Friday, May 24, 2013
Business Tax Tip: Understanding The Balance Sheet
Nicole Newman for Examiner.com writes: Since the Corbett administration has nicely dismantled the women and minority business enterprise program, my business has to find a third party agency to certify our disadvantaged status. We selected the Small Business Administration 8(a) program because it is one of only a few free certification programs left. We spent 8 hours getting our paperwork in order on the SAM and GLS databases when we hit a snag in the requirements. One of the requirements is to have the last 3 years' balance sheets. We had the Profit/Loss (Income Statement) and the Statement ofCash Flows but we didn't have a balance sheet.
Richard Pittelkow, a business advisor for the West Central Indiana Small Business Development Center says "A Balance Sheet summarizes a company’s Assets, Liabilities and Owners’ Equity (Net Worth) at a specific point in time, usually at the end of an accounting period. The purpose of a Balance Sheet is to give users an idea of the company’s financial condition along with displaying what the company owns and owes. It helps business owners quickly get a handle on the financial strength and capabilities of their business. Balance Sheets, along with Income Statements, are also the most basic elements in providing financial reporting to potential lenders such as banks, investors, and vendors who are considering how much credit to grant to companies."
Norm Brodsky, a seasoned entrepreneur says "Think of a balance sheet as a thermometer that provides a reading on the health of a business at the moment you take its temperature. You can quickly determine a business's solvency, for example, by checking its ratio of current assets (those assets expected to be converted to cash within the next year) to current liabilities (those that must be paid within a year). If the ratio is less than 1 to 1, the business is technically bankrupt. Granted, there's some wiggle room. You can postpone paying some bills or speed up collection of receivables and thereby keep the business afloat. But if the ratio falls below, say, 0.8, watch out. You're well down the path to insolvency—even if your company is profitable. Cash and profits are not the same. If you run out of cash, you're out of business."
Luckily for me, Freshbooks upgraded the system October 2012 and added the balance sheet report. On the first of many tries, my balance sheet did not balance! The equity I had invested in the business did not translate to assets (as we had to take many losses with our first accountant!) Then I researched the intangible assets (like reputation, name recognition, and intellectual property such as knowledge and know how.) and my balance sheet finally balanced.Business Dictionary says "Intangible assets are the long-term resources of an entity, but have no physical existence. They derive their value from intellectual or legal rights, and from the value they add to the other assets."
Step 1 is to make the balance sheet balance. That is just the step 1, now you have to know how to interpret the numbers to get the financial picture. Quickbooks says "On completion of an accurate balance sheet for your business, you will be able to determine:
- The productivity and solvency of the business.
- The amount of capital retained in the business.
- How fast or slow assets can be converted to capital.
The productivity and solvency is calculated by the of days of Working Capital – [(Current Assets minus Current Liabilities) divided by (Total Annual Expenses divided by 365)]. Richard Pittelkowsays "This calculates how easily the company can handle the normal ups and downs of revenues while still paying its bills. Eventually, every business will have a month, a quarter, or a year when cash-out exceeds cash-in and without a cushion, the company risks going out of business when this occurs even if vendors, creditors, and employees know the set back is only temporary. In addition, the lack of sufficient Working Capital can be evidence of mismanagement to lenders and investors. Companies should have at least 30 days of Working Capital, and financially strong companies will have 180 days or more."
In the start-up phase of most businesses, the owner is investing more than retaining capital. Every business owner should be looking to see when the amount invested in the business is being returned to the business.
The SBA 8(a) program is specifically looking for three years to conduct trend analysis. Richard Pittelkow points out these questions when looking at trends "Is the receivables cycle lengthening? Can receivables be collected more aggressively? Is some debt noncollectable? Has the business been slowing down payables to forestall an inevitable cash shortage? Are Net Profits being retained in the business for future growth or being withdrawn by the owners? Is exhausted equipment being regularly replaced? Are the debts of the company trending up or down?"
Norm Brodsky said "Numbers run companies. It's your responsibility as an owner to know and to understand not only the income statement but also the balance sheet of your business. You ignore them at your peril." That's sound advice that we are ready to take!
5 ways to help middle-class clients with estate planning
TOM NAWROCKI for LifeHealthPro writes: Estate planning is commonly thought of as something only the truly wealthy need to deal with. After all, the current exemption for the estate tax is $5.25 million, so anyone with assets significantly lower than that doesn’t need to worry about heirs being subject to that tax.
But there are plenty of issues surrounding estate planning that middle-income people will eventually have to deal with, aside from the estate tax. The obvious concern is drawing up a will, which is more closely connected to a client's personal attorney rather than his financial advisor, but there are other avenues of estate planning that can be beneficial for middle-class clients.
Here are some of the issues advisors can present to middle-income clients and prospects in order to try to bring them on as estate planning clients.
Transferring property at death: Although a will covers the “who” when it comes to receiving property, there’s a lot more to the “how” of it that a financial advisor can help with, especially as far as disposing of property prior to one’s death. It can be hard for older people to come to grips with giving their personal effects away, but it’s easier if they can tell their heirs that the directive is coming from their financial advisor.
There are personal effects to consider, such as jewelry and heirloom pieces that parents want to go to particular children or other heirs. An advisor can help focus clients' thinking at a young enough age that they can make long, considered decisions about these things and have plenty of time to consult with their children.
And there are larger items, such as real estate, that need to be planned for. Selling real estate greatly alters one’s financial picture heading into retirement; giving away real estate to one’s heirs will, at the very least, trigger gift taxes. Either way, a good advisor can help.
Powers of attorney: This is another area that is best addressed long before it is actually needed. Clients will be reluctant to give up power over their personal medical decisions until it becomes physically necessary, which opens up an opportunity for an advisor’s help. No one wants to make these decisions when they’re on a feeding tube.
Of particular value is explanation of the various forms of power of attorney, such as how a durable power of attorney is stronger than the normal assignment, or what can trigger a springing power of attorney. It may be more comforting — and would definitely be less expensive — for a client to hear this advice from a financial expert rather than a lawyer.
Elder care planning: A recent study showed that lifetime health care costs for a retired couple average about $240,000. Long-term care figures to add a sizable amount on top of that. Helping clients structure their finances and insurance so they can cover these costs without being a burden to their children is a crucial move for an advisor. Given how many of these expenses occur at the end of one’s life, this planning can often fit in as part of an overall estate plan.
Establishing a trust: It doesn’t take an estate-tax-worthy estate in order for there to be a sizable legacy to pass to the next generation. There are, of course, various flavors of trusts — revocable, living, etc. — that middle-class families can choose from. Again, it can be very expensive to consult with an attorney to start these up, especially for people who aren’t even sure it’s the right solution for them. A financial advisor may be able to steer them toward another alternative, such as a custodial account, for a lot less money. Even if they want to establish a trust, clients may appreciate that their advisor can at least show them the ropes, so they’re fully prepared when they do meet with an attorney.
Managing life insurance: Most people make their life insurance decisions on their own or, perhaps, with the consultation of an insurance broker. But it’s also an important part of an estate plan and should be treated as such. Even if clients have already invested heavily in life insurance, an advisor can provide guidance in this area.
ETFs: More Tax-Efficient than Apple?
John Spence for ETF Trends writes: Apple (NasdaqGS: AAPL) has faced intense scrutiny lately over using foreign subsidiaries to cut its U.S. income taxes.
Of course, no one likes to pay taxes, which is why the tax efficiency of stock ETFs versus mutual funds is a key selling point.
The tax advantages of ETFs stem from how the exchange-listed financial products are traded between investors. Their tax efficiency is also related to how ETFs create and redeem shares, which is different than traditional mutual funds.
When investors buy an equity mutual fund, the portfolio manager puts the cash to work by buying company shares. Conversely, when the fund receives redemption requests from shareholders, the manager sells stock to raise the cash, which can trigger a capital gain distribution for all the shareholders remaining in the fund.
ETFs take a different approach. Investors trade ETFs on an exchange in the secondary market like individual securities.
“When one investor sells ETF shares and another investors buys them on the exchange, the underlying securities of the ETF don’t need to be sold in order to raise cash for the redemption,” Invesco PowerShares notes in a primer on tax efficiency.
Furthermore, trading firms known as authorized participants or APs are responsible for working with the ETF manager to create and redeem large blocks of shares, called creation units. These exchanges are “in-kind” transactions that involve stock rather than cash.
These large creation units are created and redeemed based on demand for the ETF, and selling pressure.
“An in-kind redemption process enables the fund manager to purge the lowest cost-basis stocks through stock transfers during the creation and redemption process,” according to Invesco PowerShares. “The result may be greater tax efficiency because shareholder activity and resulting portfolio turnover don’t affect the portfolio to the same extent as with mutual funds.”
Advisers Help Avoid 'Twice-Taxed' Syndrome
Arden Dale for the Wall St. Journal writes: Financial advisers are telling some clients it could be better to spend or give away dividends, interest and IRA distributions, instead of plowing the money back into the market where it will be taxed again.
Many people automatically reinvest income from investments and retirement accounts, when it would make more sense to direct that money to living expenses or use it for gifts to family or charity.
The place to start, advisers say, is with a master plan that encompasses cash flow, living expenses and any giving goals. There are variables that shift as people age, such as sources of income. When IRA account holders reach 70 1/2, they must begin taking required minimum distributions, which can amount to a lot money if the account is large.
The distributions are subject to federal and state taxes, as are dividends and interest earned on savings. "Clients that are already paying taxes on such amounts should consider using it as part of their cash flow," said Laura M. Sundquist, a financial planner and accountant at Sage Financial Design Inc. in Simsbury, Conn.
When that income is reinvested, any dividends and gains from those investments face new taxes. Ms. Sundquist is often surprised to see that retirees fail to consider this and put the money back into the markets, often through automatic dividend reinvestment plans.
The "one piece of homework" she gives clients, said Ms. Sundquist, is to figure out how much they need to live on a monthly basis. Once she has that figured, she calculates how much to draw from various sources, such as dividends, interest, retirement accounts, and Social Security, and takes taxes into account.
Weighing taxes is more important than ever. Changes in federal tax rates this year raised the top rate on dividends to 20% from 15%. Interest and retirement account income is taxed as ordinary income, with a new top rate of 39.6%.
Thomas H. Zimmerman, a financial planner in Evanston, Ill., who manages about $190 million, said his firm is "all about doing the master plan first." He updates clients' comprehensive plans every year, mapping out cash flow in the fourth quarter.
Though most of his clients are worth between $3 million and $5 million, many of them still rely partly on required minimum distributions to cover their cost of living, according to Mr. Zimmerman. Whatever is left over of a distribution, they may invest.
One client, the retired CEO of a smaller publicly traded company, uses $50,000 of a distribution to fund a family limited partnership that buys foreclosed homes and refurbishes them to rent out. The man's children are investors in the partnership, which he enjoys using to teach them about business.
Advisers with retired clients who are charitably inclined say the most tax-efficient use of a required minimum distribution is often to roll part or all of it over directly to a favorite cause. The law now allows a direct rollover up to $100,000.
This works especially well when a charitable contribution brings a taxpayer's adjusted gross income below $200,000--$250,000 for couples--so that the new 3.8% surtax on investment income won't apply, according to Larry Maddox, president of Horizon Advisors, a Houston firm with $205 million under management.
When giving goals are more centered around family, it's tax-efficient to give interest, dividends or retirement account distributions. A person can give unlimited tax-free gifts of up to $14,000 this year to separate individuals.
How to Carry Over Tax Losses and Deductions
Angela M. Wheeland, Demand Media writes: The Internal Revenue Service allows you to deduct certain expenses from your income to lower your income tax bill. Some deductions have a limit, and if your expense exceeds this limit, you can carry over the remaining amount to future tax returns. Because some expenses require you to take the deduction in the year you paid the expense, not all qualify. You can only carry over deductions for capital loss, net operating loss, donations to charity, investment interest expense and the business use of your home deduction.
CAPITAL LOSS
STEP 1
Grab Schedule D from last year's tax return.
STEP 2
Look at the total amount of your loss from last year, which is located on the top of the second page of Schedule D. The most you can claim as a capital loss is $3,000 -- or $1,500 if you're married and filing separately, as of 2013. If the amount of your capital loss exceeds this amount, you can carry over the remaining amount.
STEP 3
Download a copy of the Schedule D instructions from the IRS website.
STEP 4
Complete the "Capital Loss Carry-over Worksheet" in the Schedule D instructions to calculate the amount of your carry-over.
STEP 5
Enter the carry-over amount from your short-term loss in the line labeled "Short-term Capital Loss Carry-over" on Schedule D.
STEP 6
Enter the carry-over amount from your long-term loss in the line labeled "Long-term Capital Loss Carry-over" on Schedule D.
NET OPERATING LOSS
STEP 1
Look at the line just below the "Itemized Deductions or Standard Deduction" line on Form 1040 -- Line 41 as of 2013. If the amount listed in this line is a negative number, you have a net operating loss carry-over.
STEP 2
Download Form 1045 from the IRS website and complete Schedule A-Net Operating Loss on the form to calculate your net operating loss. Schedule A-NOL is typically located on the second page of Form 1045.
STEP 3
Enter the amount of your net operating loss in the line labeled "Other Income" on Form 1040. To offset your income, you'll have to enter this amount as a negative number.
STEP 4
Attach a statement to your current year tax return showing how you figured your net operating loss.
DONATIONS TO CHARITY
STEP 1
Look at your receipts from last year's donations and compare this amount to your adjusted gross income from last year's return. Depending on the charity, your contributions are limited to 50 percent, 30 percent or 20 percent of your adjusted gross income. For example, if your income was $50,000 and you donated to a 50 percent charity, the maximum deduction you could claim last year was $25,000. For a list of charities and percentages, refer to Publication 526 on the IRS website.
STEP 2
Subtract the deduction amount you claimed last year from your allowable amount to determine your carry-over. The deduction amount you claimed last year is located in the "Gifts to Charity" section on Schedule A.
STEP 3
Calculate your maximum deduction for this year based on the charity. If you earned $60,000 this year and donated to a 50 percent charity, the most you can claim is $30,000.
STEP 4
Subtract the carry-over amount from your maximum deduction for this year. If your carry-over amount exceeds your maximum deduction, you can carry over the remainder amount to next year's tax return. For example, if your maximum deduction is $30,000 and your carry-over amount is $35,000, you can only claim $30,000 and carry over the remaining $5,000 to next year's return. Carry-overs are valid for up to five future tax returns.
STEP 5
Enter the amount of your carry-over in the line labeled "Carry-over from Prior Year" in the "Gifts to Charity" section on Schedule A.
INVESTMENT INTEREST EXPENSE
STEP 1
Look at the line labeled "Other Expenses" in the "Job Expenses and Certain Miscellaneous Deductions" section of Schedule A from your previous year's tax return. Because investment interest expense is the only miscellaneous expense you can carry over, if this amount includes several expenses, only consider your investment interest expense for the year.
STEP 2
Multiply last year's adjusted gross income by 2 percent. If the amount of your investment interest expense exceeds this amount, you have a carry-over.
STEP 3
Multiply your current year's adjusted gross income to determine your deduction limit.
STEP 4
Subtract last year's carry-over amount from this year's deduction limit. If the carry-over amount exceeds this year's deduction limit, you can carry the remaining amount to future tax returns.
STEP 5
Enter the amount of your carry-over for investment interest expense in the line labeled "Other Expenses" on Schedule A. Write "Investment Interest Expense Carry-over" in the description line.
HOME OFFICE DEDUCTION
STEP 1
Grab Form 8829 from your last year's income tax return.
STEP 2
Look at the last two lines on the form. The first line describes your carry-over of operating expenses from last year. The second line describes your carry-over from casualty losses and depreciation.
STEP 3
Download Form 8829 from the IRS website.
STEP 4
Enter the carry-over amount for operating expenses and casualty loss and depreciation in the corresponding line in "Part II" on Form 8829.
The Roth - Child strategy
Stewart Welch for AL.com writes: How would you like to help your child blaze a path towards becoming a multimillionaire and teach them the value of hard work and the importance of saving for the future all at the same time? Here’s a concept that I call The Roth-Child Strategy… a play on words related to the famous Rothschild family. You may remember that during the 1800’s the Rothschild family accumulated what was believed to be the largest private wealth in the world. Their name is synonymous with wealth even today. The Roth-Child Strategy harnesses the combined power of the Roth IRA along with the power compounding of investment returns over long periods of time. Here’s an example of how it might work:
You have a daughter, age sixteen, who has a summer job as a nanny-sitter for a family. She’ll earn $13 per hour working five days a week from eight in the morning until six in the evening. Her total weekly wages would be $650. Over the course of nine weeks, she’ll earn $5,850. You agree to ‘match’ up to $5,500 of her earnings by contributing to a Roth IRA in her name. Together you open an investment account and decide how to invest her money. Since she’s very young, it would be entirely appropriate to invest 100% in stocks or stock mutual funds. Well researched stocks in companies that she can relate to may create more lasting interest for her. Companies like McDonald’s, Apple, Microsoft, and Verizon are great companies whose products she likely uses often. These companies also pay dividends and have a history of raising their dividends over time which would be another great thing for her to observe.
I recommend using a Roth IRA because of its unique characteristics. Remember, you don’t receive a tax deduction for contributions to a Roth IRA. Perfect…since a tax deduction would be worthless for a sixteen-year-old earning $5,850. Once the money is invested, it grows tax-deferred, meaning there are no current income taxes on interest, dividends or capital gains. Even better, at retirement, all distributions are tax free! The Roth IRA is the perfect incubator for growing wealth for a teenager!
I think you’ll be astonished at the effect of tax free compounding over fifty-plus years! Let’s take a look at how the ‘numbers’ might work. If during this summer, you invested $5,500 in a Roth IRA and assuming a 10% return, by her age sixty-five, her account would be worth over $500,000!
Let’s take this strategy a step further. Let’s assume you do this every summer until she graduates from college. Over six summers you will have invested a total of $33,000 and by her age sixty-five, assuming a 10% return, her total Roth IRA account would be worth over $3,000,000! If she chose not to tap this money during retirement but left it to her children, assuming death at age ninety, your grandchildren would inherit a whopping $33 million! All of this because you chose to encourage her to work, save and invest. Now that’s what I call a great legacy!
A couple of technical points are in order. To contribute to a Roth IRA, you must have earned income. You are allowed to contribute dollar-for-dollar of your earnings up to the Roth IRA limit, which this year is $5,500. Under current law, you are never required to take withdrawals from a Roth IRA whereas a traditional IRA has mandatory withdrawals beginning at age 70½. When your grandchildren receive their inheritance, it too, will be income tax free! According to Ron Stokes, CPA of Birmingham, Alabama, “The daughter will need to file a tax return as evidence of earned income. Assuming this is W2 income (wages versus self -employment income) and there is no unearned income, it will be a simple tax return and she could earn up to $6,100 in 2013 before owing federal taxes.” I’d encourage you to have her fill it out and file it herself (you can help her but don’t do it for her). The historical return for stocks over the past sixty years has been 10.7%.
If you’d like to have me answer your financial question email me at stewart@welchgroup.com and place AL.com in the subject line.
The Internal Revenue Service announced that interest rates will remain the same for the calendar quarter beginning July 1, 2013, as in the prior quarter.
The rates will be:
- three (3) percent for overpayments [two (2) percent in the case of a corporation];
- three (3) percent for underpayments;
- five (5) percent for large corporate underpayments; and
- one-half (0.5) percent for the portion of a corporate overpayment exceeding $10,000.
Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points.
Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.
The interest rates announced today are computed from the federal short-term rate determined during April 2013 to take effect May 1, 2013, based on daily compounding.
IRS Reminds Those with Foreign Assets of U.S. Tax Obligations
The Internal Revenue Service reminds U.S. citizens and resident aliens, including those with dual citizenship who have lived or worked abroad during all or part of 2012, that they may have a U.S. tax liability and a filing requirement in 2013.
The filing deadline is Monday, June 17, 2013, for U.S. citizens and resident aliens living overseas, or serving in the military outside the U.S. on the regular due date of their tax return. Eligible taxpayers get two additional days because the normal June 15 extended due date falls on Saturday this year. To use this automatic two-month extension, taxpayers must attach a statement to their return explaining which of these two situations applies. See U.S. Citizens and Resident Aliens Abroad for additional information additional information on extensions of time to file.
Nonresident aliens who received income from U.S. sources in 2012 also must determine whether they have a U.S. tax obligation. The filing deadline for nonresident aliens can be April 15 or June 17 depending on sources of income. See Taxation of Nonresident Aliens on IRS.gov.
Federal law requires U.S. citizens and resident aliens to report any worldwide income, including income from foreign trusts and foreign bank and securities accounts. In most cases, affected taxpayers need to fill out and attachSchedule B to their tax return. Certain taxpayers may also have to fill out and attach to their return Form 8938, Statement of Foreign Financial Assets.
Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.
Generally, U.S. citizens, resident aliens and certain nonresident aliens must report specified foreign financial assets on Form 8938 if the aggregate value of those assets exceeds certain thresholds. Instructions for Form 8938 explain the thresholds for reporting, what constitutes a specified foreign financial asset, how to determine the total value of relevant assets, what assets are exempted and what information must be provided.
Separately, taxpayers with foreign accounts whose aggregate value exceeded $10,000 at any time during 2012 must file Treasury Department Form TD F 90-22.1. This is not a tax form and is due to the Treasury Department by June 30, 2013. For details, see Publication 4261: Do You Have a Foreign Financial Account? Though this form can be filed on paper, Treasury encourages taxpayers to file it electronically.
Taxpayers abroad can now use IRS Free File to prepare and electronically file their returns for free. This means both U.S. citizens and resident aliens living abroad with adjusted gross incomes (AGI) of $57,000 or less can use brand-name software to prepare their returns and then e-file them for free.
Taxpayers with an AGI greater than $57,000 who don’t qualify for Free File can still choose the accuracy, speed and convenience of electronic filing. Check out the e-file link on IRS.gov for details on using the Free File Fillable Forms ore-file by purchasing commercial software.
A limited number of companies provide software that can accommodate foreign addresses. To determine which will work best, get help choosing a software provider. Both e-file and Free File are available until Oct. 15, 2013, for anyone filing a 2012 return.
Any U.S. taxpayer here or abroad with tax questions can use the online IRS Tax Map to get answers. An International Tax Topic Index page was added recently. The IRS Tax Map assembles or groups IRS forms, publications and web pages by subject and provides users with a single entry point to find tax information.
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