Self-Employed People Do Stupid Things

Posted May 15, 2012 by thomas

Here are some common mistakes I see people making all the time, and some things you can do to run a tighter ship, and ensure long term success.

1.       Failure to have an exit plan. No one stays in business forever. Everyone leaves business in one of five ways: death, disability, retirement, the sale of your business or bankruptcy. Naturally, you don’t want to be disabled or bankrupt, and if you leave business by dying, I hope it’s a long way off and you are working because you love what you do and didn’t want to retire!  So you try to plan for a successful sale of your business. That means you have to keep your business prepared for sale from day one. Keep a good set of books. And set your business up so that it still works, even without you there to run it. If your business is all about you, you have nothing worth buying to anyone else when you want to quit working or go do something else. Don’t name your business after yourself, for example. Give it a brand name that still has value and meaning after you sell to someone else. People pay for a good name – but only if they still get to use it after you leave the business.

2.       Failure to get organized.  A lot of self-employed people start on a shoestring, or they go into business accidentally, in a way. As a result, many don’t invest time in creating and keeping a book-keeping system, or keeping records of receipts and expenses. No matter how small your business is, do that from the get go. Invest in the software you need – there are lots of software suites that are very affordable now, compared to a generation ago. Make sure you back up everything you have.

3.       Failure to pay self-employment tax. Self-employed people often overlook this one, or they gloss right over it and they hope the IRS doesn’t notice. Believe me, the IRS has ways of finding you out. You must plan on setting aside up to 15.3 percent of your profits each year for Social Security and Medicare tax. Don’t worry, you’ll get (most of) it back later, in the form of Social Security benefits and health care after you turn 65. Yes, the Social Security “trust fund,” such as it is, is in danger of exhaustion. That doesn’t mean it disappears entirely. When current workers can’t pay enough to offset retirees, they’ll adjust the social security tax upward, raise the retirement age or roll back benefits to match, most likely. The difference just gets made up out of the general Treasury fund. To file and pay your self-employment tax, you need to fill out and file Schedule SE.

4.       Miscategorize employees. Self-employed small business owners sometimes try to get away with treating workers as independent contractors, rather than as employees. This is easier for the employer, because there are no minimum wage or overtime requirement, and you don’t need to withhold taxes or pay the employers’ half of the employee payroll taxes: Social Security, Medicare, and Federal Unemployment Tax.

But the IRS is constantly on the lookout for businesses that attempt to sidestep labor laws by treating workers as independent contractors when they should be employees. Except for independent professionals, like lawyers and doctors, you generally need to treat those who work for you as employees under the following circumstances:

• You not only specify their tasks but also their methods.
• You direct them to use your materials.
• You provide them training.
• You expect them to work for you exclusively.
• You direct them to wear a particular uniform.
• You closely monitor their work hours.

There is no hard and fast rule on when a worker crosses the independent contractor line to become an employee. The IRS looks at the overall relationship between you and the worker. There are severe penalties for failing to withhold taxes and forward payroll taxes and income taxes to the IRS.

5.         Form general partnerships. If you go into a business with one or more friends, and you don’t take steps to form a corporation, limited partnership or a limited liability company, you are, by default, a general partnership. These are easy to set up and administer, but they create a nightmare of potential liability problems for all the partners. If one partner gets sued, even for something totally unrelated to business, all the other partners are “jointly and severally liable” for all other partners’ debts. Whoever sued your partner can go after your personal assets to satisfy any judgment.

So, do yourself a favor and get your things in order. It’ll pay off in the end and who knows, you may actually be able to sell your business for a profit some day.

Mortgage Modifications: Can I Get a Cram Down?

Posted May 13, 2012 by thomas

If you are having trouble keeping up with the payments on a house that’s not worth what you paid for it, and it’s worth less than your outstanding balance (“underwater,” in mortgage parlance),  you’re not alone. There’s a lot of that going around.

But if it’s your personal residence, you cannot ordinarily qualify for a ‘cram-down’ of your balance. That is, there’s no law requiring lenders to unilaterally reduce the amount you owe to the current market value of the house. Some people claim that rich landlords are being given preferential treatment – investment properties qualify for cram-down treatment in the courts, but ordinary families can’t get that same deal.

Actually, in this sense, Chapter 13 bankruptcy law treats car loans better than home loans – you can frequently get a cram-down of the balance outstanding on a car under Chapter 13 rules. But not on mortgages on your personal residence. Again, that’s an arrangement that shocks the conscience of a lot of people, who are pounding the table calling for a change in the law to allow a judge to write down the balance on mortgages.

There’s certainly a populist appeal to the argument. But in reality it’s not that quite cut-and-dried.

Why? Several reasons: Personal home loans already receive preferential treatment under the law in other ways. For example, the IRS allows you to deduct the interest on a home mortgage – a courtesy it doesn’t extend to personal car loans or credit card debts. It doesn’t matter if you desperately need your car to get to work, or you need to use a credit card to put food on the table. The IRS sees both of those as personal expenses, and therefore not deductible (though you still get a standard deduction, just for being alive, that covers basic subsistence needs). Home mortgage interest, though, qualifies as a deduction. In a sense, that deduction represents a massive tax subsidy that renters are paying to homeowners, since it will be renters who will have to pick up the slack. There’s no deduction available on personal residence rent.

Second, many states also enact an effective “back-door” cram-down, by making home loans non-recourse. That is, the mortgage is secured by the underlying property, and only that property. If the bank forecloses, and the property is not sufficient to pay off the loan, that’s it. The bank has no option to file a lawsuit for the difference.

This is the same as a cram-down, except that you will have to give up the home.

Third, Congress also recently passed a law that gave insolvent foreclosed homeowners a big break: The Mortgage Forgiveness Debt Relief Act. Here’s how it works:

Normally, when you owe a creditor money, and they forgive the loan and write it off, it’s taxable income to you. Ordinary income tax. Full-boat. After all, you’re getting the economic benefit of the transaction, and mathematically, money not paid is the same as money earned. That’s true for investment properties, too. If a lender forgives you part of a debt on a property, you pay income tax on the amount forgiven. The lender takes a bad debt tax deduction. You pick up the slack. The IRS expects to get paid one way or another.

But under the terms of the Mortgage Forgiveness Debt Relief Act, you can exclude up to $2 million in forgiven debt from a personal residence from income. It’s a freebie.

Most families who have just gone through foreclosure on a significantly upside down house would be crushed by the income tax on, say, a $100,000 debt forgiveness anyway. So the IRS is letting homeowners off easy. No such luck for the landlord, though.

Fourth, courts are rightly very reluctant to start rewriting contracts freely entered into by both parties.

The counterargument, however, is that allowing these cram-downs makes sense from a public policy perspective. If cram-downs allow someone with a reduced income to afford to refinance their home, it may prevent a foreclosure. This in turn reduces the inventory overhang of buyerless houses.

A populist strain of thought asserts that the banks themselves received a generous bailout in the form of TARP – it’s only fair that they pay it forward by reducing balances on mortgages owed to the current market value of the house.

The two sides are both going to battle it out for a while… at least until housing prices recover to their peak 2006 levels and nobody’s upside-down anymore. Then the cycle begins anew.

What to Do

If you’re upside down and foreclosure is inevitable, you might consider making sure you can complete the process this year. The Mortgage Debt Forgiveness Act of 2007 ends at the end of this year. At that point, unless Congress extends the provisions of the law, forgiven mortgage debt becomes taxable as income.

For additional help, contact your lender. They may be able to help you either under their own program (believe me… they would MUCH rather keep you in the property than foreclose on it and stick themselves with a house they have trouble selling), or under the Making Home Affordable program. Check the link for eligibility.

Wages Are Rising, Though Unemployment Remains Stubborn

Posted by thomas

The unemployment rate has now remained above 8 percent for 39 straight months – the longest 8+ streak for the U3 number since the Great Depression. Meanwhile, the chronic unemployment rate – the percentage of unemployed individuals who remain out of work for six months or longer, approaches a post-Great Depression high.

That’s not much of an improvement at all, for an economy supposedly in recovery.

To put things into perspective, the “recovery officially started in June, 2009. Since that time, the economy has actually shed some 355,000 jobs. Some recovery!

But unemployment is just one small data point in a very large economic picture. Are there other more encouraging signs?

Wages Poking Up in Some Markets

Well, a recent survey conducted by PayScale.com, a nationwide compensation consultancy firm, has some promising news. Their proprietary PayScale Index, which measures compensation trends in dozens of industries, is tracking a broad increase in compensation across the country.

Some key findings, from PayScale’s own analysts:

• The Puget Sound metros lead the way in wage growth. The Seattle metro saw a 3.2% growth from Q1 2011 to Q1 2012. Houston (2.7%), Philadelphia (1.8%) and St. Louis (1.7%) were the next highest.

• Houston’s growth is partially fueled by the powerful surge in wages in the Mining, Oil & Gas Exploration industry. That industry led wage growth at 4.9% from Q1 2011 to Q1 2012.

• While most industries grew in the past year, a lone industry saw a drop in wages from Q1 2011 to Q1 2012. Food Services & Accommodation is still fighting negative conditions and as a consequence wages declined 0.2%.

• Workers at larger companies saw bigger wage increases than those at small companies. Large company employees enjoyed increases of 2.5%, three times the rate experienced by small company employees.

In addition, PayScale’s 2012 Compensation Best Practices Report indicated that the percentage of companies that had decreased in size over the previous year was down to 14 percent, compared to 41 percent in 2009.

Of those companies most likely to have increased in size in 2011, information, media and communications led the way with 57 percent. Other high-growth niches include warehousing and transportation, with 55 percent reporting employment expansion in 2011.

Politics

The employment numbers are highly charged, every election year. They’ve been so ever since the Carter Administration succumbed after a single term under the onslaught of Reagan and the GOP’ weaponization of the “misery index”, a composite of the inflation and unemployment numbers for 1979, which were miserable indeed that year.

But take everything you hear about employment with a pinch of salt. The truth is not as bad as the GOP tries to make things seem (well, with unemployment, anyway. With the debt situation, it’s worse). The unemployment situation is nowhere near as good as the Obama Administration paints it, either. The truth is invariably somewhere in the middle – and difficult to measure, as employment is a notoriously lagging economic indicator.