M&A Transactions: Avoid Surprises From The IRS

If you’re considering buying or selling a business — or you’re in the process of a merger or acquisition — it’s important that both parties report the transaction to the IRS in the same way. Otherwise, you may increase your chances of being audited.

If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.

What’s reported?

When buying business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:

  • Equipment,
  • Buildings and improvements,
  • Software,
  • Furniture, fixtures and
  • Intangibles (including customer lists, licenses, patents, copyrights and goodwill).

In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.

IRS scrutiny

The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the IRS finds that different allocations are used, auditors may dig deeper and the investigation could expand beyond just the transaction. So, it’s in your best interest to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.

The tax implications of buying or selling a business are complicated. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best postacquisition results, consult with us before finalizing any transaction.

© 2019

Private Companies: Beware of SEC Scrutiny

The Securities and Exchange Commission (SEC) doesn’t monitor just publicly traded companies. It also looks at the dealings of some private companies, often to the surprise of their owners and executives.

Reasons for SEC scrutiny

The SEC’s mission is to protect the public as well as the integrity of the financial markets. That mission extends to not only public companies but also private ones that may be acquired by a public company or that are large enough to consider an initial public offering (IPO).

Ultimately, whether a private company attracts regulatory scrutiny depends on its disclosures regarding current and projected financial performance. Therefore, private companies must walk a fine line between 1) enticing would-be investors with attractive financial projections, and 2) painting an overly optimistic picture that’s unhinged from reality.

Interest in private company activities

Increasingly, the SEC has unleashed enforcement actions and investors have filed lawsuits related to allegedly misleading or erroneous statements made by private (or formerly private) companies. So, companies contemplating an IPO or a merger with a public company should begin developing their approach to SEC compliance as soon as possible.

The risk of attracting the attention of the SEC is particularly concerning if there’s a secondary market for your company’s pre-IPO shares. These are known as “security-based swaps” for purposes of SEC regulation. If the swaps are available to retail investors who don’t meet the criteria of an “eligible contract participant” under the Dodd-Frank Act, the securities must follow specific rules, including the existence of a registration statement and the ability to trade on a national securities exchange.

Additionally, the Financial Accounting Standards Board (FASB) recently proposed Accounting Standards Update No. 2019-600, Disclosure Improvements — Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative. The updated FASB guidance — which would apply to both public and private entities — would better sync U.S. Generally Accepted Accounting Principles (GAAP) with the SEC’s updated disclosure requirements.

Proactive compliance

It takes time to create and deploy an effective corporate governance program that complies with the SEC rules. Start the process by determining whether retail investors participate in trading that raises your company’s compliance risk. Pay close attention to every financial disclosure and the publicly available information that may affect trading. This effort should also include keeping track of material, nonpublic information available to insiders who may sell shares in the secondary market.

Next, create and deploy policies regarding how your company compiles its financial reports. Implement tools and procedures designed to prevent financial crime — such as internal fraud, bribery and corruption — and ensure compliance with SEC regulations. For example, you might consider setting up an anonymous whistleblower hotline for employees to report concerns regarding the company’s activities.

We can help

Companies on their way to becoming public represent a small, but growing, segment of the SEC’s enforcement activity. Protect your company against unwanted scrutiny by learning and complying with the SEC’s financial reporting rules and regulations.

Contact us to get a comprehensive assessment of your private company’s corporate governance practices. Now’s the time to shore them up, rather than waiting for an IPO or a merger with a public company.

© 2019

Bartering: A Taxable Transaction Even If Your Business Exchanges No Cash

Small businesses may find it beneficial to barter for goods and services instead of paying cash for them. If your business engages in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

Income is also realized if services are exchanged for property. For example, if a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.

Barter clubs

Many business owners join barter clubs that facilitate barter exchanges. In general, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

Bartering is generally taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,000 credit units one year, and that each unit is redeemable for $1 in goods and services. In that year, you’ll have $2,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income at a 24% rate.

Required forms

By January 31 of each year, the barter club will send you a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services, and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

If you don’t contract with a barter exchange but you do trade services, you don’t file Form 1099-B. But you may have to file a form 1099-MISC.

Many benefits

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. Contact us for more information.

© 2019

The Pros and Cons of Interim Reporting

The Securities and Exchange Commission (SEC) requires certain public companies to publish quarterly financial statements to give investors insight into midyear performance. Though interim reporting generally isn’t required for private companies, stakeholders in smaller entities can benefit even more than those of public companies from this type of information. But it’s also important to understand the potential shortcomings.

Upsides

Interim financial statements cover periods of less than a year. They show how a company is doing each month or quarter.

If you think of annual financial statements as report cards for a business, interim reports would be like progress reports that may forewarn of troubles ahead — or reassure you that everything is going well. A lender or investor might request interim financial statements if a company:

  • Has implemented a turnaround plan to avert bankruptcy,
  • Has previously reported a major impairment loss,
  • Is in an industry that is experiencing a downturn, or
  • Is seeking new investors or applying for a loan.

These reports may provide peace of mind. Or they might signal impending financial turmoil due to, say, the loss of a major customer, significant uncollectible accounts receivable or pilfered inventory.

Early detection of such problems is critical for smaller businesses. While large public companies can often recover from a bad quarter or year, waiting until year end to discover these issues can be disastrous to a smaller business.

Downsides

Interim reports also have certain drawbacks and limitations. Unlike annual financial statements, interim financial statements are usually unaudited and condensed. So, when reviewing interim reports, revisiting last year’s complete annual financial statements may be helpful. Also check that accounting practices are consistent between the interim and year-end financial statements.

Specifically, interim numbers may omit estimates for bad-debt write-offs, accrued expenses, prepaid items, management bonuses or income taxes. And sometimes tedious bookkeeping procedures, such as physical inventory counts, updating depreciation schedules and composing detailed footnote disclosures, aren’t completed until year end. Instead, interim account balances often reflect last year’s amounts or may be based on historic gross margins.

For seasonal businesses, there are operating peaks and troughs. So you can’t multiply quarterly profits by four to reliably predict year end performance. Instead, you may need to benchmark current year-to-date numbers against last year’s monthly (or quarterly) results.

For more information

If interim statements reveal irregularities, you should consider digging deeper to find out what’s happening. Our accounting and auditing pros can help you address unresolved issues and determine an appropriate course of action.

© 2019

Which Entity is Most Suitable for Your New or Existing business?

The Tax Cuts and Jobs Act (TCJA) has changed the landscape for business taxpayers. That’s because the law introduced a flat 21% federal income tax rate for C corporations. Under prior law, profitable C corporations paid up to 35%.

The TCJA also cut individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and LLCs (treated as partnerships for tax purposes). However, the top rate dropped from 39.6% to only 37%.

These changes have caused many business owners to ask: What’s the optimal entity choice for me?

Entity tax basics

Before the TCJA, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations. A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation, their current 21% tax rate helps make up for it. This issue is further complicated, however, by another tax provision that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, that deduction is available only through 2025.

Many factors to consider

The best entity choice for your business depends on many factors. Keep in mind that one form of doing business might be more appropriate at one time (say, when you’re launching), while another form might be better after you’ve been operating for a few years. Here are a few examples:

  • Suppose a business consistently generates losses. There’s no tax advantage to operating as a C corporation. C corporation losses can’t be deducted by their owners. A pass-through entity would generally make more sense in this scenario because losses would pass through to the owners’ personal tax returns.
  • What about a profitable business that pays out all income to the owners? In this case, operating as a pass-through entity would generally be better if significant QBI deductions are available. If not, there’s probably not a clear entity-choice answer in terms of tax liability.
  • Finally, what about a business that’s profitable but holds on to its profits to fund future projects? In this case, operating as a C corporation generally would be beneficial if the corporation is a qualified small business (QSB). Reason: A 100% gain exclusion may be available for QSB stock sale gains. Even if QSB status isn’t available, C corporation status is still probably preferred — unless significant QBI deductions would be available at the owner level.

As you can see, there are many issues involved and taxes are only one factor.

For example, one often-cited advantage of certain entities is that they allow a business to be treated as an entity separate from the owner. A properly structured corporation can protect you from business debts. But to ensure that the corporation is treated as a separate entity, it’s important to observe various formalities required by the state. These include filing articles of incorporation, adopting by-laws, electing a board of directors, holding organizational meetings and keeping minutes.

The best long-term choice

The TCJA has far-reaching effects on businesses. Contact us to discuss how your business should be set up to lower its tax bill over the long run. But remember that entity choice is easier when starting up a business. Converting from one type of entity to another adds complexity. We can help you examine the ins and outs of making a change.

© 2019

In Pursuit of Global Tax Transparency

In today’s global economy, multinational corporations engage in numerous cross-border transactions. But how they report those transactions is often vague. To help minimize stakeholders’ exposure to potential hidden risks, the Financial Accountability & Corporate Transparency (FACT) Coalition wants multinationals to disclose more information about corporate taxes.

A global movement

The FACT Coalition is a nonpartisan group of more than 100 state, national and international organizations working toward a fair global tax system and curbing corrupt financial practices. Its website reports that, until the passage of the Tax Cuts and Jobs Act (TCJA), the 500 largest U.S. companies had $2.6 trillion stashed offshore, costing taxpayers over $750 billion in unpaid taxes. But tax reform didn’t completely stop the problem. Under the TCJA, offshore tax avoidance is expected to cost an additional $14 billion in lost tax revenue over the next decade.

As of March 2019, the United States and 77 countries require multinationals to file country-by-country reports privately to tax authorities, according to a standard set by the Organisation for Economic Co-operation and Development (OECD). But few countries require public disclosures of such information, except by certain banks and oil, gas and mining companies.

What inquiring minds want to know

The FACT Coalition recently issued a report titled Trending Toward Transparency: The Rise of Public Country-by-Country Reporting. It urges Congress, the U.S. Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) to up the ante.

Specifically, the FACT Coalition wants multinational corporations to publicly disclose, on an annual, country-by-country basis:

  • The number of entities,
  • The names of principal entities,
  • Primary activities of these entities,
  • The number of employees,
  • Total revenues broken out by third-party sales and intragroup transactions of the tax jurisdiction and other tax jurisdictions,
  • Profit/loss before tax,
  • Tangible assets other than cash and cash equivalents,
  • Corporate tax paid on a cash basis,
  • Corporate tax accrued on the profit or loss (including reasons for any discrepancies), and
  • Significant tax incentives.

The FACT Coalition believes that “these enhanced disclosures are essential for investors to effectively value and assess the risks related to the public companies in which they have invested.”

Transparent reporting

Some multinationals, such as Vodafone and Unilever, voluntarily provide country-by-country tax disclosures. Should your company report similar information? Companies that are upfront about their tax strategies may engender trust and goodwill with stakeholders.

Contact us to discuss whether the benefits of expanded global tax disclosures outweigh the costs. We can help you collect this information and report it to your investors to a user friendly format.

© 2019

2019 Q3 Tax Calendar: Key Deadlines for Business and Other Employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the third quarter of 2019. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

July 31

  • Report income tax withholding and FICA taxes for the second quarter of 2019 (Form 941) and pay any tax due. (See the exception below, under “August 12.”)
  • File a 2018 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

August 12

  • Report income tax withholding and FICA taxes for the second quarter of 2019 (Form 941), if you deposited on time and in full all of the associated taxes due.

September 16

  • If a calendar-year C corporation, pay the third installment of 2019 estimated income taxes.
  • If a calendar-year S corporation or partnership that filed an automatic six-month extension:
    • File a 2018 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
    • Make contributions for 2018 to certain employer-sponsored retirement plans.

© 2019

How Auditors Use Nonfinancial Information

Every financial transaction your company records generates nonfinancial data that doesn’t have a dollar value assigned to it. Though auditors may spend most of their time analyzing financial records, nonfinancial data can also help them analyze your business from multiple angles.

Gathering audit evidence

The purpose of an audit is to determine whether your financial statements are “fairly presented in all material respects, compliant with Generally Accepted Accounting Principles (GAAP) and free from material misstatement.” To thoroughly assess these issues, auditors need to expand their procedures beyond the line items recorded in your company’s financial statements.

Nonfinancial information helps auditors understand your business and how it operates. During planning, inquiry, analytics and testing procedures, auditors will be on the lookout for inconsistencies between financial and nonfinancial measures. This information also helps auditors test the accuracy and reasonableness of the amounts recorded on your financial statements.

Looking beyond the numbers

A good starting point is a tour of your facilities to observe how and where the company spends its money. The number of machines operating, the amount of inventory in the warehouse, the number of employees and even the overall morale of your staff can help bring to life the amounts shown in your company’s financial statements.

Auditors also may ask questions during fieldwork to help determine the reasonableness of financial measures. For instance, they may ask you for detailed information about a key vendor when analyzing accounts payable. This might include the vendor’s ownership structure, its location, copies of email communications between company personnel and vendor reps, and the name of the person who selected the vendor. Such information can give the auditor insight into the size of the relationship and whether the timing and magnitude of vendor payments appear accurate and appropriate.

Your auditor may even look outside your company for nonfinancial data. Many websites allow customers and employees to submit reviews of the company. These reviews can provide valuable insight regarding the company’s inner workings. If the reviews uncover consistent themes — such as an unwillingness to honor product guarantees or allegations of illegal business practices — it may signal deep-seated problems that require further analysis.

Facilitating the audit process

Auditors typically ask lots of questions and request specific documentation to test the accuracy and integrity of a company’s financial records. While these procedures may seem probing or superfluous, analyzing nonfinancial data is critical to issuing a nonqualified audit opinion. Let’s work together to get it right!

© 2019

Hiring This Summer? You May Qualify for a Valuable Tax Credit

Is your business hiring this summer? If the employees come from certain “targeted groups,” you may be eligible for the Work Opportunity Tax Credit (WOTC). This includes youth whom you bring in this summer for two or three months. The maximum credit employers can claim is $2,400 to $9,600 for each eligible employee.

10 targeted groups

An employer is generally eligible for the credit only for qualified wages paid to members of 10 targeted groups:

  • Qualified members of families receiving assistance under the Temporary Assistance for Needy Families program,
  • Qualified veterans,
  • Designated community residents who live in Empowerment Zones or rural renewal counties,
  • Qualified ex-felons,
  • Vocational rehabilitation referrals,
  • Qualified summer youth employees,
  • Qualified members of families in the Supplemental Nutrition Assistance Program,
  • Qualified Supplemental Security Income recipients,
  • Long-term family assistance recipients, and
  • Qualified individuals who have been unemployed for 27 weeks or longer.

For each employee, there’s also a minimum requirement that the employee have completed at least 120 hours of service for the employer, and that employment begin before January 1, 2020.

Also, the credit isn’t available for certain employees who are related to the employer or work more than 50% of the time outside of a trade or business of the employer (for example, working as a house cleaner in the employer’s home). And it generally isn’t available for employees who have previously worked for the employer.

Calculate the savings

For employees other than summer youth employees, the credit amount is calculated under the following rules. The employer can take into account up to $6,000 of first-year wages per employee ($10,000 for “long-term family assistance recipients” and/or $12,000, $14,000 or $24,000 for certain veterans). If the employee completed at least 120 hours but less than 400 hours of service for the employer, the wages taken into account are multiplied by 25%. If the employee completed 400 or more hours, all of the wages taken into account are multiplied by 40%.

Therefore, the maximum credit available for the first-year wages is $2,400 ($6,000 × 40%) per employee. It is $4,000 [$10,000 × 40%] for “long-term family assistance recipients”; $4,800, $5,600 or $9,600 [$12,000, $14,000 or $24,000 × 40%] for certain veterans. In order to claim a $9,600 credit, a veteran must be certified as being entitled to compensation for a service-connected disability and be unemployed for at least six months during the one-year period ending on the hiring date.

Additionally, for “long-term family assistance recipients,” there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit, over two years, of $9,000 [$10,000 × 40% plus $10,000 × 50%].

The “first year” described above is the year-long period which begins with the employee’s first day of work. The “second year” is the year that immediately follows.

For summer youth employees, the rules described above apply, except that you can only take into account up to $3,000 of wages, and the wages must be paid for services performed during any 90-day period between May 1 and September 15. That means that, for summer youth employees, the maximum credit available is $1,200 ($3,000 × 40%) per employee. Summer youth employees are defined as those who are at least 16 years old, but under 18 on the hiring date or May 1 (whichever is later), and reside in an Empowerment Zone, enterprise community or renewal community.

We can help

The WOTC can offset the cost of hiring qualified new employees. There are some additional rules that, in limited circumstances, prohibit the credit or require an allocation of the credit. And you must fill out and submit paperwork to the government. Contact us for assistance or more information about your situation.

© 2019

AUP Engagements: A Middle Ground Between Audits and Consulting Services

Your CPA offers a wide menu of services. An audit is a familiar type of attestation service that provides a formal opinion about whether the company’s financial statements conform to U.S. Generally Accepted Accounting Principles (GAAP).

Consulting services, in contrast, provide advice or technical assistance that’s only for internal purposes. That is, lenders and other third parties can’t rely on the findings, conclusions and recommendations presented during a consulting project.

If you need a report that falls somewhere between these alternatives, consider an agreed upon procedures (AUP) engagement.

Scope

An AUP engagement uses procedures similar to an audit, but on a limited scale. It can be used to identify specific problems that require immediate action. When performing an AUP engagement, your CPA makes no formal opinion; he or she simply acts as a fact finder. The report lists:

  • The procedures performed, and
  • The CPA’s findings.

It’s the user’s responsibility to draw conclusions based on those findings. AUP engagements may target specific financial data (such as accounts payable, accounts receivable or related party transactions), nonfinancial information (such as a review of internal controls or compliance with royalty agreements), a specific financial statement (such as the income statement or balance sheet) or even a complete set of financial statements.

Advantages

AUP engagements boast several advantages. They can be performed at any time during the year, and they can be relied on by third parties. Plus, you have the flexibility to choose only those procedures you feel are necessary, so AUP engagements can be cost-effective.

Specifically, AUP engagements can be useful:

  • In M&A due diligence,
  • When a business owner suspects an employee of misrepresenting financial results, and
  • To determine compliance with specific regulatory requirements, such as the Health Insurance Portability and Accountability Act (HIPAA) or the Federal Information Security Management Act (FISMA).

In addition, lenders or franchisors may request an AUP engagement if they have doubts or questions about a company’s financials or the effectiveness of its internal controls — or if they want to check on the progress of a distressed company’s turnaround plan.

Contact us

AUP engagements can be performed to supplement audits and consulting engagements — or as a standalone service. We can help you customize an AUP engagement that fits the needs of your business and its stakeholders.

© 2019