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Resolving the Banking Crisis: It’s Not About Credit, It’s About Structure

It’s Not About Credit, It’s About Structure

The current banking crisis is not primarily a credit crisis. Instead, it is a structural crisis caused by some institutions being considered “too big to fail.” This perception creates an uneven playing field in the banking industry, making it difficult for smaller banks to compete with their larger counterparts.

Large depositors and businesses cannot afford to take even the smallest risk of keeping their operating deposits at any institution other than those deemed too big to fail. Even if the risk of failure is as low as 0.0001%, this risk is still infinitely higher than the zero risk associated with banks that are too big to fail.

The longer we allow this unlevel playing field to persist, the more community banks will fail and at an accelerating rate. This poses a threat to the overall stability of the banking system and local economies.

Potential Solution: Level the Playing Field

There are several potential solutions to this problem. One such solution could be breaking up the larger banks, ensuring that all banks are small enough to fail. While this may be the most sustainable long-term solution, a more practical immediate solution for the current situation involves drastically increasing the amount of deposit insurance available for deposits at smaller banks.

Furthermore, the cost of this increased deposit insurance should be borne by the larger banks that are considered too big to fail. These banks are the root cause of the problem, and they unfairly benefit from a lower cost of capital due to the implicit guarantee provided by the federal government.

By implementing these changes, we can help level the playing field in the banking industry and support the survival and success of community banks. This will ultimately contribute to a more stable and resilient financial system that serves the needs of all its stakeholders.

What Silicon Valley Bank’s Failure Can Teach Us about Personal Financial Planning

On March 10, 2023, Silicon Valley Bank (SVB) failed. This was the second largest bank failure in American history. SVB primarily served tech industry start-ups and they were widely considered an important part of our nation’s banking sector. The failure of SVB is likely due to many causes and events but the underlying cause is simple: They did not have money when they needed it.

Cash flow and personal financial planning

This is intriguingly simple but also confusing. To help explain, I like to provide an analogy between prudent bank management and prudent individual financial planning. The analogy is instructive for both understanding bank failures and also understanding what you can do to improve your personal financial security.

When most people think of bank failure, they usually think of unqualified borrows or risky derivatives. This is certainly one way a bank fails, but there is another, more basic threat to any bank’s operations. Specifically, investment timelines must match needed-use timelines. Banks should not invest in long-term assets if they need or might need the money in the near term. This is called liquidity planning or asset-liability management.

In other words, it comes down to cash flow and timing. Cash needs to be available when you need it.

The importance of asset-liability management

The same holds true for individuals. We need to plan and adjust our use of money and our investment decisions based not only on how much we are going to spend but also on when we plan to spend it.

If we know we need money in six months because we plan on buying a house and a house purchase requires a down payment, it would be unwise to put the down payment money into risky long-term investments, like the stock market. While the stock market is a great long-term investment, it might lose value in the near term.

Most people understand that even if an investment is a good investment over the long term, the short term is very volatile and a prudent person would not risk the down payment for their house on a long-term stock investment. Similarly, as it relates to retirement planning, the closer you get to retirement, the less risk you can afford to take with your retirement nest egg and the less you should have invested in long-term investments like the stock market.

Long-term investments vs short-term needs

While there were other factors at play and there is still a lot we do not know, unfortunately, lack of liquidity planning and poor asset-liability management appear to be the main causes of the SVB bank failure. SVB needed money but the money they needed was invested in long-term investments.

For the same reasons you do not invest your new home down payment in long-term investments, banks should also not invest liquidity needed to cover deposit withdrawals in long-term investments, but this is what SVB appears to have done. Then, when SVB needed the money, they were forced to sell their long-term investments at a loss and they did not have the money needed to survive.

The problem of risk in liquidity planning

Some people might argue that these situations are not analogous because no one can predict a “run on the bank,” and banks should invest for the long-term. However, not all banks are created equal, just like not all individuals have the same financial situation or job security.

SVB had a concentration of deposits from risky tech-sector start-ups. They should have known that these deposits were less stable than traditional banks. Therefore, they should have been more conservative with their liquidity planning. Similarly, as individuals, prudent financial planning includes exercising financial discipline and saving an emergency reserve of cash that is sufficient to weather a storm, especially if you have a risky job.

How to Maximize Your Tax Refund for 2022

Written by Charles Renwick. Published by Quicken on September 20, 2022.

https://www.quicken.com/blog/how-to-maximize-your-tax-refund

Another year-end is approaching and it’s time to start thinking about taxes.

“But I get a W-2. There’s nothing I can do for tax planning!”

I hear this a lot. It is true, the options available to W-2 employees are more limited than the options available to small business owners. But that doesn’t mean you don’t have options. Let’s take a look at the problem, review some common expenses you need to deduct, and consider ways to save money on taxes this year.

Maximizing your refund as a W-2 employee

The W-2 problem in tax planning

The Tax Cuts and Jobs Act of 2017 made significant changes to how individuals are taxed. Perhaps the most impactful changes were the revisions to the individual deduction rules. Specifically, the standard deduction was doubled, and previously allowed deductions like unreimbursed business expenses for W-2 employees were limited or eliminated.

While this “simplified” tax reporting for thousands of Americans, it also created a situation that does not seem fair because now, only small business owners can take advantage of the most popular deductions.

Popular deductions that W-2 employees can’t claim

Home office: As a W-2 employee in the cloud-computing, post-COVID-19 era, you probably sometimes work from home. You might think that you can deduct your home office expenses. Sorry, you can’t.
Cell phone: You likely use your cell phone for work all the time, right? If you’re like most people, your cell phone is used for business calls and emails more than it is for personal calls and emails. But can you get a tax deduction if you pay for your cell phone bill yourself? Nope.
Mileage/vehicle: Gas is expensive and you go the “extra mile” to get the job done for the company. The company budgets are tight and your boss can only reimburse a fraction of your actual costs of ownership. But at least you get a tax deduction, right? Wrong again.

The solution

So if you have all these business expenses but you can’t deduct them because you’re not a small business owner, what can you do? Become a small business owner! It’s actually easier than you think. The two best ways to become a small business owner are:

Buy and manage rental properties, or
Work a side gig that pays a 1099

When you have rental properties or a side gig that pays a 1099, you open up opportunities to deduct lots of your expenses that you can’t deduct as a W-2 employee. The particular rules for each deduction are important and I am not suggesting you claim deductions unrelated to your new small business. But overlapping expenses that are necessary for your new small business are fair game, and you are entitled to deduct at least a portion of these expenses that would otherwise not be deductible.

Using business deductions to maximize your refund

Rental property or 1099 tax planning: the basics

At a high level, rental property operations and 1099 side gigs are considered business. Therefore, they get to take business deductions. What qualifies as a business deduction is very much based on the business purpose and facts and circumstances, but in general, there are lots of expenses that qualify that you would not otherwise be able to deduct.

Popular rental property or 1099 tax deductions

Again, the business purpose and your specific facts and circumstances are the main considerations when looking for deductions, but here is a list of popular deductions to give you an idea of the kinds of things you should be tracking because they are usually deductible.

Internet Expenses
Business Meals
Business Travel Expenses
Advertising Expenses
Supplies Expenses
Insurance Expenses
Repairs and Maintenance
Professional Services
Rent Expenses
Utilities Expenses

Other things to consider

Your tax deduction increases your return on investment (ROI)

Rental property investments and side gigs are already a great economic opportunity for growing wealth. But the additional tax benefits you gain make these opportunities even more compelling. For example consider this scenario:

You pay a marginal 25% income tax rate
You make an extra $5,000 working a side gig
This side gig allows you to access $5,000 in deductions you previously were not able to access

What’s the economic result? You effectively increase your side gig income by 33%. Why? Because without the deductions, you would have had to make $6,666 in income to keep that $5,000 after taxes. In other words, your deductions allow you to earn that $5,000 tax free.

Does this mean you’ll get a big tax refund? Not necessarily. That depends on the rest of your financial picture including how much you paid in taxes during the year and how much you owe overall. But those business deductions are reducing your total tax obligation. Whether you get a bigger refund or you just pay less, you win either way.

Keep clean records and receipts

Documentation is always important when it comes to ensuring you have minimal risk if audited, and you need to keep your records and receipts for three years. Using accounting software like Quicken keeps you organized and ensures you don’t miss any deductions.

Use a CPA

This is a general disclaimer but also some good advice. As you can see from the example above, a small side gig has significant tax consequences. In fact, the amount of money at stake is far greater than the nominal cost of using a CPA. Because everyone’s situation is different and the facts and circumstances matter, a CPA can make sure everything is done correctly. Plus, a CPA might identify additional tax savings opportunities.

So what are you waiting for? Year-end is approaching — start planning now!

Want to Save Taxes? Maximize Deductions and Use the S-Corp Structure

Tax guidance is provided by Charles Renwick, CPA. Everyone’s situation is different and the general guidance provided herein should only be used as a starting point for assessing your individual and business tax situation.

You Are a Small Business Owner – Take Taxes Seriously

Do you own a small business? Are you a real estate professional or other professional that receives a 1099? If so, you are a small business owner and you operate as a small business. As a result, you have the responsibility of paying your own taxes. If you do not plan or develop a tax strategy, you will likely face significant tax liabilities. The good news is that with a little planning and a strategy, you can legally reduce your tax bill, significantly.

Note, if you have not already formed an LLC and opened a business bank account, you should do that first. The mechanics of forming an LLC are not the subject of this article, however most of the tax strategies discussed in this article are only available if you already have an LLC in place.

Small Business Taxes

Generally, small business face two primary tax filing and payment obligations:

Income Tax – Federal (and State if applicable)
Payroll Tax – Federal

Income Tax

While all individuals with income over $650 are subject to federal income tax filing requirements, income taxes are likely actually not the primary tax that will impact your total tax bill. This is because the federal government provides various deductions and credits to reduce income tax liability for lower income taxpayers. Additionally, the income tax brackets are progressive, which means income over various thresholds is taxed at a higher rate than income below the thresholds. One common misconception is that earning a higher income will subject all of your income to a higher tax bracket. This is not true. Only the income above the bracket threshold is subject to the higher tax rate. The income below the threshold is still taxed at the lower rate.

To be clear, due to the standard deductions, child credits, and progressive tax bracket structure, it is not uncommon for there to be little or no income tax for self employed individuals that are married and have multiple children and with income less than $60,000. That said, as income increases into the $100,000 range, deductions and credits can phase out and income tax liabilities can increase significantly.

Payroll Tax

To most people’s surprise, payroll taxes are the primary tax paid by both self employed individuals and non-self employed individuals. Payroll taxes consist of the “Social Security Tax” and the “Medicare Tax”. Together, these taxes total 15.3% of all employment earnings below $137,700 (adjusted annually for inflation). While 15.3% might not seem like a lot, the government does not provide child credits or standard deductions against this tax. Thus, when compared to the income tax, it is easy to see why this tax is much greater for individuals making less than $137,700. For example, for a married individual with three kids making $80,000, there will likely be no federal income tax due, however there will be payroll taxes due of $12,240 ($80,000 *15.3%).

How to Minimize Taxes

Clearly, you need to have a strategy to reduce both your income tax and your self employment tax and in most cases for small businesses, it is more important to focus on reducing your self employment tax. Fortunately, there are two primary ways to legally reduce both of these taxes:

Maximize Your Business Deductions
Use the S-Corporation Tax Structure

Maximize Your Deductions

Maximizing your deductions is the most effective way to reduce both your income tax and payroll tax liability. In many cases, if you receive 1099 income of less than $35,000, there are likely available deductions that will reduce your income to a sufficiently low level so that no tax is due.

Common Deductions

Car Mileage and/or Car Depreciation
Home Office
Advertising
Business Meal
Medical expenses

Deductions – Blocking and Tackling

While there are some very specific rules that apply to some deductions, the most important thing you can do to ensure you maximize your deductions is to keep as much documentation as possible.

Keep track of all your spending (use an accounting system like Xero or Quickbooks)
Keep all your receipts (digitize them)
Track the miles on your car (take picture of odometer every year)
Business/Family travel (documented the business component)

The importance of proper documentation cannot be overstated if you get audited by the IRS. While the chance of an audit is remote, having clean books and records is of primary importance. If you do not have receipts and documentation, the IRS will disallow your deductions and you will have to pay tax and penalties on those deductions.

Deductions – Conflicting Goals and Limits

While keeping robust documentation and being aggressive with your business deductions is usually the best approach, there are times when you might not want to be aggressive with your tax deductions. Specifically, if you need to report enough income to qualify for home/business loans. While you will pay no taxes if there are sufficient deductions to fully offset income, you will likely not meet the income requirements to qualify for home mortgage, if needed. Additionally, there are limits to what you can reasonably deduct. The more money you make, the more likely you will not be able to find allowable deductions to reduce or eliminate your tax liability. Thus, a second strategy must also be employed.

S-Corporation Tax Structure

As noted previously, 100% of your net income (revenue less deductions) will be subject to the “self employment tax” if you do not adopt a tax planning strategy. This 15.3% can be very significant, even at low income levels. For example, 15.3% of $30,000 is $4,590! Is there anything that can be done to reduce this liability? Yes, establish an S-Corporation tax structure!

What are IRS Tax Structures?

The IRS code defines different types of tax entities/structures that are subject to taxation and/or reporting:

Individuals (sole proprietors)
C-Corporations (double taxation)
Partnerships (pass-through)
S-Corporations (hybrid)
Estates and Trusts (other)

While the history and development of these various structures is beyond the scope of this article, at a high level, C-Corporations are called C-Corporations because the rules governing the taxation of these entities are published in Subchapter C of the IRS code. Similarly, S-Corporations are governed by the rules in Subchapter S of the IRS code.

From a tax and liability perspective, there are two ends of the spectrum. C-Corporations provide liability protection to owners but are subject to double taxation (tax at the corporate level and also at the owner level), however corporate stock owners are not subject to self employment tax. Sole proprietors have no liability protection, do not have double income taxation, but are subject to self employment taxes.

Fortunately, the IRS also established a “middle ground”, The S-Corporation. This entity is not subject to double income taxation, the owners have liability protection, and the owners are not subject to self employment tax.

Why would anyone not choose to be an S-Corporation?

If all one needs to do to avoid paying self employment taxes is become an S-Corporation, why wouldn’t everyone become an S-Corporation? The simple answer is because S-Corporations require additional paperwork and have associated accounting compliance costs. Specifically, S-Corporations require an additional tax return and are subject to all of the rules of Subchapter S (rules that are not applied to individuals). Maintaining compliance with these rules and requirements generally requires the assistance of a CPA. However, considering that even at low income levels, the amount of tax savings available is significant, most savvy small business owners become an S-Corporation for tax purposes.

What About LLCs?

As you can see, LLCs are not on the list of entities/structures defined by the IRS code. LLCs are relatively new hybrid structures and the IRS has established a rule that allows LLCs to elect their tax status. If you make no election and you are a single member LLC (one owner), you will be taxed as an individual with all of your income subject to both income tax and self employment tax. If you make no election and you are a multi-member LLC, you will be taxed as a partnership. The IRS allows you to either stay in these default categories or to elect taxation as if you were a C-corporation or as an S-Corporation. Thus, an LLC simply needs to make an election to be taxed as an S-Corporation. This is called “Making the S-Election”!

To be clear, forming an LLC for your business and making the S-Election is generally the most advantageous tax and liability structure for most small businesses (including real estate agents)!

Cost of Compliance

As noted previously, the primary cost associated with implementing a tax structure is the cost of compliance, specifically, the cost associated with engaging a CPA. However, when considering this cost, it is important to consider not only the total cost but also the marginal cost. In most cases, both the total cost and the marginal cost are significantly lower than the tax savings. In other words, tax compliance is not actually a cost but a profit center.

Marginal Cost Analysis

When evaluating the cost/benefit of a new tax approach, you should not only consider the total cost but you should focus on the marginal cost. The marginal cost is the additional cost associated with additional compliance. This is important because without adopting any tax structure or planning, you will still face compliance costs. Specifically, you still need to prepare your taxes. Generally, a self employed individual without a tax structure will either use online software, use a national chain (H&R Block) or hire a local CPA. Thus, you already have this compliance cost. The typical cost of this type of service annually is $450-$600. Since you will incur regardless of your approach, this cost is not a marginal cost. The annual cost associated with implementing a S-Corporation tax structure is $700-$1,500. This is a marginal cost. It is more than you will pay if you do not implement a tax structure.

While the total cost of compliance with an S-Corporation structure is the sum of both of these costs, the marginal cost is only $700-$1,500. In other words, it is worth implementing an S-Corporation tax structure if it will result in savings of $700-$1500. As noted earlier, self employment taxes on $30,000 = $4,590 so this type of tax savings is generally achievable. Additionally, most CPAs also provide deduction maximization strategies as part of their compliance fee, thus you get to truly minimize your tax liabilities. As you can see, the savings typically significantly outweighs the costs, especially the marginal costs.

Summary and Next Steps

Taxes can quickly become your largest cost and if you do not plan properly you can quickly owe the IRS a considerable amount of money. However, with a bit of planning and with the help of a qualified CPA, you do not have to pay more than you legally owe and you can save (keep) a considerable amount of money. Just follow these simple steps:

Establish an LLC
Keep good records and use and accounting system
Contact a CPA and make the S-Election

While there are time constraints on when an S-Election can be filed (the standard time frame is within 75 days of the formation of your LLC or within 75 days of the beginning of the year), a good CPA can petition for a late filing exception and the IRS may accept this up until March 15 of the following year, if you already have a CPA. For example, you have until March 15, 2021 to try to get an S-Election accepted by the IRS so that you can take advantage of the S-Corporation tax structure for 2020.

About the Author

Charles Renwick, CPA is a Chartered Financial Analyst (CFA), Certified Public Accountant (CPA), licensed in both Louisiana and Georgia. As Managing Director of CMR Associates, Charles provides a broad range of business services for private clients and individuals. Charles focuses on state and federal tax strategies, tax structure compliance, business system development/implementation, and investment analysis. Email Contact: cmr@cmrtax.com

When is tax due on Series EE savings bonds?

CPA Business and Personal Tax Expert - Series EE Savings Bonds

You may have Series EE savings bonds that were bought many years ago. Perhaps you store them in a file cabinet or safe deposit box and rarely think about them. You may wonder how the interest you earn on EE bonds is taxed. And if they reach final maturity, you may need to take action to ensure there’s no loss of interest or unanticipated tax consequences.

Interest deferral

Series EE Bonds dated May 2005 and after earn a fixed rate of interest. Bonds purchased between May 1997 and April 30, 2005, earn a variable market-based rate of return.

Paper Series EE bonds were sold at half their face value. For example, if you own a $50 bond, you paid $25 for it. The bond isn’t worth its face value until it has matured. (The U.S. Treasury Department no longer issues EE bonds in paper form.) Electronic Series EE Bonds are sold at face value and are worth their full value when available for redemption.

The minimum term of ownership is one year, but a penalty is imposed if the bond is redeemed in the first five years. The bonds earn interest for 30 years.

How they’re taxed

Series EE bonds don’t pay interest currently. Instead, the accrued interest is reflected in the redemption value of the bond. The U.S. Treasury issues tables showing the redemption values.

The interest on EE bonds isn’t taxed as it accrues unless the owner elects to have it taxed annually. If an election is made, all previously accrued but untaxed interest is also reported in the election year. In most cases, this election isn’t made so bond holders receive the benefits of tax deferral.

If the election to report the interest annually is made, it will apply to all bonds and for all future years. That is, the election cannot be made on a bond-by-bond or year-by-year basis. However, there’s a procedure under which the election can be canceled.

If the election isn’t made, all of the accrued interest is finally taxed when the bond is redeemed or otherwise disposed of (unless it was exchanged for a Series HH bond). The bond continues to accrue interest even after reaching its face value, but at “final maturity” (after 30 years) interest stops accruing and must be reported.

Note: Interest on EE bonds isn’t subject to state income tax. And using the money for higher education may keep you from paying federal income tax on your interest.

Deferral won’t last forever

One of the principal reasons for buying EE bonds is the fact that interest can build up without having to currently report or pay tax on it. Unfortunately, the law doesn’t allow for this tax-free buildup to continue indefinitely. When the bonds reach final maturity, they stop earning interest.

Series EE bonds issued in January 1989 reached final maturity after 30 years, in January 2019. That means that not only have they stopped earning interest, but all of the accrued and as yet untaxed interest is taxable in 2019.

If you own EE bonds (paper or electronic), check the issue dates on your bonds. If they’re no longer earning interest, you probably want to redeem them and put the money into something more lucrative. Contact us if you have any questions about the taxability of savings bonds, including Series HH and Series I bonds.