Posted on

A Refresher on Major Tax Law Changes for Small-Business Owners

The dawning of 2019 means the 2018 income tax filing season will soon be upon us. After year end, it’s generally too late to take action to reduce 2018 taxes. Business owners may, therefore, want to shift their focus to assessing whether they’ll likely owe taxes or get a refund when they file their returns this spring, so they can plan accordingly.

With the biggest tax law changes in decades — under the Tax Cuts and Jobs Act (TCJA) — generally going into effect beginning in 2018, most businesses and their owners will be significantly impacted. So, refreshing yourself on the major changes is a good idea.

Taxation of pass-through entities

These changes generally affect owners of S corporations, partnerships and limited liability companies (LLCs) treated as partnerships, as well as sole proprietors:

  • Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%
  • A new 20% qualified business income deduction for eligible owners (the Section 199A deduction)
  • Changes to many other tax breaks for individuals that will impact owners’ overall tax liability

Taxation of corporations

These changes generally affect C corporations, personal service corporations (PSCs) and LLCs treated as C corporations:

  • Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
  • Replacement of the flat PSC rate of 35% with a flat rate of 21%
  • Repeal of the 20% corporate alternative minimum tax (AMT)

Tax break positives

These changes generally apply to both pass-through entities and corporations:

  • Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets
  • Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
  • A new tax credit for employer-paid family and medical leave

Tax break negatives

These changes generally also apply to both pass-through entities and corporations:

  • A new disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
  • New limits on net operating loss (NOL) deductions
  • Elimination of the Section 199 deduction (not to be confused with the new Sec.199A deduction), which was for qualified domestic production activities and commonly referred to as the “manufacturers’ deduction”
  • A new rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
  • New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

Preparing for 2018 filing

Keep in mind that additional rules and limits apply to the rates and breaks covered here. Also, these are only some of the most significant and widely applicable TCJA changes; you and your business could be affected by other changes as well. Contact us to learn precisely how you might be affected and for help preparing for your 2018 tax return filing — and beginning to plan for 2019, too.

© 2018

Posted on

Time to Celebrate! FASB Expands VIE Exception for Private Companies

The Financial Accounting Standards Board (FASB) recently gave private companies long-awaited relief from one of the most complicated aspects of financial reporting — consolidation of variable interest entities (VIEs). Here are the details.

Old rules

Accounting Standards Codification (ASC) Topic 810, Consolidation, was designed to prevent companies from hiding liabilities in off-balance sheet vehicles. It requires businesses to report on their balance sheets holdings they have in other entities when they have a controlling financial interest in those entities.

For years, the decision to consolidate was based largely on whether a business had majority voting rights in a related legal entity. In 2003, in the wake of the Enron scandal, the FASB amended the standard to beef up the guidelines on when to consolidate.

New rules

The updated standard introduced the concept of VIEs. Under the VIE guidance, a business has a controlling financial interest when it has:

  • The power to direct the activities that most significantly affect an entity’s economic performance,
  • The right to receive significant benefits from the entity, and
  • The obligation to absorb losses from the entity.

Private companies contend that some of their most common business relationships could be considered VIEs under ASC 810. These relationships are set up for tax or estate planning purposes — not to trick investors or pump up stock prices.

Private company alternative

Private companies told the FASB that the VIE model forced them to consolidate multiple affiliated and subsidiary businesses onto a parent’s balance sheet. This frustrated lenders and creditors, who wanted cleaner balance sheets. In addition, in companies where ownership is shared among close relatives, determining who holds the power may not always be clear.

In 2014, the FASB issued an updated standard that let private companies ignore the VIE guidance for certain leasing transactions. Private companies applauded this update, but problems persisted with the consolidation guidance for transactions that didn’t involve leases.

So this past October, the FASB issued Accounting Standards Update (ASU) No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, which expands the exception to include all private company VIEs. However, a private company that makes use of the latest amendments to Topic 810 must disclose in its financial statements its involvement with, and exposure to, the legal entity under common control.

Right for you?

The amendments in ASU No. 2018-17 are effective for private companies for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Early adoption is permitted. Contact us to determine whether this election makes sense for your business — and, if so, when you should adopt the simplified alternative.

© 2018

Posted on

Business Owners: An Exit Strategy Should Be Part of Your Tax Planning

Tax planning is a juggling act for business owners. You have to keep your eye on your company’s income and expenses and applicable tax breaks (especially if you own a pass-through entity). But you also must look out for your own financial future.

For example, you need to develop an exit strategy so that taxes don’t trip you up when you retire or leave the business for some other reason. An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money from the business.

Buy-sell agreement

When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Among other benefits, a well-drafted agreement:

  • Provides a ready market for the departing owner’s shares,
  • Prescribes a method for setting a price for the shares, and
  • Allows business continuity by preventing disagreements caused by new owners.

A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income.

Succession within the family

You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.

Under the annual gift tax exclusion, you can gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift.

With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.

Plan ahead

If you don’t have co-owners or want to pass the business to family members, other options include a management buyout, an employee stock ownership plan (ESOP) or a sale to an outsider. Each involves a variety of tax and nontax considerations.

Please contact us to discuss your exit strategy. To be successful, your strategy will require planning well in advance of the transition.

© 2018

Posted on

Conducting an Effective Post – M&A Audit

So, you’re about to merge with another company. What’s next? The integration process typically starts with audited financial statements that reflect the results and financial position of the combined entity. This exercise requires a close partnership between the external audit team and in-house accounting personnel from both companies. Collaboration is key to a seamless transition.

Prepare the audit team

It’s important to notify your audit team about M&A plans long before a transaction takes place — even if there’s still a chance the deal might fall through. This gives the audit team time to pull specialists together who can help you generate timely, accurate postacquisition financial statements.

For example, you’ll need someone with experience applying the business combination rules under U.S. Generally Accepted Accounting Principles (GAAP) and tax experts who know the rules for reporting different types of deal structures under today’s federal and state tax rules. Likewise, if you’re acquiring a company that uses different accounting systems, you’ll need someone who’s familiar with the acquired company’s software, especially if it’s no longer supported by the vendor.

Anticipate auditor needs

Even if your team of specialists has been assembled in advance, once you’ve merged, expect audit fieldwork to take more time than usual. The auditors will review documents associated with the merger, such as due diligence workpapers and legal documents governing the purchase. They’ll also ask to review prior financial statements and audit reports for the acquired company.

The audit partner might even ask to review board minutes discussing the acquisition, as well as minutes from meetings conducted by the team responsible for the integration of the newly acquired entity.

Documents don’t tell the full story, however. The audit team will interview key members of your team, such as accounting personnel and members of the due diligence team. To streamline the process, designate an employee to serve as the audit liaison. He or she will be the primary point of contact to gather your auditor’s requests for information and access to company employees and executives.

Contact us

M&As provide opportunities to enhance your company’s value. But it’s hard to gauge the relative success of a transaction without reliable, timely financial statements. Our auditors can help you allocate the purchase price to acquired assets and liabilities and otherwise report combined financial results in accordance with U.S. GAAP.

© 2018

Posted on

How to Prepare for Year-End Physical Inventory Counts

As year end approaches, it’s time for calendar-year entities to perform physical inventory counts. This activity is more than a compliance chore. Proactive companies see it as an opportunity to improve operational efficiency.

Inventory basics

Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value. There are three types of inventory:

  1. Raw materials,
  2. Work-in-progress, and
  3. Finished goods.

Estimating the value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. The value of work-in-progress inventory can be especially hard to assess, because it includes overhead allocations and, in some cases, may require percentage-of-completion assessments.

Physical counts

A physical inventory count gives a snapshot of how much inventory your company has on hand at year end. For example, a manufacturing plant might need to count what’s on its warehouse shelves, on the shop floor and shipping dock, on consignment, at the repair shop, at remote or public warehouses, and in transit from suppliers and between company locations.

Before counting starts, you should consider:

  • Ordering or creating prenumbered tags that identify the part number and location and leave space to add the quantity and person who performed the count,
  • Conducting a dry run a few days before the count to identify any potential roadblocks and determine how many workers to schedule,
  • Assigning two-person teams to count inventory to minimize errors and fraud,
  • Carving the location into “count zones” to ensure full coverage and avoid duplication of efforts,
  • Writing off any unsalable or obsolete items, and
  • Precounting and bagging slow-moving items.

It’s essential that business operations “freeze” while the count takes place. Usually, inventory is counted during off-hours to minimize the disruption to business operations.

Auditor’s role

If your company issues audited financial statements, one or more members of your external audit team will be present during your physical inventory count. They aren’t there to help you count inventory. Instead, they’ll observe the procedures, review written inventory processes, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.

Be ready to provide auditors with invoices and shipping/receiving reports. They review these documents to evaluate cutoff procedures for year-end deliveries and confirm the values reported on your inventory listing.

Making counts count

When it comes to physical inventory counts, our auditors have seen the best (and worst) practices over the years. For more information on how to perform an effective inventory count, contact us before year end.

© 2018

Posted on

Accounting for Overheads Costs

Accurate overhead allocations are essential to understanding financial performance and making informed pricing decisions. Here’s guidance on how to estimate overhead rates to allocate these indirect costs to your products and how to adjust for variances that may occur.

What’s included in overhead?

Overhead costs are a part of every business. These accounts frequently serve as catch-alls for any expense that can’t be directly allocated to production, including:

  • Equipment maintenance and depreciation,
  • Factory and warehouse rent,
  • Building maintenance,
  • Administrative and executive salaries,
  • Taxes,
  • Insurance, and
  • Utilities.

Generally, such indirect costs of production are fixed, meaning they won’t change appreciably whether production increases or diminishes.

How are overhead rates calculated?

The challenge comes in deciding how to allocate these costs to products using an overhead rate. The rate is typically determined by dividing estimated overhead expenses by estimated totals in the allocation base (for example, direct labor hours) for a future period of time. Then you multiply the rate by the actual number of direct labor hours for each product (or batch of products) to establish the amount of overhead that should be applied.

In some organizations, the rate is applied companywide, across all products. This is particularly appropriate for organizations that make single, standard products — such as bricks — over long periods of time. If your product mix is more complex and customized, you may use multiple overhead rates to allocate costs more accurately. If one department is machine-intensive and another is labor-intensive, for example, multiple rates may be appropriate.

How do you handle variances from actual costs?

There’s one problem with accounting for overhead costs: Variances are almost certain. There are likely to be more variances if you use a simple companywide overhead rate, but even the most carefully thought-out multiple rates won’t always be 100% accurate.

The result? Large accounts that many managers don’t understand and that require constant adjustment. This situation creates opportunities for errors — and for dishonest people to commit fraud. Fortunately, you can reduce the chance of overhead anomalies with strong internal control procedures, such as:

  • Conducting independent reviews of all adjustments to overhead and inventory accounts,
  • Studying significant overhead adjustments over different periods of time to spot anomalies,
  • Discussing complaints about high product costs with nonaccounting managers, and
  • Evaluating your existing overhead allocation and making adjustments as necessary.

Allocating costs more accurately won’t guarantee that you make a profit. To do that, you have to make prudent pricing decisions — based on the production costs and market conditions — and then sell what you produce.

Need help?

Cost accounting can be complex, and indirect overhead costs can be difficult to trace. We can help you understand how to minimize the guesswork in accounting for overhead and identify when it’s time to adjust your allocation rates. Our accounting pros can also suggest ways to monitor cost allocations to prevent errors and mismanagement.

© 2018

Posted on

Buy Business Assets Before Year End to Reduce Your 2018 Tax Liability

The Tax Cuts and Jobs Act (TCJA) has enhanced two depreciation-related breaks that are popular year-end tax planning tools for businesses. To take advantage of these breaks, you must purchase qualifying assets and place them in service by the end of the tax year. That means there’s still time to reduce your 2018 tax liability with these breaks, but you need to act soon.

Section 179 expensing

Sec. 179 expensing is valuable because it allows businesses to deduct up to 100% of the cost of qualifying assets in Year 1 instead of depreciating the cost over a number of years. Sec. 179 expensing can be used for assets such as equipment, furniture and software. Beginning in 2018, the TCJA expanded the list of qualifying assets to include qualified improvement property, certain property used primarily to furnish lodging and the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.

The maximum Sec. 179 deduction for 2018 is $1 million, up from $510,000 for 2017. The deduction begins to phase out dollar-for-dollar for 2018 when total asset acquisitions for the tax year exceed $2.5 million, up from $2.03 million for 2017.

100% bonus depreciation

For qualified assets that your business places in service in 2018, the TCJA allows you to claim 100% first-year bonus depreciation — compared to 50% in 2017. This break is available when buying computer systems, software, machinery, equipment and office furniture. The TCJA has expanded eligible assets to include used assets; previously, only new assets were eligible.

However, due to a TCJA drafting error, qualified improvement property will be eligible only if a technical correction is issued. Also be aware that, under the TCJA, certain businesses aren’t eligible for bonus depreciation in 2018, such as real estate businesses that elect to deduct 100% of their business interest and auto dealerships with floor plan financing (if the dealership has average annual gross receipts of more than $25 million for the three previous tax years).

Traditional, powerful strategy

Keep in mind that Sec. 179 expensing and bonus depreciation can also be used for business vehicles. So purchasing vehicles before year end could reduce your 2018 tax liability. But, depending on the type of vehicle, additional limits may apply.

Investing in business assets is a traditional and powerful year-end tax planning strategy, and it might make even more sense in 2018 because of the TCJA enhancements to Sec. 179 expensing and bonus depreciation. If you have questions about these breaks or other ways to maximize your depreciation deductions, please contact us.

© 2018

Posted on

LIFO Lessons Learned

You have choices when it comes to reporting inventory costs. One popular technique — the last-in, first-out (LIFO) method — assumes that merchandise is sold in the reverse order it was acquired or produced. That is, it allocates the most recent costs to the cost of sales. Although this method is often preferred for tax purposes, internal accounting personnel may be hesitant to use it for various reasons.

Tax benefits

Assuming your inventory costs generally increase over time, LIFO offers a definite tax advantage over other inventory reporting methods. By allocating the most recent — and, therefore, higher — costs first, LIFO maximizes your cost of goods sold, which minimizes your taxable income.

In contrast, the first-in, first-out (FIFO) method assumes that merchandise is sold in the order it was acquired or produced. Thus, the cost of goods sold is based on older — and often lower — prices.

Financial reporting challenges

Before you jump headfirst into using LIFO, it’s important to recognize that it’s not permitted under International Financial Reporting Standards. The approach also involves sophisticated record keeping and calculations.

For example, the “LIFO conformity rule” generally requires you to use the same inventory accounting method for tax and financial statement purposes. Switching to LIFO may reduce your tax bill, but it could also depress your current earnings and reduce the value of inventories on your balance sheet, thus giving the appearance of a weaker financial position.

LIFO also can create a problem if your inventory levels are declining. As higher inventory costs are used up, you’ll need to start dipping into lower-cost “layers” of inventory, triggering taxes on “phantom income” that the LIFO method previously has allowed you to defer.

Moreover, if a C corporation elects S corporation status, the business must include a “LIFO recapture amount” in income for the C corporation’s last tax year. The recapture amount is the excess of your inventory’s value using FIFO over its value using LIFO. Fortunately, you can spread out the tax payments over four years in equal, interest-free installments.

One of the biggest challenges in using LIFO is the need to measure changes in inventory costs. If you currently use LIFO, you may be able to enjoy additional savings by electing to use the inventory price index computation method. It may enable you to reduce administrative costs — and it might even generate greater tax benefits — if you rely on government indexes to calculate LIFO values rather than developing an internal index.

Right for you?

If you’re contemplating a switch to LIFO, there are various issues to address and forms to complete. Contact us to help decide whether it’s right for your business.

© 2018

Posted on

Now’s the Time to Review Your Business Expenses

As we approach the end of the year, it’s a good idea to review your business’s expenses for deductibility. At the same time, consider whether your business would benefit from accelerating certain expenses into this year.

Be sure to evaluate the impact of the Tax Cuts and Jobs Act (TCJA), which reduces or eliminates many deductions. In some cases, it may be necessary or desirable to change your expense and reimbursement policies.

What’s deductible, anyway?

There’s no master list of deductible business expenses in the Internal Revenue Code (IRC). Although some deductions are expressly authorized or excluded, most are governed by the general rule of IRC Sec. 162, which permits businesses to deduct their “ordinary and necessary” expenses.

An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your business. (It need not be indispensable.) Even if an expense is ordinary and necessary, it may not be deductible if the IRS considers it lavish or extravagant.

What did the TCJA change?

The TCJA contains many provisions that affect the deductibility of business expenses. Significant changes include these deductions:

Meals and entertainment. The act eliminates most deductions for entertainment expenses, but retains the 50% deduction for business meals. What about business meals provided in connection with nondeductible entertainment? In a recent notice, the IRS clarified that such meals continue to be 50% deductible, provided they’re purchased separately from the entertainment or their cost is separately stated on invoices or receipts.

Transportation. The act eliminates most deductions for qualified transportation fringe benefits, such as parking, vanpooling and transit passes. This change may lead some employers to discontinue these benefits, although others will continue to provide them because 1) they’re a valuable employee benefit (they’re still tax-free to employees) or 2) they’re required by local law.

Employee expenses. The act suspends employee deductions for unreimbursed job expenses — previously treated as miscellaneous itemized deductions — through 2025. Some businesses may want to implement a reimbursement plan for these expenses. So long as the plan meets IRS requirements, reimbursements are deductible by the business and tax-free to employees.

Need help?

The deductibility of certain expenses, such as employee wages or office supplies, is obvious. In other cases, it may be necessary to consult IRS rulings or court cases for guidance. For assistance, please contact us.

© 2018

Posted on

Audit Opinions: How Your Financial Statements Measure Up

Audit opinions differ depending on the information available, financial viability, errors discovered during audit procedures and other limiting factors. The type of opinion your auditor issues tells stakeholders whether you’re in compliance with accounting rules and likely to continue operating as a going concern.

The basics

To find out what type of audit opinion you’ve received, scan the first page of your financial statements. Known as the “audit opinion letter,” this is where your auditor states whether the financial statements are fairly presented in all material respects, compliant with Generally Accepted Accounting Principles (GAAP) and free from material misstatement. But the opinion doesn’t constitute an endorsement or evaluation of the company’s financial results.

Most audit opinion letters consist of three paragraphs. The introductory paragraph identifies the company, accounting period and auditor’s responsibilities. The second discusses the scope of work performed. The third paragraph contains the audit opinion.

In general, there are four types of audit opinions, ranked from most to least desirable.

1. Unqualified. A clean “unqualified” opinion is the most common (and desirable). Here the auditor states that the company’s financial condition, position and operations are fairly presented in the financial statements.

2. Qualified. The auditor expresses a qualified opinion if the financial statements appear to contain a small deviation from GAAP, but are otherwise fairly presented. To illustrate: An auditor will “qualify” his or her opinion if a borrower incorrectly estimates warranty expense, but the exception doesn’t affect the rest of the financial statements.

Qualified opinions are also given if the company’s management limits the scope of audit procedures. For example, a qualified opinion may result if you deny the auditor access to a warehouse to observe year-end inventory counts.

3. Adverse. When an auditor issues an adverse opinion, there are material exceptions to GAAP that affect the financial statements as a whole. Here the auditor indicates that the financial statements aren’t presented fairly. Typically, an adverse opinion letter contains a fourth paragraph that outlines these exceptions.

4. Disclaimer. Even more alarming to lenders and investors is a disclaimer opinion. Disclaimers occur when an auditor gives up midaudit. Reasons for disclaimers may include significant scope limitations, material doubt about the company’s going-concern status and uncertainties within the subject company itself. A disclaimer opinion letter briefly outlines the auditor’s reasons for throwing in the towel.

Ready, set, audit

Before fieldwork starts for the audit of your 2018 financial statements, let’s discuss any foreseeable scope limitations and possible deviations from GAAP. Depending on the situation, we may be able to recommend corrective actions and help you proactively communicate with stakeholders about the reasons for a less-than-perfect audit opinion.

© 2018