Just Another Reason That It’s Time To Re-do the Tax Code

July 31st, 2014

The current version of the Internal Revenue Code is large, complex, and flawed. There have been calls on both sides of the aisle in Congress to substantially revise it, and there are several compelling reasons to do so:

  • It’s been a long time since we’ve had a new version. The time between the 1939 Code and the 1954 Code was 15 years. The time between the 1954 Code and the 1986 Code, which is the current version, was 32 years. It’s now been 28 years since enactment of the 1986, so it’s really time for a change.
  • There are many tax rules that are outdated or mean to help a specific taxpayer or industry (e.g., special write-off allowances for film and TV and motorcross arenas). Several rules were created to incentivize certain actions by individuals and businesses; they may no longer be necessary or desirable. For example, there were a slew of energy-related tax breaks (some of which expired but could be extended).

I’d like to suggest another reason for a change:

A number of rules have fixed dollar limits that have not been updated in years. (Dozens of tax rules are indexed annually for inflation, but many are not.) As a result of inflation, however modest in recent years, these fixed dollar limits are ridiculous and do not reflect Congress’ original intent. Examples:

  • The dollar limit on deducting business gifts is $25 per person per year. This limit was fixed in 1962. In today’s dollars, it would have to be $197.30 (based on the BLS inflation calculator).
  • The dollar limit on deducting capital losses in excess of capital gains (the amount that can offset ordinary income is $3,000). This limit became effective in 1978. In today’s dollars, it would be $10,966.70.
  • The dollar limit for treating losses from Sec. 1244 (small business) stock as ordinary income is $50,000, or $100,000 on a joint return. This limit became effective for stock issued after November 6, 1978. In today’s dollars, it would be $182,778.37, or 365,556.75 on a joint return.
  • The dollar limit for excluding dependent care assistance (employer paid or an employee-funded FSA) is $5,000. The limit was set in 1986. In today’s dollars, it would be $10,873.31.

It’s time to have a national discussion about what we want the Tax Code to be. (The House Ways and Means Committee started the discussion with the release of a bill entitled The Tax Reform Act of 2014, which would cut the size of the code by 25% and make other dramatic changes.)

Here are some questions I’d pose in the discussion about a new Tax Code:

  • Should it be a sure revenue raiser so the federal government has the funds to pay its bills as well as start to pay down the national debt?
  • Should it encourage certain activities by individuals and businesses (e.g., going “green;” hiring certain types of workers; purchasing capital equipment)?
  • Should it be an anti-poverty tool? (That’s what Nina Olsen, the National Taxpayer Advocate, called the earned income tax credit.)
  • Should it make U.S. corporations competitive with those in other developed countries?
  • Should it eliminate the marriage penalty entirely (so that it makes no difference taxwise whether a couple is married or not)?

I’m up for this discussion. Is Congress?

The House Gets Small Business — Where’s the Senate?

July 24th, 2014

There are only a few days left before Congress recesses to begin campaigning for the mid-term election. It won’t be back until after November 4, at which time it will be a lame duck session. In the past several weeks, the House has passed a number of rules that I view as favorable to small businesses. The Senate won’t take up the measures until after Election Day.

Here are some of the bills that have passed the House:

Permanent sales tax moratorium on Internet access. Since 1998, Congress has temporarily banned states from imposing sales tax on the Internet if it had not previously done so. Now, the House voted favorably on the Permanent Internet Tax Freedom Act (H.R. 3086).

This measure would not only bar states that haven’t yet taxed access, but also eliminate sales taxes in those 7 states that did. The Senate agreed to this last year, so hopefully the law will be enacted before the end of this year.

One sticking point:  Some Senators want to expand the law to cover sales taxes on Internet sales, which would bring up a whole other issue, so passage of a permanent ban on sales taxes for Internet access isn’t certain.

Permanent research credit. First enacted in 1981 and extended 15 times, this tax break rewards companies that increase their R&D expenditures. Finally, the House voted favorably on the American Research and Competitiveness Act (H.R. 4438), which makes the credit permanent.

The White House has indicated its opposition to a permanent extension by threatening a veto; the Senate has also raised concerns about the cost of a permanent credit.

Note: In the past, the U.S. had the best tax credit in all industrialized countries, it is now ranked 27th and would move to 15th with the permanent credit.

Permanent tax breaks for buying equipment and machinery. Instead of depreciating the cost of these items over 5, 7, or longer periods, special accelerated write-offs in the tax law are designed to spur these capital investments:

  • Sec. 179 (first-year expensing) is a deduction for costs of up to set dollar limit (because of an overall annual investment limit, the rule applies only to small businesses). Last year, the deduction limit was $500,000. This year it is scheduled to be $25,000. This break entered the Tax Code through Small Business Tax Revision Act of 1958 (it was $2,000, or $4,000 for married persons each claiming a write-off), in 1981 it went to $5,000, and after 1986, $10,000. The dollar limit really started to jump beginning in 1997. You can read a complete legislative history here.
  • Bonus depreciation lets costs to be deducted in the first year up to a set percentage (over any Sec. 179 deduction). Last year, the deduction was 50% of costs; this year it is scheduled to be zero. This measure first appeared after 9-11 at 30% and has come and gone since then; it’s been as high as 100%.
  • The House voted to make the 2013 rules for both tax breaks permanent through America’s Small Business Tax Relief Act (H.R. 4457) and Act to Modify and Make Permanent Bonus Depreciation (H.R. 4718).

In my view, a permanent law is better than a temporary one. It enables businesses to plan ahead with some measure of certainty. Of course, a permanent law can always be repealed or replaced. But when laws are only temporary, businesses have to wait out Congressional bickering before knowing what the rules will be so plans can be made.

You may recall that at the end of 2013, 55 tax provisions expired. Many of these (including the research credit, the enhanced Sec. 179 deduction, and bonus depreciation) have been continually subject to extenders. Yet 2014 is more than half over and we still don’t know for certain what the tax rules for the current year will be. Is this any way to run a government?

Hobby Lobby Case and Your Small Business

July 17th, 2014

On June 30, 2014, the U.S. Supreme Court announced its decision in a case brought by a company contesting the government’s rule under the Affordable Care Act (“Obamacare”) that it provide 20 types of contraceptives to employees despite the religious objections of its owners to 4 of these types. The company’s owners were victorious. The court said that regulations issued by the Department of Health and Human Services violate the Religious Freedom Restoration Act of 1993 (RFRA), which generally prohibits the government from substantially burdening a person’s exercise of religion.

Bottom line: The Court said that a closely-held corporation (the legal entity of the litigants Hobby Lobby Stores, Inc. and Conestoga Wood Specialties Corp.), is a person for purposes of the RFRA, thus protecting, at least on this contraception issue, the religious liberty of the humans who own and control it.

Immediate impact
The decision allows owners of businesses that are not public companies to follow their conscience (there must be a “sincere” religious belief) when it comes to the contraception coverage mandate of the Affordable Care Act . The way in which a business is organized — as a sole proprietorship, partnership, limited liability company, or corporation — does not matter.

When it comes to corporations, the government may seek to limit the application of the decision to those defined in the Internal Revenue Code as a closely-held business, which are corporations that:

  • Have more than 50% of the value of its outstanding stock owned directly or indirectly by 5 or fewer individuals at any time during the last half of the tax year, and
  • Are not personal service corporations.

Of course, the requirement to provide health coverage (“employer mandate”), and all that this entails, does not apply to most small businesses. The mandate only applies to large companies — those with 50 or more full-time and/or full-time equivalent employees. The mandate takes effect in 2015 for companies with 100 or more employees, or 2016 for companies with 50 to 99 employees. Only 2% of all small businesses have more than 50 employees.

Long-term impact
No one can say for sure what this decision will mean in the future. The decision should not be taken as a free pass for small businesses to object to all government actions or positions on a religious basis; they may not prevail as did Hobby Lobby. For example, small businesses likely won’t be able to refrain from serving gay customers on religious grounds (this issue has not come before the U.S. Supreme Court but lower courts around the country have ruled against businesses taking this stance).

On the other hand, there could be some backlash from the decision. One possible argument that can now be made by creditors is that the so-called corporate veil, which protects the personal assets of owners, is less than inviolate. The claim may seem far fetched, but the argument would be that if that veil is pierced for purposes of the Patient Protection Act, could it not also be breached for purposes of company debts?

While the First Amendment of the U.S. Constitution and RFRA protect the free exercise of religion by small business owners, this protection won’t give blanket protection in all situations. Consult with an attorney when taking any position on religious grounds that runs counter to government rules.

Note: On July 17, 2014, the Department of Labor issued a ruling that any business dropping coverage for certain contraception methods must give notice to employees.

Summertime Reading

July 10th, 2014

For many people, spreading out on the beach may mean reading pulp fiction or gossip magazines and zoning out. For others, like me, it’s an opportunity to read books on business that have been waiting to be read. (I’m not making any judgments about which path is better, and maybe you can do both.)

Whether you like holding a book or an iPad (or other Kindle device), keep Benjamin Franklin’s advice in mind: “An investment in knowledge pays the best interest.”

Here is a list of books that I hope to tackle this summer (likely I won’t get to all of them despite my ambitions). Some are new publications; others have been out for some time but I haven’t read them yet.

  • Shark Tank Jump Start Your Business; How to Launch and Grow a Business from Concept to Cash by Michael Parrish DuDell. The book contains contributions from the Sharks on the ABC show: Mark Cuban, Barbara Corcoran, Lori Greiner, Robert Herjavec, Daymond John, and Kevin O’Leary.
  • The Business Book (Big Ideas Simply Explained) by DK Publishing. The book uses interesting graphics to help explain business concepts.
  • Thinking, Fast and Slow by Daniel Kahneman. This best seller explains influences on thinking.
  • The Innovator’s Dilemma: The Revolutionary Book that Will Change the Way You Do Business by Clayton M. Christensen. The book focuses on “disruptive technology” which means new technology that changes the way things are done.
  • The Entrepreneurial Mind: 100 Essential Beliefs, Characteristics, and Habits of Elite Entrepreneurs by Kevin D. Johnson.
  • Like a Virgin: Secrets They Don’t Teach You in Business School by Richard Branson. An interesting guy should make for an interesting book.

What books are you reading, or planning to read, this summer? Please share them with me.

Summertime and Your Business

July 3rd, 2014

Now that we’re into summer, is your business ready for the season? Here are some changes you might consider at this time.

Casual dress code
Some businesses relax their dress code during the summer to allow for more casual attire. This can be a slippery slope, with some employees wearing what an owner may deem to be inappropriate attire.

If you want to change your dress code, be clear about what is and is not acceptable. Ties may become optional in the hot weather but likely flip flops are out. See the EEOC’s rules on permissible dress codes.

Summertime hours
Depending upon the nature of your business, you may need to extend your hours of operation or opt to restrict them. Be sure to well publicize any changes so customers and clients are not caught off guard.

Energy savings
Adjust thermostats and make other savvy moves to save energy costs when the temperature rises. California offers tips to businesses that can be applied to businesses nationwide, including:

  • Conduct an energy audit to find ways to save
  • Turn off lights and equipment after hours
  • Set energy-saving features on office equipment to put them into sleep mode when not in use
  • Purchase ENERGY STAR equipment

Also, be prepared for periodic brownouts by making contingency plans.

Strategic planning
If your business is slow at this time of year, it’s an opportunity to focus on long-range planning.

  • Marketing. Review and refresh your marketing activities. This will enable you to ramp up your efforts after Labor Day when people return from vacation and are ready to focus on business.
  • Taxes and finance. Meet with your CPA to review your business’ activities year-to-date and assess how things have gone. Maybe you need to make changes in your operations (e.g., cutting certain expenses; changing pricing). You can also do some mid-year tax planning.
  • Staff training. Now may be a great time to spare employees while they attend workshops or classes to learn or improve job skills.

To paraphrase George Gershwin, the living may be easy in summertime, but that’s no excuse for a business owner to take a permanent vacation at this time of the year. Use the time well to enhance your business — and enjoy!

Are You Liable for Trust Fund Penalties?

June 26th, 2014

You are if you’re an employer who willfully failed to deposit with the Treasury the required income taxes and the employee share of FICA withheld from wages.

These taxes are called trust fund taxes because you are withholding and depositing them on behalf of employees. Unfortunately, when cash is tight, some employers may use these funds to pay other bills. A report from the Treasury Inspector General for Tax Administration said that as of June 30, 2012, employers owed the government $14.1 billion in delinquent employment taxes.

What the report found
It criticized the government for not taking sufficient collection action in trust fund recovery penalty (TFRP) cases. For example, the IRS often failed to initiate collections before the statute of limitations on collections expired. But even if the collection period was still open, by delaying collections, the financial ability to pay had declined. While only a small sample of employers was used, the report found that the untimely actions averaged more than 500 days to review and process.

The report recommended that the IRS should:

  • Ensure that revenue officers take timely action for TFRP cases
  • Enhance communications and training for TFRP cases
  • Improve the IRS scheduling system so collections cases aren’t barred by the statute of limitations

The report contained a memorandum sent to the IRS commissioner of the Small Business/Self-Employed Division. It acknowledged that the division has made some improvements in timeliness since the Government Accountability Office’s recommendations made in 2008 along similar lines.

When employers are personally liable
Regardless of the entity used for your business, you are personally liable for a 100% TFRP if you are a “responsible person” who willfully fails to deposit the trust fund taxes within the meaning of the tax law. Thus, even if you own a corporation or limited liability company, you are personally at risk for this penalty if you are an owner who is aware that the taxes haven’t been deposited and who has authority over which bills get paid (e.g., ability to sign checks, review payments).

If there is more than one “responsible person,” the IRS is free to go after any such individual for the entire penalty. Then the person who pays the taxes can seek “contribution” (the pro rata share) from co-owners (the responsible person can ask his/her co-owners for their share but likely a lawsuit is needed).

What to do
In light of the Inspector General’s report and the huge amount of revenue at stake, small business owners can expect that the IRS’ SB/SE Division will be more attuned to uncollected trust fund taxes. To avoid exposure to this personal penalty, be sure that your business implements strategies to pay this tax obligation, including:

  • Regular monitoring of deposits with the Treasury for trust fund taxes
  • Using cash flow strategies so as not to fall short of the funds needed to make the tax deposits
  • Working with tax advisors to ensure that payroll taxes are properly computed and deposited according to the applicable deposit schedule

The Deluge of Businesses for Sale: What It Means to You

June 19th, 2014

It’s been reported that between 7 and 10 million businesses will be up for sale in the next several years as Baby Boomer owners retire (or die). The book entitled The $10 Trillion Opportunity expects $10 trillion to change hands in the next decade or so from the sale of these businesses. If you’re planning on selling your company within this time frame, make sure you are positioned to get the most you can in light of the number of other businesses for sale.

Get your financials in order

You won’t be able to get a good valuation or speak with prospective buyers unless you know where you stand from a numbers perspective. Your business may be humming along and you may be taking out a comfortable amount each month, but that doesn’t speak to the financial condition of your business.

Work with your CPA to:

  • Create a P&L statement, which is a report of your income and expenses. As long as your revenue exceeds your expenses, you’ll show a positive number (a profit).
  • Create a balance sheet, which is a net worth statement for your business. It lists your assets, liabilities, and owner’s equity.
  • Review your debt. How much do you owe and when do you expect to have this paid off?

Do a valuation projection
A formal valuation by an expert usually costs thousands of dollars, and you may need to invest this money when you plan to sell. But before then, you can get a good idea about what your company is worth with some informal valuations. Here are some calculators you can use to get a general idea about valuation:

Think about your customers or clients
For some business owners, they are the company in the eyes of their customers/clients. No owner, no company. If this sounds like your situation, it can be turned around by developing relationships between customers/clients and others in your company. This takes time and requires communication with customers and clients. Get started now.

Develop a succession plan
While millions of owners are set to retire, the percentage of those with formal succession plans is very low. One source says only 25% of Boomer owners have begun to plan for their exit.  Work with an expert who can help you identify some of your concerns (e.g., target date, valuation).

For many business owners, death is their only exit strategy. But for many others, it makes sense to plan for a profitable exit so they can enjoy what they’ve created. Those who plan to continue working indefinitely still need to address succession planning so the business can continue (with ownership passing to their children, their employees, or others) after their demise.

Lessons from My Dad

June 12th, 2014

Father’s Day is a few days away and this day reminds me of the lessons I learned from my dad at the dinner table each day while I was growing up. He was a co-owner of a machine shop that made parts for such items as telephone equipment, helicopters, and the Minuteman missile. Needless to say, his lessons—spoken and unspoken—had a profound impact on me.

Running a business is 24/7. My dad talked about the routine and the not-so-routine events of his business day. He talked about some of the challenges he faced and the solutions he devised. I remember the amazing looking machines (drill presses and such) he put together to make the parts he contracted to sell. He lived his business and he shared it with his family.

Taking risks is routine. By definition, being a business owner means taking risks. My dad took a big one when the company built a factory in the Bronx. He put everything on the line to get it done (I was young but looking back I believe our house was used for collateral). But I learned that taking risks is just something you do.

Employees come and go. In small businesses, employees become a sort of family, where personal matters—births, graduations, wedding, deaths—are shared with everyone. But no matter how close owners feel to employees, employees may not share the same feelings. They may not even feel loyalty. Some may even leave to start competing companies (a group left my father’s company en masse to set up their own machine shop not far away). Still this shouldn’t stop owners from working to create good feelings in the workplace.

Dealing with the government is part of daily operations
. I recall various interactions he had with the Defense Department, OSHA, IRS, and the NLRB. To be a government contractor with the Defense Department, he had to go through an FBI background check. He talked about how it went. He talked about the company’s IRS audit. And more. I learned that it was just routine to deal with the government, and something that could not be avoided, when running a business.

My dad died many years ago. I wish he could have seen the developments in technology that happened since then and the changes they made in the way business is run today. He would surely have embraced them. Maybe he does see them?

Vacation Planning for You and Your Staff

June 5th, 2014

I’m taking my own advice and planning a vacation for myself this summer. Doing this had led me to understand some of the challenges that business owners face when taking time off. This is especially true for owners who don’t want to be tethered to the office by mobile devices. Here are some lessons I’ve learned:

Schedule vacation days in advance

As the owner, you may have first dibs on the days you’ll be away, but you need to coordinate with your staff. Some employees may want to use their days in one stretch; others prefer to take time off here and there. For small businesses, coordinating time off is critical for having sufficient staff throughout the summer vacation period.

Set company policy about how much advance is needed for an employee to request time off. Decide whether decisions about granting time off will be based on seniority, first-come, a lottery, or some other way.

Determine what will need to be done during the time when you/employees are off. Do what’s possible in advance. For me, this always means working double time for weeks in advance to satisfy the work deadlines that fall during my vacation. Discuss with customers and clients about scheduling work after your/your employees’ vacations.

Arrange for backup
Make sure you’re covered for any problems that need to be addressed while you are away. This can be done by giving an employee these responsibilities.

Also see that employees can cover for each other when needed. If necessary, hire temporary workers to fill in gaps in your staffing. With temporary workers, you pay the agency a fee for their services; they remain the employees of the agency.

Looking ahead to next year
How many vacation days do you offer? Federal law does not mandate that you give any paid time off, but you’d be hard-pressed to hire and retain good workers without a paid vacation policy. According to InfoPlease, the average in the U.S. is only 13 days, far fewer than vacation days in other developed countries (Italy (42), France (37), Germany (35), Brazil (34), Britain (28), Canada (26), and Japan and Korea (25)).

Caution: Check your state’s law about vacation days. If you offer them, there are certain rules governing how vacation days accumulate and whether unused days must be paid when employment terminates. For example, in California, earned vacation time is considered wages (and vacation time is earned or vests) as labor is performed (e.g., 10 vacation days a year would mean 5 have been earned after 6 months).

Relax! Enjoy your time off. Studies show you’ll live longer. Certainly, the time off can help you relieve stress, rethink, and refocus on your business when you return.

Penalty Relief for Unfiled Retirement Plan Returns

May 29th, 2014

If you have a qualified retirement plan and it’s not a SEP or SIMPLE IRA, you must review annual filing requirements regarding information returns to tell the government about your plan. Recently the IRS and the Department of Labor created a temporary pilot program that gives penalty relief for certain non-filers.

Who has to file
Plan administrators (typically owners in the case of small businesses) must file one of the following forms each year:

  • Form 5500, Annual Return/Report of Employee Benefit Plan
  • Form 5500-SF, Short Form Annual Return/Report of Employee Benefit Plan
  • Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan

Exception: No form is required for one-participant plans [owner(s) and spouse(s)] with assets of $250,000 or less at the end of the year.

Filing deadline
The annual return is due at the end of the 7th month after the close of the plan’s tax year. Thus, if you maintain your plan on a calendar year, the 2013 return is due on July 31, 2014.

Penalty relief
Under a pilot program starting June 2, 2014, exclusively for small business (owner-spouse) plans, plans of business partnerships (also treated as one-participant plans if there are no common law employees covered), and certain foreign plans, no penalty will be imposed for failing to file if the requirements of the pilot program are satisfied no later than June 2, 2015.

My guess is that this pilot program will be used by owners who believed they were exempt from annual filing because of their misinterpreting the $250,000 asset threshold in these situations:

  • A small plan is terminated. The exemption does not apply to the final year of the plan. A plan must file a final return, even if assets never exceeded the $250,000 threshold
  • A plan is a ROBS (rollover as business startup) arrangement. The exemption applies only if the individual (and spouse) wholly own a business, whether incorporated or unincorporated. In a ROBS arrangement, the plan, not the individual, owns the business so the exemption cannot be used; a return must be filed regardless of the amount of plan assets.

Steps for relief:

  • Determine eligibility for the pilot program, as explained earlier.
  • Complete the required form in the 5500 series, including all schedules and attachments. If there is more than one delinquent return, they can all be included in a single submission.
  • Mark in red letters in the top margin of the first pate: “Delinquent return submitted under Rev. Proc. 2014-32, Eligible for Penalty Relief.”
  • Complete a paper copy of a transmittal schedule and attach it to the front of each delinquent return (one transmittal schedule for each delinquent return).
  • Mail the returns to the appropriate address (it depends on the form number being filed). Usually the government encourages e-filing, but in this case a paper return is required.

Note: Currently, there is no fee for this relief. If the pilot program becomes permanent, the IRS may impose a fee.

Check with your tax advisor to make sure you’re in compliance with filing requirements. If not, determine eligibility to get caught up without any penalty. Instead of relying on the pilot program, you can still request relief due to reasonable cause; this hasn’t changed.