Insurance: How to Protect Yourself

Insurance baffles many people. Some insurance you are "forced" to carry, such as basic coverage for auto liability and homeowner's insurance, and other coverage you want, but may not be able to afford, such as health and disability insurance, and of course, coverage you hope never to have to use, such as life insurance. Today, we will discuss the risk transfer aspects of insurance, so we will be dealing with those areas of protection that can keep you and your family out of harm's way financially, through the proper use of liability insurance protection.

We will speak today on personal liability, and save other types of liability protection (i.e. E&O, D&O, Business Insurance, etc.) for another day. The three most common insurance policies that provide personal liability protection to your family are Home, Auto, and Umbrella insurance coverage. We will deal with these coverages individually at first, and then tie them together at the end of this post.

Auto Insurance

In California (as well as most, if not all other states), the government forces you to carry at least a basic level of liability insurance. Commonly, this shows up as 15/30/5. What that means is that you must have at least enough insurance to cover:

1. Any harmed individual for $15,000 of personal injury damages
2. All persons injured in a common accident to a total of $30,000 for personal injuries
3. Property damage coverage of at least $5,000 per accident.

As you can imagine, it does not take a very severe accident incur liability in excess of these required amounts. While auto insurance is compulsory, at least 25% of our fellow drivers still have no coverage. The state is cracking down on this by requiring all insurance companies in the state to be linked electronically to the DMV for up-to-the-minute policy status information. If your coverage lapses, is cancelled, or goes out-of-force for any reason, DMV can immediately cancel the registration on your vehicle. It is getting harder to not have coverage, but not impossible.

My recommendation, unless you really have no assets or income to protect, is to always get the maximum amount of coverage that you can afford. As you will find, once you have the basic coverage, it can cost very little to increase your liability amounts, as compared to the amount of coverage that you would receive.

A search at 21st.com provides the following pricing data for a sample policy (42 y.o. male, single, LA County, clean DMV):

Coverage-------------------------------Limit--------------------Premium 
Bodily Injury Liability-----------------$15,000/30,000------$130.00 
Property Damage Liability-----------$5,000-------------------78.00

Bodily Injury Liability-----------------$250,000/500,000---$169.00 
Property Damage Liability-----------$100,000---------------$98.00

As you can see, the difference between the minimum and the maximum coverage for this good driver is only $59 per six months. Less than $10 per month provides over $550,000 in additional protection. Maximizing coverage is a very small investment with a very big upside in protection.

Some other questions for auto insurance concern other coverages, and which coverages might be necessary. Well, if you owe money on your car, your lender will require that you carry Comprehensive (other than collision) and Collision coverage on your vehicle. Collision is the category that pays to fix your car if you are found to be at-fault in an accident in which your car is damaged. Comprehensive covers for theft, vandalism, natural disasters, and any other harm that comes to your vehicle other than an accident. Your lender will tell you the maximum deductible amounts that they will allow.

You also have the option of purchasing Medical Payments Coverage, Uninsured Motorists' Coverage, and optional coverages including coverage for Accessories, Towing & Disablement, and others that vary from company-to-company. My quick recommendations for these are as follow:

Uninsured Motorists' Coverage: Get an amount that matches your liability coverage

Medical Payments Coverage: $5,000 if you don't have health insurance or if you have a high deductible Health Insurance Policy (HSA or MSA Plans)

Accessories: If you have over $1,000 in electronics or a special paint job, you need this coverage

Towing & Disablement: Unless this came with your car, buy it with your insurance. It is probably cheaper than AAA or other independently-purchased coverage, and may be less restrictive.

Homeowner's/Renter's Insurance

Your mortgage company will require you to have replacement coverage for your home. Renters are four times more likely to suffer a break-in, so renter's coverage is highly recommended. Both policies also include liability protection for injuries sustained by visitors or guests to your property, as well as fire legal liability should your property burn and cause harm to the property of others (e.g. The neighboring apartment).

Again, max-out your liability coverage, because it does not cost much to do so. Also, be sure that you get "replacement coverage" for all of your personal property. You don't want to have to accept ACV (Actual Cash Value) or depreciated valuations, plus your deductible, if you should have a theft, fire or other property loss.

Discounts are available if you have a home alarm system with monitoring, sprinklers, smoke detectors, fire extinguishers, and/or other safety-related items. Check with your agent for these discounts, and take the appropriate steps to maximize your protection and savings.

Umbrella Policies

A personal umbrella policy does not protect you just in the rain. An umbrella policy protects you from all insured losses, over and above the amount of your other coverage. For example, if you purchase $1 million of umbrella protection, you have just increased all of your liability protections by $1 million. This means your auto is now $1.25 million instead of $250K, and your home is now $1.50 million instead of $500K.

Umbrella policies can be issued in amounts up to $5 million, but any amount over $2 million will probably require additional underwriting. Ask your agent how much coverage is appropriate for your situation.

It is unlikely, although possible, that you could have an exposure that will exceed these coverage amounts. If you do find yourself involved in a lawsuit that could exceed these amounts, have an attorney send a letter to the insurance company advising them to settle within policy limits if they should have the opportunity. This will further protect you, but see an attorney for legal advice if this happens to you.

Summary

Your auto, homeowners'/renters', and umbrella policies exist to shift the responsibility for losses from your family to the insurance company. Hopefully, you will never need to file a claim against any of these coverages. However, if you ever need to file a claim, you will be glad that you protected yourself as fully as possible.

Be sure to review all of your coverages with your agent at each renewal opportunity, in order to ensure that your coverages are appropriate and that you are receiving all savings to which you are entitled. We will discuss other types of insurance in future articles, but if you have any questions, be sure to post them here.

Until next time, be careful out there!

Business: How to Incorporate/Form LLC

This week, we will follow-up my previous post regarding business structure. As you can imagine, my advice regarding business structure is almost always a recommendation to incorporate or form an LLC. While neither of these is all that difficult to complete, you must follow certain rules and procedures in order to do it properly. In addition, each state has its own rules, so I can only provide generic assistance in this forum. I highly suggest that you work with your accountant and attorney to decide which type of entity to form, and get their help with the formation, documentary requirements, and on-going administrative assistance.

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With any luck, this will be a painless process, and you can have your company formed in just a few days. If you want to perform this process yourself, please visit our sponsor above to secure the necessary forms. The incorporation kit includes instructions for each state in which you may want to set-up your entity.

The first step is to decide which state you want for your corporate home. Nevada and Delaware are two of the friendliest states in which to incorporate. One big advantage of a Nevada corporation is that you don't have to issue your shares or reveal the names of your stockholders. If privacy is an issue, this is a good place to call your corporate home. Your CPA and attorney can help you make this decision.

You must also file as a foreign corporation in each state in which you have a physical presence. For example, if your corporate home is in Nevada, but you really do business in California, then you will need to also register your corporation with the Secretary of State of California, and pay the requisite fees.

Filing instructions for a corporation or an LLC are quite similar. Where they differ is in the amount of administration that is required. Many people who form LLCs are under the incorrect assumption that they don't need to be as careful about keeping the business separate from their personal lives. It is possible to lose the protection of an LLC, much the way one would "pierce the corporate veil." You must maintain the LLC as a separate entity from your person, in order to keep your liability protection in place. Also, you may have to pay the same franchise fee every year, whether you form an LLC or corporation. Each state may have requirements that you update your registration on a regular basis. This could be an annual or biannual requirement. Again, have your CPA or attorney do the research for each state in which you will register.

I highly recommend that you have a complete library of commonly-used business forms available on your computer at all times. Having these forms handy can save you a ton of time and thousands of dollars in attorneys' fees. The forms available from our sponsor have all been reviewed by attorneys, and are probably valid in all states. Double-check with your own attorney prior to using these forms, but you should be able to save a ton of money (not to mention time) by not having to ask your attorney to create these forms for you.

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While this article can only provide a limited amount of information with regard to the process, I hope that it has provided enough to get you started. In short, see your CPA or attorney in order to form an LLC or corporation. If you feel confident enough that you can perform the process yourself, then visit our sponsor above, and use the incorporation/LLC kit to get started.

I wish you luck in your new venture! Be sure to let me know if I can help you with your financial planning needs, whether they be personal or corporate. See you next week!

Happy Tax Day!

Celebrate Good Times, Come On!

Well, maybe not quite, for most of us. CPAs are working feverishly to complete those last tax returns and extensions, and looking forward to the company parties this weekend. For the rest of us, we may be relieved, broke and/or worried now!

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Probably the most oft-heard question for me on April 15 of each year is, "What if I'm not done with my taxes? What do I do?" Well, PANIC!!! No, not really.

Usually, people are late for one of three reasons:

1) They are waiting for that last W-2 or 1099 to show up.

2) They are trying to decide on those final expense item amounts.

3) They just procrastinated too long, and there is no hope of filing on time.

If you are waiting for a form, but you know what data should be on it, there is no need for concern. If you need a W-2, but have your final paycheck of the year from the provider, then just copy the information from that last pay-stub as if it came from a W-2. If you file electronically, there is no need to attach forms anyway, so you should be fine.

If you are waiting for a 1099, stop waiting. Just be sure to include the amounts from any unreceived 1099 forms in "Other Income" on your Schedule C or Schedule K, and be done with it. The form may never come, but it doesn't matter, as long as you counted the income in your calculations.

If you are unsure of an expense amount, it is OK to guesstimate. Unless you are way off, it should not throw up any red flags. If you missed by a lot, you can always file a 1040X later to correct your return.

It is important to file by today if you want to get your stimulus check in May. If you file an extension, or if you file late, you might not get your stimulus check until October.

If you procrastinated, here is what you should do. First, calculate all of your income amounts. Second, estimate your deductions. Third, determine what your tax is based on these rough figures. Fourth, complete Form 4868 and request a six-month extension to file, and include any estimated tax due, and mail the form by midnight tonight.

If you know that you will have a refund coming, you don't really even have to file Form 4868. Just be sure to file when you have your numbers together.

Some people are confused about the stimulus check. Let me try to clear it up for you.

Basically, every person who has at least $3,000 of earned income (including SS, disability, and retirement income), and files a return showing this income, will receive at least $300 from the stimulus package. If you paid income tax, you will receive up to $300 of that tax back in addition to the first $300, which means you could receive up to $600. For a joint return, this is $600 - $1,200. If you have children, who qualify as dependents, you will receive $300 per. If they file their own tax returns, they will receive their own refund, but you won't get $300 for them. Those are the breaks!

Anyway, this is a special edition, so I made it short-and-sweet. See you on Saturday!

Credit: What is a FICO Score?

I didn't plan on bringing you another credit-related post so soon. In fact, I expected that I would probably be giving you a post on tax issues about now, but maybe I'll do another post on tax day for that one. Anyway, today we will talk about one of the greatest mysteries in the world of credit: The (dreaded) FICO Score!

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The reason that the FICO score is such a mystery, is that Fair, Isaac, and Company (the developers of the FICO score) won't release the formula that they use to compute it. Over time, we have figured some things out about what drives the score, and I will share with you some of what we have learned to this point.

I'm sure that by now, everyone has heard of the FICO score, as it has become a topic of major discussion, and is one of the major components in the process of applying for any loan, but especially with regard to mortgage loans. With all of the news about the housing crisis and the tightening of mortgage lending, the FICO score has become a point of contention.

The basic breakdown of your FICO score is as follows:

• Payment History - 35%
• Outstanding Balances - 30%
• Length of Credit History - 15%
• Amount of New Credit - 10%
• Types of Credit Used - 10%

Payment History

If you pay your bills on time, this helps a lot. If you have late payments, collections, back child support, and/or judgments appearing on your credit report, this hurts a lot. The amount past due, length of delinquencies, time since you last paid late, number of past due items, and number of accounts "paid as agreed" all play a role in determining the "Payment History" portion of your score. Obviously, if you pay all of your accounts on time, this is a huge help to your score!

Amounts Owed

Obviously, the amount of money that you owe is a factor here, but what is less obvious is that the amount you owe for certain types of debt can work against you. If you have amounts owing to Finance Companies (i.e. Wells Fargo Finance, Finance & Thrift, etc.), this will lower your score, even if the payments are always on time, because these are considered "lenders of last resort." If you could have been granted credit at better rates, the assumption is that you would have used another credit card or finance method. The unfortunate part of this is that these institutions often finance autos and furniture at stores you frequent, so you might have a balance with them, even if you have stellar credit otherwise.

American Express can also lower your credit score, because they don't show a credit limit. This means that the FICO system assumes that you are using 100% of your available credit on the card. Also, if you have an account where the limit has been lowered, this can hurt you as well. You don't want to be over your credit limit on any account, because you will take a severe hit to your score. The outstanding balance as a proportion of the credit limit is also a factor, with any balance in excess of 20% of the credit limit working against you, albeit on a sliding scale. For best results, stay under 20%. To avoid any dings, stay under 45%.

Length of Credit History

This is how long you have had a credit record, as well as how long your existing accounts have been open. If you have accounts with histories over two years, DO NOT CLOSE THEM! You can stop using them, but it is better in most cases to keep the accounts open with a zero balance.

New Credit

This runs in concert with Length of Credit History, but takes a special look at recently opened accounts and the number of recent credit inquiries. This factor also looks at your attempts to re-establish good payment patterns after a series of past payment problems.

Types of Credit Used

This looks at what proportion of your credit usage is comprised of mortgages, installment (auto or other purchase-money) loans, credit cards, finance company accounts, etc. If you have 100% credit cards, this can count against you, while a mortgage will generally help your score.

Summary

Keep in mind that your FICO score takes into account ALL of the above issues. Yes, some of these issues seem to overlap, but the overall weighting of each issue is as stated above. Your FICO score only takes into account information on your credit report, so your job, income, and education level do not play a part in your score, but they may affect a lender's desire to offer you credit. Also, the Credit Reporting Agency does not determine whether you get credit; only your lender makes that decision, but your credit score will be an important factor in that decision.

Clarification

You may hear some things in the news about FICO '08. This is a change to the scoring system that eliminates the advantage of riding on someone else's credit history by becoming an authorized user on their established cards. At this point, only Experian plans to use it, as both TransUnion and Equifax are in litigation opposing its implementation. If you plan to use this 'credit riding' technique, you can probably continue to do so for the foreseeable future. With most lenders looking at your mid-score, and TU and EQ still using the old formula, your EX score will matter less.

In a later posting, I will provide tips on how to Keep and Maintain a High FICO. Stay tuned!

Business Start-Up: Choosing the Right Structure

One of the first questions that I pose to anyone who wants to start a new business is "What will be the structure of your company? Will you incorporate, set-up an LLC/LLP, or operate as a partnership or proprietorship?" The answer to this question will provide the basis for setting the company's legal status as an entity. Today, we will review the most common types of business structure, and we will explore the advantages and disadvantages of each.

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The most common types of business ownership are Sole Proprietorship (also includes Husband/Wife ownership), Partnership (various forms), and Corporation. LLC and LLP are other options, and include some of the benefits of a Corporation with some of the benefits of non-corporate structures. We will explore each of these in this issue.

Sole Proprietorships and Partnerships

By far, the easiest form of company set-up is the sole proprietorship. All you have to do is decide that you want to go into business, and then go through some basic set-up steps to legitimize it. If this will be a home-based business, you will file a name registration with your county (commonly referred to a DBA or "Doing Business As..."), publish it in a local paper, open a bank account in the business name, secure any licenses required (Home Occupation Permit, Business License, Resale Permit, etc.), and you are good to go! You will typically file your business income and expenses on IRS Schedule C and attach it to your Form 1040 at the end of the year.

While a sole proprietorship is easy to form, I generally don't recommend it as a business structure unless the business is never expected to ever grow larger than being home based, and it has minimal to no legal liability exposure. A partnership follows the same series of events as listed above, with the addition of the need for a partnership agreement. Partnerships can be either General Partnerships or Limited Partnerships.

A General Partnership has one or more General Partners, each of whom assumes full personal legal liability for the partnership. A Limited Partnership has one or more General Partners, along with one or more Limited Partners who may invest money, but who are not allowed to participate in the daily activities of the partnership in any capacity. A Limited Partner's liability for the partnership's actions is limited to the amount of money s/he has invested in the partnership.

Perhaps the single biggest disadvantage of a Sole Proprietorship or Partnership is the unlimited personal liability that attaches to the owners of either entity. If the business should go bankrupt, whether through mismanagement, a lawsuit, or other business reasons, the owner(s) must take personal responsibility for payment of the business' debts. Often, this causes the owner(s) to file for bankruptcy protection themselves. Another issue that can handicap either of these entities is the acquisition of credit. Since the business is not a separate legal entity from the owners, the owners usually wind up using their personal credit capacity to fund the business. This can make deduction calculations difficult, in addition to making credit acquisition difficult for the business.

A partnership will file an information report to the IRS every year on Form 1065. This form includes Schedule K, which details how the income and expenses of the partnership are to be allocated amongst the partners. Since a partnership is not a legal entity, it will not pay taxes directly to the IRS, but each member of the partnership will.

Each partner will receive a Schedule K-1 from the business, and will use this form to complete their income tax return. Note that the due date for Form 1065 is one month prior to the due date for the personal income tax returns of the partners. This is to allow the partners time to complete their returns by the standard tax filing day. The information from Schedule K-1 is reported by each partner on Schedule E, which is then attached to their Form 1040 and filed with the IRS.

Corporations and Incorporation

Incorporating can be a simple process, but the decision to set-up a corporation, as well as the continuing administrative requirements to keep a corporation legal, can be daunting. Setting-up the corporation does not take a lot of work, but you must follow some key steps in order to do it properly. A corporation may be set-up as a C-corp or an S-corp. S-corps are more common if you have a smaller company and/or a limited number of investors. An S-corp cannot sell shares to the public.

The first decision is to determine which of the fifty United States is most beneficial to the business as a home state. This does not have to be the same state in which the business operates, nor does the business have to have a physical presence in that state, other than a person who will agree to receive any court or legal documents on behalf of the corporation in that state. This is usually an attorney or accountant, but can be any person of legal age whom you authorize. They must have a physical presence (residence or office) in the state of incorporation, and they must be available to receive personal service of documents on behalf of the corporation.

When filing, you should have Articles of Incorporation and Bylaws to file with the Secretary of State of the state in which you will incorporate. You will also be required (in most states) to name the directors and officers of the corporation. In most states, these can all be the same individual. You will be required to keep corporate books and records. These records include Corporate Minutes, key decisions, Stock/Share records, and more. Today's sponsor has more information and guides available which can help you with this. Be sure to visit their site for more information.

You must also register your corporation in the states in which you will have a physical presence and conduct business. For example, you may decide to register your corporation in Nevada or Delaware, but actually operate your business in California. While your initial registration will be in Nevada or Delaware, you will also have to be a registered corporation in California. You do not have to register in every state in which you have customers (i.e. mail order), but you must register in any state in which you will have an office. There are exceptions to this, based on your line of business, so check with your attorney or CPA for additional requirements.

A corporation helps you to avoid the unlimited liability provisions of proprietorships and partnerships, but you must be careful to run your corporation as a completely separate entity from your person or your household. DO NOT pay any personal bills from the corporation. DO pay yourself a salary from the company, and use this money to pay your personal bills. If you don't truly run your corporation as a separate entity, then you run the risk of having your corporate status invalidated in court, and you could find that you are now subject to unlimited personal liability for the actions of the corporation.

Having a corporation also simplifies the process of procuring credit and trade lines in the business name. If done properly, you can avoid having these items appear on your personal credit report, and you can also avoid having to sign personal guarantees for these credit lines. If you would like more information on Business Credit, see future articles, or contact me by commenting on this blog. Since all comments are moderated by me, you don't have to worry about your personal contact information showing up on this site.

A corporation will file taxes on Form 1120 (c-corp) or Form 1120S (s-corp). A c-corp may issue dividends, and these dividends will be reported on a Form 1099-DIV issued to each shareholder. An s-corp will issue a Schedule K-1, just like a partnership, and the owners will transfer this information to Schedule E.

Limited Liability Companies (LLC/LLP)

An LLC/LLP works very similar to a corporation, but the recordkeeping requirements are less stringent, as you don't need to keep corporate books and records, but you must still ensure that you are running the business as an independent entity. An LLC/LLP has a manager and members. The manager is selected as the company's representative and the rest of the owners are the members.

An LLC/LLP can also get business credit, just like a corporation, and liability for the actions of the company is limited to the amount invested by the owners. Also, limited liability owners of an LLC/LLP ARE allowed to participate in the daily activities of the business (unlike a Limited Partnership), while maintaining their limited liability status.

An LLC/LLP is appropriate for many small businesses, and I highly recommend this business structure to most of my clients. As the business grows, you may eventually convert to a full corporation, but in most cases an LLC provides liability protection, access to business credit, and simpler administration.

Tax filing for an LLC is simple. If the LLC has only one owner, the owner can report all LLC income and expense data on a Schedule C, just as if the entity were a sole proprietorship. If structured as an LLP, or if an LLC with partners, then Form 1065 would be filed, and each manager and member would receive a Schedule K-1 and report on Schedule E. An LLC has the option to be treated as a corporation, in which case it would file Form 1120 instead.

Speak to an Attorney or CPA or Both!

Prior to setting-up your business, I recommend that you retain counsel and a CPA who will work with you and your business. The attorney can ensure that you are following the proper legal proceedures with respect to your business structure and set-up, as well as the ongoing administration of your status. The CPA will help you set-up your company books and records, and s/he will also be in charge of your annual audit and financial reporting.

We have not talked in detail about business credit here, but we will be speaking to these issues in future posts. Your CPA and attorney may play a pivotal role in assisting you with regard to business credit. In any event, you will (or should) find their guidance and counsel of help and comfort while operating your new venture. Your CPA will also help you with tax issues, if necessary. We will discuss some of the tax issues of each type of business structure in future posts as well.

Regardless of whether you set-up your new company as a proprietorship, partnership, corporation, or limited liability entity, you should be sure that you understand the pros and cons of each structure, and decide which provides the best combination of benefits for your type and scale of business. Working with your financial planner, an attorney, and an accountant will enable you to ensure that you are getting the most from your chosen business structure.

As with any of my posts, I urge you to speak to a licensed, qualified attorney or CPA in your area before acting on anything contained herein that speaks to legal or accounting issues, as I am not licensed to work in these areas. Any information contained herein is for informative purposes only, and should be verified prior to being acted upon.