Financial

Just When I Thought I Was So Smart . . .

As a professional, it’s always wise to project a good image of yourself, especially that you are intelligent. However, sometimes or many times we do things that really humble us and hopefully help us to not be so prideful. Here are a few things that I have done recently and not so recently:

GPS: My GPS on my phone showed that it would take about 2 hours to get back home, which I thought was due to traffic and was normal, even though I was about 35 minutes away. For some reason the GPS kept on taking me through side streets with lights, which seemed to appear every 200 feet. Finally, after about 20 minutes I pulled over and took a good look at the directions and realized that I was taking the bike route. Yes, it took me 20 minutes to pull over.  I think that my pride ran away at that moment.

App and phone purchases: If you know anything about children and video games then you know that you can make in-app purchases within the games to obtain more virtual money, coins, or gems. There weren’t the proper safeguards in place on their tablets and in a blink a lot purchases were made. A lot of purchases were made. Did I mention that a lot of purchases were made? We were able to get some refunds, but let’s just say that where this is a will there is a way, especially when your children then ask if they can borrow your phone and decide to go on a shopping spree at Amazon. I really don’t need a PS4.

Per diem: When I started my practice years ago during the recession it took time to acquire clients, which is normal and expected. In the meantime I could have worked per diem at another firm at least for that first year or so. However, I had such a bad experience with the previous firm that I worked for as an employee that I told myself I would never again work for anyone else. The extra cash made working per diem would have been nice and would have made the transition from employee to practitioner easier and less stressful financially.  Eventually, I did work per diem after about a year or so at a few different firms, and I met some really good people.

There are many more that I’ll keep to myself, but we all need to be humbled from time to time.

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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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Want a Better Business? Focus on Recurring Revenues!

There are more ways to make money in business that can be listed. However, one mostly overlooked business model by a majority of small businesses is the recurring revenue model. Larger businesses already know this and are taking advantage of the benefits. Here are some pros and cons and how to implement the recurring business model:

Pros: Recurring revenues, specifically monthly recurring revenues, provide a steady stream of predictable cash flow. Since you can easily predict your income you can plan ahead for the amount of expenses needed to support your revenues, such as employees, technology, supplies, inventory, etc. This will in turn significantly lower your expenses and help to increase your profit margin. Additionally, a business with recurring revenues has a much higher value than one-shot deals. Think homebuilder (one-shot) vs. a subscription service like Netflix (monthly revenues).

Cons: Many small business owners love the large payments that they receive when they land a one-time or short-term project, which do not exist with the recurring revenue model for the most part. It can take time to build a recurring revenue business, but an existing business should realistically be able to see a massive change with a one year period.

How to Implement: Take a look at the services and/or products that you provide, and determine which ones can be modified to fit the recurring revenue model. For example, a marketing company that helps clients with social media can develop a package to perform certain tasks each month in exchange for a recurring monthly fee.  Virtually any business can turn at least a portion of their business into recurring revenues

The recurring business model is not costly or difficult to implement, but rather a low-risk, high-reward activity. It takes courage and openness to change your business, but it will be worth it.

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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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Small Business, Large Profits

All small business owners want to increase sales, open new locations, obtain more customers, add employees and grow, grow, and grow some more. It sounds good, but is it really necessary? Is there an alternative?

Necessity: It is necessary to grow your business as the alternative isn’t too appealing. You have financial obligations and people that depend upon you, such as family, employees, and customers. So, yes, it is necessary, however, here is a different view on growth.

Focus on profitability: If you double your profit margin then this has the same impact as doubling the sales of your business. Even if you increase the profit margin by several percentage points then it has the same impact as increasing sales. It sounds too easy, but here are some ways to do this:

  1. Decrease the number of services/products. Spreading yourself too thin usually decreases your profitability because it is hard to do everything well.
  2. Service the proper clients by targeting a more defined niche.
  3. Use marketing methods that only target the customers that you want to serve.
  4. Plan ahead for large purchases or investments, including space requirements, people, vendors, equipment, and technology.
  5. Price your products and services properly.

The interesting fact is that when you are more profitable, then each additional dollar of business is worth more to you, which makes it easier to actually grow further.

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How Long Should You Save Your Tax Returns and Financial Records?

The IRS says that you should normally keep your records for 3 years, and for some situations you should keep them for 6 to 7 years. However, I strongly disagree and here is what you should do and how to do it:

Tax returns: Do you want to know the prudent answer to how long you should save your tax returns? Until you are dead, and even then your heirs should probably keep them until years after the estate is settled. Why should you do this even though the IRS has 3 years to audit your returns and 6 years if you under report more than 25% of your income? Here are several real-world practical reasons:

  1. It is far too common that the State of New Jersey will send a letter to you stating that you never filed a tax return from more than 10 years ago. Additionally, if you are selling your business, trying to obtain a specific license, dissolving a business, or for any number of reasons, then the State will perform research to see if you filed all of your tax returns. Even though the State may be wrong, you will still generally need to file the returns.
  2. Information carries over from year to year. As your tax return becomes more complex, your income tax information tends to carry over for many years, such as investment losses and rental property purchases.
  3. A safe way of storing your tax returns is to keep both digital and hard copies.

Financial records/receipts: What if social security has incorrect information about your earnings from 25 years ago? If you have the actual records then you can prove your case more easily. This includes tax information, such as W-2’s and paystubs. Here are some timeframes based on the types of documents:

  1. Tax documents should be saved forever, just like you save your tax returns. This especially relates to business tax records. Brokerage statements should be included as part of your tax information as they contain purchase price information.
  2. Bank and credit cards statements can be discarded after a few years. However, if they contain tax information or are connected to a business or real estate, then you should save them forever.
  3. Utility bills can be discarded after about 6 months. Sometimes you need these to prove your residency, but the timeframe needed is generally a few months.
  4. ATM and purchase receipts can be discarded once you view the transaction on your bank statement or online. However, when purchasing from a restaurant, you should make sure that the amount after a tip is accounted for actually settles, which can take several days.
  5. Receipts for improvements to your home or for large business purchases should be saved forever.
  6. If you are short on physical space then save your records electronically, but make sure that you have a cloud backup.

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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.