Laura Strombom

Laura is the owner of All About Numbers. As an IRS Enrolled Agent (EA) she is expert in all aspects of tax matters and bookkeeping procedures.

A Tale of Two Businesses

Business One: “Fred” is a skilled electrician. He worked 20 years for the same company, and one day realized that he was getting paid $20 per hour but was billing $80 an hour for his time. “This is unfair!” he thought, so he decided to sit for the contractor’s license exam and open his own business. He had $10,000 saved up, and he knew that he would be able to get clients the same way his boss did very easily.

The first year, “Fred” focused all his time and energy on getting clients and doing the work to keep them happy. He billed out only $60 for his time – this was triple his old pay, and less than his former boss was charging, so he should make tons of money and get all the work he wanted. “Fred” was so busy working he did not have time to keep very good records. He collected money from clients as he worked, and paid his bills when they came in, but did no other financial work on his business. After about 6 months, 
“Fred” realized he had a significant amount of money in the business checking account. He had been eyeing a new pickup truck, and he figured he could use the write off, so he went to the dealership and paid cash for the new truck. He still had a bunch of money left over, so he went across the street to the boat dealership and bought himself a new bass boat. He also paid cash for this boat.

By this time, the business was doing so well, that “Fred” could not keep up with the demand for his work, so he called his buddy, Joe, also an electrician. Fred told Joe he would pay him 50% of everything that he billed – which meant that Joe would make $30 an hour. Fred told Joe that he would pay him as an independent contractor so Joe would not have to worry about taxes, and Fred would not have to mess with payroll. Joe agreed, and together they wrote up a contract using resources they found online.

The calendar pages turned, and a tax return was now due. Fred was so busy he did not have time to deal with this, so he called the IRS and asked for an extension. They happily gave him one over the phone, and he did not have to pay a dime! He now had until October to deal with this mess, so off his mind it went and back to work he was.

It was really working to have Joe help out – there seemed to be even more money in the checking account. Fred decided that meant he could go on vacation. He took his wife and kids to Disney World and stayed in the nicest resort, ate the best food and saw all the attractions. He thought he had “finally made it” and should treat his family to the life they deserved. With Joe to cover the business while he was gone, he could even take a break himself.

When October arrived, Fred started to panic. That tax return was lingering in the back of his mind, and his wife was getting nervous. He did not where to begin. He went online and found do-it-yourself tax software, and started answering its questions. He did not know all the answers, but he was able to guess at the numbers and figured he was pretty close to right. He did not have time to actually figure out what they were, so he felt he did not have a choice. After answering all the questions, the software told Fred he owed the IRS $20,000. Fred was shocked! He only had $1000 in the bank. How could he owe that much money? Sure, he took his family on that trip, but that was only $10,000. How could the IRS possibly expect him to pay so much when he made so little? He went back into the software and changed some of the figures to reduce the amount he owed. When he had it down to $1000 – all the money he had – he thought that was more than fair and filed the return.

This year, at Christmas, Joe decided he needed a bonus. Afterall, Fred was driving the new truck, fishing in his new boat and taking his family on vacation while Joe was doing all the work. Joe told Fred that if he did not get a bonus, he would quit. Fred could not let Joe go, so he gave him $5,000 – again, all the money that was in the checking account. He also went to the dealership and financed a new truck for Joe.

The calendar page turned again, and Fred’s wife insisted they not wait until October to file their taxes again. So Fred opened up the new year’s software and began putting in numbers. This time, he spent a little bit more time trying to add up receipts, but he did not know what he had done with all of them. When he finished, the software this year suggested that Fred owed $30,000 in takes. Impossible, thought Fred. I am struggling to pay my bills, I can hardly take out enough money from the business to feed my family and they want me to pay them $30,000? He again went back into the software and adjusted the figures to get to an amount he thought was fair. This year, the software came back with a refund from something called the earned income credit, so Fred did not have to pay anything. This was more than fair, he thought, and the return was filed.

For some reason, things started to feel tight. Fred had been struggling to pay his family bills since Christmas, but now, it seemed there was no money available. Fred and Joe were busy working a bunch, so Fred just figured it was the bad economy and that prices had just gone up on everything. Funny, Joe did not seem to be struggling, but he did not have a wife and kids to support either.

In August, Fred got a letter from the IRS. They were interested in examining that first return he filed. Fred went into a panic – he knew he did not have anything to support the numbers he claimed! He thought he could talk some sense into the auditor, however, so he kept the appointment they assigned. After 2 hours with the auditor, Fred left with bad news. They were disallowing many of the deductions he had claimed, and they were suggesting that he now owed them $28,000 plus interest and penalties. He did not understand how that could be! He went home resolved to find more receipts, but in the end, he was not able to find anything to reduce this bill. Because of the major changes on this return, the examiner asked to review the following years return. Fred gulped because he knew this would be bad too. He was right to be afraid, as the auditor came back with a proposed assessment of an additional $39,000 in taxes, plus interest and penalties, plus he was now ineligible for the earned income credit for the next 10 years.

Faced with huge bills to the IRS, Fred felt more discouraged than ever, and realized he needed to put in more hours and make some changes. He sat down with Joe and explained to him that he needed to do more of the work himself and was going to let Joe go. Joe understood, and went on his way. Fred was feeling like he would be able to get back on his feet again by working the crazy hours he did in the beginning doing all the work himself.

A few weeks later, Fred is contacted by the state of California. Apparently, Joe filed for unemployment benefits. The state of California had no record of Fred as an employer. The state wanted to meet with Fred to determine whether or not he should have treated Joe as an employee. Fred felt confident that he would prevail in this audit, after all, he and Joe had an independent contractor agreement. Unfortunately, the state of California did not agree as the independent contractor agreement has no bearing on whether or not Joe was legally an employee. Because Fred had control of Joe, as well as a variety of other factors, Fred should have classified him as an employee and paid all the proper taxes. Because of an agreement between the Department of Industrial Relations (DIR) and the Employment Development Department (EDD), Fred was fined substantially by the DIR for not following proper employment procedures and for not having worker’s compensation insurance on his employee.

Things went from bad to worse as Fred started realizing his phone was ringing much less than it had before. He opened up the newspaper to make sure his ad was still running, and there he saw next to his ad was another ad with a familiar phone number attached. Joe was now his competitor. After doing some additional research, Fred soon discovered that Joe had been working on the side for quite some time and had obtained his own contractor’s license. Apparently, Joe was billing the work he did through his own business even when the work came to him through Fred.

Dejected, defeated and financially in shambles, Fred decided to contact a bankruptcy attorney. Things went from bad to worse when he learned that the fines from the DIR are not dischargeable in bankruptcy, that the taxes he was assessed were too recent to be discharged, and that in short, there was nothing he could do to erase any of these large bills.

Today, Fred is back at work for his original employer. He is earning the same $20 per hour he was earning a few years back, and very grateful that all he has to do is his job.

Business Two: Marvin, also an electrician, had long dreamed of being his own boss. He had visions of operating a full scale electrical construction business. He met with advisors on several topics related to the business he wanted to open as he knew he was an excellent electrician, but he knew nothing about running a business. With the help of his advisors, he was able to create a business plan, a marketing plan and a budget. He saved up for two years to have enough money in the bank to support his family for 6 months before he began the business.

Once all the startup requirements were in place, Marvin opened his doors. From day one, he had a bookkeeping service set up to handle his invoicing, job costing, recordkeeping and other financial affairs. He consulted with the EDD and figured that when it was time to hire his first employee, he would use a labor service until he had enough work to handle the commitment of a full time employee. He had a payroll service and worker’s compensation insurance broker lined up to help him with both of these tasks. Marvin had worked with the accountant at the bookkeeping service to create his budget. Through this process Marvin knew that in order to cover his overhead expenses, taxes and direct costs, he needed to charge no less than $75 per hour for his labor. He also had a system in place to work with the accountant and the bookkeeper monitor his costs to make sure they stayed in line with his budget.

Much like Fred, Marvin quickly had plenty of work to keep him busy. He watched his bank account grow, and then he watched it fall as he paid his quarterly estimated tax payments. He took out of the account a set amount of money each week to cover his families expenses, and his family lived within the confines of this budgeted amount, no matter how much more money was available to take from the business.

Marvin received monthly financial statements from his bookkeeper and accountant that showed how he was doing compared to his budget. He met with his accountant quarterly to review major expenditures, to discuss strategies of improving his profits, and to determine if there was enough strength in the company to either invest in growth or to treat his family to something special.

When the calendar pages turned, Marvin met with the accountant to review the year end books, and to provide personal information for his tax return. In March, Marvin received a small refund from the IRS that he used to buy his wife some flowers. He was thrilled that he and the accountant had planned so well that the IRS had not been holding too much of his money throughout the year.

Today, Marvin no longer works in the field. He works in the office making sure that his staff of 20 electricians are all doing quality work, on time and on budget. He still works closely with his accountant, meeting with her at least once a quarter to review his financial position. Marvin does not make any major purchases without first contacting his accountant to make sure he is making the right decisions regarding financing, timing and tax planning. Marvin has no less than 6 figures in his bank account at any given time, and he has never been audited by the IRS. Marvin’s story has a much happier ending than Fred’s, yet both men started from the same place. The difference is that Marvin realized he was an expert electrician, but not an expert businessman. He knew he needed to partner with others who were experts in their fields to make his business successful. Marvin’s story is also shorter, because it is much smoother without any catastrophes to report.

If you are a business owner, how many things in Fred’s story can you relate to? How about Marvin’s? Which story would you rather call your own? If you want to be like Marvin, call All About Numbers today to setup your free initial consultation. We will partner with you to make your story a smooth success!

 

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Monday, 18 December 2017

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