How Declining Marginal Costs Will Affect Your Future

How many products and services do we use for free (legally) that cost others a significant amount to develop? Look at your phone. Free apps probably far outnumber paid apps. How much do you pay for your personal email service? How many websites do you pay to access? What was your long distance phone bill last month?

Compare this to 25 or 50 years ago. Not much was free except a neighbor doing a good deed. I’m not aware of free software that long ago. Over the holidays my extended family brought up memories of long distance phone bills in the hundreds of dollars per month.

What has changed?

The difference is marginal cost. Technology has driven the marginal cost of many products to zero or near zero. The marginal cost is the cost of providing one additional unit (not taking into account fixed costs).

Software as a Service (SaaS), or software delivered over the Internet, is a perfect example of a near-zero marginal cost product. Good software can take many millions of dollars to develop and support (fixed cost), but the cost of providing that software to one additional person is almost zero.

Declining marginal costs have significantly impacted our society. Overall, I believe the impact has been positive, but it has upended entire industries.

Consider the music industry. The zero marginal cost nature of digital music decimated artists and music labels who profited from selling CD’s. In the days of Napster, many argued that free music didn't hurt anyone because downloading a song didn’t cost the artist any extra. The industry has adapted, but it is forever changed.

None of this is news to you. Even if you didn’t think of the changes in terms of marginal cost, you can see how it affects your life now.

But have you thought about how zero marginal costs might affect your future? Investors need to consider what industries may decline and what opportunities will rise in their wake. Business owners and managers need to consider how this trend will affect the industry they operate in. Students need to consider what career paths will be in highest demand and what will become obsolete.

I have been thinking about this concept since reading the book, The Zero Marginal Cost Society, by Jeremy Rifkin. The author extrapolates the trends toward zero marginal cost to other industries. He argues that almost every aspect of our lives is trending this direction. Over time, almost everything we need will have a near-zero marginal cost.

He even argues that zero marginal costs will eventually relegate capitalism to a small niche. Capitalists won’t be willing to invest in significant fixed costs when the investment can’t be recouped through free or near-free products.

It almost sounds socialist, but the author isn't arguing that government needs to take over and provide the fixed costs for everything we need. Rather, he argues that the abundance made possible by zero marginal costs will lead to collaboration and cooperation between groups of people to provide for the fixed costs.

Consider the following examples of how near-zero marginal costs are changing society:

Open source software projects like Linux and Mozilla have brought together thousands of people, in a remarkable unstructured way, who donate their time and expertise to build great products that millions can enjoy for free.

Online education is being provided inexpensively and free by the same organizations that charge tens of thousands of dollars per semester for the same education in a classroom. I recently took a massive open online course (MOOC) on scaling startups taught by two Stanford business school professors. The class was free for thousands of students. It could be free because the online delivery platform and class curriculum was already developed. Providing the class to one extra student has no cost.

3D printers are barely beginning to show their potential. 3D printers can create body parts, houses, cars, and almost anything you can think of with minimal raw material cost. Why pay up front for a container of trinkets from China and wait weeks for delivery when you can print only what you need right from your office?

Solar energy is basically free after the equipment cost. The high equipment costs make for a long payback period, which has limited adoption. However, the speed of technology improvement and price decrease is rivaling what we have seen with computing power.

The sharing economy provides access to expensive assets for a small marginal cost. In urban areas, services like Uber and Zipcar meet personalized transportation needs for a small cost per ride. Airbnb and VRBO provide convenient access to a wide variety of properties. My family just went in with two other families on renting a house near Disneyland. We have access to a good-sized house with a bed for every person for less than half of what we each would have had to pay for a small hotel room. Access is becoming more important that ownership

I don’t know if the radical societal changes will come to pass as completely and as quickly as the author predicts. However, there is no question that many aspects of society have changed and will continue to change because of declining marginal costs. It would be wise to consider how these changes will affect our investments, our careers, and our daily lives.

Question: In what ways do you think zero marginal costs will affect our future? 

What I Learned from Working Toward my 2015 Goals

A year ago I wrote about my goal-setting process. My life plan, inspired by Michael Hyatt, is the guide I use to keep my life on track. I review it regularly and make minor revisions throughout the year. Near the end of the year I reflect on what I accomplished that year, make major revisions to my life plan, and set new goals that will help me carry out that plan.

2015 was an interesting year. I learned a lot as I worked toward my goals. In some areas I failed miserably on goals that should have been fairly easy, and in other areas I reached stretch goals that I didn’t really think were possible.

Here are 3 lessons I learned from working toward my goals this year.

1. Don’t look beyond the mark

In Old Testament times the House of Israel was given the Law of Moses. The Law of Moses was meant to clearly point them toward Jesus Christ. By the time Jesus was born, the Jewish leaders had so complicated and corrupted the law that they no longer recognized it for what it was.

The prophet Jacob in the Book of Mormon described this as "looking beyond the mark” (Jacob 4:14). The mark was Jesus, who was right in front of them, and they looked beyond that mark to a Jehovah who would deliver them from their political bondage.

This year I often found myself looking beyond the mark. When I didn’t feel like I was gaining as much traction in certain areas as I should, I tried to think of what more I should be doing. I would start outlining plans for working on areas in which I felt deficient in that moment.

However, I forgot that I already planned out what I need to do for that year. I would make the progress I was seeking if I would only follow my life plan and the goals and habits outlined in it. I didn’t need to look beyond that mark.

2. Try to be an essentialist

One of my favorite books of the year is Essentialism: The Disciplined Pursuit of Less by Greg Mckeown. It is a quick and easy read, but it outlines an incredibly profound principle. It about cutting the non-essential from our lives so we can put all of our focus into activities that we feel deeply inspired by, are particularly talented at, and meet a significant need in the world.

I am not an Essentialist by nature. Most of us probably aren’t. I want to do it all, and find myself thinking that I can do it all if I just get up earlier and manage my time better. It takes discipline, effort, and courage to cut the non-essential from our lives.

3. Make more effort

Another of my favorite books this year is The 10X Rule: The Only Difference Between Success and Failure by Grant Cardone.

The author basically says we should consider the effort required to accomplish something, and then we should put in 10x that effort. In some cases, it will require 10x the effort we think it will, and we won’t accomplish it if we don’t put in that kind of effort. In other cases, we may be able to accomplish it with less effort, but 10x effort will set us apart from our competition and/or provide 10x the benefits.

The 10x principle may seem to contradict the essentialist principle. In reality, they go hand in hand. We should carefully choose the few essential areas to focus our time on, and then we should put intense effort into those few areas.

In some areas I failed to achieve my goals, and it was simply because I didn’t put in enough effort.

Make it a great 2016!

We all have more potential that we are taking advantage of. The new year is an opportunity to refresh our life vision and set goals that will get us there.

Question: What did you learn in 2015? 

How to Unwind for Holidays

Sometimes I have a hard time with holidays. Clifton StrengthsFinder is a type of personality test. Of the 34 talent themes, my top 3 explain why holidays and I don’t always get along.

Discipline. I like to impose structure on myself. I like routine and order. Holidays mess up my routine.

Achiever. I feel best when I am achieving something tangible. On holidays I should relax and enjoy time with family and not plow through my to-do list.

Focus. I like to have a plan and purpose for spending my day. Holidays are often unstructured and unpredictable, especially when extended family gets together.

However, my natural inclinations don't excuse me from taking time to rest my mind and build relationships with friends and family.

We all need time to unwind. We all need to build non-work relationships.

So how do we unwind for the holidays?

1. Wrap up loose ends before the holiday 

Use the day or days leading up to a holiday to wrap up loose ends on projects. Get to a good stopping point and make it easy for yourself to pick up where you left off. Make good notes so you’re not worried during the holiday about forgetting something.

Clean your desk off and email inbox out. Spend your time knocking out lots of little things that have been hanging over your head. Don’t jump into a major task that you would have to leave in the middle of.

2. Clear your to-do list

I use Remember the Milk to manage my to-dos. It reduces stress because I only look at to-dos I have scheduled for today. I don’t get overwhelmed with everything I need to do.

I usually put some of my to-dos on a holiday "just in case" I have extra time. I think getting ahead on a few things during the holiday will make upcoming work days less stressful.

However, this prevents me from enjoying my holiday. If I spend time getting things done, I missed my chance to relax and spend time with family. My reduced workload in the coming days is negligible. If I don’t get those things done, I feel like I didn’t have the discipline to focus and achieve what I planned to do.

I need to put off all my to-do’s off to future dates and not expect to accomplish anything during the holiday except relax and enjoy unstructured time with family. I should have the discipline to focus on my family and not achieve anything.

3. Make plans ahead of time

This may sound like the opposite of unwinding, but as my grandpa always said, “a change is as good as a rest.”

Enjoying a holiday doesn’t necessarily mean sitting around all day and doing nothing. I means spending quality time with friends and family.

Sometimes my family spends much of a holiday asking each other what we want to do, and because we can’t decide we end up not doing anything.

Take some time to make plans before the holiday, and be intentionally about making it memorable for your friends and family.

Make the most of holidays!

Holidays’ lack of structure and productivity can be tough for me. The desire to work hard is a good thing, but we all need time to unwind and build relationships. I’m still figuring out how to unwind on holidays, but it helps to wrap up loose ends, clear my to-do list, and make plans ahead of time.

Question: How do you unwind for the holidays? 

Use Hedging to Save your Business Bundles on Foreign Exchange

Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. In my last post I introduced some terminology, warned about the outrageous foreign exchange rates that banks charge, and recommended you set up a foreign exchange service for your business.

In this post, I’ll give one more transaction cost tip, and then I’ll move on to a practice that can save you much more than a few percent on transaction costs.

Where possible, use foreign currency bank accounts and debit/credit cards 

If you frequently travel to or make purchases from a foreign country, I recommend opening a bank account denominated in that currency. This allows you to minimize transaction costs by periodically buying the foreign currency to deposit into that account.

Having a debit card on that account, or a credit card linked to it, allows you to make routine purchases, such as meals while traveling, without paying transaction costs each time.

Using your local debit or card or credit card for foreign currency transactions comes with terrible exchange rates and sometimes additional fees for each transaction.

The bank in your country might offer accounts in different currencies. For example, most Canadian banks offer accounts in both CAD and USD. Some banks also allow foreign citizens to open accounts. For example, Wells Fargo in the US allows Canadian citizens to open accounts.

Rules and conditions vary across banks, currencies, and countries, so this may not be possible in all situations.

Hedging is not just for gamblers and big businesses

Having a foreign currency bank account is an example of a simple hedge.

Hedging is basically a way to protect yourself from changing values of foreign currencies by locking in the current rate for future transactions. While minimizing transaction costs can save you a few percentage points, hedging can save you much more than that.

Foreign currency values fluctuate wildly. The Canadian dollar has lost about 30% of its value against the US dollar in the last year (late 2014 to late 2015).

If you need to purchase $100,000 USD with CAD, it would cost you $30,000 CAD more now compared to a year ago.

Using the bank account example, if you had bought USD with CAD a year ago and kept it in a USD bank account, you would have saved yourself $30,000.

In hindsight that would have been a good idea, but there are two problems. First, you tied up $100,000 for a year. Second, the USD could have declined against the CAD instead of the other way around.

A better way to hedge is to purchase a hedging instrument.

I have been involved in small businesses with cross-border money movement for almost 10 years. I didn’t even consider hedging for the first few years because I thought the costs and complexity wouldn’t be worth the benefits.

However, our foreign exchange service showed me how inexpensive and simple foreign exchange hedging can be. They approved the company for a given credit limit and suggested I hedge about half of my expected needs over the next 90 days. I simply told them how much I wanted to hedge, and they created a contract allowing me to exchange funds at a given rate at any time over the next 90 days (called a forward contract).

The only cost was the exchange rate would be a fraction of a percentage higher than the spot rate. This is a small price to pay given the potentially huge swings in exchange rates.

Over the first few months the Canadian dollar weakened, and the hedge saved us several thousand dollars.

You can save your business bundles by being intentional about foreign exchange through minimizing transaction costs and hedging against future fluctuation.

Question: How have you used hedging to protect your business against foreign exchange fluctuation? 

How To Save your Business Bundles on Foreign Exchange

Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. If you are not intentional about minimizing the cost of exchanging foreign currency, you are probably paying 2-5% more than necessary on every transaction.

If you spend $5000 on a foreign conference, that’s $100-250 more out of your pocket than necessary. That may not sound like a lot, and maybe it’s not a big deal if your only foreign experience is once a year. But these extra costs add up quickly.

If you pay a million dollars to a foreign supplier, you’re paying $20,000-$50,000 more than you need to. That’s significant.

First, some terminology 

For me to write concisely about foreign exchange, we need to understand some terminology. I’m not a foreign exchange expert, so my explanations might sound elementary to an exchange trader, but it works for the purposes of this post.

The actual exchange rate between two currencies is not an exact science. The published exchange rate between two currencies can be called the spot rate. However, when you actually exchange currencies, you never pay exactly the spot rate.

Those who trade currencies, such as banks, make money on a spread, which is the difference between what they are willing to buy the currency for and what they sell it for. The larger the spread, the more the trader makes (buy low, sell high).

For example, if a spot rate between Canadian dollars (CAD) and US dollars (USD) is 0.80 USD/CAD, is a bank might be willing to buy a $1 CAD for 75 cents USD and sell it for 85 cents. Their spread is 10 cents.

If you exchange foreign currency, you want the rate you exchange at to be as close as possible to the spot rate. As a benchmark to keep in mind while reading this post, you should never exchange foreign currency for more than about 0.5% from the spot rate (unless it’s such a small amount the convenience outweighs the cost).

For example, if you are buying CAD with USD and the spot rate is $0.800, you should not pay more than $0.804 USD for the $1 CAD.  If the amount exchanged is in the thousands of dollars or more, you could pay as little as 0.1-0.2%.

With the technicalities out of the way, here are some tips for saving money on foreign exchange. These actions aren’t reserved for big businesses. Even the smallest of businesses can easily take these steps.

NEVER let your bank exchange foreign currency (at least at their published rate)

Okay, “never" might be too a strong a word. If you need $100 worth of foreign currency, $2-5 may be worth the convenience of a local bank.

As I write this, Wells Fargo’s online rates say they will sell you $1 CAD for $0.7703 USD. The spot rate is $0.7337. This means their rate is 5% more than the spot rate (remember the benchmark is 0.5%, 1/10 of what they are charging). If you buy $10,000 CAD with USD at this rate, you are spending at least $450 more than you should be.

Like any good business, most banks are willing to negotiate their rates, especially for large amounts. Their published rate is just a starting point and what they will charge if you don’t ask.

Every bank is different, but they should be willing to go down to 2-2.5% above spot for small transactions or under 1% for large transactions.

Banks may be okay if you exchange foreign currency infrequently and in small amounts, but to avoid banks, let’s move on the next tip.

Get an account with a foreign exchange service

Many foreign exchange services offer rates at a fraction of the price of banks. This is where I get the benchmark of a maximum of 0.5% above the spot rate.

There are many services out there, but I am most familiar with GPS Capital Markets in the US and Western Union and Citizens Bank in Canada. Some banks have in-house foreign exchange services that provide better rates than their retail branches, but I’m not very familiar with those options.

Here is the actual exchange rate schedule for a foreign exchange service I recently set up for one of the businesses I work with.

$0 -$5,000                          0.50%

$5,000-$10,000                  0.40%

$10,000-$20,000                0.30%

$20,000-50,000                  0.20%

$50,000 +                           0.15%

They have no minimum transaction amount or minimum volume over time. It was easier to set up than a bank account.

Unless you have a physical location near you, these services doesn’t work if you need a small amount of foreign cash for a trip. But they work great for paying foreign suppliers, receiving funds from foreign customers, or moving money between your own banks accounts in different currencies.

The process varies, but in general you deposit or wire funds to their account in one currency, and they wire or deposit the funds to their final destination in the foreign currency.

I work with a company that has locations in Canada and the US. Most of the revenue comes in Canada and most of the expenses are in the US. The foreign exchange service I use has an account at the same bank we use in Canada.

Any time I need to move funds from Canada to the US, I fax a request to the bank to transfer Canadian funds from our account to exchange service account, the service exchanges the CAD to USD at a great rate, and they wire the USD to our US bank account. It takes me about 30 seconds to send the fax and notify the exchange service, and a few hours later the funds appear in the US account.

That’s enough foreign exchange fun for now. I’ll save more tips for my next post.

As you can see, even the smallest businesses can save a lot of money on foreign exchange by taking some simple steps.

Question: How do you save your business on foreign exchange?

Two Common Accounting Mistakes Business Owners Make

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Most business owners would rather focus on building their business than dealing with accounting. They know it’s important to have good numbers to base decisions on. They know they need to file and pay their taxes accurately and on time. But many struggle to make it happen without getting bogged down in the details themselves.

In a perfect world, companies' accounting should be accurate and up to date without requiring the business owners to think about it. They should be able to review the key metrics as needed and be confident that all other details are being taken care of.

However, many business owners operate far from this ideal. In several years of helping small businesses with accounting, I’ve seen two common mistakes that business owners make.

At one extreme, business owners pay too little attention to their accounting.

One mistake I see at this extreme is turning over accounting to inexperienced bookkeepers.

They may not realize there’s a problem until they have serious issues. They may have tax agencies coming after them for inaccurate or unpaid taxes. They may get in a cash crunch because they don’t understand their numbers.

For example, a business may take prepayments from customers, which makes their bank balance look good at times. If the customers aren’t profitable, the cost of providing the product or service will eventually drain the cash from taking prepayments.

I worked with a company that had grown rapidly to several million dollars per year in sales. As they grew, they didn’t invest in their accounting. They had hired and lost a series of low-cost bookkeepers and paid little attention to what the bookkeepers were doing. Taxes weren’t filed accurately. The books didn’t accurately show their profitability. It took a lot of work (and a high cost) to clean up the mess and put proper procedures and people in place.

Small business accounting doesn’t have to be complicated and expensive. Most business don’t even need a full-time, experienced accountant. However, it takes someone experienced to set up the systems and monitor less experienced staff.

At the other extreme, business owners try to do the accounting themselves.

Even if business owners can do their own accounting, it doesn’t mean they should. They have much more important things to do, like build the business. They shouldn’t get bogged down in the accounting details.

I saw this with another business that had grown to several million per year in revenue. The owner knew accounting basics, and as the business grew he continued to handle all the accounting. He was spending almost half of his time entering bills, sending checks, reconciling bank accounts, etc. The accounting was being done well, but it was taking the owner away from more important activities.

I helped him set up a system in which a part-time experienced accountant trained and supervised a low-cost, part-time bookkeeper. Now he hardly has to think about accounting, and half of his valuable time is freed to build his business.

A better way

There is no right way to find the balance between these extremes. It depends on the nature and size of the business.

At the small and simple end, the company’s tax accountant may be able to advise a team member who spends some of their time taking care of the day-to-day bookkeeping.

At the large and complicated end, some businesses may need one or more full-time experienced accountants led by a full or part-time CFO.

Most small business are somewhere in the middle.

A structure I’ve seen work well is to contract with a part-time, experienced accountant. This accountant could help the business’ own staff, such as an office manager, handle the accounting. Alternatively, the accountant could completely take over the accounting function, typically with his own bookkeepers.

I'm biased because I provide these part-time services, but it works well in the companies I’m involved with.

Accounting is important, and business owners need to make sure their accounting is handled properly while not spending much of their time thinking about it.

Question: How do you handle your small business accounting? 

Selling Your Home and Other Assets When Moving from Canada to the US

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including

1. Various topics, tax agencies, impact of moving, filing status, and income tax rates
2. Deductions and credits
3. Payroll tax
4. Health care and other insurance
5. Capital gains
6. Small business tax 
7. The year of the move

In this post I’ll talk about the tax implications of owning and selling your assets in Canada (either in reality or as deemed by the CRA).

Selling your personal residence 

If you sell your house before you move, or if you move from the US to Canada, you don’t need to worry about this.

If you are selling your personal residence after moving from Canada, there are a couple of gotchas to watch out for.

Non-resident withholding: If non-residents sell certain assets in Canada, the buyer is required to withhold a portion of the purchase price until the CRA issues a Certificate of Compliance. This certificate basically says the non-resident seller has complied with tax requirements and the buyer can give the rest of the money to the seller.

Each seller (i.e. both spouses) needs to file forms T2062E, T2091(IND), T2091(IND)-WS, and T1159 within 10 days of the sale at the latest to request the certificate. You can request it as you know there is going to be a sale. I’d recommend filing as soon as possible because the certificate can take a while to get. I think it took about two months to get mine, and I understand it can take a lot longer.

This one got me. I didn’t know about the withholding requirement, so 25% of the purchase price of my house was held by the buyer’s attorney for two months.

After the end of the year you have to file a Section 116 tax return to report the non-resident disposition.

There are lots of hoops to jump through if you sell your personal residence after become a non-resident.

Reduced personal residence deduction: Like the US, the gain earned on selling your personal residence in Canada is tax-free with certain restrictions and limits. However, the house is no longer your personal residence after you move, and the personal residence deduction only applies to the time it was your personal residence.

You may take a while to find a buyer, or you may rent it out before selling.

The CRA does provide some grace. The formula that calculates the personal residence portion uses full years and adds a year. This means that you have the year you move plus an extra year before you start having to pay tax on a portion of the gain.

For example, if you buy a house in 2010, move before the end of 2015, and sell the house by the end of 2016, you won’t pay any capital gains tax.

Form T2091(IND) is the form used to calculate any taxable capital gains on a personal residence.

Without thinking about this rule, we entered a lease to own arrangement that ended towards the end of the year after we moved. We barely escaped capital gains tax.

Deemed disposition 

Canada only taxes residents, while the US taxes all residents plus all US citizens wherever they live in the world.

The only way for US citizens to escape US tax is to move out and renounce citizenship. US citizens who move to Canada (or any other country) have to file a tax return in both countries. The IRS provides a credit for the tax paid to the country of residence (which is hopefully at least what would be owed to the US, otherwise, Uncle Sam will bill for the difference)

Those who leave Canada can drop their Canadian residency and voila, no more Canadian tax. However, there’s a catch. Canada won’t let anyone escape gains they haven’t paid tax on yet. The CRA treats most assets as if they are sold at market value on the moving day (“deemed disposition”), and tax is owed on any gains.

For example, you paid $1 each for shares in a private company, and they are worth $5 when you move. You have to pay capital gains tax on the $4 gain, even though it’s not a real gain. This can be a shocker if you don’t plan for it, so I recommend carefully reviewing your situation with a tax advisor experienced in this area.

Moving cross-border involves a lot of preparation, work, and stress. It’s easy to forget about the tax implications until the tax deadlines in the year after you move, but you’ll save yourself a lot of headache and probably a lot of money if you plan ahead.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Don’t Forget about Tax Before Moving Between Canada and the US!

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including

1. Various topics, tax agencies, impact of moving, filing status, and income tax rates
2. Deductions and credits
3. Payroll tax
4. Health care and other insurance
5. Capital gains
6. Small business tax 

In this post I’ll talk about the year of the move. Taxes in the year you move can be complicated and are affected by decisions you make before you move. In this post I’ll give you some things to think about, but I encourage you to get with your tax advisor as long as possible before you move. 

When moving to the US, you pick a point in time when you drop Canadian residency and become a US resident. You only file Canada tax returns for the portion of the year you were in Canada, and you file US tax returns for the portion of the year you were in the US. The exception is if you are deemed to be a resident for the entire year, which I talk about below.

When US citizens move to Canada, they still have to file US returns for the entire year (and all future years), and they file in Canada for the portion of the year they were Canadian residents.

The following are things to watch out for:

Residency rules

Normally you are considered to be a resident of the one country to which you have the closest ties. In the simplest situation, on the day you move you cease to be a resident of one country and become a resident of the other.

Of course, real situations are not usually that simple.

One rule that almost got me was the US substantial presence test. You are deemed to be a resident of the US (and are required to file US tax returns for the entire year) if you are in the US a certain number of days over the last three years according to a formula.

I moved in August, so I assumed I would only be a US resident for the part of the year I lived there. However, I spent a lot of time in the US before I moved. As I counted my days for this formula, I realized I would be considered a US resident for the entire year. That was a problem because of the way my Canadian income from a corporation was treated favorably by Canada but treated differently in the US. I had to leave the US for a couple of weeks after I moved to avoid a large tax bill. I would have been in trouble if I didn’t find out until I went to file taxes after the end of the year.

The flip side is that until you meet the substantial presence test, you are considered a nonresident. Nonresidents don’t quality for some tax deductions, such as the standard deduction and child tax credit. However, you can file back to the day you moved as a resident once you meet the test. If the tax return deadline is before you become a resident, you have to file a nonresident alien tax return and then amend it once you become a resident.

I was able to wait until I met the substantial presence test before filing a resident tax return. When I did file, I was called a dual-status alien filing a dual-status return (so you know the terminology for doing your own research).

Residency rules are complicated, and it’s important for your to do your own research on your situation.

Canadian corporations and residency 

I mentioned this in my small business tax post, corporation owners who move out of Canada need to be careful. If more than 50% of the ownership becomes non-residents of Canada, the corporation ceases to be a Canadian Controlled Private Corporation (CCPC) and will lose the associated tax benefits.

If you are closing your business as part of your move, it may be wise to dispose of all of the corporation's assets before you move. If your business generates income after you move, such as capital gains from selling assets, it will not qualify for CCPC tax advantages.

Further, as a US resident you are taxed on your worldwide income using US tax laws, including salary or dividends you take from the corporation.

Pro-rated items

Some items on tax returns are based on a full year, such as the standard deduction and personal exemption. When you are filing as a resident for only part of the year, some deductions are prorated and some aren’t. Deductions that aren’t prorated give you an advantage in that year because you get a full year of deductions/credits against a partial year of income. The US personal exemption and child tax credit are examples.

You can be strategic about deductions that are timing based. For example, if you give regular donations to organizations with presence in both Canada and the US, you can maximize your yearly donation in Canada. Canada provides more tax savings on charitable donations.

Health care

I wrote about the differences in health care systems in a previous post. I’ll mention a couple of important points related to when you move.

If you are moving from Canada, the provincial health care system will allow you to keep your coverage for a certain period after your move.

In our case, we were able to keep our Alberta Health coverage for two full months after the month we moved. We purchased inexpensive travel insurance for this period. This saved us three months of US health insurance premiums.

If you are moving to Canada, enjoy universal health care! But make sure you plan ahead because the provincial health care system may require a waiting period before you qualify for coverage.

Moving cross-border involves a lot of preparation, work, and stress. It’s easy to forget about the tax implications until the tax deadlines in the year after you move. You’ll save yourself a lot of headache and probably a lot of money if you plan ahead.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

Key Differences Between Canada and US Tax - Small Business Tax

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including various topics, tax agencies, impact of moving, filing status, and income tax rates, deductions and credits, payroll tax, health care and other insurance, and capital gains.

In this post I’ll compare small business tax.

Small business owners will find business tax to be one of the most significant differences between the two countries. As you will see, the difference is more in the structure than the total tax burden.

Sole proprietorships are the most simple business structure, and they are treated roughly the same in both Canada and the US. Beyond that, business tax structure is quite different between the countries.

Canada: Corporations are king

In Canada, most small businesses operate a C Corporations. This is surprising to Americans who are double taxed at at very high rates when using C Corps.

There are two reasons C Corps work in Canada:

1. The federal corporate tax rate is much lower (15% in Canada vs 34-35% in the US - yes, only 15% - you American read that correctly)
2. The small business deduction reduces the federal corporate tax rate to 11% on the first $500,000 in taxable income

Provinces also have a regular rate and small business deduction rate. In Alberta, for example, the rate is 3% on the first $500,000 (14% combined federal and provincial) and 12% above that (27% combined federal and provincial). Provincial rates in Canada are higher than state rates in the US, but the combined rates are still much lower in Canada.

Important caveat: the small business deduction is subject to some restrictions, including the requirement that the corporation be a Canadian-controlled private corporation (CCPC). To be a CCPC, Canadian residents must own a controlling interest in the corporation. If you and/or your spouse control the corporation, and it continues to do business in Canada after you move to the US, it will lose CCPC status.

Aside from tax rates, corporations allow income splitting between spouses. Even if one spouse does all the work for the corporation, both spouses can own the corporation and take dividends in proportion to their ownership. This isn’t an issue in the US where spouses file together, but in Canada spouses file separately.

Income splitting of regular income under certain conditions was recently added to Canadian tax law, but the newly elected Liberal government would like to repeal it. Until this change was made, corporations were one of the only ways for spouses to split income. They may soon return to that status.

Of course, money taken out of a corporation by the owner is included in the owner’s personal income. Personal income tax can be deferred indefinitely by leaving money earned by the corporation in the corporation. That money can then be invested in assets unrelated to the main corporate activity.

Many owners use corporations to build wealth with minimal taxes. For example, an attorney who earns fee income through a corporation can take just enough out of the corporation to live on and invest the rest in assets like rental properties, mutual funds, etc. This is the single biggest advantage of using the C Corp structure.

Finally, money taken out of a Canadian corporation is not double taxed. Money taken as a salary or bonus is deducted from the corporation’s taxable income, preventing double tax.

Unlike the US, even income taken as dividends is not double taxed. The ingenious Canadian tax code writers devised a way, in theory, to make owners indifferent to taking income from a corporation as salary or dividends. It’s too complicated to get into here, but income taken as a dividend can be partially credited against personal income tax. As a result, there really isn’t much difference either way in the amount of total tax paid.

Corporate tax in Canada can be complicated. Like the small business deduction, some tax rates and other benefits are subject to restriction. However, if your Canada corporation is complicated enough to worry about these restrictions, you probably wouldn’t be reading this post for tax information anyway.

US: LLC’s rule

US small business tax is much simpler. The C Corp structure is only used by businesses that are either large or have a large number of shareholders.

Many small businesses in the US operate as LLC’s. LLC are much easier to set up and maintain than corporations. LLC’s provide personal liability protection, and the tax structure is like a sole proprietorship or partnership. The LLC itself is not taxed. The LLC’s net income flows through to the owners’ personal tax return and is taxed as ordinary income.

I wrote a post here about the different types of LLC’s.

Are you American business owners ready to move to Canada yet? Are you wondering why I moved to the US?

Well, before you get too depressed, realize that corporations in Canada are not a huge advantage. Rather, Canadian tax law has simply removed the disadvantage of using a C Corp for small business. Since small business don’t use C Corps in the US anyway, nothing is lost.

If anything, Canadians should be disappointed LLC’s are not available in Canada.

Even though the structure is much different, most small business owners wouldn’t notice much of a difference in their overall tax burden.

I mentioned in previous posts that my tax bill went up slightly when I moved to the US, but it was only because I was able to use a corporation to split my income with my wife. Without this benefit, my Canada tax bill would have been slightly higher.

The biggest advantage in Canada for small business is the ability to keep money in the corporation and avoid the personal tax component. However, most people need most of their business income to live on, negating this benefit.

The bottom line: most small business owners won’t see much of a difference in their total tax bill between Canada and the US, but it is important to understand the difference in structure.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Tax - Capital Gains

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including tax agencies, impact of moving, filing status, and income tax rates; deductions and credits, payroll tax; and health care and other insurance.

In this post I’ll compare capital gains.

Put simply, capital gains occur when you sell certain property for more than you paid for it. This type of property is usually purchased for the intent of selling for a profit and/or generating income. For example, a rental property.

Capital gains are taxable. Both countries tax capital gains more favorably than regular income, but each countries handles it quite differently.

In Canada, you only include half of your capital gain in your taxable income. For example, if you earn a $100,000 salary and sell a rental property for $20,000 more than you paid for it, your tax is calculated on $110,000 of taxable income (only $10,000 of the capital gain is included). This means the tax rate on capital gains in Canada is half of your marginal tax rate (the rate top rate bracket your income falls into).

It doesn’t matter how long you owned the property for. It’s treated the same whether you sold it 1 day or 50 years after you bought it.

In the US, capital gains tax is more complicated.

The full amount of a short-term capital gain (property held for less than 1 year) is taxed as regular income. Long-term capital gains are taxed at a lower rate than regular income, but the amount depends on your tax bracket. Long-term capital gains in the 10% and 15% tax bracket aren’t taxed at all, those in the highest tax bracket are taxed at 20%, and everything in between is 15%.

Capital losses, obviously, are the opposite of capital gains. A capital loss is when you sell property for less than you paid for it.

In Canada, capital losses can only be used to reduce capital gains. If capital losses in one year are more than capital gains, you can use it to reduce capital gains in up to three previous years or any future year.

In the US, capital losses can reduce capital gains and up to $3000 of regular income. If losses are $3000 more than gains, you can carry them forward to future years.

For more information from the tax agencies’ websites, go here for Canada and here for the US.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

Key Differences Between Canada and US - Health Care and Other Insurance

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' personal tax systems and other factors impacting cost of living.

I’ve been writing a series of posts on the topic.

In my first post I wrote about the differences in tax agencies, impact of moving, filing status, and income tax rates.

In my second post I explained deductions and credits, which can be a confusing concept especially when comparing Canada and the US.

In my third post I wrote about a significant difference for those earning between $50,000 and $120,000 per year: payroll tax.

In this post I’ll take a break from tax-specific topics to discuss differences in health care and other insurance. While not specifically a tax topic, it's an area impacted significantly by government and an important cost-of-living consideration. It’s not enough compare taxes only when figuring out differences in discretionary income.

Differences in health care and insurance is a big deal. My family went from having free primary health care in Alberta to paying over $400/month for less coverage and a $10,000 deductible (meaning I pay out of pocket all health care expenses up to $10,000 per year). Family plans covering maternity and with a lower deductible can easily climb over $1000/month.

Thankfully we have been healthy, so our costs above the $400/month are minimal, but even broken bones, stitches, or minor surgeries could quickly change that.

Health Care in the US

Health care premiums vary widely across the US and have been complicated by the “Affordable” Care Act (ACA, or Obamacare - the quotes are my addition). As a side note, I work with a company that provides group health insurance to their employees, and their premiums doubled when Obamacare took effect.

If moving to the US, I recommend reviewing the healthcare.gov website and finding a reputable health insurance broker to help explore your options. Health insurance brokers are free and very helpful. I found my broker through Dave Ramsey’s ELP program.

Despite the cost (or arguably because of it), the service and quality of care in the US is generally excellent. Unlike in Canada, health care providers compete against other. My wife had two babies in the US and one in Canada. While the Canada experience was fine (we left with a healthy baby, which is the most important thing), she shared a room and received friendly but minimal service. Both times in the US she had a large private room and exceptional service.

Health Care in Canada

Health care in Canada is administered as a monopoly by each province.

There were no premiums for primary care when I lived in Alberta. Alberta is now in the process of reinstating premiums, but they are still almost nothing compared to the US. Those making less than $50,000/year still won’t pay any premiums, and premiums gradually rise to a maximum of $1000/year based on income. Each province in Canada is different, but premiums are roughly comparable across the country.

Canada gets a lot of criticism for wait times and general lack of service. I have heard far-removed horror stories of people suffering and dying while waiting for procedures. However, I and people I know don’t have many complaints. Yes, ER wait times are long, and it can take a long time to get things like MRI’s for non-urgent matters, but I believe people generally get what they need. My mom survived cancer, and she received great service during her many treatments.

When talking about health care in Canada, most people refer to primary health care. It includes basic necessities like doctor visits, surgeries, baby deliveries, cancer treatment, etc. It does not include prescription drugs, dental, vision, etc.

If moving to Canada, go to the health care website for the province you’re moving to and become familiar with residency requirements and waiting periods. Most importantly, enjoy the lower or nonexistent premiums!

Home and Auto Insurance

I will only briefly touch on auto and home insurance. I mention it because my savings in the US made up some of the difference in health care costs. I’m not familiar with the insurance market in other parts of Canada or the US, so I can only speak from my own experience. My combined auto and home premiums went from over $300/month in Canada to less than $100/month in the US (for the same two vehicles and a bigger house in the US).

When comparing costs, I recommend getting quotes from a good broker in the area you’re moving to. Again, Dave Ramsey’s ELP program is helpful in the US.

Health care and other insurance aren’t tax topics, but they are significant costs you should consider along with tax when comparing cost of living between countries.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax or insurance expert or a certified financial planner. This post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax and other advisors.

Key Differences Between Canada and US Personal Tax - Payroll Tax

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' personal tax systems. Although the principles in each country are similar, the implementation is quite different.

This is the third in a series of posts on the topic.

In my first post I wrote about the differences in tax agencies, impact of moving, filing status, and income tax rates.

In my second post I explained deductions and credits, which can be a confusing concept especially when comparing Canada and the US.

Deductions are credits are one reason income tax rates have little to do with how much income-related tax you actually pay.

In this post, I’ll explain the another reason: payroll tax.

I say "income-related” because payroll tax is not technically income tax, but it is directly related to your income. Income tax and payroll tax are calculated together in both US and Canada tax returns.

Conventional wisdom says taxes are higher in Canada than the US. They must be higher: Canada is more socialized, especially with its universal health care system that residents pay little to nothing for.

This may be true for some situations, but it wasn’t for mine. My income-related taxes went up, mainly because of payroll tax. (On top of taxes, I pay high health care premiums, but that’s another topic.)

Those who move to the US and earn between $50,000 and $120,000 find US payroll tax to be a shocker. In fact, most people earning up to $120,000 will pay much more in payroll tax than income tax.

The payroll tax concept is similar between the two countries. Both contribute to retirement and unemployment programs, and both are mostly split evenly between employees and employers. In both countries self-employed people pay both the employee and employer side.

In Canada, payroll tax consists of:

• Canada Pension Plan (CPP), which pays for retirement benefits (4.95% each up to about $50,000 in earnings)
• Employment insurance (EI), which provides unemployment benefits (up to about $50,000, employees pay 1.88% and employers pay 1.4x the employee rate - 2.63%)

In the US, payroll tax consists of:

• Federal Insurance Contributions Act (FICA), which includes:
  • Social security for retirement benefits (6.2% each up to about $120,000 - there’s the big difference)
  • Medicare for age 65+ health insurance (1.45% each on all wages with an additional 0.9% from employees only on income over $200,000)
• Federal Unemployment Tax Act (FUTA) (6% up to $7000 earnings paid by employers only)
• State Unemployment Tax Act (SUTA) (rate varies, usually paid by employers only)

ADP provides a simple guide to payroll taxes by state here.

The CRA website has a good guide to all Canada tax rates here.

In both Canada and the US, those who earn income without taxing being withheld must pay quarterly estimated tax quarterly. The deadlines and amounts required are different between the countries. Further, the calculations and requirements can be complicated.

If you are self-employed or for other reasons do not have enough tax withheld to cover the tax you owe for the year, I encourage you to review these rules carefully. Otherwise, you could be hit with significant penalties and interest.

Everyone's situation is different of course. My tax in the US is higher than Canada, but others may find the opposite depending on income level, type of income, and deductions and credits available.

When comparing the two tax systems, don’t forget payroll tax. Income tax rates get all the attention, but payroll tax is the largest factor for most people.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Personal Tax - Deductions and Credits

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

Those considering a cross-border move should understand the personal tax system differences. Although the principles in each country are similar, the implementation is quite different.

In my last post I wrote about the differences in tax agencies, the impact of moving, filing status, and income tax rates.

This time I’ll tackle deductions and credits, which is more than enough for one post.

Income tax rates are deceptive because they have little to do with how much tax you actually pay.

You don’t actually pay 33% if your income is in the 33% combined federal and state/provincial tax bracket. 33% is the marginal tax rate, which means 33 cents of tax is owed for each additional dollar earned.

However, your average tax rate is your income tax paid divided by your total income.

Thanks to deductions and credits, most people would be surprised at how low their average tax rate is.

Deductions reduce the amount of income you are taxed on. For example, in both Canada and the US, qualifying retirement contributions are deducted from taxable income before calculating tax owed.

Credits directly reduce the amount of tax you pay dollar for dollar. For example, the child tax credit in the US reduces tax by $1000 for each child.

Deductions and credits are part of both the Canada and US tax systems, but the implementation is much different. The US primarily uses deductions and Canada primarily uses credits.

In Canada, the amounts used to calculate credits are similar to the amounts the US uses for deductions. However, rather than being deductions, these amounts are added up and then multiplied by 15% to find the credit.

The end result is similar, but the US system results in more tax savings if your income above the 15% tax bracket.

For example, in the US a $1000 deduction for someone in the 25% tax bracket provides tax savings of 25% of the deduction, or $250. A Canada resident in the 25% tax bracket who is allowed a credit on $1000 gets a 15% reduction in taxes, or $150.

Confusing, I know, but it’s an important concept to understand if you want to understand how you are taxed.

The following comparisons are highlights and not comprehensive lists.

Deductions and credits similar between the US and Canada:

Retirement contributions: RRSP contributions in Canada and 401(k) contributions in the US are both treated as deductions.

Personal and Dependent: deductions or 15% credit for the filer and dependents.

Charitable Donations: Canadians benefit from a 29% credit on donations instead of 15%, and provinces add an additional credit. Alberta adds an extra 21% credit, which means Albertans get back 50% of their donations. Donations are a regular deduction in the US.

Deductions and credits different between the US and Canada:

Mortgage interest: Americans love that they can deduct interest on their personal residence mortgage.

Property tax: To further incentivize home ownership, property tax on a personal residence is deductible in the US.

Child tax credit: The US provides double tax benefits for kids. US residents get a $1000 credit for each child in addition to a deduction for each dependent.

State income tax: US residents get a federal deduction for state income tax.

Deductions and credits can be complicated, but it is important to understand how they impact the tax you actually pay. Thanks to deductions and credits, most people do not pay nearly as much tax as their top tax bracket indicates.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Personal Tax - Part 1

The US-Canada border is one of the friendliest borders in the world, despite recent debate by US presidential candidates about building a wall along it. As a result, many people move back and forth between Canada and the US. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

Those considering a cross-border move need to understand the difference between the two countries' personal tax systems. Although the principles in each country are similar, the implementation is quite different.

In this post I will summarize some of the key differences. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

The following are some keys areas of difference:

Tax agencies

To establish the terminology, the US tax agency is called the Internal Revenue Service (IRS) and the Canada tax agency is called the Canada Revenue Agency (CRA).

This is a side note, but in my experience the CRA is much friendlier and easier to contact than the IRS. I guess that’s not surprising given the friendly Canadian stereotype. They probably say sorry while seizing all of your possessions… But I digress. On to the next difference.

When you move

Canada only taxes residents, while the US taxes all residents plus all US citizens wherever they live in the world.

The only way for US citizens to escape US tax is to move out and renounce citizenship. US citizens who move to Canada (or any other country) have to file a tax return in both countries. The IRS provides a credit for the tax paid to the country of residence (which is hopefully at least what would be owed to the US, otherwise, Uncle Sam will bill for the difference)

Those who leave Canada can drop their Canadian residency and voila, no more Canadian tax. However, there’s a catch. Canada won’t let anyone escape gains they haven’t paid tax on yet. The CRA treats most assets as if they are sold at market value on the moving day (“deemed disposition”), and tax is owed on any gains.

For example, you paid $1 each for shares in a private company, and they are worth $5 when you move. You have to pay capital gains tax on the $4 gain, even though it’s not a real gain. This can be a shocker if you don’t plan for it, so I recommend carefully reviewing your situation with a tax advisor experienced in this area.

Filing status and income splitting

In Canada, everyone files individually. Until recently, spouses couldn’t split income. This was a disadvantage for families with a sole breadwinner. One spouse pays tax on their full income at the graduated tax rates.  The spouse without income can't take advantage of the lower rates on lower levels of income.

Income splitting under certain conditions was recently added to Canadian tax law, but some parties in the upcoming election are threatening to repeal it.

In the US, married couples file together. As a result, income splitting is not an issue.

Income tax rates

Both countries have a progressive tax system, which means taxpayers pay more tax on higher income levels. The tax rates on given income levels are quite similar above about $75,000 to $90,000 in taxable income.

Canada’s income tax rates are a little higher overall for two reasons.

First, using approximate 2015 numbers, Canada tax is 15% up to $45,000 and 22% up to $90,000. US tax is 10% up to $20,000 and 15% up to $75,000.  Above that, rates are close to the same.

Second, Canada’s provincial rates are higher on average than US states. For example, Utah (where I live) state tax is about 5%, and Alberta (where I moved from) provincial tax is 10%.

Closing

That’s enough tax excitement for one post. In my next post I’ll tackle some more differences, including:

- Why income tax rates have little to do with how much tax you actually pay

- The type of tax that most working US residents pay the most of (hint: it’s not income tax)

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I don’t practice tax accounting, and this post is not meant to be professional advice.

The Building Materials Industry is Ripe for Disruption

If you’re reading this, chances are you own a smartphone and can’t remember the last time you rented a DVD from a store (i.e. not Redbox). You may not have a landline, and if you do, you may only keep it because it’s free when bundled with Internet and TV service. The telephone and movie rental industries are just two examples of the countless industries that have been disrupted by newcomers with new technology, better products, and/or better methods of delivery.

Value gained, value lost

Think of the value gained and lost with each disruption. Since 2007, the year iPhone was released, Blackberry has lost 94% of its market value (from about $67 billion to $4 billion). During that same time, Apple's market value has increased by about 850% (from about $70 billion to $650 billion). That’s almost $600 billion of value created in only 8 years!

Investors who correctly predict (1) the industries that will be disrupted and (2) the companies who lead the disruption realize the bulk of the value created. Of course, on the flip side, investors and management stand to have their value destroyed if they fail to see the disruptors coming and adapt accordingly.

Industries ripe for disruption

Two industries I’m involved in are ripe for disruption. Both generate 95-97% of sales from brick and mortar stores. End consumers pay inflated prices due to the costs of physical locations and layers of middlemen who each take their cut.

Startups have just begun entering both industries with disruptive business models. They are using technology and other innovations to reduce the layers of cost between the manufacturer and the end consumer. They are making the customer experience better AND cheaper.

Building materials industry

In my last post  I wrote about the mattress industry. In this post I’ll write about the building materials industry.

Due to high mark-ups at each distribution level, consumers typically pay more than four times the cost of materials and labor to assemble a mattress.

The building materials industry doesn’t have quite the same margins, but participants make up for it with volume. Compared to the $14 billion US mattress industry, US home improvement is a many times larger $520 billion industry.

The buying process hasn't changed much for a very long time. The industry has maintained the status quo largely due to the size and weight of most materials and the perceived need by consumers to spend time choosing products from showrooms.

Startups are disrupting the building materials industry

However, new startups are now figuring out how to disrupt this entrenched industry. They are finding that they can match buyers and manufacturers online, quickly ship samples for review, and painlessly arrange the delivery logistics.

Build Direct is a leader is this disruption. Late last year they raised $50 million to build out their Home Marketplace platform, which they are now launching.

This platform is doing for building products what Amazon has done to other products like books, music, and electronics.

This platform allows homeowners and contractors to buy directly from manufacturers at wholesale prices. Build Direct ships free samples to aid the buyer decision, and then its proprietary logistics platforms figures out the fastest and cheapest way to ship the product to the buyer’s door. Buyers can do all this from the comfort of their own homes.

The platform gives manufacturers direct access to customers throughout North America and even the world. It provides analytics to help the seller with pricing and warehouse location decisions.

Traditionally, building product manufacturers don’t have access to the people who actually use their products. They can’t gather data about who they are, where they are, and what feedback they have. Any information is filtered through retailers who have no incentive to facilitate this contact.

Build Direct is leading the way, but like the Blackberry’s and LG's of the cell phone market, there is potential for further disruption by innovative new entrants.

What does this mean for you?

There’s a good chance that you’ll be looking for home-related products in the near future. You can be aware of cheaper and easier ways to buy.

If you’re an investor, you can look for opportunities to invest in this new trend and share in the value creation.

If you’re an entrepreneur, you may see opportunities to contribute to the disruption.

If you’re involved in any other industry, you can recognize that your industry will be disrupted. You can adapt and be part of the disruption, or you can be one of the value-losing stories. Be a student of your industry. Be aware of the history and the newest developments. It’s not easy to predict which trends will be fads and which will be disruptive, but at least be aware of what’s out there.

Look for significant value to be created by new startups and significant value to be lost by incumbents that don’t adapt. This is the world we live in, and it’s an exciting time to be alive!

Question: What other industries are ripe for disruption? 

The Mattress Industry is Ripe for Disruption

If you’re reading this, chances are you own a smartphone and can’t remember the last time you rented a DVD from a store (i.e. not Redbox). You may not have a landline, and if you do, you may only keep it because it’s free when bundled with Internet and TV service. The telephone and movie rental industries are just two examples of the countless industries that have been disrupted by newcomers with new technology, better products, and/or better methods of delivery.

Value gained, value lost

Think of the value gained and lost with each disruption. Since 2007, the year iPhone was released, Blackberry has lost 94% of its market value (from about $67 billion to $4 billion). During that same time, Apple's market value has increased by about 850% (from about $70 billion to $650 billion). That’s almost $600 billion of value created in only 8 years!

Investors who correctly predict (1) the industries that will be disrupted and (2) the companies who lead the disruption realize the bulk of the value created. Of course, on the flip side, investors and management stand to have their value destroyed if they fail to see the disruptors coming and adapt accordingly.

Industries ripe for disruption

Two industries I’m involved in are ripe for disruption. Both generate 95-97% of sales from brick and mortar stores. End consumers pay inflated prices due to the costs of physical locations and layers of middlemen who each take their cut.

Startups have just begun entering both industries with disruptive business models. They are using technology and other innovations to reduce the layers of cost between the manufacturer and the end consumer. They are making the customer experience better AND cheaper.

Mattress industry

In this post I’ll write about the mattress industry, and in my next post I’ll write about the building materials industry.

The mattress industry has long been lucrative. Manufacturers typically earn a 50% gross margin, and then retailers require up to a 55% margin on top of the wholesale price. This means, for example, consumers pay over $2200 for a mattress that costs $500 in material and labor to assemble.

The industry has maintained the status quo through tactics such as creating complex product lines, often customized for each retailer to make comparison shopping difficult. Often mattresses with the same materials are branded differently and sold at different price points.

Further, mattresses are big and heavy, requiring delivery by trucks rather than courier. This adds to the costs and requires consumers go to a retail showroom to try before they buy.

Startups are disrupting the mattress industry

However, new startups are now figuring out how to disrupt this entrenched industry. They are finding that they can make a mattress from the same high quality materials, compress the mattress to fit in a box that can be shipped by courier, and sell online direct to the consumer.

Through effective marketing they are convincing consumers that they don’t need to try before they buy. They can rely on website descriptions and reviews. If they’re not happy, they have between three and six months to return the mattress for a full refund, no questions asked. The seller will even arrange for free pickup of the unwanted mattress.

The so-called bed-in-a-box sellers are doing extremely well. They are paving the way with new technology and spending millions on marketing to gain acceptance for the concept in the consumer mind. They are in the process of pushing online mattress sales from 3% to potentially 20% or more of all sales. With a $14 billion US mattress market, this is opening a new 2.4B online channel.

Room for further disruption

However, like the Blackberry’s and LG's of the cell phone market, they have flaws that can be improved upon by new entrants, such as:

• Limited selection. Casper, the leader in this disruption, sells exactly one model, as do most of their competitors.
• Average materials. Most use average foam and/or latex much like mid-range conventional mattresses.
• Antiquated compression techniques. The bed-in-a-box concept is not new. It’s simply being legitimized by startups innovating marketing and customer service, not materials and superior compression. The boxes are small enough to courier, but still quite bulky, and the mattresses take several hours to expand to full size.

The incumbent manufacturers and retailers are worried. Mattress Firm, the largest mattress retailer in the US, just announced their entrance into the market with their online-only, bed-in-a-box "Dream Bed."

What does this mean for you?

You’ll need to buy a new mattress several times in your life. You can be aware of cheaper and easier ways to buy.

If you’re an investor, you can look for opportunities to invest in this new trend and share in the value creation.

If you’re an entrepreneur, you may see opportunities to contribute to the disruption.

If you’re involved in any other industry, you can recognize that your industry will be disrupted. You can adapt and be part of the disruption, or you can be one of the value-losing stories. Be a student of your industry. Be aware of the history and the newest developments. It’s not easy to predict which trends will be fads and which will be disruptive, but at least be aware of what’s out there.

Look for significant value to be created by new startups and significant value to be lost by incumbents that don’t adapt. This is the world we live in, and it’s an exciting time to be alive!

Question: What other industries are ripe for disruption? 

Why Being an Entrepreneur is Worth It!

I admit - one reason I’m writing this post is to remind myself. I’m involved in several entrepreneurial ventures, and it’s tough at times! Being an entrepreneur is difficult by definition. You’re charting new paths, starting something new with small odds of success, trying things the average person isn’t willing to try. Plus, once you get past the startup phase and start seeing “success,” you have to handle the growth without flaming out.

What’s not to love?

There’s a lot to love, actually. The trick is remembering the good things during the hard times.

Here are 3 reasons I believe being an entrepreneur is worth it:

1. Entrepreneurship can be less risky than other sources of income

Most people associate entrepreneurship with risk, and I won’t argue with that. New businesses have low survival rates. Founders often invest their own money and pledge their personal assets to guarantee loans and leases.

However, I don’t think being an entrepreneur is any more risky than other sources of income.

Most employees are completely dependent on one employer. No matter how stable the business or non-profit or government department is, a number of factors unrelated to performance can lead to job loss.

There are at least reasons entrepreneurship can less be less risky than a job.

First, a well-developed business isn’t dependent on one customer. If it loses some customers, it still has other customers to keep the business going. An employee only has one customer.

Businesses usually decline over time, giving the managers a chance to adjust. A job can be lost in a day.

Second, the best entrepreneurs are actually risk averse. They plan their finances with the expectation of unsteady income. They build up large emergency funds during the good times, knowing they will probably need it to get through the hard times. They are careful about how they spend business funds, knowing that it ultimately comes out of their pocket.

In contrast, many employees live as if their paycheck will arrive every two weeks and grow steadily over time. They don’t think they need an emergency fund, and they maximize their debt payment to income ratio. A gap in employment while living on the edge can be devastating.

2. Entrepreneurship provides freedom

Entrepreneurs don’t have complete freedom. Ultimately, they must spend their time on what customers are willing to pay them for.

However, within that broad guideline they have a lot of freedom. They can spend time on the activities they love the most and do the best.

They can design their lifestyle. Customers aren’t watching to see if they clock in at 9 am and stay later than 5 pm because everyone else is there. As long as they get results, they don’t care where or when the work gets done.

They can choose who they work with. This is a big deal. Managers in big companies may have some control over who they hire, but they probably don’t have much say in who their peers are.

Of course, the average entrepreneur probably spends more time working than the average employee. But they generally get to choose when they work, where they work, what they work on, and who they work with.

3. Entrepreneurs do work that matters

Finding meaning in work leads to a more fulfilling life. Studies have shown that once basic needs are met, people are more motivated by finding meaning than making more money.

Of course, entrepreneurs are not the only ones who find meaning in their work. However, many employees feel like a small cog in a large wheel, dependent on their steady paycheck. There is more to life!

Entrepreneurs choose to solve problems they are most passionate about and bring the most fulfillment to their lives.

Call to Action

For you entrepreneurs out there who are struggling with extreme challenges: don’t give up! It’s hard, I know. But you have the freedom to do work that matters in a way that can be less risky than being an employee.

For you employees with an entrepreneurial bug: don’t ignore it! Don’t be afraid! Get started!  If you’re not sure, read my post about knowing if it’s time to start your own business.

Being an entrepreneur right now is not for everyone. But entrepreneurship is a great way to make both a living and a difference in the world.

Question: Why else is being an entrepreneur worth it?

Should I Use Xero or Quickbooks Online?

Choosing the right accounting software for your business is an important exercise for small business owners. It may not be the most exciting exercise, but the choice will affect your business every day going forward. Plus, switching is difficult if you make the wrong decision.

Your business runs on accounting software. How well the software fits your business will determine how much time and money you spend on separate products and processes. How well the software works will be a big factor in how productive (and sane) your team is. The information you rely on to make decisions needs to be accurate without taking too much extra work to generate.

I’m a big fan of online accounting software, or software as a service (SaaS), as opposed to desktop software. With SaaS you don’t have to manage software installations or data on your own equipment.

Two of the leading accounting SaaS products for small business are Xero and Quickbooks Online (QBO).

I wrote a post almost a year ago extolling the virtues of Xero. I criticized Intuit for how slow they were to release QBO and build out its features.

However, I recently noticed that QBO has rapidly improved. I think it’s time to update my opinion.

I still love Xero and use it for most of the companies I’m involved in. It was good when I started using it five years ago (much better than QBO), and it has improved since then. QBO was extremely bare bones at the time and didn't come close to having the features we needed, such as bank feeds and multi-currency.

I recently took another look at QBO, and it has come a long way in the last 5 years. As far as I can tell, it has all the features of the Quickbooks desktop version, and possibly more. It just added multi-currency support and redesigned many of its standard reports.

Here is a comparison between Xero and QBO in a few key areas.

1. Data entry

Quick and easy data entry is essential, especially for high-volume businesses. Even a few extra seconds on each transaction adds up over time.

Both Xero and QBO have bank feeds, and the process for entering transactions from the bank feed is similar. Both allow you to create new transactions or match to existing transactions right from the feed.

Xero has a feature called cash coding. Cash coding puts all new and unmatched transactions in a list with fields that can be edited without going to a new screen. This allows you to quickly tab through and assign a name, account, and description to a long list of transactions.

Winner: Xero

2. Flexibility and ease of use

Xero is easy to use, but it is not very flexible. Usually there is only one way to do something. In addition, you can’t edit some transactions. Instead, you have to delete and re-enter if you make a mistake. For example, you can’t edit bank transfers or payments applied to bills/invoices.

Also, you can’t apply one payment to multiple bills denominated in a foreign currency. You have to pay each bill separately, and then match the separate payments to the actual payment in the bank statement.

QBO is extremely forgiving. As far as I can tell, any transaction can be edited. Further, any transaction can act as any other similar transaction. For example, you may add a bank feed withdrawal as an expense. After reconciling the bank account you may realize the withdrawal should have been a bill payment.

You can simply change the name on the expense to the vendor name and change the account to Accounts Payable. This creates a credit on the vendor account, and then you can apply the credit as a payment against the bill. No need to delete the expense, re-enter a bill payment, and re-reconcile the bank account (as you would have to do with Xero).

QBO also has familiarity going for it. Many accountants are familiar with Quickbooks desktop version, and the QBO functionality is similar.

Winner: QBO

3. Stability

Software bugs are frustrating. QBO seems to be more buggy to me. I don’t have specific examples, but often screen don’t load properly or features don’t work as expected. Sometimes the Xero site will go down for a few seconds, but I don’t remember coming across any bugs.

Winner: Xero

4. Reporting 

Neither product has the great reports compared to more expensive systems, such as Netsuite. Of course, you can find all of the standard reports like Income Statement, Balance Sheet, Aged Payables, Aged Receivables, General Ledger, etc. However, customization options are limited.

Xero has better options for customizing individual report layouts. You can group accounts together and create various detail and summary templates. It has the awesome feature of being able to use the same template across multiple companies. For example, I customize the layout of the income statement and balance sheet based on the range of account codes (from the chart of accounts). I use the same chart of account rules in most companies, which allows me to use the same template.

QBO has a wider range of reports and better ability to drill down into detail. They have also recently released a new set of nicely redesigned reports.

Winner: it’s a toss-up with a slight edge to Xero

5. Payroll integration 

Both products have integrated payroll. Xero’s service is relatively new and is being gradually rolled out to US states, but it still has a ways to go. I haven’t used Xero payroll so I can’t speak authoritatively, but it appears that state and federal filings are not automatic (a big drawback in my opinion).

QBO has both basic and full service options. I use Intuit full service payroll for several companies, and I find it extremely simple, easy to use, and inexpensive. Tax filings are completely automated. All you have to do is enter hours (if you have hourly employees) and press a button to submit payroll.

Winner: QBO

As you can see, Xero and QBO have their strengths and weaknesses. Until recently I would have recommended Xero hands-down. However, QBO, with its recent improvements, is now a contender.

Rather than recommending one over the other, I suggest signing up for a free trial and exploring the features that are most important to your business.

If you are moving from Quickbooks desktop, you can automatically convert the Quickbooks data file to either Xero or QBO. This will allow you to test the software with real data. You can re-import the data file when you make a decision and are ready to move forward.

Good luck with your accounting software search!

Question: What other accounting software should small businesses consider? 

Why I Haven't Been Sick For 3 Years

This is a "knock on wood" post. I really shouldn't put this out into the universe, but I will anyway because it’s had such a positive impact on my life. I haven't been sick for almost three years. I haven't even had a minor cold. Going back a little further, I've only been sick twice in about five years.

Before that, I probably caught a minor cold (or worse) at least every three to six months, especially in the winter. I thought getting sick a few times per year was part of life.

It’s been awesome not being forced to periodically slow down (or stop) my normal activities.

I obviously don’t know all the factors, and maybe I’ll get sick right after submitting this post. It would serve me right!

However, I did make a major lifestyle change almost 5 years ago, and I have to believe at least one of these changes have prevented me from getting sick.

In hopes of helping others improve their quality of life, here are the changes I made:

1. Eat nutrient dense foods

I’ve written before about my experience losing 30 lbs about 4 years ago. I believe the biggest factor was a change in my diet.

My typical day used to include cold cereal for breakfast (Life and Lucky Charms were my favorite), sandwich and chocolate bar for lunch, and heavy starches like pasta or potatoes for dinner (with dessert after, of course).

4 years ago I starting making 2 liters of green smoothie every morning, which would last through breakfast and lunch, and then I would usually eat a huge salad loaded with vegetables (with white wine vinegar as dressing) for dinner (with no dessert).

I haven’t been as strict since I lost the weight, but I still make sure I eat primarily nutrient dense foods (i.e. mostly vegetables and fruits). I drink at least a liter of green smoothie per day, and I regularly have a huge salad as a meal. I haven’t eaten much cold cereal over the last 4 years!

2. Limit refined sugar

I began limiting refined sugar at the same time I started focusing on nutrient dense foods. In fact, I don’t think I had any sweets while I was losing weight.

As I mentioned, I thought dessert had to be part of every meal. And snacks between meals. And bedtime snacks. I was definitely addicted to sugar. I blame it on my Grandpa Smith, who kept his work desk stocked with chocolate bars, and his mother, who we called “Candy Grandma” and was famous for her chocolates.

Limiting sugar has given me numerous benefits, and one of those benefits could be an improved immune system.

I haven’t been as strict since I lost the weight, and once in a while my addictive tendencies return. However, I make a conscious effort to eat far less sugar than I used to.

3. Exercise consistently 

I’ve always been fairly active, but about 5 years ago I started exercising almost every. I started lifting weights, and then I trained for and ran a half marathon. I continue the habit of lifting weights 2 times per week and running 3-4 times per week.

It’s good to have regular formal exercise sessions, but even moving more helps. I use a standing desk, which forces me to move more during the day. I also use my iPhone to track my steps, and I shoot for 10,000 steps every day. I try to go for a walk at the end of the day if I’m not quite there.

4. Get adequate sleep

This hasn’t been a major change because I’ve always made sure I get plenty of sleep. But I believe it’s important enough to add to the list.

I have trouble functioning on less than 7 hours, and I usually get at least 8. I would love to add an extra 2-3 hours to my day by getting less sleep, but I don’t think the trade-off is worth it.  I’d rather have a focused and productive 16 hours than a sluggish 18-20 hours.

Besides, if you don’t get enough sleep, your body may force you to rest by getting sick.

I have intentionally been light on science and details. It’s partly because I simply don’t know much, and it’s also because everyone is different.

I can’t guarantee that you’ll go 3 years without getting sick if you follow this list. I can’t guarantee I won’t get sick tomorrow and return to my pattern of getting sick several times per year.

All I know is these changes have worked for me so far!

Now it’s up to you to research and experiment to figure out how to improve your health. Improved health comes with many benefits, including less down time from being sick.

Question: What practices have improved your health? 

My Favorite 10 Books This Year (So Far)

I love books. I usually get through two or three books each month, mostly by listening to audio while doing other things. My favorite books are biographies (including stories of starting and growing companies). I also enjoy self-improvement / productivity, and once in a while I’ll throw in fiction to get a break from thinking too much.

These are the top 10 books I’ve consumed this year (so far):

Biographies

1. Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future  by Ashlee Vance. Elon Musk is incredibly inspiring. He’s building two revolutionary companies at the same time. It was interesting to learn about his struggle to get where he is today, and his future ambitions are mind-boggling.

2. The Wright Brothers by David McCullough. A year ago all I knew about the Wright Brothers was they were the first to fly a manned aircraft. Last year I visited their memorial at Kitty Hawk, which was fascinating. I was excited when their biography was released a few months after that visit.

Their unwillingness to give up inspires me the most. They spent many years learning about flying, designing their flying machines, and testing a number of iterations. During much of that time they didn’t see much hope for success, but they never lost sight of their goal.

3. Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money by Nathaniel Popper. This is a fascinating look at the origins and development of the digital currency, Bitcoin. I have heard the hype about Bitcoin over the last few years, but I had no idea how it works. Although the technology goes over my head, I at least have a basic understanding now.

4. The Innovators: How a Group of Hackers, Geniuses, and Geeks Created the Digital Revolution by Walter Isaacson. This book provides an in-depth look at how computers and the Internet were created. It reads like several biographies in one as the author describes the key players who pioneered this industry.

Self-Improvement

1. Essentialism: The Disciplined Pursuit of Less by Greg Mckeown. This is one of two books I keep downloaded in my Audible app so I can listen multiple times (the other is How Will You Measure Your Life by Clayton Christensen). This is near the top of my all-time favorite list. It has changed my thinking about how to live my life more than almost any other book.

I struggle with implementing an essentialist life, which is to focus my time on only the few most important activities. But I try to work toward that ideal, and listening to it frequently helps to keep me on track. It’s only about 6 hours long, or 3 hours on double time.

2. The Go-Giver by Bob Burg and John David Mann. I wrote a separate post about this book. The authors package the five laws of stratospheric success into a brief, engaging, and easy-to-read parable. The five laws are value, compensation, influence, authenticity, and receptivity.

3. Procrastinate on Purpose: 5 Permissions to Multiply Your Time  by Rory Vaden. Although not quite at the level of Essentialism, this book has also changed my way of thinking about time management. I wrote a book review in a separate post.

Other time management strategies focus on efficiency and prioritization. It is about allocating our 168 hours per week to get as much of your most important activities done as possible. Instead of efficiency and prioritization, Vaden describes how to multiply our time. In essence, it’s about spending time on things today that will give us more time tomorrow.

Fiction

1. No Country for Old Men by Cormac McCarthy. I first heard about this story when the movie adaptation was nominated for several academy awards. I thought if the movie is good, the book must be better. I was not disappointed. I could not stop listening through the fast-paced action and the author’s unique story-telling style.

2. The Hot Zone: The Terrifying True Story of the Origins of the Ebola Virus by Richard Preston. This book technically isn’t fiction, but I include it here because it reads like a story. I would sleep better if it was fiction. Hearing about the gruesome effects of the Ebola virus makes me think twice about touching anything. Regardless of it’s potentially scarring effect, the story is interesting.

3. The John Puller Series by David Baldacci. This is a three-book series: Zero Day, The Forgotten, and The Escape. The books are the adventures of John Puller, a combat veteran and military investigator. The events and prose can be a little over the top, but I enjoyed the suspense-filled stories.

Question: What are your favorite books of the year?