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Tax depreciation rules for business automobiles

If you use an automobile in your trade or business, you may wonder how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.

Cents-per-mile vs. actual expenses

First, note that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (56 cents per business mile driven for 2021), a depreciation allowance is built into the rate.

If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.

For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually.

  • For a passenger auto placed in service in 2021 that cost more than $59,000, the Year 1 depreciation ceiling is $18,200 if you choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
  • For a passenger auto placed in service in 2021 that cost more than $51,000, the Year 1 depreciation ceiling is $10,200 if you don’t choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
  • These ceilings are proportionately reduced for any nonbusiness use. And if a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions.

Heavy SUVs, pickups, and vans

Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.

After-tax cost is what counts

What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.

The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.

© 2021

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Accounting for business combinations

If your company is planning to merge with or buy another business, your attention is probably on conducting due diligence and negotiating deal terms. But you also should address the post-closing financial reporting requirements for the transaction. If not, it may lead to disappointing financial results, restatements and potential lawsuits after the dust settles.

Here’s guidance on how to correctly account for M&A transactions under U.S. Generally Accepted Accounting Principles (GAAP).

Identify assets and liabilities

A seller’s GAAP balance sheet may exclude certain intangible assets and contingencies, such as internally developed brands, patents, customer lists, environmental claims and pending lawsuits. Overlooking identifiable assets and liabilities often results in inaccurate reporting of goodwill from the sale.

Private companies can elect to combine noncompete agreements and customer-related intangibles with goodwill. If this alternative is used, it specifically excludes customer-related intangibles that can be licensed or sold separately from the business.

It’s also important to determine whether the deal terms include arrangements to compensate the seller or existing employees for future services. These payments, along with payments for pre-existing arrangements, aren’t part of a business combination. In addition, acquisition-related costs, such as finder’s fees or professional fees, shouldn’t be capitalized as part of the business combination. Instead, they’re generally accounted for separately and expensed as incurred.

Determine the price

When the buyer pays the seller in cash, the purchase price (also called the “fair value of consideration transferred”) is obvious. But other types of consideration muddy the waters. Consideration exchanged may include stock, stock options, replacement awards and contingent payments.

For example, it can be challenging to assign fair value to contingent consideration, such as earnouts payable only if the acquired entity achieves predetermined financial benchmarks. Contingent consideration may be reported as a liability or equity (if the buyer will be required to pay more if it achieves the benchmark) or as an asset (if the buyer will be reimbursed for consideration already paid). Contingent consideration that’s reported as an asset or liability may need to be remeasured each period if new facts are obtained during the measurement period or for events that occur after the acquisition date.

Allocate fair value

Next, you’ll need to split up the purchase price among the assets acquired and liabilities assumed. This requires you to estimate the fair value of each item. Any leftover amount is assigned to goodwill. Essentially, goodwill is the premium the buyer is willing to pay above the fair value of the net assets acquired for expected synergies and growth opportunities related to the business combination.

In rare instances, a buyer negotiates a “bargain” purchase. Here, the fair value of the net assets exceeds the purchase price. Rather than book negative goodwill, the buyer reports a gain on the purchase.

Make accounting a forethought, not an afterthought

M&A transactions and the accompanying financial reporting requirements are uncharted territory for many buyers. Don’t wait until after a deal closes to figure out how to report it. We can help you understand the accounting rules and the fair value of the acquired assets and liabilities before closing.

© 2021

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Reporting profits interest awards

During the pandemic, cash has been tight for many small businesses, which may make it hard to attract and retain skilled workers. In lieu of providing cash bonuses or annual raises, some companies may decide to give valued employees a share of their future profits. While corporations generally issue stock options, limited liability companies (LLCs) use a relatively new form of equity compensation called “profits interests” to incentivize workers. Here’s a summary of the accounting rules that are used to account for these transactions.

Types of awards

Under U.S. Generally Accepted Accounting Principles (GAAP), profits interest awards may be classified as:

  • Share-based payments,
  • Profit-sharing,
  • Bonus arrangements, or
  • Deferred compensation.

Classification is determined by the specific terms and features of the profits interest. In most cases, the fair value of the award must be recorded as an expense on the income statement. Profits interest can also result in the recognition of a liability on the balance sheet and require footnote disclosures.

Valuation

Under GAAP, fair value is the price an entity would receive to sell an asset — or pay to transfer a liability — in a transaction that’s orderly, takes place between market participants and occurs at the acquisition date. If quoted market prices and other observable inputs aren’t available, unobservable inputs are used to estimate fair value.

One of the upsides to issuing profits interest awards is their flexibility. There’s no standard definition of a profits interest; the term “profits” can refer to whatever is agreed to by the LLC and the recipient of the award. In addition, profits interest units may be subject to various terms and conditions, such as:

  • Vesting requirements,
  • Time limitations,
  • Specific performance thresholds, and
  • Forfeiture provisions.

An LLC may offer multiple types of profits interests, allowing it to customize awards for various purposes. The varieties of terms and conditions that can be incorporated into a profits interest requires the use of customized valuation techniques.

Need for improvement

Many private companies struggle with how to report profits interests. In recent years, the Financial Accounting Standards Board (FASB) has discussed ways to simplify the rules, including scaling back the disclosure requirements and providing a practical expedient to measure grant-date fair value of these awards. No changes have been made yet, however.

For more information

Accounting complexity has caused some private companies to shy away from profits interest arrangements. But they can be an effective tool for attracting and retaining workers under the right circumstances. Contact us for help reporting these transactions under existing GAAP or for an update on the latest developments from the FASB.

© 2021

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Cutoffs: What counts in 2020 vs. 2021

As year end approaches, it’s a good idea for calendar-year entities to review the guidelines for recognizing revenue and expenses. There are specific rules regarding accounting cutoffs under U.S. Generally Accepted Accounting Principles (GAAP). Strict observance of these rules is generally the safest game plan.

The basics

Companies that follow GAAP must use the accrual method of accounting, not the cash method. That means revenues and expenses must be matched to the periods in which they were earned or incurred. The end of the period serves as a “cutoff” for recognizing revenue and expenses. For a calendar-year business, the cutoff is December 31.

However, some companies may be tempted to play timing games to lower taxes or boost financial results. The temptation might be especially high in 2020, as many companies struggle during the COVID-19 pandemic.

Now or later

Test your understanding of the cutoff rules with these two hypothetical situations:

  1. As of December 31, a calendar-year, accrual-basis auto dealership has verbally negotiated a deal on an SUV. But the customer hasn’t yet signed all the paperwork. Should the sale be reported in 2020 or 2021?
  2. On December 30, a calendar-year, accrual-basis retailer pays its rent bill for January. Rent is due on the first day of the month. Can the store deduct the extra month’s rent in 2020 to help lower its tax bill?

In both examples, the transactions should be reported in 2021, not 2020. In the first example, even if the customer takes the car home for the weekend, it doesn’t matter; there’s still the possibility the customer could back out of the deal. The dealership can’t report the transaction in 2020 revenue until the customer has signed the paperwork and paid for the vehicle with cash or financing.

Audit procedures

If your financial statements are audited, your CPA will enforce strict cutoff rules — and likely reverse any items that were reported inaccurately. Audit procedures may include reviewing customer contracts and returns reported near year end. Auditors also may compare expenses as a percentage of revenues from period to period to identify timing errors. And they may vouch expenses to invoices and contracts for accuracy.

It never reflects favorably — in the eyes of investor or lenders — when auditors adjust year-end financial statements for inaccurate observation of cutoffs. Don’t give cause for others to wonder about your operations.

Timing is critical

Contact us if you need help understanding the rules on when to record revenue or expenses. We can help you comply with the rules and minimize financial statement adjustments during your audit.

© 2020

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2021 Q1 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

January 15

  • Pay the final installment of 2020 estimated tax.
  • Farmers and fishermen: Pay estimated tax for 2020.

February 1 (The usual deadline of January 31 is a Sunday)

  • File 2020 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • Provide copies of 2020 Forms 1099-MISC, “Miscellaneous Information,” and 1099-NEC, “Nonemployee Compensation” to recipients of income from your business where required.
  • File 2020 Forms 1099-NEC reporting nonemployee compensation payments in Box 1 with the IRS.
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2020. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2020. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944, “Employer’s Annual Federal Tax Return.”)
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2020 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.

March 1 (The usual deadline of February 28 is a Sunday)

  • File 2020 Forms 1099-MISC with the IRS if: 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is March 31.)

March 16

  • If a calendar-year partnership or S corporation, file or extend your 2020 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2020 contributions to pension and profit-sharing plans.

© 2020

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Red flags of deadbeat debtors

Unfortunately, many businesses have experienced problems with collections during the COVID-19 pandemic. Accounts receivable are a major item on most companies’ balance sheets. Slow-paying — or even nonpaying — customers or clients adversely affect cash flow. Proactive measures can help identify collections issues early and remedy them before they spiral out of control.

Recognize the warning signs

To stay on top of collections, be aware of the following red flags:

Anonymous clients. Some prospective customers don’t seem to exist anywhere other than, say, a vague email address. This is a sign to move cautiously. It’s not too much to expect that even start-up businesses have some sort of online presence, a physical address, and a working email address and phone number.

Empty assurances. One warning sign is clients who ask that work on their product or service start immediately, but without providing assurances that payment will be forthcoming. In some industries, it might be common practice for suppliers to provide goods or services, and follow up with invoices later. When that’s not the case, however, consider the lack of credible assurances to be a warning sign. That’s especially true if a prospective customer is vague on the budget for a project.

Future earnings as payment. Customers who promise some portion of future earnings as payment may be legitimate. But, before you begin work, nail down the terms and decide if the potential reward compensates for the risk.

Perpetual nitpicking. A client who regularly finds fault with minor details of a project may keep it from ever getting off the ground. While clients have a right to expect the level of quality promised at the outset of a project, those who seem to continually search for reasons to criticize products or services may be using their purported dissatisfaction to avoid paying for their purchase.

Take precautionary measures

If you’re skeptical you’ll be able to collect from a customer, it’s wise to ask for a retainer or deposit up front before starting a project. You can also request progress payments while the project is in process. Additional steps that can help expedite collections include:

  • Following up with a firm, but tactful, email when an invoice is overdue.
  • Moving to a phone call if follow-up emails aren’t generating a response.
  • Trying to contact the customer’s accounts payable staff or business manager, if previous follow-up efforts aren’t working.

If you have clients that continue to withhold payment after these steps, it may be time to take legal action. When it’s necessary to pursue missing payments, persistence pays off.

Need help?

Delinquent payments and write-offs can damage your company’s operations and profitability. Contact us if your business is experiencing collections issues. We can help you sort out your options.

© 2020

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Get Prepared

Now’s the time to get your company’s books ready for tax time.

Your tax preparer may have a checklist to help you get organized. Start by reconciling your accounts as of December 31.

If you owe any 1099s to independent contractors, you have until the end of January to get those out and don’t forget you’ll need to send copies to the IRS.

Pull out receipts for depreciable assets purchased in 2020. Your tax preparer will need these to update your records and calculate depreciation for your tax return.

Once you have all your tax documents ready, call your tax professional to schedule your appointment early so you can file your taxes on time.

A word to the wise: Do not underestimate the importance of accounting for the survival and growth of your business. Work with your accountant throughout the year–not just at tax time–to monitor cash flow and profits.

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Put your company’s financial statements to work for you

1. Benchmarking

Historical financial statements can be used to evaluate the company’s current performance vs. past performance or industry norms. A comprehensive benchmarking study includes the following elements:

Size. This is usually in terms of annual revenue, total assets or market share.

Growth. This shows how much the company’s size has changed from previous periods.

Liquidity. Working capital ratios help assess how easily assets can be converted into cash and whether current assets are sufficient to cover current liabilities.

Profitability. This section evaluates whether the business is making money from operations — before considering changes in working capital accounts, investments in capital expenditures and financing activities.

Turnover. Such ratios as total asset turnover (revenue divided by total assets) or inventory turnover (cost of sales divided by inventory) show how effectively the company manages its assets.

Leverage. This refers to how the company finances its operations — through debt or equity. Each has pros and cons.

No universal benchmarks apply to all types of businesses. So, it’s important to seek data sorted by industry, size and geographic location, if possible. To understand what’s normal for businesses like yours, consider such sources as trade journals, conventions or local roundtable meetings. Your accountant can also provide access to benchmarking studies they use during audits, reviews and consulting engagements.

2. Forecasting

Historical financial statements also may serve as the starting point for forecasting, which is a critical part of strategic planning. Comprehensive business plans include forecasted balance sheets, income statements and statements of cash flows.

Many items in your forecasts will be derived from revenue. For example, variable expenses and working capital accounts are often assumed to grow in tandem with revenue. Other items, such as rent and management salaries, are fixed over the short run. These items may need to increase in steps over the long run. For example, if a company is currently at (or near) full capacity, it may eventually need to expand its factory or purchase equipment to grow.

By tracking sources and uses of cash on the forecasted statement of cash flows, management can identify when cash shortfalls might happen and plan how to make up the difference. For example, the company might need to draw on its line of credit, lay off workers, reduce inventory levels or improve its collections. In turn, these changes will flow through to the company’s forecasted balance sheet.

For more information

Let’s take your financial statements to the next level! We can help you benchmark your company’s performance and create forecasts from your year-end financial statements.

© 2020

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The QBI deduction basics and a year-end tax tip that might help you qualify

If you own a business, you may wonder if you’re eligible to take the qualified business income (QBI) deduction. Sometimes this is referred to as the pass-through deduction or the Section 199A deduction.

The QBI deduction:

  • Is available to owners of sole proprietorships, single member limited liability companies (LLCs), partnerships, and S corporations, as well as trusts and estates.
  • Is intended to reduce the tax rate on QBI to a rate that’s closer to the corporate tax rate.
  • Is taken “below the line.” In other words, it reduces your taxable income but not your adjusted gross income.
  • Is available regardless of whether you itemize deductions or take the standard deduction.

Taxpayers other than corporations may be entitled to a deduction of up to 20% of their QBI. For 2020, if taxable income exceeds $163,300 for single taxpayers, or $326,600 for a married couple filing jointly, the QBI deduction may be limited based on different scenarios. These include whether the taxpayer is engaged in a service-type of trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.

The limitations are phased in. For example, the phase-in for 2020 applies to single filers with taxable income between $163,300 and $213,300 and joint filers with taxable income between $326,600 and $426,600.

For tax years beginning in 2021, the inflation-adjusted threshold amounts will be $164,900 for single taxpayers, and $329,800 for married couples filing jointly.

Year-end planning tip

Some taxpayers may be able to achieve significant savings with respect to this deduction, by deferring income or accelerating deductions at year end so that they come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2020. Depending on your business model, you also may be able to increase the deduction by increasing W-2 wages before year end. The rules are quite complex, so contact us with questions and consult with us before taking steps.

© 2020

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Year-end SWOT analysis can uncover risks

As your company plans for the coming year, management should assess your strengths, weaknesses, opportunities and threats. A SWOT analysis identifies what you’re doing right (and wrong) and what outside forces could impact performance in a positive (or negative) manner. A current assessment may be particularly insightful, because market conditions have changed significantly during the year — and some changes may be permanent.

Inventorying strengths and weaknesses

Start your analysis by identifying internal strengths and weaknesses keeping in mind the customer’s perspective. Strengths represent potential areas for boosting revenues and building value, including core competencies and competitive advantages. Examples might include a strong brand or an exceptional sales team.

It’s important to unearth the source of each strength. When strengths are largely tied to people, rather than the business itself, consider what might happen if a key person suddenly left the business. To offset key person risks, consider purchasing life insurance policies on key people, initiating noncompete agreements and implementing a formal succession plan.

Alternatively, weaknesses represent potential risks and should be minimized or eliminated. They might include low employee morale, weak internal controls, unreliable quality or a location with poor accessibility. Often weaknesses are evaluated relative to the company’s competitors.

Anticipating opportunities and threats

The next part of a SWOT analysis looks externally at what’s happening in the industry, economy and regulatory environment. Opportunities are favorable external conditions that could increase revenues and value if the company acts on them before its competitors do.

Threats are unfavorable conditions that might prevent your company from achieving its goals. They might come from the economy, technological changes, competition and government regulations, including COVID-19-related operating restrictions. The idea is to watch for and minimize existing and potential threats.

Think like an auditor

During a financial statement audit, your accountant conducts a risk assessment. That assessment can provide a meaningful starting point for your SWOT analysis. Contact us for more information.

© 2020