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6 Financial Faux Pas for Small Business Owners

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Fifty percent of small businesses fail within five years. Now, that’s a troubling statistic. What goes wrong? Are you making missteps that could lead to financial failure?

Find out the top financial mistakes that are all too common for small businesses — so you can ensure that you’re not caught in the same painful cycle.

Mistake #1: Not sticking to a budget. When you’re caught up in your business, it’s easy to overlook the importance of budgeting, which can lead to disastrous and costly consequences.

A budget provides a roadmap for your business’s financial journey, allowing you to set realistic goals, allocate resources effectively and make informed financial decisions. It also can help you identify potential financial pitfalls before they become major issues.

Mistake #2: Failing to differentiate personal and business expenses. By keeping personal and business finances separate, you not only maintain accurate records, but also protect your personal assets.

In the unfortunate event that your business faces legal issues or bankruptcy, having separate accounts can shield your personal savings, home and other assets from being seized to cover business liabilities. In addition, keeping separate accounts helps simplify your tax reporting, ensuring that you stay compliant and avoid unnecessary penalties.

Mistake #3: Using credit cards to cover business costs. While a credit card can increase your company’s purchasing power, business credit issuers can lower your credit limit and raise your interest rates at any time.

By putting major expenses on a card, you may pay significantly more in the long-run. Instead, business loans may be a smarter option due to lower rates.

Mistake #4: Expanding your headcount too quickly. During an upswing, it may be tempting to quickly to add to your team. But hiring, training and maintaining new staff is a hefty expense that might not be sustainable. And if you have to let them go, creating severance packages and extending insurance benefits also carry a price tag. Unless absolutely necessary, hold off on hiring to see if the growth persists.

Mistake #5: Neglecting to build an emergency fund. Failing to plan for unforeseen circumstances can leave your business vulnerable to financial shocks. Building an emergency fund is essential, providing a safety net to help you weather unexpected expenses, such as equipment breakdowns, legal disputes or economic downturns. Without an emergency fund, you may be forced to rely on credit cards, which can cripple your business’s financial health in the long-run.

Mistake #6: Doing your own taxes. Did you know that 77% of percent of small business owners feel the burden of business taxes? Unless you’re a tax professional, tackling your own business tax return can lead to trouble.

For example, if you claim too many deductions, you may find yourself getting audited. If you don’t claim enough, you could end up owing the government money that you haven’t budgeted for.  There are many variables that can impact your company’s tax circumstances, so it’s your best bet to consult with a trusted business or tax advisor.

Take charge of your finances now — before it’s too late

The professionals at Magone & Company can help you navigate debt traps, business taxes and smarter financial management practices to help keep your business afloat. Call us today at (973) 301-2300 for a specific evaluation of your situation.

Year-end Tax Planning for Small Businesses

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The year-end is a busy time for small businesses — from finalizing your books to forecasting for the year ahead. But it’s also a key time to take action to help lower your taxes. Read on for tax-saving strategies that may help your business save this year and next:

  • Did you know that taxpayers (excluding corporations) may receive a deduction of up to 20% of their qualified business income? If your taxable income exceeds $340,100 for a married couple filing jointly, the deduction may be limited based on paid W-2 wages, the unadjusted basis of qualified property (e.g. machinery and equipment) and whether you’re engaged in a service-type business or trade (e.g. accounting, law, health or consulting). Note that the limitations are phased in for those with taxable income up to $50,000 above their threshold, as well as for joint filers with taxable income up to $100,000  above the threshold. You may be able to claim a portion or all of this deduction by accelerating deductions or deferring income. You may also boost your deduction by increasing W-2 wages before year-end.
  • Compared to earlier years, more small businesses can use the cash method of accounting, rather than the accrual method. Your business may prefer this method as it’s easier to shift income to other years. To qualify, you must satisfy a gross receipts test, ensuring that your average annual gross receipts don’t exceed $27 million.
  • Excluding large corporations, a corporation that expects a small net operating loss (NOL) for 2023, and substantial net income in 2024, may accelerate a portion of its 2024 income or defer a portion of its 2023 deductions to create a small amount of net income for 2023.
  • The liberalized business property expensing option may give you an opportunity to save if your business possesses property and off-the-shelf computer software that’s depreciated. It covers interior improvements to a building, such as elevators, HVAC, security systems and more. For tax years beginning in 2022, the expensing limit is $1,080,000, while the investment ceiling limit caps at $2,700,000.
  • Your business may also can claim a 100% bonus first-year depreciation deduction. The 100% write-off is permitted without any proration based on the length of time that an asset is in service. It applies to machinery and equipment purchased used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described in the expensing deduction.
  • To expense the costs of certain lower-cost assets, materials and supplies, you may take advantage of the de minimis safe harbor election, also known as the book tax conformity election). To qualify, the cost of a unit of property can’t exceed $5,000 if you have an applicable financial statement (AFS). The cost of a unit must not exceed $2,500 if there’s no AFS.
  • For optimal tax affect, you may choose to strategically time employees’ year-end bonuses. Cash-basis employers may deduct bonuses in the year paid, while accrual-basis employers may deduct bonuses in the accrual year, as long as the bonus is paid within two months following the end of the employer’s tax year. If you’re an accrual employer looking to defer deductions to a higher-taxed year in the future, you may change your bonus plan before year-end to establish the payment date after the 2.5-month window.

At Magone & Company, our goal is to get you thinking about potential moves that can minimize your small business’s tax liability now and in the future. For tax planning guidance or assistance, give us a call today at (973) 301-2300.

This document is for informational purposes only and should not be considered tax or financial advice. Be sure to consult with a knowledgeable financial or legal advisor for guidance that is specific to your tax situation. 

Understanding Earnouts: The M&A Negotiating Tool with Tax Consequences

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After a lull in 2022, merger and acquisition (M&A) activity has picked up this year as expected. However, due to ongoing economic uncertainty, earnouts are likely to play a big role in many deals — which may carry significant tax consequences.

Also known as a contingent consideration, an earnout is a mechanism that promises future payments to the seller in addition to an upfront payment.

The ins and out of an earnout

Today, the gap between what sellers want and what buyers are willing to pay has widened due to several valuation variables — expected cash flows, pricing multiples and rates of return.

Earnouts can help bridge the valuation gap and facilitate deal making by offering a contingent payment that the seller only receives when specific performance targets are met by an agreed-upon date. For example, 10% of the purchase price might be contingent on whether an acquired company meets a specific revenue or earnings target over a two-year period.

Dueling tax treatments
Depending on how a deal is structured, earnout payments may be treated as either part of the purchase price or compensation to the seller for services rendered.

If an earnout is deemed part of the purchase price, it’s taxed at the capital gains rate, generally 15% or 20%. The 3.8% net investment income tax also may apply in this situation. However, if it’s considered compensation, it’s taxed at the applicable ordinary income rate, which can be as high as 37%. (Plus, it’s subject to payroll taxes.)

The characterization of an earnout affects the buyer, too. An earnout that’s treated as compensation is immediately deductible. On the other hand, the earnout must be capitalized and amortized over time if it’s considered a deferred payment on the purchase price.

Compensation vs. purchase price
Several factors can indicate whether an earnout is part of the purchase price or compensation for the seller’s services:

  • Is the seller required to perform services to receive the earnout payment?
  • Are they receiving separate reasonable compensation for those services?
  • Is the seller’s employment required for the entire earnout period?
  • Is the earnout paid even if the seller is terminated?
  • How does the earnout amount compare with reasonable compensation for the seller’s services?

Another important consideration is whether there’s any evidence of intent in documentation related to the transaction. For example, does correspondence show a difference of opinion on the target’s valuation and, in turn, the purchase price? Did the deal close after an earnout was added? Does the letter of intent connect the earnout to the seller’s continued employment?

Do your due diligence
When buying or selling a business, always consult with your tax advisor to ensure the transaction documents and structure reflect the intended tax results. The professionals at Magone & Company can help you navigate M&As to help achieve the most favorable tax position. Call us today at (973) 301-2300 for a specific evaluation of your situation.

This document is for informational purposes only and should not be considered tax or financial advice. Be sure to consult with a knowledgeable financial or legal advisor for guidance that is specific to your unique circumstances.

IRS No Longer Processing ERC Claims

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You have heard or seen on various media outlets that businesses are not taking advantage of the Employee Retention Credit (ERC). However, many companies offering assistance with filing for the credit are taking advantage of the public and making claims where none exists, all while collecting a hefty percentage of the claim.

The money that can be allegedly obtained seems too good for small business owners to pass up — and it most likely is.

In a press release, the IRS  identified several warning signs (red flags) of aggressive ERC marketing, including:

  • Unsolicited calls or advertisements mentioning an “easy application process”
  • Promoter stating they can determine ERC eligibility within minutes or claiming that a business qualifies for the ERC before any discussion of your tax situation
  • Large upfront fees to claim the credit,
  • Fees based on a percentage of the ERC refund obtained

We applaud the IRS’ recent announcement putting an immediate moratorium on processing new ERC claims through at least the end of the year. This decision comes amid rising concerns about a flood of improper claims, putting small business owners at financial risk. You could be in a much worse position if required to repay the credit (along with penalties and interest) than if you never claimed it in the first place.

Always consult a trusted tax advisor before applying for credits or filling out any paperwork that may cost you in the long run.

Business Owners: Don’t Fall for the ERC Scam

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Your business has likely been the recipient of many robocalls telling you that you’re missing out on the Employee Retention Credit (ERC). Callers promise eligibility and a fast, easy application process. Don’t fall for it, says the IRS.

The ERC (also known as the ERTC) is a tax credit that was introduced during COVID to make it easier for struggling employers to keep employees on the payroll. It was available to eligible employers for qualified wages paid from March 12, 2020 – October 1, 2021 (recovery start-up businesses qualified through December 31, 2021).

Like many pieces of pandemic-era legislation, ERC parameters changed several times, which makes claiming the credit not as straightforward as these cold callers make it out to be.

Third parties typically charge significant upfront fees, without bothering to explain that your business may not be eligible after all. If that’s the case,  your business will not only need to return the refund. You’ll also incur costs to amend your employment tax returns, and may even be subject to penalties and interest.

Don’t fall victim to this or any other scam. If you need to confirm eligibility for this or any other possible tax credits, please get in touch.

Looking for legit tax-saving opportunities? Check out our Small Business Guide to Mid-year Tax Planning.

New Guidance on Beneficial Ownership Interest Reporting

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Anti-money laundering laws and new reporting requirements are on the horizon for many businesses, thanks to the Corporate Transparency Act.

Starting in 2024, many small businesses will be required to report information about their beneficial owners to the Financial Crimes Enforcement Network (FinCEN) in an effort to build a national database for national security and law enforcement agencies to aid in the prevention of using of shell companies for criminal activity.

Will your company be affected? Maybe

Both domestic and foreign reporting companies are required to file reports. A company is considered a reporting company if a document was filed with the secretary of state or similar office to create or register the entity. Corporations (including S corporations), LLCs and other entities formed through the SOS are subject to the reporting requirements.

But because sole proprietorships, trusts and general partnerships do not require the filing of a formal document, they generally are not considered a reporting company and will not have a filing requirement. Foreign companies are required to file reports if they are registered under state law.

Some companies, like large operating companies, are exempt from reporting ownership information to a governmental authority. This entity is defined as having:

  • More than 20 full-time U.S. employees
  • An operating presence at a physical office within the U.S.
  • More than $5,000,000 of U.S.-sourced gross receipts reported on its prior year federal income tax return.

If your company meets these qualifications, you are not subject to the new reporting requirements.

Terms you need to know

Beneficial owners. Beneficial ownership information (BOI) must be reported for the reporting company’s beneficial owners and (for entities formed or registered after 2023) company applicants.

Beneficial owners of a reporting company include:

  1. Any individual who exercises substantial control over the reporting company
  2. Any individual who directly or indirectly owns or controls at least 25% of the ownership interests of the reporting company.

Individuals with substantial control are those with substantial influence over important decisions made by the reporting company. Senior officers (president, CFO, general counsel, CEO, COO and any other officer who performs a similar function) are automatically deemed to have substantial control, as are individuals with the authority to appoint or remove senior officers and board members.

BOI includes an individual’s full legal name, date of birth, street address and a unique ID number. The unique ID number can be from a nonexpired U.S. passport, state driver’s license, or other government-issued ID card. If the individual does not have any of those documents, then a nonexpired foreign passport can be used. An image of the document showing the unique ID number must also be included with the report.

Company applicants. The company applicant is the person who actually files the document that creates or registers the reporting company (e.g., an attorney). Company applicants must provide the same information that is required of beneficial owners, but only if the reporting company is formed or registered after 2023.

Because of the difficulty in tracking down information about company applicants for reporting companies that have been in existence for a number of years, reporting companies formed or registered before 2024 do not have to supply BOI for their company applicants.

Mark your calendar to get ahead of reporting requirements

For existing reporting companies created or registered before 2024, your initial report is due by January 1, 2025. For those created or registered after 2023, the initial report is due 30 days after the entity’s creation or registration.

If there is a change to previously reported information about the reporting company or its beneficial owners, an updated report must be filed within 30 days of the change. The penalties for willfully failing to file both initial and updated reports are steep — $500 per day that the report is late, up to $10,000, and imprisonment for up to two years.

If you have any questions about these new reporting rules and how they impact your business, count on Magone & Company as a knowledgeable resource. Reach out today at (973) 301-2300.