a shared responsibility payment when you file your 2019 New Jersey tax return next year.

Exceptions: There is a whole list of exemptions, and some of them are as follows: income related, such as marketplace affordability and income below filing thresholds, gaps in coverage of less than two consecutive months, hardships, and group memberships, such as being a part of a health care sharing ministry.

Penalties: The minimum penalty is the greater of 2.5% of your household income or $695 for an individual taxpayer. This increases to a maximum of $15,060 for a family of two adults and three dependents with a household income greater than $400,001.

The penalties are steep so make sure that you are properly covered or are able to receive an exception to the penalties. For those who are looking for non-traditional coverage options, health care sharing ministries such as Solidarity HealthShare or Christian Healthcare Ministries may prove to be good, low-cost options. However, make sure to perform your due diligence to make sure that these can be the right fit for you.

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8 Red Flags That Could Trigger an IRS Small Business Audit

My colleague, Brad Paladini, has granted me permission to post this article that was originally posted on his blog: 

Last year, the Internal Revenue Service (IRS) audited just over one million returns. That’s a lot less than the 1.74 million returns they audited in 2010, but it’s still no fun for the millions of taxpayers that had to go through the process!

Overall, the IRS audits only about 1 in 200 returns. But some returns attract much more scrutiny than others. The IRS doesn’t want to waste its time getting blood out of a stone, and so they focus their investigative efforts on those returns and taxpayers that are statistically more likely to have discrepancies, such as small business owners.

Common Red Flags

Here are some of the major ‘red flags’ that can increase the likelihood of attracting IRS attention in the form of a small business audit:

1)  Higher Personal Income

While the average taxpayer has a 1-in-200 chance of getting audited in any given year, those with incomes of over $1 million are looking at odds of 1-in-20. That is, if your income is greater than $1 million, the probability of your return being selected for audit is ten times greater than it is for the average taxpayer.

At the same time, if you have an income of less than $200,000, the chances of your return being audited falls to just 1 in 154, based on 2016 numbers. But if your income was above $200,000, your chances of being audited increase to 1.70 percent, or 1 in every 59 returns.

So, if you’re showing an unusually high personal income, you are more likely to face an IRS small business audit. If you own a flow-through entity, such as an S-Corporation or LLC, the audit is likely going to extend to your New Jersey business as well, and any other business interests you own.

The same is true of partnership income. If you are showing substantial income from a limited or general partnership, and the IRS flags you for an audit, the audit very well may extend to the partnership – especially if you are the managing general partner in a limited partnership and your K-1s are showing a lot of suspicious losses.

2)  Owning an All-Cash Business

Owners of businesses like restaurants, food trucks, convenience stores and other businesses that deal a lot in cash sometimes fall to the temptation to take cash transactions “off the books” in order to conceal income. Your credit card processor submits a 1099-K to the IRS detailing the credit card payments they’ve made to your business account. The IRS has a pretty good feel for how much of a business’s receipts are going to be in cash vs. credit cards, checks and other forms of payment. If your numbers are way out of whack for similar businesses in your industry, you can expect some additional IRS scrutiny.

3)  Suspiciously Low Salary Income for Corporation Owners

This is a common red flag for New Jersey business owners. Some business owners try to report as much income as possible as dividend income and little or no salary income in order to sidestep FICA taxes. The IRS is wise to this trick, and will often look closely at business owners who report W-2 salary as suspiciously low, compared to the size and profitability of their businesses.

Some people fill out their Schedule C (Business Profit and Loss) forms to show just enough income to qualify for an earned income tax credit or other lucrative tax credit, but not much more. This also attracts IRS scrutiny.

4)  Large Cash Transactions

Merchants must report cash transactions in excess of $10,000 to the IRS. Banks also report these transactions. Failure to report these transactions, or repeated transactions just below the threshold, could trigger IRS interest.

5)  Reporting Net Losses in Multiple Years

Reporting net losses in more than two years out of any given five-year period may attract a small business audit – especially for sole proprietorships, and any time business owners are trying to flow-through those losses to their personal income tax returns.

To qualify as a bona fide business, as opposed to a hobby, your enterprise needs to show a profit in at least three out of five years. The IRS presumes that if you can show a profit at least three out of five years, you are running a bona fide business set up to make a profit. Otherwise, the IRS will look closely at your claimed deductions, and you could run afoul of hobby loss rules, and get some deductions disallowed. See IRC 183 for more information.

6)  Net Operating Loss Carrybacks or Carry-Forwards

Business losses can be carried back or carried forward to apply against income in other years. But the IRS is interested in these transactions. Be sure to document any such carrybacks or carry-forwards carefully to withstand an IRS small business audit.

7)  Excessive Deductions for Vehicle Use

The IRS looks closely at 100 percent business deductions for car expenses.

First, you can deduct the IRS standard mileage rate for business use – 54.5 cents per mile for tax year 2018 (as of this writing, the 2019 mileage deduction has not been released yet.) Alternatively, you can deduct your actual vehicle operating expenses, including fuel, maintenance, repairs, and upkeep. You cannot deduct both. If you try, you may attract IRS scrutiny.

Secondly, be sure to carefully document the miles you drive and their purpose, and make sure the mileage you claim is genuinely deductible. For example, you can deduct expenses attributable to miles you drive to meet a client at a remote location, but you cannot deduct for mileage incurred driving from home to your office. That’s a personal commuting expense, not a business expense.

8)  Suspiciously High Rental Property Expenses or Rental Loss Claims

Rental losses are unusual and attract IRS attention. The IRS may look carefully at any deductions you make for depreciation, and at attempts to deduct improvement and renovation expenses entirely in the first year, rather than spreading these deductions out over a period of years under MACRS rules.

You can deduct repair expenses that are designed to restore the property to a functional condition in the year in which you incur them, but you cannot take a first-year deduction for improvements and renovations designed to enhance the value of the property. These you must deduct over a period of years, depending on the project.

Labor expenses on capital improvement projects must also be amortized over the life of the repair. Failure to adhere to these rules can trigger IRS scrutiny.

Facing an IRS Small Business Audit?

If you’ve received a notification for a pending small business audit from the IRS, the tax attorneys at Paladini Law are ready to work for you. Attorney Brad Paladini has spent his entire career helping individuals and businesses solve complicated tax problems. Brad is highly trained to negotiate and fight with the IRS on your behalf. Schedule a consultation to have your case reviewed and explore your legal options. Contact Paladini Law through our online form, or call (201) 381-4472 today.

Be Careful When Making Online Payments to the IRS

We usually recommend that taxpayers make their tax payments online to the IRS and states. Here are the benefits, but a few caveats to watch out for:

Benefits: When making payments online, your payments are generally credited on the day that you make the payment. Additionally, you can clearly apply your payments to a prior tax year, current tax year, or for estimated tax payments. This helps to minimize errors when the IRS receives your payments, such as applying them to the wrong tax year and the date the payment was made.

Beware of these issues: Recently, we discovered that it is imperative to use the primary taxpayer’s social security number when making payments online to the IRS, otherwise your payment may sit in limbo and not be applied to your account. Other tips include:

  1. Make sure that you specify the correct year that a payment should be applied to.
  2. Double-check your banking or credit card information to ensure that your payment actually gets processed.
  3. Save the confirmation that you paid your taxes as a pdf document or print it out

Overall, we have seen a much lower number of issues when clients make their payments online. Just make sure to adhere to the tips above.

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How to Successfully Start a Second Business

Quite often entrepreneurs want to start a second business or even possibly a third, fourth and so on. What are the ways to make this successful, especially without selling or potentially harming your existing business(s), and what are some alternatives?

Similar or complementary business: Instead of say, an attorney, starting a restaurant, they may consider developing software to help other attorneys manage their practice better. Since they already have the experience of being a practicing attorney, they can transfer this knowledge into helping other attorneys and ideally use it in their own law practice.

Business with similar customers: Some businesses also serve your customers with a different product or service. To determine the other business that your customers use, observe which products or service providers your customers are also using and see if there is a pattern. Also, look to see who you are referring your customers to. For example, a landscaper may constantly refer their clients to a lawn sprinkler company, pest control business, or tree removal service.

Have a foundation in place: Make sure that you have a foundation in place for your existing business(s) so that they do not suffer as you develop other businesses. This usually takes years, but the main goal is to make your current business less dependent on you with everyday tasks. If your business suffers when you are not there for a few days then you are not ready.

Alternatives to starting another business:

Add a location: If you are successful in one location and have a good business model, then it is much easier to repeat this with another location. This can include second or third offices for a medical or professional practice, additional restaurants, and additional sales offices.

Purchase an existing business in the same industry: Having a strong foundation is important because you can easily absorb another business in the same industry as long as you have all of the infrastructure in place. This can include capital, space, employees, technology, and operating procedures.

Operate a business within your existing business: Instead of creating a distinctly separate business you can operate the additional business within your own business as a separate service offering or division. This can work well if the service offering is very similar to your existing business. Legal and tax implications should always be considered.

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So You Want to Flip Homes?

Buy a house, put in a few improvements, and then sell it for a much higher price. Do it again and again. It sounds so simple, but here are a few pointers to keep in mind if you want to succeed with house flipping:

Experience: If your experience in real estate is performing repairs on your home during weekends, then you do not have the required experience. Ideally, you should have experience in both residential construction and real estate sales.  Experience as a general contractor will help you to determine the amount of time and costs to improve a potential flip, while experience in real estate sales will help you to locate a property, determine the market characteristics, and eventually sell the property.  Both are extremely important because you want to maximize your profit by investing your time and money in the right house and the smartest improvements. If you do not have this experience then you need to spend the time to learn as much as possible before purchasing a flip to minimize costly errors.

Know your costs and potential selling price: Before purchasing a property you need to estimate your cost of purchasing the property, the necessary improvements, and carrying costs such as real estate taxes, loan payments, utilities, and insurance. Just as important is the estimated selling price. If you underestimate your costs, overestimate the selling price, or underestimate the time to improve and sell the property, then your chance of profit will be greatly decreased. The formula is simple, but not always easy to accomplish; profit = the selling price minus all costs. With this in mind you want to make sure that you leave enough wiggle room to make a profit in case your estimates are off.

Capital: If you don’t have the necessary capital to purchase a fixer upper, make improvements, and pay the carrying costs, then you need to either obtain a loan or partner with someone who has the necessary capital. Make sure that you have a cushion just in case your estimates are wrong.

Time and opportunity cost: Let’s say that you are a contractor and are looking to flip a house. Make sure that you estimate that you will make more money on the time spent with your flip than during your regular construction activities. The same goes for anyone else trying to invest their time and money in a flip.

Start small: If just starting out then make sure that your first slip does not have the potential to decapitate you financially. Just think back to what happened to many house flippers about a decade ago.

Taxes: Most likely your profit will be taxed at ordinary income tax rates and possibly self-employment taxes vs. long-term capital gains rates. This is due to the fact that you are usually considered to be a dealer with the intent to buy, improve, and sell a home in a short time frame.

Alternatives: An alternative and close cousin to house flipping is to rehab a rental property, rent it out, and hold it for the long term. It is not as exciting as house flipping, but it can be very worthwhile, while also carrying less risk.

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5 Financial Truths

There is a lot of information out there about finances, and it’s hard to figure out what is exactly true or not true. Always seek the truth, especially from someone that is not trying to sell you something. Here are some examples:

College: We are led to believe that all of our children must go to college to be successful and make a lot of money. While I am a big believer in education and college, it is not the only route and it is not for everybody. With the high cost of college, the decision to attend college should not be automatic. There are alternatives, such as becoming a tradesman, learning a special skill that does not require college, starting a business, sales positions, military or government positions that do not require college, stay at home parent (yes, this is a vocation), etc.

Retirement savings: Saving for retirement is a good thing, however, it should be balanced with both short and mid-range needs. For example, if you allocate virtually all of your savings towards retirement accounts and ignore having a cash cushion, then your risk of financial catastrophe increases. If a financial crisis arises or a large purchase needs to be made, then you will have to withdraw from your retirement accounts, which is one of the worst financial decisions to make due to both income taxes and penalties on the withdrawals. Furthermore, if you do not have withholdings taken from your distributions, then you will probably end up with a tax problem once you file your return. The prudent action is to have a cash cushion of 3 to 6 months of expenses for emergencies and to save for mid-range goals, such as a house purchase.

Debts: Debt truly is a double-edged sword. There are some who advocate staying away from debts at all costs and others who encourage you to leverage yourself to make more money. The truth is that debt should be used wisely and sparingly, if necessary and as a last resort, and it should not cripple you. If you are able to avoid debt, then that is excellent, as debts increase your risk and they also encourage risky behavior and increased spending in many cases.  To prove this point, why do you think McDonald’s started to accept credit cards, why do auto loans have 7 year terms, and why can young adults take out massive loans for college?  It is to get you to spend more than you would have otherwise.  As you mature financially you should seek to decrease your debts.

Most people would not be able to afford a house without obtaining a mortgage, and if they waited to purchase a house and rented instead, then they would most likely be worse off financially over the long term. Also, some businesses may need to incur debts to purchase expensive equipment, inventory, or improvements that would not be possible if they did not incur debts. To emphasize, it should be used wisely and sparingly.

Expenses, income and savings: Most likely your expenses are way too high. If you are able to save 15- 20% of your income and have no debts then spend whatever you want. Otherwise, set aside money towards savings to steadily increase the percentage that you save each time you get paid. This way you will spend whatever is left over. If you are not able to do this then you need to take a serious look at decreasing your expenses and increasing your income. The truth is that it is really not that hard, but most people have a hard time doing this. As Yogi Berra said, “Baseball is ninety percent mental. The other half is physical.”

Home and health = wealth: In the quest for success, don’t ignore your most valued relationships or your health. Nothing can cripple your finances as quickly as health or family issues, such as divorce. With either of these issues your expenses increase exponentially while your income suffers at the same time. Make sure to prioritize.

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