Ten years of corporate tax expertise distilled into one hour

Show Transcript

Sean: 00:51 All right. Hey everybody, welcome to the podcast. I’m your host, Sean Tierney, and I’m on with Jon Bickerton. John is CPA and shareholder of Beech Fleischmann PC in Tucson. Jon Specializes in corporate tax research and development tax credit studies and cost segregation studies with an emphasis on value added client service. And John is a graduate of U of A (bear down) with the degree of Bachelor of business administration. Jon, welcome to the show.

Jon: 01:18 Okay. Thank you Sean. Appreciate it.

Sean: 01:21 Cool. All right, so your talk at PressNomics is on tax traps and opportunities. So two basically two things, right? So, uh, avoiding the traps and taking advantage of opportunities and I figured we’d start first with the traps. Can you just at a high level [inaudible] talk about like what common mistakes you see people making when it comes to tax?

Jon: 01:43 Well, I think one of the main things is, and really what my, um, my talk was geared around was basically being audit proof. Um, because of the hot button things that the IRS looks for any event that you do get audited, there’s a few things that you can expect. And it kind of what I wanted to, to go through, um, was, uh, just various things you can do to be prepared. Um, now as far as, as far as, uh, you know, traps. Um, I think one of the main things that, that you need to be concerned about is, is a, and the reason why the IRS targets a few, um, primary things on audits is because nobody does it right. So for example, um, you know, three things I see on every single information requests that the IRS issues when you’re under audit one meals and entertainment.

Jon: 02:37 Uh, the reason for that is nobody retains the proper documentation. They just charge it and they can go on their merry way. So meals and entertainment, uh, basically you need to retain some something that, uh, supports the date of the expenditure, the business purpose, who was there, all that kind of stuff. And you can get that on a receipt or actually a credit card statement. In fact, you don’t actually need to retain receipts of the expenses less than $75, as long as you have a credit card statement to substantiate it. And all that. But the reality according to that and its purpose at that point are you, how do you recommend, cause like I don’t if my credit card is just recording these things and I’m not saving receipts. How are you suggesting that people like kind of be able to attribute a meal to a certain business purpose?

Jon: 03:22 Well, if you’re using, if you rely on that credit card statement you would want to kind of go through when you get that statement and record those things. Um, when I take people out to lunch or whatever, uh, things like that, I usually write it on the back of the receipt. Um, but as, as most of us have experienced these receipts, sting grade over time, you know, they kinda get, they, uh, they get wrinkled out. They’re not easily easy to read. Uh, and there’s, I mean there’s apps out there for this stuff too. Um, we can take a picture of the receipt and just Kinda, um, recorded the business purpose at the time. Um, and that actually might be the easiest way if you can find an app that you enjoy. Um, that’s, that’s a great way to record your meals and entertainment. I mean, the reality is a lot of other people out there, in addition to the record keeping requirements, you know, you got a husband and wife who are running a small business and they go out to dinner all the time because they need to quote unquote confer with each other and talk about business.

Jon: 04:14 That one, even if you have the receipts, that’s going to be a little bit harder to defend, especially if it’s, if it’s beyond what a reasonable business needs. Um, so that’s one thing. Be careful in the meals and entertainment just because the IRS has seen a high level of abuse with it. That’s why it’s a target and requires specific substantiation. Um, so that, that’s one thing to be aware of. Uh, another is there, um, with regard to travel, again, you know what can be better than going on a vacation on the company’s dime. So people do that a lot. Um, and so there are lots of rules that surround when travel expenses are actually deductible and you have to be able to support the business purpose. For the trip, the time spent on business during the trip. I want to get into the boring details of exactly what qualifies and what doesn’t.

Jon: 05:06 Um, but that’s something that you want to make sure that you properly document your business time, uh, and the hours spent while you’re on a trip in order to deduct your, your, uh, you know, hotel costs, your travel costs, your meals and all that kind of stuff while you’re traveling. Um, the last thing is, is, uh, vehicles. Um, another thing is, is the only way, and I’ve had this question posed to me many times, like, you know, for my small business, as long as I, if I, if I have my company’s label on my card, does that make my, my navel the right off my car? No, that has nothing to do with it. Unfortunately. What the IRS is going to ask for it every single time is a mileage log. And again, you can find apps for your phone that, that kind of, um, uh, fit the bill, uh, on, on these, I mean, I use excel spreadsheets and things like that or you know, people buy, but I think an app is probably the best way to do it. If you have a, a mileage log, that means you have contemporaneous documentation and you do have to record the business purpose for the trip and all that kind of stuff as well. Um, but vehicles in order to write them off, you do need to have that contemporaneous mileage log, otherwise the IRS will absolutely disallow it.

Sean: 06:18 Okay. And is there a specific app you recommend or just suggest people go to the app store and kind of look around and see what, what they find?

Jon: 06:24 I would just think have it yet or there’s, you know, like I said, I use excel for most of the stuff myself. Yeah, I’m excited in a significant amount of driving for my job. Um, lots of meals and entertainment. But, um, we’ve also got, we’ve got our own proprietary in house tracking software, so I use that in addition. Um, so, but yeah, I think, I think just, just try to add an app or two on the app store and uh, something to kind of facilitate you keeping some records of your business travel.

Sean: 06:52 Yeah, I mean it sounds like anything is better than nothing, so just find something that you can live with. I’ve used a, I know wave accounting was the package that I was using and they have an app on the iPhone that just, it perfectly integrates with it and it allows you to capture your receipts and everything. So maybe the, maybe the advice is like check what accounting software you’re using and seeing if there’s maybe something already specifically integrated with that.

Jon: 07:14 Yeah, and a lot of times, a lot, a lot of people use quickbooks in a lot of Apps, uh, do integrate into quickbooks. And so that could be a great way of um, you know, recording the expenses first of all, but then also having the documentation to back it up.

Sean: 07:28 Cool. Cool. But the high level thinking here is you want to have substantiation that whatever you are doing, whether it’s meals or travel or your vehicle mileage or whatnot, that you have a clear business purpose for it and are able to show that.

Jon: 07:42 Got It. Yeah, exactly. And that’s the thing, if you can do that, if [inaudible] if an auditor, so when an auditor comes to audit you, they take a sample of just about anything. They don’t look at absolutely everything unless they find, let’s call it probable cause to dig deeper. You don’t want them to dig deeper. Um, mostly because of the headache. It’s gonna Cause I mean, you know, when you, when you get that audit letter, but a lot, you’re going to be in this for probably a year. Um, mostly because the auditor will come in and they’ll, they’ll kind of swoop in to look at things and then you won’t hear from them for a couple of months and then you’ll get another letter asking for more stuff. You’ll sit there and think, oh, maybe it’s over it. Nope. Not until you get that closing letter is the audit over. Um, the IRS is greatly understaffed. I mean, I think all of us, when we hear about IRS budget cuts, we get excited, you know, less IRS agents to play the world. But usually what that means is for the folks who do, uh, and run into trouble with the IRS, it means that they’re not gonna resolve their issue quickly at all. Um, it’s going to be a long haul. And these audits almost always take a year. Um, so the less that they dig, the less that they need to dig, uh, the better off you’re to be.

Sean: 08:56 And so that Spacek essentially up front, they’re just looking to see how things smell basically there. Does it look like I’m going to need to go deeper. Got It.

Jon: 09:04 And so, yeah, think first sample is, is doesn’t yield anything, then they might not dig any deeper.

Sean: 09:11 Got It. And is that a subjective, just judgment call on their part, or is there anything specifically that we need to know? Yeah,

Jon: 09:18 exactly. Yeah, you want to be, you want to be the easiest case they’ve ever had because they’re, you know, currently working on, you know, their caseload. Uh, can be stressful for them and they’re mostly focused on the problem clients. So as long as you don’t present yourself as a problem client, um, they’re not gonna pay as much attention to you because they’ve got bigger fish to fry. You want to be the small fish.

Sean: 09:39 Yup. Got It. Yeah. I mean the mental analogy I’m making here is a, it’s almost the way I think of like the club on your car when you, when you go, you just want make your car unattractive when juxtaposed to the next guys. They’re just make the thief go to the next one. So it sounds like it’s the same strategy here.

Jon: 09:55 That’s exactly right. That’s exactly right. You just want to be a slam dunk and something easy for them to get through.

Sean: 10:02 Cool. Cool. Well, so are there any, eh, are there any like red flags that attract the IRS or things that we can do? Strategies to mitigate having like not even to get into the audit scenario?

Jon: 10:16 Well, I mean, most of the time what causes an audit? And the IRS doesn’t tell us, obviously. Otherwise if they told us what not to do, we’d never do it. Um, but most of the time what I see are, uh, tax return claims that just don’t make any sense. Um,

Jon: 10:34 so for example, I had, I had a client who’s a, they’re a construction contractor. They build landscapes for, for zoos and they claimed research credits because they had, um, they had come up with a new retaining wall system, uh, which totally made sense. Uh, but, but the IRS thought that because the word landscapes was in their name, that they were a landscaper and they were claiming r and d credits. And so they got flagged for audit because, uh, landscapers generally don’t qualify for r and d credits. Uh, another time I had a client who, uh, wasn’t under my watch, but they had a, their tax repairer added an extra zero to an expense line item. Um, like it was real estate taxes and instead of it being like $5,000, it was $50,000. So completely out of the ordinary. And so that flagged them for audit as well.

Jon: 11:24 And so different little errors like that, you know, if there’s any sort of crazy unusual swings and expenses, uh, that’s something that can attract attention. Um, I had another client get audited because of a, an incredibly high mileage claim, a mileage deduction. I think he, uh, he, um, drove, uh, goods over the border and he claimed 58,000 miles when one year, so he got audited. Um, so different things like that, that’s probably the main thing that causes audits. Uh, another thing, uh, that is best to avoid if you can amended tax returns. Um, usually that when, when tax returns are filed, the vast majority of filed returns don’t get looked at. Almost every single amended tax return gets reviewed by the IRS. And so they’re taking a closer look when you change something on your tax return. Uh, so if it’s a small item, I’d probably skip it.

Jon: 12:20 Uh, if it’s a big item and you can back it up and you know, you’re okay with IRS inquiry, go ahead and a man. But we try to avoid amending, uh, whenever we can. Additionally, um, you know, so for, so for those folks who are out there kind of, you know, they’re doing a kind of independent contractor thing, um, they have their own, you know, work from home business or something like that and they file their business income on a schedule C. Those also get a lot more attention than if you were, for example, an s corporation or a partnership or a business tax return. The IRS statistically sees a lot more abuse, a lot more error, a lot more problems when someone files as a sole proprietor versus as a business. Now obviously you get away that against the cost of filing an additional tax return.

Jon: 13:10 You know, frequently the cost of filing a business tax return is, it’s more expensive at tax repair fees itself, for example, on s-corporation tax return. And that way you kind of get lumped in the bucket of, uh, not, uh, basically the bucket where the low offender bucket, uh, the low likelihood of, of uh, abuse, little likelihood of error when you kind of present yourself with a certain level of sophistication and filing a business tax return. Um, the last thing I see getting a lot of attention, um, at least recently is there’s a, there’s a bit of a loophole with, uh, with s-corporation specifically where, uh, as as a shareholder of an s corporation, you’re an employee of the company. And so anything, anything you pay yourself has to be treated as, as wages. But if you pull the profits out of the company above and beyond what you pay yourself in wages, that those profits are not subject to employment taxes and employment taxes are the FYCARE the medicare that adds up to between the personal side and the what the business has to pay about 15.3%. And so historically s-corporation shareholders have wanted to avoid paying themselves any wages and instead take everything out as a profit distribution. And so they’re escaping this 15.3% tax, which is can be significant. You know, you have $100,000 of income, that’s $15,000 of tax you can avoid. Uh, so w w a lot of these folks are trying not to pay themselves a salary while the IRS doesn’t like that. Because I mean the way the law reads is you have to pay yourself reasonable for the services

Sean: 14:52 you’re rendering to that corporation. Right? Uh, oh.

Jon: 14:56 So the IRS, if they see you know, a lot of profit and little wages paid to the owners, then that’s a red flag for them and they’re going to follow up because that’s just easy for them.

Sean: 15:05 But to, to assert that the compensation is not reasonable and they get the charge you not only the back taxes but all the penalties that come along with it and the penalties can be as high as 20% and so what is the rule of thumb in that scenario? What is the rule of thumb for an owner? Let’s say, you know, a CEO, what is reasonable to pay yourself versus taking dividends?

Jon: 15:28 As a business owner, you should have a pretty good idea of what you would need to pay somebody to do your job.

Sean: 15:34 Yeah.

Jon: 15:34 And that’s in general. And you can do like a wage study. You can, you know, you can take a look at some of the, uh, employment websites to find out what the wage ranges are for someone in a similar situation as you. Uh, so for example, if you’re a plumbing contractor, you know, how much would you pay a manager at a plumbing contractor, um, and then maybe maybe unreasonable wage is 50,000 bucks. So that’s what you pay yourself and then you take the rest out and profit distributions. As long as you have some sort of documentation that shows this is what you’re taking is reasonable.

Sean: 16:03 So here’s a question. Is there, you know, like in law, truth is a defense for slander. So you can, you can fall back on that. Is there a similar rule with accounting where it as long as you, yeah, yeah. [inaudible] [inaudible] and you can show that and you were trying to do the right thing. Is there some kind of amnesty thing? Like if they come back and they say, you know what, that’s actually a $75,000 a year role. That’s what you should’ve been paying yourself. As long as you can substantiate the decision you made, is that defense for that or does the IRS get to basically dictate what you should have claimed?

Jon: 16:37 The IRS can dictate it. Uh, but it’s, uh, it’s going to be a matter of how much trouble is going to be for them to prove it. Cause if you have documentation, then that puts the, that puts the burden of proof back on them.

Sean: 16:51 Yeah. If you have a reasonable position, it’s really hard for them to argue with it and they can [inaudible]

Jon: 16:57 but then they would have to get concurrence from their manager and it would have to go up the chain. And a lot of times this is not worth the trouble for them to kind of do that.

Sean: 17:06 Got It. So the name of the game here is not taking egregious, uh, you know, just the, the more the difficult and the more difficult you make your position to be able to substantiate your, putting yourself at risk and now you’ve got to prove it to them and et Cetera, et cetera. So it’s some balance of taking what seems reasonable and being able to prove it, it sounds like.

Jon: 17:27 Exactly, exactly. There’s got to be documentation as to as to why you decided to pay yourself what it was. You’re not. If you’re a, if you’re a doctor, you know, you can’t pay yourself $50,000 a year. You know, a plumbing contractor could get away with that. A doctor can. Yeah. It’s gotta be, it’s gotta pass the sniff test. Um, and as long as you’re kind of even borderline reasonable, you know, you also got to think through the IRS puts tremendous resources into the audits that they undertake. And so it’s going to be, you know, what’s going to be worth their while is going to be worth their while to chase after the plumbing contract. You’re paying himself $50,000 a year or the doctor paying himself $50,000 a year. Right. They going to look at their like, what, what’s gonna make the most sense for the allocation of government resources?

Jon: 18:08 Cause they get, there’s a lot of accountability on their end, so they get to make sure that if they’re going to pursue something, it’s worth their while. Cool. Great. Well, so what about other, are there any other mistakes to avoid here? Uh, I know that there’s like this idea of not lumping everything in one account and some type of like keeping things separate, but maybe you can talk about those. Yeah. You know, um, one thing I’ve seen happen often on audits is, uh, business owners that kind of use the company as their own personal piggy bank. Um, and while that’s not necessarily illegal, um, you know, on a legal protection side, I mean that’s, that’s the classic Pierce, the corporate veil, a case when the owner is not respecting the entity. So you can open yourself up to potential legal claims in the event that you’re sued, cause all ideas.

Jon: 18:58 Your LLC or your corporation is supposed to provide you a legal shield. But if you’re using it as a piggy bank, that protection can be gone. The judge can see through it and say there’s, you know, you’re not respecting the corporate form here, but on the tax side, if you’re combing like business and personal, uh, just like I said before with, um, with the audit or taking a sample, if he starts finding personal expenses, it’s going to cause him to dig deeper. Uh, and in fact, if, if you have a tough time substantiating any, because of the amount of personal expenses you, you’re going to be put on the, on the hot seat to justify anything as being business and you run the risk of the auditor just saying, I can’t audit this. There’s too many personal expenses. I’m going to disallow everything. And they can do that.

Jon: 19:41 Jada can disallow anything. Everything in the event that they determine that the, that the books are so massive that it can’t be audited. So that’s, that’s definitely something that you wanna you want to avoid. Um, and then just kind of moving on a few more serious things. You know, everybody gets into trouble every now and again as far as, you know, finances are concerned. And one of the, one of the worst things you could possibly do in the event that cashflow is tight is a, is not pay over your employee withholdings to the government. Uh, that’s called the trust fund penalty. And if, if you are determined to, uh, have intentionally not paid over the payroll taxes, the withholdings and all that stuff that the government, um, the penalty is 100% of the amounts that you did not pay over. So not only do you owe all those payroll taxes back, but you personally are responsible and the kind of actually what happens is the company gets hit with that penalty and the individual gets hit with that penalty. So the company’s responsible over 100% and then the individual is responsible to pay over a hundred percent and it’s, it can get crazy. I had a client who got in a similar situation and they, it them years to pay that off. Um, so that’s one thing you want to make sure you don’t do is uh, whole use the employer withholding money to operate. You’re going to pay that over. It’s just not worth it. That’s when the IRS turns into a loan shark.

Jon: 21:04 And there’s no such thing as a usury when it comes to the IRS. They just, they said a hundred percent penalties, but actually that’d be 200%. Since this instance, it’s at the entity level and the individual level. Um, you know, another thing too that, that folks don’t realize there’s a lot of scrutiny on foreign transactions. You know, you might remember back in the early two thousands that UBS scandal where there were tons of American tax Dodgers who had accounts in Switzerland that were earning all sorts of returns, but nobody was paying any taxes on them because of the Swiss secrecy laws. And that, uh, once it got discovered, once the whistle was blown on that, um, it just kinda blossomed into the IRS seeing opportunities everywhere for them to chase down with what they perceive as tax Dodgers. And so there are multiple forms now that, that you might get roped into filing in the event that you have foreign investments, foreign bank accounts, or as a business if you have a foreign subsidiary, if you have a foreign owner.

Jon: 22:06 Uh, all of these forms carry very stiff penalties for failure to file. I talked with a gentleman recently who had significant overseas European pensions that he was not reporting the IRS. Um, and occasionally the IRS will have amnesty, um, Amnesty provisions where as long as you, as long as you apply under the amnesty program, you pay the tax and the interest, the interest never gets waived, then they won’t, they basically won’t put you in jail. It’s pretty bad that the, the penalties for not filing the, the compliance forms. So for example, if you have a foreign bank account, a foreign bank account, and the balance ever goes over $10,000 in US funds, then all of a sudden you have the a requirement file, what’s called a foreign bank account report. Uh, and if you don’t file it and you somehow get found out, the penalty for the failure to file is $10,000.

Jon: 23:00 Likewise, if you have a rent subsidiary that you don’t report $10,000 automatically, if you have a foreign owner that you don’t report $10,000. Um, so that’s just one of those things you just want to make sure if you have any sort of foreign operations that you, uh, get with a tax professional that understands international taxation. And is it, uh, my understanding is that it’s the sum total of all your foreign bank accounts. Can we see the 10,000? It’s not just a 10,000 and needs yeah, that’s correct. Yep. Yeah. So, so yeah, you can’t play games with like moving money around. If you have more than $10,000 in foreign and foreign cash in foreign bank accounts, then the penalty is $10,000. You got the, yeah, as soon as you 10,000 bucks and it has to be reported, there’s no tax impact. I mean, you’re not going to be taxed on any of that unless it’s earning interest and you’re reporting the interest. Uh, but it’s one of those things that you just, you just have to file.

Sean: 23:55 Got It.

Jon: 23:57 So, um, and another thing that I think can be tempting for, um, for small businesses is, you know, as a small business owner, you’re incentivized definitely to treat your workers as independent contractors instead of employees. Uh, cause if they’re an employee then you run into issues with, you know, maybe you need to providing, provide them with benefits, you have to pay 50% of their employment taxes. And it’s definitely a lot more expensive for you as a business owner to have an employee and not an independent contractor. And then, you know, if your company has a 401k plan, maybe you have to contribute for him. Definitely more expensive. They have employees instead of independent contractors. Uh, and so you’re tempted to treat everybody as an independent contractor. Well, if, if it turns out that the IRS investigates and usually they don’t, unless somebody tells on you and occasionally a one of your workers who doesn’t like the fact that they have to, they’re not getting benefits or that they have to pay all their own employment taxes and they don’t like it and they tell the IRS, that’s usually when these inquiries get started. And the IRS will come back and assess you all of those back, um, employment taxes that you weren’t paying plus significant penalties, uh, while that isn’t as bad a situation as not as failing to pay over the, um, the, uh, the trust fund, the, the employer withholdings, it’s still, it’s still a bad situation and the penalties, um, rack up very quickly and it can be nasty.

Sean: 25:24 Good to know. Yeah. Cool. And then

Jon: 25:28 what is this IRS 20 factor test? What does that about? Oh yeah. So, so in order to really, cause he might have a bonafide case, you know, there’s a, the IRS has, uh, in order to make the distinction, it’s not clear cut necessarily. So the IRS, when they make their distinctions, they weigh 20 different 20 factor test. That basically what it boils down to is how much control does the, uh, does the employer have over the worker. Um, if the worker gets to dictate the timing, um, the, they bring their own tools for example, then the chances are they’re an independent contractor. But the more control the employer has to say, you will report at this time, this is what you’re going to do and this is how you’re going to do it. Then that’s evidence to suggest that they’re an employee and not an independent contractor. And so those 20 factors all deal with the level of control that a, that a oh employer or a payor exerts over a worker and the more control they have, the more likely that that worker is an employee rather than an independent contractor.

Sean: 26:30 Got It. Cool.

Jon: 26:34 Let’s, let’s shift gears in like, so if someone’s looking to work with a CPA, what tips do you recommend? How do you not the person yet? How

Sean: 26:44 do you identify who is a good CPA to work with? Do you have any recommendations there?

Jon: 26:50 Yeah, absolutely. Um, so, so what I see, I mean, you know, an accountant typically as a certain kind of personality, um, now they’re cautious, they’re conservative, um, and they’re a little worried about minute. Those are good things. I mean, you know, one of the main reasons why you have someone prepare your taxes is because you want to make sure that they’re done right. Uh, our tax code is so complex that, you know, you’re, you’re much better off most of the time. Um, having somebody else insure someone who’s a professional who’s dealt with this stuff before, um, you want to, you want to have somebody else who’s, uh, who’s going over everything and making sure that it’s being done correctly. Um, and so, but as, as you, as you look at accountants, I mean, so one of the things I see often is, is accountants can tend to be like the fact that IRS agents, so they’re gonna, you know, they don’t want to take any sort of risk.

Jon: 27:44 And, uh, you know, you may pay more taxes than you actually need to. They can interpret the, almost everybody has some level of gray area, um, that they’re dealing with in their tax return. And some accountants will interpret that in favor of the IRS and some will interpret that in, in your favor. And you typically want to find someone who’s going to interpret it in your favor. Um, cause you don’t want to pay any tax and you need to, um, you know, at the other, yeah. The other extreme end of the, of the spectrum you’ve got, uh, the shady accountants, the cheaters, um, who, uh, especially just want to impress their clients and substantiate their big fees because of all the taxes that they’re saving you. Uh, when the reality is they’re, they’re putting you in risky positions. So you wanna avoid both, both extremes. You don’t want the Shitty guy, you don’t want the overly conservative guys. So use any, anytime you, um, you test out a new account and you want to interview them to find out, you know, how they would classify themselves. You know, how aggressive are you? How conservative are you, what’s your, what’s your main goal in taking care of me? In what ways do you have my back? Um, you know, how are you looking out for me? Ask those kinds of type of questions. Is there any other thing,

Sean: 28:53 oh, I was just going to, sorry to interrupt. Is there any particular question that you could use? Almost as like a, a litmus test to know if a CPA is good or some, some type of yeah, like a, a standard thing that you could ask and within two minutes of them answering you’d say, okay, that person knows what they’re talking about.

Jon: 29:13 I would ask the question, how are you going to save me, Save, save me taxes and see how the response, so that cheater is going to give you this crazy answer. And the a, the conservative guy is going to say, well, I’m just going to make sure they’re done right. Um, but I think a reasonable person is going to give you a reasonable answer. So I think if you point it, if you put it to him that way, how are you going to save me on my taxes? Um, and if their answer is reasonable, where it sounds like one, they’re gonna keep saying amps you the opportunity to find the best answer so you can find someone who’s got a middle of the road. Cool. Cool. All right, well we’ve talked a lot about the things to avoid and the mistakes and whatnot. Can we switch gears and talk about opportunities and you know, ways to not leave money on the table here?

Jon: 30:01 Yeah, absolutely. Um, so the first thing, so in talking about let’s say tax planning, um, one of the things that, that, well, the primary question I’m always asked just as just as I said before, how do I save on taxes? And so, uh, so the, the, there’s one surefire way to save on taxes and that’s spend money. You gotta spend money in order to have deductions. Um, so the, the big thing is does that really make sense for you and doesn’t make sense for your business? Um, I have frequently had clients who want to spend a dollar to save 40 cents. They’re not looking at their business needs. They’re not looking at the things that drive revenue. They’re out there spending money cause they have the emotional, uh, fixation on not paying taxes and they hate paying tax. And so therefore they’re going to do whatever they can and not pay taxes.

Jon: 30:55 But they are, they’re doing things that don’t make sense for their cashflow, for their business growth and needs. So you want to find the happy medium of when you’re, as far as saving on taxes, spending money on the right things. So the, like I said, the way, the way that your, that you saved taxes, 99% of the time it’s going be, you have to spend, you have to spend money. Um, you know, I’ll, I’ll talk about it in my talk at PressNomics, but, uh, but retirement plans are well, great way of, of, uh, saving on taxes a while just, you know, taking money from one pocket and putting it into another. Um, again, you’re not going to have access to that money for a long time, but it’s, it’s a phenomenal way of saving for retirement as well as saving on current taxes. Um, so really you have to, you have to take a look at what makes sense for your business.

Jon: 31:43 Um, think about, uh, opportunities for investment as far as, you know, the equipment. Is that equipment going to drive your revenue, you to buy expensive machine for your manufacturing process or a new computers or anything else like that. Those will absolutely count as deductions and reduce your taxes. But did they make sense for your profitability? Um, again, you know, you want, your goal is not to not pay taxes is to end up with the most amount of money in your pocket at the end of the day. So you wanna you wanna balance, uh, you know, good business sense with your tax strategy. Yup. Um, that bed, there are a few opportunities now that exist, uh, more so than they have in the past. Um, with the tax cuts and jobs act, that was the, the Trump tax reform that took place at the end of 2017. Um, more businesses now than ever are eligible to use what’s called the cash method of accounting for tax purposes.

Jon: 32:36 So the cash method is where you’re able to, um, report based on your cashflow essentially. So if you bill your customers and you haven’t collected on that account, on those accounts receivable, you don’t have to pay tax until you actually collect. Uh, and likewise, if you haven’t paid your bills yet, um, you don’t get to deduct that. But it can provide a lot of flexibility in year end tax planning if you’re on the cash method because you can wait to bill so that you’re not collecting any receivables until the beginning of the year unless you’ve deferred that income for a whole year and you can pay down your accounts payable. Uh, if you have the cashflow to do it to minimize your tax liability one year over another. So the cash method, I mean that’s just the timing difference. You’re not going to pay any less tax over the long run using the cash method versus the accrual method.

Jon: 33:22 The accrual method is, as listeners might be aware, is where you know, if you have earned income, even if you haven’t collected it, you have to recognize the revenue. Or if you’ve incurred the expense, you know, you get a bill for services that had been performed, then you can deduct it as an expense, even though you haven’t paid it yet because it’s been incurred, the service has been performed, all that kind of stuff. That’s the accrual method. You can’t game that as much as you can. The Catholic cash method, um, you know, occasionally the accrual method will make sense for some taxpayers. So if you have significant, uh, customer prepayments under the cash method, you have to recognize that as income when, when received, even though, so for example, if you have lots of subscription income, people are prepaying you for a year of subscriptions, uh, that it makes sense to be on the accrual basis and you can defer that revenue until it’s, until it’s actually earned.

Jon: 34:12 Um, so that’s just, you know, one way to look at, at timing differences and you get, usually it’s just a one year bump. We’re able to, to have a nice deferral and then you can kind of gain it from there. Additionally, you know, um, one of the things that we suggest to our clients, uh, anyone who owns a building or is thinking about buying real estate for their business in which we operate, you know, you kinda occasionally business will go to the size where they say, you know, it doesn’t make sense for me to pay somebody else’s mortgage. I’m going to buy a building for my business. We’ll operate over there and not only will I be building equity, but you know, it’ll appreciate, I get the upside. I don’t know it as well. Well, uh, if you buy a building, um, the way that works is the way you recover your costs in a building as you depreciate it.

Jon: 34:58 But with, with most assets, you have a capital expenditure. Instead of getting an expense right away, you have to depreciate it over a certain number of years. When you buy a building, you depreciate it over 39 years. And so you don’t really feel a lot of excitement about getting the tax benefits of buying a building. However, uh, if you do think it makes sense to buy a building, um, there’s a service called cost segregation studies or you have an engineering study done in your building and you can frequently separate out 20 to 30% of the buildings costs eligible for immediate deduction. And so rather than over 39 years, you’re getting all that deduction now and you can use that to kind of basically borrow against future taxes and by reducing this year’s taxes and use that money to reinvest in your business and use that money for operations.

Sean: 35:47 Okay, great. So when would this be something like your building has an elevator in it and you determined that hey, that thing’s not going to live for 39 years, so I’m accelerating the debrief, the depreciation on the elevator and you’re basically kind of like making the lifespan of that thing shorter or is this something different than that?

Jon: 36:04 No, I mean that’s exactly what it is. Now. Elevators, unfortunately in the law, those are bye bye bylaw 39 year property, but there’s a whole bunch of other stuff. So your millwork in your kitchen or secondary lighting systems or a specialty air conditioners or things like that that an engineer can identify and cost out. That’s what’s eligible for shorter life. Got It. Cool.

Sean: 36:31 Alright. Um, what, OK, so in terms of the entity structure itself, I know you’ve mentioned s corpse and c corpse and there’s LLCs, I know and others what, how, how does one make the determination if you’re just starting out and you’re choosing an entity type, what, what thinking goes into that or what are the advantages, disadvantages of, of choosing each?

Jon: 36:53 Well the, as I said before, the sole proprietor has the advantage of not filing a separate tax return. So it’s simplicity. Now the main issue is sole proprietors, especially if you have losses on a regular basis, that can garner a lot more IRS attention than if you file as an s corporation or a partnership. In addition, all of the profits of a sole proprietorship, assuming that you are running an operating business as opposed to like investment activities. If you’re a sole proprietor and you’re running an operating business, all of your profit is subject to the self employment tax. That’s the like of the Medicare, that 50.3% up to a certain level. Um, an advantage than an s corporation is going to have is that, uh, as we said before, um, you only have to pay yourself a wage [inaudible] and at a certain level, as long as it’s reasonable and anything else that they take out of the businesses and profit distribution is not subject to that payroll tax.

Jon: 37:48 And so you can save up to 15.3% on, um, profit distributions as long as you have, you know, you’ve got your ducks in a row with regard to how much you’re paying yourself. Um, you could take out profit distributions and save that 15.3% on that profit distribution. Um, partnerships usually occur because you have to, if you have a partner, then by by default you are a partnership unless you elect to become an s corporation. Um, and that’s Kinda that there’s this, the only advantage there is, um, there’s flexibility with regard to allocation. So, for example, a lot of attorneys will form as partnerships because when they come together as partners, they’re, they each got their own book of business, but they share costs. And so they have kind of like a common pool that they contribute to. But if one guy does more business than another and an s-corporation, everything’s gotta be, even Steven, everybody gets their allocations based on their ownership.

Jon: 38:45 Whereas with the partnership, you can have an agreement that says, hey, if I bring in 500,000 and you only bring in 300,000 and I get my 500,000 and you only get your 300,000. So if the partnership, that’s the advantage there is, there’s a lot of flexibility in determining who gets what profit. Whereas in an s corporation, that’s more like, you know, you get to operate truly as an employee of the business, uh, rather than, um, you know, kind of running the, running your own ship so to speak. Got It. Cool. All right. Um, anything else? I know we, we, you’re an expert on the R and d tax credits. So that’s where I want to go next and, and spend a little bit of time on that one. But is there anything else on this subject you can think of in terms of not leaving money on the table?

Jon: 39:32 Um, you know, there’s a, there’s the, the new qualifying business income deduction for pastors. Um, that’s something that that would be good to plan for. Uh, if you’re a very small business that doesn’t have a ton of wages, there are limitations on how much you can deduct for this new deduction. The qualifying business income deduction is basically just 20% off the top of your profits. So, uh, wages don’t qualify for this. So again, you’re incentivized to pay yourself less than wages and take the rest as profits. But at the same time, there are limitations on how much you can deduct that are tied to wages. And so that’s something you definitely want to vet through with your accountant to see, to make sure that you’re maximizing it and getting the full deduction off of that. Um, partnerships, same deal, a sole proprietorships, same deal. Um, and then, you know, with retirement plans.

Jon: 40:21 I wanted to touch briefly on that. Um, you know, one thing I would say on retirement plans is the more complex it is, the more advantageous it is for the owner. So the, so the simpler, the cheaper it is to maintain. That’s, that’s the, those are the less least advantaged a tax plans or retirement plan. So for example, there’s the PSAP, the self-employed pension or the simple, those are, those are very simple. You don’t need to do any sort of government recording. Um, the benefits are fixed. But the problem is that to the extent the owner takes those benefits, he’s got to give it to the employees as well. And so, so with those, you tend to have to chip in a lot for your employees. Now when you have a 401k and a profit sharing plan layered onto that, that’s where you were as an owner.

Jon: 41:08 You can really maximize how much you’re putting away for retirement. You can, um, you can put significant amounts of away and if you have a good what’s called a, a tpa, third party administrator, um, they can really design a plan that maximizes your benefit and minimize to the extent possible the, the amount that you have to give, give to your employees. Now, at the same time, a lot of folks want to have good fringe for the employees, uh, but at the same time they want to maximize their own benefits. And so a good third party administrator will help you design a plan that accomplishes both goals. And then finally, there are still, um, there’s still the opportunity that I have a pension plan. It doesn’t make sense for all businesses, but a pension plan is where, uh, you could sock the most money away for retirement.

Jon: 41:54 Um, the one that we see in most office called the cash balance plan where you contribute to this thing above and below and beyond what you’ve already put into your 401k and your profit sharing. And, uh, the way it works is as a defined benefit, you have defined cash balance and an interest credit that happens every year. And so at the end of your career that that amount of money is guaranteed to you. Now the disadvantage of that is if the tots, if the investments that underlie that cash balance tank, you’ve got to fund the difference. But listen, it’s a great opportunity to put more money away and it’s, it can be a good, a good thing to talk about with your tax advisor. Oh, but just jumping in. Yeah, go ahead.

Sean: 42:30 I was just gonna say that makes sense on the 401k profit sharing side of things, unlike the, the hole with the escort where you’re doing the district profit distributions and that raises the red flag cause it was too lopsided or whatnot, that that doesn’t exist with the 401k. If you’re putting a huge chunk in the 401k, the IRS doesn’t care because eventually you will pay tax. Just not now. Is that kind of the thinking there?

Jon: 42:54 Well, and it tends not to be a red flag just because they haven’t seen much abuse. Um, uh, so, so that’s not as much of a hot button issue that the abuse usually comes in with the compensation side of it. Um,

Sean: 43:07 people saving too much for retirement, it doesn’t, isn’t an issue.

Jon: 43:12 And then, uh, and then there’s also a requirement if you’re, if you have a certain number of employees that, uh, that your, your plan actually has to be audited by a third party auditor. And so that’s, that’s why there typically isn’t, isn’t a lot of, um, listen, a lot of abuse there.

Sean: 43:29 Okay. Cool. All right, well, so I think let’s, let’s now transition to the last phase here and talk about the r and d tax credit. So what, what is that all about?

Jon: 43:39 Oh, sure. So, so basically this is for anyone who was doing product development, who is improving their products, improving, uh, their, um, processes, uh, in software development is a, is a big part of it. So, so basically anytime that you are in a situation where you have the opportunity to enhance or improve your, your main revenue generator, um, whether they be a product or like computer software or something along those lines. Um, if you undertake basically what in in the law, the way it’s written is if you have to tinker that, I don’t use the word tinker in the law, but if you have to tinker to figure it out. So for example, with software program, if you want to add a new feature to the website and you’ve got to get in there and you’ve got to test executable code, or if you’re, you know, adding an enhancement, your existing software program or if you have a few, have a, a widget that needs to bounce higher and you go in there and you start working with it and you testing out various materials or you’re testing that executable code or whatever the case may be.

Jon: 44:46 And at the outset, you, you’re not sure whether you can accomplish a goal or you’re not sure. You’re sure you can do it, you’re just not sure how you’re going to do it and what the end design is going to look like. Your expenses that relate to resolving that uncertainty, uh, are eligible for a tax credit. Um, now the expenses that are specifically eligible for the tax credit, that primary, the primary driver of these tax credits is wages. Um, and then you’re also allowed to pull in. So for example, for let’s say a software programmer who’s using Amazon web services, uh, not only for production but for a development space, uh, the cost to use computers, somebody else’s computer can qualify as well. Uh, for someone who’s got a tangible product that they’re trying to improve, basically your prototyping costs that you could pull into the, to the, uh, to the credits.

Jon: 45:36 So the amount that you’re spending on prototypes, materials and supplies to kind of experiment with. I’ve got clients who do destruction testing, all that kind of stuff. Those are the primary expenses that are going to be allowed for this tax credit. So if you’re having to tinker that to leading to the improvement or the development of a new product or process, I mean, you can do an engineering study on your manufacturing process or, uh, you know, certain processes as long as, as long as the, the, your, your process of figuring it out, your trial and error, your modeling simulation, whatever it is, as long as it fundamentally relies on technological principles. So technological principles for example, are, you know, engineering, computer science, physics, biology, as long as, as long as, um, what you’re doing ties into those somehow, then you can justify and then your costs to resolve your uncertainty and either bring your product to market or candidate or whatever you’re gonna do.

Jon: 46:33 Those are eligible for a tax credit, uh, and being in the state of Arizona. So the federal tax credit, uh, now one thing I should mention real quick is you get a baseline that you gotta get, you gotta get past. And, uh, so, so there’s a hurdle amount. So you always want to, you know, do some feasibility before you pay someone a ton of money to do a tax credit study for you. Um, you want to take a look at, you know, what, what kind of credits are we really looking at here? Because it’s not just a dollar for dollar credit on what you’re spending on r and, d. It’s, uh, the federal credit is 20% of your expenditures in excess of your, of your hurdle amount. And in the state of Arizona, we’ve an incredibly generous r and d credit, which is actually 24% of your expenses in excess of your, her alone amount, uh, which is actually bigger than the federal credit.

Jon: 47:17 And so, you know, Arizona, we have low tax rates to begin with. And so, um, so what I see happen frequently is that the Arizona credit will be much bigger than the federal credit. Uh, so much so that I’ve got clients who will have so many errors on a tax credit carryovers. Not only will they never pay Arizona tax again, but they’ll never even use their credits. Um, and one of the things actually that the state did to, to, to encourage further r and d work is that you can, there’s a, there’s a, an allocation each year that the state state government, uh, gives to ’em to fund a program whereby tax payers can get a refund of their r and d credit instead of claiming the tax credit. So that’s good for startups. People weren’t paying any tax yet. That’s good for folks who have r and d credits will never use.

Jon: 48:06 Um, it’s a great opportunity. In addition, um, the, the feds have a program for startups as well. As long as you fit within certain criteria, you know, your revenue isn’t over a certain threshold. We’ve only been in business for a certain number of years. You can actually use your r and d credits. It gets your payroll taxes. So if you have significant payroll tax expenses, um, then, then you can actually monetize your r and d credits and use them now instead of having them carry forward to future years. But I’ve got clients who have hundreds and hundreds of thousands of dollars of r and d credits. I mean, it can be a pretty phenomenal return on your investment and help have the government help you pay for your, your R and d expenses. Because as we all know, if you’re doing r and D, You’re taking on risk and you’re not getting a direct return on your investment just yet. Um, investing in R and d can be a, it could be a tenuous, um, proposal, but the government wants to encourage you to move ahead by offering these tax incentives to help basically pay for part of your R and d.

Sean: 49:08 [inaudible]. So, okay, so let’s just take a, just a random scenario just for the sake of having something tangible to talk about. But let’s, let’s say Pagely spends $200,000 this year on developing, you know, like on an engineering costs and that our hurdle, let’s just say as $100,000, you’re saying that too, basically 20,000. So, so of the overage, half of that $200,000, the overage above a hundred, we’re k we’re eligible for 20% of that with the federal and 24% of that with the state of Arizona in terms of getting that as tax credits. Is that, that’s absolutely correct. Okay. Absolutely. I mean that’s, that’s substantial. That’s, that’s real money.

Jon: 49:51 Yeah. Yeah. I mean, you know, I’ve had some people who, you know, assuming it was like a dollar for dollar credit, so unfortunately it’s not, it’s not that a huge, but most of the time when, especially for somebody who’s not claiming that and it was investing significant sums in, into their, their development, um, it can, it can be a real benefit. Um,

Sean: 50:12 yeah. In, just to be clear, this is, so, this is applicable to us in terms of the, the r and d that we spend on a product or on improving our website or anything like that. But if I’m a freelancer, say, and I’m, you know, taking client jobs and I spend x amount of time just trying to figure out what they need or execute work for them, that’s not considered R, d right?

Jon: 50:38 Well really all the pants. So, so there’s a concept of, of contract r and d. So if you contract with somebody and they want, so I’ve got, I’ve got a number of clients who are job shops and they do fabrication and things like that. And so they enter into fixed price contracts, but they’re not sure at the outset how they’re gonna, what the, what the end product is going to is gonna look like. And so they get a tinker a lot. And so as long as they retain the risk, um, to deliver a working product, then they, that can qualify for r. And. D. So then that becomes another, another question too. So if you’re an hourly, you know, program for programming for example, and you’re doing development for somebody else and they’re paying you hourly, then it’s their r. And, d, it’s not yours. Right? Right. So if they’re funding you or even they get the credit.

Sean: 51:27 Yeah. But as that freelancer, you can at least make them aware of that. If it’s significant, it’s, it’s just kind of a nice little gold star for you. If you make them aware of that credit, if they weren’t aware of it, then that’s tax savings for them. So it’s effectively like you’re saving them money on your cost.

Jon: 51:45 Right. Exactly.

Sean: 51:47 Cool. All right, well anything else people should know about this? I mean, it seems like a lot of the people that are going to be in the audience at PressNomics are, you know, SAS companies and software startups and freelancers. And so this seems like a pretty important thing to be aware of for those folks that weren’t aware of it.

Jon: 52:05 Oh yeah. I mean, I think the main thing is to understand it as with anything else, because this is, this is one of those incentives that people have abused, they’ll get detention. Um, and so when we do either tax credit studies or if we do a consulting engagements, we make sure that we, we cross our t’s and dot our i’s. And there are a number of number of specialty boutique firms out there that do this, you know, as kind of a, they’ll come in and they’ll, they’ll take a percentage of the credit. So if you have big credits, it’s almost like an attorney who charges like a, you know, a 33% success fee sort of thing. Um, we can’t do that based on as CPA fee have certain, um, I don’t wanna say that those guys are unethical, but our ethics standards prevent us from, from entering into engagements like that. Uh, and so we kind of, we kind of do on an hourly basis, but the main thing that, that someone needs to be aware of is as they need to get a quote at that at the outset for what the benefits are and then kind of weigh that against the cost. Because these are typically not cheap to put together because of the amount of documentation that you need to have. Um, to, to, uh, basically prepare yourself in the event that the IRS comes knocking.

Sean: 53:14 Right. So it sounds like the steps here is like, do the back of the Napkin math to see if this even makes sense. If it does, then go talk, get the quote before you engage and then if the quote makes then engage, uh, to do the, the R and d tax study. Yeah, exactly. Exactly. Perfect. Cool. Well, John, this has been super enlightening. What a, if people wanted to ask you questions or work with you, where can we send them? Um, I mean you can call me a beach Fleishman. Uh, yeah, our phone number is, uh, (520) 321-4600 ask for me. Um, and uh, if, if anybody’s going to be at the, at the center there, pass out cards, all that fun stuff. So cool. All right, well we’ll link up all that in the show notes. John, thank you so much for your time today and for speaking at PressNomics and, uh, you know, making our audience aware of all this useful information and really appreciate it. All right, thanks John. Thanks for the time. Yep. Take care.

Link(s) Mentioned

• https://apps.apple.com/us/app/receipts-by-wave/id619867797
• https://en.wikipedia.org/wiki/Piercing_the_corporate_veil
• https://en.wikipedia.org/wiki/Research_%26_Experimentation_Tax_Credit
• https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
• https://en.wikipedia.org/wiki/Tax_Cuts_and_Jobs_Act_of_2017
• https://www.irs.gov/newsroom/facts-about-the-qualified-business-income-deduction

Books

• https://amzn.to/2LqRSrp

Music

• https://open.spotify.com/track/6x14wL9HvABR2Rix8N88EH?si=bBOKHozuRHi6zoSw8KaW8w