The Mustard Bomb

My dad and mom owned a family business of one type or another for most of my at-home life.  My dad painted houses with my uncle and with my grandfather, and then he and my mom owned a hardware store together. The biggest success they had, however, was with the general store they ran together for 22 years. I began working in that store when I was 11, and I worked there with varying levels of frequency until I graduated Clemson in 1994.

My dad is what I like to call a quiet teacher. In other words, he won’t speak his lessons….he lives them, so you learn by watching. I love that about him. The man has little to no temper to speak of.  My mom, on the other hand, has a fiery temper. I inherited a pleasant mix of both, and when I was younger, I let my temper get the best of me with a customer in their store.

We sold the best hot dogs in town. It was my dad’s chili recipe that sold them, and people ordered them all day, every day.  The first order usually went out at about 6am and we didn’t stop until the machine was broken down and cleaned at 8pm each night. This particular day, a lady came in and ordered a hot dog from me. I didn’t want to be there….I was probably 13 or 14 at the time. I was half-listening, and so I didn’t make it the way she said she requested it.  She wasn’t very tactful in the way she voiced her displeasure and it embarrassed me in front of my mom. So, what did I do? I took the hot dog from her, and threw it into the wastebasket by the register, splashing chili and whatever else was on there into the air, and made a scene. Under my breath, I called her a not-repeatable name, and went back to make her another hot dog.

She explicitly asked for “no mustard.” Being the jerk that I was that day, I decided to give her "no mustard". I found a hot dog bun with an air pocket in it. Then I filled that pocket with mustard. I nicely wrapped up the hot dog and sent her on her way. I smiled at the thought of her biting into it and how suprised she would be to find a big ole' mustard bomb.

I know for sure that somewhere down the line, my dad heard about this incident. He never mentioned it to me, but I just know he knew about it. But, what did my dad do? He kept showing me how to provide good customer service. By the way he talked to his customers, who sometimes yelled at him or acted foolishly. By the way he smiled and wished every single person a nice day even if they hadn’t ever spoken a kind word to him. By the way he extended credit to people knowing he’d never get paid. He wasn’t a push-over. He just couldn’t call himself a good man if he didn’t allow them to purchase diapers for a newborn baby. I guess those uncollected receivables made up his pro-bono portfolio in the end. But his customers were loyal, and they trusted him to do right by them.  And he did, every single time.

Family businesses have this dynasty-feel to them. We feel like we are building something to leave to our children, or maybe even to our grandchildren. But a dynasty is more than a building or a sizable inheritance. I learned how to reason with an angry customer who knows beyond the shadow of a doubt that he's right; I watched my dad agonize over pricing his inventory when he knew that the local farmers' crops didn't come in as they'd hoped; I saw my dad sweep up the dirt around the gasoline pumps so that the asphalt was as clean as possible; all of those experiences taught me that owning a business is often difficult, trying and not very glamorous.  My dad’s store eventually closed when he and my mom sold it, but he had left me a dynasty. He had shown me everything he did to run a successful business. He empowered me to do exactly the same thing.

The family business is a powerful example.

"Tax Season Sucks." There... I Said It.

• Renewing your driver's license
• Leaving that little tag on your mattress
• Clicking on the "Agree" button to the Terms of Agreement of Your Bilateral Contract and Trade Agreement with iTunes each time you purchase something online
• Re-writing your health insurance information on every single field trip request that your school sends out

All of these are things that you have to do in order to be allowed to take advantage of certain opportunities in your life on a day-to-day basis. Most of the time these are things you have to do in order to do something else. (Well, maybe not that mattress thing.)   But, what do the other three have in common?

There was a law written in a galaxy far, far away that requires you to comply in order to participate in the activity in question.  In order to drive without harassment, you must have a valid driver's license.  In order to purchase Candy Crush, you have to agree with Apple's terms (which no one, including Apple, has ever read).  In order to send your child to the Peace Center to see dinosaurs dance, you must let the school know that you have insurance and that your child isn't allergic to various carpet fibers in auditoriums.  There's no way around it.  You have to do it.  If you don't there is no driving, no Candy Crush and no dancing dinosaurs.

Do these compliance requirements enrich your life?  Nope.

I'm about to blow your mind.  The same goes for tax returns.

Say what?

Tax returns do nothing to enrich your life, or mine.  That is a pretty bold statement coming from the guy who pays for dancing dinosaurs and Candy Crush with fees paid (in part) from preparing tax returns.

Tax Returns simply keep you from being harassed by the IRS or your state's department of revenue.  They have to be completed, filed a certain way, signed in a certain place, mailed to a certain destination, and then acknowledged by the agency in question. Then, if you do anything wrong, go buy some paper and lots of toner....you'll be writing letters for quite a while. 
This, my friends, sucks the life out of more entrepreneurs than you will ever know. 

We, as entrepreneurs, like to think of ourselves as a brave bunch.  After all we did start a business.  That's a risky proposition and we should be commended for doing so.  But how many times do you, as a business owner, find yourself doing something you don't enjoy....just because it has to get done?  

Why are you doing that?

 Because you've always done it.  Because businesses "like ours" do this kind of work.  Because we don't like change and neither do our clients.  

It's time to stand up and say, "I'm done."

You started your business to not only make money and fill the needs of your clients, but didn't you also want to enjoy it?  I bet if you looked at your To-Do List right now, you'd find things on there that have been sitting for weeks.... because you hate doing them. But, they remain on that to-do list because they have to get done.  When will they get done? At the last possible minute, because you hate them.
And that is going to throw a wrench into the OTHER things that are more profitable and more enjoyable....that your clients REALLY value.  

So what's stopping you from saying "NO" to the drudge work and focusing on the more profitable, satisfying, "I could do this all day" type of work?  Could it be....

• Fear of losing business
• Fear of losing revenue
• Fear of paying out more
• "It is just faster if I do it myself, because I am the only one who knows how to do it."
• "I don't know how I would teach this to someone else."
• "I don't trust someone else enough to hand this over."
• A desire to please everyone
• A desire to be "full-service"

It's a little bit of all those things, isn't it?  Would you give that same advice to your child, if they wanted to start a lemonade stand?  Would you say "Now, son, you can start this business, but you won't have any control over the work you do. I know you like lemonade, but some people prefer tea or mango smoothies. You will have to bend and cow tow to the whims of your market.  You will have to file all your incorporation documents on your own.  And don't forget you sales tax.    You'll just have to bite the bullet and do it.  That's how it is, its not going to be about the lemonade."  

Who in their right mind would start a business if that was the case?

Now, let's take this argument one step further.  What if you could outsource your very own business processes to someone else and focus on the engagements that are more profitable and more enjoyable....those engagements that your clients love so much that they say "It's a joy to write this check to your company each month"....how would you feel?

This arena, my loyal readers, is where Godwin & Associates, CPA exists to consult and advise these days.  We have taken entrepreneurs who were stuck, and helped them move past a point of frustration into one of profitability and ultimate enjoyment with their businesses again.  It's the most gratifying work we have ever done.  If you want to take your business to the next level, have a conversation with us and find out if you can move beyond the heavy sighs and lengthy To-Do Lists.  Rip that mattress tag off and say "Enough.  I deserve more than this."

Create a Personal Cash Flow Statement

As the focus on the previous tax year ends, this can be an excellent time to review your financial circumstances. You can look back at 2014 and see how much money came in and where it went during the year without adjusting for seasonal variations. The knowledge you’ll obtain by creating a personal cash flow statement can help you make realistic financial plans for 2015. (If you’re married or cohabiting, you can use this technique to create a household financial statement.)

Tabulating income

Begin the process by adding up all the spendable cash that came in during 2014. Typically, that information can be found in the monthly statements from your checking account or accounts. If you haven’t kept all the monthly statements, or if you don’t feel like juggling all the papers, you probably can retrieve all of last year’s statements online from your bank’s website.

            
If you are an employee, you probably have your paychecks (after various deductions) deposited directly into such an account; if you are retired, your Social Security checks (after Medicare deductions) go there, along with any pension you’re receiving. Self-employment income and investment income paid by checks also will show up as deposits, as well as transfers from investment or savings accounts.

           
 Generally, only cash income (payments in currency) won’t show up in a statement from a bank or investment account. If you do receive meaningful amounts of cash regularly, you should have some idea of the total. In fact, you’ll need records in case the IRS questions how much cash you've received from working during the year.

            
Once you've calculated all the income you've received, make any necessary adjustments. Subtract inflows not likely to occur again in 2015, such as exceptional gifts, bequests, asset sales, and so on. Altogether, you’ll have an idea of how much cash flow you can expect in 2015, raising or lowering the number to keep up with current circumstances, such as a higher salary this year.

Tracking your outlays

Your checking account statements also will show how much you've spent during the year: checks you wrote, bills you paid automatically, personal checks that you cashed for spending money. Be sure to include your debit card or ATM withdrawals in the money you spent during 2014, even if they are linked to an account other than your regular checking account.

            
To complete the picture of what you spent during the year, request annual statements from your credit card companies. If your credit card bills are not on auto-pay and you've paid less than the total balance, you may have increased your outstanding debt during the year. Credit cards usually charge double digit interest rates, and the interest you pay is not tax deductible, so paying down any balances (or converting to deductible home equity debt) probably should be a top financial priority for the year.

Focus on the future

Once you have calculated your cash flow from last year and the amount you spent, you can make certain plans for 2015.

            
Example 1: 
Steve and Sue Smith had $150,000 of cash flow last year and $130,000 of expenses. The Smiths contributed a total of $2,000 a month to their 401(k) plans in 2014, or $24,000 in all. Going over their cash flow, the Smiths see they’ll be able to increase their retirement savings by $20,000 in 2015 without crimping their lifestyle. They plan to boost their 401(k) salary deferrals this year.

            
On the other hand, this procedure can be valuable to show you that a cutback is necessary, and where to trim.

           
Example 2: 
Jim and Joan Jackson also had $150,000 of cash flow but they spent $170,000 last year, in addition to adding to their credit card balances. Going over their cancelled checks and their annual credit card summaries, the Jacksons were surprised to learn how much they spent on dining out and online merchandise purchases. They decide to rein in all their outlays, especially in those areas, and pay down their credit card balances.

            
Creating a personal or household cash flow statement can give you a greater grasp of your finances. In addition, this exercise is an excellent way to begin gathering the data you need to prepare for your 2015 tax return. :)

Self-Employment Tax….Merely FICA in Disguise?

I remember an episode of a popular sitcom from years ago, where someone looking at a paystub asked the question “Who is FICA, and why is he getting all my money?”  That line still makes me laugh.  For profitable, self-employed entrepreneurs, it’s not FICA who gets all the money, but IRS, in the form of self-employment tax.  It’s yet another tax imposition that many businessmen and women don’t completely understand.

 

Let’s do some math:

• When you work for an employer, your gross wages are subjected to a few different taxes.  There’s federal tax, state tax, and then there is Social Security tax and Medicare tax.  
• Social Security and Medicare tax form a duo, known as FICA tax, and they take 7.65% of your gross pay each time you receive a paycheck.
• Your employer, generous person that she is, has to then match your FICA tax with an expenditure of her own, resulting in a second 7.65% paid to the government.
• If you add those two percentages together, they come to 15.3%.  Guess what percentage self-employment tax you pay on the profit from your business venture?  You got it…15.3%.  IRS decided years ago that if you chose to leave your job and start a new business venture, and you operated as a sole proprietorship (and in some cases, a partnership), you would be responsible for both parts of the FICA duo and the employer match.  That was nice of them, huh? 
• And did I mention that this is completely separate from the income tax you have to pay on the profit?  Your profit is assessed tax on three different levels…federal, self-employment and state.

Now, it’s not all gloom and doom.  You are allowed to take an income adjustment for ½ of the self-employment tax that you are assessed on your tax return.  But still, 15.3% is quite a chunk.  That’s why I tell my clients that tax deductions for the self-employed are like gold.  You need to make sure you don’t overlook any of those allowable deductions, because the tax imposed on the profit is steep. 

Case in point:

Assume you’re in the 25% tax bracket for federal purposes and 6% tax bracket for state.  If your effective tax rate on the federal return is around 18%, you will pay 39.3% tax on the profit from your business (15.3% self-employment tax, 18% federal tax, and 6% state tax).  WHOA!  That’s crazy!

In my experience, new clients who have attempted to prepare their own taxes through a period of self-employment do not deduct too much.  They tend to be conservative and not deduct enough.  IRS is pretty generous with small business tax deductions, so make sure you take advantage of them.  You’ll never get a letter from IRS, telling you that you missed one.

Employer Retirement Plans with Income Annuities

In the private sector, employers have been moving away from traditional pensions, known as defined benefit plans. These plans, funded by employer contributions, often pay long-time employees (and usually those employees’ spouses) lifelong regular cash flow.

Instead, many companies now provide defined contribution plans, such as 401(k)s, which are funded largely by workers’ salary deferrals. The actual retirement benefit will vary, depending on how the chosen investments perform.

National security

Last year, the Treasury Department and the IRS took steps to encourage the use of substitute traditional pensions by retirees. Deferred income annuities (DIAs), which are mainly held in IRAs, were given favorable tax treatment, if certain requirements are met. Later in 2014, the Treasury and IRS issued Notice 2014-66, which made it more likely that target date funds, mainly held in 401(k) plans, will purchase DIAs, which can offer pension-like cash flow to retirees.

Setting the date

Target date funds offer a predetermined asset allocation that gradually becomes less aggressive and more conservative, as its target date approaches.

Example 1: 
Fawn Grant, age 50, plans to retire in her mid-60s. She invests her 401(k) contribution in a 2030 target date fund. Now, that fund has a balanced mix of equities, for appreciation potential, and fixed income, for stability and cash flow.

            

As this fund approaches its 2030 target date, its asset mix will shift to fewer equities and more fixed income. Many plan participants like the idea of having professional investment strategists automatically make these asset allocation decisions.

Enter deferred annuities

Notice 2014-66 clarifies that target date funds in employer sponsored retirement plans can hold DIAs. A DIA is purchased today; the resulting income stream will not begin until years later. The longer the time between the investment and the start of annuity payments, the greater the amount of periodic cash flow an annuitant will receive.

Example 2: 
Hugh Jordan purchases a DIA at age 55. If Hugh defers lifelong income payments until age 65, he will get more monthly income than he would get by starting immediately. Hugh will get even larger annuity payments by waiting until age 70, or age 75.

The recent federal notice explains that target date funds offered through employer plans will be able to include DIAs among their fixed-income holdings for participants who are nearing retirement age. If those DIAs meet certain criteria, some technical issues won’t arise.

Similarly, target date funds are considered qualified default investment alternatives (QDIAs), which helps to explain their popularity in 401(k) plans. Employers who make the proper explanation can use QDIAs for the contributions of employees who neglect to make investment choices, while the employers generally avoid liability for any investment losses.

How 401(k) pensions might work

Here is an example of how DIAs could provide lifetime income from a target date fund offered by an employer-sponsored retirement plan. Such funds might be limited to participants of similar ages. A 2033 target date fund, for instance, might be available only to employees born in 1967, 1968, or 1969. In 2033, those employees will be 66, 65, or 64.

Beginning in 2023, when the fund participants are 56, 55, or 54, the target date fund can begin to purchase DIAs as part of its fixed income allocation. For the next 10 years, the fund will purchase more and more DIAs, increasing the allocation to such annuities. In 2033, the fund’s target date, the fund will dissolve.

At this point, the participants will learn what their DIA options are. They can start to receive lifetime income right away, or they can wait until a later time to start, in order to increase the annuity payments. Other assets of the now-dissolved target date fund, besides the DIAs, can be reinvested elsewhere in the company retirement plan.

The federal notice provides one example, so not all target date funds holding DIAs inside company plans will look exactly like that. However they’re structured, the idea is to provide employees with predictable cash flow after retirement through income annuities.

Withdrawal Rules

·         It’s possible for target date funds in defined contribution plans to hold deferred income annuities and satisfy nondiscrimination requirements.

·         Among other conditions, the deferred annuities cannot provide a guaranteed lifetime withdrawal benefit (GLWB) or a guaranteed minimum withdrawal benefit (GMWB).

·         With a GLWB, the participant is guaranteed to receive a specified lifetime stream of income, regardless of the investment performance of the account, while still retaining access to the funds in the account.

·         A GMWB is similar to a GLWB, but a stream of income is guaranteed for a specified period rather than for the lifetime of the contract owner or annuitant.

·         The Treasury Dept. and the IRS are considering whether to provide guidance relating to GLWB and GMWB features in defined contribution plans.     

Renting Vs. Buying a Home

Should you buy or rent your home? This decision can include financial as well as nonfinancial factors. Even if the nonfinancial aspects are extremely important, you should not overlook the financial side.

Crucial ratio

One key to choosing between buying or renting is to determine the annual rent-to-purchase price ratio in the housing market you’re considering. The higher this ratio, the greater the advantage of buying a home.

            

Example 1: Art Smith is considering buying a home that is priced at $200,000. He can rent a comparable home in the same neighborhood for $800 a month, which is $9,600 a year. The rent-to-purchase ratio is $9,600 to $200,000, or 4.8%.

            

Example 2: In a different area of the U.S., Beth Jones also is eyeing a $200,000 home. A comparable home would rent for $1,200 a month. Thus, the rent-to-price ratio for Beth is $14,400 to $200,000, or 7.2% a month.

            

A recent study from Morningstar’s HelloWallet unit indicates that renting might be a better choice when the rent-to-price ratio is below 5%, while buying may be preferable if that ratio is over 7%. That is, the more you’ll have to pay to rent a desirable home, relative to home prices, the greater the chance that the numbers will favor a purchase. 

Assuming the rent-to-purchase price ratio is favorable, young taxpayers with relatively low early career incomes might do well to rent rather than buy a home. The same may be true for relocating retirees who have modest incomes after they stop working.

Conversely, high-income taxpayers might enjoy considerable tax savings from home ownership, assuming they are comfortable with the purchase price. Today’s low interest rates make financing a home purchase appealing, and the leverage can add to any profits from home price appreciation.

Thinking about taxes

Homeowners may enjoy multiple tax benefits that are not available to renters. Mortgage interest and property tax payments generally are tax-deductible. Moreover, profits on a sale of a home often enjoy an exemption from capital gains tax. Assuming the home was owned and occupied at least two of the preceding five years, up to $250,000 of gains are untaxed ($500,000 for married couples filing a joint tax return).

Of course, there is no way for a home buyer to know if a home eventually will be sold at a profit. What’s more, the deductions for mortgage interest may not generate any actual tax savings. That’s because those savings are available only to taxpayers who itemize deductions. Homeowners who take the standard deduction get no tax benefit from their mortgage interest or property tax deductions.

            

Example 3: Craig and Diane Emerson bought a house for $200,000, taking out a $160,000 mortgage. At a 4% mortgage rate, their interest payments this year are $6,400 (4% of $160,000). The Emersons also pay $4,000 in state and local taxes and make $2,000 in charitable donations, for a total of $12,400 in possible itemized deductions.

            

In 2015, the standard deduction is $6,300 for single filers and $12,600 for married couples filing jointly. (Taxpayers who are blind or at least age 65 have higher standard deductions.) Thus, the Emersons will choose the standard deduction and get no tax benefit from paying mortgage interest or property taxes.

Tax bracket truths

Now, what happens if the Emersons had $14,200 in itemized deductions instead of $12,400? If so, they would itemize and deduct their mortgage interest and property tax payments. In this scenario, $14,200 of itemized deductions is $1,600 greater than the standard deduction for couples, so the Emersons’ net tax deduction from home ownership would be $1,600. Assuming an effective marginal income tax rate of 20%, that $1,600 in net deductions would save them $320 in tax this year.

            

Example 4: Assume the same financial information as in example 3, but assume the Emersons have a higher income and, thus, have an effective marginal tax rate of 40%. Then that same $1,600 in net tax deductions from home ownership would save the Emersons $640 in tax. With a higher income, owning a home saves more tax.

           

             

Other issues

The decision about whether to rent or buy a home involves more than the purchase price, rental rates, and tax savings. Buying a house means saving up a great deal of cash for a down payment and putting that cash into an illiquid asset. Renting may leave you with more easily accessible cash, but will that cash be invested wisely or spent imprudently? It’s also important to decide if the responsibility of home ownership is for you.

           

Nevertheless, financial concerns are vital to residential decisions.

When Workers Are Independent Contractors

As business owners know all too well, hiring an employee costs more than just paying a salary. 

Employers generally provide benefits to employees, which can be expensive. Moreover, employers must pay a share of Medicare, Social Security, and state unemployment taxes.

            

None of the above applies when your company hires an independent contractor—a publicist to get your company’s name in the news, for example, or a freelance website designer. You pay these people the agreed-upon amount and let them worry about funding their retirement or handling payroll tax. If that’s the case, why not just use a group of independent contractors to work for your company and do with few or even no employees?

Defining the difference

The answer is that the IRS is well aware of the advantages of using contractors. Therefore, the IRS has established rules governing how independent contractors are classified, as opposed to employees. Drilling down, the major difference is a matter of control.

            

Hiring an independent contractor to do a specific task is fine. You tell the contractor what you want done, and you pay for results. However, if you tell the worker how and when and where the work is to be done, you risk having that worker re-cast as an employee by the IRS.

           

In some cases, common sense will apply. If that freelancer works on your website while doing other paying jobs for other companies, chances are the IRS will go along with independent contractor classification. On the other hand, if you have a person who works from home as a freelancer but works only on your website, does it more or less full time, and takes direction from your IT people, you may have a difficult time treating him or her as a contractor.

If you have been misclassifying employees as contractors, the penalties can be steep. Our office can discuss your workers with you, letting you know how to proceed in order to legitimately treat them as independent contractors.