Category Archives: Owning a Small Business

Conflicts of interest: When employees aren’t on your side

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One of the governing principles of the employee/employer relationship is that employees have a fiduciary duty to act in their employer’s interests. An employee’s undisclosed conflict of interest can be a serious breach of this duty. In fact, when conflicts of interest exist, companies often suffer financial consequences.

Ignorance isn’t bliss

Here’s a fictional example of a common conflict of interest: Matt is the manager of a manufacturing company’s purchasing department. He’s also part owner of a business that sells supplies to the manufacturer — a fact Matt hasn’t disclosed to his employer. And, in fact, Matt has personally profited from the business’s lucrative long-term contract with his employer.

What makes this scenario a conflict of interest isn’t so much that Matt has profited from his position, but that his employer is ignorant of the relationship. When employers are informed about their workers’ outside business interests, they can act to exclude employees, vendors and customers from participation in certain transactions. Or they can allow parties to continue participating in a transaction — even if it runs contrary to ethical best practices. But it’s the employer’s, not the employee’s, decision to make.

Cut off at the pass

Sometimes employees simply neglect to inform their employers about possible conflicts of interest. In other cases, they go to great lengths to hide conflicts — usually because they’re afraid it will jeopardize their jobs or they’re financially benefiting from them. These latter cases can be difficult to detect, which is why your company might fare better by playing offense.

For example, develop conflict of interest policies and communicate them to all employees. Provide specific examples of conflicts and spell out exactly why you consider the activities depicted to be deceptive, unethical and possibly illegal. Don’t forget to state the consequences of nondisclosure of conflicts, such as immediate termination.

Disclosing all

You might also require workers to complete an annual disclosure statement on which they list the names and addresses of their family members, their family’s employers and business interests, and whether the employees have an interest in those entities (or any others).

To help ensure accurate statements, provide employees with a hotline to call if they:

  • Have general questions or concerns about the policy,
  • Don’t understand how the policy relates to their unique circumstances, or
  • Want to report someone who appears to have a conflict of interest.

Also protect your business from conflicted vendors and customers. Before entering into a new agreement, compare the names and addresses on your employee disclosure statements with ownership information provided by prospective business partners.

Maintain standards

Conflicts of interest aren’t always clear cut because what one employer considers a serious conflict might seem negligible to another. But in general, the best way to promote your business’s success is by holding all stakeholders to the highest ethical standards. Contact us for more at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Build long-term relationships with CRM software

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Few businesses today can afford to let potential buyers slip through the cracks. Customer relationship management (CRM) software can help you build long-term relationships with those most likely to buy your products or services. But to maximize your return on investment in one of these solutions, you and your employees must have a realistic grasp on its purpose and functionality.

Putting it all together

CRM software is designed to:

  • Gather every bit and byte of data related to your customers,
  • Organize that information in a clear, meaningful format, and
  • Integrate itself with other systems and platforms (including social media).

Every time a customer contacts your company — or you follow up with that customer — the CRM system can record that interaction. This input enables business owners to track leads, forecast and record sales, assess the effectiveness of marketing campaigns, and evaluate other important data. It also helps companies retain valuable customer contact information, preventing confusion following staff turnover or if someone happens to be out of the office.

Furthermore, most CRM systems can remind salespeople when to make follow-up calls and prompt other employees to contact customers. For instance, an industrial cleaning company could set up its system to automatically transmit customer reminders regarding upcoming service dates.

Categorizing your contacts

Customers can be categorized by purchase history, future product or service interests, desired methods of contact, and other data points. This helps businesses reach out to customers at a good time, in the right way. When companies flood customers with too many impersonal calls, direct mail pieces or e-mails, their messaging is much more likely to be ignored.

Naturally, an important part of maintaining any CRM system is keeping customers’ contact data up to date. So, you’ll need to instruct sales or customer service staff to gently touch base on this issue at least once a year. To avoid appearing pushy, some businesses ask customers to fill out contact info cards (or request business cards) that are then entered into a drawing for a free product or service — or even just a free lunch!

Encouraging buy-in

A properly implemented CRM system can improve sales, lower marketing costs and build customer loyalty. But, as mentioned, you’ll need to train employees how to use the software to get these benefits. And buy-in must occur throughout the organization — a “silo approach” to CRM that focuses only on one business area won’t optimize results.

Establish thorough use of the system as an annual performance objective for sales, marketing and customer service employees. Some business owners even offer monthly prizes or bonuses to employees who consistently enter data into their CRM systems.

Making the right choice

There are many CRM solutions available today at a wide variety of price points. We can help you conduct a cost-benefit analysis of this type of software — based on your company’s size, needs and budget — to assist you in choosing whether to buy a product or, if you already have one, how best to upgrade it. Contact us today at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Hire your children this summer: Everyone wins

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If you’re a business owner and you hire your children (or grandchildren) this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college and learn how to manage money. And you may be able to:

  • Shift your high-taxed income into tax-free or low-taxed income,
  • Realize payroll tax savings (depending on the child’s age and how your business is organized), and
  • Enable retirement plan contributions for the children.

It must be a real job

When you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.

For example, let’s say a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time into the fall. The son earns $10,000 during 2019 and doesn’t have any other earnings.

The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.

The family’s taxes are cut even if the son’s earnings exceed his or her standard deduction. The reason is that the unsheltered earnings will be taxed to the son beginning at a rate of 10%, instead of being taxed at his father’s higher rate.

How payroll taxes might be saved

If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.

Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners.

Start saving for retirement early

Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA. For the 2018 tax year, a working child can contribute the lesser of his or her earned income, or $6,000 to an IRA or a Roth.

Raising tax-smart children

As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. If you have any questions about how these rules apply to your situation, don’t hesitate to contact us at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Consider a Roth 401(k) plan — and make sure employees use it

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Roth 401(k) accounts have been around for 13 years now. Studies show that more employers are offering them each year. A recent study by the Plan Sponsor Council of America (PSCA) found that Roth 401(k)s are now available at 70% of employer plans, up from 55.6% of plans in 2016.

However, despite the prevalence of employers offering Roth 401(k)s, most employees aren’t choosing to contribute to them. The PSCA found that only 20% of participants who have access to a Roth 401(k) made contributions to one in 2017. Perhaps it’s because they don’t understand them.

If you offer a Roth 401(k) or you’re considering one, educate your employees about the accounts to boost participation.

A 401(k) with a twist

As the name implies, these plans are a hybrid — taking some characteristics from Roth IRAs and some from employer-sponsored 401(k)s.

An employer with a 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts.

As with traditional 401(k)s, eligible employees can elect to defer part of their salaries to Roth 401(k)s, subject to annual limits. The employer may choose to provide matching contributions. For 2019, a participating employee can contribute up to $19,000 ($25,000 if he or she is age 50 or older) to a Roth 401(k). The most you can contribute to a Roth IRA for 2019 is $6,000 ($7,000 for those age 50 or older).

Note: The ability to contribute to a Roth IRA is phased out for upper-income taxpayers, but there’s no such restriction for a Roth 401(k).

The pros and cons

Unlike with traditional 401(k)s, contributions to employees’ accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key 401(k) tax benefit. On the plus side, after an initial period of five years, “qualified distributions” are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, regular 401(k) distributions are taxed at ordinary-income rates, which are currently up to 37%.

In general, qualified distributions are those:

  • Made after a participant reaches age 59½, or
  • Made due to death or disability.

Therefore, you can take qualified Roth 401(k) distributions in retirement after age 59½ and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts. And unlike traditional 401(k)s, which currently require retirees to begin taking required minimum distributions after age 70½, Roth 401(k)s have no mandate to take withdrawals.

Not for everyone

A Roth 401(k) is more beneficial than a traditional 401(k) for some participants, but not all. For example, it may be valuable for employees who expect to be in higher federal and state tax brackets in retirement. Contact us if you have questions about adding a Roth 401(k) to your benefits lineup at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

What type of expenses can’t be written off by your business?

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If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. It doesn’t explicitly state that you can deduct office supplies and certain other expenses.

Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automatic defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers a heart attack.

It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retains the 50% deduction for business meals.)

Examples of not ordinary and unnecessary

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures.

In one case, a man engaged in a business with his brother was denied deductions for his private airplane expenses. The U.S. Tax Court noted that the taxpayer had failed to prove the expenses were ordinary and necessary to the business. In addition, only one brother used the plane and the flights were to places that the taxpayer could have driven to or flown to on a commercial airline. And, in any event, the stated expenses including depreciation expenses, weren’t adequately substantiated, the court added. (TC Memo 2018-108)

In another case, the Tax Court ruled that a business owner wasn’t entitled to deduct legal and professional fees he’d incurred in divorce proceedings defending his ex-wife’s claims to his interest in, or portion of, distributions he received from his LLC. The IRS and the court ruled the divorce legal fees were nondeductible personal expenses and weren’t ordinary and necessary. (TC Memo 2018-80)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep records to substantiate the expenses you’re deducting. Consult with us for guidance at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Employee vs. independent contractor: How should you handle worker classification?

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Many employers prefer to classify workers as independent contractors to lower costs, even if it means having less control over a worker’s day-to-day activities. But the government is on the lookout for businesses that classify workers as independent contractors simply to reduce taxes or avoid their employee benefit obligations.

Why it matters

When your business classifies a worker as an employee, you generally must withhold federal income tax and the employee’s share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer’s share of these taxes, pay federal unemployment tax, file federal payroll tax returns and follow other burdensome IRS and U.S. Department of Labor rules.

You may also have to pay state and local unemployment and workers’ compensation taxes and comply with more rules. Dealing with all this can cost a bundle each year.

On the other hand, with independent contractor status, you don’t have to worry about employment tax issues. You also don’t have to provide fringe benefits like health insurance, retirement plans and paid vacations. If you pay $600 or more to an independent contractor during the year, you must file a Form 1099-MISC with the IRS and send a copy to the worker to report what you paid. That’s basically the extent of your bureaucratic responsibilities.

But if you incorrectly treat a worker as an independent contractor — and the IRS decides the worker is actually an employee — your business could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren’t, including penalties under federal laws.

Filing an IRS form

To find out if a worker is an employee or an independent contractor, you can file optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Then, the IRS will let you know how to classify a worker. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and inadvertently trigger an employment tax audit.

It can be better to simply treat independent contractors so the relationships comply with the tax rules. This generally includes not controlling how the workers perform their duties, ensuring that you’re not the workers’ only customer, providing annual Forms 1099 and, basically, not treating the workers like employees.

Workers can also ask for a determination

Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.

If a worker files Form SS-8, the IRS will send a letter to the business. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

Defending your position

If your business properly handles independent contractors, don’t panic if a worker files a Form SS-8. Contact us before replying to the IRS. With a proper response, you may be able to continue to classify the worker as a contractor. We also can assist you in setting up independent contractor relationships that stand up to IRS scrutiny. 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

How entrepreneurs must treat expenses on their tax returns

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Have you recently started a new business? Or are you contemplating starting one? Launching a new venture is a hectic, exciting time. And as you know, before you even open the doors, you generally have to spend a lot of money. You may have to train workers and pay for rent, utilities, marketing and more.

Entrepreneurs are often unaware that many expenses incurred by start-ups can’t be deducted right away. You should be aware that the way you handle some of your initial expenses can make a large difference in your tax bill.

Key points on how expenses are handled

When starting or planning a new enterprise, keep these factors in mind:

  1. Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
  2. Under the federal tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. We don’t need to tell you that $5,000 doesn’t go far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
  3. No deductions or amortization write-offs are allowed until the year when “active conduct” of your new business commences. That usually means the year when the enterprise has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Has the activity actually begun?

Examples of expenses

Start-up expenses generally include all expenses that are incurred to:

  • Investigate the creation or acquisition of a business,
  • Create a business, or
  • Engage in a for-profit activity in anticipation of that activity becoming an active business.

To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example would be the money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the outlay must be related to the creation of a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing the new business and filing fees paid to the state of incorporation.

An important decision

Time may be of the essence if you have start-up expenses that you’d like to deduct this year. You need to decide whether to take the elections described above. Recordkeeping is important. Contact us about your business start-up plans. We can help with the tax and other aspects of your new venture. 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Deducting business meal expenses under today’s tax rules

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In the course of operating your business, you probably spend time and money “wining and dining” current or potential customers, vendors and employees. What can you deduct on your tax return for these expenses? The rules changed under the Tax Cuts and Jobs Act (TCJA), but you can still claim some valuable write-offs.

No more entertainment deductions

One of the biggest changes is that you can no longer deduct most business-related entertainment expenses. Beginning in 2018, the TCJA disallows deductions for entertainment expenses, including those for sports events, theater productions, golf outings and fishing trips.

Meal deductions still allowed

You can still deduct 50% of the cost of food and beverages for meals conducted with business associates. However, you need to follow three basic rules in order to prove that your expenses are business related:

  1. The expenses must be “ordinary and necessary” in carrying on your business. This means your food and beverage costs are customary and appropriate. They shouldn’t be lavish or extravagant.
  2. The expenses must be directly related or associated with your business. This means that you expect to receive a concrete business benefit from them. The principal purpose for the meal must be business. You can’t go out with a group of friends for the evening, discuss business with one of them for a few minutes, and then write off the check.
  3. You must be able to substantiate the expenses. There are requirements for proving that meal and beverage expenses qualify for a deduction. You must be able to establish the amount spent, the date and place where the meals took place, the business purpose and the business relationship of the people involved.

Set up detailed recordkeeping procedures to keep track of business meal costs. That way, you can prove them and the business connection in the event of an IRS audit.

Other considerations

What if you spend money on food and beverages at an entertainment event? The IRS clarified in guidance (Notice 2018-76) that taxpayers can still deduct 50% of food and drink expenses incurred at entertainment events, but only if business was conducted during the event or shortly before or after. The food-and-drink expenses should also be “stated separately from the cost of the entertainment on one or more bills, invoices or receipts,” according to the guidance.

Another related tax law change involves meals provided to employees on the business premises. Before the TCJA, these meals provided to an employee for the convenience of the employer were 100% deductible by the employer. Beginning in 2018, meals provided for the convenience of an employer in an on-premises cafeteria or elsewhere on the business property are only 50% deductible. After 2025, these meals won’t be deductible at all.

Plan ahead

As you can see, the treatment of meal and entertainment expenses became more complicated after the TCJA. Your tax advisor can keep you up to speed on the issues and suggest strategies to get the biggest tax-saving bang for your business meal bucks. Contact us at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Divorcing business owners need to pay attention to tax implications

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If you’re getting a divorce, you know it’s a highly stressful time. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and your marital property will include all or part of it.

Transferring property tax-free 

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

For example, let’s say that, under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:

  • A year after the date the marriage ends, or
  • Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

Future tax implications

Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the IRS now extends the beneficial tax-free transfer rule to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Avoid adverse tax consequences

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Your tax advisor can help you minimize the adverse tax consequences of settling your divorce under today’s laws. Contact us at 205-345-9898 or info@covenantcpa.com for more info.

© 2019 CovenantCPA

Present yet unaccounted for: The problem of presenteeism

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Absenteeism has typically been a thorn in the side of many companies. But there’s a flip side to employees failing to show up to work: “presenteeism.” This is when employees come in to work unwell or put in excessive overtime.

Now you probably appreciate and respect workers who are team players and go the extra mile. But employees who come to work when they aren’t operating at full physical or mental capacity may make mistakes, cause accidents, create confusion and ultimately hurt productivity. In other words, presenteeism can slowly and silently erode your bottom line unless you recognize and deal with it.

Address mental health

A common response to presenteeism is, “But we offer paid sick days.” Although paid sick days do generally help resolve incidences of a physical ailment or injury, they may not adequately address struggles with mental illness or extreme personal stress (such as a divorce or financial crisis). Some managers may raise an eyebrow at those taking a “mental health day,” so sufferers end up coming in to work when they really may need the day off.

How can you help? If you sponsor a health care plan, it likely offers coverage for mental health and substance use disorder services, including behavioral health treatment. Be sure employees are aware of this. Also, reinforce with employees that you’ll honor the sick-day provisions spelled out in your employee manual for all types of ailments (physical, mental and psychological). Train supervisors to support employees’ well-being and encourage those who need to take time off to do so if they need it.

Discourage excessive overtime

Another common cause of presenteeism is the perceived notion among many workers that they must work excessive overtime to prove themselves. Many companies still operate under an “old school” culture that says putting in extra overtime will make the boss happy and lead to quicker raises and promotions.

Generally, many managers assume that, if an employee is absent, his or her productivity must be suffering. Conversely, if that same employee is putting in extra time and skipping vacations, he or she must be highly productive. But these assumptions aren’t always true — they must be supported by a thorough, objective and analytical performance evaluation process.

You can prevent this type of presenteeism by strongly encouraging, if not strictly enforcing, vacation time. Communicate to employees your concerns about overworking and remind them to take advantage of the time off that they’ve earned. (Doing so can also deter fraud.)

Find the balance

Having a workforce full of dedicated, hard-working employees is still a goal that every business should strive for. But, at the same time, work-life balance is a concept that benefits both employers and employees. Our firm can help you analyze the numbers related to productivity that can help you make optimal decisions regarding staffing and workflow. Call us or email us today at 205-345-9898/ info@covenantcpa.com.

© 2019CovenantCPA