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Businesses Aren’t Immune to Tax Identity Theft

Tax identity theft may seem like a problem only for individual taxpayers. But, according to the IRS, increasingly businesses are also becoming victims. And identity thieves have become more sophisticated, knowing filing practices, the tax code and the best ways to get valuable data.

How it works

In tax identity theft, a taxpayer’s identifying information (such as Social Security number) is used to fraudulently obtain a refund or commit other crimes. Business tax identity theft occurs when a criminal uses the identifying information of a business to obtain tax benefits or to enable individual tax identity theft schemes.

For example, a thief could use an Employer Identification Number (EIN) to file a fraudulent business tax return and claim a refund. Or a fraudster may report income and withholding for fake employees on false W-2 forms. Then, he or she can file fraudulent individual tax returns for these “employees” to claim refunds.

The consequences can include significant dollar amounts, lost time sorting out the mess and damage to your reputation.

Red flags

There are some red flags that indicate possible tax identity theft. For example, your business’s identity may have been compromised if:

  • Your business doesn’t receive expected or routine mailings from the IRS,
  • You receive an IRS notice that doesn’t relate to anything your business submitted, that’s about fictitious employees or that’s related to a defunct, closed or dormant business after all account balances have been paid,
  • The IRS rejects an e-filed return or an extension-to-file request, saying it already has a return with that identification number — or the IRS accepts it as an amended return,
  • You receive an IRS letter stating that more than one tax return has been filed in your business’s name, or
  • You receive a notice from the IRS that you have a balance due when you haven’t yet filed a return.

Keep in mind, though, that some of these could be the result of a simple error, such as an inadvertent transposition of numbers. Nevertheless, you should contact the IRS immediately if you receive any notices or letters from the agency that you believe might indicate that someone has fraudulently used your Employer Identification Number.

Prevention tips

Businesses should take steps such as the following to protect their own information as well as that of their employees:

  • Provide training to accounting, human resources and other employees to educate them on the latest tax fraud schemes and how to spot phishing emails.
  • Use secure methods to send W-2 forms to employees.
  • Implement risk management strategies designed to flag suspicious communications.

Of course identity theft can go beyond tax identity theft, so be sure to have a comprehensive plan in place to protect the data of your business, your employees and your customers. If you’re concerned your business has become a victim, or you have questions about prevention, please contact us.

© 2018

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Cash vs. Accrual Reporting: Which is Right for Your Business?

Small businesses often use the cash-basis method of accounting. As businesses grow, they usually convert to accrual-basis reporting for federal tax purposes and to conform with U.S. Generally Accepted Accounting Principles (GAAP).

Starting this tax year, the Tax Cuts and Jobs Act (TCJA) has increased the threshold for businesses that qualify for the simpler cash method for federal tax purposes. Here’s how these accounting methods compare and how the TCJA could affect your financial and tax reporting decisions.

Cash method

Companies that use the cash-basis method of accounting recognize revenue as customers pay invoices and expenses as they pay bills. So, cash-basis entities often report large fluctuations in profits from period to period, especially if they’re engaged in long-term projects. This can make it hard to benchmark a company’s performance from year to year — or against other entities that use the accrual method.

Cash-basis entities also tend to postpone revenue recognition and accelerate expense payments at year end. This strategy can temporarily defer the company’s tax liability. But the flipside is that it can make a company appear less profitable to lenders and investors.

Accrual method

The more complex accrual-basis accounting method conforms to the matching principle under GAAP. That is, revenue (and expenses) are “matched” to the periods in which they’re earned (or incurred).

Accrual-basis entities report several asset and liability accounts that are generally absent on a cash-basis balance sheet. Examples include prepaid expenses, accounts receivable, accounts payable, work in progress, accrued expenses and deferred taxes.

TCJA considerations

Under the TCJA, for tax years beginning after 2017, businesses with average annual gross receipts of $25 million or less for the previous three tax years are eligible for the cash method of accounting for federal income tax purposes. Under prior law, the gross-receipts threshold for the cash method was only $5 million.

In addition, for tax years beginning after 2017, the TCJA modifies Section 451 of the Internal Revenue Code so that a business recognizes revenue for tax purposes no later than when it’s recognized for financial reporting purposes. So, if you use the accrual method for financial reporting purposes, you must also use it for federal income tax purposes.

These changes could prompt more companies to opt for the simpler, tax-deferred cash method for both financial reporting and tax purposes. But it’s not right for everyone.

Look before you leap

As your small business grows, you might be tempted to switch to the accrual method of accounting to reduce variability in financial reporting from year to year — and to attract more sophisticated lenders and investors who prefer GAAP financials. But doing so could accelerate your tax obligations. On the other hand, if you’re newly eligible for the cash method for tax purposes, you may want to switch to that method for the simplicity and tax deferral it offers.

If you’re in either situation, contact us to discuss the pros and cons of these two options to ensure you’re using the optimal method based on your circumstances.

© 2018

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How to Reduce the Tax Risk of Using Independent Contractors

Classifying a worker as an independent contractor frees a business from payroll tax liability and allows it to forgo providing overtime pay, unemployment compensation and other employee benefits. It also frees the business from responsibility for withholding income taxes and the worker’s share of payroll taxes.

For these reasons, the federal government views misclassifying a bona fide employee as an independent contractor unfavorably. If the IRS reclassifies a worker as an employee, your business could be hit with back taxes, interest and penalties.

Key factors

When assessing worker classification, the IRS typically looks at the:

Level of behavioral control. This means the extent to which the company instructs a worker on when and where to do the work, what tools or equipment to use, whom to hire, where to purchase supplies and so on. Also, control typically involves providing training and evaluating the worker’s performance. The more control the company exercises, the more likely the worker is an employee.

Level of financial control. Independent contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers. Employees are more likely to be paid by the hour or week or some other time period; independent contractors are more likely to receive a flat fee.

Relationship of the parties. Independent contractors are often engaged for a discrete project, while employees are typically hired permanently (or at least for an indefinite period). Also, workers who serve a key business function are more likely to be classified as employees.

The IRS examines a variety of factors within each category. You need to consider all of the facts and circumstances surrounding each worker relationship.

Protective measures

Once you’ve completed your review, there are several strategies you can use to minimize your exposure. When in doubt, reclassify questionable independent contractors as employees. This may increase your tax and benefit costs, but it will eliminate reclassification risk.

From there, modify your relationships with independent contractors to better ensure compliance. For example, you might exercise less behavioral control by reducing your level of supervision or allowing workers to set their own hours or work from home.

Also, consider using an employee-leasing company. Workers leased from these firms are employees of the leasing company, which is responsible for taxes, benefits and other employer obligations.

Handle with care

Keep in mind that taxes, interest and penalties aren’t the only possible negative consequences of a worker being reclassified as an employee. In addition, your business could be liable for employee benefits that should have been provided but weren’t. Fortunately, careful handling of contractors can help ensure that independent contractor status will pass IRS scrutiny. Contact us if you have questions about worker classification.

© 2018

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It’s Important to Monitor Your SEC Filing Status

As public companies grow, they may move from one filing status or issuer category to another. Recent and proposed changes to the Securities and Exchange Commission (SEC) rules for some categories could affect your company’s financial reporting and audit procedures.

Categories of public companies

Under existing rules, public companies fall into different filing categories, based on their public “float” (the amount of shares available to the public for trading):

  • Smaller reporting companies (SRCs) are nonaccelerated filers that meet certain other requirements, including annual revenues under $50 million if their public float is zero.
  • Nonaccelerated filers have a public float of less than $75 million and aren’t otherwise required to accelerate their filing deadlines.
  • Accelerated filers have a public float between $75 million and $700 million and meet other requirements.
  • Large accelerated filers have a public float of more than $700 million and meet certain other requirements.

Finally, there’s the emerging growth company (EGC). Generally, an EGC is a new public company that has gross revenues under $1 billion in its most recent fiscal year and meets certain other requirements. EGCs enjoy a variety of benefits during their first five years of existence, including scaled-back disclosures and exemption from the auditor attestation of a company’s internal control over financial reporting as required by Section 404(b) of the Sarbanes-Oxley Act.

A company that ceases to be an EGC must begin complying with Sec. 404(b), except for nonaccelerated filers, which are exempt from that requirement unless they become accelerated or large accelerated filers. (Congress currently is considering legislation that would extend the exemption for certain companies, however.)

Changes to public float thresholds

On June 28, 2018, the SEC voted unanimously to issue the final rule in Release No. 33-10513, Amendments to Smaller Reporting Company Definition. The rule increases the public float threshold for SRCs to $100 million and nonaccelerated filers to $250 million.

To complicate matters, the SEC did not make conforming changes to the definition of an accelerated filer. Rather, it eliminated the automatic exclusion of SRCs in the definitions of accelerated and large accelerated filers. As a result, a registrant could be both an SRC and an accelerated filer. As an accelerated filer, a company would still be required to comply with Sec. 404(b).

The new SEC rule will be effective 60 days after publication in the Federal Register, which normally occurs a few weeks after a rule is posted on the SEC’s website. The SEC said 966 additional companies will be eligible for smaller company status in the first year of the new threshold.

Annual assessment

Changes in filing status affect the form, content and timing of financial reports, as well as the extent of external audit procedures. So, it’s a good idea to re-evaluate your company’s status well before the end of each fiscal year. We can help you evaluate your filing status based on the SEC’s evolving guidelines. If a change is anticipated, we can help you prepare for new filing, disclosure and audit requirements.

© 2018

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Choosing the Right Accounting Method for Tax Purposes

The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.

Cash vs. accrual

Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.

In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:

1. Expressly prohibited from using the cash method, or
2. Expressly required to use the accrual method.

Cash method advantages

The cash method offers several advantages, including:

Simplicity. It’s easier and cheaper to implement and maintain.

Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.

Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.

Accrual method advantages

In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.

The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).

If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.

Making a change

Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.

If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.

© 2018

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Transitioning to Remote Audits


Are you comfortable communicating electronically with your auditors? If so, a logical next step might be to transition from on-site audit procedures to a more “remote” approach. Remote audits can help reduce the time and cost of preparing audited financial statements.

21st century audits

Traditionally, audit fieldwork has involved a team of auditors camping out for weeks (or even months) in one of the conference rooms at the headquarters of the company being audited. Now, thanks to technological advances — including cloud storage, smart devices and secure data-sharing platforms — many audit firms are testing the feasibility of remote auditing as a replacement for sending auditors on-site.

In addition to saving time and audit fees, allowing auditors to work remotely improves the work-life balance for auditors and in-house accounting personnel. Your employees won’t need to stay glued to their desks for the duration of the audit, because they can respond to the auditor’s inquiries and document requests remotely.

Best practices

Changing the format of an audit requires flexibility, including a willingness to embrace the technology needed to facilitate the exchange, review and analysis of relevant documents. You can facilitate the transition process by:

Being responsive to electronic requests. Auditors who are out of sight shouldn’t be out of mind. Answer all remote requests from your auditors in a timely manner. If a key employee will be on vacation or out of the office for an extended period, give the audit team the contact information for the key person’s backup.

Giving employees access to the requisite software. Sharing documents with remote auditors may require you to install specific software on employees’ computers. But your company’s policies may prohibit employees from downloading software without approval from the IT department.

Before remote auditors start “fieldwork,” ask for a list of software and platforms that will be used to interact with in-house personnel. Give the appropriate employees access and authorization to share audit-related data from your company’s systems. Work with IT specialists to address any security concerns they may have with sharing data with the remote auditors.

Tracking audit progress. With less face-to-face time with your auditors, you have fewer opportunities to receive updates on the team’s progress. Ask the engagement partner to explain how they’ll track the performance of their remote auditors, and how they plan to communicate the team’s progress to in-house accounting personnel.

Wave of the future

Like remote working arrangements with employees and contractors, remote audits are a growing trend that could potentially reduce the costs of preparing financial statements. But not every audit firm or business is ready to embrace remote auditing. Contact us to discuss ways to make next year’s audit more efficient and cost-effective.

© 2018

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Close-Up on the New QBI Deduction’s Wage Limit

The Tax Cuts and Jobs Act (TCJA) provides a valuable new tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction generally applies to income from sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). It can equal as much as 20% of QBI. But once taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other filers, a wage limit begins to phase in.

Full vs. partial phase-in

When the wage limit is fully phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).

When the wage limit applies but isn’t yet fully phased in, the amount of the limit is reduced and the final deduction is calculated as follows:

1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
3. The result is subtracted from the gross deduction to determine the final deduction.

Some examples

Let’s say Chris and Leslie have taxable income of $600,000. This includes $300,000 of QBI from Chris’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. Computing the deduction is fairly straightforward in this situation.

The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit — and the deduction — is $50,000.

What if Chris and Leslie’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

To calculate the amount of their deduction, the couple must first calculate 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:

($60,000 – $50,000) × 85% = $8,500

That amount is subtracted from the $60,000 gross deduction for a final deduction of $51,500.

That’s not all

Be aware that another restriction may apply: For income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it. Please contact us to learn whether your business is a specified service business or if you have other questions about the QBI deduction.

© 2018

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Using Analytical Procedures in An Audit Provides Many Benefits

Analytical procedures can make audits more efficient and effective. First, they can help during the planning and review stages of the audit. But analytics can have an even bigger impact when used to supplement substantive testing during fieldwork.

Defining audit analytics

AICPA auditing standards define analytical procedures as “evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.” Analytical procedures also investigate “identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.” Examples of analytical tests include trend, ratio and regression analysis.

Using analytical procedures

During fieldwork, auditors can use analytical procedures to obtain evidence, sometimes in combination with other substantive testing procedures, that identifies misstatements in account balances. Analytical procedures are often more efficient than traditional, manual audit testing procedures that typically require the business being audited to produce significant paperwork. Traditional procedures also usually require substantial time to verify account balances and transactions.

Analytical procedures generally follow these five steps:

1. Form an independent expectation about an account balance or financial relationship.
2. Identify differences between expected and reported amounts.
3. Investigate the most probable cause(s) of any discrepancies.
4. Evaluate the likelihood of material misstatement.
5. Determine the nature and extent of any additional auditing procedures needed.

When using analytical procedures, the auditor must establish a threshold that can be accepted without further investigation. This threshold is a matter of professional judgment, but it’s influenced primarily by the concept of materiality and the desired level of assurance.

For differences that are due to misstatement (rather than a plausible explanation), the auditor must decide whether the misstatement is material (individually or in the aggregate). Material misstatements typically require adjustments to the amount reported and may also necessitate additional audit procedures to determine the scope of the misstatement.

Your role in audit analytics

Done right, analytical procedures can help make your audit less time-consuming, less expensive and more effective at detecting errors and omissions. But it’s important to notify your auditor about any major changes to your operations, accounting methods or market conditions that occurred during the current accounting period.

This insight can help auditors develop more reliable expectations for analytical testing and identify plausible explanations for significant changes from the balance reported in prior periods. Moreover, now that you understand the role analytical procedures play in an audit, you can anticipate audit inquiries, prepare explanations and compile supporting documents before fieldwork starts.

© 2018

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Does Your Business have To Begin Collecting Sales Tax On All Out-Of-State Online Sales?

You’ve probably heard about the recent U.S. Supreme Court decision allowing state and local governments to impose sales taxes on more out-of-state online sales. The ruling in South Dakota v. Wayfair, Inc. is welcome news for brick-and-mortar retailers, who felt previous rulings gave an unfair advantage to their online competitors. And state and local governments are pleased to potentially be able to collect more sales tax.

But for businesses with out-of-state online sales that haven’t had to collect sales tax from out-of-state customers in the past, the decision brings many questions and concerns.

What the requirements used to be

Even before Wayfair, a state could require an out-of-state business to collect sales tax from its residents on online sales if the business had a “substantial nexus” — or connection — with the state. The nexus requirement is part of the Commerce Clause of the U.S. Constitution.

Previous Supreme Court rulings had found that a physical presence in a state (such as retail outlets, employees or property) was necessary to establish substantial nexus. As a result, some online retailers have already been collecting tax from out-of-state customers, while others have not had to.

What has changed

In Wayfair, South Dakota had enacted a law requiring out-of-state retailers that made at least 200 sales or sales totaling at least $100,000 in the state to collect and remit sales tax. The Supreme Court found that the physical presence rule is “unsound and incorrect,” and that the South Dakota tax satisfies the substantial nexus requirement.

The Court said that the physical presence rule puts businesses with a physical presence at a competitive disadvantage compared with remote sellers that needn’t charge customers for taxes.

In addition, the Court found that the physical presence rule treats sellers differently for arbitrary reasons. A business with a few items of inventory in a small warehouse in a state is subject to sales tax on all of its sales in the state, while a business with a pervasive online presence but no physical presence isn’t subject to the same tax for the sales of the same items.

What the decision means

Wayfair doesn’t necessarily mean that you must immediately begin collecting sales tax on online sales to all of your out-of-state customers. You’ll be required to collect such taxes only if the particular state requires it. Some states already have laws on the books similar to South Dakota’s, but many states will need to revise or enact legislation.

Also keep in mind that the substantial nexus requirement isn’t the only principle in the Commerce Clause doctrine that can invalidate a state tax. The others weren’t argued in Wayfair, but the Court observed that South Dakota’s tax system included several features that seem designed to prevent discrimination against or undue burdens on interstate commerce, such as a prohibition against retroactive application and a safe harbor for taxpayers who do only limited business in the state.

Please contact us with any questions you have about sales tax collection requirements.

© 2018

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Auditing Related-Party Transactions

Business owners generally prefer to work with entities they know and trust. But related-party transactions can provide opportunities for individuals to act in a manner that’s inconsistent with the interests of shareholders. That’s why auditors take pains to identify and properly address related-party transactions.

What is a related party?

Accounting Standards Codification (ASC) Topic 850 defines a related-party transaction as one that takes place between:

  • A parent entity and its subsidiaries,
  • Subsidiaries of a common parent,
  • An entity and trusts for the benefit of its employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of the entity’s management,
  • An entity and its principal owners and managers (or members of their immediate families), and
  • Affiliated entities.

What’s the risk?

Related-party transactions sometimes involve contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s length transactions between unrelated third parties. For example, a spinoff business might lease office space from its parent company at below-market rates. Or a closely held manufacturer might pay the owner’s son an above-market salary and various perks that aren’t available to unrelated employees.

How do auditors address these transactions?

Given the potential for double dealing with related parties, auditors spend significant time hunting for undisclosed related-party transactions. Examples of documents and data sources that can help uncover these transactions are:

  • A list of the company’s current related parties and associated transactions,
  • Minutes from board of directors’ meetings, particularly when the board discusses significant business transactions,
  • Disclosures from board members and senior executives regarding their ownership of other entities, participation on additional boards and previous employment history,
  • Bank statements, especially transactions involving intercompany wires, automated clearing house (ACH) transfers, and check payments, and
  • Press releases announcing significant business transactions with related parties.

Audit procedures that target related-party transactions include 1) testing how related-party transactions are identified and coded in the company’s enterprise resource planning (ERP) system, 2) interviewing accounting personnel responsible for reporting related-party transactions in the company’s financial statements, and 3) analyzing presentation of related-party transactions in financial statements.

Accurate, complete reporting of these transactions requires robust internal controls. A company’s vendor approval process should provide guidelines to help accounting personnel determine whether a supplier qualifies as a related party and mark it accordingly in the ERP system. Without the right mechanisms in place, a company may inadvertently omit a disclosure about a related-party transaction.

Get it right

Undisclosed related-party transactions can raise a red flag to lenders and investors — and may even require a business to restate its financial results. Our auditors are committed to finding, disclosing and reporting these transactions in a transparent manner that complies with U.S. Generally Accepted Accounting Principles (GAAP). Contact us for help.

© 2018