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Posts by Marcus Mire

S Corporation Losses May NOT Be Deductible

Have you ever heard of the term “basis” as it relates to S Corporation stock ownership?  If you’re not familiar with the term, you should be, especially as it relates to potentially deducting your share of losses allocated to you by an S Corporation.

Let me give you a common scenario when a new business is formed, and an S Corporation election is made:

  1. New business started up 1/1/17
  2. Business borrows $100,000 from the bank to buy equipment, furniture, etc.
  3. Owners do NOT contribute money personally to the business
  4. Business shows $50,000 loss (on paper) due to accelerated depreciation (write offs)

How much of the $50,000 loss described above can the shareholders deduct?  Answer… ZERO!!

Why?  S Corporation losses are limited to your BASIS.  There’s that word again.  What is basis?  Basis is the cumulative amount of income (or losses) less distributions plus capital contributed.

In the example above, the shareholders borrowed money from the bank (i.e. didn’t contribute personally) and proceeded to lose $50,000 for the year.  Their basis at the end of the year is ZERO and NONE of the losses are allowed.  Essentially, based on tax law, the government is saying that YOU (Mr. Shareholder) haven’t lost anything.  You borrowed the money.

Let’s change the scenario a bit and say that the shareholders contributed $100,000 instead of borrowing the $100,000.  The $100,000 of capital contributed gives the shareholders BASIS.  Now the losses become deductible because the shareholders have, in effect, lost something.  They’ve depleted (by way of losing money) their capital so to speak.

The moral of the story is this:  Be careful when you borrow money in an S Corporation especially in the start-up years.  You may be banking on tax losses that aren’t available to you.

A better way to organize your business (from the start-up phase) might be as an LLC that is taxed as a partnership.  Partnerships can deduct losses (related to borrowed money) because partnership basis (as opposed to S Corporation basis) IS increased by debt if the partners personally guarantee the debt.  The losses described above would have been deductible in a partnership assuming the partners guaranteed the $100,000 debt.

Above said, this is the reason you should consult with a tax adviser BEFORE organizing your business.  I’d love to help you avoid this trap!

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Why you need timely, accurate accounting.

Having timely, accurate accounting information is essential to running a healthy business.  As I progress through my business career and interact with lots of “business” people, I’m noticing a scary trend.  Many business owners do not see the need to have timely, accurate accounting done by someone in house (controller) or an outsourced CPA firm.  This worries me.  Let me tell you why…

1.      You will have difficulty selling your business.

Think a successful business or business owner will take your word on how well the business is performing?  Think a couple of spreadsheets will do the trick?  The answer is a resounding NO!  I’ve personally seen a business owner try to sell his business to a potential suitor only to be turned down and ultimately questioned due to a lack of timely financial statements.  Deficiencies in this area lead successful people to question just how serious you are about your business.  It tells them that you don’t value data and make sound business decisions according to that data.  Essentially, you’re flying by the seat of your pants or running the business off feel or emotion.  Numbers are black and white and tell the picture.

2.      You won’t proactively plan for taxes throughout the year.

Wouldn’t it be nice to have a projection of your Federal and State tax liabilities, at least, quarterly?  Imagine taking large sums of your money out of your business only to realize later that most of that money should have been used to pay tax liabilities.  Having taxes estimated on a regular basis allows you to set aside tax funds, operate your business, and take personal distributions with the remainder without regret.

3.      Growing the business will be hard.

A lack of financial records will make it difficult to expand, open a new location, or build a talented team.  Similarly, getting financing will be extremely difficult.  How will you prove to any lender that your company is strong financially and able to pay the debt back timely?  Employees will also recognize your lack of financial reporting when it comes time to account for out of pocket expenses.  Would you work for a company that is cavalier about employee reimbursements?  Without accurate, timely financial reporting, growing your small business will be hard.

These are just a few of the many reasons to get serious about having timely, accurate accounting for your business.  This data is invaluable in making proactive financial decisions.

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Early withdrawals from a 401(k) can be costly

If you’re considering taking a 401(k) withdrawal before you’ve reached 59 ½ years old, I would think twice.  In most cases (excluding those where you’ve left your employer in/after the year you turned 55), taking a 401(K) withdrawal before you reach 59 ½ will cost you.

Let’s walk through a simple example:

Sample Facts:

  • 40 year old taxpayer
  • $100,000 401(k) balance that is being entirely distributed
  • Distribution does not meet one of the IRS exclusions for escaping the 10% early withdrawal penalty.
  • Taxpayer’s marginal Federal tax bracket is 25%
    • For this example we’ll exclude state income tax

 

401(k) distribution taxable income                         $100,000

Less:  Fed income tax on distribution (25%)        ($25,000)

Less:  Early Withdrawal Penalty (10%)                    ($10,000)

 

Net after tax                                                                         $65,000

Now, let’s stop and think for a second.  A $100,000 distribution costs the taxpayer $35,000.  Another way to put it is to say the taxpayer paid a 35% interest rate (obviously much more if you annualized the rate).  I bring up the interest concept because an alternative to a complete distribution of your 401(k) is borrowing from (taking a loan against) your 401(k) account.   A second option would be tapping into the equity in your home or other assets you could borrow against.  I really would use the complete distribution of a 401(k) (assuming early withdrawal) as a last resort.

The tax code does allow taxpayers to take early withdrawals from a 401(k) that are NOT subject to the 10% penalty (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions).  These distributions are still taxable for income tax purposes.  Given the example above, you’d still be paying 25%.

Here’s another thought, numbers aside.  Many people go through the process of distribution funds (early) from a 401(k), consulting with their 401(k) custodian, and withholding Federal income tax from the distribution and still end up with a tax bill.  Why?  Because they underestimate the tax burden (early withdrawal penalty) and/or the distribution puts them in a higher tax bracket because of the additional income.  Maybe the top tax bracket they normally reach is 25%, but this additional income puts them in the 28% or 33% bracket?  You can see how this can cause an unanticipated tax burden.

Again, there may be financial situations that simply demand you take an early withdrawal from your 401(k), but I would strongly suggest that you educate yourself on the potential costs so you are not surprised when you file your tax returns.

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Donating Appreciated Property for Tax Savings

Clients are always asking me for tax saving measures to take before the end of the year.  While most suggestions involve spending money to get a dollar for dollar deduction (cash donations to charity, increased retirement plan contributions, etc.), the Internal Revenue Code offers a creative planning opportunity.

If you own appreciated property (stock in this example), you can get a deduction for the value of this property if you donate it to a qualified charity.

Let’s look at a simple example:

  • 1,000 shares of XYZ Company stock purchased for $10/share in 1990 (total cost = $10,000)
  • Assume shares of XYZ Company stock are currently selling for $100/share (total value = $100,000)
  • If we stop right here we can see that the taxpayer has an unrealized long-term capital gain of $90,000. Assuming the taxpayer is not in the highest marginal income tax bracket, selling the stock would result in a $13,500 ($90,000 x 15%) tax hit.
  • Instead, let’s assume the taxpayer donated the stock to the LSU Foundation. Let’s also assume the taxpayer’s marginal tax bracket is 33%.
    • The taxpayer would receive a $100,000 charitable donation deduction which would save $33,000 in Federal tax ($100,000 x 33%)
    • Effectively the taxpayer has converted a $10,000 investment into $33,000 of Federal tax savings. Did I mention that $0.00 gain is recognized on this transaction?  Not only do you get a deduction for the fair market value of the property, but the unrealized gain is not recognized.  It simply goes away.

The example above is meant to be a simple one (i.e. does not consider phase out of itemized deductions or the 30% AGI limitation used when donating appreciating stock) but the point is clear.  Donating appreciated stock (assuming the taxpayer’s alternative is donating cash/check) is a great way to save income tax without depleting cash.

 

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Louisiana Technology Donations can be Big Tax Savings

Most taxpayers are aware of the benefits of making charitable donations.  It’s pretty simple in most cases.  You give to a charity and you get a charitable donation deduction that saves Federal income tax at your marginal tax rate.

For example:  If you donate $10,000 and you’re in the 28% tax bracket, you save $2,800 of Federal tax.  Pretty simple right?

The state of Louisiana offers a type of donation that works like the example I described above, but also offers substantial Louisiana income tax savings.  This deduction applies to donations (of a technological nature) made to educational institutions.  What’s really cool is that Louisiana gives you a 29% credit (to the extent you have Louisiana income tax) that reduces your Louisiana income tax dollar for dollar.  This credit combined with the Federal tax savings from the charitable deduction can be huge.

Let’s take a look at an example:

  • $10,000 donated to a local high school toward the purchase of new servers
  • Taxpayer ‘s marginal Federal tax rate is 33%
Federal tax savings                          $3,300 ($10,000 x 33%)
Louisiana tax savings                      $2,900 ($10,000 x 29%)
Total tax savings                               $6,200 ***

***Simple example above ignores the small Louisiana benefit from the charitable contribution deduction.

The total tax savings of $6,200 provides tax savings at a 62% clip.  That’s huge!  I can’t think of many other situations where making a tax move saves 62%.

To make the donation you should contact an educational institution (school)  and inquire of their technology needs.  Given the popularity of this tax saving donation, many schools begin developing a “wish list” of technology items as year end approaches.  Simply making a cash donation toward the purchase of technology will suffice.  I’ve seen schools list “partial payment…” as the description of the items donated on Form R-3400 (more on form below).

Once the donation is made, the school is required to provide Form R-3400 “Certification of Donation or Contribution of Property of a Sophisticated and Technological Nature.”  This form, along with copies of the invoices of the items donated (if not cash) or items that will be/have been purchased with your donation (cash) should be attached to your timely filed Louisiana individual income tax return to substantiate the donation and ultimate credit received.

If you’re charitably inclined, a Louisiana resident,  and looking to reap big tax savings before year end, you should definitely be considering making technology donations to a local school. Contact Us. 

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Cash Receipts and Disbursements Not the Best Way to Determine Profitability

Speaking with entrepreneurs recently (especially those w/businesses that buy/sell inventory) I’ve noticed a lack of understanding of the difference between cash flow and net income, profitability.

Let me give you an example:

  • Business selling inventory
  • Start business by purchasing 10,000 units at $1/unit; total purchase = $10,000
  • Sell 1,000 of those units for $5/unit; total sales = $5,000

Let’s stop here for a second.  At this point, many of you might come to the conclusion that you haven’t made any money (profits).  After all, cash spent ($10,000) exceeds cash received ($5,000 sales) and so your net cash flow is negative $5,000.   This view of the facts doesn’t tell the whole story.

Let’s view the facts using simple accounting:

  • Sales                                                  $5,000
  • Less: Cost of Goods Sold           ($1,000)
  • Equals: Gross Profit                     $4,000

Some of you may be thinking how can I have gross profit when I’ve spent more than I’ve collected in sales?  Good question!  The reason is that you’ve sold each of the 1,000 units for more than you paid for them individually.  The remaining $9,000 ($10,000 initial purchase less $1,000 cost of good sold) of inventory remains on your Balance Sheet as an asset.  It is not “expensed” on your Profit and Loss Statement until the units are actually sold.

Assuming the inventory doesn’t expire/spoil (think produce or other food type products) then your $9,000 of inventory will remain at that value on your Balance Sheet and will be “costed” to the Profit and Loss Statement at $1/unit.

My point is this.  Having the proper understanding of accounting for sales, inventory and cost of goods sold would lead you to better decision making.  Let’s say these items are flying off the shelves quickly and you’re profiting $4/unit ($5 sales price less $1 per unit cost), you definitely would consider buying more inventory even BEFORE you’d recouped your initial $10,000 investment.  Waiting until you recouped your initial $10,000 investment would cause you to miss profitable sales in the interim.

Above said, any credible accounting software that has an inventory function should be able to handle the accounting properly.  I recommend Xero or QuickBooks (desktop version) to handle inventory and consult on either software.

I hope this simple example will help you gain an understanding the differences between cash flow and profitability.  I’d love to help clarify the accounting to be used for sales, inventory, and costs of good sold.

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Cloud-based Accounting Tools for Your Business

We’ve been working hard researching and implementing cloud-based accounting and financial tools to help our clients organize their data and cut down on data entry while increasing accuracy.  From an accounting perspective, our focus has centered on Xero (www.xero.com) and all of the ways Xero can help run your business more efficiently.  The beauty of Xero is its seamless integration with many other cloud-based accounting and financial solutions.  At PRM we’re using these solutions for accounts receivable, accounts payable, collections, vendor payments, and document retention all while cutting down on data entry time, streamlining our digital processes, and increasing efficiency and accuracy.  All of the solutions we’ve adopted can be accessed in the cloud via web browser, phone, or tablet.  These solutions really do make it easy to run your business wherever you are.

Bill.com (www.bill.com)

Bill.com is a great tool for digitally managing accounts receivable, accounts payable, collections, and vendor payments

  • Simply fax, scan or email your bills to bill.com. No more opening mail, handwriting approvals and G/L coding directly on the bill.  com’s automated system handles everything from approval to coding once the bill is received.
  • The entire A/P approval and payment process can be managed digitally. Paying vendors is also a breeze using bill.com’s ACH or “ePayments.”
  • Easily syncs w/Xero and QuickBooks further reducing data entry. Payments received and payments made using bill.com flow into your accounting software updating A/P and A/R seamlessly.

What bill.com customers are saying…

https://vimeo.com/111689100

https://player.vimeo.com/video/116381760?width=720&height=405&iframe=true

Hubdoc (www.hubdoc.com)

Hubdoc is a great storage tool for financial documents and receipts.

  • Hubdoc imports your financial documents and receipts in 3 easy ways:
    • Snap and send a picture of your receipt to your Hubdoc account using the Hubdoc app. We’ve been using this for all debit and credit card charges.  Once in Hubdoc we have the ability to sync w/Xero.  Data entry is easier (automated) AND the transaction will include a copy of your receipt.  What better way to defend yourself in an IRS audit than to have the transaction properly coded and have a receipt attached?
    • Link your financial accounts to Hudoc
      • We’ve linked our bank and credit cards to Hubdoc. Hubdoc automatically imports each month’s statement
    • Forward invoices from your inbox or have vendors send invoices to Hubdoc for you
      • Hubdoc recognizes your email address so you can easily import documents into your account via email. Simply send a vendor invoice from your email account and Hubdoc places the invoice in your account
      • Have vendors send their invoices to a specific email address provided by hubdoc. My vendors can send an email to marcusmire.hubdoc@app.hubdoc.com and those invoices will automatically import into my account

Quick Hubdoc video

https://www.youtube.com/watch?v=qH27ZChAfdg

Give these tools a try.  My bet is that you’ll be amazed at the ease of use, quick set up, and convenience.

I’d love to talk with you about these tools and how they can transform your business’ efficiency.

 

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Benefits of a Roth 401(k)

A Roth IRA can be a great vehicle for retirement savings.  Taxpayers make after-tax (non-deductible) contributions to a Roth IRA.  Contributions accumulate along with earnings in the Roth IRA and can be withdrawn TAX FREE once the taxpayer reaches 59 ½ years old.  Contributing to a Roth IRA forgoes a current tax deduction for tax-free withdrawal of contributions and related earnings in retirement (after 59 ½ years old).

A drawback of Roth IRAs is the potential for taxpayers being excluded from making contributions as their income grows.  Taxpayers cannot contribute to a Roth IRA once their adjusted gross income reaches $133,000 (single filer) or $194,000 (married filer).

Taxpayers that participate in 401(k) plans at work or are self employed can avoid the Roth IRA contribution adjusted gross income phase outs ($133,000/single, $194,000 married) described above by making Roth contributions within a 401(k) plan.  Most 401(k) plans allow for employee Roth contributions and these contributions are NOT subject to the adjusted gross income limitations described above for taxpayers contributing to Roth IRAs.  Further sweetening the Roth 401(k) deal is ability to make larger employee contributions to a 401(k) than to a Roth IRA.  Roth IRA contributions are limited to $5,500 ($6,500 if 50 years or older) while Roth 401(k) contributions are limited to $18,000 ($24,000 if 50 years or older).

Consider this example:

  • Married couple in their 30s with an adjusted gross income of $320,000
  • Roth IRA contributions allowed = ZERO
    • Contributions allowed are “phased out” when adjusted gross income reaches $194,000 for a married couple
  • Roth 401(k) contributions allowed = $36,000 ($18,000 each)

A Roth 401(k) makes PERFECT sense for a high-income, young taxpayer.  Why?  Consider a taxpayer that would normally be excluded from making Roth IRA contributions because their adjusted gross income exceeds the phase out thresholds.  Not only can that taxpayer contribute to a Roth 401(k), he can contribute over three times the amount ($18,000 vs. $5,500) that could be contributed to a Roth IRA.

The reason being “young” is a big factor in this example is the time horizon for earnings growth.  Roth IRAs are popular to young taxpayers because of the length of time earnings grow that will ultimately be distributed tax free assuming distributions after 59 ½ years old.

A Roth 401(k) option is available even if you’re self-employed.  Consult your financial adviser about setting up a “Solo K” plan that allows for employee Roth contributions.

For taxpayers that fit the right criteria (high income, young), Roth 401(k) contributions make a TON of sense.

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Accounting Made Simple, Smart and Secure with Xero Accounting

In today’s on the go, information at your fingertips world, being able to do business anywhere is essential.  That’s why I’ve become a Xero Certified Advisor.

Xero is a cloud-based accounting software that connects people with the right numbers anytime, anywhere, on any device, allowing you to focus on what you do best – running your business.  Here are a few key features of Xero and why I believe it’s a great solution for many small businesses:

Bank Feeds –  allows you to automatically import account transactions into Xero from your bank or other financial institution.  Once “bank feeds” are up and running, you’ll no longer need to download and import bank statements to get transactions into Xero.  No more gathering bank and credit card statements!

Real Time – use Xero to collaborate in real time with your accountant via Xero’s web-based access.  With “bank feeds” importing data daily, adjusting journal entries can be made as needed, and reports can be produced on a frequency (monthly, quarterly, etc.) that you choose.  No more swapping flash drives with backup data, waiting on adjusting entries from your accountant, or waiting until year-end to have a set of accurate financial statements.  Real-time data also leads to better decision making through timely analysis of financial information.

Mobile – Xero’s mobile app gives you freedom, with easy access to the essential tools for doing business on the move. With Xero mobile you can get paid faster by sending an invoice the minute you’ve finished a job, capture receipts on the go, and stay on top of your cash flow by reconciling bank transactions from wherever you happen to be.

I’d love to show you the features of Xero and how I can offer you a flat-rate monthly price based on your needs.  No guesswork as to the amount of your invoice each month.  If you’re interested in learning more about Xero and how it can help your business, give me a call or contact us here!

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Employ your children and get a tax deduction

Business owner clients often ask me about putting their children on the payroll.  It’s a common strategy that can really save money depending on the number of children you can employ and how much you can reasonably pay them.  Self-employed individuals and partnerships, including LLCs filing as partnerships where the only partners (LLC members) are husband and wife, reap the biggest benefits by employing children.

The beauty of this strategy is the shifting of taxable income from parent (who typically is in a much higher tax bracket) to child.  Depending on the amount of wage paid to the child, the child could pay $0.00 tax.  See example below.

Applicable info to consider

  1. Wages paid to children are exempt from Social Security and Medicare withholding as well as employer matching in a parent’s unincorporated business (example = self-employed consultant), a partnership (or LLC filing as a partnership) in which each partner (LLC member) is a parent of the child, or a single-member LLC filing as a sole proprietorship.
  2. A dependent’s (child’s) standard deduction ($6,300 for 2016) can be used to offset wages paid to the child.  Simply stated, paying a child wages of $6,300 will go untaxed to the child.
  3. Since earned income (i.e. wages) is the prerequisite for making traditional or Roth IRA contributions, the funds paid to your child could be invested for future growth
  4. Wages paid by a parent’s business to a child are deductible by the parent’s business if the work is done by the child in connection with the parent’s trade or business.
    1. Caution: Wages paid to a child must be reasonable in relation to the services rendered.  The business owner should keep detailed records of the child’s employment, including payroll records, in case Federal or state taxing authorities or labor departments seek verification.

Let’s take a look at an example:

John is a self-employed geologist operating his business as a sole proprietorship.  His marginal Federal tax rate is 28% and his state tax rate is 6%.  John has a 16 year old son name Carter.  John hires Carter to handle various computer tasks including technical data entry as well as administrative tasks.  Carter works 15 hours per week throughout the year earning $6,000.  John may deduct the $6,000 as wage expense from his business income.  The wages are exempt from BOTH Social Security and Medicare tax and Carter pays $0.00 income tax.

Carter’s tax return calculation:

Wages                                                    $6,000

Less:  Standard Deduction             ($6,300)

Taxable Income                                     $-0-

The beauty of this scenario is that John saves approximately $2,800 between Federal and state income tax as well as self-employment tax while Carter pays $0.00.  To sweeten the deal, Carter could contribute $5,500 (max for individuals under 50) to a Roth because he has earned income, wages.

John could increase Carter’s pay to $11,800 and Carter would still owe $0.00 Federal income tax assuming Carter made a $5,500 maximum traditional IRA (contrast that to a Roth contribution where you do not get a tax deduction) contribution.

Carter’s tax return calculation:

Wages                                                  $11,800

Less:  IRA Deduction                       ($5,500)

Less:  Standard Deduction            ($6,300)

Taxable Income                                    $-0-

As always, the above examples do not illustrate all of the possible measures that can be used to save a few dollars by employing your children and paying them a reasonable wage.  If you have any questions about this technique, feel free to contact us.

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