banknotes Business banking news and tips from your friends at Community Bank, N.A. SPRING 2017 Tax Filing Mistakes Business Owners Must Avoid Every year American taxpayers must confront what is arguably one of the most complex tax codes in the world. But, nobody has it harder than small business owners who must be able to navigate many additional layers of nuanced tax rules seemingly designed to keep tax accountants fully employed. Because of that, mistakes are very common with business tax returns and some can be very costly. The new administration promises a more simplified tax code in the near future, but, until then, business owners must take extra measures to avoid these common tax filing mistakes: Inaccuracies Underpaying Estimated Taxes Mixing Business with Pleasure Claiming 100% of Your Vehicle for Business Use Claiming Business Losses in Consecutive Years Filing a Schedule C Not Working with a Tax Professional Continued on page 2 For more information on business banking visit www.cbnabusinessbanking.com banknotes what sinside 2 Tax Filing Mistakes Business Owners Must Avoid 5790 Widewaters Parkway DeWitt, NY 13214 3 Protect Your Business (and Your Family) with a Buy-Sell Agreement 5 SPECIAL FEATURE: What You Don t Know About Your Cash Flow Can Hurt You This information is intended only for the use of the individual(s) or entity named above. If you are not the intended recipient, you are hereby notified that any disclosure, copying, distribution, or the taking of any action in reliance on the contents of this information is prohibited. If you have received this in error, please notify the sender by returning the mailer to sender. We are sending this mailer according to our established business relationship.
Tax Filing Mistakes Business Owners Must Avoid Continued from cover page Inaccuracies The most common tax filing mistake can also be the most punishing mistake you can make, which is to file an inaccurate return. The IRS could charge your business with a 20 percent penalty if you are found to be negligent in reporting income or understating the amount you owe in taxes. The most common applications of this penalty are when a business can t validate a deduction and when it fails to report all of their income. These mistakes tend to occur as a result of poor recordkeeping, which must be highly attentive to tracking taxrelated events and transactions year round. Underpaying Estimated Taxes The IRS expects small businesses to remit income taxes throughout the year with estimated payments. If, after filing your annual tax returns, the IRS finds that you underestimated your taxes, it will hit you with an estimated tax penalty. Although you aren t required to estimate the amount precisely, you must come pretty close to paying everything you owe. If your business earns less than $150,000, you must pay at least 90 percent of your final tax bill in estimated payments, or 100 percent of your taxes owed from the previous year. If you earn more than $150,000, you must pay a minimum of 110 percent of your previous year s taxes in estimated payments. If you underpay in any quarter, the IRS will attach a penalty to the amount that was underpaid; so there is no opportunity to play catch-up in a subsequent quarter. Your best bet is to overestimate your tax bill for the year to avoid the possibility of a penalty. 2 Mixing Business with Pleasure Few things raise the ire of the IRS more than mixing personal expenses with business expenses. In many cases, the mistake is unintentional; however, if you present the IRS with credit card record of business expenses that includes personal expenses, it could negate them as business deductions. This goes back to attentive recordkeeping, but it can be solved in large part by simply keep your personal life and business life completely separate. That includes separate checking accounts, separate credit cards and separate reporting. Claiming 100 Percent of Your Vehicle for Business Use Business owners who want to maximize their vehicle expense deductions often make the mistake of going overboard by trying to claim 100 percent business use. This can only be justified if you have a separate vehicle for personal use. If you try to claim more than 50 percent use, you will need precise records that include mileage logs, travel dates and times and the purpose of each trip. Claiming Business Losses in Consecutive Years It s not that the IRS doesn t want you to be profitable; they just don t want you avoiding taxes. Businesses that report losses year after year are considered suspect by the IRS and the first place they look is your business deductions. The IRS is on the lookout for people who try to claim their hobby expenses as business losses, which is illegal under the tax code. If you experience a few bad years, you may need to prove your business is legitimate and justify your deductions. Filing a Schedule C The vast majority of small business owners file their taxes as sole proprietors, which requires filing a Schedule C with their individual tax return. The Schedule C is where you take business deductions that can lower your taxable income. It is the easiest way to report your business income and expenses, but, according to many tax experts, it can also increase the chances of an audit. Of course, you have nothing to fear as long as you have impeccable records. However, you may want to consider a different business structure that separates your personal and business taxes. A subchapter S corporation is a popular business structure for small business owners because all business income and expenses are run directly through the business and the business owner only pays through personal taxes on the profits reported. Not Working with a Tax Professional Most of the common filing mistakes business owners make can be significantly reduced or eliminated simply by working with an IRS-certified tax professional. Look for one experienced in working with small businesses and who guarantee their work. The cost could not be any higher than the amount of time you lose by doing your taxes on your own. The more precise and more organized your records, the less it will cost you. The biggest reason for working with a tax professional is to be able to keep up with the changing rules that affect business owners every year. That alone can be worth the cost.
Protect Your Business (and Your Family) with a Imagine the following scenario: You run a successful business with your business partner of 20 years. Your business partner dies unexpectedly. After the funeral, your deceased partner s spouse shows up at your office with her two grown children. They ask for the key to your partner s office not to clean it out, but to move in. They are your new partner, whether you like it or not. That is the nightmare scenario business owners face when they don t have properly drafted, fully-funded buysell agreement in place. What Happens to the Business When a Partner Dies? If you are in a business with multiple owners, each owner has an interest in the business based on the terms of their partnership or corporate agreement. That business interest has a certain monetary value based on its proportionate share of the business. When a partner dies, his business interest becomes part of his estate. The partner s survivors are entitled to receive the value of the business interest. Absent a financial arrangement to buy out your partner s family, you may have only two options neither of your choosing. First, you may be required to liquidate the business in order to raise the money owed to your partner s family. Your second option may be to accept your partner s spouse or his children as your new partner. The Critical Importance of a Buy-Sell Agreement For any business with multiple owners or partners, one of their most critical planning issues is preparing for business continuation in the event of the death of one of the owners or partners. Buy-sell agreements are the most effective way for business owners to plan for the orderly transfer of business interests where two or more owners are actively involved in the business. A properly crafted agreement can ensure that the business interests of the deceased partner will transfer in an orderly manner to the benefit and satisfaction of all parties. The agreement specified a formula for valuing each partner s interests along with specific terms for purchasing their interests. A buy-sell agreement can also provide assurances to clients, employees and investors of the business stability during a time of transition. For a buy-sell agreement to be effective, it must be funded to ensure the capital is available at the time of death of a partner. The preferred funding method for buy-sell agreements is life insurance. It is the most cost effective means of creating the capital when it is needed. Using the valuation formula established in the agreement, an amount sufficient to buy out the interests of a surviving family is purchased on each owner. The coverage should also provide an extra reserve for the business to use to continue its operations and find a replacement if needed. Depending on the number of owners, the life insurance can be purchased by each owner on the life of the other owners (cross purchase agreement); or, the business can purchase and own the life insurance on each owner (entity plan). Most buy-sell arrangements are structured in one of two ways: A cross purchase agreement or a stock purchase (entity plan) agreement. The determining factor is the number of owners who are party to the agreement. Cross Purchase Agreement For non-corporate businesses with three or fewer owners, a cross purchase agreement is the simplest and most effective. The cross purchase agreement is typically used in partnership structures. Each owner or partner owns a life insurance policy on the lives of the other owners and is named as the beneficiary on each policy. Under Section 162 of the tax code, the business may bonus the amount of the premiums to the owners, which is tax deductible to the business and taxable as compensation to the owners. 3
Buy-Sell Agreement Upon the death of an owner, the proceeds of the policy are paid to surviving owners, who then use them to purchase the interests of the deceased owner from his estate. The surviving owners receive a 100 percent step-up in the cost basis of the interests purchased. Stock Redemption or Entity Plan Agreement A stock redemption arrangement is best suited for businesses structured as a C-Corp, S-Corp or LLC. In all cases, the business, or entity, agrees to purchase the shares of the owners upon their death. The entity purchases a life insurance policy on each owner and is the named beneficiary of the policies. The premium payments are not a deductible business expense. Upon the death of an owner, the entity uses the death benefit proceeds to buy back the shares from the deceased owner s estate. Depending on the legal structure of the business, the surviving owners may or may not receive a step-up in the cost basis of the purchased shares. In a C-Corp, the owners do not receive a step-up in the cost basis, while, in an S-Corp, the owners receive a 100 percent step up under certain conditions. Owners in an LLC may receive a step up that is proportionate to their share of the business. For businesses owners, a buy-sell agreement may be the most important planning tool they will ever need. It is also a complex legal document which should be drafted by a business attorney. Because there can be tax implications in the transfer of business interests, for the business, the owners and their estates, the agreement should be reviewed by a qualified tax professional. Contribution limits for plan year 2016 Through the tax code, business owners in particular are afforded tremendous opportunities to substantially reduce their taxes, making it easier to make the maximum contribution to their retirement plan. The combination of current tax savings and the tax-deferred compounding of earnings can be worth hundreds of thousands of dollars in additional capital over a twenty or thirty year period. It is well worth the time and effort spent today to explore the best retirement plan options for you and your business. Because all retirement plan options involve tax considerations, you should consult your tax advisor before making any decisions. 4
SPECIAL FEATURE: What You Don t Know About Your Cash Flow Can Hurt You As important as cash flow is to a business, many business owners tend not to think about it until they are on the verge of a problem. All businesses are susceptible to cash flow crunches during economic downturns or markets that experience sudden shifts in demand. Even profitable businesses can experience cash flow shortages during periods of strong growth if their cash flow can t keep up with their increasing expenses. The chances of a business surviving any of these problems are low if it takes its cash flow management lightly. At any stage of its growth whether it s in the startup phase or it s striving to get to the next level what a business doesn t know about its cash flow can hurt its chances of overcoming inevitable problems. Here s what all business owners need to know about their cash flow to avoid serious problems in the future. Knowing When, Where and How Cash Needs Will Occur Small business owners can increase their chances of overcoming cash flow problems when they know how much cash they should have coming in and going out, both now and in the future. To do that, they need a reliable six to 12-month cash flow forecast that includes monthly expenditures, cash on hand and incoming cash. The forecast should be broken down by cash sources and their timing, including cash sales, credit sales with payment terms, cash loans and advances and investments from owners. The same itemization needs to be done with cash going out, including recurring payments, payroll and other operational expenditures and payments to suppliers. As cash flow is tracked on a monthly basis, it should be compared to the forecast, adjusting future cash flow projections as needed. The forecast should be able to tell you how much cash on hand is needed at each interval and how much excess cash flow can be set aside in a cash reserve. Knowing Your Business Every aspect of your business affects its cash flow. The key is to know how your cash flow is affected and the measures to take to minimize or eliminate any adverse effects. Seasonal or Business Cycles: Your cash flow forecast should account for known seasonal and other market cycles that can change the amount of cash coming in and going out. That includes the need to staff up or add inventory. Those needs should be paid for in advance of expected receipts out of a cash reserve or from a line of credit. Expenses: While it seems obvious that you should know your expenses, some business owners aren t so clear on how to manage their expenses during a cash flow crisis. Cutting the wrong expenses, such as marketing or key staff functions, could make things worse over the long-term while not addressing the core issues that caused the problem. Inventory: Money spent on inventory is cash out until those goods are sold. When you purchase inventory, you need to have a firm grasp of how quickly it moves and the timing of receivables after they are sold. Vendors, Suppliers and Customers: Very often the first indication of a potential cash flow problem is when your vendor asks you to accelerate payments or shortens your payment terms. Or, it s a client that needs to delay a payment. You should always have your finger on the pulse of your vendors and clients to know if trouble looms. Knowing Your Sources for Meeting Cash Needs There are a number of reasons why a business might experience an unexpected cash crunch a sudden business opportunity, the need to replace a key employee, the sudden loss of a contract or a disruption in the market. In many cases, the cash flow shortage is only temporary. However, if it is not addressed quickly, it could have a long-lasting affect on the business. A business should always have a ready source of capital to meet a temporary need. The best source of capital for businesses is a line of credit from a bank. It is a low Continued on back page 5
cost form of borrowing that allows the business to borrow what it needs, when it needs it, so it is best for controlling interest expense. Businesses that lack the credit or operational history to qualify for a bank line of credit could look to other sources, such as invoice factoring. With invoice factoring, the business sells its invoices to a factoring company in exchange for a cash advance of up to 90 percent of the collectible value of the invoice. When the invoice is eventually paid, the business receives the balance less a factoring fee. It s a more expensive form of borrowing, but it is a quick and reliable source of capital. Knowing Your Cash Management Processes Many cash flow problems can be avoided with the use of sound, proven cash management processes. Speeding up your receivables and more effectively timing your payables, is the key to smoothing out your cash flow and increasing your cash on hand. If you don t know the average age of your receivables or when exactly you pay your bills, you can t really get a firm grasp of your cash flow situation. By utilizing the latest technology available through your business bank, such as electronic processing, remote deposit, automated billing and automated payroll, you can streamline your cash management processes which reduce your costs while increasing your cash on hand. Talking with your business banker about cash management is the most important conversation you can have about improving cash flow. If banking was a sport, we medaled. # 3 in the nation -Forbes