Something You Didn't Know About New Jersey Unemployment Tax

Is that person that provides services to your company an employee or independent contractor?  The answer to this question has always been a contentious issue between businesses and federal and state governments.    The primary reason for contention is that payment for independent contractors' services are not subject to payroll taxes, and payment for services of employees are.  Therefore, independent contractor classification causes the government to lose much needed payroll tax revenue.

The determination of independent contractor status is largely dependent on the degree of control exercised by the business that engages the subcontractor.  Basically, if the business controls when, where, and how the work is done, the person doing the work is an employee, not an independent contractor.  The IRS has developed a list of twenty questions to assist in this determination.  This list of questions can easily be found on the internet.  Please contact me if you want me to send you a copy.

It has been our experience that disputes over independent contractor status have centered around services provided by individuals.  The IRS and most states have generally respected arrangements where payments were made to other businesses for services provided by those businesses.  Some examples of these types of relationships include landscapers, building cleaning and maintenance companies, and transportation (school and other bus) companies.  However, it now appears that New Jersey Unemployment will no longer respect such arrangements.  Authorized by NJSA 43:21-19(3)(g), NJ Unemployment auditors are classifying employees of other businesses as employees of the business under audit and assessing tax for the payments made to these businesses.

The final sentence of NJSA 43:21-19(3)(g) states "Each individual employed to perform or to assist in performing the work of any agent or employee of an employing unit shall be deemed to be employed by such employing unit for the purposes of this chapter...whether such individual was hired or paid directly by such employing unit or by such agent or employee; provided the employing unit had actual or constructive knowledge of the work."

Read it again and think about it.  As long as you know that your grass is being cut or your office is being cleaned, New Jersey has the right to require your business to pay unemployment and disability tax on the payments for services that you make to the business performing such services.  Practically, this provision will not be applied unless the subcontractor fails to comply with NJ Unemployment laws, but there is no mechanism to determine if subcontractors are in compliance.  We recently had an audit where this law was applied.  When asked how a business could determine if subcontractors are in compliance, the auditor's response was that before hiring a subcontractor, we should request copies of their NJ Unemployment Tax reporting forms.  That is ridiculous!  Would you share your confidential payroll information with a customer?

New Jersey doesn't understand why businesses are leaving and relocating to more tax and business friendly states.  It is time to wake up, and stop trying to tax businesses out of existence.

Buy Sell Agreements

When was the last time you reviewed your buy sell agreement?  If you are like most business owners, the most likely answer is NEVER.  Maybe you read it before you signed it when you started the business, and maybe you didn't.  Many buy sell agreements are formula based, that is, they call for the application of a multiple to a business performance measure.  Examples of simple formula based valuation methods are 1 times sales, 5 times net income, or something in between.

The problem with formula based valuations is that a result that may have made sense ten or twenty years ago may not make sense today.  For example, a formula based on a multiple of sales is probably not fair if the business consistently loses money.  Because no one knows if they are going to be a buyer or seller until the buy sell is triggered, it is important that the agreement be fair to both parties.  If the formula isn't fair, it is not uncommon for a costly and time consuming dispute to arise.

The thing to do it get out your buy sell agreement, read it, and ask your accountant to calculate the formula value specified by the agreement, as of December 31, 2010 or any other date.  You may be surprised by the result.  Look at it from the standpoint of both a buyer and a seller, because you don't know which one you will be.  If you were the seller, would you be happy with the price that you would receive?  If you were the buyer, how do you feel about the price to be paid?  What you will probably see is that formula based valuations never yield results that are fair to both parties.

There is a simple and effective solution to the problem of formula based valuations.  That solution is to change the buy sell to require that upon the occurrence of a triggering event, the business be valued by a qualified professional.  The agreement should define the triggering event, the standard of value, and the qualifications or credentials of the valuator.  To avoid disputes, many agreements actually name the individual or firm who will preform the valuation.  It is much easier to agree on such matters when the agreement is drafted then when it is triggered and emotions may be running high.

I learned a lot about buy sell agreements when I did a prepublication review of Chris Mercer's new book  Buy Sell Agreements for Closely Held and Family Business Owners.  If you are interested in purchasing this book, you can do so at  www.mercercapital.com.

Your thoughts and comments are welcome.

How Much Alternative Minimum Tax Do You Pay?

I've been reading and hearing a lot of talk about proposals to increase tax rates for the wealthy, that is, those with taxable income above $250,000.  I imagine there are some places in America where $250,000 of income qualifies you as wealthy, but the New York metropolitan area is definitely not one of those places.  In New Jersey we pay the highest state income tax, real estate tax, and sales tax in the country.  And the worst part is, that thanks to the alternative minimum tax, many of us do not even get any federal tax benefit from paying these taxes.  The alternative minumum tax ("AMT")is a separate computation, one that includes adjustments to your regular taxable income.  The adjustement that affects so many of our clients is the one that disallows the deduction for all state income taxes and real estate taxes.    If the tax computed using the AMT calculation is higher than the regular tax, the alternative minimum tax becomes your tax liability.

As I recall, the AMT was implemented as another way to tax "the rich", especially those who participated in tax shelters.  Although we haven't finished all of our 2010 tax returns, so far 138 of our clients have paid a total of $1,373,000 of alternative minimum tax.  These clients include a single working mother with $84,000 of adjusted gross income, and another individual with $59,000 of adjusted gross income. These examples are some of the many.  I don't think that anyone can argue that either one is "rich", or that the AMT was intended to apply to them.  After all, state income taxes and real estate taxes on a residence are far from qualifying as tax shelters.

However, there is a bright side to the AMT.  If regular income tax rates are increased, those of us who are subject to AMT will not pay any additional income taxes unless the alternative minimum tax rate is also increased, or the regular income tax rate increase causes your regular tax to exceed the AMT.  Many people pay so much AMT that a small increase in the regular tax rates will have no effect on their liability.

The alternative minimum tax is unfair to people who pay high state income and property taxes.  If Congress plans to make changes to our tax code that result in additional tax on individuals and families, I urge them to also change the AMT to eliminate state income taxes and property taxes as an add-back.  I believe that such a change will give AMT relief to most people who are currently subject to it.

End of Tax Season Ramble

A little over two weeks remaining in tax season; it has been one of the harder ones in recent memory.  Clients received their tax information late, and as a result sent us their stuff much later than in prior years.  We never forget that we are in the client service business, but with so many clients sending their tax stuff at the last minute, each probably thinking that they are the only one, but not realizing that they are one of at least a hundred.  At KRS we all work very hard to get it done, and done right, but as April 18 draws closer, it becomes physically impossible to get all the work done at the last minute.  I guess that is why the IRS invented extensions.  If you are one of those who has not yet sent us your documents, let us know and we will get an extension.

Speaking of customer service, when did the US Post Office forget, or when will they figure out, that they are in the customer service business?  This week we learned that after six years in the same office, mail that did not include our recently assigned suite number (585), was returned to the senders.  We attempted to contact everyone to let them know that the suite number is required, but, as people do, many forgot.  Our office is in a relatively small town, and the post office knows who we are, and what we are.  There is no excuse for returning our mail without so much as a telephone call.  I see a lot of news about the Post Office financial problems and how to solve them.  Thinking about customer service would be a step in the right direction.

A friend just turned me on to Joe Bonamassa, a great young blues guitarist.  He has a fair amount of stuff on YouTube; my favorite is at Royal Albert Hall where he performs with Eric Clapton.  His music is also on itunes.  I have not liked most of the new music I hear, but Joe is breath of fresh air.  Check him out and let me know what you think.

Capital Grill opened up in Garden State Plaza mall.  Great food, great service, and the biggest wine list I ever saw.  Not inexpensive, but definitely worth it.  I had a steak with a Kona coffee crust, it was delicious.  If you are going, be sure to make a reservation.  On the Saturday we were there,  the wait was over two hours for those without reservations.

This is my favorite time of year.  Three things I love are the NCAA basketball tournament, the Masters, and the end of tax season.

Next time I will get back to business, that is, how to improve yours.  I also welcome comments and suggestions.  I see that I have many readers in England and France.  If you are one of them, please let me know what you think.

What Is Your Business Worth?

What is my business worth?  I am often asked that question by business owners who think the answer is as simple as multiplying some number (usually gross receipts) by some other number (usually five) to come up with the answer.  Trust me, valuing a business is not that simple.

In order to know what a business is worth, one must understand what is being sold, and how the buyer evaluates how much he will pay for it.  The price paid for a business is based on a thorough and unemotional analysis, one that evaluates the subject company and compares its potential risks and rewards to other potential investments.  What does this mean in plain language?  No one cares about the sacrifices you made in starting the business, or how much money you made last year or last week.  The buyer is interested in projected future cash flow (reward) and the chance that the cash flow will not be achieved (risk).  The bottom line is this: if I buy this business, how much money will I make?  If the business is a risky one, there is a greater chance that the projected cash flows will not be achieved, so he will probably require a higher return to compensate me for taking the risk, and pay less for the business.  If there is little risk associated with the business, he is probably willing to pay a higher price.  But if the business does not have positive cash flow, it probably isn't worth much more than the value of its net assets.

There are two types of risk; those that can be controlled and those that cannot.  Examples of risks that cannot be controlled are the economy, unemployment, tax law, and other government policy.  Risks that often can be controlled are diversification risk (customer, product, supplier), technology, competition, and management depth.  For example, when the economy is in recession, almost all business is affected, and little can be done about it.  But a business that lacks diversification can take steps to diversify.  For example, if the continued success of your business is based on one product, customer, or supplier, you should take steps to diversify; the loss of the one customer or supplier upon which your business depends would be viewed as a great risk by any potential buyer.  Management depth is a risk that is often overlooked.  I know so many business owners that are so proud of the fact that they know everything about their business and no one else knows anything.  Guess what?  This is very bad.  If something happens to that person, the business is not worth much.

Another way to decrease the perceived risk, and increase the price of your business, is to maintain excellent accounting records,  records that tell the story of your business without explanation.  Time and time again, I see businesses sold where the seller left dollars on the table because the accounting records did not tell the complete story.  Every business owner thinks they can explain away the problems, but each explanation adds to the buyer's perception of risk, until there are so many explanations that the buyer just walks away. There are many excellent accounting software packages available, and there is no reason why every business does not have computerized accounting records, that tell the financial story of your business.

When should you start getting ready to sell your business?  Right now is the perfect time. Even though you think you are not a seller, you never know when the time will come, and when it does you have to  be ready.  What can you do right now to improve cash flow?  A few ideas are reducing payroll, managing inventory, and dropping unprofitable products or customers.  What about risk?  When was the last time your looked for new customers?  Can you identify other sources for your products?  What are you doing to be better than the competition?  You should be thinking about these things every day!  What about your accounting records?  Do you have accurate accrual basis financial statements within two weeks after the end of every month?  If not, something is wrong.  Go to Staples and buy QuickBooks.  You will be glad you did.

We welcome your comments, both positive and negative, and are happy to respond to all questions.