Tariffs Become Reality

Summary

Motley Fool Money: "Tariffs Become Reality" – March 4, 2025

Hosted by Dylan Lewis, Ricky Mulvey, and Mary Long

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Introduction: Tariffs Take Effect

In this episode of Motley Fool Money, hosted by Ricky Mulvey alongside guest analyst Jason Moser, the primary focus is on the tangible impact of recently implemented tariffs. As the global trade landscape shifts, the discussion delves into the immediate consequences for businesses and investors alike.

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Tariffs Implementation: A New Trade Reality

[00:31] Ricky Mulvey opens the conversation by addressing the activation of President Donald Trump's tariffs:

"President Donald Trump's 25 tariffs on goods from Canada and Mexico have taken effect. Today was the deadline. Now it's 20% on Chinese goods. That was up from 10 just a few weeks ago. And in response, we're getting some tit for tat, retaliatory tariffs. China announced those on agricultural products. Canada is going to tariff more than $100 billion worth of American goods over the next three weeks. That's according to the AP. Mexico President Claudia Sheinbaum says she will announce her response on Sunday." [00:31-01:20]

These tariffs mark a significant escalation in the ongoing trade tensions, with China increasing tariffs on goods from 10% to 20%, and Canada responding with over $100 billion in tariffs on American products. Mexico is also poised to announce its retaliatory measures, indicating a broader escalation in the trade war.

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Impact on Businesses: Strategic Responses

[05:02] Ricky Mulvey shifts the discussion to how companies are adapting to the new tariff landscape:

"Taiwan Semiconductor announced that it is investing $100 billion on a new manufacturing plant in the United States. This is the largest single foreign direct investment in U.S. history." [05:02]

Jason Moser adds context by highlighting similar massive investments:

"Apple committing $500 billion here domestically over the coming four years, going to build out some server capacity in other facilities, and then also Eli Lilly committing to an additional $27 billion investment to build four new manufacturing sites here domestically." [05:48]

These strategic moves by major corporations like Taiwan Semiconductor, Apple, and Eli Lilly illustrate a significant shift towards domestic manufacturing. This pivot not only aims to mitigate the impact of tariffs but also aligns with the Trump administration's push for "Made in America" initiatives. Moser notes that such investments are part of a broader trend of companies diversifying their supply chains to reduce dependence on foreign manufacturing, particularly in China.

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Earnings Spotlight: Target's Performance Under Scrutiny

The episode transitions into an in-depth analysis of Target’s recent earnings report.

[07:00] Ricky Mulvey cites Target's CFO, Jim Lee, highlighting softer performance:

"During February, we saw record performance around Valentine's Day. However, our top line performance for the month was soft as uncharacteristically cold weather across the US affected apparel sales and declining consumer confidence impacted our discretionary assortment overall." [07:00]

Jason Moser interprets these results, suggesting a dual impact of broader economic challenges and specific company issues:

"It's a fair say it's a little bit of both... weather is a very legitimate excuse. But in regard to Target, the consumer continues to spend cautiously... Consumers have become increasingly resourceful... That's pressuring Target a little bit." [07:00-08:18]

The discussion points out that Target faces stiff competition from retail giants like Walmart and Costco, compounded by rising inventory levels—which have increased by 7.1% year-over-year—posing challenges in clearing stock without impacting margins.

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Investment Insights: Target as a Value Play

Ricky Mulvey explores the investment potential of Target amidst these challenges:

"This is really becoming a cash flow story, not a growth story... It has about 9 billion left in its authorization. And when you look at the chart long term, not the stock chart, but the earnings per share and the share count, you're seeing two, you're seeing two movements." [10:26]

Jason Moser concurs, categorizing Target as a value investment:

"To me, Target seems like a value play. It’s the kind of company that you want to buy on maximum pessimism... earning per share are up, share count declining... shares around 13 or so times trailing Earnings today, that's pretty darn low historically speaking." [11:26-12:25]

Moser suggests that while Target may not exhibit explosive growth, its steady earnings and strategic share buybacks make it an attractive option for long-term investors seeking stability and value.

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Spotlight on Okta: A High-Flying Tech Player

Shifting focus, the hosts discuss Okta, a security verification company, which reported better-than-expected earnings.

[12:25] Ricky Mulvey highlights Okta's robust performance metrics:

"Okta actually jumping a rare green stock today on better than expected earnings... year on year revenue growth of about 13% and dollar based net retention at 107%." [12:25]

Jason Moser elaborates on these strong indicators, emphasizing Okta's expanding customer base and strategic partnerships:

"They are bringing folks in and expanding those relationships... 70% of their deals were partner influenced... revenue from Amazon Web Services marketplace grew over 80%." [13:16-15:02]

Moser underscores Okta's position in the mission-critical identity security market, noting its extensive integration network with over 7,000 applications and its potential to capture a significant share of the $80 billion market.

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Concluding Thoughts: Navigating a Complex Trade Environment

As the episode draws to a close, Ricky Mulvey and Jason Moser reflect on the intertwined nature of global trade policies and corporate strategies. The implementation of tariffs has not only disrupted existing supply chains but has also spurred significant investments in domestic manufacturing and technology infrastructure.

Moser advises investors to remain vigilant and adaptive, emphasizing the importance of diversification and long-term value considerations in their portfolios. The episode underscores the critical balance between navigating immediate economic challenges and leveraging strategic opportunities presented by shifting trade dynamics.

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Key Takeaways

• Tariffs Impact: The activation of Trump's tariffs on Canada, Mexico, and China has led to retaliatory measures, creating a challenging trade environment.

• Corporate Investments: Major companies like Taiwan Semiconductor, Apple, and Eli Lilly are investing billions in U.S.-based manufacturing to mitigate tariff effects and align with domestic production policies.

• Target's Performance: Target faces mixed earnings results influenced by weather, consumer confidence, and inventory challenges, positioning it as a value investment amidst competitive pressures.

• Okta's Growth: Okta demonstrates strong performance with significant revenue growth and customer retention, benefiting from strategic partnerships and a robust integration network.

• Investment Strategy: Emphasis on diversification, value-focused investments, and adaptability to evolving global trade policies are crucial for long-term portfolio resilience.

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Notable Quotes:

• Ricky Mulvey: "Trade war is usually bad for everyone. [...] everybody's losing." [01:31]

• Jason Moser: "The longer [the trade war] goes on, the more problematic it can become." [01:31]

• Ricky Mulvey: "This is really becoming a cash flow story, not a growth story." [10:26]

• Jason Moser: "Target seems like a value play... shares around 13 or so times trailing Earnings today, that's pretty darn low historically speaking." [12:25]

• Jason Moser: "Identity security represents an $80 billion total addressable market opportunity." [15:02]

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This comprehensive discussion provides investors with valuable insights into the current trade environment, corporate responses, and strategic investment opportunities, offering a nuanced understanding of how tariffs are reshaping the business landscape.

Transcript

[Ricky Mulvey]

Foreign the tariffs hit the floor. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by, you know, I'll call you, my domestic trading partner, trading partner of opinions, it's Jason Moser. Thanks for being here, man.

[Jason Moser]

Ricky, thanks for having me. Always a pleasure.

[Ricky Mulvey]

Sometimes we try to avoid the tariff stuff, but today it is unavoidable. We got it. We got to address this head on. Jmo, and this is subject to change by the time we are recording this at 1:30pm Eastern, 11:30 mountain time for, for the three of us who live out here, but subjects between this recording and the time you're listening. President Donald Trump's 25 tariffs on goods from Canada and Mexico have taken effect. Today was the deadline. Now it's 20% on Chinese goods. That was up from 10 just a few weeks ago. And in response, we're getting some tit for tat, retaliatory tariffs. China announced those on agricultural products. Canada is going to tariff more than $100 billion worth of American goods over the next three weeks. That's according to the AP. Mexico President Claudia Sheinbaum says she will announce her response on Sunday.

[Allison Southwick]

Oh, boy.

[Ricky Mulvey]

Trade war is usually bad for everyone. Jmo, what do you make of this actually happening and not being a negotiating tactic with the can getting kicked down the road?

[Jason Moser]

Well, I do, I do like your point there. I mean, it's just sort of as the information is coming out, right? It seems like this is changing not just by the day, but by the hour. So tomorrow we could wake up and face a completely different headline. But I mean, I think the general consensus is this is politics, right? I mean, tariffs are a long used negotiating tool. Nothing new there. The risk I think here is just in how long this goes on, right? I mean, the longer it goes on, the more problematic it can become. And I mean, when you, when you consider some of the numbers there, I mean, we import close to, I think $4 trillion annually here domestically, Mexico and Canada are like really big part of that somewhere to the tune of 30%, not to mention our relationship with which, with China. So, yes, I mean, this is, this is that tit for tat costs going up across the board for everyone seems like a lose, lose, lose, right? I mean, everybody's losing. So I can't imagine this continues on forever given the nature of tariffs being a negotiating tool. But we shall see.

[Ricky Mulvey]

We're seeing companies make moves to sort of protect themselves from a prolonged trade war. You know, the policy for, from the Trump administration, if you are a company leader. He wants more stuff made in America.

[Jason Moser]

Yeah.

[Ricky Mulvey]

And we're going to talk about one of those companies in a sec. But as an investor, are you, you know, are you looking at your portfolio in a different way? Earlier today I was looking at Home Depot sales to see how much they're doing in the US Pretty much all of their business, in fact, is in the United States. But has this, you know, trade spat Tarifor round two. Is this leading you to, you know, look at the companies you own in a different way, if at all?

[Jason Moser]

That's a good point about Home Depot sales. And it's also worth noting, I mean, Home Depot supply chain is, is very much tied to China. And what we've seen over the last several years is a lot of these companies are trying to figure out ways making the investments required to diversify that supply chain away. I'm not really investing any differently. I think it's a very fair concern and, and in something for people to think about. I just continue to invest. I'm dollar cost averaging into my retirement account and typically that money goes into just an s and P500 index fund. And then I'm letting the dividend cash accumulate. I'm not out really making too many purchases right now because it does feel like this could get a little bit worse before it gets better. I don't know. Not trying to time it, but. But speaking of timing, I mean, timing, this stuff is just really difficult. Right. It's a fool's errand, little fool's errand. And I think this is just a good reminder in the value of diversification. Right. Holding levels of cash that make you feel comfortable and then that ultimately allows you to take advantage of opportunities if they arise. Because these are times when opportunities do come up.

[Ricky Mulvey]

Yeah. I've enjoyed doing the game theory in my mind. And you're right. Even if you get the sales right for a company like Home Depot, maybe you don't get the bank shot with all of the supply chain.

[Jason Moser]

Yeah, you got to look at those margins.

[Ricky Mulvey]

We're also looking at companies respond to this, maybe long term. Taiwan Semiconductor announced that it is investing $100 billion on a new manufacturing plant in the United States. This is the largest single foreign direct investment in U.S. history. And you know, as investors, we're not, you know, you don't want to play the tariff war game. But Jamo, you're certainly seeing companies making moves based on this new administration's policy.

[Jason Moser]

There is no doubt there. I mean, it's a very good example There in a couple of others that come to mind here that we just saw headlines on. Apple committing $500 billion here domestically over the coming four years, going to build out some server capacity in other facilities, and then also Eli Lilly committing to an additional $27 billion investment to build four new manufacturing sites here domestically. So, I mean, that is something where, I mean, companies I think have been more focused on this over the last several years because this isn't really, and this isn't the first. We've been talking about sort of supply chain reliance there. But, but it's, it's just sort of another notch in the belt as to why we keep on talking about it in what companies can ultimately do. And we're seeing more and more companies take action.

[Ricky Mulvey]

And just as a consumer of news, sometimes it is difficult for me to, you know what is directly tied to this new trade policy and what's already been in the works for years. And now if you're a, if you're a public relations person at Taiwan Semiconductor, you say, you know what, maybe we should let President Trump announce our new facility and get some good graces with this administration.

[Jason Moser]

There was a little political gamesmanship there. Yeah, I'd imagine.

[Ricky Mulvey]

So let's get to some earnings Target Tarjay announcing this morning, full year, comparable sales, essentially flat. Jmo, this is one of the longest earnings calls that I come across. They really give you a lot of detail here, but the headline came from CFO Jim Lee. This is getting attention. Quote, during February, we saw record performance around Valentine's Day. However, our top line performance for the month was soft as uncharacteristically cold weather across the US Affected apparel sales and declining consumer confidence impacted our discretionary assortment overall, end quote. You never like to hear a retailer saying the consumer is getting a little softer. But when you're looking at this commentary, looking at these earnings, how much of this is an economic problem and how much of this is a Target problem?

[Jason Moser]

So I think it's fair to say it's, it's a little bit of both. Now, Target has definitely had its fair share of internal issues lately. Weather is one of those things we always kind of like to have fun with. And, and it sounds like a funny excuse, but the fact of the matter, it's a very legitimate excuse. And with retailers specifically, I mean, those are sales that you just aren't going to necessarily recoup. Right. I mean, whether does have that, that impact on certain businesses. But I think in regard to Target, I mean, you look at what we were Just digging into last quarter through, through that earnings call. The, the language in there was very similar. The consumer continues to spend cautiously, most notably in discretionary categories. They also noted that consumers have become increasingly resourceful. Right. I mean we are no dummies. We know that there are deals to be had especially now and we're going to go find them and we have a lot of tools that we can use to, to do just that thing. And so that I think is something that's, that's pressuring Target a little bit as well, I think all things considered. I mean it does feel like it's a combination of both and for a company like Target where they are up against some real behemoths in, in competition out there. I mean think about Walmart, Costco, other businesses like that. That's just. You're going up against the best of the best. Yeah.

[Ricky Mulvey]

And Walmart to be fair, also seeing a shift away from general merchandise. As they say consumer wallets have been stretched over the past couple of years. But jmo, you never see a company crediting weather for any good performance. It's always the bad weather is taken away from sales. It's not. You know, it was really sunny in Q3, so we saw more people coming on down to Target town. How about the inventory situation? This is something that is plagued Target for a few years now and they talked a lot about it on the earnings call. The importance of getting milk when you go to Target and you need to find milk because if you lose one of those sales, you lose a lot of other sales. How's the vibe? Is the situation fully under control?

[Jason Moser]

I would. So I wouldn't say it is fully under control. I mean inventories are up 7.1% from a year ago now. They did note in the call that was due to a few factors. They pulled forward some inventory receipts in order to sort of update their offerings especially in apparel and hard lines. They did add to new food distribution centers and made some international investments as well. So that had an impact as well. But, but generally speaking, yeah, I think that's something always to keep an eye on with, with a company like this. Because when those inventory. Inventory is very tricky. Right. I mean do you want it to be up, do you want to be down? It shouldn't be too much either way. But when you start seeing that inventory going up like that, that going to have a little bit of a tougher time clearing that inventory out and, and ultimately may have to resort to more deal making with consumers which obviously impacts margins.

[Ricky Mulvey]

And one Partnership I wanted to get your take on is that Target has a partnership with Champion to sell quote sportswear that's designed to lounge or live in rather than performance wear meant for the gym. This begs a very important question, Jason. Can we call apparel sportswear if you aren't supposed to wear it while playing sports?

[Jason Moser]

Well, isn't that just athleisure, right, Ricky? I mean it's like I, you know, I'm wearing stuff that makes me look like I play sports, but I don't really play sports. But it looks cool, right? That's, that's athleisure, isn't it?

[Ricky Mulvey]

I want to talk about the, the stock for a little bit because if you look at Target, yes, they will tell you about their growth initiatives, the satisfaction that they are tracking when people use their self checkout line. But this is really becoming a cash flow story, not a growth story. And that can be a good thing for long term investors. Cash flow stories can reward shareholders. We talked about Home Depot earlier. Their long term investors have benefited fabulously from that long term cash flow story. In the case of Target, the company bought back about $500 million worth of stock in the quarter. It has about 9 billion left in its authorization. And when you look at the chart long term, not the stock chart, but the earnings per share in the share count, you're seeing two, you're seeing two movements. Earnings per share is rising in the share count is generally declining. I bring this up with you because I'm looking for the next autozone here. I'm looking for the next Home Depot. Is Target worth considering? Is a sleeper stock or a defensive play? Or do you think there's better options out there?

[Jason Moser]

To me, Target seems like a value play. It seems like the kind of company that you want to buy on maximum pessimism, right? Doing the valuation work and realizing that maybe there's a little bit more potential here than the current price indicates. And then what happens with value investments? You need to be prepared to sell them whenever you feel like that valuation gets out of control. I mean, when you look at Target over the last five and 10 years, this has not been some like the world on fire investment. I mean it is not close to beating the market. That could be for a number of reasons. I like the idea that earnings per share are going up, share accounts coming down. We obviously know they have a strong dividend yield there. But to me it just seems more like a value style investment at this point given the competitive landscape. And so with shares around 13 or so times trailing Earnings today, that's pretty darn low historically speaking. So maybe there is, maybe there is something here. We got to maybe look under the hood and do a little bit more work.

[Ricky Mulvey]

So this is one if you're considering you're keeping it on a short leash and you want to know what your intrinsic value is for the company before you pull the trigger. Let's hit Okta real quick. Octa actually jumping a rare green stock today on better than expected earnings. The security verification company announced year on year revenue growth of about 13%. The ones I'm paying attention to are that dollar based net retention, that is what current customers are spending and, and it's at 107%. That translates to current customers are sticking with Okta and they're spending more. And also the company pointing out that it has beaten the rule of 40 every year is a public company. That is revenue growth plus profit margin to show a healthy software as a service company. Fast growing company. Shareholders are liking it. What stood out to you from the quarter?

[Jason Moser]

Well, it's no Axon Ricky, but that 107% dollar base net retention rate was certainly encouraging. I do tell you it's nice to see that they are bringing folks in and expanding those relationships. That's basically, that's basically what that boils down to. I think for me looking, looking at the quarter, the numbers are very good. The guidance I thought was, was pretty noteworthy. They're guiding for 10% revenue growth this current quarter and 9 to 10% revenue growth for the full year. I wonder if that perspective could change here as, as the year carries on. But we talk a lot about mission critical stuff and certainly Okta operates in that environment. What they offer is fairly mission critical share repurchases to this point. They don't spend a ton on share repurchases yet they just ultimately go to offset dilution. But it is interesting to see that stock based compensation is coming down as a percentage of revenue. That's good. I'd like to see that maybe this company's kind of growing up and that's a good sign of that big focus on their partner ecosystem in the call. And think large cloud service providers. They did say in the fourth quarter over 70% of their deals were partner influenced. And to kind of quantify that a little bit better, they said in fiscal 25 revenue from Amazon Web Services marketplace grew over 80%. So I think it's just another indicator of the benefits that companies like Okta have plugging into those big partner networks like Amazon, Google, Microsoft and And so on. And then I think remaining performance obligations that that increased 25% across the $4 billion mark. And, and that's the RPO is just a good indicator. It kind of gives you some revenue visibility. It's a good indicator of financial health and one that can give you a good way to look at growth prospects as well.

[Ricky Mulvey]

You really tried to do the compliment sandwich there. This is a company that's growing relationships with customers. It's doing pretty well. And your first thought is this is no act.

[Allison Southwick]

How.

[Ricky Mulvey]

How many times a day are you thinking about Axon over there? My man.

[Jason Moser]

I tell you man, you just got me, you diverted my attention here with the word sandwich.

[Ricky Mulvey]

I experience. So my experience with Okta is as a, as a user we use it for a two factor authentication. And I've always thought, you know, this seems pretty replicable for any cyber security company which is you try to log on to your email, you got to go to your phone, you click a button, you enter a code, you do a little dancy dance, then you can respond to emails. But you know, I know you, you focus on this world a little bit more than me. What's so special about Okta's product?

[Jason Moser]

The replicable part? I think that's true to an extent, but I don't think it's necessarily as easy to replicate particularly in our multi device work from everywhere and anywhere world. I mean Okta's had a lot of time to really work on building all of this out and in competitors. You know, companies just in the cybersecurity space, they need to ask themselves is it really worth trying to catch up. But I think one of the things that stands out with Okta, it's a neutral cloud based identity solution. So its interoperability I think is really one of its advantages. Just it's ultimately it allows customers to go on their terms. It integrates with virtually any application, service or cloud that they choose. I mean the Okta integration network boasts more than 7,000 interfaces, cloud, mobile and web applications, Internet of things devices and IT infrastructure providers. So it's just, it's a very involved business. They've done a very good job of building out this network of capability. Again, kind of going back to that idea of mission critical. I mean identity security represents an $80 billion total addressable market opportunities. The company views it today and my suspicion is, is that they are well on their path to capturing more of.

[Ricky Mulvey]

That good place to end it. Jason Moser, go get yourself a sandwich. But thanks for being here. In the meantime, appreciate your time and your insight.

[Jason Moser]

Thank you.

[Ricky Mulvey]

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[Robert Brokamp]

The majority of American workers get their paychecks from an employer. But for many Americans, their boss is that person staring back at them in the mirror. Oh, so good looking. Oh wait, I may have to report myself to HR now. According to the U.S. bureau of Labor Statistics, more than 10% of the U.S. workforce is self employed. Then there are the people who have a primary job but earn a little extra money in their off hours. According to a Bankrate survey, more than a third of US Adults earn extra income through a side hustle. While being your own boss has its benefits, it also comes with some unique financial planning challenges. Taxes, retirement planning, cash flow and legal issues are all different when you're working for yourself. But no worries if you count yourself among one of these people. Here are a few bits of advice for making the most of your self employment while protecting what you've already accumulated and keeping Uncle Sam happy. The first one is to separate yourself from your business.

[Allison Southwick]

Yeah, in most situations you don't have to file any paperwork to work for yourself. You just start doing the work and collecting the money and you're essentially acting in what is known as a sole proprietor. And in some situations you may actually have to register as such. But in most cases it's just a business structure that sort of automatically forms when you begin working for yourself. And most self employed folks are sole proprietors. The problem is there's no legal separation between you and the business. Right? So if you ever get sued for something you did, said or sold while doing the work, people can come after your personal assets. You're also personally liable for any of the debts of the business. And it works the other way around too, right? So if you're sued for something you did outside work, lawyers can come after your business. So most people should create a separate legal entity for their business. And the most common option is a limited liability corporation or llc. It puts a box around your business so customers can't come after your personal property. And it protects the business itself. It's a state legal entity, so the rules vary from state to state, but in many cases you can just establish an LLC by visiting the website of the Secretary of State in your state. There are other options such as a C Corp, an S Corp, which may be appropriate if you're running an actual fun time business. You have employees, maybe inventory, and particularly if you want there to be shares of stock in your company. So see an attorney to help choose the right business structure for you. But for most solopreneurs and side giggers, an LLC is the way to go.

[Robert Brokamp]

Now you're going to want to have a system for handling inconsistent cash flow.

[Allison Southwick]

One of the challenges of being self employed is that you don't receive a regular paycheck of the same amount on a predictable schedule. So you might be wondering, how are you going to pay the cost of the business as well as your personal bills when you're not sure how much you're going to make? So I'm going to explain one way to do it, and it's loosely based on a system developed by a fellow named Mike Michalowicz. This is an abridged version, so I recommend that you get Mike's book, which is called Profit first, to learn more. You also find lots of podcasts and YouTube videos about the Profit first system. So it starts by having a collection of separate bank accounts for your business. And this is important no matter what system you follow. You should have separate accounts for your business income and expenses. Otherwise, if you're mixing your personal and business money, that can lead to legal problems. Okay, so all of your income from your business goes into one separate bank account and then twice a month you send that money to a few other accounts. First account is your profit account, and Mikhailowich suggests you just start with 1% of your income, but you're just ensuring that you're profitable from day one. The next account is your owner's comp. This is your base salary, the bare minimum that you can expect to pay yourself and if you've been doing your business for a while, you base this on maybe your slowest month of the year or your slowest quarter of the year. Just a bare minimum that you can feel comfortable that you know for sure you're going to get. The other account is taxes, because taxes are a lot more complicated when you're self employed. Rather than having an employer withholding taxes, you have to send taxes to the government four times a year. So you want an account for that, you want to collect enough of those taxes so that money is there when you need to send the money. And then the final account is expenses. And this is just based on your regular expenses for the business. And if you get to this point and you don't have enough money to cover your expenses, then it's sort of a come to Jesus moment where you have to right size your business. So you do all that and then every quarter you pay yourself 50% of what's in the profit account. You lead the other 50% as sort of an emergency fund, but this is sort of like a bonus. Then you pay the taxes out of the tax account to the state and federal authorities, and then every quarter you adjust the percentages. And Mikhailowich says it takes a good 48 quarters to get the percentages right. The benefits of this system is that as the name suggests, you make sure that you pay yourself a profit first. You're also establishing a base amount of pay that you can budget for. You're also making sure that you have enough money in your tax account when it comes time to pay the taxes. And finally, it ideally forces you to keep your expenses in line with what you could afford.

[Robert Brokamp]

Speaking of taxes and expenses, you're also going to want to track and maximize the value of your expenses.

[Allison Southwick]

One of the benefits of having your own business is that you get to deduct what the IRS calls ordinary and necessary expenses. What does that mean? Well, here's an explanation straight from IRS.gov's an ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for a trade or business. An expense does not have to be indispensable to be considered necessary, end of quote. So if you're about to buy something, just ask yourself, would I be buying this if I didn't have my business? If the answer is no, then that's probably a good candidate for a deduction. And you can also write off a portion of expenses for something that use for both personal and professional reasons, such as like a cell Phone, a laptop, Internet service, stuff like that. You can write off a portion of your rent or your home. If part of your residence is used exclusively for business purposes, you can take a deduction for miles that you drive that are attributable to your business, even 50% of the cost of meals if they had a legitimate business purpose. So there are a lot of possibilities, but make sure you do the research first. The IRS has a whole webpage devoted to this. Look for the guide to business expense resources on IRS.gov and finally, it's very important to keep all your receipts and write on the receipt the business reason for the expense. If you ever get audited, a bank account or a credit card statement will not often be enough and the deduction will be disallowed.

[Robert Brokamp]

You know, while we're talking about taxes, let's just keep talking about taxes, including how to determine the best tax strategy for you.

[Allison Southwick]

Yeah, as I said earlier, taxes are a lot more complicated. If you're self employed, not only do you have to pay estimated taxes four times a year, but you're responsible for the employee and the employer portion of Social Security and Medicare taxes, also known as FICA or payroll taxes, which when you total Those up, it's 15.3% of wages. Another interesting part about this is if you're an llc, there's no such thing as being taxed as an llc. You have a choice of how you'll be taxed. Most choose to be taxed as a sole proprietor, which means that their income expenses show up in the schedule C of their own tax return. However, it might, and I say might be advantageous to be taxed as an S corp or be an S corp in order to pay less in payroll taxes. So this is a complicated topic, so I'm going to try to illustrate it with an example. So let's say you're a sole proprietor, an LLC choosing to be taxed as a sole proprietor. Your business income, that's your income after expense is $100,000. That's also going to be your wages. So Your wages are $100,000. You apply 15.3% of payroll taxes to that, you're going to pay payroll taxes of $15,300. Now let's say you choose to be taxed as an S corp. The interesting thing about an S corp is that you're an employee and you choose your wage. It has to salary for what you do. But let's say again, the business income is $100,000. You're going to choose a salary of $60,000. The other $40,000 is going to be a profit distribution to you. Social Security taxes are only applied to wages. In this example, you're only going to apply it to the 60,000 you paid yourself as a salary. That's lowering your FICA taxes to a little over $9,000. So you've saved $6,000 in FICA taxes by being taxed as an S corp. You'll find all kinds of articles and YouTube videos extolling the benefits of being taxed as an S corp. And there definitely are benefits, but they often leave out some of the downsides. So first of all, if you're going to be an employee, you have to have a payroll, you have to run a payroll, and that will cost you a few hundred dollars a year. Also, if you work with an accountant, and you probably should, they're going to charge you probably another thousand to two thousand dollars to file the return for an S corp. You're going to be lowering your Social Security benefits because you're paying less into the system and your benefit is determined by how much you pay into the system. And then finally, any money that you want to contribute to a retirement account can only come from wages. So in our example we said that you were giving yourself a profit distribution of $40,000. None of that could be contributed to a retirement account. All that said, choosing to be taxed as an escrow could still make a lot of sense in a lot of situations. So you most definitely want to work with a professional to figure out which one is right for all.

[Robert Brokamp]

Right, well, let's keep talking about retirement because of course choosing the best retirement plan is also a huge consideration.

[Allison Southwick]

Yeah, when you work for a company, you're stuck with the type of plan and the financial services company that your employer chooses. But when you work for yourself, you get to choose the account type and the provider. And we could do a whole episode on the different retirement account options for the self employed. But for now, let's just hit the highlights. The first one is just a regular old ira, open to anyone with earned income or married to someone with earned income. One type of account that is popular with self employed folks is the SEP ira. It's sep, it has higher contribution limits than a regular ira. Best for self employed solopreneurs or maybe if you have a partner. Generally not best for anyone with employees. Another type is the simple ira, also higher contribution limits than a regular ira. You'll find that's most commonly used by small businesses with employees and the cash flow to make a small employer match, and then finally the solo 401k or often called the one participant 401k. And this is if you're the only employee or the only other employee is your spouse, and in most situations this is the account with the highest potential contribution limits. Because you make the employee contribution and you can make an employer match, it does have somewhat higher costs and paperwork, especially once the account gets over $250,000. But this is nowadays probably the most popular account for solopreneurs. So do some research or work with a professional to determine which account type is best for you. And when looking for providers, make sure they offer the Roth account if that's an option you want. All of these can be Roth accounts, but not every provider offers it as an option. Currently, solo 401k offerings are more likely to allow for Roth contributions, but even that's not true in every case.

[Ricky Mulvey]

As always, people on the program may have interests in the stocks they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley fool editorial standards and are not approved by advertisers. Motley fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. Be back tomorrow.