So You Want to Be Your Own Boss, eh?

Over the years I’ve had a lot of people come in for consultations about starting a new business.  Either they’ve already taken the plunge and want to understand what they’re getting themselves into from an accounting, recordkeeping, and tax perspective, or they’re currently an employee and are considering going out on their own.  And then there are the people who come to me at tax time (after the prior tax year has ended) because they need someone to prepare tax returns for their first year of small business activity.  Regardless of the reason for these people showing up at my office, many times the result of the meeting is them scratching their head wondering what they got themselves into, and whether having their own small biz is even worth it.  Having been a small biz person myself for about twenty years, my answer is “yes”, it’s definitely worth it.  Those who know me personally know that in some respects I march to the beat of my own drum, and I told somebody recently that at this point in my life/career, I couldn’t even picture myself being an employee of somebody else.  Being my own boss, I set my own hours and schedule from day to day and week to week, I don’t have to get permission to take a day off or a vacation, and I pretty much come and go as I please.  At the same time, all the responsibility falls on my shoulders.  I can’t blame somebody else if a client should complain, it’s up to me to get the work done for the clients, and it’s up to me to network or do whatever else is needed to obtain and retain clients.  And that’s just the way I like to lead my professional life!  For those of you who are considering going into business for yourself, there are some important things to consider when you’re thinking of taking the plunge into entrepreneurship (is that an actual word?  My autocorrect didn’t change it!)

Taxes: As a CPA, of course the very first thing I need to bring up is taxes, as that’s generally the main reason why prospective or new small biz owners consult with me.  From an income tax perspective, there’s generally no difference between how much you’re going to pay as an employee vs how much you’re going to pay as a sole proprietor small business.  What I mean is that $100K will be taxed to you the same way if that’s your W-2 income or that’s your net business income.  There are a couple of small intricacies that make it a bit different, but I don’t want to bog you down with tax-speak right now.  The big difference that a lot of people don’t expect or anticipate is what’s called self-employment tax.  As an employee, you have 7.65% withheld from your paycheck for “FICA”, which is Social Security and Medicare.  As a cost of having employees, your employer kicks in a matching 7.65% expense of their own, and 15.3% is paid in to the government on your behalf.  As a self-employed small biz owner, you’re responsible for both of those halves out of your own pocket, which is the self-employment tax.  So being in biz for yourself will cost you an additional 7.65% in FICA tax.  Again, I’m oversimplifying it a bit, but if your net biz income is $100K, you’re going to pay $7650 more in FICA than if you received that same $100K as an employee, which is a substantial chunk of dough.  The other point I want to make regarding taxes has to do with actually getting that tax paid in to the fed and state governments.  As an employee it’s very easy; your employer withholds FICA, fed, and state tax from your gross pay and you receive your net paycheck.  When you’re self-employed, you’re responsible for getting all that tax paid in yourself, via quarterly estimated tax payments.  There’s the actual physical payments that you need to remember to do, but even before you get to that, you need to be disciplined enough to set that money aside (and not spend it) so you’ll have it on hand to pay it in every quarter.  Between self-employment tax, federal income tax, and state income tax, I generally recommend to people that they set aside anywhere from 25 to 40% of what they receive from their clients, to cover their taxes.  Depending on how much one expects to make from their small biz, that amount could be even higher.

Insurance: I’ll keep this one brief, but as an employee, many times you have a whole “menu” of insurance options available through an employer, such as health, dental, vision, disability, and life.  As a self-employed person you’ll either have to get those items covered through your spouse (if offered at her/his work) or you’ll have to find those items yourself, and pay for them on your own.  Health insurance generally can be 100% deducted as a self-employed business owner, but, again, I won’t bog you down with the ins and outs of doing that.

Retirement: As with taxes and insurance, when it comes to saving money for retirement, it’s all on you.  You can set up your own SEP (simplified employee pension) or Solo 401K, but, again, it’s up to you to set it up and to fund it.  On the plus side, there’s the opportunity to sock away a lot more dough as a self-employed person than you can as an employee.

Liability: As an employee, liability for what happens between your employer and their clients is usually your employer’s issue, not yours (disclaimer…I’m not an attorney) but when it’s your business you need to insulate yourself from liability as best as possible, through business insurance and also by setting your business up as either a corporation or limited liability company (LLC).

As I said at the beginning, I wouldn’t trade being my own boss for being an employee.  I like the “thrill of the chase” when it comes to drumming up biz, and I like to be able to help people and have the fees wind up in my pocket at the end of the day.  I think you’ll find the same to be true for you, as long as you have some good information and understand what you’re getting yourself into.

Do you have any thoughts or interesting anecdotes about your own experiences with entrepreneurship?  Please share them.

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Is it a Business, or is it a Hobby?

How many of you out there make really good homemade hummus? I’m typing with one hand, while I raise the other. My wife thinks that it’s better than the pre-made store bought stuff, and that I should sell it to the public. For all my clients, no, I’m not quitting my day job (yet, haha!). Aside from figuring out a catchy name for it (JayTheCPA’s hummus doesn’t quite roll off the tongue), could I really make a go of this as a business, or is it really just a hobby?

If you’ve been doing some sort of activity that you love to do (baking cakes for friends, for example), is this something that you can deduct the expenses for, and reduce your taxes? I’ll give you a big resounding maybe!

IRS has various rules to determine whether an activity is a bona fide business, or just a hobby. If an activity is an actual business, for a sole proprietor the income and expenses are shown on Schedule C, as part of your individual income tax return, and if your expenses exceed your income, the resulting loss can offset other income items on your tax return. If the activity is a hobby, expenses can only be deducted to the extent of income, so if you have no income, you can’t deduct any expenses. If you do have income, the expenses are deducted as a miscellaneous itemized deduction, subject to a floor/deductible/”haircut” of 2% of your adjusted gross income. The bottom line is that if you’ve got a hobby, you’re probably not going to get much of a tax deduction for it, if at all.

So how do you know whether your activity is a business or a hobby? Here are a few of IRS’s factors for determining the answer:

1-how is the activity carried on – IRS will look at whether the activity is being conducted in a businesslike manner. Is there a separate bank account? Are books and records being kept?

2-what is the individual’s expertise – there should be extensive knowledge of the activity, potentially showing that advice has been sought from experts.

3-time and effort on the activity – if you have a full time job and pursue the activity an hour a week, it may indicate that this is not a serious business activity for you.

4-history of income or losses from the activity – while you may be able to get away with showing a loss on Schedule C for a year or two, showing losses year after year would indicate that there’s no real profit motive for the activity, in which case IRS will deem the activity a hobby, and disallow previous losses claimed.

IRS looks at a number of other factors when making a determination of whether an activity is a business or a hobby. At this point, my hummus making (and other culinary adventures) is strictly a hobby, so I’ll keep IRS out of what’s left of my hair, and will leave the expenses off my tax return. Before you start taking deductions for your hobby, contact your friendly neighborhood CPA for advice. Do you have any interesting tax stories regarding hobbies? Please share.

To Err is Human, To Deduct Divine

I think I erred once, but it turns out I was just plain wrong! Anyhow, this article isn’t about erring, but about claiming some of those divine tax morsels, deductions!

If you’re a new small business owner, you may not know what the @#$% is deductible and what isn’t. Even if you’re not a new owner, there could still be deductions available that you may not have thought of. I’ll give you a little bit of free advice right now…contact a CPA! I have to try; after all, it is my blog. O.K., since I’m such a nice guy, I’ll give you a few ‘freebies’.

Business Meals-unfortunately only 50% of what you spend on business meals is deductible, but 50% is better than zero! The key to getting the deduction is to keep good records, which includes having an entry in your calendar or organizer showing the name of the person you’re dining with, and having a receipt with the date. I’m often asked about whether you need to keep every business meal receipt, and isn’t there a minimum amount, below which you don’t need a receipt? My answer is “don’t argue with me, just keep your receipts”. No, I’m not really that tough, but the fact is, if you’re ever audited, and you tell the auditor that all of your business meals were $20 so you didn’t keep any receipts, you’re gonna get your deduction tossed out. It’s better to be able to substantiate most of your meals than none of them, so keep your receipts; it’s really not difficult to do.

Cell Phones-or smartphones; who doesn’t use them these days? Yes, I understand that you use yours to yack with your friends, send text messages, write a five-star review of your favorite CPA on Yelp (thank you everybody!), and IRS understands it too. If you use your cell phone for business, don’t be afraid to take some sort of deduction for it.

Cost of Incorporating-if you set up a corporation or LLC, the cost of doing that (attorney fees, filing fees, etc) is deductible. There are certain rules for how much can be deducted and when, so consult a professional (another shameless plug; gotta love it).

Business Use of Car-when it comes to using your car for business, remember one thing; commuting is never deductible, so if you drive from home to the office (or vice versa), forget it. On the other hand, if you drive to a client site or to one of those business meals, that auto use is deductible. The rules to follow for claiming a business auto deduction are too numerous for this article; just know that it’s something to take advantage of.

Cabs and Public Transportation-I took the Metro last week to go to a client in DC. Am I going to take a deduction for the cost of that round trip fare? You’re damned right I’m going to. And you should too, if you’re taking a bus, train, cab, etc to a client, or to that business meal.

CPA-yes, another shameless plug, but you can write me off…as a tax deduction..that is..not as a person, or trusted advisor. Think of it as Uncle Sam paying part of my bill!

Those are but a few of the many things that you can claim as a deduction as a small business owner. Employees of others may also be able to claim some of these deductions, but there are a few more hoops to jump through to be able to do that. I hope you found this helpful, and please pass this along to somebody you think might benefit from this information. If you’ve got any favorite deductions you’d like to share with the masses, please leave a comment. Now get out there and start deducting, woo hoo!

Should Your Independent Contractors Really Be Employees?

About a half year ago, I wrote about some mistakes that small business owners make https://mycpajay.wordpress.com/2012/03/19/mistakes-small-business-owners-make-that-can-cost-themdoh/. One of the items that I briefly discussed was classifying employees as independent contractors, which has become an issue that IRS and state unemployment funds have zeroed in on, in recent past. This article will discuss the issue in a little more detail, and give a few tips on how to stay on the right side of the law.

Here are some interesting stats:

-a 2005 Bureau of Labor Statistics report indicated that contractors made up only 7.4% of all workers, or about 10.3 million workers

-a 2011 study found that 16 million workers were classified as independent contractors, and predicted a higher use of contractors in the next ten years

-a 2000 Department of Labor study found that 10-30% of all employers misclassified workers, and in 2008, IRS found that when employers asked IRS for proper classification, only 3% of workers in question were actually independent contractors, and not employees. You don’t need to be a math whiz to see that most workers are employees!

Considering that it can be about 30% cheaper to call somebody an independent contractor, you can understand why people would want to take that route, even if a person really should be considered an employee. To throw a little fear into you, a 2009 Government Accountability Office report said that 71% of IRS worker misclassification examinations resulted in a change of the worker status. Based on that, the odds are not on your side if you misclassify an employee as a contractor, and you’re called in for an audit. So what can you do to better your odds of classifying correctly?

Review Form 1099s for proper classification-Form SS-8 (Determination of Worker Status For Purposes of Federal Employment Taxes…) is a great guide for determining who has control over the worker, which is one of the main determinants of whether the worker is independent or not. Figure out whether similar workers are categorized differently.

Review workers who received Form W-2 are now treated as contractors-If there’s a reason why somebody who had been an employee is now considered independent, make sure you’ve got a clear, documented explanation for the change.

Review your vendor list, check register, and accounts payable-you can add to your troubles if you were required to file Form 1099-MISC for people who actually are independent, but you didn’t. Penalties can add up. Starting with 2011 business returns, there are now two specific questions about this, so if you have 1099 filing responsibilities, don’t forget to do it.

As I mentioned at the beginning, the employee vs independent contractor issue is something that’s receiving more and more attention, and probably won’t go away any time soon, so make sure you’re doing the right thing, to save yourself from potential major headaches in the future.

Please pass this article on to any small business owner you know, who may benefit from this information, and leave a comment if you’ve had any experiences with this issue, or were audited.

Jay E Reiner CPA PLLC, 1400 14th St N, Arlington, VA 22209

Spring Cleaning, a Little Late

It’s hot as hell outside, and you just want to hibernate in the air conditioning. Trying to figure out what to do while you’re chilling out? How about organizing your tax records?! If you start organizing yourself now, come this tax season, you’ll be cool as a cucumber, and ready to make your favorite CPA’s day, with all of your organized records. IRS has some recordkeeping tips for individuals and small business owners.

What to Keep – Individuals

IRS recommends keeping records that support items on your tax return for at least three years after the return has been filed. Some of these records are bills, credit card and other receipts, invoices, auto mileage logs, canceled or imaged checks, and any other records to support deductions or credits claimed on a tax return. You should also keep records relating to property at least three years after you’ve sold or otherwise disposed of the property. Examples of this include a home purchase or improvement, stocks and other investments, IRA transactions, and rental property records.

What to Keep – Small Businesses

Similar to individuals, for small businesses, IRS recommends the three year timeframe for retention of business records. Examples of these include records that document gross receipts, proofs of purchases, expenses, and assets. These can include cash register tapes, bank deposit slips, purchase and sales invoices, credit card charges, Forms 1099-MISC, canceled or imaged checks, account statements, petty cash slips, and real estate closing statements. Electronic records can include databases, saved files, emails, faxes, and others.

IRS generally doesn’t require records to be kept in any special manner, but common sense would indicate that having a designated place to keep your tax records is a good idea. If you have all of your records in one place, it will make your job a lot easier when preparing to meet with your CPA, or if you should be one of the unfortunate souls who receives an IRS notice, or need to substantiate something for an audit.

The morale of the story is, even when it’s brutally hot and humid outside, you can be one of the coolest people around, when you have your tax records in order (at least this CPA will think you’re cool!). How organized are your tax records? Leave a comment, telling us the good, bad, and the ugly! Please forward this article along to anybody who you think needs to get their tax @#$% together.

Do I need an Outsourced CFO?

Whether you’re starting a business or are already established, you probably have many different concerns, including keeping costs under control, the instability of the economy and business climate, staffing/employee issues, and trying to figure out the best plan for your business’s future growth, profit, and security. Using an outsourced Chief Financial Officer (CFO) makes sense when considering all of these things. Below are some of the benefits of having an outsourced CFO on your team, as well as when to consider using such a service.

What Is an Outsourced CFO?

I’m guessing that we’re all familiar with the term “outsourcing”, regardless of whether that means somebody local or in another country. As it relates to CFO services, some of the more common services that an independent professional can do include preparing and analyzing financial statements (including balance sheet, income statement and cash flow). Additional services may include helping with future growth models and projections, assistance with a business plan, developing an operating budget, and more.

Benefits of an Outsourced CFO

Independent and Objective viewpoint: Unlike internal staff, an external consultant has no preconceptions or agendas in relation to the business agenda.

Creative solutions: Since many consultants have a breadth of experience in a variety of industries, they often bring a new perspective to operations that could be beneficial in the long run.

Networks: In many cases, an external CFO has connections in a variety of fields and industries that may benefit you, particularly for business growth.

When do you need an Outsourced CFO?

As I mentioned above, an outsourced CFO can help when starting a business, or during growth periods:

Start Up: Utilizing the knowledge of an experienced CFO to help you build the proper financial structure initially will pay off in the long run.

Business Growth: As the bookkeeping function starts to morph into something more than payroll, accounts payable, collections, billing, etc. a CFO is necessary to help the company with more advanced activities, such as financial statements and compliance.

Full-timer Is Unnecessary: There comes a time in every business when the financial portion of the company becomes more complex and begins to take up more and more time. However, there is also a gap between this period and the need for a full-time CFO. It’s during that gap when outsourcing CFO services makes the most sense.

Preparing Business Plans: Unless you have experience in this area, it’s best to work with a professional who knows how to prepare the documentation needed by funding sources.

Sounding Board: When a business owner seeks an objective, independent review of his/her business, having a dependable consultant to speak with may be invaluable, especially if it helps you to avoid a costly mistake later.

In the end, to determine if this model is right for your business, weigh the benefits against potential risks. Do your homework. Be diligent about keeping your finger on the pulse of your business and engaging with the chosen CFO through open and frequent communication. And if you’re in the Northern Virginia/DC metro area, contact me about CFO services.

As always, feel free to pass this along to others who may benefit from it, and if you have your own outsourced CFO experience, please share it!

S Corporations and Reasonable Compensation

If you’re a small business owner, you may have heard the term “S corporation” or “S corp”. If you haven’t, then I’m guessing that you haven’t had a conversation with a CPA lately. Small businesses choose to make an “S” election to eliminate the self-employment tax on net income that a sole proprietor, single or multi-member LLC, or partnership would ordinarily be subject to. While there is this valuable tax benefit (13.3% for 2012) to being an S corporation for tax purposes, it’s extremely important to be aware that the savings on self-employment tax is not a giveaway by IRS, and if you’re not careful, it can cost you.

While it’s very tempting to just claim the net income from your S corp on your personal tax return, and only pay income tax (and no self-employment tax) on that income, IRS wants to see you pay yourself a “reasonable compensation” if you perform services for your S corp. If you’re the 100% shareholder and only person involved in your S corp, it would be difficult to claim that you provided no services for your own business, so you need to take a salary, the same way that you would pay a salary to an employee, since you’re in reality an employee of your own S corp. As such, you also become involved with filing quarterly payroll tax returns, making federal and state unemployment contributions, and issuing yourself a W-2 at the end of the year.

If you’re a small business that has made the S election, and are thinking “the heck with taking a reasonable compensation”, be advised that this is something that has seen a lot of noncompliance and abuse in recent past, and it’s on IRS’s radar. They’ve won many court cases on this subject, in spite of the fact that the Internal Revenue Code doesn’t explicitly define what “reasonable compensation” means, even though they’ve issued a fact sheet about compensation for S Corporation officers (just Google “FS-2008-25”).

Making an S election can be a source of significant tax savings, even with the additional costs of using a payroll service to issue paychecks to you and file payroll tax returns, and having a CPA prepare a separate tax return for the business (Form 1120S). It may be worth your while to invest a few dollars in having your tax professional run a side by side comparison of how much total tax you’d pay without having the S election vs. how much you’d pay with the election.

Please share this article with fellow business owners, and leave a comment on your own experience with being an S corp.