What the Austin Plane Crash Means for Small Businesses

On February 18th, a sunny Thursday morning, a small plane crashed into the building that is home to the Internal Revenue Service in Austin, Texas. 

The Piper Cherokee PA-28, apparently piloted by Andrew Joseph Stack III, caused what one eyewitness described as a "giant fireball about 50 feet wide."

On a Web site registered to Stack, there is a 3195 word essay, which news outlets have begun describing as a suicide note.

I'm not going to dissect Stack's motives. There'll be enough of that in the news over the coming days and weeks. Company.com doesn't endorse Stack's motivations, nor are we trying to capitalize on an incident that cost (so far) two lives -- but the obscure tax reference that Stack pointed to in his essay raises questions that we can answer.

Stack notes in his essay that he and his wife had "a boatload of undocumented income." While Stack doesn't go into detail about where his tax liability came from, it is, in part, one of the contributing factors to his decision that morning. If you're in a similar position, perhaps you have accrued a large tax liability, please call an expert now. Company.com recommends a company like 2020 Tax Resolution Services. The crux of Stack's essay comes down to how Section 1706 of the Tax Reform Act of 1986 affected him personally, and may affect you.

In Section 1706 of the 1986 Tax Reform Act, there was a provision for the treatment of contract personnel. Section 1706 was a clarification and amendment of Section 530 of the Revenue Act of 1978. Section 530 says that if you are an employer, you have two options for hiring someone. The first is as a full employee of your company, where you pay the employment taxes and offer benefits, etc. You produce a W2 for the employee at tax time. The second is that you act as a broker for them, and they are an independent contractor. You produce a 1099-MISC for them at tax time, and they pay their own self-employment taxes and purchase their own benefits.

Section 530 says that there are three requirements that an employer must consider if the employer expects to not have to pay employment taxes for the contracted individual.

1.  There been a court case or IRS ruling that your business could rely on for support, or has the IRS audited your company and has not reclassified independent contractors as employees. A significant section of your industry treat similar employees in the same way. You have talked to a business lawyer who advised you that your method of classification is acceptable.

2.  Your business (and any business it grew from) must treat (and have treated) similar workers as independent contractors. If you have classified these workers as employees, you should continue to do so -- and if you are currently treating them as employees, new hires should also be employees.

3.  You must file all tax information correctly. If you hire someone as an employee you pay their employment taxes and provide a W2, independent contractors pay their own taxes and get a 1099-MISC. 

If you are treating someone as an independent contractor and you aren't compliant with these guidelines, you are probably going to get your contractor and/or yourself into some trouble.

In 1986, the government amended Section 530 to permit employers to not be compliant if the employee/independent contractor is  "an engineer, designer, drafter, computer programmer, systems analyst, or any other similarly skilled worker in a similar line of work."

Effectively this allowed employers to reclassify skilled employees as independent contractors and:

1.  Not have to pay employment taxes for the contractor.

2.  Take a cut of the contractor's income as a brokerage or agency fee.

I think that the advantages to employers are self-evident here.

In the days leading up to the Austin plane crash, Associated Press Writer, Dave Gram, reported that the "the IRS and 37 states are cracking down on companies that try to trim payroll costs by illegally classifying workers as independent contractors rather than full employees." The IRS also announced that it was about to commence a 3-year study into companies who abuse these rules. 

Investigations in New York found nearly 31,500 cases of misclassification and the IRS in New York has "ordered employers to pay more than $28 million in past-due wages, taxes and penalties." Gram reported.

It's not just small-businesses that try to cut costs in this way. In recent years, Target, Comcast, FedEx Ground, and UPS have all been involved in lawsuits centering on employee classification abuse.

Hiring independent contractors is a way to reduce costs and maintain a flexible workforce in the current economic climate, but employers must comply with the rules set out in Section 530. What you should take away is this: if you are a business owner who is misclassifying full employees as contractors, either inadvertently or deliberately, the IRS will find you. 

Company.com tried to reach the IRS for comment, but did not receive a response to our inquiry. 

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With thanks to Chris Thorpe of Holland Shipes Vann, Atlanta, for his inestimable help with tax legalese. 

Debt vs EquityHow Much Will You Give Up To Get What You Want?

 Let’s say you know how to turn a $20 million business into a $50 million business.

You need $5 million more to make it happen. Your couch has $0.82 under the cushions. What now? Where does the rest of the money come from?

Most of the time, you’ve got three options: Bootstrapping, by either increasing your personal investment or using your business’s retained earnings, obtaining a bank loan, or selling a portion of the company.

You have a fourth option for raising millions, but first you have to date Tiger Woods.

You've probably already invested just about everything that you can in your company. Maybe even more. Increasing your own personal investment may not be an option for you.

Your company needs to retain earnings, too.  It needs cash reserves to see it through the lean times when checks from your customers get "lost in the mail."

That leaves banks and outside investors. That's right—you're going to trust the future of your business to bankers and strangers.

Before looking for money, ask yourself these questions: How much of your business do you want to own? Do you plan to sell and get out altogether? How much control are you prepared to give up in order to grow your business? How much time do you want to spend with your family? Just kidding about that last one—you  own a small business. Your kids believe you exist like they believe in the Tooth Fairy.

There are pros and cons with each source of capital. Both hope to make money from doing business with you. Bank loans  allow you to keep complete control of your business, but they also add liabilities to your balance sheet. Conversely, private investors don’t need to be paid back each month, but they will own part of your business and they'll expect to have some say in how you spend their money.

For any loan, the lender wants to know that your business is generating enough money to repay the principal and interest. They will also look at the assets owned by your company to make sure that, if you default, they can sell off your company’s assets to recover their money. If you can't satisfy those two criteria, you won't get very far with an institutional lender.

However, by using a loan to grow, you won't dilute the share of ownership enjoyed by each owner—the bank doesn't become a stake-holder, it becomes a creditor to be repaid. The bank isn't the mob. The mob is more polite. Even if you run into cash-flow problems, or lose a valuable customer, the bank will want its payment. But you do get to maintain everything the way you want, without interference from a banker who probably doesn’t know anything about your business.

If you decide to use bank loan to grow your business, Mitch Jacobs, founder and CEO of On Deck Capital, Inc., of New York, warns that you should “expect to have a lien on the entire business. A lender is likely to name specific assets that they will also have a lien on, and that becomes backing for their loan.”

You should also expect conditions, or covenants, as part of your loan package which might include guarantees about “income levels, net income levels, revenue levels. There might be certain balance sheet covenants like the book value of the business.” Jacobs said.

So what if you don't want to go to a bank, or if your cash-flow or assets can't support the kind of investment you need? Banks are not to be interested in your great idea. Banks are interested in what your accounts have looked like in the past, right up until the moment they cut you a check. They want to bet on proven success. If your business is younger, or is high risk/high reward, you might need to find a venture capital group or an angel investor.

Richard Upton, General Partner at Harbor Light Capital Partners in Keene, NH, said that “most venture capital firms evaluate over 100 opportunities for each investment consummated.” To put that in perspective—you have, at best, a 1 in 100 chance of securing venture capital if you apply for it.  According to the National Safety Council, the odds of you meeting your maker in a motor-vehicle accident are 1 in 85.  You do the math.

Venture capital groups will expect to own part of your business for a specific length of time. That portion is related to the value of your business. If your business is worth $20 million, and you secure a $5 million investment, then the investor will own $5 million of $25 million, or 20 percent of the company. As your company grows to $50 million, the investor still owns 20 percent, or $10 million, while you own the remaining 80 percent, valued at $40 million. You can leverage your $40 million share to buy the $10 million share owned by your investor.

Angel investors operate in a similar way to venture capitalists, and there is probably an angel investment network in your region. While venture capital groups often manage large funds for multiple investors, angels are usually wealthy  individuals. Angels usually demand a higher return on their investment and a bigger share of the company. Venture capital managers don't always have more business experience than angel investors, but angels may feel more emotionally involved with your business—for better or worse.

As long as the investor has an ownership stake of your company, they might expect a seat in your board room, or veto power over spending above a specified amount. If an outside investor put money into your company, it's because they see an exceptional growth potential for their money, and you can expect a degree of pressure to achieve that return. After all, if your business fails, it's their money that you're losing, too—and unlike a bank your private investor can't sell your assets to recover their losses.

How you choose to grow your business is up to you.  If you can secure financing that suits your needs, the question becomes whether you're going to go to the couch or an outside investor to get the change you're looking for.

I need a tax credit services vendor--how do I pick one?

This all comes down to two things. Experience and integrity. The vendor you choose should have testimonials from businesses like yours which have been able to increase their bottom line by decreasing their tax burden. You ought to be able to go to the Better Business Bureau and not see complaints about the way your vendor conducts its business. Remember—this is your taxes. Only being mean to your customers and spending money while generating no income will put you out of business faster than screwing up your taxes. Got it?

Track record is important. A tax credit services provider that isn't up-to-date with current credits, or doesn't know how to apply them, will not save your business any money. Equally, a service that has a history of applying all of the credits available, and letting the IRS check whether they should be applied is more likely to land you with an audit, and potentially fines. The thin line you have to walk if you were doing this yourself is the same line that your provider will need to walk.

If you can't get your vendor on the phone to ask questions, if they aren't being proactive about informing you of new credits and how they will impact your business, if they don't understand your business ... these are signs that the question you should be asking is “Do I have the right vendor for my business?”

  

I want to handle all my own tax credits.

Do it yourself? Sure you can!

While outsourcing can save a lot of time tracking credit eligibility if you hire a couple of dozen or more new employees,  if you only hire a handful of new people each year, it can be worthwhile doing the work yourself. The time your HR people spend on the phone getting help from the IRS, and from the Department of Labor will usually be more than offset by the tax credits you end up claiming.

If you have the time to make sure that you have all the up-to-date paperwork. You'll need to be  educated about what makes your company eligible for specific credits, whether multiple credits can be claimed under specific circumstances, what conditions would disqualify you from claiming certain credits—and there's a whole lot more you'd need to know.

The fact is that unless you have a background in this area, your time is probably better spent working on other areas of your business and having an expert deal with this. After all, it's taxes—and there are few surer ways to undermine your business than by filing inaccurate taxes. For example, if you apply credits where none are eligible, and underpay your company's taxes by $60,000 for the year, the IRS will demand the $60,000 underpayment and apply an additional penalty of $6,000 for the significant underpayment. And that's the best case. If they believe that your company's underpayment constitutes fraud, that fine will be bumped up to as much as $45,000. There are all kinds of penalties that the IRS can impose, and you'll need to be aware of them, and what to do to avoid making a mistake on your taxes and having to pay them.

So yes, you can do this yourself. But if you have more than about 30 eligible new hires, you probably want to look at outsourcing.

If you decide to handle this internally, remember that being too aggressive or too cautious in applying credits can impact your bottom line. It's a thin line to walk, so you should find a contact at your local IRS and Department of Labor offices for when you need to ask questions.

Why would my company need a tax credit services provider?

Large companies, with teams of accountants and tax lawyers, probably have enough skill in their finance and human resources departments that outsourcing offers little benefit to them. But for small-to-medium sized companies there may be an advantage in bringing in expert help to make sure that any tax entitlements are claimed.

In some special employment zones, you can claim up to three-times the normal tax credit for your employee, and some industry sectors, such as food retail, are far more likely to employ eligible workers.

If your company is using a CPA, either within your company or contracting with a local vendor, you can be pretty sure that your tax paperwork is going to be completed accurately. But some credits are an ongoing task, in need of attention for several months after you hire an employee, which is something that your CPA may not have the resources to manage—remember, tax credit compliance is an HR function, not an accounting one.

Outsourcing can save a lot of time tracking credit eligibility if you hire a couple of dozen or more new employees, but if you only hire a handful of new people each year, it can be worthwhile doing the paperwork yourself. The time your HR people spend on the phone getting help from the IRS, and from the Department of Labor will usually be more than offset by the tax credits you end up claiming.

If you do outsource, using a company that specializes in tax credit services is the best way to make sure that all of the available tax credits your company is entitled to are claimed. Tax credit services providers are often staffed by former IRS employees, human resources professionals, and CPAs—this gives them an advantage in understanding the way the IRS will most likely interpret how new tax credits can be applied. The reputations of these companies are linked to their ability to maximize the tax credits your business is able to claim, and so they need to be up-to-date with any new tax breaks that your company may be eligible for.

Which companies offer tax credit services?

Tens of thousands of companies want to help you with your taxes. Google returns almost 75 million results for the search string “tax credit services.” Some of the more recognizable names in this field are TaxBreak, iApplicant, and ADP Tax Credit Services.

Unfortunately, not all of the companies your search will turn up actually do the assessment and monitoring that some of the credits need. “Employment tax credits must be filed within 28 days of the hire date, with a separate filing for each employee. If tax credit screening and compliance is all that a company does, you can assume that they do it well,” said Larry Cummings, Chief Connector, at TaxBreakLLC, based in Gadsden, Alabama.

As with any vendor relationship, the key is to maintain regular contact. If you can assess and express your needs and expectations, you will have a much better chance of finding the right vendor for you. Remember that not all vendors offer the same products, and that offerings with the same name are not necessarily the same product from company to company.

Tax credit service - Why the WOTC is nothing to do with your tax preparer

The government wants to pay you $9000 for your most recent hourly-paid new hire. It will be paid in the form of tax credits available to your business, and it's not a deduction. It's a credit which is applied dollar for dollar to your tax bill. If the credits reduce your tax bill to the point that the government actually owes you money, you'll get a check from the IRS.

But how do you know which employees qualify for which credits, and how do you know if you're claiming the right amount?

If you have any employees, there are a number of tax credits out there for you to claim. The Work Opportunity Tax Credit (WOTC), Empowerment Zone Tax Credit (EZ), and the Renewal Community Tax Credit (RC) can realize substantial tax savings for your company. To assess the eligibility of an employee, you need to fill out IRS form 8850. [www.irs.gov/pub/irs-pdf/f8850.pdf]

The WOTC credit makes up 95% of federal employment tax credit claims, so it's the one you're most likely to need to file. There is a list of nine criteria governing eligibility, and your new hire only needs to have qualified for one of them. The employee may be eligible if they are a:

• Member of a family receiving Food Stamps
• Member of a family receiving Aid to Families with Dependent Children (AFDC)
• Veteran of the US Military
• Ex-felon, pardoned, paroled or work-release individuals
• Vocational rehabilitation referral
• Summer Youth employee
• Supplemental Security Income (SSI) recipient
• Resident of an Empowerment Zone, Renewal Community, Enterprise Community or Rural Renewal Community
• Receiving Long Term Family Assistance (TANF), formerly known as Welfare to Work

The timeliness of you having a tax credit applied to your taxes depends on the state where your business is located. In January 2010, Larry Cummings, Chief Connector at Gadsden, Alabama-based TaxBreakLLC.com, said, “Rhode Island is taking over three years to apply some of these credits. Right now Iowa, Ohio, Virginia, and Colorado have the fastest processing times.”

You may have heard horror stories about how much work it can be, but there can be significant value in making sure you claim the credits your company is entitled to. According to Cummings, “up to 20 percent of new hires qualify for tax credits worth up to $9000 per eligible new hire. There is a lot of money not being claimed because 95% of small businesses think that the process is too difficult, or that their CPA is taking care of it." To do the quick math here—if you have 100 employees, 20 of whom are eligible, you can reduce your tax burden by up to $180,000.

If Cummings is right, and your CPA or tax preparer isn't taking care of it, here's the reason:

Tax credits are nothing to do with the IRS. Okay, that's only partly true, but it's the thing you need to bear in mind. Tax credits like the WOTC are not administered by the IRS. They belong to the Department of Labor, and therefore they should be in the scope of your human resources, rather than accounting, function.

Your tax preparer handles your taxes once a year, but some credits are an ongoing task, in need of attention for several months after you hire an employee.

For most small businesses, contracting with a tax credit service is the best way to make sure you don't miss out on the federal and state allowances available to your company. Most business tax preparation organizations will provide an analysis of write-offs, deductions, and tax breaks your business is entitled to. But—and this is important—they may will not be able to provide tax credit information for your workforce, because some of those credit claims need to be submitted within a specific time-frame after hiring, and others need to be monitored on some pre-defined frequency. Your tax preparer was likely not involved early enough in the process to help you with it, or doesn't have the resources to monitor your employees eligibility on an ongoing basis. Remember, assuring that your employees are eligible is a human resources function, not an accounting function.

Companies such as TaxBreak LLC [www.taxbreakllc.com], and Job Match LLC [www.iApplicants.com] will work proactively for you by matching your employees' W-2 forms against available credits. They may also assist in training your managers to assess eligibility of new employees at the hiring stage.

All tax credit services want to make money, often as a percentage of the total credits they process for your business, but those requirements change from industry to industry, and state to state. As a result of this, the industry your company is in, and the location of your business, will affect the amount of tax credits you are likely to be able to claim. The profit margin is related to the number of W-2s that are processed, and the amount of credit per W-2. So if you have a large number of employees, each eligible for a small credit, that is going to be less attractive to a tax credit services provider, simply because it's more work for less money.

If you are claiming a WOTC credit for an employee who was released from prison in the last year, you'll need discharge paperwork and maybe parole records to demonstrate that your employee is eligible. Any documents you need to use when preparing your company's taxes need to be appropriately filed and available at tax-time. Bad record keeping can result in your company not being able to provide supporting information to demonstrate eligibility for tax credits it may be claiming.

You might just squeak through without all the documentation you need, but remember—if you get audited, the IRS will usually not go back more than 3 to 6 years unless you are still using Enron and WorldCom's accounting playbook, in which case there is no limit to how far back they can investigate your company's tax returns.