Planning over budgeting

Somedays it feels like all we do is parse semantics, doesn’t it?

Budgeting, planning, it is all the same thing, right?  Well, no – not really.  Yes, far too often they are used interchangeably, but the truth is that planning is far more important than budgeting.  Budgeting is really about allocating your resources.  Planning identifies what you want to accomplish and how your resources can help you make that happen.

This is why the distinction is important.  I am starting to help clients plan for the next year and part of that is looking at what we have accomplished through today.  It is part looking at the numbers and part looking at the strategy and seeing if we are off target.

To me, there is nothing worse than not being able to answer the question, “How did we get here?”  Or worse, hearing the glib answer, “We performed well (poorly).”  Duh.

What was the plan?  Did we think we were going to break into a new market?  Did we succeed?  What is the acquisition cost per new customer?  Are we getting repeat business?  Can we grow in that are?  At what cost?

There is nothing harder to do than listen to someone say how profits are holding steady, while knowing that it is because money is not being spent on carrying out the plan.  Of course you have profit, we are not spending money on project X, which, by the way, two years ago we all agreed that it was going to be the flagship product within 5 years.  Why did the company plan to allocate thousands of dollars on advertising if we don’t want to spend it?

These are hard questions to listen to, much less respond.  No one likes having their parade rained upon, and yet, well, there it is. The plan drives how resources are acquired and spent, otherwise you just have a budget.

That isn’t to say budgeting isn’t a useful tool, it is.  But my experience has been, budgets are typically devoid of planning.  We spend money in that area last year, lets continue to spend money in that area.  We generated revenues selling widgets last year, lets budget to generate 5% more in sales.  There is no plan, no vision, nothing to be held accountable to until it is too late.

I do lots of budgeting for non-profits and the most fun I have is helping them rethink the budget process into the planning process.  We start by looking at the big picture and then start asking how we get there.  Then, once we get consensus, we start putting numbers to actions.  It is extremely rewarding to see these professionals see the results and understand that there is a reason for spending money, other than the satisfaction of having money to spend.

So take time, do planning.  Think about where you want to be and how you want to get there and THEN allocate resources.  You will get tremendous benefits from it, mostly from thinking about how you are going to get from A to B.  If you need help, let me know, I am always open to helping companies and non-profits think about their plans and how they translate into action and money.

 

Winning tax planning

The Committee Advising Superior Hobbies (CASH for short) has had a busy week, what with so many possible changes in the air and nothing tangible to work with from our dear congressional representatives.  So, while we anxiously await the text of what was supposedly agreed to yesterday, I thought I would share some of the very best tax advise the committee can offer.

  1. Documentation Wins

This is far and away the most important thing to remember.  Quick story (hopefully but you know how I can run on and on).  A few years ago we had a client who owned several restaurants in Portland.  The owners were planning on a trip to Europe.  Naturally, the subject of tax deductibility came up.  Can the business pay for the trip?

The answer:  It depends.

If you are serious about this being a business trip then by all means I think it can be defended.  But it won’t be easy because you will have to work.  We had them hold a board meeting to discuss the positioning of the restaurants and how to possibly give them a more authentic European feel.  While they could get some of the information from books, there is nothing better than hands-on real-world experience.  The Company agreed to send 4 key employees to Europe for 2 weeks.  They were to explore at least two different restaurants a day and make notes of ambiance, food, menu, etc.

When they returned, they needed to write a report for the board and present their findings.  The board would then see how they could incorporate those discoveries into their restaurants.  Because they wanted to make sure that the changes would not potentially put them at risk they also invited their corporate counsel to the meeting – and the accountants were invited to cover costs and investment recovery information.

They followed the rules and the company reimbursed the key employees for their trip.  And 2 accountants and 2 attorneys got an excellent meal and a great presentation on how the restaurants could change to become even more authentic.

Yes, having the receipt for the new mixer is important to prove you purchased it but having the right documentation to back up a big decision like a business trip is even more important.

2.   The right business structure Wins

A couple came to me wanting to take a trip around the world.  They inherited over $1.0 Million from a grandparent.  They wanted to be able to write-off the trip if at all possible.  It is possible, but there are gotcha’s for the unwary.

It is important to realize that LLC’s and S Corporations get dragged into the Hobby Loss rules, not just sole proprietorships or rentals.  What isn’t subject to IRC 183 is a plain old boring C Corporation.

We created a plan to incorporate a business structured as a C Corporation with an initial capital contribution of about $200,000.  It hired two employees (yes the couple) who were hired to film a documentary about 20 somethings who inherited a bunch of money and were traveling around the world.  The Company purchased all the camera equipment and even paid them a salary for doing all this work.

When they got back they edited the film and actually were able to sell it to various outlets for stock footage for about $100,000.  After about 3 years, the Company was liquidated.  The shareholders had a $100,000 loss and priceless memories.  That $100,000 loss was a capital loss – which was used to offset a $150,000 capital gain from the sale of stock from an investment from one of their inherited investments.

3.   Pigs get fat

I know, the good tax planning stories are not nearly as much fun as the horrible “no planning at all” stories.  But boring is good.  The goal is to grow fat, lazy and content, not be led to the slaughterhouse because you gorged.  Paying some tax always beats paying no tax and getting caught – and subsequently paying penalties and interest and possibly worse.

So, the committee encourages you to seek out competent and thoughtful tax planners.  Make sure they are asking lots of questions and are advising you on the hard work you have to do to reduce your taxes – because it ain’t easy and it ain’t free.  And if you are looking for a solid, creative and effective tax advisor, contact me and I will be happy to refer you to one in my network.

Have a great day.

The Traveling Salesman

I love telling stories about the good, and not-so-good, things clients have done over the years.  Actually, to be honest, I like the not-so-good stories as they are educational and hopefully stop others from going down a path they might regret.

Part of my role is technical compliance and final reviewer of tax work.  My responsibility is to make sure that any significant tax position taken was backed up by adequate documentation and research.  I couldn’t stop clients from taking risky positions, but I could stop the firm from agreeing to dumb things that we couldn’t defend.

One tax return comes to mind.  It was a new client and I was having trouble getting my head around his small business.  It was on Schedule C and reported a loss of about $100,000.  He had a W2 for about $150,000 so was getting about 30K back in refunds.

What stood out most were two items.  Negative gross profit of $60,000 and an RV on the books which generated about $25,000 of depreciation.

Negative gross profit, by the way, comes from when you sell your product for less than the total cost of those products.  In this case, he had revenues of $12,000 and Cost of Goods sold of $72,000.

I wouldn’t sign off and the partner wanted to know what my concerns were.  I asked him if he talked to the client about his “business” and the answer was, “Not really.”

So, I was indulged and the client came in for a meeting.  I asked him to explain how his business worked.  He bought product, he told us and traveled up and down I-5 stopping at county fairs to sell his product.

Interesting.  We didn’t notice any fees for space rental at any events, though.

That’s because he parked his RV in the lot and sold on the outside.  Ok.

How many customers did the $12,000 represent?  We inquired.

One, he replied.  One client.  So what was the $4,000 of meals and entertainment?

He took this client out to dinner and to various ball games and other events because of their loyalty.

Who is this client? we asked dreading the answer.

His wife.

Yeah.  He and his wife took the summer off to travel and he bought stuff and he “sold” it to her.  Because she was such a loyal customer, he gave her a substantial discount on buying the stuff she “wanted”.  And he rewarded her loyalty with dinners and events.

Now, I know you are thinking BS, I am making this up.  I swear I am not.  Public accountants get some of the most entertaining and too-good-to-be-true stories out there.

Our main problem was that his prior accountant let him get away with it.  We suggested that he face the fact that on audit, the IRS would probably say this was a hobby (we didn’t bother to let him know it was probably outright tax fraud) and to protect the prior losses, he should shut down his business and maybe consider starting it up in 2 or more years after a cooling-down period.

He said no thank you but appreciated our advice.  He paid us for the work we did, took his “records” and went to find another tax preparer who wouldn’t be so nosey.

The moral of the story?  You may have heard the old saying that “Pigs get fat and hogs get slaughtered”.  Sometimes, it doesn’t pay to push the boundaries of acceptability.  He may never have been audited – hell he might have even been turned down by the next dozen tax preparers and decided he wasn’t going to win and dropped it – but it was still an extremely risky position to take and there was no real defense.

There are ways to make a business work while you travel.  But the odds are, the bigger the loss, the greater the risk, so documentation is vital to winning.  So, as you prepare for the end of the year and are looking to work with someone who wants to help you be successful, consider an accountant with integrity and who is willing to help you get everything right to protect you from major risks.  If you need the name of one, feel free to write me and I will send back the contact information for one or two to help you.

Have a great Tuesday.

 

The tangled web of pass-throughs

No doubt like many a tax-nerd, I spent part of the weekend trying to understand the senate and house tax bills and their impact on clients.  Obviously, it is a waste of time as there is no guarantee that either will become law as the tax acts are going to conference but, it is educational none-the-less.

I wrote the other day about how it works for individuals but now, what about someone who owns rental properties or other pass-through business?

Nothing I have read so far indicates that they are doing much in the way of changing the Passive Activity Loss (PAL) rules, so your investment in a rental property while probably still follow current law which means that you will likely not be able to take rental losses if you make more than $125K.  On the other hand, if your rental is a Passive Income Generator (PIG), you could see some tax savings… maybe.

What you should realize is that the very generous immediate write-off for business purchases does not include buildings.  You will still need to capitalize the purchase of rental property.  And it appears that the tax life will likely remain as it is today – 27.5 for residential and 39 for commercial.

If your rental is a PIG and throws off $10,000 of income, your tax liability would be no more $2,500 under the House’s version as this one taxes pass-through income at 25% maximum.  Obviously, if your total income puts you in a lower tax bracket, you would be taxed at that rate.  The senate version, on the other hand, provides a deduction of 23% of taxable income.  But as will all things tax-related, it isn’t quite that simple.  It limits the deduction to 50% of wages paid.

Since this is a rental property, you will likely not have employees.  Therefore 50% of zero is, of course, zero.  Since this is zero, you would pay tax at your regular tax rate.  Again, if you are in a lower tax bracket, it doesn’t really matter but, if you make more than $200,000, then you are in the 32% bracket and there really isn’t any savings.

The senate version is aimed at S Corporations and attempts to exert pressure on shareholder/employees to take “reasonable compensation”.  But take the following fact patterns.  Z Company has $1.0 Million of profits before taking into consideration officer wages.  Z Company employs 50 employees and has $2.0 Million in payroll.

50% of $2.0Million is $1.0 Million.  23% of $1.0 Million is $230,000.  Without the owner/officer taking payroll, they will get the full 23% deduction.  It doesn’t matter that the owner did not take wages.  For what it is worth, W2 wages could be as low as $560,000 in this example, with or without officer compensation, before the shareholder starts to lose the deduction.

Another problem is that both versions limit the types of businesses that can qualify.  Professional services businesses will not get to take advantage of the lower rates since it is assumed that professionals do not employ others.  So, take a doctors office: the doctor has a front desk person, an office manager, four nurses and the doctor.  Six employees.  Compared to a small contractor with a bookkeeper, a foreman and 4 laborers.  Also six employees.  If they both make the $1.0Million of profit and pay $600,000 in wages, the contractor gets the deduction of $230,000 and the doctor doesn’t.  This is true even if the contractor works more hours than the doctor.

It will be interesting to see how the pass-through entity issue plays out in conference.

Have a great day.