Accounting – Sometimes Less Is More

I was recently asked by a client to assist with setting up some accounting policies for his bookkeeper. When reviewing the client’s financials, I could immediately see why this was necessary.

Here’s an example of “more:”

·         A chart of accounts that reads like a phone book

·         A balance sheet that is 4 pages long

·         A profit and loss that has a line item for every.single.vendor

For example, here is what I saw on my client’s chart of accounts:

·         Taxes

·         Taxes & licenses

·         Property taxes

·         Income taxes (which he never had to pay)

·         Taxes – payroll

·         Payroll taxes

·         Sales tax (again, he never had to pay sales tax)

·         Car taxes

This is what we proposed:

·         Taxes – Property & Other

·         Taxes – Payroll

·         Business license

Boom! This was only one example of what we changed. The financial statements were condensed from nearly 9 pages (most of which were never reviewed) to only 3 pages (all of which contained useful information for our advisory work). The banker who had to review those statements each quarter thought we had invented the wheel and maybe even fire.

Accounting isn’t about endless data. It’s about useful data. Sometimes less is, in fact, more.

IRS Summertime Tax Tip 2015: Back to School Education Tax Credits

If you, your spouse or a dependent are heading off to college in the fall, some of your costs may save you money at tax time. You may be able to claim a tax credit on your federal tax return. Here are some key IRS tips that you should know about e tax credits:

• American Opportunity Tax Credit.  The AOTC is worth up to $2,500 per year for an eligible student. You may claim this credit only for the first four years of higher education. Forty percent of the AOTC is refundable. That means if you are eligible, you can get up to $1,000 of the credit as a refund, even if you do not owe any taxes.


• Lifetime Learning Credit.  The LLC is worth up to $2,000 on your tax return. There is no limit on the number of years that you can claim the LLC for an eligible student.


Things to remember with these credits:

• One credit per student.  You can claim only one type of education credit per student on your tax return each year. If more than one student qualifies for a credit in the same year, you can claim a different credit for each student. For instance, you can claim the AOTC for one student, and claim the LLC for the other.

• Qualified expenses.  You may use qualified expenses to figure your credit. These include the costs you pay for tuition, fees and other related expenses for an eligible student. Refer to IRS.gov for more on the rules that apply to each credit.

•  Eligible educational institutions.  Eligible schools are those that offer education beyond high school. This includes most colleges and universities. Vocational schools or other postsecondary schools may also qualify. If you aren’t sure if your school is eligible:

o Ask your school if it is an eligible educational institution, or
o See if your school is on the U.S. Department of Education’s Accreditation database.

• Form 1098-T.  In most cases, you should receive Form 1098-T, Tuition Statement, from your school by Feb. 1, 2016. This form reports your qualified expenses to the IRS and to you. The amounts shown on the form may be different than the amounts you actually paid. That might happen because some of your related costs may not appear on the form. For instance, the cost of your textbooks may not appear on the form. However, you still may be able to include those costs when you figure your credit. Don’t forget that you can only claim an education credit for the qualified expenses that you paid in that same tax year.

• Nonresident alien.  If you are in the United States on an F-1 Student Visa, the tax rules generally treat you as a nonresident alien for federal tax purposes.  To find out more about your F-1 Student Visa status, visit U.S. Immigration Support. To learn more about resident and nonresident alien status and restrictions on claiming the education credits, refer to Publication 519, U.S. Tax Guide for Aliens.

• Income limits. These credits are subject to income limitations and may be reduced or eliminated, based on your income.

Visit IRS.gov and use the Interactive Tax Assistant tool to see if you are eligible to claim education credits. Visit the IRS Education Credits Web page to learn more. Also see Publication 970, Tax Benefits for Education. You can get it on IRS.gov/forms at any time.

Following Up is Like Gold

I ran over a muffler on I-385 a few months ago.  I have no idea how that muffler got there, but it was shiny and looked like a piece of rogue sheet metal….until I got right up on it and couldn’t get out of the way.  So, I managed to put a hole the size of a loaf of bread in the floor of my car.  When you run over a muffler at the rate of speed of 55 mph, that’s what happens. 23 days later, I still didn’t have the use of my car.  The insurance company blamed the body shop for losing the paper, and the body shop blamed the insurance company for not returning phone calls.

Since the incident, every time I wanted to find out what was going on at the body shop, I had to call.  Even after they promised to keep me in the loop every couple of days, I had to call.  I finally felt so much like a nuisance that I limited my calls to one per week, so as not to inconvenience Becky at the body shop.  Let’s not discuss the inconvenience of being down to one car for almost a month.

I learned something valuable. We should be following up BEFORE it crosses your mind to call us. We should be more proactive.

Silence isn’t golden. Family businesses know their business, but they don’t necessarily know everything that we know. When a client receives a tax notice from the ever-cordial IRS or SC Department of Revenue, they freak out. They bring those notices to us for resolution in a timely manner (in other words, please help me with this because I have no idea what to do next). Our job is to ease their minds and provide solutions. Easing their minds equates to regular updates as we work with IRS to resolve the issue. Our silence only frustrates the client, like the body shop’s silence frustrated me. I just want to know that my problem will soon not be a problem anymore.

The blame game never works.  Family businesses have enough on their plates, with making profit and paying their employees for great work. If I get a phone call from the client, asking for follow-up on the tax notice, and I blame IRS for not getting back to me or blame Congress for budget cutbacks which make me hold for an agent for nearly an hour, I have only frustrated my client even more. When I called the insurance agent and asked about the status, and he blamed Becky because he most certainly remembered sending her what she needed, nothing was solved. I just became angrier.

Just this once, yes, I should be able to read your mind.  If I’m as good at my job as I think I am, then I should be documenting when I called you and updated you last, and when you expect me to update you again. I should be able to read your mind, and contact you before you actually request information from me. Becky promised me that she could call me last week and update me, since the work was finally commencing and she knew I was anxiously awaiting the return of my car. But, she didn’t. When I called her, she told me that there was another hold-up with the insurance company. At this point, I just have to believe her. I wonder how many times my clients have felt that way? Well, no more. I don’t want you to JUST believe me because you have no other choice. I want you to TRUST that I have your best interest at heart, knowing that I’m doing all I can for you.

I finally did get my car back, and the repairs were complete. It didn't come without its share of curse-inducing moments, however. One thing is certain, I am sure the experience made me a better CPA for my family business clients. I might owe that shiny muffler a thank-you note.

“You Don’t Know My Business”

Many a wise statement has been made by the embattled entrepreneur.  Remember these?

“I’m convinced that about half of what separates the successful entrepreneurs from the non-successful ones is pure perseverance.” Steve Jobs

“Timing, perseverance, and ten years of trying will eventually make you look like an overnight success.” Biz Stone, co-founder of Twitter.

I have been in meetings with clients over my career, where we are discussing why their respective businesses were not flourishing as they intended, or why they’re working so hard and not making as much profit as they felt they should. Then, I am  asked for my opinion, and after voicing it I immediately know I've hit a nerve. The client’s face gets red, and these words come out of his mouth…

“Well, you don’t know my business.”

The ultimate defense mechanism, right up there with “I know you are, but what am I?” and “Your mamma!”

Are there intricacies within the four walls of your business of which I’m not aware? I’m certain there are. Have I ever stood behind your desk/counter and interacted directly with your customers? Nope. Are there universal truths in all businesses, some of which I am aware and will use to help you? AFFIRMATIVE.

In no particular order, here are three of my universal thoughts about your business:

No matter what you’re doing, it is your job to provide your marketplace with an awesome service/product and delight your client base by filling a need in their world. If this weren't true, you wouldn't be talking to me. I may be boiling down the main purpose of your business to three lines of text, but maybe you’re over thinking things. Heck, we all do it. We think our business challenges are so great that it can’t be this easy to think about. I disagree. I know that to accomplish the task, we need to be innovative, forward-thinking, customer-centric and somewhat maniacal in our approach to service.

You have the same number of hours with which to work that I do. 
I once told a former client that he needed to raise his prices to achieve better margins because he would never grow and flourish at his current pace. He replied with the quote that titles this blog, to which I replied “Are you going to somehow create more hours in your work day? OK, if you can’t do that, then you need to raise your hourly rate to make more money (he refused to entertain the idea of value pricing or bundling his services into a flat fee package). If you have indeed hit a wall, and you’re maxed out with the number of hours you can work, this is a simple fix.” I gave him other advice as well, and while he’s not a client anymore, I found out the other day from a client who contracts with his company that he changed his pricing policy and initiated other changes I recommended. His team size has doubled, his wife is much happier with her life, and he has moved to new office space nearly three times the size of his former office. We all have the same number of hours to work each day/week/year. How you price makes all the difference in the world, and there are more options out there than $xxx.xx per hour. Maybe I wasn't totally off the mark after all.

If you don’t take care of your team/employees, the talent will someday leave and you’ll be screwed. 
Taking the people who work with you for granted will hurt you. Period. Read any recent studies on employee satisfaction, and you’ll find that higher pay isn't the only way employees feel valued. I don’t think it’s even in the top 3 or 4. There are more subtle, personal, moral-building things you can do as the boss-man to make people want to work with you, sacrifice their waking hours to help you build something, and spend more time with you than they spend with their family. One of our new clients asked me to prepare her employee’s personal tax return as part of my engagement with her company, because she knew the employee would value that perk. BRILLIANT! I had never even thought of offering that to any of my other clients. I asked her nicely if I could steal it, and she agreed.

I believe that realizing these universal truths has helped us make lasting differences in our clients’ lives. I’m not a know-it-all, and I hope that I never come off sounding like one.  But I find that it helps to remember this quote about the game of baseball from “Bull Durham:”

“A good friend of mine used to say, ‘This is a very simple game. You throw the ball, you catch the ball, you hit the ball. Sometimes you win, sometimes you lose, sometimes it rains.’ Think about that for a while.”

Getting Healthy versus Staying Healthy

My wife and I started a new workout regimen. We recently decided to begin working out daily for 30 minutes. A few weeks in, and we are sticking to our goal and noticing some changes. We have more energy, we feel better, and we know in our heads that we are doing the best thing for our bodies.

My chiropractor once told me that it is much easier to stay healthy than to get healthy. Once you figure out what’s wrong with you, and you fix that problem, then you have to maintain the wellness. It’s easier on your body if you take care of yourself and stay well because you don’t experience those hills and valleys of sick, then well, sick, then well. It’s just good business, you could say.

Physical health is similar to business health. We began working with a client a few years ago, purely for tax advisory/planning and QuickBooks file review each quarter. We did our job, notified them when profits were high and we had tax planning opportunities, and carried on. 
Then one day we noticed that they were getting really busy, and the bookkeeping was beginning to suffer. They used to close each month no later than the 6^th of the following month; then one month it was the 10^th; and the next month it was the 20^th. Before we knew it, they were an entire quarter behind in updating their accounting records and tax planning was nearly impossible. 
So, we set about helping them “get healthy.” We cleaned everything up, made sure that all the activity was entered and reconciled, and then we proposed a plan to help them “stay healthy.” 
To this day, nearly two years later, we handle most of their accounting work, their payroll, the business and personal taxes, and we do everything from assist in forecasting the acquisition of a new client to the purchase of new real estate. Staying healthy (accounting-wise) is a heck of a lot easier than getting healthy.

Today, I emailed that client to let them know that I had prepared a tax projection for 2015 and we needed to get ahead of a serious liability before we moved too much further into 2015. I got the greatest thank-you email and we scheduled a time to meet. No shots, no fasting, no prodding…just staying healthy and making entrepreneurs better.

"Because I Deserve it" Isn't on Your Income Statement

I had a very interesting conversation with a small business owner the other day. We were reviewing his cash flow, and I noticed that his cash was dwindling at a quicker rate than normal, but his general overhead and payroll expenses weren't changing month-over-month. His sales were down about 25% from the year before, so the cash trend was worrisome to me. I then examined his Shareholder Dividends account, and noticed some drastic increases there. I had found my cash flow leak, and it was the owner.

So, I asked some questions, mostly because I was concerned that something personal had happened and he needed cash quickly. That’s never a good thing and I wanted to help.  

“I took that money out because I deserve it.”

What he said to me made me sit back and scratch my head.

I have to say, I've never heard anyone say that before. I’m sure people think it…heck, as business owners, we all think it sometimes. It’s just never been spoken.

“Why do you think you deserve that cash?” I asked.

“Because I took all the risk, I paid the taxes on the profit, and I’m not paying myself enough. Therefore, I deserve to take this money out,” he replied.

Well, I can’t argue with the fact that he took the risk. As entrepreneurs, that’s what we do when we start a new business. And since he is the sole shareholder, he also paid the taxes on the profit. He’s got me there. I had been on his case to raise his payroll a bit, but he hadn't done it yet because he hates paying Social Security and Medicare tax. He’ll never see a penny of that money, or so he says. But, it’s the word “deserve” that I have a problem with.

In the setting above, with less sales, less profit, and presumably less cash in the long run, did it make sense for the owner to deplete the cash because he “deserved” it? In this case, I argued that it wasn't a wise move.

I think dividends are dangerous to some S-Corporation shareholders. It looks like free money, but it’s not. I see companies get into cash flow trouble when the owner takes cash out of the company as a dividend, mostly because owners only read the Income Statement and they don’t show up there. Out of sight, out of mind. When we work with family businesses, we stress the importance of allocating profits for the future, for things like expansions or periods of time when cash is tight. In my client’s case here, cash flow could be tight before year-end if the sales trend continued, and where would he get cash to keep things moving?

I asked this question. “If you are sitting here in six months and sales are trending downward, and cash flow works out as we have projected, will you be comfortable firing 5 or 6 people to help ease your problem?”

His face drooped a little. “No, I don’t want to fire anyone. I can’t fire anyone. I’ll take less pay if I have to.”

But isn't that what you are doing now? How well is that working?

I looked at him over the rim of my glasses. “My advice is to start acting like that concerned boss today, and ease up on the dividend checks. I don’t see a “Because I Deserve It” account on your Income Statement. What I do see is “Payroll” and “Payroll Tax” line items. We can raise your pay slightly if you need more cash, but maybe we should talk about how you spend your personal money to make sure we don’t create a problem at your business in six months.”

I really hope I see progress when we meet again. When I checked up on him last week, he seemed to be upbeat since sales were up and he felt good about his personal cash position. He seemed more humble and less deserving. He and his team will reap the rewards of that change of heart.

Who’s the Problem? It’s Probably You.

I normally write my blog posts from home on Wednesdays.  But, at 10:10 am on Thursday morning after a quick meeting with my team, I realized a harsh truth.

They had a few questions regarding one of our business clients’ accounting records for last month, and they had been spinning their wheels on it since yesterday. Lo and behold, I had taken notes during my last meeting with the client, but I hadn't communicated it to them.

Crap.

How much time had they wasted due to my poor communication? I feel like dirt right now. Their time is valuable, and while I don’t track time and use it to price anything, I don’t want them wasting their time. They look at it as “I’m spending so much time on this account right now, and it’s probably costing Jonathan money.” I look at it like “I want their work time to be productive and rewarding, but experiencing uncertainty due to my lack of communication isn't helping further that.” They may not blame me for it to my face, but some of this is my fault.

I read the other day that when something happens over and over again, and it’s causing you problems at work, it more than likely isn't a people problem. It’s a process problem. Man, was that ever made clear to me today.

DIY Payroll…Go Buy Some Stamps

Did you get into business to write letters and beg for forgiveness? No, not unless you’re working the customer service desk at Comcast. You got into business to provide a valuable service/product, become profitable, and provide for your employees and your family.

Payroll is one of the most important aspects of your business. Even if you’re the only person getting paid, it’s crucial that the work be done accurately and that you make those pesky tax deposits in exactly the right manner, for the right amount, at the right time. If those tax deposits aren’t handled properly, IRS puts you on their Christmas card list and off we go!

We work with many clients who began processing their own payroll, submitting their own payroll tax deposits, and things started out fine. Then one day, they forgot to make that federal tax deposit. The notices started rolling in, and one day the certified letter came with the threat to freeze the business bank accounts and seize the amount that was due. That day, the business decided they needed help. The thing is, at that point, it’s almost too late to get help. IRS is ready to come take your children and your pets. Stuff got real.

Entrepreneurs are "do-everything" people, and consequently they seek out a payroll solution so they can continue to, you know, do everything. Just like those terrible ads that attempt to sell DIY accounting services, there are equally terrible DIY payroll ads. Payroll is promised to be "easy" and "quick." It's a hollow promise, people. Payroll, in my opinion, isn't a DIY activity. I liken payroll to dentistry and electrical repair...don't try those things at home.

I have two quick examples of why you should never do your own payroll:

Several years ago, I asked one of our long-time clients if he wanted to turn over his payroll to us. He begged off, mostly to save some money. After about three months, he sent me an IRS notice. I responded at an additional charge to him, and sent him some suggestions to keep this from happening again. Three months later, we got another notice...and six months after that, we got two more. Guess what we were asked to do? You got it...he begged us to take over the payroll, and there hasn't been a notice since then.

I had to call IRS the other day for a client. I was on hold off and on for 2.5 hours and I spoke to 9 different agents. I know how irritated I was, but imagine as a business owner if you had gone through that. Would it have ruined your entire day and caused you to be completely unproductive and miss a deadline? Could you have been doing something to make your clients happy instead of talking to Doris in Philadelphia who was ready for her lunch break and really didn’t care about your tax problems? Probably.

We never say that clients aren’t smart enough to handle their payroll. If that was all they had to do, they’d do fine. But, it’s not. It’s one very important, time-intensive, deadline-driven, mess-this-up-once-and-you’re-doomed-to-a-life-of-writing-letters-to-Doris aspect of the business. Things spiral out of control when it takes you an entire day of holding on the line with IRS to argue about a tax notice and come away with no resolution. Consider allowing a major leaguer to take on this task for you, because the minor leagues won’t cut it when it comes to payroll.

Why Do I Need You?

My first response to this question is “You may not.”  We are really big on making sure you are a good fit for our firm, because a mistake in judgment here costs you and it costs me.

If that one doesn't work, then I have a series of questions/rebuttals/comments that will hopefully answer your question. The last thing I want is for you to pay me and not gain any value from it; conversely, I am not fond of wasting my time with work that isn't valuable to you, my prospective client. See how we have the same concerns in mind?

Here are examples of replies when I begin to talk about my services and prices:

But I don’t bring in very much money. 
I get that, but I assume it is your goal to change that situation as quickly as possible. If it is, then I encourage you to consider our fees an investment in your company and use our expertise to help you make more money. We are generally the first ones to say “This isn't a good fit for our firm.” Assuming we haven’t yet told you that, we know we can help you. It’s up to you now to make that decision of spending the money to have unlimited access to our knowledge and expertise, or move on to someone else. The most important thing to consider:  If we aren't delivering value to you, then we aren't the right firm for you.

But my business isn't very big.
Here’s the thing….the size of your business has nothing to do with profitability. Of course you’re not GM. Hardly anyone actually is that large. Some of my most profitable clients are family-owned businesses, operating out of a home office. But, even if it’s just you, there are complexities and strategies with which we can help you. One of the proudest moments I had with a prospect involved my offering him to serve as his Pricing Committee for the first year of his business. I would sit down with him, review all of his contracts for new customers, and make recommendations on how he could be more profitable. He couldn't afford the monthly cost of that service in the beginning, but his eyes lit up and he said “I never would have thought of even asking you to do that with me. That’s an amazing service.”  See how creative we can be!  The most important thing to consider:  No, you aren't that big yet, but you want to be, and we can help you get there.

I just don’t think it’s that complicated/I don’t think it’s that involved.
This is where I get confused. You called me and asked for this meeting, so I assumed you thought the work was more complicated than you could handle. I have yet to meet anyone who came in, admitting that their work was extremely complicated and they absolutely had no way of knowing what to do. Most often, it’s the opposite, and they think that the QuickBooks Pro file they just handed me is Hop On Pop. You may think it’s not that complicated, but trust me, it is. The most important thing to consider: You want things done right. You may not be able to pull that off. You aren't an accountant, because if you were, you wouldn't be in my office. You owe it to yourself and your family to invest in expertise to make sure the information you rely on to make business decisions is accurate, and that you are doing everything in your power to be successful.

I just don’t know why everything has to cost so much.
It’s at this point that I realize we are not a good fit, if nothing else has thrown off the red-flag alerts before now. If you’re a start-up, I know that every single person you've talked with before me (and let’s face it, I’m usually the last person you meet with, even though everyone from your father-in-law to your banker has told you to call someone like me before now) has asked you for a retainer or your credit card number. You’re tired of spending money. Maybe you have a home office, little to no overhead, and the thought of plopping down 2-5% of your revenue to a CPA firm makes you hive up. The most important thing to consider: Here’s the deal, my friend.  You’ll realize more benefit than you’ll ever pay me.  Period. 

And this is the real world. Everything costs something. And around here, we either do it ourselves or we pay someone else to do it.  Isn't that what you want your customers to do?

Is the 1099 Life Working for You?

Meghan recently sent me an article where Elizabeth Warren was quoted as saying that the “1099 economy” is a huge problem in the US workforce. I agree that when businesses hide behind paying someone as a subcontractor when that person is really an employee, they should be made to change the classification. It’s bad for the worker, as well as fraudulent for workman’s compensation insurance issues and payroll taxes.

But what about the new “on-demand” labor force, with people who are classified as independent contractors with Uber and Airbnb? These business owners are now creating income by sharing things they already own, and becoming self-employed in the process. Does that muddy up the definition of who is an independent contractor and who isn’t?

Think of the independent contractor relationship in the simplest way possible:  Think of the home-building process. You engage a builder to build your house, and that builder calls up his favorite carpenter. He tells the carpenter that he needs the house framed by a date in the future. He doesn’t care when the carpenter works; he doesn’t supply the hammers and nails to the carpenter; and if the carpenter needs a new ladder, he has to buy it. The builder doesn’t buy it for him. The builder pays a lump sum for the project as opposed to paying the carpenter by the hour. That’s the textbook independent contractor relationship. There is no control over the hours worked, no expectation of being in an office from 9-5, and the carpenter buys a new drill if his old one breaks. If your relationship with a questionable worker doesn’t fit this description, then you could have a problem.

Going back to our example above, using the IRS definition of an independent contractor, those new business owners in the “on-demand” labor force fit the bill. They’re not employees, paying taxes as they work. That’s where independent contractors get into trouble, from our perspective. They only know that they’ve embarked on a venture for profit, and they have no idea how their taxes are calculated or what comprises “taxable income.” This information isn’t intuitive, nor is there an instruction manual. That’s why most self-employed individuals learn lessons the hard way.

We advise our clients on these questions quite often. The taxes are very important, as are the matters of complying with both federal and state law about how you compensate someone who works for you and how that compensation is reported. Clients say, “I just wanted to start a business and make a little money. This compliance sucks.”

Amen, I say. Pull up a chair.

http://www.buzzfeed.com/mathonan/elizabeth-warren-on-rise-of-the-1099-economy-a-real-problem

Are You Being Clear?

I don't like the term "full-service." I have used it to describe my firm in the past, but I don't use it anymore.  Why?

I think describing your business as "full-service" is a cop-out these days. The age in which we live now allows for specialization like never before. Being all things to all people is exhausting and not nearly as profitable as being focused on the ideal client and serving them like the expert you are.  
Being full-service used to mean "I'll pump your gas, change your oil, check your tire pressure, and clean your windshield." What happened to those guys?  
Digital, self-serve pumps happened. That little knob you push in your car that cleans your windshield happened. Quick Lube happened. Those businesses specialized and made more money being "special" to their ideal customer.

The point is this....as an entrepreneur of a successful company that's been around the block a few times, you have the ability to make a product/provide a service that is specific to your ideal client/customer and CHANGE THEIR LIVES. Do you take advantage of that power? Most don't, because saying no to someone is scary.  
And let's face it....to specialize, you have to say no to others in order to say yes to the right type of work. 

When you're starting out, you can't afford to be niche-focused because you need to eat and pay the bills. But what happens when you've been around and you've experienced success? Do you even realize when you became "successful"?  (Sometimes the creep of success manifests itself in the problems you are having, not the money you are making... but this is another conversation.)  

Full-service implies you'll work for anyone with a pulse and a checkbook. Full-service doesn't make you stand out. You now should know who your ideal clients are, and you should be able to focus on providing profitable, life-changing work for them.  

Explore the freedom of specializing, and re-learn why you started your business in the first place.



Jason Fried talks about his decision to do less in order to do more.  We really enjoyed this video.  If you have 3 1/2 minutes, you probably will to!  Check it out:

http://www.inc.com/jason-fried/inc-live-why-you-should-power-pivot-your-mission.html

No One Understands AMT

Have you ever been asked to explain any of these things?

•  The Holy Trinity
•  The Tooth Fairy
•  Why you only ever see one shoe on the side of the road, and never two?
•  How your Aunt Dottie is always drunk, no matter what time of day it is, and you never see her drink anything?

If you've ever been asked to explain the Alternative Minimum Tax (AMT) to someone, you see what I’m getting at. I would have an easier time explaining the benefits of waxing to a bear.

When a client is all of a sudden subject to the AMT for the first time, their eyebrows go up and their mouth begins to form the words “What the hell…”. I can see it coming…that incredulous tone bordering on defensive that signals I have some explaining to do and quick. As though I handed them a tax return prepared in Latin and have asked them to recite it an audience.  And I don’t blame them. AMT is difficult to understand, and difficult to explain.

So, what is the AMT?

The present AMT was enacted in 1982 (thanks, President Reagan).  Like all magical alternate universes, it wasn’t necessarily created for evil.  But, in order to understand AMT, you must visit the alternate universe much like an alien.  This universe requires you to suspend what you know about regular income taxes and calculate a different tax, an alternative tax, one where some deductions are allowed and some aren't; where you make money and pay taxes, but like the portkey in Harry Potter, a seeming ordinary and innocuous event transports you to a magical and alternate universe, where you could owe more tax. In the regular universe, there are deductions that one can take.  In the AMT universe, where Voldemort and IRS live, some of those deductions vanish.  POOF!

The two common disallowed deductions that impact our clients when assessing taxes in the land of AMT are:

•  state income taxes paid

•  miscellaneous itemized deductions.  

For regular universe income taxes, these are great deductions. In the land of AMT, they don’t exist. So, when you add those deductions back to your taxable income, along with other required calculations (remember that portkey), turn your head to the left and spit in the air, then assess the flat tax rate of 26% or 28%, if your tax under AMT is higher you must pay it. If not, then you pay your regular income tax. 

But, how did I get to the land of AMT?
Most people are under the assumption that if they make a lot of money, they will be subject to AMT. Not true. It’s funny that AMT was created to level the playing field between the higher income earners and average income earners, but it only succeeded (in my opinion) in subjecting more average income earners to a higher level of tax. As with every road that Congress paves, hell was involved, as were good intentions. So, income is only a small part of how you end up in the land of AMT. 
You don't find AMT. You don't plan a vacation to AMT. You end up there, like that bar you end up visiting at 1am. A series of situations occurred that lead to AMT. 

The AMT form instructions are 14 pages long. FOURTEEN PAGES OF IRS-SPEAK. Harry Potter is 7 books, and it is far easier to explain. This blog post wasn't intended to tell you how to avoid AMT. It's tricky, it is everywhere and nowhere at the same time. It wasn't even a good attempt at explaining AMT.
This blog post was written to increase your awareness of AMT, and also let you know that we can meet to discuss if and how AMT impacts you.

So, bring your abacus, your Latin-to-English dictionary, and a shot glass and we’ll discuss it further. Try to avoid portkeys on your way.

Is Tax Avoidance Really a Strategy?

I know…I know. Some of you are already raising your eyebrows. Let me be clear about something. I didn’t reference “tax evasion.” I referenced tax avoidance. There is a difference, and it’s not 10-25 years.

Every business owner wants to avoid taxes, but maximize profit at the same time. Sounds easy enough, right? Sure. And we will meet on my private yacht to discuss how to do this.

I recently worked with a client who was interested in selling an expensive business vehicle to a family member who was NOT involved in the business. When we met to discuss the decision, I casually mentioned that the sale was going to result in income to him. 

“But why should I have any income on the sale?  I am planning to pretty much give this truck to him.” (Client, annoyed)

“I think that’s honorable, but you can’t do that.  You can’t just sell this truck that would appraise for $25k to your family member for $10 and avoid the gain.  You’ll record the sale at FMV.  And remember when we fully depreciated the truck a few years ago to avoid taxes?  Yeah, all of that depreciation comes back and guess what?  It’s not capital gain.  It’s ordinary income.”

“But I still owe $20k on the loan.  I won’t have any money after I pay those taxes and the loan balance.” (Client, more annoyed)

“That is absolutely correct.” (Me, hesitant)

“I want my money back.”

He didn’t actually say that last line, but I know he was thinking it.  

The fact is that most clients looked at the accelerated depreciation rules we had in place over the last 13 years as license to buy assets, finance them to the hilt, avoid taxes, and disregard the tax implications of selling them. It’s a pretty good gig, until you realize the idea only works until you sell the assets.

It’s hard to advise a client to pay some tax to avoid more pain later, but I think we are not doing our job if we don’t at least raise the issue. The fact is that while you can certainly avoid taxes in a perfectly legal manner by rapidly depreciating qualifying asset purchases, that decision comes home to roost when you consider selling them. We take for granted that clients can see the future as well as we can, and while we work for some of the smartest clients around, it’s our job to analyze the transaction as it stands now and as it may stand later. As an IRS agent told me the other day, these difficult conversations are why we get paid the big bucks.

Raise your hands if you think your tax rates will be less in 5 years than they are right now. Exactly as I thought…there’s only one of you.  So, those generous depreciation rules we had in place from 2000-2014 were just that. They were generous, for a time. Yes, we used the rules to reduce taxes in the short-term, only to potentially expose the client to a gain they didn't expect on the back-end. Legal tax-avoidance at its best, but swallowing the tax on the gain when those assets are sold is a difficult task.

Don’t let depreciation cause you heartburn. The most powerful antacid can’t cut that pain.