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Cost control takes a total team effort
“That’s just the cost of doing business.” You’ve probably heard this expression many times. It’s true that, to invoke another cliché, you’ve got to spend money to make money. But that doesn’t mean you have to take rising operational costs sitting down.
Cost control is a formal management technique through which you evaluate your company’s operations and isolate activities costing you too much money. This isn’t something you can do on your own — you’ll need a total team effort from your managers and advisors. Done properly, however, the results can be well worth it.
Asking tough questions
While performing a systematic review of the operations and resources, cost control will drive you to ask some tough questions. Examples include the following:
Is the activity in question operating as efficiently as possible?
Are we paying reasonable prices for supplies or materials while maintaining quality?
Can we upgrade our technology to minimize labor costs?
A good way to determine whether your company’s expenses are remaining within reason is to compare them to current industry benchmarks.
Working with your team
There’s no way around it — cost-control programs take a lot of hard work. Reducing expenses in a lasting, meaningful way also requires creativity and imagination. It’s one thing to declare, “We must reduce shipping costs by 10%!” Getting it done (and keeping it done) is another matter.
The first thing you’ll need is cooperation from management and staff. Business success is about teamwork; no single owner or manager can do it alone.
In addition, best-in-class companies typically seek help from trusted advisors. An outside expert can analyze your efficiency, including the results of cost-control efforts. This not only brings a new viewpoint to the process, but also provides an objective review of your internal processes.
Sometimes it’s difficult to be impartial when you manage a business every single day. Professional analysts can take a broader view of operations, resulting in improved cost-control strategies.
Staying in the game
An effective, ongoing program to assess and contain expenses can help you prevent both gradual and sudden financial losses while staying competitive in your market. For further information about cost control, and customized help succeeding at it, please contact us.
© 2018
IRS Audit Techniques Guides provide clues to what may come up if your business is audited
IRS examiners use Audit Techniques Guides (ATGs) to prepare for audits — and so can small business owners. Many ATGs target specific industries, such as construction. Others address issues that frequently arise in audits, such as executive compensation and fringe benefits. These publications can provide valuable insights into issues that might surface if your business is audited.
What do ATGs cover?
The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:
The nature of the industry or issue,
Accounting methods commonly used in an industry,
Relevant audit examination techniques,
Common and industry-specific compliance issues,
Business practices,
Industry terminology, and
Sample interview questions.
By using a specific ATG, an examiner may, for example, be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides.
What do ATGs advise?
ATGs cover the types of documentation IRS examiners should request from taxpayers and what relevant information might be uncovered during a tour of the business premises. These guides are intended in part to help examiners identify potential sources of income that could otherwise slip through the cracks.
Other issues that ATGs might instruct examiners to inquire about include:
Internal controls (or lack of controls),
The sources of funds used to start the business,
A list of suppliers and vendors,
The availability of business records,
Names of individual(s) responsible for maintaining business records,
Nature of business operations (for example, hours and days open),
Names and responsibilities of employees,
Names of individual(s) with control over inventory, and
Personal expenses paid with business funds.
For example, one ATG focuses specifically on cash-intensive businesses, such as auto repair shops, check-cashing operations, gas stations, liquor stores, restaurants and bars, and salons. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.
Cash-intensive businesses may be tempted to underreport their cash receipts, but franchised operations may have internal controls in place to deter such “skimming.” For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.
Likewise, for gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.
Avoiding red flags
Although ATGs were created to enhance IRS examiner proficiency, they also can help small businesses ensure they aren’t engaging in practices that could raise red flags with the IRS. To access the complete list of ATGs, visit the IRS website. And for more information on the IRS red flags that may be relevant to your business, contact us.
© 2018
Say, just how competitive is your business anyway?
Every business owner launches his or her company wanting to be successful. But once you get out there, it usually becomes apparent that you’re not alone. To reach any level of success, you’ve got to be competitive with other similar businesses in your market.
When strategic planning, one important question to regularly ask is: Just how competitive are we anyway? Objectively making this determination entails scrutinizing key factors that affect profitability, including:
Industry environment. Determine whether there are any threats facing your industry that could affect your business’s ability to operate. This could be anything from extreme weather to a product or service that customers might use less should the economy sour or buying trends significantly change.
Tangible and intangible resources. Competitiveness can hinge on the resources to which a business has access and how it deploys them to earn a profit. What types of tangible — and intangible — resources does your business have at its disposal? Are you in danger of being cut off or limited from any of them?
For example, do you own state-of-the-art technology that allows you to produce superior products or offer premium services more quickly and cheaply than competitors? Assess how suddenly this technology could become outdated — or whether it already has.
Strength of leadership team. As the owner of the business, you may naturally and rightly assume that its management is in good shape. But be open to an objective examination of its strengths and weaknesses.
For instance, maybe you’ve had some contentious interactions with employees as of late. Ask your managers whether underlying tensions exist and, if so, how you might improve morale going forward. There’s probably no greater danger to competitiveness than a disgruntled workforce.
Relationships with suppliers, customers and regulators. For most businesses to function competitively, they must rely on suppliers and nurture strong relationships with customers. In addition, if your company is subject to regulatory oversight, it has to cooperate with local, state and federal officials.
Discuss with your management team the steps the business is currently taking to measure and manage the state of its relationships with each of these groups. Have you been paying suppliers on time? Are you getting positive customer feedback (directly or online)? Are you in compliance with applicable laws and regulations — and are there any new ones to worry about?
Loss of competitiveness can often sneak up on companies. One minute you’re operating in the same stable market you’ve been in for years, and the next minute a disruptor comes along and upends everything. Contact us for more information and other profit-building ideas.
© 2018
A review of significant TCJA provisions affecting small businesses
Now that small businesses and their owners have filed their 2017 income tax returns (or filed for an extension), it’s a good time to review some of the provisions of the Tax Cuts and Jobs Act (TCJA) that may significantly impact their taxes for 2018 and beyond. Generally, the changes apply to tax years beginning after December 31, 2017, and are permanent, unless otherwise noted.
Corporate taxation
Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
Replacement of the flat personal service corporation (PSC) rate of 35% with a flat rate of 21%
Repeal of the 20% corporate alternative minimum tax (AMT)
Pass-through taxation
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% — through 2025
New 20% qualified business income deduction for owners — through 2025
Changes to many other tax breaks for individuals — generally through 2025
New or expanded tax breaks
Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023
Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million (these amounts will be indexed for inflation after 2018)
New tax credit for employer-paid family and medical leave — through 2019
Reduced or eliminated tax breaks
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, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction — effective for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers
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 excessive employee compensation
New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation
Don’t wait to start 2018 tax planning
This is only a sampling of some of the most significant TCJA changes that will affect small businesses and their owners beginning this year, and additional rules and limits apply. The combined impact of these changes should inform which tax strategies you and your business implement in 2018, such as how to time income and expenses to your tax advantage. The sooner you begin the tax planning process, the more tax-saving opportunities will be open to you. So don’t wait to start; contact us today.
© 2018
Manage health benefits costs with a multipronged approach
Many companies offer health care benefits to help ensure employee wellness and compete for better job candidates. And the Affordable Care Act has been using both carrots and sticks (depending on employer size) to encourage businesses to offer health coverage.
If you sponsor a health care plan, you know this is no small investment. It may seem next to impossible to control rising plan costs, which are subject to a variety of factors beyond your control. But the truth is, all business owners can control at least a portion of their health care expenses. The trick is taking a multipronged approach — here are some ideas:
Interact with employees to find the best fit. The ideal size and shape of your plan depends on the needs of your workforce. Rather than relying exclusively on vendor-provided materials, actively manage communications with employees regarding health care costs and other topics. Determine which benefits are truly valued and which ones aren’t.
Use metrics. Business owners can apply analytics to just about everything these days, including health care coverage. Measure the financial impacts of gaps between benefits offered and those employees actually use. Then appropriately adjust plan design to close these costly gaps.
Engage an outside consultant. Secure independent (that is, non-vendor-generated) return-on-investment analyses of your existing benefits package, as well as prospective initiatives. This will entail some expense, but an expert external perspective could help you save money in the long run.
Audit medical claims payments and pharmacy benefits management services. Mistakes happen — and fraud is always a possibility. By regularly re-evaluating claims and pharmacy services, you can identify whether you’re losing money to inaccuracies or even wrongdoing.
Renegotiate pharmacy benefits contracts. As the old saying goes, “Everything is negotiable.” The next time your pharmacy benefits contract comes up for renewal, see whether the vendor will do better. In addition, look around the marketplace for other providers and see if one of them can make a more economical offer.
There’s no silver bullet for lowering the expense of health care benefits. To manage these costs, you must understand the specifics of your plan as well as the economic factors that drive expenses up and down. Please contact our firm for assistance and additional information.
© 2018
Tax document retention guidelines for small businesses
You may have breathed a sigh of relief after filing your 2017 income tax return (or requesting an extension). But if your office is strewn with reams of paper consisting of years’ worth of tax returns, receipts, canceled checks and other financial records (or your computer desktop is filled with a multitude of digital tax-related files), you probably want to get rid of what you can. Follow these retention guidelines as you clean up.
General rules
Retain records that support items shown on your tax return at least until the statute of limitations runs out — generally three years from the due date of the return or the date you filed, whichever is later. That means you can now potentially throw out records for the 2014 tax year if you filed the return for that year by the regular filing deadline. But some records should be kept longer.
For example, there’s no statute of limitations if you fail to file a tax return or file a fraudulent one. So you’ll generally want to keep copies of your returns themselves permanently, so you can show that you did file a legitimate return.
Also bear in mind that, if you understate your adjusted gross income by more than 25%, the statute of limitations period is six years.
Some specifics for businesses
Records substantiating costs and deductions associated with business property are necessary to determine the basis and any gain or loss when the property is sold. According to IRS guidelines, you should keep these for as long as you own the property, plus seven years.
The IRS recommends keeping employee records for three years after an employee has been terminated. In addition, you should maintain records that support employee earnings for at least four years. (This timeframe generally will cover varying state and federal requirements.) Also keep employment tax records for four years from the date the tax was due or the date it was paid, whichever is longer.
For travel and transportation expenses supported by mileage logs and other receipts, keep supporting documents for the three-year statute of limitations period.
Regulations for sales tax returns vary by state. Check the rules for the states where you file sales tax returns. Retention periods typically range from three to six years.
When in doubt, don’t throw it out
It’s easy to accumulate a mountain of paperwork (physical or digital) from years of filing tax returns. If you’re unsure whether you should retain a document, a good rule of thumb is to hold on to it for at least six years or, for property-related records, at least seven years after you dispose of the property. But, again, you should keep tax returns themselves permanently, and other rules or guidelines might apply in certain situations. Please contact us with any questions.
© 2018
No tax deductions for business entertaining
The good news is that the TCJA of 2017 lowered corporate tax rates from a graduated schedule that reached 35% to a 21% flat rate. The bad news? Many business expenses are no longer tax deductible. That list includes all outlays that might be considered entertainment or recreation.
As of 2018, tickets to sports events can’t be deducted, even if you walk away from the game with a new client or a lucrative contract. The same is true if you treat a prospect to seats at a Broadway play or take a valued vendor out for a round of golf. Those outlays will be true costs for business owners without any tax relief.
Drilling down
Does that mean that you should drop all your season tickets supporting local teams? Cancel club memberships? Pack away your putter and your tennis racquet? Before taking any actions in this area, take a breath and crunch some numbers.
Example: In recent years, Luke Watson spent about $20,000 a year on various forms of entertainment, which his company claimed as a business expense. Indeed, these were valid expenses and helped his LW Corp. grow rapidly.
Assume that LW Corp. paid income tax at a 34% rate. In 2017 and prior years, business entertaining was only 50% deductible. Thus, LW Corp. deducted $10,000 (half of Luke’s expenses) and saved $3,400 (34% of $10,000). With $3,400 of tax savings and $20,000 of out-of-pocket costs, Luke’s net cost for entertaining was $16,600 under the law in effect during 2017.
Now suppose that Luke has the same $20,000 of entertainment costs in 2018 and that those costs would have still been 50% tax deductible at the new 21% tax rate. His tax savings would have been only $2,100, so the net entertainment cost would have been $17,900. As it is, under the new law his actual entertainment cost would be the full $20,000 with no tax benefit.
This example assumes that LW Corp. pays the corporate income tax on its profits. If Luke operates his business as an LLC or an S corporation, with business income passed through to his personal tax return, the calculation would be different, but the principle would be the same.
Business entertainment has been done mainly with after-tax dollars. Under the new TCJA, you’ll entertain clients and prospects solely with after-tax dollars. You should be careful about how this money is spent and judge the expected benefit. Nevertheless, if business entertaining has paid off for your company in the past, it may still prove to be valuable even without tax breaks.
Fine points
Meal expenses associated with operating a trade or business, including employee travel meals, generally continue to be 50% tax deductible. However, keep in mind that the rules have changed for meals provided for the employer’s convenience. Previously, these were 100% deductible if they were excludible from employees’ gross income as de minimis fringe benefits. That might have been the cost of providing free drinks and snacks to employees at the workplace. Now outlays for such meals are only 50% deductible and they’re scheduled to become nondeductible after 2025.
On the bright side, the new law doesn’t affect expenses for recreation, social, or similar activities primarily for the benefit of a company’s employees, other than highly compensated employees. So, your business likely can still pay for holiday office parties with pre-tax dollars.
The new tax law will change divorce tactics
When couples divorce, financial negotiations often involve alimony. The tax rules regarding alimony were dramatically changed by the Tax Cuts and Jobs Act (TCJA) of 2017, but existing agreements have been grandfathered. In addition, the old rules remain in effect for divorce and separation agreements executed during 2018. Next year, the rules will change, and the roles will be reversed.
Under divorce or separation agreements executed in 2018, and for many years in the past, alimony payments have been tax deductible. Moreover, these deductions reduce adjusted gross income, so they may have benefits elsewhere on a tax return. While the spouse or former spouse paying the alimony gets a tax deduction, the recipient reports alimony as taxable income.
Shifting into reverse
Beginning with agreements executed in 2019, there will be no tax deduction for alimony. As an offset, alimony recipients won’t include the payments in income.
Example 1: Joe and Kim Alexander get divorced in 2018. Joe expects to be in a 35% tax bracket in the future, whereas Kim anticipates being in a 22% bracket. Suppose that the proposed agreement has Joe paying $3,500 a month ($42,000 a year) in alimony.
Joe will save $14,700 in tax (35% times $42,000), but Kim will owe $9,240 (22% times $42,000). Net, the couple will save over $5,000 per year in taxes. This type of calculation will affect the negotiations, as it has in the past. Assuming the relevant rules are followed, it may make sense to tip the agreement toward Joe paying alimony to Kim, perhaps in return for other considerations.
Example 2: Assume that the Alexanders’ neighbors, Len and Marie Baker, have identical finances. They divorce in 2019. If Len pays $42,000 a year in alimony, he will get no deduction and won’t get the $14,700 in annual tax savings that Joe did in example 1. Marie, on the other hand, will pocket $42,000, tax-free, without the $9,240 tax bill faced by Kim in example 1.
Moving things along
Just as people shouldn’t “let the tax tail wag the investment dog,” so taxes shouldn’t dominate divorce or separation proceedings. However, it’s also true that taxes shouldn’t be ignored. If you are in such a situation, our office can help explain to both parties the possible savings available from executing an agreement during 2018, rather than in a future year.
The new rules will be in effect beginning in 2019. With no alimony deduction and a tax exemption for alimony income, it may be desirable to consider after-tax, rather than pre-tax, income when making decisions. Speaking very generally, there may be less cash for the couple to use after-tax.
Keep in mind that, as of 2019, not all states will have alimony tax laws that conform to the new federal rule. Your state may still offer tax deductions for alimony payments and impose income tax on alimony received. That’s all the more reason to look at after-tax results when calculating a divorce or separation agreement.
Getting personal
The impact of the new TCJA on spousal negotiations may go beyond the taxation of alimony. Among other provisions to consider, the TCJA abolishes personal exemptions. As a tradeoff, the standard deduction was almost doubled (see CPA Client Bulletin, April 2018).
In some past instances, divorcing spouses would agree that the high bracket party would claim the children’s personal exemptions, which effectively were tax deductions, in return for some other consideration. Now those exemptions don’t exist, so they shouldn’t be part of divorce negotiations. If you previously entered into an agreement that included the treatment of children’s personal exemptions, you may want to consult with counsel to see about possible revisions.
Trusted advice
Defining alimony
Payments to a spouse or former spouse must meet several requirements to be treated as alimony for tax purposes. The following are some key tests:
The payments are made under a divorce or separation agreement.
There is no liability to continue the payments after the recipient’s death.
The payments aren’t treated as child support or a property settlement.
The payments are made in cash (including checks or money orders).
TCJA changes to employee benefits tax breaks: 4 negatives and a positive
The Tax Cuts and Jobs Act (TCJA) includes many changes that affect tax breaks for employee benefits. Among the changes are four negatives and one positive that will impact not only employees but also the businesses providing the benefits.
4 breaks curtailed
Beginning with the 2018 tax year, the TCJA reduces or eliminates tax breaks in the following areas:
1. Transportation benefits. The TCJA eliminates business deductions for the cost of providing qualified employee transportation fringe benefits, such as parking allowances, mass transit passes and van pooling. (These benefits are still tax-free to recipient employees.) It also disallows business deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. And it suspends through 2025 the tax-free benefit of up to $20 a month for bicycle commuting.
2. On-premises meals. The TCJA reduces to 50% a business’s deduction for providing certain meals to employees on the business premises, such as when employees work late or if served in a company cafeteria. (The deduction is scheduled for elimination in 2025.) For employees, the value of these benefits continues to be tax-free.
3. Moving expense reimbursements. The TCJA suspends through 2025 the exclusion from employees’ taxable income of a business’s reimbursements of employees’ qualified moving expenses. However, businesses generally will still be able to deduct such reimbursements.
4. Achievement awards. The TCJA eliminates the business tax deduction and corresponding employee tax exclusion for employee achievement awards that are provided in the form of cash, gift coupons or certificates, vacations, meals, lodging, tickets to sporting or theater events, securities and “other similar items.” However, the tax breaks are still available for gift certificates that allow the recipient to select tangible property from a limited range of items preselected by the employer. The deduction/exclusion limits remain at up to $400 of the value of achievement awards for length of service or safety and $1,600 for awards under a written nondiscriminatory achievement plan.
1 new break
For 2018 and 2019, the TCJA creates a tax credit for wages paid to qualifying employees on family and medical leave. To qualify, a business must offer at least two weeks of annual paid family and medical leave, as described by the Family and Medical Leave Act (FMLA), to qualified employees. The paid leave must provide at least 50% of the employee’s wages. Leave required by state or local law or that was already part of the business’s employee benefits program generally doesn’t qualify.
The credit equals a minimum of 12.5% of the amount of wages paid during a leave period. The credit is increased gradually for payments above 50% of wages paid and tops out at 25%. No double-dipping: Employers can’t also deduct wages claimed for the credit.
More rules, limits and changes
Keep in mind that additional rules and limits apply to these breaks, and that the TCJA makes additional changes affecting employee benefits. Contact us for more details.
© 2018
A net operating loss on your 2017 tax return isn’t all bad news
When a company’s deductible expenses exceed its income, generally a net operating loss (NOL) occurs. If when filing your 2017 income tax return you found that your business had an NOL, there is an upside: tax benefits. But beware — the Tax Cuts and Jobs Act (TCJA) makes some significant changes to the tax treatment of NOLs.
Pre-TCJA law
Under pre-TCJA law, when a business incurs an NOL, the loss can be carried back up to two years, and then any remaining amount can be carried forward up to 20 years. The carryback can generate an immediate tax refund, boosting cash flow.
The business can, however, elect instead to carry the entire loss forward. If cash flow is strong, this may be more beneficial, such as if the business’s income increases substantially, pushing it into a higher tax bracket — or if tax rates increase. In both scenarios, the carryforward can save more taxes than the carryback because deductions are more powerful when higher tax rates apply.
But the TCJA has established a flat 21% tax rate for C corporation taxpayers beginning with the 2018 tax year, and the rate has no expiration date. So C corporations don’t have to worry about being pushed into a higher tax bracket unless Congress changes the corporate rates again.
Also keep in mind that the rules are more complex for pass-through entities, such as partnerships, S corporations and limited liability companies (if they elected partnership tax treatment). Each owner’s allocable share of the entity’s loss is passed through to the owners and reported on their personal returns. The tax benefit depends on each owner’s particular tax situation.
The TCJA changes
The changes the TCJA made to the tax treatment of NOLs generally aren’t favorable to taxpayers:
For NOLs arising in tax years ending after December 31, 2017, a qualifying NOL can’t be carried back at all. This may be especially detrimental to start-up businesses, which tend to generate NOLs in their early years and can greatly benefit from the cash-flow boost of a carried-back NOL. (On the plus side, the TCJA allows NOLs to be carried forward indefinitely, as opposed to the previous 20-year limit.)
For NOLs arising in tax years beginning after December 31, 2017, an NOL carryforward generally can’t be used to shelter more than 80% of taxable income in the carryforward year. (Under prior law, generally up to 100% could be sheltered.)
The differences between the effective dates for these changes may have been a mistake, and a technical correction might be made by Congress. Also be aware that, in the case of pass-through entities, owners’ tax benefits from the entity’s net loss might be further limited under the TCJA’s new “excess business loss” rules.
Complicated rules get more complicated
NOLs can provide valuable tax benefits. The rules, however, have always been complicated, and the TCJA has complicated them further. Please contact us if you’d like more information on the NOL rules and how you can maximize the tax benefit of an NOL.
© 2018
3 ways to supercharge your supervisors
The attitudes and behaviors of your managers play a critical role in your company’s success. When your managers are putting forth their best effort, the more likely it is that you’ll, in turn, get the best performances out of the rest of your employees. Here are three ways to supercharge your supervisors:
1. Transform them into teachers. Today’s managers must be more than team leaders — they must also be teachers. Attentive managers look for situations that will help subordinates learn how to work smarter and more efficiently.
Typically, learning occurs most readily when rewards are applied as close to the intended behavior’s occurrence as possible. Thus, train managers to look for moments when employees are being successful and to immediately recognize those efforts. Managers should praise them in the presence of others and regularly. Low-cost rewards such as the occasional free lunch or gift card can also be highly motivational.
2. Turbo-boost their reaction times. Be sure managers address problems right away. The operative word there is “address,” and its meaning may vary depending on the nature of the trouble.
For minor difficulties, just leaving a friendly voice mail or carefully worded email may do the trick. But for more serious conflicts or dilemmas, a thorough investigation is important, followed by face-to-face meetings documented in writing. In either case, it’s imperative not to let problems fester.
3. Turn off their micromanagement switch. While managers need to keep an eye out for good and bad behavior, they shouldn’t micromanage. Those who perch atop employees’ shoulders, checking every detail of their work, are as bad for a business as rude customer service or defective products.
Why? Because the more managers micromanage, the more they communicate the wrong message — that they don’t believe employees can get the job done. Micromanaging not only lowers morale, but also hinders efficiency, as the manager is basically spending valuable time doing the employee’s job rather than his or her own.
In the day-to-day grind of keeping a business running, managers can understandably get worn down. If yours need a lift, consider reinforcing the points above in training sessions or during performance evaluations. For further information and other ideas, contact us.
© 2018
The Importance of a Quality Plan Audit
Federal law requires employee benefit plans with 100 or more participants to have an audit as part of their obligation to file an annual return/report (Form 5500 Series).
A quality audit will help protect the assets and the financial integrity of your employee benefit plan and help you determine whether the necessary funds will be available to pay retirement, health, and other promised benefits to your employees. The higher the quality of a plan’s financial statement audit, the more reliable the information used to manage and administer the plan.
A quality audit also will help you carry out your legal responsibility to file a complete and accurate annual return/report for your plan each year. As such, selection of an experienced and reliable auditor is very important.
Recent Department of Labor (DOL) studies of audit quality have identified significant deficiencies in plan audits. Accordingly, the DOL has implemented various enforcement strategies with respect to audit deficiencies. The penalties for such audit failures can be substantial. The DOL can assess penalties on plan sponsors of up to $1,100 a day capped at $50,000 per annual report filing where the required auditor’s report is missing or deficient.
Independent audits of employee benefit plan financial statements are an important accountability mechanism. If your employee benefit plan is required to have an audit, it is the plan administrator’s duty to hire an independent qualified public accountant, and to ensure that the plan has obtained a quality audit in accordance with Employee Retirement Income Security Act of 1974 (ERISA) and U.S. Department of Labor (DOL) requirements. The sponsor of the plan is the plan administrator under the law unless another individual or entity is specifically designated to assume this responsibility.
Plan administrators should use the same care and prudence in hiring a plan auditor that they use when hiring any individual or entity that provides services to the plan. Plan sponsors should make the selection of the plan auditor a high priority and exercise due care during every phase of the auditor selection process.
FMD can help with your Employee Benefit Plan Audit.
What to Look for When Hiring an Employee Benefit Plan Auditor?
When a plan sponsor hires one or more service organizations to handle plan administration functions, the agreement typically establishes that the service organization(s) assumes liability for its performance of those functions. The employer is required to periodically monitor the service organization to ensure it is handling the plan’s investments prudently. Prudence focuses on the process for making fiduciary decisions; therefore, it is wise to document decisions and the basis for those decisions, including an employer’s selection and monitoring processes.
The Department of Labor (DOL) provides the following tips as a starting point for plan sponsors hiring service organizations:
Information about the firm itself (e.g., financial condition and experience with retirement plans of similar size and complexity)
The quality of the firm’s services (e.g., the identity, experience and qualifications of professionals who will be handling the plan’s account; any recent litigation or enforcement action taken against the firm; and the firm’s experience or performance record)
A description of business practices (e.g., how plan assets will be invested if the firm will manage plan investments or how participant investment directions will be handled; the proposed fee structure; and whether the firm has fiduciary liability insurance)
Document the hiring process
Ensure the service organization is clear about the extent of its fiduciary responsibilities
Obtain a fidelity bond for individuals handling plan funds or other plan property
Monitor the plan’s service organizations
Other important points to consider when hiring a service organization are the ability to access data maintained by the service organization on both a daily and annual basis, and whether the service organization agrees to obtain a Service Organization Controls (SOC 1) report. And finally, you should ensure that a service organization hired to prepare the plan’s financial statements will provide you with the support you need to understand those financial statements.
FMD can help with your Employee Benefit Plan Audit.
How Are You Preparing for Your Employee Benefit Plan Audit?
Employee benefit plans are a complex area that require intimate knowledge of plan design as well as performance.
When considering an auditor for your plan, be sure to ask the following questions:
Is your auditor looking at your plan’s operations, documents, and amendments?
Does your auditor understand the difference between the requirements for the financial statements and your Form 5500?
Does your auditor invest in training to keep up-to-date on the latest issues?
Is your auditor a member of the AICPA Employee Benefit Plan Audit Quality Center?
Does your auditor assign an experienced benefit plan auditor to service your account?
Do you understand that the plan fiduciary is responsible for the work performed by auditors
At Fenner, Melstrom & Dooling, PLC, we realize that one of the most important factors in choosing an auditor is feeling comfortable with the people you will be working with. Our ongoing commitment to provide financial and business wisdom, means we are continuously broadening our knowledge, honing our skills, and sharing valuable insights with our clients.
FMD can help with your employee benefit plan audit.
Defer Tax with a Section 1031 Exchange, but New Limits Apply this Year
Normally when appreciated business assets such as real estate are sold, tax is owed on the appreciation. But there’s a way to defer this tax: a Section 1031 “like kind” exchange. However, the Tax Cuts and Jobs Act (TCJA) reduces the types of property eligible for this favorable tax treatment.
What is a like-kind exchange?
Section 1031 of the Internal Revenue Code allows you to defer gains on real or personal property used in a business or held for investment if, instead of selling it, you exchange it solely for property of a “like kind.” Thus, the tax benefit of an exchange is that you defer tax and, thereby, have use of the tax savings until you sell the replacement property.
This technique is especially flexible for real estate, because virtually any type of real estate will be considered to be of a like kind, as long as it’s business or investment property. For example, you can exchange a warehouse for an office building, or an apartment complex for a strip mall.
Deferred and reverse exchanges
Although a like-kind exchange may sound quick and easy, it’s relatively rare for two owners to simply swap properties. You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance.
When you sell your property (the relinquished property), the net proceeds go directly to the QI, who then uses them to buy replacement property. To qualify for tax-deferred exchange treatment, you generally must identify replacement property within 45 days after you transfer the relinquished property and complete the purchase within 180 days after the initial transfer.
An alternate approach is a “reverse” exchange. Here, an exchange accommodation titleholder (EAT) acquires title to the replacement property before you sell the relinquished property. You can defer capital gains by identifying one or more properties to exchange within 45 days after the EAT receives the replacement property and, typically, completing the transaction within 180 days.
Changes under the TCJA
There had been some concern that tax reform would include the elimination of like-kind exchanges. The good news is that the TCJA still generally allows tax-deferred like-kind exchanges of business and investment real estate.
But there’s also some bad news: For 2018 and beyond, the TCJA eliminates tax-deferred like-kind exchange treatment for exchanges of personal property. However, prior-law rules that allow like-kind exchanges of personal property still apply if one leg of an exchange was completed by December 31, 2017, but one leg remained open on that date. Keep in mind that exchanged personal property must be of the same asset or product class.
Complex rules
The rules for like-kind exchanges are complex, so these arrangements present some risks. If, say, you exchange the wrong kind of property or acquire cash or other non-like-kind property in a deal, you may still end up incurring a sizable tax hit. If you’re exploring a like-kind exchange, contact us. We can help you ensure you’re in compliance with the rules.
© 2018
New Tax Deduction for Pass-through Entities
Many small businesses are pass-through entities, including S corporations, partnerships, sole proprietorships, LLCs, and LLPs. The label indicates that all business earnings are passed through to the owners’ personal income tax returns. Thus, they avoid the corporate income tax.
The TCJA contains a new tax benefit for pass-throughs. This provision is complex, but it is relatively straightforward for taxpayers with taxable income below $157,500 in 2018, or $315,000 on a joint return. Such business owners may qualify for a tax deduction that equals 20% of their qualified business income (QBI).
Example: Melanie Foster runs her business as an LLC. In 2018, her QBI (the net of her company’s domestic business taxable income, gain, deduction, and loss) is $140,000. On the joint tax return that Melanie files with her husband, the taxable income is $235,000. This taxable income is before the QBI deduction.
Here, Melanie can deduct $28,000 (20% of $140,000) from their taxable income. Note that this deduction doesn’t reduce the Fosters’ adjusted gross income, which can impact many areas on their tax return.
Over the limits
For taxpayers over $157,500 or $315,000 in taxable income, other factors come into play, which can reduce the QBI deduction. Moreover, some service businesses, such as medical practices and law firms, don’t merit the Q (for qualified) in QBI if their income is over certain limits. Our office can illustrate the value of the deduction for your pass-through business income.
Home Equity Hassle
A key component of the TCJA is the expansion of the standard deduction. The numbers for 2018 are $24,000 (married couples filing jointly), $18,000 (heads of household), and $12,000 (all others). These amounts are almost double the respective standard deductions in 2017. However, personal exemptions were eliminated.
As a give-and-take, the new tax law trims some itemized deductions. Taxpayers can either itemize or use the standard deduction, so some shift to the standard deduction is likely.
Down with debt deductions
Among the trimmed itemized deductions are those for mortgage interest. The new law caps deductions to interest on $750,000 worth of debt used to buy, build, or substantially improve a main or second home. For loans incurred before December 15, 2017, the old rules remain in place, so interest on up to $1 million of such debt is still deductible.
These rule changes affect only newer home loans in the $750,000–$1 million range. Of broader impact, interest on home equity loans or lines of credit are no longer deductible (unless the proceeds of these loans are used to purchase or improve the home that secures the loan). Previously, interest on home equity debt up to $100,000 generally could be deducted. (All of these home loan interest tax changes are scheduled to end after 2025, reverting to 2017 law.)
Therefore, home equity debt now looks like many other types of loans: the interest is nondeductible. Should you keep the one you have? That depends on your situation. If you wish to reduce your debt load, paying down home equity debt has become more attractive. Prepaying a nondeductible loan at, say, 5% is the equivalent of earning 5% on your money, after tax, with no market risk.
Another option is to update your existing home debt. A so-called cash out refinance might provide you with spending money, although the full interest deduction may not be available. Our office can help you crunch the numbers to see if the expense involved would make it worthwhile, and how it will impact the after-tax cost of residence related debt.
Yet another alternative is to use a personal loan to pay off the home equity debt. An unsecured personal loan might be preferable to a loan or line of credit that places your home at risk.
Positive Prognosis for Medical Deductions
Many miscellaneous itemized deductions, including unreimbursed employee business expenses (see the CPA Client Bulletin, February 2018), no longer can be used to reduce your income, starting with 2018 tax returns. Some observers predicted a similar demise for medical and dental expenses. As it turned out, these deductions not only were retained, the tax benefit was enhanced.
Playing the percentages
Under the law in effect during 2017, unreimbursed medical and dental expenses could be deducted only to the extent they exceeded 10% of adjusted gross income (AGI).
Example: Ivan Larson had $100,000 of AGI in 2017 and $9,100 of unreimbursed medical or dental expenses. Because 10% of his AGI was $10,000, Ivan’s outlays were under the threshold, so he wasn’t expecting a tax deduction for them.
Surprisingly, the TCJA lowered the threshold to 7.5% of AGI, effective for 2017 and 2018. For Ivan, that was $7,500 of expenses (7.5% of his $100,000 AGI), so his deduction for last year was $1,600 (his $9,100 of costs minus the $7,500 threshold).
Under the TCJA, the threshold will move back to 10% of AGI next year. Therefore, you may want to accelerate elective medical expenses such as prescription sunglasses and tooth implants into 2018.
If you plan to incur such expenses this year, before they may be absolutely necessary, you should be confident that your total of unreimbursed medical and dental costs will exceed 7.5% of AGI in 2018. You also should believe that you won’t be taking the standard deduction: $12,000 this year for Ivan, a single taxpayer.
Unless you itemize deductions and your total of unreimbursed medical and dental costs will top 7.5% of AGI, accelerating elective outlays into 2018 will be a wasted effort. You’ll be better off waiting until 2019 to make such payments when they might be tax deductible under the law that will be in effect then.
Are State and Local Taxes Reasons for Relocation?
As many people are all too aware, some states and localities impose higher income and property taxes than others. Residents of high tax areas may have taken some solace by itemizing deductions on their tax returns and reducing federal income tax obligations by deducting the taxes paid.
Example: Jennifer Knight deducted $25,000 worth of state income tax and local property tax on her 2017 tax return. Assuming Jennifer was in a 25% tax bracket, she reduced her net outlay for those taxes with $6,250 in tax savings (her 25% tax rate times the $25,000 tax deductions). In this scenario, Jennifer’s actual tax cost was $18,750, not $25,000, because she cut her federal tax bill by $6,250.
New rules
Under the TCJA, there is still an itemized deduction for taxes paid, but it is now capped at $10,000 a year, starting in 2018. Some people refer to this as the SALT deduction for state and local taxes. It mainly covers property and income taxes, although taxpayers can choose to include sales tax instead of income tax towards the $10,000 cap. (The $10,000 limit is the same for single filers and couples filing jointly, so there is a true “marriage penalty” here.)
As might be expected, taxpayers and politicians in high tax states and localities have loudly protested the cutback in the deduction for taxes paid. Is this the final straw? The added burden that will drive people to move to areas where income and property tax (and perhaps estate tax) are less of a burden?
Relocation may make sense, but such a decision should be made with care. Calculate how much extra you’ll be paying in tax now, considering the loss of the taxes paid deduction and all the other features of the TCJA. Don’t forget to include the alternative minimum tax (AMT), which still impacts many individuals. People who owe the AMT get no tax benefit from deducting state or local taxes. Our office can help with this computation.
Then, find out how much you’d owe after a move to a different area. Include income taxes and, assuming you’ll be a homeowner, likely property tax. Find out if sales tax will be meaningful in the new area. Determine the state’s estate tax exemption and estate tax rates, if you expect to leave assets to loved ones.
Typically, you’ll discover that relocating is a puzzle with many different parts of varying sizes. Effectively paying more in state and local tax under the TCJA may be a key piece of that puzzle, but it’s just one thing to consider before calling the movers.