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Accelerate Depreciation Deductions with a Cost Segregation Study

Is your business depreciating over a 30-year period the entire cost of constructing the building that houses your operation? If so, you should consider a cost segregation study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago due to enhancements to certain depreciation-related tax breaks.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). Most times, you depreciate a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — such as equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases — computers or furniture, for example — the distinction between real and personal property is obvious. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.

Identifying and substantiating costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

Speedier depreciation tax breaks

The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously this break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. And it temporarily increased first-year bonus depreciation to 100% (from 50%).

Making favorable depreciation changes

Fortunately, it isn’t too late to get the benefit of speedier depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file, that will result in “automatic” IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not right for every business. We must judge whether a study will result in overall tax savings greater than the costs of the study itself. To find out whether this would be worthwhile for you, contact us.

© 2019

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Reasons Why Cash is King

Dollar Pipeline – lots of 20 Dollar Bills building a tube.

In financial reporting, investors and business owners tend to focus on four key metrics: 1) revenue, 2) net income, 3) total assets and 4) net worth. But, when it comes to gauging short-term financial performance and creditworthiness, the trump card is cash flow.

If a business doesn’t have enough cash on hand to pay payroll, rent and other bills, it can spell disaster — no matter how profitable the company is or how fast it’s growing. That’s why you can’t afford to cast aside the statement of cash flows and the important insight it can provide.

Monitoring cash

The statement of cash flows reveals clues about a company’s ability to manage cash. It shows changes in balance sheet items from one accounting period to the next. Special attention should be given to significant balance changes.

For example, if accounts receivable were $1 million in 2018 and $2 million in 2019, the change would be reported as a cash outflow of $1 million. That’s because more money was tied up in receivables in 2019 than in 2018. An increase in receivables is common for growing businesses, because receivables generally grow in proportion to revenue. But a mounting receivables balance also might signal cash management inefficiencies. Additional financial information — such as an aging schedule — might reveal significant write-offs.

Continually reporting negative cash flows from operations can also signal danger. There’s a limit to how much money a company can get from selling off its assets, issuing new stock or taking on more debt. A red flag should go up when operating cash outflows consistently outpace operating inflows. It can signal weaknesses, such as out-of-control growth, poor inventory management, mounting costs and weak customer demand.

Categorizing cash flows

The statement of cash flows typically consists of three sections:

1. Cash flows from operations. This section converts accrual net income to cash provided or used by operations. All income-related items flow through this part of the cash flow statement, such as net income; gains (or losses) on asset sales; depreciation and amortization; and net changes in accounts receivable, inventory, prepaid assets, accrued expenses and payables.

2. Cash flows from investing activities. If a company buys or sells property, equipment or marketable securities, the transaction shows up here. This section could reveal whether a company is divesting assets for emergency funds or whether it’s reinvesting in future operations.

3. Cash flows from financing activities. This shows transactions with investors and lenders. Examples include Treasury stock purchases, additional capital contributions, debt issuances and payoffs, and dividend payments.

Below these three categories is the schedule of noncash investing and financing transactions. This portion of the cash flow statement summarizes significant transactions in which cash did not directly change hands: for example, like-kind exchanges or assets purchased directly with loan proceeds.

Keep a watchful eye

Effective cash management can be the difference between staying afloat and filing for bankruptcy — especially in an unpredictable economy. Contact us to help identify potential problems and find solutions to shore up inefficiencies and shortfalls.

© 2019

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Setting Up a Health Savings Account for Your Small Business

Healthcare and medical business concept

Given the escalating cost of employee health care benefits, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). For eligible individuals, HSAs offer a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the key tax benefits:

  • Contributions that participants make to an HSA are deductible, within limits.
  • Contributions that employers make aren’t taxed to participants.
  • Earnings on the funds within an HSA aren’t taxed, so the money can accumulate year after year tax free.
  • HSA distributions to cover qualified medical expenses aren’t taxed.
  • Employers don’t have to pay payroll taxes on HSA contributions made by employees through payroll deductions.

Who is eligible?

To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2019, a “high deductible health plan” is one with an annual deductible of at least $1,350 for self-only coverage, or at least $2,700 for family coverage. For self-only coverage, the 2019 limit on deductible contributions is $3,500. For family coverage, the 2019 limit on deductible contributions is $7,000. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,750 for self-only coverage or $13,500 for family coverage.

An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2019 of up to $1,000.

Employer contributions

If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from an employee’s gross income up to the deduction limitation. There’s no “use-it-or-lose-it” provision, so funds can be built up for years. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

Distributions

HSA distributions can be made to pay for qualified medical expenses, which generally mean those expenses that would qualify for the medical expense itemized deduction. They include expenses such as doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.

If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.

As you can see, HSAs offer a flexible option for providing health care coverage, but the rules are somewhat complex. Contact us if you’d like to discuss offering this benefit to your employees.

© 2019

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Nonprofits: New Alternatives for Reporting Goodwill and Other Intangibles

nonprofit banner – word abstract in vintage letterpress printing blocks stained by color inks

Did you know that the Financial Accounting Standards Board (FASB) recently extended the simplified private-company accounting alternatives to not-for-profit organizations? Many merging nonprofits, including educational institutions and hospitals, welcome these practical expedients. Here are the details.

Alternative for goodwill

The first alternative accounting method allows for the amortization of goodwill on a straight-line basis over 10 years (or less if a shorter useful life is more appropriate). It applies only to:

  • Goodwill recognized in a business combination after initial recognition and measurement,
  • Amounts recognized as goodwill in applying the equity method of accounting, and
  • The excess reorganization value recognized by entities that adopt fresh-start reporting under U.S. Generally Accepted Accounting Principles (GAAP) for reorganizations.

Once an alternative has been elected, the organization must apply all the alternative’s subsequent measurement, derecognition, presentation and disclosure requirements to existing goodwill and all future additions to goodwill that fall within the scope of the accounting alternative.

Upon adoption of the accounting alternative, the organization must decide whether to test goodwill at either the entity level or the reporting unit level. However, annual impairment testing isn’t required under the alternative. Rather, testing for impairment is required only if a triggering event occurs that indicates that the fair value of the nonprofit entity (or the reporting unit) may be below its carrying amount.

Alternative for identifiable intangible assets

The second accounting alternative allows a nonprofit organization to bypass the separate recognition of noncompete agreements and customer-related intangible assets unless they can be sold or licensed independently from other assets of a business. In other words, such items would be considered part of goodwill. Nonprofits that elect this alternative would recognize fewer intangible assets in a business combination.

It applies to nonprofit organizations that are required to recognize or consider fair value of intangible assets when:

  • Applying the acquisition method for a business combination,
  • Evaluating the nature of a difference between an investment’s carrying amount and the underlying equity in the net asset of an investee when applying the equity method of accounting, or
  • Adopting fresh start accounting for reorganizations.

If an organization decides to elect the accounting alternative for accounting for identifiable intangible assets, it also must adopt the accounting alternative for goodwill. However, a nonprofit that elects to adopt the accounting alternative for goodwill isn’t required to adopt the accounting alternative for accounting for identifiable intangible assets.

Effective date and transition

Nonprofits can immediately elect to use these alternative reporting methods. If elected, the goodwill accounting alternative should be applied prospectively to all existing goodwill and for all new goodwill generated in acquisitions. And the alternative for accounting for identifiable intangible assets should be applied prospectively upon the occurrence of the first transaction within the scope of the alternative. Contact us for more information. Our accounting professionals can help determine if these alternatives are right for your organization.

© 2019

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Understanding and Controlling the Unemployment Tax Costs of Your Business

As an employer, you must pay federal unemployment (FUTA) tax on amounts up to $7,000 paid to each employee as wages during the calendar year. The rate of tax imposed is 6% but can be reduced by a credit (described below). Most employers end up paying an effective FUTA tax rate of 0.6%. An employer taxed at a 6% rate would pay FUTA tax of $420 for each employee who earned at least $7,000 per year, while an employer taxed at 0.6% pays $42.

Tax credit

Unlike FICA taxes, only employers — and not employees — are liable for FUTA tax. Most employers pay both federal and a state unemployment tax. Unemployment tax rates for employers vary from state to state. The FUTA tax may be offset by a credit for contributions paid into state unemployment funds, effectively reducing (but not eliminating) the net FUTA tax rate.

However, the amount of the credit can be reduced — increasing the effective FUTA tax rate —for employers in states that borrowed funds from the federal government to pay unemployment benefits and defaulted on repaying the loan.

Some services performed by an employee aren’t considered employment for FUTA purposes. Even if an employee’s services are considered employment for FUTA purposes, some compensation received for those services — for example, most fringe benefits — aren’t subject to FUTA tax.

Recognizing the insurance principle of taxing according to “risk,’’ states have adopted laws permitting some employers to pay less. Your unemployment tax bill may be influenced by the number of former employees who’ve filed unemployment claims with the state, the current number of employees you have and the age of your business. Typically, the more claims made against a business, the higher the unemployment tax bill.

Here are four ways to help control your unemployment tax costs:

1. If your state permits it, “buy down” your unemployment tax rate.Some states allow employers to annually buy down their rate. If you’re eligible, this could save you substantial unemployment tax dollars.

2. Hire conservatively and assess candidates. Your unemployment payments are based partly on the number of employees who file unemployment claims. You don’t want to hire employees to fill a need now, only to have to lay them off if business slows. A temporary staffing agency can help you meet short-term needs without permanently adding staff, so you can avoid layoffs.

It’s often worth having job candidates undergo assessments before they’re hired to see if they’re the right match for your business and the position available. Hiring carefully can increase the likelihood that new employees will work out.

3. Train for success. Many unemployment insurance claimants are awarded benefits despite employer assertions that the employees failed to perform adequately. This may occur because the hearing officer concludes the employer didn’t provide the employee with enough training to succeed in the job.

4. Handle terminations carefully. If you must terminate an employee, consider giving him or her severance as well as outplacement benefits. Severance pay may reduce or delay the start of unemployment insurance benefits. Effective outplacement services may hasten the end of unemployment insurance benefits, because a claimant finds a new job.

If you have questions about unemployment taxes and how you can reduce them, contact us. We’d be pleased to help.

© 2019

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Internal Audit 2.0: Paperless and continuous Auditing Trends

Technology is altering the traditional approach to internal audits. Instead of reviewing reams of paperwork, today’s auditor is learning to use electronic records. In turn, going paperless facilitates a concept known as “continuous auditing,” where internal auditors continually gather data to support their procedures. Here’s how your business can modernize this process.

Targeting specific areas

Not every functional area of your company lends itself to paperless and continuous auditing. To determine whether sufficient, timely and accurate electronic data exists, you’ll need to review the systems that store and generate your company’s data.

For example, if a portion of your inventory accounting processes still relies on paper, it may not present an ideal candidate for paperless and continuous auditing. Alternatively, if your accounts payable (AP) process functions entirely on electronic records, it’s logical to include AP in the continuous audit program.

Planning the program

Before you can adopt a continuous audit program, you must determine:

  • Your primary and secondary business goals, and
  • The key risks you hope to mitigate.

Then you can design your program accordingly. For example, if you plan to continuously audit the AP process and you’re concerned about occupational fraud, you may decide to put a rule in place that looks for the creation of vendors whose address matches that of an employee.

From a practical perspective, it’s important to document how often you plan to sample the data that the continuous audit program makes available. Keep in mind that a daily review of the output often generates the greatest benefit.

Ensuring accountability

To help ensure accountability, a process must exist to review and evaluate the audit output. For example, if the review of employee payroll data uncovers unusual payroll disbursements, a process must exist to investigate those discrepancies.

The individual who should be responsible for reviewing the data will depend on the size and structure of your company. It could fall to the internal audit department, someone within the fraud team or a department manager.

Time for change?

Robust internal audits help management correct operational issues quickly, which prevents money from being wasted and risks from spiraling out of control. If implemented correctly, paperless and continuous auditing can improve your company’s internal audit and oversight abilities while also reducing its costs. Contact us for help converting paper records to an electronic format, as well as planning and implementing a continuous internal audit program that targets the optimal areas of your business operations.

© 2019

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The Chances of an IRS Audit are Low, but Business Owners Should Be Prepared

Many business owners ask: How can I avoid an IRS audit? The good news is that the odds against being audited are in your favor. In fiscal year 2018, the IRS audited approximately 0.6% of individuals. Businesses, large corporations and high-income individuals are more likely to be audited but, overall, audit rates are historically low.

There’s no 100% guarantee that you won’t be picked for an audit, because some tax returns are chosen randomly. However, completing your returns in a timely and accurate fashion with our firm certainly works in your favor. And it helps to know what might catch the attention of the IRS.

Audit red flags

A variety of tax-return entries may raise red flags with the IRS and may lead to an audit. Here are a few examples:

  • Significant inconsistencies between previous years’ filings and your most current filing,
  • 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.

How to respond

If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS won’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 crystal clear),
  • Gather the specific documents and information needed, and
  • •Respond to the auditor’s inquiries in the most expedient and effective manner.

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.

© 2019

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Measuring Fair Value for Financial Reporting

Two hands holding a caliper, measuring the word “Improvement”.

Business assets are generally reported at the lower of cost or market value. Under this accounting principle, certain assets are reported at fair value, such as asset retirement obligations and derivatives.

Fair value also comes into play in M&A transactions. That is, if one company acquires another, the buyer must allocate the purchase price of the target company to its assets and liabilities. This allocation requires the valuation of identifiable intangible assets that weren’t on the target company’s balance sheet, such as brands, patents, customer lists and goodwill.

What is fair value?

Under U.S. Generally Accepted Accounting Principles (GAAP), fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Though this term is similar to “fair market value,” which is defined in IRS Revenue Ruling 59-60, the terms aren’t synonymous.

The FASB chose the term “fair value” to prevent companies from applying IRS regulations or guidance and U.S. Tax Court precedent when valuing assets and liabilities for financial reporting purposes.

The FASB’s use of the term “market participants” refers to buyers and sellers in the item’s principal market. This market is entity specific and may vary among companies.

What goes into a fair value estimate?

When valuing an asset, there are three general valuation approaches: cost, income and market. For financial reporting purposes, fair value should first be based on quoted prices in active markets for identical assets and liabilities. When that information isn’t available, fair value should be based on observable market data, such as quoted prices for similar items in active markets.

In the absence of observable market data, fair value should be based on unobservable inputs. Examples include cash-flow projections prepared by management or other internal financial data.

While a CFO or controller can enlist the help of outside valuation specialists to estimate fair value, a company’s management is ultimately responsible for fair value estimates. So, it’s important to understand the assumptions, methods and models underlying a fair value estimate. Management also must implement adequate internal controls over fair value measurements, impairment charges and disclosures.

Valuation pros needed

Asset valuations are typically outside the comfort zone of in-house accounting personnel, so it pays to hire an outside specialist who will get it right. We can help you evaluate subjective inputs and methods, as well as recommend additional controls over the process to ensure that you’re meeting your financial reporting responsibilities.

© 2019

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3 Tips for Employers

If you’re ready to offer your employees open enrollment for benefits, your planning should mostly be done at this point. Even so, consider tightening up the following three communication areas to make sure your open enrollment is a success.

First,

make sure to get the word out about the value of your benefit offerings regularly. Benefits can comprise 20% to 40% of an employee’s total compensation, so sharing this information is important to help your company attract and retain the best and brightest.

Second,

communicate through channels most likely to reach your employees throughout open enrollment. This means via smartphones and apps for younger workers and print and in-person presentations for an older workforce.

Third,

make sure you communicate simply in a language your employees understand. Eliminate jargon to increase understanding. As important, give employees easy-to-reach resources should they have questions.

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Short Bits

BUSINESS COSTS UP.

Running a business can be expensive, but costs have remained stable, despite almost full employment in the workplace. Compensation costs for civilian workers increased 2.8% for the 12-month period ended March 2019, compared with a compensation cost increase of 2.7% during the previous year. Wages and salaries increased 2.9% during the latest period, up from 2.7% the year before, while benefit costs rose 2.6%. Wages comprised 70% of total costs, with benefit costs making up the rest.

WATCH OUT!

While compensation costs were tame, the 2019 second quarter increase of 3.7% year over year for full-time wage and salary workers indicates business costs could be rising. This increase was more than double the coinciding inflation increase (see next Item). The median weekly earnings during this time were $908. Broken down, that was $1,000 for men and $814 for women, or 81.4% of what men earn, indicating more room for progress.

INFLATION TAME.

Inflation remains tame, according to the Bureau of Labor Statistics. The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.6% for the year ending June 2019. Prices for all items, less food and energy, rose 2.1% during this time, while food prices increased 1.9%. The good news was that energy prices fell 3.4% over the last 12 months.

EMPLOYMENT STEADY.

The U.S. Bureau of Labor Statistics reported 164,000 new nonfarm jobs in July, with unemployment remaining unchanged at 3.7%. The Bureau added that job growth occurred in the professional and technical services, health care, social assistance, and financial activities sectors.