Numerous tax limits affecting businesses have increased for 2020

An array of tax-related limits that affect businesses are annually indexed for inflation, and many have increased for 2020. Here are some that may be important to you and your business.

Social Security tax

The amount of employees’ earnings that are subject to Social Security tax is capped for 2020 at $137,700 (up from $132,900 for 2019).

Deductions

  • Section 179 expensing:
    • Limit: $1.04 million (up from $1.02 million for 2019)
    • Phaseout: $2.59 million (up from $2.55 million)
  • Income-based phase-out for certain limits on the Sec. 199A qualified business income deduction begins at:
    • Married filing jointly: $326,600 (up from $321,400)
    • Married filing separately: $163,300 (up from $160,725)
    • Other filers: $163,300 (up from $160,700)

Retirement plans

  • Employee contributions to 401(k) plans: $19,500 (up from $19,000)
  • Catch-up contributions to 401(k) plans: $6,500 (up from $6,000)
  • Employee contributions to SIMPLEs: $13,500 (up from $13,000)
  • Catch-up contributions to SIMPLEs: $3,000 (no change)
  • Combined employer/employee contributions to defined contribution plans (not including catch-ups): $57,000 (up from $56,000)
  • Maximum compensation used to determine contributions: $285,000 (up from $280,000)
  • Annual benefit for defined benefit plans: $230,000 (up from $225,000)
  • Compensation defining a highly compensated employee: $130,000 (up from $125,000)
  • Compensation defining a “key” employee: $185,000 (up from $180,000)

Other employee benefits

  • Qualified transportation fringe-benefits employee income exclusion: $270 per month (up from $265)
  • Health Savings Account contributions:
    • Individual coverage: $3,550 (up from $3,500)
    • Family coverage: $7,100 (up from $7,000)
    • Catch-up contribution: $1,000 (no change)
  • Flexible Spending Account contributions:
    • Health care: $2,750 (no change)
    • Dependent care: $5,000 (no change)

These are only some of the tax limits that may affect your business and additional rules may apply. If you have questions, please contact us.

© 2019

Accounting for indirect job costs the right way

Construction contractors, professional service firms, specialty manufacturers and other companies that work on large projects often struggle with job costing. Full cost allocations are essential to gauging whether you’re making money on each job. But some companies simply lump indirect job costs into overhead or fail to use meaningful cost drivers, thereby skewing their profit reports. Here’s what you should know to avoid this pitfall and get a clearer picture of your company’s profitability.

Indirect job costs vs. overhead costs

The Financial Accounting Standards Board defines job costs as “the sum of the applicable expenditures and charges directly or indirectly incurred in bringing [a job] to its existing condition and location.” These may include direct costs, such as labor and materials, and indirect costs. The latter can be divided into two groups:

Costs identified with more than one job. These typically consist of benefits for frontline workers, workers’ compensation insurance and insurance to minimize the company’s liability risks. This category also may include company vehicle costs, such as gasoline, maintenance and repair expenses, and equipment depreciation.

Costs that are only indirectly related to jobs. Common examples of these indirect costs include project manager salaries and benefits, cell phone bills, payroll service fees, and vehicle tracking and monitoring systems.

Indirect costs and overhead are often confused. The term “overhead” refers to costs related to running your company that you can’t attribute directly or indirectly to a project. They tend to be consistent over time. It’s important to not include overhead costs, such as office rent, when identifying indirect costs.

Using a cost driver

You can systematically allocate indirect job costs using a “cost driver.” Two common cost drivers are labor hours and dollars.

For example, suppose liability insurance for an engineering firm costs $100,000 annually. That amount divided by 12 months is $8,333 a month. To follow the allocation process through to completion, you would tabulate the billable hours for each job on a monthly schedule. Then, perhaps with your accountant’s help, you could divvy up that $8,333 each month to put those dollars onto that month’s active jobs pro rata. Now that $100,000 is no longer overhead — those dollars are indirect job costs.

Once indirect costs are allocated and included in the reports given to managers tracking the progress of cash outflows to their jobs, your company’s management team can discuss how to avert upcoming cash flow problems. This can buy you some time to make corrections.

Monitoring the bottom line

We can find meaningful methods of allocating job costs to help evaluate your company’s profitability. Contact us for more information.

© 2020

Cents-per-mile rate for business miles decreases slightly for 2020

This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business decreased by one-half cent, to 57.5 cents per mile. As a result, you might claim a lower deduction for vehicle-related expense for 2020 than you can for 2019.

Calculating your deduction

Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.

The cents-per-mile rate comes into play if you don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date and the destination.

Using the mileage rate is also popular with businesses that reimburse employees for business use of their personal vehicles. Such reimbursements can help attract and retain employees who drive their personal vehicles extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.

If you do use the cents-per-mile rate, be aware that you must comply with various rules. If you don’t, the reimbursements could be considered taxable wages to the employees.

The rate for 2020

Beginning on January 1, 2020, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 57.5 cents per mile. It was 58 cents for 2019 and 54.5 cents for 2018.

The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the mileage rate midyear.

Factors to consider

There are some situations when you can’t use the cents-per-mile rate. In some cases, it partly depends on how you’ve claimed deductions for the same vehicle in the past. In other cases, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.

As you can see, there are many factors to consider in deciding whether to use the mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2020 — or claiming them on your 2019 income tax return.

© 2019

Benchmarking financial performance

You already may have reviewed a preliminary draft of your company’s year-end financial statements. But without a frame of reference, they don’t mean much. That’s why it’s important to compare your company’s performance over time and against competitors.

Conduct a well-rounded evaluation

A comprehensive benchmarking study requires calculating ratios that gauge the following five elements:

1. Growth. Business size is usually stated in terms of annual revenue, total assets or market share. Is your company expanding or contracting? An example of a ratio that targets changes in your company’s size would be its year-over-year increase in market share. Companies generally want to grow, but there may be strategic reasons to downsize and refocus on core operations.

2. Liquidity. Working capital ratios help assess how easily assets can be converted into cash and whether current assets are sufficient to cover current liabilities. For example, the acid-test ratio compares the most liquid current assets (cash and receivables) to current obligations (such as payables, accrued expenses, short-term loans and current portions of long-term debt).

3. Profitability. This evaluates whether the business is making money from operations — before considering changes in working capital accounts, investments in capital expenditures and financing activities. Public companies tend to focus on earnings per share. But smaller ones tend to be more interested in ratios that evaluate earnings before interest, taxes, depreciation and amortization. EBITDA ratios allow for comparisons between companies with different capital structures, tax strategies and business types.

4. Turnover. Such ratios as total asset turnover (revenue divided by total assets) or inventory turnover (cost of sales divided by inventory) show how well the company manages its assets. These ratios also can be stated in terms of average days outstanding.

5. Leverage. Identify how the company finances its operations — through debt or equity. There are pros and cons of both. For example, within limits, debt financing is generally less expensive and interest on debt may be tax deductible. Equity financing, however, can help preserve cash flow for growing the business because equity investors often don’t require an annual return on investment.

Seek input from the pros

Most companies use an outside accounting firm to compile, review or audit their preliminary year-end financial results. This is a prime opportunity to conduct a comprehensive benchmarking study. We can help take your historical financial statements to the next level by identifying comparable companies, providing access to industry benchmarking data and recommending ways to improve performance in 2020 and beyond.

© 2020

New law provides a variety of tax breaks to businesses and employers

While you were celebrating the holidays, you may not have noticed that Congress passed a law with a grab bag of provisions that provide tax relief to businesses and employers. The “Further Consolidated Appropriations Act, 2020” was signed into law on December 20, 2019. It makes many changes to the tax code, including an extension (generally through 2020) of more than 30 provisions that were set to expire or already expired.

Two other laws were passed as part of the law (The Taxpayer Certainty and Disaster Tax Relief Act of 2019 and the Setting Every Community Up for Retirement Enhancement Act).

Here are five highlights.

Long-term part-timers can participate in 401(k)s.

Under current law, employers generally can exclude part-time employees (those who work less than 1,000 hours per year) when providing a 401(k) plan to their employees. A qualified retirement plan can generally delay participation in the plan based on an employee attaining a certain age or completing a certain number of years of service but not beyond the later of completion of one year of service (that is, a 12-month period with at least 1,000 hours of service) or reaching age 21.

Qualified retirement plans are subject to various other requirements involving who can participate.

For plan years beginning after December 31, 2020, the new law requires a 401(k) plan to allow an employee to make elective deferrals if the employee has worked with the employer for at least 500 hours per year for at least three consecutive years and has met the age-21 requirement by the end of the three-consecutive-year period. There are a number of other rules involved that will determine whether a part-time employee qualifies to participate in a 401(k) plan.

The employer tax credit for paid family and medical leave is extended.

Tax law provides an employer credit for paid family and medical leave. It permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The credit is equal to 12.5% of eligible wages if the rate of payment is 50% of such wages and is increased by 0.25 percentage points (but not above 25%) for each percentage point that the rate of payment exceeds 50%. The maximum leave amount that can be taken into account for a qualifying employee is 12 weeks per year.

The credit was set to expire on December 31, 2019. The new law extends it through 2020.

The Work Opportunity Tax Credit (WOTC) is extended.

Under the WOTC, an elective general business credit is provided to employers hiring individuals who are members of one or more of 10 targeted groups. The new law extends this credit through 2020.

The medical device excise tax is repealed.

The Affordable Care Act (ACA) contained a provision that required that the sale of a taxable medical device by the manufacturer, producer or importer is subject to a tax equal to 2.3% of the price for which it is sold. This medical device excise tax originally applied to sales of taxable medical devices after December 31, 2012.

The new law repeals the excise tax for sales occurring after December 31, 2019.

The high-cost, employer-sponsored health coverage tax is repealed.

The ACA also added a nondeductible excise tax on insurers when the aggregate value of employer-sponsored health insurance coverage for an employee, former employee, surviving spouse or other primary insured individual exceeded a threshold amount. This tax is commonly referred to as the tax on “Cadillac” plans.

The new law repeals the Cadillac tax for tax years beginning after December 31, 2019.

Stay tuned

These are only some of the provisions of the new law. We will be covering them in the coming weeks. If you have questions about your situation, don’t hesitate to contact us.

© 2019

Wayfair revisited — It’s time to review your sales tax obligations

In its 2018 decision in South Dakota v. Wayfair, the U.S. Supreme Court upheld South Dakota’s “economic nexus” statute, expanding the power of states to collect sales tax from remote sellers. Today, nearly every state with a sales tax has enacted a similar law, so if your company does business across state lines, it’s a good idea to reexamine your sales tax obligations.

What’s nexus?

A state is constitutionally prohibited from taxing business activities unless those activities have a substantial “nexus,” or connection, with the state. Before Wayfair, simply selling to customers in a state wasn’t enough to establish nexus. The business also had to have a physical presence in the state, such as offices, retail stores, manufacturing or distribution facilities, or sales reps.

In Wayfair, the Supreme Court ruled that a business could establish nexus through economic or virtual contacts with a state, even if it didn’t have a physical presence. The Court didn’t create a bright-line test for determining whether contacts are “substantial,” but found that the thresholds established by South Dakota’s law are sufficient: Out-of-state businesses must collect and remit South Dakota sales taxes if, in the current or previous calendar year, they have 1) more than $100,000 in gross sales of products or services delivered into the state, or 2) 200 or more separate transactions for the delivery of goods or services into the state.

Nexus steps

The vast majority of states now have economic nexus laws, although the specifics vary:Many states adopted the same sales and transaction thresholds accepted in Wayfair, but a number of states apply different thresholds. And some chose not to impose transaction thresholds, which many view as unfair to smaller sellers (an example of a threshold might be 200 sales of $5 each would create nexus).

If your business makes online, telephone or mail-order sales in states where it lacks a physical presence, it’s critical to find out whether those states have economic nexus laws and determine whether your activities are sufficient to trigger them. If you have nexus with a state, you’ll need to register with the state and collect state and applicable local taxes on your taxable sales there. Even if some or all of your sales are tax-exempt, you’ll need to secure exemption certifications for each jurisdiction where you do business. Alternatively, you might decide to reduce or eliminate your activities in a state if the benefits don’t justify the compliance costs.

Need help?

Note: If you make sales through a “marketplace facilitator,” such as Amazon or Ebay, be aware that an increasing number of states have passed laws that require such providers to collect taxes on sales they facilitate for vendors using their platforms.

If you need assistance in setting up processes to collect sales tax or you have questions about your responsibilities, contact us.

© 2019

Nonprofits: Are you ready for the new contribution guidance?

When the Financial Accounting Standards Board (FASB) updated its rules for recognizing revenue from contracts in 2014, it only added to the confusion that nonprofits already had about accounting for grants and similar contracts.

Fortunately, last year, the FASB provided some much-needed clarification with Accounting Standards Update (ASU) No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. Calendar-year nonprofits must follow this guidance when preparing their 2019 year-end financial statements.

Complicated rules

Nonprofits traditionally have taken varying approaches when they:

  • Characterize grants and similar contracts as exchange transactions (also known as reciprocal transactions) or contributions (nonreciprocal transactions), and
  • Distinguish between conditional and unconditional contributions.

The FASB’s updated revenue recognition guidance — ASU 2014-09, Revenue from Contracts with Customers — eliminated some of the previous guidance for nonprofits and imposed extensive disclosure requirements that didn’t seem relevant to contributions. ASU 2018-08 clarifies matters by laying out rules that will help nonprofits determine whether a grant or similar contract is indeed a contribution — and, if so, when they should recognize the revenue associated with it.

Exchange vs. contribution

To determine how to treat a grant or similar contract, you must assess whether the “provider” receives commensurate value for the assets it’s transferring. If it does, you should treat the grant or contract as an exchange transaction. ASU 2018-08 stresses that the provider (the grantor or other party) in a transaction isn’t synonymous with the general public. So, indirect benefit to the public doesn’t represent commensurate value received. Execution of the provider’s mission or positive sentiment received from donating also doesn’t constitute commensurate value received.

What if the provider doesn’t receive commensurate value? You then must determine if the asset transfer is a payment from a third-party payer for an existing transaction between you and an identified customer (for example, payments made under Medicare or a Pell Grant). If it is such a payment, the transaction won’t be considered a contribution under the ASU, and other accounting guidance would apply. If it isn’t such a payment, the transaction is accounted for as a contribution.

Conditional terms

According to ASU 2018-08, a conditional contribution includes:

  • A barrier the nonprofit must overcome to receive the contribution, and
  • Either a right of return of assets transferred or a right of release of the promisor’s obligation to transfer assets.

Unconditional contributions are recognized when received. However, conditional contributions aren’t recognized until you overcome the barriers to entitlement.

Is there a barrier to overcome before your organization can receive a contribution? Consider the inclusion of a measurable performance-related barrier, limits on your nonprofit’s discretion over how to conduct an activity or a stipulation that relates to the purpose of the agreement (not including administrative tasks and trivial stipulations such as production of an annual report). Some indicators might prove more important than others, depending on circumstances. And no single indicator is determinative.

Net effect

As a result of the updated guidance, nonprofits will likely account for more grants and similar contracts as contributions than they did under the previous rules. Check with your CPA to determine what that means for your financial statements, loan covenants and other matters.

© 2019

FAQs about prepaid expenses

The concept of “matching” is one of the basic principles of accrual-basis accounting. It requires companies to match expenses (efforts) with revenues (accomplishments) whenever it’s reasonable or practical to do so. This concept applies when companies make advance payments for expenses that will benefit more than one accounting period. Here are some questions small business owners and managers frequently ask about prepaying expenses.

When do prepaid expenses hit the income statement?

It’s common for companies to prepay such expenses as legal fees, advertising costs, insurance premiums, office supplies and rent. Rather than immediately report the full amount of an advance payment as an expense on the income statement, companies that use accrual-basis accounting methods must recognize a prepaid asset on the balance sheet.

A prepaid expense is a current asset that represents an expense the company won’t have to fund in the future. The remaining balance is gradually written off with the passage of time or as it’s consumed. The company then recognizes the reduction as an expense on the income statement.

Why can’t prepaid expenses be deducted immediately?

Immediate expensing of an item that has long-term benefits violates the matching principle under U.S. Generally Accepted Accounting Principles (GAAP).

Deducting prepaid assets in the period they’re paid makes your company look less profitable to lenders and investors, because you’re expensing the costs related to generating revenues that haven’t been earned yet. Immediate expensing of prepaid expenses also causes profits to fluctuate from period to period, making benchmarking performance over time or against competitors nearly impossible.

Does prepaying an expense make sense?

Some service providers — like your insurance carrier or an attorney in a major lawsuit — might require you to pay in advance. However, in many circumstances, prepaying expenses is optional.

There are pros and cons to prepaying. A major downside is that it takes cash away from other potential uses. Put another way, it gives vendors or suppliers interest-free use of your business’s funds. Plus, there’s a risk that the party you prepay won’t deliver what you’ve paid for.

For example, a landlord might terminate a lease — or they might file for bankruptcy, which could require a lengthy process to get your prepayment refunded, and you might not get a refund at all. Banks also might not count prepaids when computing working capital ratios. And since reporting prepaid expenses under GAAP differs slightly from reporting them for federal tax purposes, excessive prepaid activity may create complex differences to reconcile.

With that said, your company might receive a discount for prepaying. And companies without an established credit history, that have poor credit or that contract services with foreign providers, may need to prepay expenses to get favorable terms with their supply chain partners.

For more information

Start-ups and small businesses that are accustomed to using cash-basis accounting may not understand the requirement to capitalize business expenses on the balance sheet. But matching revenues and expenses is a critical part of accrual-basis accounting. Contact us with any questions you may have about reporting and managing prepaid assets.

© 2019

Risk Assessment: A Critical Part of the Audit Process

Audit season is right around the corner for calendar-year entities. Here’s what your auditor is doing behind the scenes to prepare — and how you can help facilitate the audit planning process.

The big picture

Every audit starts with assessing “audit risk.” This refers to the likelihood that the auditor will issue an adverse opinion when the financial statements are actually in accordance with U.S. Generally Accepted Accounting Principles or (more likely) an unqualified opinion when the opinion should be either modified or adverse.

Auditors can’t test every single transaction, recalculate every estimate or examine every external document. Instead, they tailor their audit procedures and assign audit personnel to keep audit risk as low as possible.

Inherent risk vs. control risk

Auditors evaluate two types of risk:

1. Inherent risk. This is the risk that material departures could occur in the financial statements. Examples of inherent-risk factors include complexity, volume of transactions, competence of the accounting personnel, company size and use of estimates.

2. Control risk. This is the risk that the entity’s internal controls won’t prevent or correct material misstatements in the financial statements.

Separate risk assessments are done at the financial statement level and then for each major account — such as cash, receivables, inventory, fixed assets, other assets, payables, accrued expenses, long-term debt, equity, and revenue and expenses. A high-risk account (say, inventory) might warrant more extensive audit procedures and be assigned to more experienced audit team members than one with lower risk (say, equity).

How auditors assess risk

New risk assessments must be done each year, even if the company has had the same auditor for many years. That’s because internal and external factors may change over time. For example, new government or accounting regulations may be implemented, and company personnel or accounting software may change, causing the company’s risk assessment to change. As a result, audit procedures may vary from year to year or from one audit firm to the next.

The risk assessment process starts with an auditing checklist and, for existing audit clients, last year’s workpapers. But auditors must dig deeper to determine current risk levels. In addition to researching public sources of information, including your company’s website, your auditor may call you with a list of open-ended questions (inquiries) and request a walk-through to evaluate whether your internal controls are operating as designed. Timely responses can help auditors plan their procedures to minimize audit risk.

Your role

Audit fieldwork is only as effective as the risk assessment. Evidence obtained from further audit procedures may be ineffective if it’s not properly linked to the assessed risks. So, it’s important for you to help the audit team understand the risks your business is currently facing and the challenges you’ve experienced reporting financial performance, especially as companies implement updated accounting rules in the coming years.

© 2019

The Art and Science of Goodwill Impairment Testing

Goodwill shows up on a company’s balance sheet when the company has been acquired in a business combination. It represents what’s left over after the purchase price in a merger or acquisition is allocated to the company’s tangible assets, identifiable intangible assets and liabilities. Periodically, companies must test goodwill for “impairment” — that is, whether the carrying value on the balance sheet has fallen below its fair value. This assessment can be complicated.

Reporting recap

Under current U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheet must test goodwill at least annually for impairment. In lieu of annual impairment testing, private companies may elect to amortize acquired goodwill over a useful life of up to 10 years.

All companies — regardless of whether they’re publicly traded or privately held — must test goodwill for impairment when a triggering event happens. Examples of triggering events that could lower the fair value of goodwill include:

  • The loss of a key customer or key person,
  • Adverse regulatory actions,
  • Unanticipated competition, and
  • Negative cash flows from operations.

Impairment may also occur if, after an acquisition has been completed, there’s an economic downturn that causes the parent company or the acquired business to lose value. Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement, which may raise a red flag to lenders and investors.

Quantifying impairment

Calculating goodwill impairment was originally a two-step process: First, businesses must figure out whether an impairment exists, and then they must put a dollar figure on it. The second step includes determining the implied fair value of goodwill and comparing it with the carrying amount of goodwill on the balance sheet.

The rules for testing goodwill impairment were simplified in Accounting Standards Update (ASU) No. 2017-04, Intangibles — Goodwill and Other, Simplifying the Test for Goodwill Impairment. The changes go live for fiscal periods starting after:

  • December 15, 2019, for public companies that file with the Securities and Exchange Commission,
  • December 15, 2020, for other public companies,
  • December 15, 2021, for privately held businesses.

Early adoption is permitted for testing dates after January 1, 2017. The updated guidance nixes the second step of the impairment test. Instead, a business will perform the impairment test by comparing the fair value of a reporting unit that includes goodwill with its carrying amount.

Who can help?

Few companies employ internal accounting staff with the requisite training and time to handle impairment testing. And most auditors won’t perform valuation services for their audit clients for fear of violating their independence standards. Instead, valuation specialists are often called in to handle these complex assignments. Contact us for more information.

© 2019