Barbara’s Blog

From time to time, every business experiences a cash shortfall. Bills come in from vendors, employees have to be paid, an installment on your bank loan is due, and the landlord is knocking at the door.

What do you do?

Don’t use the money you’ve set aside for certain tax obligations because you can be held personally liable for 100% of this money.

Tax money that’s sacrosanct
Some of the money that a company collects is not to be touched. The company is merely a fiduciary holding the money in trust.

Examples of trust fund taxes:

• Withholding from employees’ paychecks for federal income taxes and FICA
• Withholding from employees’ paychecks for state income taxes and, where applicable, other state tax obligations (e.g., disability contributions)
• State sales taxes

Potential penalties
If you fail to pay over these trust fund taxes, you can face a 100% penalty for the unpaid taxes. The federal government has a Trust Fund Recovery Penalty. And many states, including California, have the same rule for state payroll taxes. The penalty applies if a “responsible person” (someone with decision-making power and check-writing authority) willfully fails to pay these taxes. Willfulness is inferred when a responsible person knows the taxes are unpaid but chooses to pay others instead.

Regardless of whether there are other owners besides you or that you set up your company as a corporation or limited liability company to achieve personal liability protection, the government can seek to recover all of the trust fund money from you. The government has three years to go after any responsible person and up to 10 years to collect the amount owed. The personal assets of the responsible person are fair game here. And the IRS can get your assets using a federal tax lien, levy, or seizure action.

Let’s take an example. Say you have an S corporation with three equal owners, all of whom have the authority to make day-to-day business decisions (including who to pay) and to write checks or make electronic bank transfers. Your business is in a cash crunch and with the limited funds you have, you choose to pay your vendors so you’ll continue to have inventory. You don’t pay the U.S. Treasury the amount owed for income tax withholding and the employees’ share of FICA. The IRS can choose to recoup all of the unpaid taxes from you alone. You and your co-owners are “jointly and severally liable” for these taxes. It means that the government usually pursues the person with the deepest pockets. If you pay, you can seek to recover a share from your co-owners, but that isn’t the government’s concern.

State sales taxes
Like wage withholding, merchants who collect sales taxes are merely holding the funds for their states. Say your state has an 8% sales tax rate and you sell a $10 item. You collect $10.80 from the customer; 80¢ belongs to the state. The failure to pay your sales tax collections can result in serious penalties. Ever notice a store on Main Street that’s been shut with a notice posted on the door saying “Closed due to failure to pay sales taxes”?

What to do?
If you find yourself in a cash crunch, recognize that the first parties to be paid are the federal and state government with respect to trust fund money. After that, it’s up to you to decide how to apportion the limited funds you have among your employees, vendors, and other creditors.

If you need additional cash, don’t be tempted to use trust fund money. Use any other resource you can to meet your obligations. Borrow from family and friends. Tap out your credits. Even take distributions from your retirement accounts (though this should definitely be a last resort).

Finally, let this difficult experience teach you a valuable lesson about cash flow management. Use software or online solutions to help. And work closely with your CPA or other financial advisor so you never again face a cash crunch.

On January 1, 2013, the top tax bracket for individuals rose to 39.6% (the top bracket used to be 35%). The 39.6% bracket applies to singles with taxable income over $400,000 and joint filers over $450,000. However, this new top tax bracket does not only impact individual income taxes. It also affects some business taxes, which will have the overall impact of raising income taxes even more.

Taxation of capital gains and qualified dividends
If you are a sole proprietor or an owner of/or in a partnership, limited liability company, or S corporation, your share of capital gains from the sale of your business’ property is subject to a 20% tax if you are in the 39.6% tax bracket. Last year, the top capital gain rate for this purpose was 15%.

If your business is incorporated and it distributes dividends to you which are treated as “qualified dividends,” those dividends are taxed at 20% if you are in the 39.6% tax bracket. Again, the top rate on qualified dividends was 15% last year.

Section 444 election
Partnerships and S corporations usually must use a calendar year (the same tax period used by its owners). However, they can elect to use a fiscal year if they make a special tax payment intended to thwart the benefit of tax deferral under the fiscal year. This election is called a Section 444 election, and the required payment is the highest individual income tax rate, plus one percentage point. Thus, the payment amount for 2013 is 40.6% (39.6% + 1%). Last year, the required payment was 36%. This required payment applies regardless of whether the owners in these electing entities are high-income taxpayers.

The required payment is due on May 15, 2013, for a company that has already made an election. The due date for a company first making the election in 2013 is May 15, 2014. The required payment is made with Form 8752, Required Payment or Refund Under Section 7519, which must be filed each year the section 444 election is in effect. Find out more about this required payment in IRS Publication 538.

PHC tax
Owners of personal holding companies (PHCs), which is a special type of C corporation that has limited ownership and receives certain types of income, may be subject to a special tax on excess passive income. The PHC tax rate for 2013 is 20%; it was 15% last year. Again, the rate applies without regard to the tax bracket of the PHC’s shareholders.

Accumulated earnings penalty
If a C corporation accumulates more than a set amount of its earnings rather than distributing it to shareholders, it may be subject to a special penalty. The corporation can accumulate any amount for the reasonable needs of the business (e.g., a proposed expansion project or a buyout of a retiring owner). Above these reasonable needs, accumulations are restricted to $250,000 ($150,000 for personal service corporations). Excess accumulations are taxed in 2013 at 20%; the penalty rate had been 15% last year. The penalty applies without regard to the tax bracket of the corporation’s shareholders.

Conclusion
Talk with your tax advisor to learn all of the ramifications that the new top personal tax bracket may have on your overall tax picture.

On May 6 the Senate decisively (69 to 27) passed a bill that would require online sellers (other than “small” ones) to collect sales tax from remote buyers if they are based in a state with sales tax. The House is about to take up the matter; passage in the House is questionable.

Here are some of the key issues about the law that I think are worth noting and are often overlooked or mischaracterized in serious discussions about “fairness.” I also offer my solution.

The tax is on consumers
Discussions seem to imply that online and mail order merchants are paying the sales tax. This isn’t so. The tax is levied on customers; the merchants act as tax collectors responsible for turning over the collected sales tax to their state.

It is true, however, that the act of collection entails considerable cost to merchants. As things stand now, they would have to compute the appropriate amount of tax. There are more than 9,000 different sales tax jurisdictions in the U.S., so calculation is no small feat. (The bill would require states to simplify their tax rates and provide free software to merchants to compute collections.) Then there are the administrative costs of filing sales tax returns and remitting the taxes.

The tax exempts very small sellers
Under the bill, there is a $1 million pass for online and mail order merchants (“remote sellers”), effectively exempting very small businesses. The collection obligation would apply only if total annual from remote sales exceed $1 million. It should be recognized that bricks-and-mortar stores with sales of $1 million or less are not exempt from sales tax collections.

The law could be better
The Marketplace Fairness Act attempts to right a wrong; that the absence of sales tax on online purchases drives consumers away from Main Street and to the Internet or mail order catalogs. It makes sense to me that all businesses, large and small, wherever based, should be subject to the same rules. However, a better solution would be to simplify the tax rules for all merchants. Let states that want to use the new law (if enacted) enable merchants to collect sales taxes at a flat rate (if the states in which they are based impose a sales tax). Then let the states sort out how to apportion that tax among its cities and counties.

Conclusion
It’s always hard to use the words “tax” and “fair” in the same sentence. I don’t want consumers to lose sight of their added sales tax burden if the law is enacted. Many who have enjoyed sales tax-free online purchases will have to factor in the new tax cost to their spending. The revenue that the online merchants have been reaping has always been subject to income taxes (assuming they are in states with an income tax).

Will this impact overall sales and have a negative effect on the economy? Will it depress total tax collections (income tax and sales tax)? Who knows?

Luddites were 19th century English textile workers who smashed the newly invented machines they feared would replace them. We now know that machines and other technology are enhancements used to increase productivity and don’t necessarily replace workers. Still, the post-recession economy may prove the Luddites right.

Technology replacing workers
New machines, software, cloud applications, and other technologies continue to debut. They help to make companies run more efficiently and, in many cases, using fewer workers. Earlier this year, AP reported “Some occupations are beneficiaries of the march of technology, such as software engineers and app designers for smartphones and tablet computers. Overall, though, technology is eliminating far more jobs than it is creating.”

Other findings by AP:

• Technology is enabling startups to launch with one-third fewer employees than in the 1990s
• Companies in the S&P 500 Index grew profits post-recession by one-third while cutting their payrolls in half

Low-paid workers
Those who have jobs may not have enough spending money to oil the economy. Kiplinger reported that 28% of workers are in jobs that earned them less than the poverty level (this is 5% more than in 2002). The Kiplinger Letter had it right: “An economy can’t grow if too many workers don’t have money to spend.”

The answer from some economists and politicians has been to raise the minimum wage. However, many small business owners have said that a higher minimum wage will force them to use fewer workers. What’s the right answer? I don’t know.

Conclusion
Early in the last century, the story goes that Henry Ford paid his workers $5 an hour, an unprecedented sum for the times, so that they could afford to buy the cars he sold. The real story (the reason for the high pay and how it was figured) may be somewhat different, but the lesson seems sound. In the short run, replacing workers with technology and paying low wages are helpful to the bottom line. I’m no economist, but it seems to me that in the long run, there may be few left to buy what we have to sell. The Luddites in the 19th century were concerned with their jobs; now it seems that they had a point when it comes to the economy.

Tragedy and trauma are the words that come to mind when I remember the images of the bombings at the Boston Marathon’s finish line. As the days passed, and residents in Watertown, MA, and other areas were ordered to stay in their homes, I began to think about the impact that these events have on small business. Here’s my take.

1. Always expect the unexpected. Life is unpredictable and your course can change in an instant. The best laid plans often have to be postponed, remade, or abandoned due to things beyond your control (e.g., weather, power outages, and now domestic terrorist events). Having a Plan B can come in handy.
2. Consider business interruption coverage. Businesses near the site of the bombing had their glass blown out and suffered other property damage. These losses are probably covered by a business owners’ policy (BOP) (check whether your policy covers losses due to terrorist acts and riots because these occurrences may be excluded). But these businesses and others in the Boston/Cambridge area became part of crime scenes and were shut by authorities, causing substantial losses (e.g., Legal Seafood had to dispose of thousands of dollars of fish that could not be consumed because of the closure). Business interruption insurance provides protection in these instances, helping you pay your bills as well as giving you the profits you would have earned during the time you could not operate. Talk with your insurance agent about this coverage.
3. Review your “absence” policy. Your doors may have been closed, or your business was outside the parameter of mandated closures, yet employees may have been unable to get to work. Transit systems were shut and residents in certain areas were told to stay put. Do you pay your workers for their absence? Businesses with strict policy about absences should re-think the treatment of workers who are prevented from showing up because of no fault of their own. A paycheck for these days means a lot (it’s a show of good faith to your workers and an indication of normalcy).
4. Review your supply chain. Your business may be across the country, but if your suppliers were in Boston, your shipments may have been delayed. This is a lesson for businesses everywhere: Make sure to have alternate suppliers that you can turn to when your shippers—for whatever reason—cannot meet your needs.
5. Enjoy every moment. Too often, company owners are so wrapped up in their business activities that they fail to enjoy the process. Take time to celebrate small achievements (such as landing a new customer), milestones (such as reaching your 5th year in business), and the personal and professional moments of your people (such as completing an education course, getting married, or being promoted).

Terrorist experts have predicted that events similar to the bombings in Boston may happen again, in other locations. While we don’t want to live in constant fear or to change our way of life, small alterations in our outlook and our actions can help us get through whatever we may face in the future.

The Tax Foundation says today is the date on which taxpayers will have earned enough money to cover government obligations (federal, state, and local) for 2013.

Tax Freedom Day means that all of the productivity of Americans for more than 3½ months is required to support the government’s activities. What’s more, with rising taxes and higher income, Tax Freedom Day is 5 days later than in 2012. Depending on the state you’re in, your Tax Freedom Day may be earlier or later. Residents in Louisiana and Mississippi had theirs on March 29; for residents in Connecticut, their day is May 13.

Professor John Cochrane, professor of finance at the University of Chicago Booth School of Business, argues in a Wall Street Journal article that America needs an alternative maximum tax (AMaxT).

At what point does paying a sizable chunk of income for taxes become too much for individuals and start to hurt the economy? While he doesn’t have a magic number, he suggests that 50% of income might be the tipping point. His reasoning: If the government takes more than half of what someone earns, the economy will suffer because people will work less, which will result in less revenue.

When he says “taxes” he’s referring to the entire government take in the form of federal income taxes; Social Security and Medicare taxes; property taxes; sales taxes; state and local income taxes; real estate transfer taxes; estate taxes; and for business owners, the employer share of Social Security and Medicare taxes; state unemployment insurance; licensing fees; and other government fees (that are really taxes).

He also says that corporate taxes, which are really paid by people (investors; consumers) should be credited in some way to individual taxpayers if there is an alternative maximum tax.

He concludes: “So the AMaxT is most important for the backstop promise it makes to young people and entrepreneurs. Yes, start a company, go to school, work hard, invest, hire people. We guarantee you that no matter what happens, no matter how loud the zombies chant, no matter what clever “revenue enhancers” they come up with, you will get to keep some reasonable fraction of what you earn. Go for it.”

Readers in my age group may remember that when the marginal personal income tax rates ran to 70%, there was a 50% “max tax” on earned income (starting in 1972). (Remember Form 4726?) This cap on the federal income tax rate for earnings (wages; net earnings from self-employment) ended when the top marginal rate fell in 1981, so the need for the max tax ended.

Karl Marx said “There is only one way to kill capitalism—by taxes, taxes, and more taxes.” Are government officials trying to kill capitalism? Your guess is as good as mine.

Margaret Thatcher died on April 8th at the age of 87. She was known as the ‘Iron Lady’ and one of the most influential people of the 20th century.  She grew up as the daughter of a grocer; the family lived over the store (there was no hot water or an indoor toilet). At home she learned the value of hard work. Thatcher went on to a brief career in chemistry and ultimately to be Britain’s first woman Prime Minister, a post she held for 11 years.

She was an inspiration to me and she left behind important lessons that I’d like to share.

“My policies are based not on some economics theory, but on things I and millions like me were brought up with: an honest day’s work for an honest day’s pay, live within your means, put by a nest egg for a rainy day, pay your bills on time, support the police.”

“Pennies don’t fall from heaven — they have to be earned here on Earth.”

“You may have to fight a battle more than once to win it.”

“Being powerful is like being a lady. If you have to tell people you are, you aren’t.”

“The problem with Socialism is that you eventually run out of other people’s money.”

“Look at a day when you are supremely satisfied at the end. It’s not a day when you lounge around doing nothing; it’s a day you’ve had everything to do and you’ve done it.”

“Any woman who understands the problems of running a home will be nearer to understanding the problems of running a country.”

“There is no liberty unless there is economic liberty.”

“Plan your work for today and every day, and then work your plan.”

“What is success? I think it is a mixture of having a flair for the thing you are doing; knowing that it is not enough, knowing that you have got to have hard work and a certain sense of purpose.”

Yes, if you check the definitions under the Affordable Care Act.  Definitions matter because they govern what rules you must follow. The Affordable Care Act has conflicting definitions for different purposes.

• Employer mandate to provide health coverage. Here you’re a large employer if you have more than 50 full-time employees on your payroll. If you do, then starting in 2014, you’ll have to provide affordable health coverage or pay a penalty (“play or pay”) (it’s much more complicated than this brief statement). By exclusion, you’re a small business exempt from this mandate if you have 50 or fewer employees.
• Health exchanges. Here you’re a small business if you have more than one but fewer than 100 employees. If so, you can use the Small Business Health Options Program (SHOP) to offer a menu of health coverage plans to employees. Unfortunately, however, SHOPs were supposed to be open on October 1 of this year to enable employees to select their coverage for 2014; employees have only a single plan until 2015. Note: Just to confuse things even more, states can limit participation in these exchanges to up to 50 employees until 2016.

Thus, if you have 60 employees, you must comply with the employer mandate in 2014 but you can put employees in the SHOPs if you don’t want to use private health insurance. Make sense?

Other federal laws
The Affordable Care Act isn’t the only place where definitions for small business are confusing. The Tax Code has more than a dozen different definitions for different purposes. Like the Affordable Care Act, some are based on the number of employees. However, some definitions are based on gross receipts, some on the value of assets, and one on the amount of equipment purchased in the year.

For your convenience, here is a partial list of federal laws that tie the definition of small business to the number of employees. If you have fewer employees than the number listed, you are exempt from complying with the law.

• Age Discrimination in Employment Act: 15
• Americans with Disabilities Act: 20
• COBRA: 20
• Equal Pay Act: 2
• Fair Labor Standards Act: 2
• Family and Medical Leave Act: 50
• Title VII of the Civil Rights Act: 15

State laws
States often adopt more stringent definitions to force smaller companies to offer benefits and rights to employees than otherwise required under federal law. For example, a number of states have “mini-COBRA” requiring companies that offer health coverage to extend continued coverage if they have as few as two employees. Check your state’s laws carefully to make sure you are in compliance.

Bottom line
Don’t assume you are a small business because you don’t view yourself as large. The government may put you into the “large business” category for some purposes even though you are still a small business. When in doubt, consult with a knowledgeable attorney on the area you are concerned about.

It seems to be the norm these days. The Bureau of Labor Statistics reported recently that the average number of hours worked by all types of full-time employees in the U.S. (other than on farms) in February was 34.5 hours (up 0.1 hour from January). Hours for those in manufacturing: 40.9 hours (up 0.2 hours). For owners, who knows? Many owners I know work 60 hours a week or more.

Impact on health

Do long work hours adversely impact health? An article in a scientific journal suggests they can kill you! Working longer than eight hours increases the chances of coronary disease by 40% to 80%. You certainly don’t want this for yourself or your staff.

Reasons for overwork

There’s no single answer for why you and your staff are putting in long hours. Examine which of these possible reasons apply in your situation so you can address them properly.

Technology

The ability to work after regular work hours is all too easy these days, with smartphones, tablets, and WiFi just about everywhere you go. The result: the boundary of the workday has virtually disappeared.

What to do: Limit business time during off hours. Mute devices and wait until business hours to respond to business communications.

Smaller workforce

The recession (which continues for many small businesses despite economic indicators) forces many companies to make do with the staff they have, even if it’s smaller than would be optimum. Employees who are still with the company must handle more work than when the company was fully staffed.

Even more problematic are the companies that are now flourishing and could use more help. Even if they could afford the substantial added cost of new workers (wages, employment taxes, workers’ compensation, and employee benefits your current staff enjoys), there’s a sticking point that isn’t easily overcome. If a company becomes a “large” employer (more than 50 full-time employees), it’ll be subject to the employer mandate for providing affordable health coverage (or paying a penalty) starting in 2014. The determination of whether an employer is “large” is based on 2013 payroll.

What to do: Some companies are alleviating overwork for existing staff by taking on part-timers (less than 30 hours a week). They can carry some of the extra work load without triggering the employer mandate in 2014. Determine whether part-timers may be a solution for your business.

Competitiveness

Maybe it’s compulsion that drives some people to work longer hours that may be required by an employer or the scope of the job. Certainly, with the lack of job security these days, many feel compelled to show their commitment to the company in the hopes of increasing their worth to the business (which is meant to create some job security).

What to do: Be clear to workers what is and is not required of them. Simply sitting longer at a desk and looking busy doesn’t help your business. For some types of businesses, it makes more sense to set tasks or projects that need to be completed; when they are done, the workday can end. Sometimes this may require extended hours, but good planning and scheduling can help to limit employees’ hours.

Final thought

As the saying goes: Stop and smell the roses.

I recently participated in a webinar hosted by Brother Online, and wanted to pull together a set of tips to help SMBs with filing their taxes for 2012.

If you have not yet filed your business’ income tax return for 2012, there are still some pointers that can help you legally minimize your taxes and avoid IRS scrutiny of your return.

Take advantage of extended tax rules and know what actions can trigger IRS audits so you can steer clear of them.

Use extended tax breaks

As part of the deal to avert the “fiscal cliff,” many tax breaks that had expired at the end of 2011 were extended for 2012 (and in many cases 2013 as well). Check to see if any of these favorable deductions, tax credits, or other tax rules apply to you:

Hiring incentives. If you hired certain employees in 2012, you may be eligible for a tax credit based on a portion of their wages. Such credits include:

• Work opportunity credit for hiring workers from certain targeted groups (e.g., certain veterans; ex-felons). To claim the credit, you must submit Form 8850 to your state workforce agency. Usually this must be done within 28 days of the workers’ start of employment. However, for workers hired in 2012, you have until April 29, 2013, to act.
• Empowerment zone credit for hiring workers for businesses within certain government-designated areas.
• Indian employment credit for hiring workers on Indian reservations.

Equipment purchases. Instead of depreciating the cost of equipment and machinery over three, five, or seven years, you can opt to claim first-year expensing (“Section 179 deduction”). The deduction limit for 2012 is $500,000. This limit phases out when total purchases for the year exceed $2 million. You must be profitable to benefit from this deduction. You can also use 50% bonus depreciation, provided the items are new (not pre-owned). You need not have been profitable for this write-off.

Certain building improvements. If you made leasehold, restaurant, or retail improvements (e.g., a new wiring system), you may not be limited to simply depreciating them over 39 years, the usual period for depreciating commercial realty. Instead, you can use first-year expensing up to $250,000. You can also depreciate costs over 15 years.

Of course, the full the cost of repairs are immediately deductible. Regulations defining repairs versus capital improvements were supposed to be effective for 2012, but have been postponed until 2014. However, you are permitted to use them for 2012 and 2013 returns. Check whether the safe harbors and de minimis rules in the regulations are helpful to you.

Avoid audit red flags

While there is no way to guarantee you won’t be audited, there are actions to follow that minimize your exposure.

• Classify your workers correctly. Don’t label an employee as an independent contractor merely to avoid the cost of being the worker’s employee. This IRS audit target can cost you dearly in penalties if you misclassify workers and the IRS finds out.
• Report income correctly. Merchants receiving Form 1099-K, reporting payment transactions through financial institutions, PayPal, and other payment processors, must report their gross receipts on their returns. They do not have to reconcile the income reported with amounts on this information return, but should report all income.

Work with your tax advisor

Your advisor can help you timely file your return. He or she can also help assess which tax breaks you qualify for.

Filing extensions. Your unincorporated business (e.g., partnership; sole proprietorship) has until April 15th to file the 2012 return. If, for any reason, you can’t file by this date, ask for a filing extension:

• Sole proprietors file Form 4868 to have a filing extension to October 15th.
• Partnerships (and limited liability companies filing partnership returns) file Form 7004 to have a filing extension to September 15th.

Returns for calendar-year corporations were due on March 15th.  Corporations that failed to file and did not request extensions should file as soon possible to minimize late filing penalties.

Conclusion

Taxes are a cost of doing business successfully. However, you do not have to pay more than the law requires. Staying current on tax developments and working with your advisor can go a long way toward obtaining favorable tax results. Good luck!