Is Barter Better? Maybe Not...

At some point in most business owners' career, the idea of swapping goods or services comes up. It seems to have a beautiful simplicity about it. If you have someone do some computer work for you in exchange for designing their business cards, you're not out any cash and he doesn't have to report any income. Right?

Not so fast. The IRS is on to that one. It's known as "barter", defined by the IRS as "an exchange of one taxpayer's property or services for another taxpayer's property or services". And, reading further on the IRS website, "The fair market value of property or services received through barter is taxable income."

Yes, in our example, both you and your computer guy will need to report on your tax returns the fair market value of the services each receives. The same would apply if goods changed hands. Furthermore, each of you would have to issue a 1099-MISC to the other if the value over the course of the year was $600 or more. You can also each write off the amount as a business expense. So it seems like a wash and who cares in that case? But if one of you is not providing something for business use, then only one side of the transaction has a tax impact. If I do my friend Ann's taxes in exchange for a year's supply of her excellent tea, I don't get to write off the tea (unless it is going in my office's break room for the use of the employees--but it isn't). She and I still both have to report the fair market value of the tea and the tax prep as income. I do not have to issue Ann a 1099-MISC because I was not using the tea for business purposes. That does not, however, meant that Ann is not required to report the value of that tea as income. The IRS isn't too concerned if you write it off as an expense but they definitely care that you report the income!

If you join an actual bartering exchange, it gets even more fun as you will get your transactions reported by the exchange on a 1099-B. In this case the 1099-B replaces the need to issue a 1099-MISC for all transactions that go through the exchange.

The barter rules apply to your employees, too. If your employee works a little extra in exchange for free football tickets, that's a taxable event. You need to increase his wages on his paycheck even though he didn't receive any cash, and withhold taxes on that amount (and pay your share of the employment taxes too). In addition, overtime rules could apply.

Any exchange that would normally be taxable, whether business-related or not, is subject to the barter rules. Check out the IRS Bartering Tax Center for all the details.

You may ask, how is the IRS going to know about your bartering activity? Without a 1099, they probably won't. But you didn't hear that here. I'm just telling you what's required.

Sales Tax and the Internet

This morning I sat in on a webinar hosted by a company that provides sales tax services to businesses. Of course, it was essentially a sales pitch, but there was a lot of good information presented--enough to make me consider never selling anything again! While that's not going to happen, it was an eye-opener for me, and I thought I was reasonably familiar with sales tax rules. 

At least I feel reasonably comfortable with the California sales tax regulations as they apply to my clients' businesses. I didn't think I needed to worry too much about sales tax in other states for any of my clients because none of them have a "physical presence" in any other states. The "physical presence" provision, in case you are interested, came about in 1992 as a result of a petition by a mail-order retailer named Quill. But in the 20 years since this ruling, interstate sales have exploded, thanks to the Internet, and revenue-starved states are turning a hungry eye toward those interstate sales.

Some creative states have developed some, um, interesting definitions of "physical presence". For example, if you advertise on cable television in Alabama, whether or not you are actually in Alabama, you are considered to have a physical presence and must collect Alabama sales tax.

If you live in California (and probably elsewhere--it's hard enough to keep up with California laws), and you buy something from an out-of-state vendor who does not need to collect sales tax, you still owe the California Board of Equalization sales tax on the purchase. As a convenience, you can report and pay it when you file your California income tax return. How many people actually do this? I don't have any statistics but I bet it's not as many people as actually made those purchases.

Non-compliance, whether intentional or not, costs the states a staggering amount of revenue each year. So they aren't very forgiving about non-compliance, and plenty of people have been put out of business by demands for uncollected sales taxes, plus the penalties and interest. Any developments on the sales tax front deserve the business owner's attention. And internet sales are in the crosshairs, as the tax that is currently not being collected on internet sales is estimated to run in the billions.

In 2000, the Streamlined Sales and Use Tax Agreement (SSUTA) was crafted by the Streamlined Sales Tax Governing Board "to simplify and modernize sales and use tax administration...in order to substantially reduct the burden of tax compliance." The goal was to find solutions to the complexity in state sales tax systems resulting from current laws governing online sales tax and remote sellers (SSUTA Website).

There are currently three online sales tax bills that Congress is considering, two of which rely on the SSUTA to help establish online sales tax regulations. The bills are the Main Street Fairness Act, the Marketplace Fairness Act and the Marketplace Equity Act (the first two rely on the SSUTA). I'm not going to go into the details here (I got my information here) but heads up that if you sell to buyers in other states, you will probably be entering a whole new world of sales tax collecting and reporting. As for me, I'm going to check out the services provided by the company that hosted the webinar (it was Avalara) to ensure compliance for me and my clients.

Under-the-Table Employees are Skating on Thin Ice!

Employees are expensive. Employer payroll taxes and worker's compensation insurance add significantly to the cost, over and above the wage rate paid to the employee. Complying with labor laws and filing the required payroll tax returns take time and resources. Many business owners get around this by classifying people as "independent contractors" or even by paying them cash and not reporting the cost, known as paying "under the table".

The people they hire often go along with this because they don't get payroll taxes withheld and often get paid a premium if the employer doesn't have to report the wages and pay the additional costs. So what's the downside?

The downside for the "under-the-table" worker is that they are not covered by unemployment insurance, disability insurance or worker's compensation. In addition, their wages don't go into their Social Security base. Plus it's illegal to not report income. Those are risks many are willing to take, or they just don't realize that this is the case, until they come face-to-face with the consequences.

A friend's daughter just ran up against this the hard way. Working under the table in a high-risk recreational industry, she was severely injured and is currently in the hospital undergoing treatment. Thankfully, she has medical insurance, and is doing well, but she is not going to be able to work for quite a while, and has no coverage for disability or worker's compensation. And her injuries are likely to cause her ongoing problems for years to come. The costs of this accident to the worker are going to be too high to dismiss as a risk of working under the table, and a claim will most likely be made to worker's comp.

The owner of the business will probably be getting some heat from the employment agencies and worker's comp authorities. Because of the high injury rate in this industry, the worker's comp rates are among the highest in the state, so it's a common practice to not report workers. Businesses who comply with the employment laws are often forced out of business by the costs, so it's understandable. But an incident like this can put the owner out of business anyway, by the time taxes, penalties and costs are paid. In addition, the businesses who don't pay the costs associated with complying with the law are unfair competition for those companies who do comply.

A sound business model needs to incorporate ALL the costs of doing business. Paying someone extra to dodge the employment costs may seem fair, but the incident described above make it clear that this is not fair to the employee, and can ultimately be the undoing of the business.

Are You an Employer? Do You Know?

Do you have employees? Sounds like a simple question. But every day, people get surprised to find out that their independent contractors are actually employees in the eyes of the government. They usually find this out the hard way, when their "contractor" discovers that they don't qualify for the benefits they would get as employees, such as unemployment compensation or disability insurance.

Many business owners have people working for them on a fairly casual basis and pay them as independent contractors. This seems like the simplest solution, but it can backfire under an audit, or if the worker files a claim.

The IRS provides guidance on determining whether your worker is a contractor or an employee guidance. The amount of control you exert over the worker is the main determinant. If you control when and how the person works for you, and provide work space and tools, then that person is generally considered to be an employee. That means you will be withholding payroll taxes and paying the employer's share, and are responsible for submitting that money to the government and filing the appropriate payroll tax returns. Your state law will also have something to say on the matter so be sure to check the appropriate labor and taxing agencies for guidance. You are also responsible for providing worker's compensation insurance.

If your worker is, in fact, an independent contractor, you still need to do some paperwork. You should have a Form W-9 on file (available on the IRS Website) and will need to submit Form 1099 at the end of the year if you paid them $600 or more. Currently, you do not need to report money paid to corporations, but the IRS has their eye on this exception. An effort to change the rules last year was mostly foiled, but that could change in the future.

If it turns out that the government finds that your contractor is really an employee, you will be liable for back taxes as well as penalties, interest and fines, so it pays to check out the rules! What may seem simple at the start of hiring workers could turn into a mess down the road.

Life Lessons from a Broken Lawnmower-the Sequel

A month or so ago, I posted this to my personal blog, but it works for business too. I also added a paragraph at the end that I think is the real life lesson! Here's the original "Life Lessons from a Broken Lawnmower."
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It's 2 pm and I'm showered and shampooed. I smell pretty good (at least I think so). I've had lunch and am sipping a glass of ginger ale. Quite a change from a couple hours ago.

I had planned to go Horse Expo today. Tomorrow and Sunday I'm enrolled in a horse clinic so today was the only day I could make it. But it's been a hectic week and there are many tasks still undone, and with the weekend booked, this is the only day to get things done. The most pressing item on the list is mowing the grass, which is getting to the "fire danger" stage. So I regretfully decided to skip Expo and all that glorious shopping in favor of mowing grass. Very regretfully, as mowing causes my wrists to go numb and my allergies to flare up, not to mention that it's just a dirty, hot, miserable job.

Side note: I've been following Loral Langemeier (aka "The Millionaire Maker") and she doesn't even want to talk to you if you clean your own house, and I suspect that mowing your own acreage falls into the same category--as a business owner, you should spend your time on more important things, and outsource the housecleaning-type of work. So I have been pondering hiring out all the heavy-duty outdoor maintenance to the neighborhood "guy", Alberto. Alberto does so much work for everyone around here that one neighbor suggested renaming the area to "Albertoville".

I pulled out the lawnmower and filled it with gas, which left just a tiny bit of gasoline in my 5-gallon can. I primed it and pulled the cord. Cord refused to be pulled. Completely locked up. And I've been bragging about how reliable that lawnmower is, too. I took the housing where the cord resides apart but didn't see anything obviously wrong (who am I kidding? I don't even know what I was looking for.).

Life lesson #1: Don't waste your last resources (gas in this case) on something you are not sure is going to work.

After sulking for a bit (because by then it was too late to head for Sacramento for Horse Expo anyway), I pulled myself together and decided that I must deal with this. I hear that all habits can be broken over a period of 3 weeks, so I've decided to break the procrastination habit, and here was an opportunity. If something is broken, you get it fixed, right? So I optimistically called the local repair place only to be told that they are backed up for about five weeks, and from the symptoms it sounded like the mower was dead anyway.

Not quite ready to accept their diagnosis, but clearly not able to get the machine repaired in a timely fashion, I determined the next options were to find Alberto, to borrow a mower, or to rent one. Alberto, who is normally working somewhere around here, was nowhere to be found. I don't like to borrow things with moving parts since I seem to deliver the kiss of death to them, so I called the local rental place and was able to reserve a high-weed mower. At the rental place, they brought out the monster machine and went over all the operating procedures (I bought the insurance just in case). After making sure it was full of gas, they went to load it on the truck, and it turned out the blade was stuck on "on", so it shredded part of their ramps when they tried to load it. Clearly a safety issue. They found another one and loaded it, and I made it safely home and was able to unload it and get it started without incident.

Actually, the machine made mowing much less onerous than with my mower, because it was self-propelled, oblivious to gopher mounds and uneven ground, and didn't spit the grass out the side to aggravate my allergies (I don't know what it did with the grass. Not my problem). I won't go as far as saying it made mowing a joy, but it sure was easier.

Life Lesson #2:  The right tools make the job easier and the results better.

After about half an hour, the thing ran out of gas. When they switched machines at the rental place, apparently nobody checked the gas level. I put the last tiny bit of my gasoline in it, crossed my fingers, and prayed that we would make it through. See Life Lesson #1.

Since the mowing was going so well, I continued on to the grassy area in back of the house that I hadn't really planned on mowing since my mower couldn't possibly handle it, and finally, I am ready for fire season. Assuming we don't get some unseasonable rain that makes the grass grow all over again.

I got the mower loaded back on the truck (I was worried about that but it went smoothly) and headed down the driveway to return it. I reached the end of my driveway at exactly the same moment that Alberto drove in to my neighbor's driveway. Sheesh--where was he 3 hours ago?

Life Lesson #3: Sometimes it's best to wait awhile, and the solution will just show up. I just wish I could figure out how to reconcile this with "Don't procrastinate".

So I have spent many many aggravating hours on this issue. I have spent money renting equipment that I still had to operate. I still have a broken lawnmower. There is billable work waiting to be tackled, and I need to spend some time on business development.

 

Life Lesson #4:  Loral Langemeier is right.
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So--that was the original post several weeks ago. But by now, much of that grass has grown back and needs to be mowed again. I'm in the middle of refinancing and the appraiser is coming on Tuesday, and I think it will help the property value if the place doesn't  look abandoned. A client suggested just checking the underside of the mower to see if there is something blocking the blade. I was sure the problem was much more complicated than that, but I didn't want to rent the big mower again, so I checked the bottom of the mower, and sure enough, there was a big chunk of dried grass preventing the blade from turning. I removed the grass and, voila, the darned thing started right up. I have cleaned the bottom of the mower before but it usually gets dirty in the earlier part of the year when the grass is green and moist, and keeps pretty clean after the grass dries out, so I hadn't figured on his being a problem. But it was. Bringing us to Life Lesson #5: TRY THE SIMPLE SOLUTION FIRST! (But I'm still planning on turning this job over to Alberto in the future!)

Am I Going to Make Money on This? Understanding Fixed and Variable Costs

I recently sat in on a webinar hosted by a business coach. The topic was taking steps to pursue your dream of starting your business, and the subject of money came up, as it usually does! The point was to run the numbers to make sure your idea will actually work, a refreshing change to "Do what you love, the money will follow." Actually, often if you do what you love, the money WILL follow, but not if you aren't smart about it. The coach mentioned reviewing your fixed and variable costs, and then moved on.

Fixed and variable costs are a bit of a mystery to many small business owners. In reality, it's pretty basic concept. Fixed costs are the ones that are not likely to change, or won't change much, no matter how much business goes up or down. Rent is an example of a fixed cost, as are most salaries. Variable costs are the ones that go up or down in relation to how much business you do. If you are manufacturing a product, variable costs include the cost of materials and hourly labor.

Some of the confusion is because people often think of costs in terms of a percentage of sales. If your rent is $500 per month, and you are making a product that you sell for $100 and your materials and labor are $50 per unit, then your material and labor are always going to be 50% of sales--but the total amount you will spend per month on them will vary as your sales volume changes. But rent will always be $500, even though rent as a percent of sales will change with volume.

In truth, many items are not strictly fixed or variable. You may have a commitment to your production staff to pay them for a certain number of hours regardless of how many units are produced. If your operations grow, you may need to rent more space. Utilities are often a blend, with a base amount that you will spend no matter what your production volume is, but as production and sales grow, they may grow as well.

Why is this important? When crunching the numbers to see if you will be making a profit, you need to understand what costs are fixed and what are variable.The first thing you should do is see what volume of sales you need to make to break even. This is called "break-even analysis".

Very loosely speaking, your gross margin is likely to be the difference between your sales dollars and the variable costs associated with those sales. To break even, you need to sell enough units so that margin covers your fixed costs. Your scenario planning should look at results based on various levels of sales to see how much profit you can make at different levels of sales, or give you a heads-up about when you will not be breaking even.

Doing this planning may not be the most fun or glamorous part of starting your business, but it can be the difference between making it big and not making it at all! It will at least give you an eye-opening look at your plan and let you make adjustments so you can, in fact, do what you love and have a good chance that the money will indeed follow.

Choosing a Credit Card Processor

Recently I did some research for a client on selecting a credit card processor. I knew this was a complicated topic but found out that it is even more complex than I thought. 

If you just start googling “Credit Card Processors”, you will find a lot of pages that compare discount rates. The comparisons usually start with a “Qualified” rate. The “Qualified” rate is the lowest rate available, but it’s not the one you should use to compare rates! It’s likely that the bulk of your transactions will not fall into this category.

To get the “qualified” rate, depending on your processor, a lot of things have to be in place. You will probably need to be swiping the card. The card is most likely a bare-bones-basic type of card that is not a business card, not a rewards card, and the transaction is not international.

The other 2 types of rates are the “non-qualified” (the highest rate) and the “mid-qualified” rates. The processor can decide which cards or transactions will fall into either of these categories. Rewards cards will often be mid-qualified, as will keyed-in transactions. “Non-qualified” cards or transactions will often be corporate or certain types of rewards cards, or the transaction may be international. Other things that can push you into this rate are not using the Address Verification System (AVS), a mismatch between the billing address and the address associated with the card, or not batching out the transaction within 48 hours.

Because the definition of which transactions fall into each of these categories can vary, it’s important to understand how your processor is defining the categories.

Using these 3 types of discount rates is considered to be a “tiered” plan. Alternatively, you may be offered an “Interchange-Plus” rate. There are standard, fixed rates associated with all cards, the most basic of which is the “Interchange” rate. An “Interchange-Plus” rate will add a certain percent to the base rates for each card (this can include the interchange rate, plus any other assessments associated with that particular card such as rewards programs). 

Which plan is most beneficial depends largely on how your processor defines the 3 tiers in the Tiered plan. When I was shopping, I was told that the Interchange-Plus plan would always be the best, but when I checked back with the bank, I found that my client would actually be getting the bulk of the rewards cards transactions classified as “Qualified”, making it a much better deal, considering how many rewards cards are being used.

Besides the discount rate, other fees to look out for are monthly or annual fees, early termination fees if you are in a contract, Gateway fees if you process cards online (and PCI Compliance fees as well--PCI Compliance is a topic for another day) and the per-transaction fee. If you will be swiping cards, will you be buying or leasing the equipment (buying generally works out better, and you don’t need to buy from your processor).

Be sure to have a list of questions prepared when shopping and ask a LOT of questions, particularly about the fees and how transactions are classified in the Tiered System. I found when talking to some of the broker companies that the sales people really didn’t know some of the answers about those fees and how the particular transactions would be classified.

Also, find out how they get paid. Some processors deduct the fee each month from your checking account. Others deduct the fee from each settlement. You may get a better rate if the fee is deducted from each settlement, but be sure you factor in the extra time it may take for data entry to your accounting software and to reconcile your bank statement. I use QuickBooks a lot to do client work, and adjusting each deposit for the fee takes additional time that I charge the clients for. I do have a workaround, but it adds an extra step and that takes time for reconciliation. In any event, if you are paying for bookkeeping, you could wipe out savings in the credit card processing fee by paying for extra bookkeeping time.

The best fit will probably depend on how you process transactions (swiped, keyed-in, online, etc), the number of transactions you will process, the average dollar amount, whether you have international transactions, etc. If you have a lot of activity, a monthly fee may be offset by lower discount rates. If you only have occasional activity, you may want to avoid the monthly fee and pay a higher rate.

Good luck and happy shopping!

Over a Barrel

Over a Barrel: “out of one’s control; in a dilemma”. The phrase comes from the image of somebody draped over a barrel in a helpless position.  Not a place you want to find yourself! But sometimes you can find yourself in that position because you didn’t read the fine print, or you didn’t check out a situation, or something you thought wasn’t going to be a problem turned out to be a big problem.

When I moved to my little country parcel about 14 years ago, I loved the landlocked location about a mile from a reasonably good-sized town. It was private and secure and quiet and away from the roadway. It seemed ideal. Until I tried to get cable TV and internet. I made the routine call to Comcast to set things up and was startled to run into the brick wall entitled “Your location is unserviceable”.

Huh? The entire neighborhood had cable. I called Comcast and after a LOT of phone transfers, finally found somebody who told me that my driveway is 497 feet long and therefore, my home is “unserviceable”. Fourteen years later, after more attempts to get service than I can count, the location is still “unserviceable”. Comcast has the gold medal in “just say no”. And they have me over a barrel since they control the infrastructure that delivers high-speed internet in my neighborhood. This is definitely out of my control, and it has me in a dilemma, since I have a home-based business that needs good internet access, and I can’t get high-speed internet. I now have an office in town just to get the level of internet access I need to run my business.

I’m not sure I would have passed on buying the house if I had checked first, but at least I would have known about the problem and wouldn’t have spent fourteen years after the fact trying to find workarounds. So it really pays to check out a situation before you sign on the dotted line. Long-term contracts, cancellation fees, licensing agreements, unavailable services, incompatibilities  and the like can have surprises lurking in the fine print if you don’t check and then spend some time imagining what the consequences may be. I signed up for phone service with a 2-year contract. Well after the 2 years was up, I decided to change providers and was surprised to find that I would have an early termination fee. Why? Because that 2-year contract renews every 2 years! So to avoid the fee, you need to know the renewal date and schedule your switch for that date, or slightly before (not slightly after!)

When Cowboy's over a barrel, it's kinda cute. When it's you, not so much.

Obviously I’m not very curious about the contracts I sign and the situations I get into, but I’m learning to ask a lot more questions! I suggest that before you sign a contract, read it carefully, then before signing, take a little quiet time and try to imagine all the scenarios that could cause you problems. Don’t get caught over a barrel!