The importance of estate planning

The lives of people who have been diagnosed with cancer are often turned completely inside out. This includes their finances -- savings can be depleted, jobs may be jeopardized and priorities may change. Given all of these changes, it is important to know what steps can be taken to secure your finances.

Financial and estate planning are important, however, many people prefer to avoid doing it. Although it’s often emotionally difficult, estate planning has benefits that bring peace of mind and a sense of security. Some of the benefits include: documenting your wishes regarding distribution of your assets; ensuring that you receive the level of medical care you want; reducing the burden of difficult decisions and tasks on loved ones; reducing taxes and government fees on your estate (probate).

Being prepared allows you to direct other decisions as well. For example, you can name a guardian and specify funeral arrangements. Planning your funeral preferences in advance will save unnecessary expense and anxiety at a difficult time in your loved one’s lives.

Estate planning is preparing and documenting a plan of how to distribute your property. This usually involves completing advance health care directives, naming a power of attorney, developing a will and establishing trusts.

Regardless of how much money you have, your health or your age, you need to have documentation that states exactly how to transfer your assets to the people you choose. If your wishes and intentions are not in writing, they can be challenged and perhaps never carried out as you want.

Should I Hire a Contractor or an Employee?

FROM ENTREPRENEUR.COM

Hiring the right person for the right job, whether a contractor or an employee, is a task that all employers will find themselves doing again and again. 

Here are some typical questions that might arise in handling staffing issues at professional services businesses, with my answers, based on my experience:

1. What is a scalable workforce and how can it help my business?

Scalability, by definition, is the ability to change in size. Services companies and other knowledge-based businesses are unique from other firms in that they scale by adding people. With a services business, the fundamental revenue driver is payment for the delivery of services by people at the firm. Thus, when the ability to scale depends on the number of people offering services, it begs the question, Does the company hire a contractor or bring on a new employee?  

The business probably falls into one of two categories: The workforce is scaled for growth, fluctuating depending on how many projects are acquired. Or the workforce remains steady, regardless of the number of projects in the pipeline. 

If the company can scale its business for growth, it becomes more flexible in being able to accept a large opportunity that comes along by quickly adding more resources (such as independent contractors). This solves the problem of having to turn away work due to limited resources. If the company has a slow month, then managers can easily slim down the workforce and scale back costs. 

2. Can an owner truly grow a business with independent contractors?

Tapping into a network of providers is a really strong strategy for growing a business. Then it's always possible to say yes to more work. Keeping a reliable, trustworthy, solid base of contractors who can be hired on an ad-hoc basis is a good idea.

Small business owners should also focus on empowering their managers to oversee the delivery of projects, keep an ear to the ground for additional projects and continually look for opportunities to provide fresh services to clients. Managers need to have a keen sense of providing value and keeping client needs in mind to provide exceptional service. 

3. When is it time to hire a contractor?

Keep a budget for hiring contractors as needed. Here are some indications that a project might be better suited for a contractor:

a) The business does not have employees available to perform the tasks.

b) Demand is uncertain.

c) The job requires a specialized skill that the company lacks or the business owner doesn't plan to specialize in.

4. When is it time to hire a full-time employee? Is there a tipping point when it makes the most sense?

The decision to hire full-time employees doesn't have anything to do with the size of the organization as much as its profit margins. If the billable time of current full-time employees is at or above 85 percent and the profit margins are at least 50 percent, those are good indicators that the company is ready to add another full-time employee. A company makes less of a profit margin on contractors, so it's important to factor in their workload.

If these numbers aren't being reached, the company is better off keeping its costs variable (by using contractors) until the firm can reach these margins.

5. What's a good mix between employees and contractors?

The answer will depend on each company's unique circumstances, but a 30 percent contractor base is generally a good number for a small services business. The 85 percent chargeability is the magic number to hit before bringing on additional employees. If the company is not there yet, work on increasing the profit margins and use the network of contractors to take on more work.

6. Do clients care if the work is contracted out?

It’s OK to scale the business by tapping into contractors and customers won’t care as long as the company owns the quality of the work. This is why it’s so important to develop a network of trustworthy contractors. Sourcing quality talent is a skill on its own and there’s great value in knowing where the best talent is and how to manage it.

5 Factors of Audit Risk for Small Businesses

While your risk of being audited is low and likely to stay low according to the IRS commissioner*, it’s still scary to think you may find yourself under the IRS microscope. Can you avoid this? Maybe. Will knowing your risk factors put you more at ease? Hopefully.  Here are 5 factors that impact audit risk for small businesses.

Entity type

Believe it or not, the way in which you organize your business from a legal standpoint impacts your audit risk. Statistics in the 2014 IRS Data Book show that an S corporation or partnership (including a limited liability company filing a partnership return)—regardless of income or other factors—had only a 0.4% chance of being audited in the government’s fiscal year ending September 30, 2014. In contrast, a sole proprietorship with gross receipts between $100,000 and $200,000 had a 2.4% audit risk (or 6 times as great as the other pass-through entities).

Does this mean that sole proprietorships should change their entity form? Not necessarily, because it is less costly from an administrative perspective to operate as such. However, it’s important to recognize that being a sole proprietor places greater need on owners to maintain good books and records and follow tax rules.

Income

The amount of gross receipts (fees, sales receipts, and other earnings before any deductions) impacts the audit risk of sole proprietorships. Here’s what the Data Book shows for the government’s 2014 fiscal year:

Gross receipts	Percentage of returns audited
Under $25,000	1.0
$25,000 to under $100,000	1.9
$100,000 to under $200,000	2.4
$200,000 or more	2.1

Does this mean that if you’re a sole proprietor, you should control your income to minimize audit risk? Of course not. Knowing your audit risk simply puts you on the alert to use good business practices as protection in case of audit.

Location

IRS offices are staffed differently in various locations across the country, enabling some offices to conduct more audits than others. There is no current data on how this impacts your audit risk (in prior years, certain districts such as Manhattan, NY, and Houston, TX were known to have higher audit risks).

Again, should you relocate to a place with little or no IRS coverage? No. Just be prepared to face an audit if you have to by carefully tracking your income and expenses.

Deductions

The type and amount of deductions claimed can flag a return for audit. Because travel and entertainment expenses deducted for business may arguably be more personal in nature, the IRS looks carefully at these write-offs to make certain they are legitimate and that they’ve been adequately substantiated.

Also IRS computers are purported to select returns of businesses that take unusually high deductions relative to their income. (One government agency reported back in 2004 the average expenses for sole proprietorships.) Once selected, an agent may look a little more closely before deciding whether to commence an examination. This may simply be asking for substantiation of deductions claimed on the return (a process that can be done by mail or phone).

Businesses should take every deduction to which they are entitled. However, they must have required documentation (e.g., receipts, logs) for them.

Type of business

Cash businesses are suspected of omitting income because they can; there is little or no paper trail. In fact, cash businesses are said to be a large part of the more than $450 billion tax gap. The tax gap is the spread between what the government thinks it should collect and what it actually collects.

There is an IRS audit guide specifically for cash intensive businesses (e.g., beauty shops, car washes, laundromats, and many other types of small businesses), which instructs agents about what to look for during an audit. Cash businesses should review this guide to learn what they can do to create audit protection, just in case they are selected for examination.

Conclusion

Some people continue to believe that taking a home office deduction is an audit red flag. There are no statistics or other evidence to show this is true. According to the SBA, 52% of all businesses in the U.S. are home-based, so it’s not likely that the IRS is going after every one of them.

The conclusion that these factors lead to is that no one thing triggers an audit; you are at risk under any of these or other factors. The best course of action: Retain all receipts and other tax papers (even if scanned into your smartphone or desktop), conscientiously record income and expenses, and work with a tax professional.

To Gift Or Not To Gift: That Is The Question

FROM MONDAQ.COM

For many years, the general rule of thumb in estate planning has been that an individual should gift assets during his or her lifetime. Lifetime gifting can offer many benefits. Most significantly, any future appreciation in the gifted asset is removed from the estate.

In 2015, an individual can transfer up to $5.43 million during his or her life without incurring any gift tax liability. This amount is often referred to as the "exemption amount," and it is indexed yearly for inflation. Upon death, the exemption amount translates into an estate tax exemption, meaning that $5.43 million (also indexed for inflation), less what has been used during the individual's lifetime by making gifts, can pass free of estate tax.

The Narrowing Gap Between Estate and Gift Tax Rates

Recent changes in the law have made the income tax consequences of estate planning increasingly relevant. The state tax liabilities, basis issues, ages, and life expectancies of the donor and donee must be considered, and there are tax planning techniques that may allow an individual to take advantage of lifetime gifting while reducing future income tax liability.

Each individual has a "basis" in every asset he or she owns. When an individual sells an asset, he or she must pay income tax, often at the capital gains tax rate, on the difference between the asset's sale price and his or her basis in the asset. The basis is usually the price paid for the asset; however, when an individual receives an asset as a lifetime gift, the individual takes a "carryover" basis equal to the donor's basis in the property immediately prior to the gift (increased by any gift tax actually paid by the donor upon transfer). Conversely, when an individual dies owning an asset, the recipient's basis in the asset is adjusted to reflect the value of the asset on the decedent's date of death, which in many cases results in a "stepped-up" basis.

Historically, estate tax rates have been significantly higher than capital gains tax rates. Thus, it was generally preferential to make lifetime gifts rather than hold an asset until death in order to receive a stepped-up basis. However, recent legislation significantly lowered the top federal estate tax rate from 55% to 40% and increased the top federal long-term capital gains tax rate from 15% to 23.8% (20% plus a 3.8% tax to fund the Affordable Care Act, often referred to as the "Medicare Tax"), narrowing the gap between the estate tax rate and the capital gains tax rate.

To illustrate, assume Parent, a New York City resident, owns an apartment in the city that she bought 40 years ago, currently worth $5.43 million with a basis of $100,000. If Parent gives the apartment to Daughter in 2015, Parent will owe $0 in federal gift tax. If the apartment appreciates to $12.43 million by the time of Parent's death in the year 2017, then the gift has saved roughly $2.2 million in federal estate tax (40% of the $7 million in appreciation, less the deduction for state-level estate taxes paid). In addition, New York also imposes a separate state-level estate tax (with an indexed exemption that will not match the federal exemption amount until 2019) and would levy its own estate tax bill of approximately $1.45 million, bringing the total tax to roughly $3.65 million.

However, assume that two years after Parent's death, Daughter needs to sell the apartment. Daughter has a carryover basis of $100,000 in the apartment, and the apartment has appreciated further and is now worth $13 million. Federal income tax on $12.9 million would be due, which at the top current long-term capital gain rate of 23.8% would result in approximately $3.07 million in federal income taxes for Daughter. The income tax effect is further exacerbated if we assume Daughter is a New York City resident with a top aggregate federal, state, and city effective capital gains rate of 36.5% – this bumps her total tax bill up to approximately $4.7 million. Thus, in this scenario, making a lifetime gift of the apartment was not the tax-optimal choice.

The Takeaway

Before the narrowing of the gap between estate/gift and capital gains tax rates, the decision whether to gift assets during one's lifetime rather than retain such assets until death for the basis step-up was simple – lifetime gifting was almost always the preferred choice. However, in the current era of ever-increasing income tax rates, a careful analysis of all of the relevant factors, such as state tax liability, basis issues, the age and life expectancy of the individual owning the assets, and the age and financial situation of the individual likely to receive the assets, is critical. In addition, there are certain tax planning techniques that may allow an individual to take advantage of lifetime gifting while at the same time reducing future income tax liability.

How Tax Preparers Like H&R Block are Making the Tax Code More Complicated for America’s Poor

FROM IJRREVIEW.COM

H&R Block has lobbied Congress to make qualifying for an important low-income tax credit in the future more difficult; and so far, they’re succeeding.

The H&R Block business model, and that of other tax return preparers, is predicated on taxes being difficult to file. But, as Vox reported Monday, the Senate Appropriations Committee passed a funding bill that targets one of the most important credits for low-income people: the Earned Income Tax Credit (EITC).

The funding bill covers the IRS. The accompanying report instructs the IRS to quadruple the length of the form that taxpayers must fill out with their eligibility information. The IRS requires the form to qualify for the EITC. The bill, being considered by the full Senate, would expand this form from one to four or five pages.

In a statement, H&R Block told IJReview:

“This issue is about reducing tax fraud and protecting the future of the EITC. By its own estimate, the Treasury Department believes $16–19 billion in improper EITC payments were paid out in 2014. …

“That’s a threat to the millions of Americans who legitimately receive the EITC. Reducing fraud … will better protect this program and the people who really deserve it.”

Despite the program’s frequent overpayments, it is one of the few tax provisions that receives praise for alleviating poverty across party lines.

The EITC offers refunds for people who don’t make enough money to file taxes normally. Currently, Vox reports, recipients only have to fill out a single-page form. The IRS also offers free tax preparation centers for poor people who have trouble completing their returns.

Despite this, in 2014, about two-thirds of EITC recipients paid to have their returns prepared, which means checks are cut to tax preparers instead of America’s working poor.

More about the Earned Income Tax Credit:

• It is a federal tax credit for low- and moderate-income working people;
• People with and without children and spouses are eligible;
• Creates an incentive to work because the value of the credit grows with each additional dollar of earnings until the worker reaches the maximum;
• EITC expansions have been found to be the most importantreason why employment rose among single mothers in the 1990s — not welfare reform, not a strong economy;

In the 2015 tax year, families with children and an annual income below $39,000 may be eligible for the federal EITC. That threshold can go up to $53,300, depending on marital status and number of children. Working people with no children and incomes below $14,800 (up to $20,300, depending on marital status) may also be eligible.

Almost 28 million Americans received EITC tax credits in 2013, accordingto the IRS, with an average refund of $2,407. These payments totaled $66 billion and, currently, four out of five people eligible for the tax credit claim it.

But if Congress implements this change in paperwork, according to Robert Greenstein, President of the Center on Budget and Policy Priorities:

“No one should be surprised to see large numbers of individuals who now file their own returns either giving up and not claiming the EITC due to the added complexity or turning to paid preparers, who could charge hundreds of dollars for their services.”

In a letter sent late last year to the IRS commissioner and the Department of the Treasury, H&R Block CEO William Cobb defended the change as an effort to reduce improper payments and fraud.

H&R Block emphasized this again to IJReview:

“This is not about competitive business interests.”

H&R Block has spent over $14.3 million in lobbying since 1998, according to the Center for Responsive Politics.

Taxes and new businesses

Starting a new business can be exciting. However, it can also be overwhelming, especially when it comes to determining tax obligations.

While income tax obligations are the most obvious, other decisions you may make when starting out will affect your business. Below are some tax tips to consider.

• Structure: When starting your business, you must choose a business structure that is right for you. Your choices are many, including sole proprietorships, limited liability companies, partnerships and corporations. The most common type of business structure is a limited liability company or corporation because of the potential benefit of liability protection offered to owners.

Business structure will also determine how business taxes will impact your business. Generally, there are four types of business taxes: income, self-employment, employment and excise tax. Depending on the type of business you operate, there may be additional state and local taxes that could apply. It’s important to determine those obligations at the start of your business so you can register with the appropriate federal or state agencies and obtain any licenses or permits necessary to run your business.

• Accounting: Another item to consider when starting your new business is an accounting method, which your business will need to track the organization’s income and expenses. In most cases, you can choose the cash method or accrual method, as long as you use a consistent method.

As a business owner, you should know how each method works as well as the advantages and disadvantages of each so you can choose the better one for your business.

• Health care: If your new business is going to have employees, make sure to consider the tax issues that come with employee health care. Depending on the number of employees you have, you may be subject to the Affordable Care Act and information reporting responsibilities to the Internal Revenue Service regarding minimum essential coverage that you offer.

These are just a few of the decisions that you will consider when starting your new business. With proper information and planning, you can get your new business up and running and minimize the risk of being caught off guard later.

Recent Tax Bracket Changes Will Impact Small Business Owners

One of the most significant changes is the new tax brackets, now totaling seven. It is important that businesses are aware of their new tax bracket so that they are prepared for their upcoming tax bill.

Another notable change is the alterations to taxation on capital gains. Capital gains taxes have been expanded and, underscoring the importance of recognizing a new tax bracket,businesses are taxed for capital gains according to their tax bracket. There are also changes in how ordinary and qualified dividends are each treated for taxation.

Small businesses should also be aware of the changes to payroll (FICA) taxes. These include Social Security tax, Medicare tax and the additional Medicare tax for high-earners. The Social Security tax is 12.4 percent on income up to earnings of $118,500 and Medicare is now at 2.9 percent on all earnings. Medicare for higher-earning employees is at 0.9 percent on all income over $250,000 if married and filing jointly.

New tax rules also allow for expanded contributions to retirement accounts. In a variety of 401(k) and IRA accounts, contributions are expanded to allow more income to be invested before taxes.

“In addition to being aware of these changes, there are a lot of steps that small businesses can take to make tax preparation easier in the spring. Saving every receipt for potential deductions, for instance, can have a significant impact on the tax bill,” says Rice. “Staying organized, with careful bookkeeping, is another way to make tax time painless. We work with a lot of small businesses and it is important to think about your taxes throughout the year, not only during tax season.”