June, 2007

Doctor's Orders!

Before you get involved with other things this summer, schedule a mid-year checkup. No, we're not talking about the height/weight/blood pressure kind of checkup, we're talking about the income statement/balance sheet/cash flow kind of checkup - a review of your business's financial operating fundamentals.

If you review your vital financial information only when year-end rolls around, you may not know there's a problem until it's too late. The more often you take your company's "pulse," the sooner you'll be able to notice - and react to - changes in your business situation.

Check Your Vital Signs. What should you be looking at? Start with the operating fundamentals. For example, what's the status of accounts payable? When's the last time you ran an aging report for accounts receivable? How quickly is your inventory turning? What is your profit margin? These numbers are critical to running your business. You can't make accurate decisions if your figures are old. And, by keeping track of key financial ratios, you can more readily spot trends that should be addressed sooner rather than later.

Monitor Your Budget. Next, check your spending. If over spending is a problem, creating a comprehensive budget that establishes realistic guidelines is an effective remedy. Make sure you have a budgeted amount for every line item expense on your operating statement. Then track and compare actual spending to budgeted amounts on a regular basis.

Reduce Your Debt. Avoid the temptation to take out all your profits in good years. Instead, consider reinvesting some of those earnings in the business. Using retained earnings instead of debt to capitalize your business saves money - and provides a safety net that will be there to help you through periods of lackluster sales or unexpected expenses. A healthy debt-to-equity ratio will also look great when it's time to borrow money or sell your business.

See a Specialist. Helping owners build and maintain healthy businesses is our specialty. Let's schedule that mid-year review of your company's finances soon.

In a recent release of data from individual income-tax returns, the IRS focuses on returns for tax year 2005 that were filed in 2006. The data show an increase in total tax liability of 11.6% compared to a year earlier. Here are some other highlights.

Income. Salaries and wages reported on the returns rose 5.2% over the previous year. Capital gains taxed at the favorable long term rate soared by 36.7%, while qualified dividends, also taxed at a preferential rate, increased by 9%.

Deductions. About 35% of payers itemized their deductions, on average claiming total deductions of $22,693. An estimated 11.2 million taxpayers elected to deduct state and local general sales taxes instead of state and local income taxes. The interest paid deduction represented 34.7% of all itemized deductions.

AMT. Compared to the prior year, 30.65% more returns reported an alternative minimum tax (AMT) liability. In all, taxpayers lost $15.9 billion to the AMT.

The mortgage you can qualify for and the mortgage you can handle could be quite different. If you're in the market for a new mortgage, review your finances carefully. Before you sign on the dotted line, make sure you are comfortable with the size of the loan and the terms of the loan agreement.

How much can you afford to pay? Applying the 28%/36% ratios that mortgage lenders commonly use can help you assess your situation. Under these measures, your monthly housing payment (mortgage, real estate taxes, and homeowners insurance) should not be more than 28% of your gross monthly income, and your monthly housing payment plus payments on all other debts combined should not exceed 36% of your gross monthly income.

Example. Gary earns $10,000 a month. Multiplying $10,000 by 28% results in a maximum housing payment of $2,800. Looking at his other debts, Gary makes a monthly car payment of $500 and pays another $400 a month on student loans - $900 total. Applying the 36% ratio leaves a maximum of $2,700 for his monthly housing payment ([$10,000 x 36%] - $900).

Fixed or adjustable rate? A fixed rate mortgage offers the certainty of a monthly payment of principal and interest that will not change for the life of the loan. The tradeoff for that certainty is usually a higher interest rate than the initial rate available on an adjustable rate mortgage (ARM). The lower ARM payment may allow you to qualify for a more expensive_ home. However, if mortgage rates rise, you risk an upward adjustment in the amount of your monthly payment after the rate on your loan is reset. This risk may not be a major concern if you expect your income to increase or you plan to sell your home before the rate adjustment date.

Interest only? If you choose a mortgage that requires you to pay only interest for a period of time, you could be looking at a significant spike in your monthly payment when you're finally required to start paying down principal. If you can't afford the new payment, you might be able to sell your home. On the other hand, if you find yourself in a falling real estate market, your home could be worth less than the amount you borrowed. Bottom line: Approach an interest-only loan with extreme caution.

What do you do when a valuable employee announces his or her departure? Hopefully, you have a strategy for filling key vacancies already in place. You may even have a few names or résumés on file.

Scouting Tips Hiring the best people possible is important for all businesses - but it's especially critical for small businesses. So recruiting should always be on your mind, especially at networking functions, such as Chamber of Commerce or trade association meetings. Social gatherings can also be prime scouting opportunities. Keep a list of prospects with contact information and brief notes. Employees can be a valuable resource, too. Consider creating an employee referral program that offers rewards if referrals turn into hires.

The Windup . . . Be prepared by compiling job descriptions, qualification requirements, and interview questions for all positions. Make sure you ask all candidates the same questions - and note their answers. When making a decision, choosing the candidate with the right personality who can be trained usually trumps hiring an expert with the wrong personality.

. . . and the Pitch - When you find a candidate you want to hire, it's time for a sales pitch. You may not be able to offer top dollar compensation, but there are many other benefits to working for a small business, including flexibility and a unique work culture. And the biggest benefit of all? Everyone plays an integral role in the company's success.

As Mark Twain observed, land is something they've stopped making. As for undeveloped land, not only have they stopped making it, it is becoming increasingly scarce in some areas. To permanently restrict development, some landowners are granting conservation easements over their properties to land trusts or other qualified nonprofit organizations - and gaining valuable tax breaks in the process.

The donation of a conservation easement can give rise to a federal income-tax deduction for the difference between the land's unrestricted value and its new value with the limited development or usage rights specified in the easement. If the easement is granted in 2007, it is deductible up to 50% of adjusted gross income (AGI), and any deductible amount over that limit may be carried forward for 15 years. Farmers and ranchers who meet tax law requirements are eligible to deduct 2007 conservation easement donations up to 100% of their AGI.

As for federal estate taxes, up to 40% of the value of land subject to a qualified conservation easement is excludable from the owner's gross estate. The exclusion is capped at $500,000.

There's a new (k) on the retirement savings block - the Roth 401(k). The tax law now allows employers with 401(k) plans to add a Roth contribution option, which, in turn, gives employees a new tax-planning opportunity. The Roth contribution option also opens the door to Roth benefits for highly compensated employees - a door that's been closed until now.

Not Too Taxing The main difference between the two contribution options is taxes. Traditional 401(k) deferrals are pretax contributions, while Roth 401(k) deferrals are after-tax contributions. Earnings on both contribution types accumulate tax free. Withdrawals of traditional deferrals and earnings are taxed when distributed. Roth contributions were already taxed, so they are distributed tax free. The big tax payoff for Roth 401(k) accounts is that, as long as certain requirements are met, earnings are not taxed when distributed.

To Roth, or Not To Roth Who might benefit? Young employees, who have decades ahead of them to save and generally pay taxes at a relatively low rate, may benefit from making Roth contributions. The chance to build a healthy nest egg of tax-free income for retirement is an attractive opportunity.

The future tax benefits of Roth contributions may boost participation among lower paid employees, which can help your plan pass nondiscrimination testing. And highly paid employees, many of whom are barred from opening Roth IRAs because of income restrictions, will finally be able to take advantage of Roth benefits.

Plan Sponsor Requirements Adding a Roth 401(k) option is relatively simple. There will be some additional administrative work and some added expense, since Roth contributions must be accounted for separately. And a plan amendment will be required. If you currently offer a 401(k) match, you can continue to match Roth contributions, although matching funds must be treated as pretax contributions.

If you'd like to discuss the pros and cons of adding a Roth contribution option to your 401(k), call us. We'll conduct a thorough review.

American consumers devoted almost one third (32.7%) of their annual spending to housing in 2005, says the U.S. Bureau of Labor Statistics' recently released Consumer Expenditure Survey. Other major items in the average budget were transportation (18%), food (12.8%), and personal insurance and pensions (11.2%).

Job prospects for new college graduates appear brighter this year. Employers responding to a survey by the National Association of Colleges and Employers said they intend to hire 17.4% more graduates than they did in 2006. Based on a recent review of tax return filings in 2006, the Treasury Inspector General for Tax Administration says that more than 100,000 taxpayers may have improperly claimed deductions for unsubstantiated noncash charitable contributions totaling as much as $1.8 billion.

Among workers in the private sector, the rate of participation in employer- provided medical plans was 52% in March 2006, according to the government's National Compensation Survey. About 55% of participating workers had indemnity (fee for service) plan coverage, while approximately 29% were covered by prepaid (health maintenance organization) plans.

Suzanne, a single parent, has purchased life insurance to provide financial protection for her daughter Rachel. Suzanne has taken an important estate planning step. However, simply buying a policy may not be enough.

Because Rachel is still young, Suzanne should also take steps to ensure that the insurance benefits will be used as she intends. insurance trust. A trust is a legal arrangement under which a trustee agrees to manage the trust assets for the benefit of the trust beneficiary.

With a life insurance trust, the trustee is the designated owner and beneficiary of the insurance policy. The trustee collects the insurance proceeds, invests the money, and makes distributions to or for the benefit of the trust beneficiary (Rachel, in this situation) according to the instructions the trust creator (Suzanne) puts in the trust agreement. Suzanne also might consider arranging for her estate to distribute trust to be managed for Rachel's benefit.

You don't have to be a single parent like Suzanne to consider including a life insurance trust in your estate plan. If properly arranged, a trust can be used to reduce potential estate taxes by removing life insurance proceeds from your gross estate. If you would like to discuss your personal financial planning concerns, please contact us soon for an appointment.

Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you. Talk to us before taking any action.

Question. Our oldest child is headed for college this fall, and we'll be paying her tuition. She's still a dependent, so I'm interested in finding out about the Hope Scholarship credit.
Answer. The Hope credit is for the qualified expenses of first and second year college students. For 2007, the maximum credit is $1,650 per student. Taxpayer eligibility phases out at certain income levels, so if you and your spouse file jointly, your modified adjusted gross income for 2007 can't be more than $94,000 to be eligible for the full credit. The credit phases out entirely at AGI levels of more than $114,000.

Question. I'm a self-employed electrician. I did some work for a local company, but was never paid because it went out of business shortly thereafter. Can I deduct the unpaid fees?
Answer. It depends. You can only deduct a "bad debt" if you've reported the unpaid fees as income on your return. Cash- method taxpayers don't report income until it is received, so you won't be able to claim a deduction if you use that method of accounting.