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Reviewing your disaster plan in a tumultuous year
It’s been a year like no other. The sudden impact of the COVID-19 pandemic in March forced every business owner — ready or not — to execute his or her disaster response plan.
So, how did yours do? Although it may still be a little early to do a complete assessment of what went right and wrong during the crisis, you can take a quick look back right now while the experience is still fresh in your mind.
Get specific
When devising a disaster response plan, brainstorm as many scenarios as possible that could affect your company. What weather-related, environmental and socio-political threats do you face? Obviously, you can now add “pandemic” to the list.
The operative word, however, is “your.” Every company faces distinctive threats related to its industry, size, location(s), and products or services. Identify these as specifically as possible, based on what you’ve learned.
There are some constants for nearly every plan. Seek out alternative suppliers who could fill in for your current ones if necessary. Fortify your IT assets and functionality with enhanced recovery and security capabilities.
Communicate optimally
Another critical factor during and after a crisis is communication, both internal and external. Review whether and how your business was able to communicate in the initial months of the pandemic.
You and most of your management team probably needed to concentrate on maintaining or restoring operations. Who communicated with employees and other stakeholders to keep them abreast of your response and recovery progress? Typically, these parties include:
Staff members and their families,
Customers,
Suppliers,
Banks and other financial stakeholders, and
Local authorities, first responders and community leaders (as appropriate).
Look into the communication channels that were used — such as voicemail, text messaging, email, website postings and social media. Which were most and least effective? Would some type of new technology enable your business to communicate better?
Revisit and update
If the events of this past spring illustrate anything, it’s that companies can’t create a disaster response plan and toss it on a shelf. Revisit the plan at least annually, looking for adjustments and new risk factors.
You’ll also want to keep the plan clear in the minds of your employees. Be sure that everyone — including new hires — knows exactly what to do by spelling out the communication channels, contacts and procedures you’ll use in the event of a disaster. Everyone should sign a written confirmation that they’ve read the plan’s details, either when hired or when the plan is substantially updated.
In addition, go over disaster response measures during company meetings once or twice a year. You might even want to hold live drills to give staff members a chance to practice their roles and responsibilities.
Heed the lessons
For years, advisors urged business owners to prepare for disasters or else. This year we got the “or else.” Despite the hardships and continuing challenges, however, the lessons being learned are invaluable. Please contact us to discuss ways to manage costs and maintain profitability during these difficult times.
© 2020
Understanding the passive activity loss rules
Are you wondering if the passive activity loss rules affect business ventures you’re engaged in — or might engage in?
If the ventures are passive activities, the passive activity loss rules prevent you from deducting expenses that are generated by them in excess of their income. You can’t deduct the excess expenses (losses) against earned income or against other nonpassive income. Nonpassive income for this purpose includes interest, dividends, annuities, royalties, gains and losses from most property dispositions, and income from certain oil and gas property interests. So you can’t deduct passive losses against those income items either.
Any losses that you can’t use aren’t lost. Instead, they’re carried forward, indefinitely, to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity aren’t used up in this way, you’ll be allowed to use them in the tax year in which you dispose of your interest in the activity in a fully taxable transaction, or in the tax year you die.
Passive vs. material
Passive activities are trades, businesses or income-producing activities in which you don’t “materially participate.” The passive activity loss rules also apply to any items passed through to you by partnerships in which you’re a partner, or by S corporations in which you’re a shareholder. This means that any losses passed through to you by partnerships or S corporations will be treated as passive, unless the activities aren’t passive for you.
For example, let’s say that in addition to your regular professional job, you’re a limited partner in a partnership that cleans offices. Or perhaps you’re a shareholder in an S corp that operates a manufacturing business (but you don’t participate in the operations).
If you don’t materially participate in the partnership or S corporation, those activities are passive. On the other hand, if you “materially participate,” the activities aren’t passive (except for rental activities, discussed below), and the passive activity rules won’t apply to the losses. To materially participate, you must be involved in the operations on a regular, continuous and substantial basis.
The IRS uses several tests to establish material participation. Under the most frequently used test, you’re treated as materially participating in an activity if you participate in it for more than 500 hours in the tax year. While other tests require fewer hours, all the tests require you to establish how you participated and the amount of time spent. You can establish this by any reasonable means such as contemporaneous appointment books, calendars, time reports or logs.
Rental activities
Rental activities are automatically treated as passive, regardless of your participation. This means that, even if you materially participate in them, you can’t deduct the losses against your earned income, interest, dividends, etc. There are two important exceptions:
You can deduct up to $25,000 of losses from rental real estate activities (even though they’re passive) against earned income, interest, dividends, etc., if you “actively participate” in the activities (requiring less participation than “material participation”) and if your adjusted gross income doesn’t exceed specified levels.
If you qualify as a “real estate professional” (which requires performing substantial services in real property trades or businesses), your rental real estate activities aren’t automatically treated as passive. So losses from those activities can be deducted against earned income, interest, dividends, etc., if you materially participate.
Contact us if you’d like to discuss how these rules apply to your business.
© 2020
4 steps to improving your company’s sales
Most salespeople would tell you that there are few better feelings in life than closing a deal. This is because guiding a customer through the sales process and coming out the other side with dollars committed isn’t a matter of blind luck. It’s a craft — based on equal parts data mining, psychology, intuition and other skills.
Many sales staffs have been under unprecedented pressure this year. The COVID-19 pandemic triggered changes to the economy that made many buyers cut back on spending. Now that the economy is slowly recovering, sales opportunities may be improving. Here are four steps your salespeople can follow to improve the odds that those chances will come to fruition:
1. Qualify prospects. Time is an asset. Successful salespeople focus most or all their time on prospects who are most likely to buy. Viable prospects typically have certain things in common:
A clear need for the products or services in question,
Sufficient knowledge of the products or services,
An identifiable decision-maker who can approve the sale,
Adequate financial standing, and
A need to buy right away or soon.
If any of these factors is missing, and certainly if several are, the salesperson will likely end up wasting his or her time trying to make a sale.
2. Ask the right questions. A salesperson must deeply understand a prospect’s motivation for needing your company’s products or services. To do so, inquiries are key. Salespeople who make great presentations but don’t ask effective questions tend to come up short.
An old rule of thumb says: The most effective salespeople spend 80% of their time listening and 20% talking. Actual percentages may vary, but the point is that a substantial portion of a salesperson’s “talk time” should be spent asking intelligent, insightful questions that arise from pre-call research and specific points mentioned by the buyer.
3. Identify and overcome objections. A nightmare scenario for any salesperson is spending a huge amount of time on an opportunity, only to have an unknown issue come out of left field at closing and kill the entire deal. To guard against this, successful salespeople identify and address objections during their calls with prospects, thereby minimizing or eliminating unpleasant surprises at closing. They view objections as requests for information that, if handled correctly, will educate the prospect and strengthen the relationship.
4. Present a solution. The most eloquent sales presentation may be entertaining, but it will probably be unsuccessful if it doesn’t satisfy a buyer’s needs. Your product or service must fix a problem or help accomplish a goal. Without that, what motivation does a prospect have to spend money? Your salespeople must be not only careful researchers and charming conversationalists, but also problem-solvers.
When you alleviate customers’ concerns and allow them to meet strategic objectives, you’ll increase the likelihood of making today’s sales and setting yourself up for tomorrow’s. Our firm can help you identify optimal sales strategies and measure the results.
© 2020
The easiest way to survive an IRS audit is to get ready in advance
IRS audit rates are historically low, according to the latest data, but that’s little consolation if your return is among those selected to be examined. But with proper preparation and planning, you should fare well.
In fiscal year 2019, the IRS audited approximately 0.4% of individuals. Businesses, large corporations and high-income individuals are more likely to be audited but, overall, all types of audits are being conducted less frequently than they were a decade ago.
There’s no 100% guarantee that you won’t be picked for an audit, because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare for one in advance. On an ongoing basis you should systematically maintain documentation — invoices, bills, cancelled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all your records in one place. And it helps to know what might catch the attention of the IRS.
Audit hot spots
Certain types of tax-return entries are known to the IRS to involve inaccuracies so they may lead to an audit. Here are a few examples:
Significant inconsistencies between tax returns filed in the past and your most current tax return,
Gross profit margin or expenses markedly different from those of other businesses in your industry, and
Miscalculated or unusually high deductions.
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can catch the IRS’s eye, especially if the business is structured as a corporation.
Responding to a letter
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the harshest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited email messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
Keep in mind that the tax agency won’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. You’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If the IRS chooses you for an audit, our firm can help you:
Understand what the IRS is disputing (it’s not always clear),
Gather the specific documents and information needed, and
Respond to the auditor’s inquiries in the most expedient and effective manner.
The IRS normally has three years within which to conduct an audit, and often an audit doesn’t begin until a year or more after you file a return. Don’t panic if you’re contacted by the IRS. Many audits are routine. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one will happen in the first place.
© 2020
Reinforce protection of your company’s mobile devices
Whether it’s a smart phone, tablet or laptop, mobile devices have become the constant companions of today’s employees. And this relationship has only been further cemented by the COVID-19 pandemic, which has thousands working from home or other remote locations.
From a productivity standpoint, this is a good thing. So many tasks that once kept employees tied to their desks are now doable from anywhere on flexible schedules. All this convenience, however, brings considerable risk.
Multiple threats
Perhaps the most obvious threat to any company-owned mobile device is theft. That could end a workday early, hamper productivity for days, and lead to considerable replacement hassles and expense. Indeed, given the current economy, thieves may be increasing their efforts to snatch easy-to-grab and easy-to-sell technological items.
Worse yet, a stolen or hacked mobile device means thieves and hackers could gain possession of sensitive, confidential data about your company, as well as its customers and employees.
Amateur criminals might look for credit card numbers to fraudulently buy goods and services. More sophisticated ones, however, may look for Social Security numbers or Employer Identification Numbers to commit identity theft.
5 protective measures
There are a variety of ways that businesses can reinforce protections of their mobile devices. Here are five to consider:
1. Standardize, standardize, standardize. Having a wide variety of makes and models increases risk. Moving toward a standard product and operating system will allow you to address security issues across the board rather than dealing with multiple makes and their varying security challenges.
2. Password protect. Make sure that employees use “power-on” passwords — those that appear whenever a unit is turned on or comes out of sleep mode. In addition, configure devices to require a power-on password after 15 minutes of inactivity and to block access after a specified number of unsuccessful log-in attempts. Require regular password changes, too.
3. Set rules for data. Don’t allow employees to store certain information, such as Social Security numbers, on their devices. If sensitive data must be transported, encrypt it. (That is, make the data unreadable using special coding.)
4. Keep it strictly business. Employees are often tempted to mix personal information with business data on their portable devices. Issue a company policy forbidding or severely limiting this practice. Moreover, establish access limits on networks and social media.
5. Fortify your defenses. Be sure your mobile devices have regularly and automatically updated security software to prevent unauthorized access, block spyware/adware and stop viruses. Consider retaining the right to execute a remote wipe of an asset’s memory if you believe it’s been stolen or hopelessly lost.
More than an object
When assessing the costs associated with a mobile device, remember that it’s not only the value of the physical item that matters, but also the importance and sensitivity of the data stored on it. We can help your business implement a cost-effective process for procuring and protecting all its technology.
© 2020
The tax rules for deducting the computer software costs of your business
Do you buy or lease computer software to use in your business? Do you develop computer software for use in your business, or for sale or lease to others? Then you should be aware of the complex rules that apply to determine the tax treatment of the expenses of buying, leasing or developing computer software.
Purchased software
Some software costs are deemed to be costs of “purchased” software, meaning software that’s either:
Non-customized software available to the general public under a non-exclusive license or
Acquired from a contractor who is at economic risk should the software not perform.
The entire cost of purchased software can be deducted in the year that it’s placed into service. The cases in which the costs are ineligible for this immediate write-off are the few instances in which 100% bonus depreciation or Section 179 small business expensing isn’t allowed or when a taxpayer has elected out of 100% bonus depreciation and hasn’t made the election to apply Sec. 179 expensing. In those cases, the costs are amortized over the three-year period beginning with the month in which the software is placed in service. Note that the bonus depreciation rate will begin to be phased down for property placed in service after calendar year 2022.
If you buy the software as part of a hardware purchase in which the price of the software isn’t separately stated, you must treat the software cost as part of the hardware cost. Therefore, you must depreciate the software under the same method and over the same period of years that you depreciate the hardware. Additionally, if you buy the software as part of your purchase of all or a substantial part of a business, the software must generally be amortized over 15 years.
Leased software
You must deduct amounts you pay to rent leased software in the tax year they’re paid, if you’re a cash-method taxpayer, or the tax year for which the rentals are accrued, if you’re an accrual-method taxpayer. However, deductions aren’t generally permitted before the years to which the rentals are allocable. Also, if a lease involves total rentals of more than $250,000, special rules may apply.
Software developed by your business
Some software is deemed to be “developed” (designed in-house or by a contractor who isn’t at risk if the software doesn’t perform). For tax years beginning before calendar year 2022, bonus depreciation applies to developed software to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either deduct the development costs in the year paid or incurred or choose one of several alternative amortization periods over which to deduct the costs. For tax years beginning after calendar year 2021, generally the only allowable treatment will be to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If following any of the above rules requires you to change your treatment of software costs, it will usually be necessary for you to obtain IRS consent to the change.
Contact us
We can assist you in applying the tax rules for treating computer software costs in the way that is most advantageous for you.
© 2020
IRS announces per diem rates for business travel
In Notice 2020-71, the IRS recently announced per diem rates that can be used to substantiate the amount of business expenses incurred for travel away from home on or after October 1, 2020. Employers using these rates to set per diem allowances can treat the amount of certain categories of travel expenses as substantiated without requiring that employees prove the actual amount spent. (Employees must still substantiate the time, place and business purposes of their travel expenses.)
The amount deemed substantiated will be the lesser of the allowance actually paid or the applicable per diem rate for the same set of expenses. This notice, which replaces Notice 2019-55, announces:
Rates for use under the optional high-low substantiation method,
Special rates for transportation industry employers, and
The rate for taxpayers taking a deduction only for incidental expenses.
Updated general guidance issued in 2019 regarding the use of per diems under the Tax Cuts and Jobs Act (TCJA) remains in effect.
High-low method
For travel within the continental United States, the optional high-low method designates one per diem rate for high-cost locations and another for other locations. Employers can use the high-low method for substantiating lodging, meals and incidental expenses, or for substantiating meal and incidental expenses (M&IE) only.
Beginning October 1, 2020, the high-low per diem rate that can be used for lodging, meals and incidental expenses decreases to $292 (from $297) for travel to high-cost locations and decreases to $198 (from $200) for travel to other locations. The high-low M&IE rates are unchanged at $71 for travel to high-cost locations and $60 for travel to other locations. Five locations have been added to the list of high-cost locations, two have been removed and 10 that remain on the list are now considered high-cost for a different portion of the calendar year.
Although self-employed persons can’t use the high-low method, they can use other per diem rates to calculate the amount of their business expense deduction for business meals and incidental expenses (but not lodging), or for incidental expenses alone. (Employees can no longer deduct their unreimbursed expenses because of the suspension of miscellaneous itemized deductions by the TCJA, so these other rates are effectively unavailable to them.) The special rate for the incidental expenses deduction is unchanged at $5 per day for those who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.
A simpler process
The per diem rules can greatly simplify the process of substantiating business travel expense amounts. If the amount of an allowance is deemed substantiated because it doesn’t exceed the applicable limit, any unspent amounts don’t have to be taxed or returned. If an employer pays per diem allowances that exceed what’s deemed substantiated, however, the employer must either treat the excess as taxable wages or require actual substantiation. When substantiation is required, any unsubstantiated portion of the allowance must be returned or treated as taxable wages. Please contact us to discuss the rules further.
© 2020
Business website costs: How to handle them for tax purposes
The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when Internet website costs can be deducted.
Fortunately, established rules that generally apply to the deductibility of business costs, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.
Hardware or software?
Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.
In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2020, the maximum Sec. 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Was the software developed internally?
An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.
A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.
If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.
Are you paying a third party?
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
What about before business begins?
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
Need Help?
We can determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions or want more information.
© 2020
Weighing the risks vs. rewards of a mezzanine loan
To say that most small to midsize businesses have at least considered taking out a loan this year would probably be an understatement. The economic impact of the COVID-19 pandemic has lowered many companies’ revenue but may have also opened opportunities for others to expand or pivot into more profitable areas.
If your company needs working capital to grow, rather than simply survive, you might want to consider a mezzanine loan. These arrangements offer relatively quick access to substantial funding but with risks that you should fully understand before signing on the dotted line.
Equity on the table
Mezzanine financing works by layering a junior loan on top of a senior (or primary) loan. It combines aspects of senior secured debt from a bank and equity-based financing obtained from direct investors. Sources of mezzanine financing can include private equity groups, mutual funds, insurance companies and buyout firms.
Unlike bank loans, mezzanine debt typically is unsecured by the borrower’s assets or has liens subordinate to other lenders. So, the cost of obtaining financing is higher than that of a senior loan.
However, the cost generally is lower than what’s required to acquire funding purely from equity investment. Yet most mezzanine instruments do enable the lender to participate in the borrowing company’s success — or failure. Generally, the lower your interest rate, the more equity you must offer.
Flexibility at a price
The primary advantage of mezzanine financing is that it can provide capital when you can’t obtain it elsewhere or can’t qualify for the amount you’re looking for. That’s why it’s often referred to as a “bridge” to undertaking ambitious objectives such as a business acquisition or desirable piece of commercial property. But mezzanine loans aren’t necessarily an option of last resort; many companies prefer their flexibility when it comes to negotiating terms.
Naturally, there are drawbacks to consider. In addition to having higher interest rates, mezzanine financing carries with it several other potential disadvantages. Loan covenants can be restrictive. And though some lenders are relatively hands-off, they may retain the right to a significant say in company operations — particularly if you don’t repay the loan in a timely manner.
If you default on the loan, the lender may either sell its stake in your company or transfer that equity to another entity. This means you could suddenly find yourself with a co-owner who you’ve never met or intended to work with.
Mezzanine financing can also make an M&A deal more complicated. It introduces an extra interested party to the negotiation table and can make an already tricky deal that much harder.
Explore all options
Generally, mezzanine loans are best suited for businesses with clear and even aggressive growth plans. Our firm can help you fully explore the tax, financial and strategic implications of any lending arrangement, so you can make the right decision.
© 2020
Prioritize customer service now more than ever
You’d be hard-pressed to find a business that doesn’t value its customers, but tough times put many things into perspective. As companies have adjusted to operating during the COVID-19 pandemic and the resulting economic fallout, prioritizing customer service has become more important than ever.
Without a strong base of loyal buyers, and a concerted effort to win over more market share, your business could very well see diminished profit margins and an escalated risk of being surpassed by competitors. Here are some foundational ways to strengthen customer service during these difficult and uncertain times.
Get management involved
As is the case for many things in business, success starts at the top. Encourage your management team and fellow owners (if any) to regularly interact with customers. Doing so cements customer relationships and communicates to employees that cultivating these contacts is part of your company culture and a foundation of its profitability.
Moving down the organizational chart, cultivate customer-service heroes. Post articles about the latest customer service achievements on your internal website or distribute companywide emails celebrating successes. Champion these heroes in meetings. Public praise turns ordinary employees into stars and encourages future service excellence.
Just be sure to empower employees to make timely decisions. Don’t just talk about catering to customers unless your staff can really take the initiative to act accordingly.
Systemize your responsiveness
Like everyone in today’s data-driven world, customers want immediate information. So, strive to provide instant or at least timely feedback to customers with a highly visible, technologically advanced response system. This will let customers know that their input matters and you’ll reward them for speaking up.
The specifics of this system will depend on the size, shape and specialty of the business itself. It should encompass the right combination of instant, electronic responses to customer inquiries along with phone calls and, where appropriate, face-to-face (or direct virtual) interactions that reinforce how much you value their business.
Continue to adjust
By now, you’ve likely implemented a few adjustments to serving your customers during the COVID-19 pandemic. Many businesses have done so, with common measures including:
Explaining what you’re doing to cope with the crisis,
Being more flexible with payment plans and deadlines, and
Exercising greater patience and empathy.
As the months go on, don’t rest on your laurels. Continually reassess your approach to customer service and make adjustments that suit the changing circumstances of not only the pandemic, but also your industry and local economy. Seize opportunities to help customers and watch out for mistakes that could hurt your company’s reputation and revenue.
Don’t give up
This year has put everyone under unforeseen amounts of stress and, in turn, providing world-class customer services has become even more difficult. Keep at it — your extra efforts now could lay the groundwork for a much stronger customer base in the future. Our firm can help you assess your customer service and calculate its impact on revenue and profitability.
© 2020
ESOPs offer businesses a variety of potential benefits
Wouldn’t it be great if your employees worked as if they owned the company? An employee stock ownership plan (ESOP) could make this a reality.
Under an ESOP, employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some tax breaks, an extra-motivated workforce and a clearer path to a smooth succession.
How they work
To implement an ESOP, you establish a trust fund and either:
Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).
The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business must formally adopt the plan and submit plan documents to the IRS, along with certain forms.
Tax impact
Among the biggest benefits of an ESOP is that contributions to qualified retirement plans (including ESOPs) are typically tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. But C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loans. That is, the interest isn’t counted toward the 25% limit.
Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan may be tax-deductible for C corporations, so long as they’re reasonable. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)
In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sales, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period.
Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.
Risks to consider
An ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while these plans do offer many potential benefits, they also present risks such as complexity of setup and administration and a strain on cash flow in some situations. Please contact us to discuss further. We can help you determine whether an ESOP would make sense for your business.
© 2020
5 key points about bonus depreciation
You’re probably aware of the 100% bonus depreciation tax break that’s available for a wide range of qualifying property. Here are five important points to be aware of when it comes to this powerful tax-saving tool.
1. Bonus depreciation is scheduled to phase out
Under current law, 100% bonus depreciation will be phased out in steps for property placed in service in calendar years 2023 through 2027. Thus, an 80% rate will apply to property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026, and a 0% rate will apply in 2027 and later years.
For certain aircraft (generally, company planes) and for the pre-January 1, 2027 costs of certain property with a long production period, the phaseout is scheduled to take place a year later, from 2024 to 2028.
Of course, Congress could pass legislation to extend or revise the above rules.
2. Bonus depreciation is available for new and most used property
In the past, used property didn’t qualify. It currently qualifies unless:
The taxpayer previously used the property and
The property was acquired in certain forbidden transactions (generally acquisitions that are tax free or from a related person or entity).
3. Taxpayers should sometimes make the election to turn down bonus depreciation
Taxpayers can elect to reject bonus depreciation for one or more classes of property. The election out may be useful for sole proprietorships, and business entities taxed under the rules for partnerships and S corporations, that want to prevent “wasting” depreciation deductions by applying them against lower-bracket income in the year property was placed in service — instead of against anticipated higher bracket income in later years.
Note that business entities taxed as “regular” corporations (in other words, non-S corporations) are taxed at a flat rate.
4. Bonus depreciation is available for certain building improvements
Before the 2017 Tax Cuts and Jobs Act (TCJA), bonus depreciation was available for two types of real property:
Land improvements other than buildings, for example fencing and parking lots, and
“Qualified improvement property,” a broad category of internal improvements made to non-residential buildings after the buildings are placed in service.
The TCJA inadvertently eliminated bonus depreciation for qualified improvement property.
However, the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES Act) made a retroactive technical correction to the TCJA. The correction makes qualified improvement property placed in service after December 31, 2017, eligible for bonus depreciation.
5. 100% bonus depreciation has reduced the importance of “Section 179 expensing”
If you own a smaller business, you’ve likely benefited from Sec. 179 expensing. This is an elective benefit that — subject to dollar limits — allows an immediate deduction of the cost of equipment, machinery, off-the-shelf computer software and some building improvements. Sec. 179 has been enhanced by the TCJA, but the availability of 100% bonus depreciation is economically equivalent and has greatly reduced the cases in which Sec. 179 expensing is useful.
We can help
The above discussion touches only on some major aspects of bonus depreciation. This is a complex area with tax implications for transactions other than simple asset acquisitions. Contact us if you have any questions about how to proceed in your situation.
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Helping employees understand their health care accounts
Many businesses now offer, as part of their health care benefits, various types of accounts that reimburse employees for medical expenses on a tax-advantaged basis. These include health Flexible Spending Accounts (FSAs), Health Reimbursement Arrangement (HRAs) and Health Savings Account (HSAs, which are usually offered in conjunction with a high-deductible health plan).
For employees to get the full value out of such accounts, they need to educate themselves on what expenses are eligible for reimbursement by a health FSA or HRA, or for a tax-free distribution from an HSA. Although an employer shouldn’t provide tax advice to employees, you can give them a heads-up that the rules for reimbursements or distributions vary depending on the type of account.
Pub. 502
Unfortunately, no single publication provides an exhaustive list of official, government-approved expenses eligible for reimbursement by a health FSA or HRA, or for a tax-free distribution from an HSA. IRS Publication 502 — “Medical and Dental Expenses” (Pub. 502) comes the closest, but it should be used with caution.
Pub. 502 is written largely to help taxpayers determine what medical expenses can be deducted on their income tax returns; it’s not meant to address the tax-favored health care accounts in question. Although the rules for deductibility overlap in many respects with the rules governing health FSAs, HRAs and HSAs, there are some important differences. Thus, employees shouldn’t use Pub. 502 as the sole determinant for whether an expense is reimbursable by a health FSA or HRA, or eligible for tax-free distribution from an HSA.
Various factors
You might warn health care account participants that various factors affect whether and when a medical expense is reimbursable or a distribution allowable. These include:
Timing rules. Pub. 502 notes that expenses may be deducted only for the year in which they were paid, but it doesn’t explain the different timing rules for the tax-favored accounts. For example, a health FSA can reimburse an expense only for the year in which it was incurred, regardless of when it was paid.
Insurance restrictions. Taxpayers may deduct health insurance premiums on their tax returns if certain requirements are met. However, reimbursement of such premiums by health FSAs, HRAs and HSAs is subject to restrictions that vary according to the type of tax-favored account.
Over-the-counter (OTC) drug documentation. OTC drugs other than insulin aren’t tax-deductible, but they may be reimbursed by health FSAs, HRAs and HSAs if substantiation and other requirements are met.
Greater appreciation
The pandemic has put a renewed emphasis on the importance of employer-provided health care benefits. The federal government has even passed COVID-19-related relief measures for some tax-favored accounts.
As mentioned, the more that employees understand these benefits, the more they’ll be able to effectively use them — and the greater appreciation they’ll have of your business for providing them. Our firm can help you fully understand the tax implications, for both you and employees, of any type of health care benefit.
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Take a fresh look at your company’s brand
A strong, discernible brand is important for every business. Even a company that never undertakes a formal branding effort will, over time, establish a brand through its communications with customers and interactions with the public. For this reason, it’s a good idea to regularly take a fresh look at your brand and determine whether tweaks or even a major overhaul may be in order.
Who are you?
When reassessing your brand, consider the strengths of your business and whether these have evolved over time — or very recently. Some companies have pivoted during the COVID-19 pandemic to address the changed circumstances of daily life. Look at strong suits such as:
Distinctive skills, such as excellence in product design,
Exceptional customer service,
Providing superior value for your price points, and
Innovation in your industry.
You need to match your business’s passions and strengths to your customers’ needs and wants. To that end, ask current customers what they like about doing business with you. Survey both customers and prospects about what they consider when making buying decisions.
What’s your personality?
Look at any widely known brand and you’ll see a logo and branding effort that conveys a certain personality. Some companies want to appear creative and playful; others want to communicate stability and security.
What personality will draw today’s customers to your business? You may think that every company in your line of business has pretty much the same target audience. If that’s true, you must come up with an edge that differentiates your company from its rivals.
Businesses tend to have various points of contact with customers ranging from business cards to print advertisements or catalogs to the front page of your website to social media accounts. All play a role in your brand’s personality. Review what your company does at each point of contact, considering whether and how these efforts accurately and effectively represent the business’s core values and emphasize its strengths. Doing so will give you more insight into the best way to portray your personality through your brand.
What’s the competition up to?
No company is an island. Your competitors have brands all their own — and they’re after your target audience. So, in creating or refining a brand, you’ll need to identify their tactics and come up with countermeasures. To do so, engage in competitive intelligence gathering by looking at their:
Latest products or services,
Current prices and special offers,
Marketing and advertising methods, and
Social media activities.
Sometimes a full rebranding campaign may be necessary to differentiate yourself from a competitor. For example, let’s say a major player has entered your market and you’re worried about visibility, or perhaps your brand is blurring together with a competitor’s.
Are you making an impression?
In the end, branding can make a big difference in whether your business gets lost in the shuffle or makes a singular impression. Our firm can help you assess your marketing budget, including allocations for branding, and identify opportunities for cost-effective improvements.
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5 common accounting software mistakes to avoid
No company can afford to operate without the right accounting software. When considering whether to buy a new product or upgrade their current solutions, however, business owners often fall prey to some common mistakes. Here are five gaffes to avoid:
1. Relying on a generic solution. Some companies rush into buying an accounting system without stopping to consider all their options. Perhaps most important, they may be missing out on specific versions for their industries.
For instance, construction companies can choose from many applications with built-in features specific to how their businesses work. Nonprofit organizations also have industry-specific accounting software. If you haven’t already, check into whether a product addresses your company’s area of focus.
2. Spending too much or too little. When buying or upgrading something as important as an accounting system, it’s easy to overspend. Those bells and whistles can be enticing. Then again, frugal-minded business owners may underspend, picking up a low-end product and letting staff deal with the headaches.
The ideal approach generally lies somewhere in the middle. Perform a thorough review of your accounting needs, transaction volume and required reports, as well as your employees’ proficiency and the availability of tech support. Then calculate a reasonable budgeted amount to spend.
3. Getting stuck in a rut. Assuming you already have an accounting system, one of the keys to managing it is knowing precisely when to upgrade. You don’t want to spend money unnecessarily, but you also shouldn’t risk errors or outdated functionality by waiting too long.
There’s no one-size-fits-all answer. Your financial statements are a potentially helpful source of information. A general rule of thumb says that, when revenues hit certain benchmarks (perhaps $5 million, $10 million or $15 million), a business may want to start thinking “upgrade.” The right tipping point depends on various factors, however.
4. Neglecting the importance of integration and mobile access. Once upon a time, a company’s accounting software was a standalone application, and data from across the company had to be manually entered into the system. But integration is the name of the game these days. You should be able to integrate your accounting system with all (or most) of your other software so that data can be shared seamlessly and securely.
Also consider the availability and functionality of mobile access to your accounting system. Many solutions now include apps that users can use on their smartphones or tablets.
5. Going it alone. Which accounting package you choose may seem an entirely internal decision. After all, you and your staff will be the ones using it, right? But you may be forgetting one rather obvious person who could help: your accountant.
We can help you assess and determine your accounting needs, set a feasible budget, choose the right solution (or upgrade) and implement it properly. Going forward, we can even periodically test your system to ensure it’s providing accurate data and generating the proper reports.
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Thoughtful onboarding is more important than ever
Onboarding refers to “[a formal] process of helping new hires adjust to social and performance aspects of their new jobs quickly and smoothly,” according to the Society for Human Resource Management.
Traditionally, a comprehensive onboarding program’s objective is to deliver multiple benefits to the company. These include stronger employee performance and productivity, higher job satisfaction and a deeper commitment to the business. New hires who are properly onboarded should also experience reduced stress and an enhanced sense of career direction.
What’s more, an onboarding program allows you to be crystal clear about compliance procedures, HR policies, compensation and benefits offerings. In other words, this is a crucial opportunity for you to explain to a new hire many issues, including all the measures you’re using to cope with the COVID-19 crisis.
3 parts to a program
What does a comprehensive onboarding program look like? Specifics will depend on the size, industry and nature of your company. Generally, however, an onboarding program can be segmented into three parts:
1. Preparing for the job. The onboarding process should begin before a new hire starts work. This involves steps such as discussing his or her specific acclimation needs, choosing and preparing a workspace (or introducing the platform and procedures for working remotely), and designating a coach or mentor.
2. Optimizing day one. As the saying goes, “You never get a second chance to make a good first impression.” An onboarding program might involve an itemized start-date schedule that lays out everything from who will greet the new employee at the door — or who will conduct a first-day video call — to what paperwork must be completed to a detailed itinerary of meetings (virtual or otherwise) throughout the day.
3. Following up regularly. Even a great first day can mean nothing if a new hire feels ignored thereafter. An onboarding program could establish continuing check-in meetings with the employee’s direct supervisor and coach/mentor for the first 30 or 60 days of employment. From then on, interactions with the coach/mentor could be arranged at longer intervals until the employee feels comfortable.
When the time is right
Onboarding in the year 2020 and beyond involves so much more than giving new employees their marching orders. It entails helping a new hire feel safe, supported and fully informed. We can help you calculate when the time is right to expand your workforce and accurately measure the productivity of workers added to your payroll.
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File cash transaction reports for your business — on paper or electronically
Does your business receive large amounts of cash or cash equivalents? You may be required to submit forms to the IRS to report these transactions.
Filing requirements
Each person engaged in a trade or business who, in the course of operating, receives more than $10,000 in cash in one transaction, or in two or more related transactions, must file Form 8300. Any transactions conducted in a 24-hour period are considered related transactions. Transactions are also considered related even if they occur over a period of more than 24 hours if the recipient knows, or has reason to know, that each transaction is one of a series of connected transactions.
To complete a Form 8300, you will need personal information about the person making the cash payment, including a Social Security or taxpayer identification number.
You should keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.
Reasons for the reporting
Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”
What’s considered “cash”
For Form 8300 reporting, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders.
Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.
Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.
E-filing and batch filing
Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.
The IRS also reminds businesses that they can “batch file” their reports, which is especially helpful to those required to file many forms.
Setting up an account
To file Form 8300 electronically, a business must set up an account with FinCEN’s BSA E-Filing System. For more information, interested businesses can also call the BSA E-Filing Help Desk at 866-346-9478 (Monday through Friday from 8 am to 6 pm EST) or email them at BSAEFilingHelp@fincen.gov. Contact us with any questions or for assistance.
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Strengthen your supply chain with constant risk awareness
When the COVID-19 crisis exploded in March, among the many concerns was the state of the nation’s supply chains. Business owners are no strangers to such worry. It’s long been known that, if too much of a company’s supply chain is concentrated (that is, dependent) on one thing, that business is in danger. The pandemic has only complicated matters.
To guard against this risk, you’ve got to maintain a constant awareness of the state of your supply chain and be prepared to adjust as necessary and feasible.
Products or services
The term “concentration” can be applied to both customers and suppliers. Generally, concentration risks become significant when a business relies on a customer or supplier for 10% or more of its revenue or materials, or on several customers or suppliers located in the same geographic region.
Concentration related to your specific products or services is something to keep a close eye on. If your company’s most profitable product or service line depends on a few key customers, you’re essentially at their mercy. If just one or two decide to make budget cuts or switch to a competitor, it could significantly lower your revenues.
Similarly, if a major supplier suddenly increases prices or becomes lax in quality control, your profit margin could narrow considerably. This is especially problematic if your number of alternative suppliers is limited.
To cope, do your research. Regularly look into what suppliers might best serve your business and whether new ones have emerged that might allow you to offset your dependence on one or two providers. Technology can be of great help in this effort — for example, monitor trusted news sources online, follow social media accounts of experts and use artificial intelligence to target the best deals.
Geography
A second type of concentration risk is geographic. When gauging it, assess whether many of your customers or suppliers are in one geographic region. Operating near supply chain partners offers advantages such as lower transportation costs and faster delivery. Conversely, overseas locales may enable you to cut labor and raw materials expenses.
But there are also risks associated with geographic centricity. Local weather conditions, tax rate hikes and regulatory changes can have a substantial impact. As we’ve unfortunately encountered this year, the severity of COVID-19 in different regions of the country is affecting the operational ability and capacity of suppliers in those areas.
These same threats apply when dealing with global partners, with the added complexity of greater physical distances and longer shipping times. Geopolitical uncertainty and exchange rate volatility may also negatively affect overseas suppliers.
Challenges and opportunities
Business owners — particularly those who run smaller companies — have always faced daunting challenges in maintaining strong supply chains. The pandemic has added a new and difficult dimension. Our firm can help you assess your supply chain and identify opportunities for cost-effective improvements.
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Why do partners sometimes report more income on tax returns than they receive in cash?
If you’re a partner in a business, you may have come across a situation that gave you pause. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.
Why is this? The answer lies in the way partnerships and partners are taxed. Unlike regular corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his share of a partnership’s loss to offset other income.)
Separate entity
While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.
A partnership must file an information return, which is IRS Form 1065. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.
Here’s an example
Two individuals each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his partnership interest from $50,000 to $10,000.
Other rules and limitations
The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters.
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Even if no money changes hands, bartering is a taxable transaction
Even if no money changes hands, bartering is a taxable transaction
During the COVID-19 pandemic, many small businesses are strapped for cash. They may find it beneficial to barter for goods and services instead of paying cash for them. If your business gets involved in bartering, remember 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.
For example, if a computer consultant agrees to exchange services with an advertising agency, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there is contrary evidence.
In addition, if services are exchanged for property, income is realized. 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. Another example: If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.
Joining a club
Many businesses 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.
Forms to file
By January 31 of each year, a barter club will send participants 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.
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 if you need assistance or would like more information.
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