Jacqueline Frew of Frew & Associates is this week’s guest blogger. Ms. Frew specializes in tax planning for individuals, business owners and businesses. In this blog post, Ms. Frew provides helpful year-end tips to save on this year’s and next year’s taxes.
The 2013 tax year includes both tax increases and the expiration of many tax deductions if congress does not act before the year-end.
For businesses, tax breaks that are available through the end of this year but won’t be around next year unless Congress acts include: 50% bonus first-year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation; the research tax credit; and the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
High-income-earners have other factors to keep in mind when mapping out year-end plans. For the first time, they have to take into account the 3.8% tax surtax on unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a non-indexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than unearned income, and others should consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimate tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax. For example, consider an individual who earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed.
Year-End Tax Planning Moves for Individuals
• Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
• If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2013.
• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
• Postpone income until 2014 and accelerate deductions into 2013 to lower your 2013 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2013 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2013. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2014 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
• If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2013.
• If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as-is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by re-characterizing the rollover or conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
• It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2014.
• Consider using a credit card to prepay expenses that can generate deductions for this year.
• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2013 if doing so won’t create an alternative minimum tax (AMT) problem.
• Take an eligible rollover distribution from a qualified retirement plan before the end of 2013 if you are
facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2013. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2013, but the withheld tax will be applied pro rata over the full 2013 tax year to reduce previous underpayments of estimated tax.
• Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2013, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated.
• If you pay very little in state income taxes (retirees for example), accelerate big ticket purchases into 2013 in order to assure a deduction for sales taxes on the purchases if you will elect to claim a state and local general sales tax deduction instead of a state and local income tax deduction. Unless Congress acts, this election won’t be available after 2013.
• You may be able to save taxes this year and next by applying a bunching strategy to miscellaneous itemized deductions, medical expenses and other itemized deductions.
• If you are a homeowner and have not claimed energy credits in the past, make energy saving improvements to the residence, such as putting in extra insulation or installing energy saving windows, or an energy efficient heater or air conditioner. You may qualify for a tax credit if the assets are installed in your home before 2014.
• Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2013. Thus, consider prepaying eligible expenses if doing so will increase your deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2013 in connection with enrollment at an institution of higher education during 2013 or for an academic period beginning in 2013 or in the first 3 months of 2014.
• If you are age 70-1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before yearend, can achieve important tax savings.
• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2013, you can delay the first required distribution to 2013, but if you do, you will have to take a double distribution in 2014 the amount required for 2013 plus the amount required for 2014. Think twice before delaying 2013 distributions to 2014 bunching income into 2014 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2014 if you will be in a substantially lower bracket that year, for example, because you plan to retire late this year.
• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2013 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Year-End Tax-Planning Moves for Businesses & Business Owners
• Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2013, the expensing limit is $500,000 and the investment ceiling limit is $2,000,000. And a limited amount of expensing may be claimed for qualified real property. However, unless Congress changes the rules, for tax years beginning in 2014, the dollar limit will drop to $25,000, the beginning-of-phase-out amount will drop to $200,000, and expensing won’t be available for qualified real property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant yearend planning opportunities.
• Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus write-off generally won’t be available next year unless Congress acts to extend it. Thus, enterprises planning to purchase new depreciable property this year or the next should try to accelerate their buying plans, if doing so makes sound business sense.
• Nail down a work opportunity tax credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2013. Under current law, the WOTC won’t be available for workers hired after this year.
• Make qualified research expenses before the end of 2013 to claim a research credit, which won’t be available for post-2013 expenditures unless Congress extends the credit.
• If you are self-employed and haven’t done so yet, set up a self-employed retirement plan.
• Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2014, and disposing of a passive activity to allow you to deduct suspended losses.
• If you own an interest in a partnership or S corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.
These are just a few tips for a merrier tax season.
09.30.13 | Five Ways to Manage Cash Burn
Many companies, both small and large, believe that all growth is good but it is not. If your business cannot obtain the cash needed either through operations or through outside financing such as a bank you may grow yourself right out of business. One example of this is Krispy Kreme Donuts. Krispy Kreme closely monitored the quality of its products through its store bakery locations but once Krispy Kreme rapidly expanded into grocery store chains it did not have the financial resources to make sure quality standards were consistent. In other words, they spread themselves to thin. Krispy Kreme also made the mistake in believing that increased volume from grocery store chains would be enough to offset the higher costs and lower wholesale price from the grocery store channel without accounting for increase in operational structure and costs from their business model change. If you are a fast growing company, here are some strategies to ensure your future existence:
- Closely Track Cash Flow – Profit is not the same as cash flow. Cash flow is what the business has left after paying all of its expenses, unfinanced business investments such as equipment purchases for cash and debt payment obligations. It is critical that your business has two sets of income statements. One on an accrual basis, which shows business profits and one on a cash basis which shows your cash flow. With a cash flow based income statement you can calculate when your business will be low on cash and you can plan ahead on what to do about it. Some ideas could be to cut back on hiring or business investments, roll out new products sooner, obtain bank financing or investor capital and so on.
- Closely Watch Spending – Make sure that you are running your operations as efficiently as possible and with the right people. Nothing burns cash more quickly that wasted resources.
- Outsource Non-key Functions – If you are a direct marketing company, you would not outsource the marketing department since this department’s inner workings are your company’s secret sauce; however, it would make sense to outsource payroll, which is a processing function. Other good examples would be the accounting function as well. These are departments that serve specific and necessary services but are not directly contributing to the operations of the company.
- Constantly Monitor Business Performance – Make sure that you understand why and how your business is growing. By knowing this critical information you will know where to invest within your business operations for the greatest payback. Many businesses do not have this capability in house so this is a great way to use an outsourced resource such as an outsourced CFO for business analysis on a project or part-time basis.
- Build Financing Sources Before Things Get Desperate – While the business is healthy, you should actively be building relationships with capital sources such as banks and investors. They can get to know you and your business. If you wait until the business is on its last leg the depth of financing sources are both shallower and more expensive.
By incorporating these cash burn strategies into your business operations, you will be well on your way of sustaining your business through its rapid growth cycle and coming out successfully on the other side.
Finally, the day has arrived. Today companies can advertise private placements to the general public using general advertising methods including social media; however, the private placements can only be sold to accredited investors. Notice that I said accredited investors not just plain ordinary investors and this is a different funding source than through crowd funding which has a different set of rules. Accredited investors are believed to be more investment savvy and thus have less rules but it is up to you, the seller, to verify that your buyer of the private placement meets this definition. According to the SEC here are your options to do just that:
- On the basis of net income by reviewing tax returns or through a statement from the investor that he or she expect to hit the SEC income requirements
- On the basis of net worth by reviewing the investors personal financial statements showing assets and liabilities
- Third-party written confirmations such as a registered broker-dealer, SEC-registered financial advisor, licensed attorney or CPA
With the Patient Protection and Affordable Care Act (PPCA) becoming fully effective in 2015, it will become more important than ever to get the independent vs. employee classification correct. In 2015, any company with 50 or more employees will be required to offer healthcare insurance benefits to its employees working at least 30 hours per week. Independent contractors are not considered employees and thus employers would not be required to provide insurance benefits for independent contractors and would be able to save money not only from employment related taxes but also from insurance costs.
Given that the misclassification of independent contractors is an ongoing IRS issue combined with the upcoming implementation of PPCA, the IRS will be even more diligent in making sure businesses are following the rules. The IRS provides the following guidance on classification:
1. Behavioral – If the company has the right to control and how and what the worker does then he or she is not an independent contractor
2. Financial – If the company controls how the worker is paid as well what is reimbursed and what tools are used then the worker is not an independent contractor.
3. Relationship Type – If the worker receives employee-like benefits such as vacation pay and/or the relationship is such that it is critical to the ongoing operations of the business over the long-term then the employee is likely not an independent contractor.
It does not matter if you have a written contract in place. The treatment of the worker will overrule any written contract if the nature of the work falls into one of the three categories listed above. In addition, it does matter if the worker is full-time or part-time for classification purposes. For more insight on worker classification, visit IRS.gov or discuss with your tax specialist.
08.26.13 | Introduction to Business Models
I came across this excellent white paper entitled Building Resilence – Introduction to Business Models that discusses in detail the concept of business models. In the business world we throw this term around loosely but this white paper produced by CGMA does a great job of breaking down different aspects of business models from not only the financial perspective but also from the perspective of human capital, industry sector and so on. If you are in the process of updating your own business model or strategic plan this white paper is an excellent resource.
Let me know what you think.
As been said many times before, cash is king for the life of any business for the long-term. With that in mind, managing accounts receivable is an integral part of ensuring that cash is consistently coming into the business to cover not only expenses but needed reinvestments in the business for future growth. These reinvestments can be in the form of new employees as well equipment and additional locations. As a result, accounts receivable is not only important to the finance team but is even more important to the senior management team because it will enable executives to implement their growth strategy only if their financial house is in order. In other words, successful cash management facilitates company growth.
Accounts receivable is the amount of money that customers owe for services or products that the company provided to their customers. The fact that there are accounts receivable is not bad in itself; however, it is bad if the amount of accounts receivables is not in line with the industry or common business practices. As an executive, you want to make sure that your finance team has the right accounts receivable practices in place. Below are some steps to help to manage accounts receivables:
- Properly Track and Monitor Your Accounts Receivable
Most accounting or practice management systems have some way to track accounts receivables. Make sure your business is using it appropriately. Your system should know by type of client and by payer type what is owed and also be able to track trends in payment cycles. This information will help you figure out who are the best paying and worst paying customers. This is important because if your worst paying customers are coming from one industry type then it make sense for the business to stop pursuing that particular type of customer. In addition, your accounts receivable monitoring should include a dashboard on dollars outstanding by delinquency bucket and the movement (i.e. trends) between the buckets in order to inform you of any positive or negative trends in accounts receivable movement month to month. Also, this accounts receivable dashboard should monitor how your business’ accounts receivable compares to industry norms.
2. Record Sales and Payments Promptly
By recording sales and payments as soon as possible, you are able to invoice the customer with the most recent and accurate information. Incorrect invoices are the most common reason for customers not to pay on time. In addition, it eats up staff resources to investigate customer invoice errors.
3. Establish and Adhere to Credit Policies
I have many clients who have well thought out credit policies in place but do not follow them. The credit policies were created for a reason, to prevent accounts receivable accounts to become severely delinquent but also to maintain good relationships with clients that are not severely delinquent. Some key components of any credit policy are:
- Assessment of the customer’s ability to pay
- Firm limit on extending additional credit for delinquent accounts
- Standardized collection processes for each delinquency cycle. For example, for clients who are 10 days past due, a “sorry did your check get lost in the mail” communication would go out to the client. If that same client progresses to the next stage of delinquency, 30 days past due then a soft collection letter would go out.
4. Offer Multiple Client Options for Payment
By offering different payment options such as credit cards and cash then accounts receivable can greatly be reduced. However, any non-cash option must make sense for your business because there is a cost for these non-cash options. Credit card companies charge businesses a fee of 3-5% of the transaction amount for credit card processing services. In addition, clients should have multiple ways to pay – - phone, web and in-person.
5. Offer Discounts for Early Payment
As part of your credit policy, you should have terms set out for clients for early pay discounts. Your company’s policy may be not to offer early pay discounts. The decision for early pay discounts depends on the immediate cash needs of your individual business. By getting clients to pay early through a discount you can internally finance project less expensively than a bank; however, if your business is not in need of the money in less than a 30 day pay cycle then it makes no sense to offer a discount. In addition, if you are a business with few competitors and in high demand you may be able to have tighter customer pay cycles, example payment due upon receipt instead of 30 days, since clients that have fewer competitive choices will not be able to go elsewhere for more favorable payment terms.
Managing accounts receivable does not have to be difficult. The key is to keep on top of it through execution of written credit policies and continual and consistent monitoring. By doing this you will be able to respond to negative trends immediately and ensure the financial health of your business.
08.05.13 | Cash Crunch Remedies
Many businesses small and large can experience cash flow problems. Look at Hostess Brands that has been in and out of bankruptcy court for many reasons over the years. Hostess has a strong brand but poor cash management. Hostess suffered from lack of investment back into its facilities as well as out of line compensation costs for its employees. Without being able to get cost savings from efficient operations to offset any higher labor costs, Hostess was doomed in the long-term. The only way to get out of a cash crunch is (1) get access to funds either through investors or lenders, (2) increase sales and (3) lower expenses. None of these options were viable for Hostess. However, these options can be viable for your business.
No matter the size of the business, it all comes down to how well you manage what you have. Cash management is one of those things that you have to get right. Here are my top tips for managing and improving your cash position when cash is tight.
- Only pay what you can afford – With overdraft fees running over $35 a pop, it makes no sense to pay avoidable bank fees, especially during a cash crunch. If you cannot afford the expense and it is a necessity to keeping your business running, work with the vendor to delay payment rather than further irritating the vendor with a bounced check.
- Lower expenses – Look at all your expenses and eliminate or cut down items that will not impact your customer or staff goodwill. Start with large expenses and work your way down to the smaller items.
- Renegotiate everything – Review your existing contracts to make sure you’re not being overcharged. If contracts are at or near renewal, be open to new bidders. Examples include telephone, leases, equipment rentals and so on.
- Extend payment terms – Reach out to lenders and renegotiate payment terms including interest rates for those of you with excellent credit and monthly payments. Do not be afraid to ask for a no payment period or reduced payment amount for a specific time period, say six months, with interest and principle tacked on to the end of the loan. This is a really inexpensive way to fund a project that would increase the revenue to your business.
- Increase sales – Get rid of slow moving inventory by selling it to customers at a discount via a sale. Cash is king and old product sitting on a shelf is not doing anything to help the business and its cash position.
- Do not invest in new products – When cash is tight, it makes no sense to invest in something that is unproven. Reinvest cash in items that are proven to generate lots of cash to get the business out of the danger zone.
- Increase customer retention – It is cheaper to keep a customer than to acquire a new customer. Former customers are already familiar with your brand. Always have some part of your marketing budget set aside for customer retention such as birthday discounts and customer appreciation events.
- Cash collections – Poor billing and collection practices can quickly make your business cash poor. Make sure your billing is timely and accurate. Make sure to pursue past due bills. Some customers will not pay until they receive a collection call. In other words, the squeaky wheel gets the oil.
Implement these tips in your business and you will be well on your way out of your short-term cash crunch. To learn more about Loftis Consulting and how its consultants can help your business thrive and grow, please visit the Loftis Consulting website.
Prime Property Preservation, a Maryland-based property management company, was founded by a team of industry veterans with many years maintaining and improving residential and commercial properties. The company is currently focused on securing and maintaining residential properties for banks and other financial institutions but plans to expand to the commercial property sector in the near future.
Loftis Consulting is honored to have Prime Property Preservation as a client. Currently, we are providing strategic planning and financial services such as pricing strategy developmental services and accounting services to Prime as part of our part-time CFO service offering. We expect our relationship to continue to grow in the future.
10.04.12 | WSJ: Small Business Banking by Amazon.com
In a recent Wall Street Journal article, the writer highlighted the fact that Amazon.com is now offering small businesses that sell their products on Amazon.com a financing option. As with any credit situation, you should always make sure that the financing package makes since for your business. To read the full article go click the link and let me know what you think.
08.27.12 | WSJ: When Freemium Falls Short
In a recent Wall Street Journal article, the writer highlighted the risks of a freemium business model. Freemium is when a start-up venture offers it service for free for a Basic level service package and charges a fee for service levels above Basic. For example, an online billing company may offer a free online billing system for up to five billable customers and then charge $25 per month for 6-10 billable customers and so on. The strategy is to get customers in the door to try the product and hopefully the customer will upgrade to a fee based plan because (1) the product fits their needs and (2) the fee based plans offers something worth paying for in the customer’s mind.
As noted in the WSJ article, it is critical to not give too much away at the Basic level and make it worthwhile for customers to switch to a fee-based service level. The bottom line, when developing a Freemium strategy the conversion rate of non-paying customers to paying customers is critical to the long-term success of the business. If customers are not converting fast enough for the business to become profitable before it burns through its cash it is critical to change the business model immediately until it is right. Here is the link to the full WSJ article.
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