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Planning Business Finances

History shows that typically, before the pandemic, more than half of new businesses will fail within two years. The main reason is because they run out of money. Their initial funding was inadequate, often because the owner started without a reliable budget or financial projections in their business plan. They don’t – or don’t know how to – do the necessary homework to learn the real cost of delivering their product or service.

Projecting the financial needs for a new business is not the time for being overly optimistic or taking wild guesses. It’s important to invest the time needed to research actual costs and develop realistic assumptions for revenue and expenses. The investment will really pay off.  

Planning business finances so you don’t run out of money can be done by following these three realistic assumptions:

  1. Revenue Takes Time to Ramp-Up

Even with a huge demand for your business in your market, achieving projected revenues will take time. Ramping up and making contacts does not happen overnight. Top potential revenue will not happen in the first year. Develop one-to-five-year projections to illustrate revenue growth and the crossover point when expenses are expected to be covered, adjusting as needed.

  1. Expenses are Always More Than You Think

Research the actual cost of labor, materials, space, transportation, equipment, etc., based on market rates and quality requirements. Worker costs should include the employer portion of payroll taxes, benefits, licenses, training. Don’t forget back-office costs, like payroll services, billing, financial management and reporting, and tax preparation.

  1. Build in a Financial Cushion

Avoid failure from under-estimating costs and over-estimating revenue by building in a financial cushion. Initial funding needs should include an amount equal to a few months of estimated expenses to cover payroll and overhead in the months when revenue is not enough to cover costs. Of course, that’s on top of funding for equipment, legal fees, and other start-up costs.

Planning business finances is not an easy task. Don’t take the easy way out by guessing or painting a rosy picture that probably won’t come true. Avoid being among the one-half of new businesses that fail within two years by applying these three realistic assumptions about revenue, expenses, and funding.

Not Ready to File by May 17?

For the second year in a row, the income tax filing deadline is delayed. This year, the filing due date for the IRS and most states is May 17th instead of the “normal” April 15th. Despite the delay, the tax deadline can sneak up on you. If you’re in a panic because you haven’t started gathering your tax documents, you can probably relax. 

You can request a tax filing extension to postpone from May 17th to October 15th. You don’t need to provide a reason for needing the extension, but it does take a little time to get it done right and avoid possible underpayment penalties.

Three tips for getting an income tax filing extension:

  1. You Must Apply

Individuals can request a tax filing extension by filing IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, online at the IRS website, via approved tax software, or in paper form. It must be sent or postmarked no later than midnight on the original due date. The extension is automatically approved if a refund is expected or if the estimated amount due is paid with the extension request.

  1. Pay Amounts Due

Use the IRS Form 4868 instructions at https://www.irs.gov/pub/irs-pdf/f4868.pdf to estimate your 2020 income tax liability. Compare your estimated taxes to your tax withholding or quarterly estimated payments and enter the numbers on the extension request. If you owe more in taxes than you’ve paid in, the balance due must be paid with the extension request. Failure to pay the amount due results in an underpayment penalty and interest accrued daily on the unpaid balance.

  1. Check Your State

Each state has its own set of rules and processes for its residents to request an income tax filing extension. As mentioned above, most states followed the IRS and delayed their 2020 tax filing deadline, but some did not match the IRS’ May 17th deadline. Check your state’s tax department website for deadline updates and links to information about requesting an extension of time to file for 2020.

Rushing at the last minute is stressful and causes mistakes, especially with an already stressful activity like filing your income tax returns. Get more time to file your 2020 federal income tax return by requesting a tax filing extension. Go to the IRS website at https://www.irs.gov/forms-pubs/extension-of-time-to-file-your-tax-return for details and help estimating any taxes you owe with the extension request.

Enhanced Child Tax Credit for 2021

Tax rule changes in recently-passed Congressional bills in response to the pandemic are head-spinning. Overall, these changes provide targeted financial support and tax relief for people who have suffered financial hardship because of COVID-19. The IRS just came out with guidance on one of these changes, an enhanced Child Tax Credit. Temporary changes to the Child Tax Credit are intended to provide relief to taxpayers with eligible dependent children and bridge the financial gap until the American economy recovers.

The enhanced Child Tax Credit is part of the $1.9 trillion American Rescue Plan that President Joe Biden signed into law in March 2021. Formally called Child Tax Credit Improvements for 2021, families need to know about its valuable provisions:

  • Child Tax Credit increases are in effect for 2021 only.
  • The Child Tax Credit is increased from $2,000 to $3,000 per eligible child, for children who are age 6 and older.
  • For children under the age of 6, the Child Tax Credit is increased to $3,600 per eligible child.
  • The age for qualifying children has also been increased from children under age 17 to children under age 18. This change allows more children to be considered eligible for the Child Tax Credit.
  • The Child Tax Credit is fully refundable, meaning that eligible taxpayers could receive a tax refund that exceeds her or his tax federal withholding.
  • Income limitations for the Child Tax Credit remain at $200,000 for single taxpayers and $400,000 for married filing joint. The income limitation for the Additional Child Tax Credit is phased out by $50 for every $1,000 of modified adjusted gross income more than the threshold (e.g., $150,000 married filing joint).
  • Advance payments of one-half of the eligible Child Tax Credit will be issued in equal periodic payments from July to December 2021. Any eligible Child Tax Credit not paid in advance will be received when the taxpayer files her or his 2021 income tax return.

Guidance on the new tax rules for the enhanced Child Tax Credit is fresh off the presses. The IRS plans to post more information on its website (www.irs.gov), along with a portal for taxpayers to change personal information that may impact the amount of the advance payments, like the birth of a child or a change in which separated or divorced parent claims the child as an eligible dependent. 

These enhancements to the Child Tax Credit for 2021 are temporary. Knowing the valuable rule changes can help to bridge the financial gap for many American families.

Business Meal Deduction Update

Legislation recently passed by Congress for COVID-19 relief contains some tax rule changes that are intended to encourage taxpayer spending. One change that took effect January 1, 2021, temporarily increases the business deduction for meals from 50% to 100% until the end of 2022.  The deduction increase could provide business owners the incentive to enjoy a not-from-home meal while conducting business activities.

As usual, the temporary rules are not simple. The IRS guidance recently announced the details and definitions needed by taxpayers to follow the rules while also doubling their business meal deductions: 

  1. The temporary rules apply to any expense paid or incurred after December 31, 2020, and before January 1, 2023, for food or beverages provided by a restaurant.
  1. The term “restaurant” means a retail business that “prepares and sells food or beverages for immediate consumption.” The food or beverages can be consumed on the restaurant’s premises, carried out, or delivered. However, a restaurant does not include a business that primarily sells pre-packaged food or beverages not for immediate consumption, like a grocery store or a vending machine.
  1. An employer may not treat an on-site eating facility as a restaurant under the temporary rules, either employer-operated or operated by a third party.

Those temporary rules are in addition to all the other rules that aren’t changing for 2021 and 2022, including:

  1. Business owners also need to be present for the meal and be engaged in conducting business activities. Alternatively, the business owner must be represented by an individual who is connected to the business, such as an employee or contractor.
  1. Meals cannot be lavish or extravagant under the circumstances. 
  1. As always, a documented record must be kept of the date, amount, business purpose and attendees at the meal.

Not simple at all. But it could be worth your time to learn about the temporary rules for deducting business meal expenses. It could double your business meal deduction! Need more details? The IRS has it for you here – https://www.irs.gov/pub/irs-drop/n-21-25.pdf.

Another IRS Impersonation Scam

Impersonating the IRS is a favorite way for scammers to intimidate their victims. Who isn’t afraid of the IRS? It’s gotten even worse recently with all those tempting Economic Impact Payments and other COVID-19 funding just waiting to be stolen. Email phishing scams allow criminals to hit thousands of potential victims in seconds, and then sit back and watch how much money they can reel in.

At the end of March, the IRS warned about another IRS impersonation scam that targets educational institutions, including students and staff who have “.edu” email addresses. The scam emails display the IRS logo and use various subject lines to get potential victims’ attention, such as “Tax Refund Payment” or “Recalculation of your tax refund payment.” 

The phishing emails ask people to click a link and submit a form to claim their refund. Who wouldn’t want a refund, right? The problem is, the link asks for all kinds of personal information, like:

  • Social Security number
  • First Name
  • Last Name
  • Date of Birth
  • Prior Year Annual Gross Income (AGI)
  • Driver’s License Number
  • Current Address
  • City
  • State/U.S. Territory
  • ZIP Code/Postal Code
  • Electronic Filing PIN

The IRS would never ask for personal information. So, what should you do with a scam email?

  • Do Not Open or Click

Resist temptation to open or reply to any suspicious email, no matter how enticing. And don’t even think about clicking on a link in a suspicious email!

  • Report to Authorities and Delete

Report phishing emails to the Federal Trade Commission at www.ftc.gov/complaint and to the Anti-Phishing Working Group at [email protected]. Forward tax-related emails to the IRS at [email protected]. After reporting, delete the original email.  

Need more protection and detection help? The IRS has it for you here – https://www.irs.gov/businesses/small-businesses-self-employed/tax-scams-how-to-report-them and the Federal Trade Commission has more for you here – https://reportfraud.ftc.gov/#/?pid=A.

About the Home Office Deduction

Tax clients ask me all the time about taking a home office deduction. That topic has come up even more often since COVID-19 has so many people working at home. However, everyone with an office at home isn’t eligible for a home office deduction, even if she or he owns a business. Lots of rules apply. It can be pretty confusing. 

So, let’s “un-confuse” the topic:

  1. Who is eligible for a home office deduction?

Only individuals who own a business are eligible for the deduction. Yes, some employees used to be eligible under special circumstances, but those rules changed at the end of 2017. Now, only business owners who use space in her or his home exclusively and regularly to substantially conduct business operations can consider taking a home office deduction. No non-business activity can be conducted in a home office. That means no personal items in the home office, even clothes in the closet.

  1. What home expenses can be deducted?

Deductible home office expenses are either direct or indirect, based on the expense type and business percentage of the home used for business. The most common method used to calculate the business percentage is dividing the square footage used exclusively for business by total square footage. Shared spaces, like hallways, cannot be included in office space.  

  • Direct Expenses: Expenses that benefit only the home area that is exclusively used for business, such as painting or repairs in the home office, are direct expenses that are fully deductible.
  • Indirect Expenses: Expenses for keeping up and running the entire home, such as the mortgage interest, real estate taxes, insurance, utilities, and general repairs are deductible based on the business use percentage, described above.

Expenses to maintain the non-living home space, such as lawn care, are not deductible. For business owners who don’t want to hassle with tracking all the various home office expenses, the IRS has a Simplified Option that allows a standard deduction of $5 per square foot, limited to 300 square feet.  

Eligibility for a home office deduction is determined by a lot of rules that can be confusing. We address the basics here, but there’s more to it. Details and examples are on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction.

RMD Rule Reminder

Keeping up with tax rule changes was never easy. But the flurry of tax changes in response to the COVID-19 pandemic has been absolutely head-spinning. A few of those changes impact the rules for required minimum distributions (RMDs) from retirement accounts. RMD rules are how the IRS prevents taxpayers from avoiding tax payments on retirement funds that were invested pre-tax, or before any taxes were paid on the income used for the retirement investment.

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act (aka “Secure Act”) was signed into law. The Secure Act changed IRA distributions and contributions in three big ways:

  • Required Minimum Distribution (RMD) Age Increase

Under prior tax law, RMDs had to begin no later than April 1 following the year in which a person turned age 70½. For taxpayers who were not already age 70½ by December 31, 2019, the age to start taking RMDs is extended to 72. Distributions don’t have to be postponed to 72; it’s just an option. What’s better – waiting or not – depends on individual circumstances.

  • Contribution Age Restrictions Repealed 

Before the Secure Act, workers over age 70½ were not eligible to make contributions to an IRA. That contribution age limit has been eliminated. Yea! Slight damper on that celebration, though – the same rules about who can and cannot deduct a traditional IRA contribution apply, regardless of age. 

  • Inherited IRA “Stretch Distributions” Eliminated for Non-Spouses

Traditional IRAs that are inherited by someone other than the owner’s spouse can no longer be distributed over the life of the beneficiary. Distributions now must be taken within a ten-year period after inheritance. This new rule eliminates the options for non-spouse beneficiaries to use inherited traditional IRAs as part of his or her own retirement planning.

So, what does this mean for 2021 RMDs?

  • Individuals who reached 70½ in 2019 or earlier and were not required to take an RMD for 2020 are required to take an RMD for 2021 by December 31, 2021. 
  • Individuals who did not reach age 70½ in 2019 will reach age 72 in 2021 will have their first RMD due by April 1, 2022, and their second RMD due by December 31, 2022. 
  • To avoid having both amounts included in their income for the same year, the taxpayer can make the first withdrawal by December 31, 2021, instead of waiting until April 1, 2022. After the first year, all RMDs must be made by December 31.

Tax rules are always changing. Keeping up is always challenging. For help to meet the challenge, checkout the IRS website – HTTPS://WWW.IRS.GOV/NEWSROOM/TAX-TIME-GUIDE-IRS-REMINDS-TAXPAYERS-OF-RECENT-CHANGES-TO-RETIREMENT-PLANS.

Tax and Retirement Savings with a SEP IRA

Every taxpayer wants to reduce her or his tax bill. Business owners, especially, are constantly on the hunt for tax deductions. In addition, business owners who want to retire some time in the future are looking for ways to fund that nest egg. My tax clients who own their own businesses ask about tax and retirement savings regularly. That’s at least one thing that COVID-19 hasn’t changed!

Good news for business owners who want tax and retirement savings – they can do both with a SEP IRA! A “Simplified Employee Pension Individual Retirement Arrangement,” or SEP IRA, is the retirement plan of choice for many small business owners. Here are three reasons why:

  • Easy and Flexible

A SEP IRA is easy to set-up with your bank, your investment advisor or a mutual fund. Just set it up and fund the account before filing the year’s tax return, or by the tax return due date, including extensions. Annual contributions amounts are flexible, which is good if business cash flow varies from year-to-year.

  • Generous Contribution Limits

A SEP IRA allows you an annual contribution of up to 25 percent of net business profits, after netting out the deductible half of self-employment taxes. That calculation is a little tricky so you’ll need some help to get it right. There is an annual dollar limit, too. For 2021, it’s up to $58,000. Contributions must be made for eligible employees.

  • No Costs

A SEP IRA has no start-up or operating costs that are often required for a conventional retirement plan. However, any investments selected to fund the account may have a management or investment advisory fee. It’s important to get a clear understanding of any fees or charges that will defray your retirement funds.

Business owners should keep in mind that distributions from a SEP IRA work just like a traditional IRA – any funds taken out before age 59½ are subject to a 10% early withdrawal penalty, on top of the federal and state income tax. 

Saving for today and tomorrow at the same time could be the best news of 2021! Business owners on the hunt for ways to achieve tax and retirement savings at the same time should set up and fund a SEP IRA. Want to know more? As usual, the IRS website has more helpful details, at https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep.