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Beware the Ides of March – If You Own a Pass-Through Entity

Shakespeare’s words don’t apply just to Julius Caesar; they also apply to calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes. Why? The Ides of March, more commonly known as March 15, is the federal income tax filing deadline for these “pass-through” entities.

Not-so-ancient history

Until the 2016 tax year, the filing deadline for partnerships was the same as that for individual taxpayers: April 15 (or shortly thereafter if April 15 fell on a weekend or holiday). One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April filing deadline. After all, partnership (and S corporation) income passes through to the owners. The earlier date allows owners to use the information contained in the pass-through entity forms to file their personal returns.

For partnerships with fiscal year ends, tax returns are now due the 15th day of the third month after the close of the tax year. The same deadline applies to fiscal-year S corporations. Under prior law, returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.

Avoiding a tragedy

If you haven’t filed your calendar-year partnership or S corporation return yet and are worried about having sufficient time to complete it, you can avoid the tragedy of a late return by filing for an extension. Under the current law, the maximum extension for calendar-year partnerships is six months (until September 16, 2019, for 2018 returns). This is up from five months under the old law. So the extension deadline is the same — only the length of the extension has changed. The extension deadline for calendar-year S corporations also is September 16, 2019, for 2018 returns.

Whether you’ll be filing a partnership or an S corporation return, you must file for the extension by March 15 if it’s a calendar-year entity.

Extending the drama

Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now.

But to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There probably won’t be any tax liability from the partnership or S corporation return. But, if filing for an extension for the entity return causes you to also have to file an extension for your personal return, it could cause you to owe interest and penalties in relation to your personal return.

We can help you file your tax returns on a timely basis or determine whether filing for an extension is appropriate. Contact us today.

© 2019

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How to Report Stock Compensation Paid to Non-employees

The accounting rules for reporting stock compensation have been expanded. They now include share-based payments to non-employees for providing goods and services, under recent guidance issued by the Financial Accounting Standards Board (FASB).

Old Rules

Under existing U.S. Generally Accepted Accounting Principles (GAAP), the FASB requires businesses that give stock awards to independent contractors or consultants to follow a separate standard from the one used for employee stock compensation.

Under Accounting Standards Codification (ASC) Subtopic 505-50, Equity — Equity-Based Payments to Non-Employees, the measurement date for nonemployees is determined at the earlier of the date at which:

  • The commitment for performance is complete, or
  • The counterparty’s performance is complete.

This requires judgment and tracking issues that have led to inconsistencies in financial reporting, especially if nonemployees are awarded stock options on a one-by-one basis, rather than a single large grant.

The FASB originally chose to apply different stock compensation guidance to nonemployees because independent contractors and consultants were perceived as having significant freedom to move from company to company. In theory, independent contractors could watch stock price movements to determine where to work.

However, the FASB now believes the assumptions behind the dual standards were overstated, because full-time employees also have the freedom to move from job to job.

New Rules

In June 2018, the FASB issued Accounting Standards Update (ASU) No. 2018-07, Compensation — Stock Compensation: Improvements to Non-employee Share-Based Payment Accounting. It eliminates the separate guidance for stock compensation paid to non-employees and aligns it with the guidance for stock compensation paid to employees.

Under the aligned guidance, all share-based compensation payments will be measured with an estimate of the fair value of the equity the business is obligated to issue at the grant date. The grant date is the date the business and the stock award recipient agree to the terms of the award. Essentially, compensation will be recognized in the same period and in the same manner as if the company had paid cash for goods or services instead of stock.

The guidance doesn’t cover stock compensation that’s used to provide financing to the company that issued the shares. It also doesn’t include stock awards tied to a sale of goods or services as part of a contract accounted for under the new-and-improved revenue recognition standard.

Effective Dates

The updated standard is effective for public companies for fiscal years that begin after December 15, 2018. Private companies have an extra year to implement the changes for annual reports.

Early adoption is generally permitted, but businesses aren’t allowed to follow the changes in ASU No. 2018-07 until they’ve implemented the new revenue recognition standard. Contact us for more information.

© 2019

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The Home Office Deduction: Actual Expenses vs. the Simplified Method

If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. Thanks to a tax law change back in 2013, there are now two methods for claiming this deduction: the actual expenses method and the simplified method.

Basics of the deduction

In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.

Actual expenses

Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:

  • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
  • A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
  • A depreciation allowance.

But keeping track of actual expenses can be time consuming.

The simplified method

Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.

As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.

Flexibility in filing

When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.

Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation.

© 2019

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Auditing Cashless Transactions

Like most businesses, you’ve probably experienced a significant increase in the number of customers who prefer to make cashless payments. And you may be wondering: How does the acceptance of these types of transactions affect the auditing of your financial statements?

Cashless transactions require the exchange of digital information to facilitate payments. Instead of focusing on the collection and recording of physical cash, your auditors will spend significant time analyzing your company’s electronic sales records. This requires four specific procedures.

1. Identifying accepted payment methods

Auditors will ask for a list of the types of payments your company accepts and the process maps for each payment vehicle. Examples of cashless payment methods include:

  • Credit and debit cards,
  • Mobile wallets (such as Venmo),
  • Digital currencies (such as Bitcoin),
  • Automated Clearing House (ACH) payments,
  • Wire transfers, and
  • Payments via intermediaries (such as PayPal).

Be prepared to provide documents detailing how the receipt of cashless payments works and how the funds end up in your company’s bank account.

2. Evaluating roles and responsibilities

Your auditors will request a list of employees involved in the receipt, recording, reporting and analysis of cashless transactions. They will also want to see how your company manages and monitors employee access to every technology platform connected to cashless payments.

Evaluating who handles each aspect of the cashless payment cycle helps auditors confirm whether you have the appropriate level of security and segregation of duties to prevent fraud and misstatement.

3. Testing the reconciliation process

Auditors will review prior sales reconciliations to test their accuracy and ensure appropriate recognition of revenue. This may be especially challenging as companies implement the new accounting rules on revenue recognition for long-term contracts. Auditors also will test accounting entries related to such accounts as inventory, deferred revenue and accounts receivable.

4. Analyzing trends

Cashless transactions create an electronic audit trail. So, there’s ample data for auditors to analyze. To uncover anomalies, auditors may, for example, analyze sales by payment vehicle, over different time periods and according to each employee’s sales activity.

If your company has experienced payment fraud, it’s important to share that information with your audit team. Also tell them about steps you took to remediate the problem and recover losses.

Preparing for a cashless future

Before we arrive to conduct fieldwork, let’s discuss the types of cashless payments you now accept — or plan to accept in the future. Depending on the number of cashless methods, we’ll amend our audit program to review them in detail.

© 2019

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When Are LLC Members Subject to Self-Employment Tax?

Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.

SE tax background

Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.

General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.

(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)

LLC uncertainty

Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

Review your situation

The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.

Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.

© 2019

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Public Companies to Disclose Stock Hedging Policies and Practices

Does your company have policies in place regarding the use of hedging transactions by company insiders? Final Securities and Exchange Commission (SEC) guidance will soon require public companies to disclose whether their officers, employees and directors are allowed to offset a decrease in the market value of the company’s stock. Here’s what you should know to provide up-to-date disclosures.

Hedging concerns

Starting in the 1980s and 1990s, many companies adopted stock-compensation programs to help align the financial interests of executives and other company insiders with those of public shareholders. However, in the years leading up to the 2008 financial crisis, the growing prevalence of hedging instruments made many investors suspect those common interests had eroded.

Critics said a short-sale hedge could protect an executive, employee or director who receives stock incentives against a subsequent drop in the stock price. Similarly, selling a stock future increases the value of the insider’s position as the stock price drops.

Disclosure requirements

SEC Release No. 33-10593, Disclosure of Hedging by Employees, Officers, and Directors, was issued on December 20, 2018. Mandated by Section 955 of the Dodd-Frank Act, the rule amends Item 402 of Regulation S-K under the Securities Act of 1933.

The new rule doesn’t direct companies to establish policies regarding hedging. Rather, it requires a company to describe any policies it has adopted regarding the ability of its employees (including officers) or directors to purchase financial instruments that hedge or offset any decrease in the market value of equity securities granted as compensation, or held directly or indirectly by the employee or director. The new disclosure is required in a proxy statement or information statement relating to an election of directors.

The rule requires companies to disclose fully their hedging policies and practices for securities of:

  • The company,
  • Any parent company,
  • Any subsidiary of the company, or
  • Any subsidiary of the company parent.

Alternatively, companies can choose to provide a summary of hedging practices that includes a description of any categories of hedging transactions that are specifically permitted or disallowed. If a company doesn’t have any such policies, it needs to disclose that fact or state that hedging is generally permitted.

Effective date

The new disclosure rule goes into effect for fiscal years beginning on or after July 1, 2019. However, companies that qualify as smaller reporting companies (SRCs) or emerging growth companies (EGCs) will get an extra year to comply.

An SRC has a public float of less than $250 million. EGC is a class of company established in 2012 that’s eligible for lighter disclosure and reporting requirements for the first five years after going public. Listed closed-end funds and foreign private issuers (FPIs) won’t be subject to the new disclosure requirements.

Contact us to help your public company comply with the new SEC rule. We can draft comprehensive disclosures and, if necessary, help you implement effective hedging policies.

© 2019

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Fundamental Tax Truths for C-Corporations

The flat 21% federal income tax rate for C corporations under the Tax Cuts and Jobs Act (TCJA) has been great news for these entities and their owners. But some fundamental tax truths for C corporations largely remain the same:

C corporations are subject to double taxation.

Double taxation occurs when corporate income is taxed once at the corporate level and again at the shareholder level as dividends are paid out. The cost of double taxation, however, is now generally less because of the 21% corporate rate.

And double taxation isn’t a problem when a C corporation needs to retain all its earnings to finance growth and capital investments. Because all the earnings stay “inside” the corporation, no dividends are paid to shareholders, and, therefore, there’s no double taxation.

Double taxation also isn’t an issue when a C corporation’s taxable income levels are low. This can often be achieved by paying reasonable salaries and bonuses to shareholder-employees and providing them with tax-favored fringe benefits (deductible by the corporation and tax-free to the recipient shareholder-employees).

C corporation status isn’t generally advisable for ventures with appreciating assets or certain depreciable assets.

If assets such as real estate are eventually sold for substantial gains, it may be impossible to extract the profits from the corporation without being subject to double taxation. In contrast, if appreciating assets are held by a pass-through entity (such as an S corporation, partnership or limited liability company treated as a partnership for tax purposes), gains on such sales will be taxed only once, at the owner level.

But assets held by a C corporation don’t necessarily have to appreciate in value for double taxation to occur. Depreciation lowers the tax basis of the property, so a taxable gain results whenever the sale price exceeds the depreciated basis. In effect, appreciation can be caused by depreciation when depreciable assets hold their value.

To avoid this double-taxation issue, you might consider using a pass-through entity to lease to your C corporation appreciating assets or depreciable assets that will hold their value.

C corporation status isn’t generally advisable for ventures that will incur ongoing tax losses.

When a venture is set up as a C corporation, losses aren’t passed through to the owners (the shareholders) like they would be in a pass-through entity. Instead, they create corporate net operating losses (NOLs) that can be carried over to future tax years and then used to offset any corporate taxable income.

This was already a potential downside of C corporations, because it can take many years for a start-up to be profitable. Now, under the TCJA, NOLs that arise in tax years beginning after 2017 can’t offset more than 80% of taxable income in the NOL carryover year. So it may take even longer to fully absorb tax losses.

Do you have questions about C corporation tax issues post-TCJA? Contact us.

© 2019

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Private Companies: Have You Implemented the New Revenue Recognition Standard?

Private companies that follow U.S. Generally Accepted Accounting Principles (GAAP) must comply with the landmark new revenue recognition standard in 2019. Many private company CFOs and controllers report that they still have significant work to do to meet the demands of the sweeping rules. If you haven’t started the implementation process, it’s time to get the ball rolling.

Lessons from public company peers

Affected private companies must start following Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Accounting Standards Codification Topic 606), the first time they issue financial statements in 2019. For private companies with a fiscal year end or issuing quarterly statements under U.S. GAAP, that could be within the next few months. Other private companies have until the end of the year or even early 2020. No matter what, it’s crunch time.

Public companies, which had to begin following the standard in 2018, reported that, even if the new accounting didn’t radically change the number they reported in the top line of their income statements, it changed the method by which they had to calculate it. They had to comb through contracts and offer paper trails to back up their estimates to auditors. Public companies largely reported that the standard was more work than they anticipated. Private companies can expect the same challenges.

An overview

The revenue recognition standard erases reams of industry-specific revenue guidance in U.S. GAAP and attempts to come up with the following five-step revenue recognition model for most businesses worldwide:

1. Identify the contracts with a customer.2. Identify the performance obligations in the contract.3. Determine the transaction price.4. Allocate the transaction price to the performance obligations.5. Recognize revenue as the entity satisfies a performance obligation.
In many cases, the revenue a company reports under the new guidance won’t differ much from what it reported under old rules. But the timing of when a company can record revenues may be affected, particularly for long-term, multi-part arrangements. Companies also must assess:

  • The extent by which payments could vary due to such terms as bonuses, discounts, rebates and refunds,
  • The extent that collected payments from customers is “probable” and won’t result in a significant reversal in the future, and
  • The time value of money to determine the transaction price.

The result is a process that offers fewer bright-line rules and more judgment calls compared to old U.S. GAAP.

We can help

Our accounting experts can help you avoid a “fire drill” right before your implementation deadline and employ best practices learned from public companies that made the switch in 2018. Contact us for help getting your revenue reporting systems, processes and policies up to speed.

© 2019

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Insights And Tips

Business Taxes

Business owners should keep an eye out for some tax features that may not last long.

Bon Voyage

Tax year 2019 is the last year to get a paid leave credit of between 12.5% and 25% of taxes for offering paid family or medical leave. There are a number of qualifiers and employers in states where mandated paid leave isn’t eligible, so talk to your advisor to learn more.

Bonjour

The Cadillac tax was delayed, for the second time, from 2020 to 2022 — unless Congress delays it further or repeals it altogether. You’ll pay what amounts to a penalty if you offer employees health insurance plans with premiums that exceed certain limits. Talk to your tax professional if you want to plan ahead.

In 2019, look for an increase in Section 179 expensing on qualified property to $1,020,000, phasing out at $2,550,000. ESOP limits also increase in 2019.

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Short Bits

RETIREMENT ASSETS GROW.

The Investment Company Institute (ICI) estimated total U.S. retirement assets at $28.3 trillion as of the end of June 2018, accounting for almost one-third of household financial assets. Of that amount, about $9.26 trillion was in IRAs, making them the largest contributor. IRA assets grew $4.2 trillion since 2010. Where else are people investing for their retirement? Defined contribution plans like 401(k)s held more than $7.8 trillion in assets.

CONSISTENCY MATTERS.

When employees consistently contributed to their retirement plans — meaning actively in the same 401(k) plans from the beginning of 2011 to the end of 2016 — their balances more than doubled. The Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI) found that the average 401(k) plan account balance of these participants grew at 14.2% compounded annually to $167,330, more than double the average account balance of $75,358 among all participants during the same time.

IMPORTS COST MORE.

Trade uncertainty is causing a slight uptick in imports. Prices for U.S. imports rose 3.5% from October 2017 to October 2018, according to the Bureau of Labor Statistics. Prices rose 2.4% the year before. Fuel imports recorded the biggest increase at 30.2% while industrial supplies and materials import prices rose 14.2%.

BUSINESS CONFIDENCE HIGH.

The NFIB Research Foundation’s October 2018 Small Business Optimism Index maintained its recent strong performance, recording a 107.4, just off its record high. The report found that the percentage of small business members with one or more unfilled job openings is at a 45-year high.