Taxes

Some Horrible Ways to Lower Your Tax Bill That are Not Recommended

I don’t think that I ever met anyone that likes to pay taxes. Everyone feels better when their taxes are paid in full with no outstanding balances, but not actually paying them. Sometimes this hatred of paying taxes can go too far and here are a few examples of what not to do:

Understate your income: As a business owner there is a huge temptation to “pocket” any cash that is received or cash checks instead of depositing them to your account. However, if you understate your income too much then you may be facing jail time and massive penalties.

Overstate expenses: Maybe you really like cars and use multiple cars for your business. However, if your spouse does not work in your business then her car payment is not a tax deduction. The same goes for personal meals, personal expenses, and outright lying about your expenses and deductions. Most likely you do not give 15% of your income to charitable. It’s possible, but not very probable.

Losing money in a side business: The main purpose of starting a business is to make money. Maybe some contemporary experts think that you should try to change the world, but most likely you are selling a product or service that is not going to cure illnesses. Sometimes a newer business owner is so intent on losing money to not pay taxes that they never let their business actually become a business. A business can only lose money for so long. The same goes for real estate investments and traditional investing.

Spend a dollar to save a quarter: Do not ever spend money on an unnecessary tax deductible expense just to save taxes. The math is very simple – spend $1 to produce $.25 of tax savings, which equals $.75 lost.

Multi-state taxation: The tax laws are extremely complex and each state has its own set of rules. However, don’t let this stop you from doing business or working in other states to take advantage of opportunities.

Tax-exempt investments: Even though municipal bonds are exempt from Federal taxes and possibly state taxes, this does not mean that they are appropriate for you. You must do the math to make sure you compare after tax returns of taxable investments to tax exempt investments, otherwise you may be worse off economically.

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An Observation Regarding Money Worries

There are a few things that I noticed over the years that seem to contradict each other regarding money worries. There seems to be a link between being charitable, concerns over saving too much, and stress about money.

Charitable giving: some people make a lot of money and give little to nothing to charity, especially as a percentage of their income, and the opposite is sometimes true regarding those with modest incomes. Theoretically, the greater your income then the greater should be your charitable giving. Why does this make sense? I believe that it has to do with a scarcity mentality and a fear of letting go. If you are overly concerned with not having enough money, whether real or imagined, then why would you part with your money?

Overly concerned about saving: Let’s face it, it is daunting to think that we have to make sure to save enough for retirement, college, a house or a larger house, 6 months of expenses for an emergency fund, weddings, sweet 16 parties (they can be over the top nowadays), vehicles, business ventures, and everything else. It even makes me exhausted just writing that! However, some take it too far and save so much or are concerned so much about saving that they get really stressed out. Although I am an advocate for saving up for most of the above (I’m not a big fan of massive weddings and outlandish sweet 16 parties), you have to balance that with current needs or you will be miserable. Who wants to eat the cheap steak to save an extra $10 for their retirement?

Do any of these apply to you? Maybe just a little?

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If You Are Looking for a Good Business Partner Then Pay Attention to What They Do, Not What They Say

Running a business is probably one of the most challenging, while equally rewarding endeavors that only the brave embark on. Some go at it alone, while others choose a business partner because sometimes 1 + 1 = 3 or 5 or 10. However, before choosing a partner you must minimize the risk of choosing the wrong partner by paying attention at what they do or have done, not just what they say.

Look at their past: No one is perfect, but generally, when a person is not able to overcome some of their difficulties, then there is a high probability that they will not magically fix their problems when you are their partner. Rather they will bring these issues into your business and wreak havoc. One time events or actions may not be too meaningful, but repeated patterns are a very bad sign.

Specific examples:

Tax problems: It is not uncommon for business owners to have a tax problem at one time or another due to the complexity and burden of an ever increasing number of taxes, fees, penalties, etc. that they need to be aware of. However, if there is a history of not filing tax returns, especially willfully, or not paying their taxes then watch out.

Health, mental, and addictions: The number of times that I speak to people regarding mental issues or addictions is so high that it doesn’t seem real and seems to be on the rise. Just because someone has a mental illness, doesn’t mean that they will make a bad business partner, unless it is not under control and has been for some time. The same goes for addictions, which can include gambling, spending, drugs, alcohol, and everything else. If the addiction was in the way past and has been overcome, then that is a plus. If it constantly resurfaces or is currently happening then that is a sign that it has not been defeated. Unfortunately, it is hard to know these things, especially if you only know a potential business partner casually. Although, thorough background checks and taking a look at the last year or so of bank statements may shed some truth.

Half truths or lies: Maybe your potential business partner ran a business in the past and it didn’t work out, which is not that uncommon. They may have the issues above, they may not be so good at running a business, or maybe there is another reason. One way to find out is to ask a lot of questions and then try to verify their answers with some research and legwork. For example, they may say that their landlord kicked them out of the building because the building was sold. Well, you can easily find out if the building was sold, speak directly to the old and new landlord, and look at their bank statements to see if they were actually paying their rent. Another example is to ask if they ever filed bankruptcy and then look into the public records to see if this is the truth and/or to have them run a credit report in front of you.

These are all of the bad things to look out for, but what are the good things to look out for? The answer is to look for the exact opposite. As I tell my children often: seek truth.

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When Should Your Parents Stop Being Involved in Your Financial Affairs?

Our parents raised us and shaped who we are today, and there is probably nothing that we can do in comparison to what our parents did for us, except for perhaps raise our own children well. But, when should our parents stop taking charge of our finances, career and/or business?

It is a good for us to always seek counsel from our parents, especially on matters that they may have more experience with or needed expertise. Even when we are in our fifties it is wise to communicate financial issues with a knowledgeable parent. However, make sure to separate having trust in someone versus their ability to competently advise you.

Once you are in the workforce and are an adult, then you need to deal with your employer directly. Several examples have been shared with me regarding parents contacting their adult child’s previous employer over payroll issues. Even worse is that in those situations the adult child was a professional that advises others! Again, feel free to seek the advice of your parents, but do not have them act as your “proxy.” I can just picture this now, “This is Mr. Smith, and I am calling to let you know that Timmy will not be at work today because he is under the weather. Please cancel his meetings with the executive vice-presidents of Fortune 500 Co.”

Sometimes you may own and operate a business and employ one of your parents, which does happen occasionally. Your parent may be able to give you insight that you are not seeing regarding employees, customers, or finances. However, unless you hired your parent as a strategic advisor because they have developed successful companies in the past, or the CEO, which small business owners actually are, then your parent should not be actively deciding the direction of the company or connections with key people.

Anecdotally, it seems that adults who enforce boundaries with their parents make better financial decisions, are more successful, and have more confidence.  I’ll let the psychologists further elaborate on this topic.

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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.