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Understanding Interest Rates

From a mortgage to credit cards, interest rates affect nearly everyone’s budget. Understanding how interest rates are set and how your credit score affects the rate you receive can show you ways to potentially pay less.

HOW RATES ARE SET

The twelve Fed members of the Federal Open Market Committee set the federal funds rate. The prime interest rate is actually set by individual banks. The federal funds rate is the amount banks charge each other for short-term loans and the starting point to set the prime rate for consumers. So, there is not just one prime interest rate. The prime rate you see published is usually an average of several large banks’ prime rates for that day. However, the most used prime rate is the one that the Wall Street Journal publishes daily.

Alternatively, some international banks or large banks with many international customers use the London Interbank Offer Rate (LIBOR) instead of the federal funds rate as their starting point.

CREDITWORTHINESS COUNTS

Banks generally charge their most creditworthy customers the prime rate. If you have less than an excellent credit score, you will pay a higher rate.

Variable interest rate loans, like adjustable-rate mortgages and credit cards, are impacted by the prime rate. For example, when the prime rate rises, the rate on your credit card will likely rise. Personal and auto loans have a fixed rate, which will not fluctuate with interest rates.

YOUR CREDIT SCORE

Depending on which model is used, credit scores range from fair to excellent. The interest rate you receive is influenced by your credit score, which you can improve over time, if necessary. The following responsible credit behaviors impact your credit score:

  • Consistently pay bills on time
  • Keep credit card balances low—the ratio between balance and credit limit is important
  • Apply for credit only when absolutely necessary
  • Pay off debt—the ratio between debt and income is important
  • Check your credit reports regularly.
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Reminder of Special Tax Breaks

The December 2020 stimulus package provided a few noteworthy tax breaks for companies.

A temporary tax break for 2021 and 2022 allows businesses to deduct 100% of business meals eaten at a restaurant, up from the usual 50%.

For businesses hard hit by the COVID-19 pandemic, the Employee Retention Tax Credit is available for the first half of 2021. Eligible businesses that were either shut down by the government or incurred at least a 20% reduction in gross receipts for one of the first two quarters of 2021 may qualify for this credit of up to $14,000 per employee. Claim this credit when you file quarterly form 941.

The Work Opportunity Tax Credit and the Family Medical Leave Tax Credit were extended to December 31, 2025.

Employers who pay qualified education expenses, including student loan payments, for employees can deduct up to $5,250 per employee through 2025.

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Tax Benefits for Education

The IRS provides numerous tax breaks for higher education expenses. Tax credits and tax-deferred savings plans take some of the sting out of paying for college.

TAX CREDITS

The American Opportunity Tax Credit is available to students in the first four years of higher education. Using this credit can offset up to $2,500 of qualified education expenses per year. Students pursuing a degree or other education credential who are enrolled at least half time for one academic period are eligible. Although there are additional requirements to claim this credit, including income limitations, up to $1,000 of this credit is refundable.

The Lifetime Learning Credit (LLC) is another educational tax credit. It’s available to undergraduate and graduate students enrolled for at least one academic period in the year. The LLC isn’t limited to degree-seekers. Costs related to acquiring or improving job skills qualify. While this credit isn’t refundable, there is no limit to the number of years you can claim it.

TAX-DEFERRED SAVINGS PLANS

Qualified tuition plans, commonly known as 529 plans, come in two forms: prepaid tuition plans and education savings plans. Tuition plans allow savers to buy tuition credits at participating universities at current prices, while education savings plans use investment accounts to save cash for future education expenses.

Education savings plans are the more versatile of the two types of 529 plans. They can be used at any university and up to $10,000 per year can be used for elementary and secondary school tuition.

Coverdell Education Savings Accounts allow savers to put away up to $2,000 for each beneficiary per year that can be used for college, secondary, or elementary school expenses and qualified distributions are tax-free.

You can only claim one of the tax credits each year per student but the credit can be used together with savings plans, as long as there is no double-dipping.

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March 2021 Short Bits

FAST STIMULUS PAYMENTS

The IRS successfully delivered millions of stimulus payments during the COVID-19 pandemic last year. Within two weeks of the passage of the CARES Act, the IRS distributed $147 billion to more than 81 million people. By comparison, in 2008, the last time stimulus payments were issued by the IRS, it took 75 days to get the first payments out. With the launch of the Get My Payment tool, an additional 16.6 million requests for payment were received. By the end of October 2020, the IRS had delivered approximately $270 billion in stimulus relief to taxpayers.

SOCIAL SECURITY INCREASES

Approximately 70 million Americans are seeing a 1.3% increase in their Social Security benefit payments in 2021. Federal benefit rates increase when the cost-of-living rises, as measured by the Department of Labor’s Consumer Price Index. These cost of living adjustments were first enacted in 1972 and automatic annual adjustments began in 1975. The year that saw the highest adjustment was 1980 with a 14.3% increase, while there have been several years with no adjustment, most recently 2016.

WOMEN’S HISTORY

National Women’s History Month goes back to 1857 but wasn’t officially recognized by Congress until 1981. According to the U.S. Census Bureau, women age 85 and older outnumber men in the same age bracket two to one. And overall, there are slightly more females than males in the U.S. In 2018, there were 166 million women compared with only 161 million males and earnings difference still exist. While 58% of women, age 16 and older, participate in the workforce they only earn 82% of what males earn for similar work.

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March 2021 Questions and Answers

Question:

I will claim an automobile deduction on my tax return and have used the standard mileage rate in previous years. However, in 2020 I incurred significant car expenses that will outweigh the standard mileage deduction. Can I switch to deducting actual costs for 2020?

Answer:

Yes, you’ll be able to switch to the actual expenses method if you own your car and you used the standard mileage rate in the first year that you used your vehicle for business. The rules are different though if you lease your car. If you’re leasing your car, you’ll need to take the standard rate for the entire lease term.

Question:

I’ve heard that I should have errors and omissions insurance, but I’m not sure what it is and why would my business need it?

Answer:

Generally, errors and omissions (E&O) insurance protects against litigation claiming you made a mistake while providing a professional service. Some of the common types of claims that E&O insurance covers include: negligence, errors, omissions, misrepresentation, and inaccurate advice. This type of insurance usually covers court costs and settlement amounts, which can quickly add up. If your business is vulnerable to such lawsuits, then you should consider carrying E&O insurance.

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Flexible Work Arrangements

Offering the right benefits to your employees keeps them engaged and motivated. Besides monetary benefits like a competitive salary or health insurance, consider non-financial perks like flexible work arrangements.

FLEXIBLE LOCATIONS

Telecommuting or remote working are two options for flexible locations. With telecommuting, employees usually work in the office certain days and work outside the office the other days. Remote employees work outside the office all the time. The benefit of offering flexible locations is that you can recruit talent from all areas, rather than just locally.

FLEXIBLE SCHEDULES

Instead of employees working 9-5 Monday through Friday, consider letting them choose the schedule that works best for them. Night owls may be more productive working from 2 pm to 10 pm. You could offer a compressed work week that allows employees to work four 10 hour days. You’ll want to ensure you have proper employee coverage and have employees commit to their chosen schedule.

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Workers’ Compensation Insurance

Workers’ compensation insurance provides benefits to employees who become ill or injured on the job and offers employers some protection from injured employees’ lawsuits. The premiums are paid by the employer.

STATE MATTERS

Workers’ compensation programs are administered at the state level and the requirements vary. Some states require insurance when you hire your first employee and some exempt certain agricultural and construction businesses.

Some states don’t require coverage for certain kinds of workers. Independent contractors, domestic home workers, volunteers, and seasonal workers are generally not required to be covered by workers’ compensation. And business owners generally can choose to be exempt from coverage.

WHAT’S COVERED

Generally, any work-related injury or illness qualifies for workers’ compensation benefits. The injury can be sudden, like a fall, or can be long-term, like carpal tunnel or lung diseases from working in coal mines or around asbestos.

NAME THE PRICE

Rates and premiums are set by the state and consider the employer’s type of business and the employee’s job classification. For example, trucking companies usually have higher premiums than an attorney’s office. Also, the volume and dollar amount of an employer’s past claims will usually increase premiums.

SHARING INFORMATION

Employers are required to post notices that inform employees of their rights and benefits that are available. And if an employee incurs an injury, the employer must provide a claim form promptly.

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March 2021 Client Profile

Beth is self-employed and preparing to file her taxes, but hasn’t received some of her 1099s. She doesn’t want to file for an extension. What should she do?

Fortunately, Beth doesn’t need her 1099s to file her tax return. Unlike W-2s, 1099s don’t need to be submitted with a tax return.

Beth has a few options. She can call her customers and ask for a duplicate 1099. However, if she earned less than $600 from her customer, they aren’t required to provide a 1099, and therefore they likely didn’t prepare one.

If she uses accounting software to track her revenue and expenses, she can use a profit and loss report to calculate her income. Alternatively, she can review the bank statements from her business bank account and track the deposits she received. Hopefully, if she received cash payments, she kept a log of them since she’ll need to include her cash payments as income on her tax return. And if Beth uses electronic methods such as PayPal to receive money from her customers, she’ll need to include these payments too.

Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.

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Triple Tax Advantages of HSAs

Medical Tax Savings Web Header Banner – Health savings account or flexible spending account – HSA, FSA, tax-sheltered savings

If you have a high-deductible health insurance plan, you’re likely eligible to open a health savings account (HSA). Similar to flexible spending accounts, these tax-advantaged savings accounts allow you to contribute money to cover your medical expenses. But HSAs have three distinct tax advantages.

TAX-FREE CONTRIBUTIONS

Just like 401(k) contributions, you can make pre-tax payroll deductions to fund your HSA. You’ll benefit from having lower taxable income and a generous contribution limit. In 2021, a family can contribute up to $7,200 while singles enjoy a $3,600 limit.

TAX-FREE GROWTH

If your HSA funds are invested in mutual funds, stocks, or other similar vehicles the earnings are tax-free, leaving more money to cover medical expenses. Unlike a flexible spending account (FSA), where contributions don’t roll over at the end of the year, money in an HSA can be used in the future. And HSAs don’t have required minimum distributions like 401(k) or IRA plans.

TAX-FREE WITHDRAWALS

When your HSA funds are used to pay for qualified medical expenses, these withdrawals are tax-free. Qualified medical expenses include things like office visits, co-pays, dental expenses, vision care and prescription medication for you, your spouse, or your dependents. Just remember you can’t use HSA money to pay for medical expenses you incurred before establishing your HSA.

RETIREMENT PLANNING & HSAs

Using an HSA is not only a savvy way to save on taxes; it can help you in retirement. If you contribute to your HSA while not making withdrawals you could accumulate a sizeable fund to help cover your medical expenses in retirement. Medicare premiums are a qualified medical expense, so you could use your HSA funds to pay your premiums once you retire.

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Business Start-Up

Starting a business involves research, planning and making critical financial and legal decisions. Once you’ve landed on your product or service offering, consider these steps when launching your new business.

Funding

Will you fund it or will you seek outside capital from investors or businesses?

Structure

How you structure your business impacts your registration requirements and taxes.

Location

Selecting your location, whether it’s a storefront or an online store, impacts your taxes and legal requirements.

Register

Once you’ve settled on a business name, register with your state to ensure no other businesses are operating with your name.

Bookkeeping

Keep personal and business finances separate by opening a business bank account.