An FLP Can Save Tax in a Family Business Succession

One of the biggest concerns for family business owners is succession planning — transferring ownership and control of the company to the next generation. Often, the best time tax-wise to start transferring ownership is long before the owner is ready to give up control of the business.

A family limited partnership (FLP) can help owners enjoy the tax benefits of gradually transferring ownership yet allow them to retain control of the business.

How it works

To establish an FLP, you transfer your ownership interests to a partnership in exchange for both general and limited partnership interests. You then transfer limited partnership interests to your children.

You retain the general partnership interest, which may be as little as 1% of the assets. But as general partner, you can still run day-to-day operations and make business decisions.

Tax benefits

As you transfer the FLP interests, their value is removed from your taxable estate. What’s more, the future business income and asset appreciation associated with those interests move to the next generation.

Because your children hold limited partnership interests, they have no control over the FLP, and thus no control over the business. They also can’t sell their interests without your consent or force the FLP’s liquidation.

The lack of control and lack of an outside market for the FLP interests generally mean the interests can be valued at a discount — so greater portions of the business can be transferred before triggering gift tax. For example, if the discount is 25%, in 2018 you could gift an FLP interest equal to as much as $20,000 tax-free because the discounted value wouldn’t exceed the $15,000 annual gift tax exclusion.

To transfer interests in excess of the annual exclusion, you can apply your lifetime gift tax exemption. And 2018 may be a particularly good year to do so, because the Tax Cuts and Jobs Act raised it to a record-high $11.18 million. The exemption is scheduled to be indexed for inflation through 2025 and then drop back down to an inflation-adjusted $5 million in 2026. While Congress could extend the higher exemption, using as much of it as possible now may be tax-smart.

There also may be income tax benefits. The FLP’s income will flow through to the partners for income tax purposes. Your children may be in a lower tax bracket, potentially reducing the amount of income tax paid overall by the family.

FLP risks

Perhaps the biggest downside is that the IRS scrutinizes FLPs. If it determines that discounts were excessive or that your FLP had no valid business purpose beyond minimizing taxes, it could assess additional taxes, interest and penalties.

The IRS pays close attention to how FLPs are administered. Lack of attention to partnership formalities, for example, can indicate that an FLP was set up solely as a tax-reduction strategy.

Right for you?

An FLP can be an effective succession and estate planning tool, but it isn’t risk free. Please contact us for help determining whether an FLP is right for you.

© 2018

This webinar has concluded.

Do you have customers outside of your home state? If so, this ruling may impact you.

Under the Tax Cuts and Jobs Act, employees can no longer claim the home office deduction. If, however, you run a business from your home or are otherwise self-employed and use part of your home for business purposes, the home office deduction may still be available to you.

Home-related expenses

Homeowners know that they can claim itemized deductions for property tax and mortgage interest on their principal residences, subject to certain limits. Most other home-related expenses, such as utilities, insurance and repairs, aren’t deductible.

But if you use part of your home for business purposes, you may be entitled to deduct a portion of these expenses, as well as depreciation. Or you might be able to claim the simplified home office deduction of $5 per square foot, up to 300 square feet ($1,500).

Regular and exclusive use

You might qualify for the home office deduction if part of your home is used as your principal place of business “regularly and exclusively,” defined as follows:

1. Regular use. You use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use.

2. Exclusive use. You use the specific area of your home only for business. It’s not necessary for the space to be physically partitioned off. But, you don’t meet the requirements if the area is used both for business and personal purposes, such as a home office that also serves as a guest bedroom.

Regular and exclusive business use of the space aren’t, however, the only criteria.

Principal place of business

Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don’t have another fixed location where you conduct substantial administrative or management activities.

Examples of activities that are administrative or managerial in nature include:

• Billing customers, clients or patients,
• Keeping books and records,
• Ordering supplies,
• Setting up appointments, and
• Forwarding orders or writing reports.

Meetings or storage

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if you physically meet with patients, clients or customers on your premises. The use of your home must be substantial and integral to the business conducted.

Alternatively, you may be able to claim the home office deduction if you have a storage area in your home — or in a separate free-standing structure (such as a studio, workshop, garage or barn) — that’s used exclusively and regularly for your business.

Valuable tax-savings

The home office deduction can provide a valuable tax-saving opportunity for business owners and other self-employed taxpayers who work from home. If you’re not sure whether you qualify or if you have other questions, please contact us.

© 2018

Once upon a time, some parents and grandparents would attempt to save tax by putting investments in the names of their young children or grandchildren in lower income tax brackets. To discourage such strategies, Congress created the “kiddie” tax back in 1986. Since then, this tax has gradually become more far-reaching. Now, under the Tax Cuts and Jobs Act (TCJA), the kiddie tax has become more dangerous than ever.

A short history

Years ago, the kiddie tax applied only to children under age 14 — which still provided families with ample opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).

What about the kiddie tax rate? Before the TCJA, for children subject to the kiddie tax, any unearned income beyond a certain amount ($2,100 for 2017) was taxed at their parents’ marginal rate (assuming it was higher), rather than their own likely low rate.

A fiercer kiddie tax

The TCJA doesn’t further expand who’s subject to the kiddie tax. But it will effectively increase the kiddie tax rate in many cases.

For 2018–2025, a child’s unearned income beyond the threshold ($2,100 again for 2018) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2018 taxable income exceeds $12,500. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000.

Similarly, the 15% long-term capital gains rate takes effect at $77,201 for joint filers but at only $2,601 for trusts and estates. And the 20% rate kicks in at $479,001 and $12,701, respectively.

In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax will not only not save tax, but it could actually increase a family’s overall tax liability.

The moral of the story

To avoid inadvertently increasing your family’s taxes, be sure to consider the big, bad kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren who’re no longer subject to the kiddie tax but in a lower tax bracket, consider transferring such assets to them.

Please contact us for more information about the kiddie tax — or other TCJA changes that may affect your family.

© 2018

Join Yeo & Yeo’s Tammy Moncrief, CPA, and David Jewell, CPA as they provide a comprehensive overview of the tax law changes impacting businesses, and discuss critical planning considerations and opportunities.

This webinar has concluded.

Meal, vehicle and travel expenses are common deductions for businesses. But if you don’t properly document these expenses, you could find your deductions denied by the IRS.

A critical requirement

Subject to various rules and limits, business meal (generally 50%), vehicle and travel expenses may be deductible, whether you pay for the expenses directly or reimburse employees for them. Deductibility depends on a variety of factors, but generally the expenses must be “ordinary and necessary” and directly related to the business.

Proper documentation, however, is one of the most critical requirements. And all too often, when the IRS scrutinizes these deductions, taxpayers don’t have the necessary documentation.

What you need to do

Following some simple steps can help ensure you have documentation that will pass muster with the IRS:

Keep receipts or similar documentation. You generally must have receipts, canceled checks or bills that show amounts and dates of business expenses. If you’re deducting vehicle expenses using the standard mileage rate (54.5 cents for 2018), log business miles driven.

Track business purposes. Be sure to record the business purpose of each expense. This is especially important if on the surface an expense could appear to be a personal one. If the business purpose of an expense is clear from the surrounding circumstances, the IRS might not require a written explanation — but it’s probably better to err on the side of caution and document the business purpose anyway.

Require employees to comply. If you reimburse employees for expenses, make sure they provide you with proper documentation. Also be aware that the reimbursements will be treated as taxable compensation to the employee (and subject to income tax and FICA withholding) unless you make them via an “accountable plan.”

Don’t re-create expense logs at year end or when you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. The IRS considers timely kept records more reliable, plus it’s easier to track expenses as you go than try to re-create a log later. For expense reimbursements, require employees to submit monthly expense reports (which is also generally a requirement for an accountable plan).

Addressing uncertainty

You’ve probably heard that, under the Tax Cuts and Jobs Act, entertainment expenses are no longer deductible. There’s some debate as to whether this includes business meals with actual or prospective clients. Until there’s more certainty on that issue, it’s a good idea to document these expenses. That way you’ll have what you need to deduct them if Congress or the IRS provides clarification that these expenses are indeed still deductible.

For more information about what meal, vehicle and travel expenses are and aren’t deductible — and how to properly document deductible expenses — please contact us.

© 2018

In January 2017, the Governmental Accounting Standards Board (GASB) issued Statement No. 84 Fiduciary Activities (GASB 84). The Statement is effective for fiscal years beginning after December 15, 2018, which in practice means for fiscal years ending December 31, 2019, and later. Fiduciary activities are those activities that state and local governments carry out for the benefit of individuals and other agencies outside the government such as employee groups, members of the public, and other governments. This article is the second of a two-part series of articles on GASB 84, which will focus on the financial statement changes that will need to be made going forward.

Read part one of our series: GASB 84 Planning Ahead For a Smooth Transition

GASB 84 defines four generic types of fiduciary funds:

• Pension (and other employee benefit) trust funds are used to accumulate resources to fund pension and other post-employment benefit (OPEB) plans either as defined in GASB Statement No. 67 or 74, or in a qualifying trust. A “qualifying trust” is one that:
  • The government itself is not a beneficiary of
  • Is dedicated to providing benefits to recipients in accordance with the benefit terms
  • Is legally protected from the creditors of the government
  • Contributions to the trust and earnings on the contributions are irrevocable
• Investment trust funds are used to report the external portion of investment pools held in a qualifying trust. In this case, the “qualifying trust” definition does not include the irrevocable contribution criteria as it does for Pension and OPEB trusts.
• Private-purpose trust funds are those funds held in a qualifying trust (same definition as Investment trust funds) that are not required to be reported in Pension (and other employee benefit) or Investment trust funds. These funds are used for specific purposes (such as endowments or scholarship funds) that were originally defined by the person or organization that gave the funds to the government.
• Custodial funds are used to report fiduciary activities that are not required to be reported as another fiduciary fund type. In practical terms, this equates to what was historically reported in Agency funds.

The Custodial funds are new, which replace the former Agency funds. The other three fiduciary fund types are not new, as they were originally defined by GASB Statement No. 34. The terminology of Agency funds to Custodial funds was changed to avoid any confusion between the terminology of agency funds and agencies of a government, such as larger governments that refer to its various departments as “Agencies;” now there will be no ambiguity over that terminology. The Custodial funds are the area where the most significant changes will take place.

The basic financial statements for fiduciary funds defined by GASB 84 are as follows:

• Statement of Fiduciary Net Position – full accrual basis financial statement that shows all of the assets and liabilities of the fiduciary activities.
• Statement of Changes in Fiduciary Net Position – shows how net position changes during the year.

These basic financial statements are not new, but the way they are applied (especially in the Custodial funds) will be different. The most significant change is that Agency funds formerly presented everything in the Statement of Fiduciary Net Position as assets and liabilities, but now Custodial funds will show Net Position (the difference between assets and liabilities) where it had not been before. GASB 84 also has criteria about when liabilities are supposed to be recognized, which is when an event occurs that compels the government to pay, such as an accounts payable or accrued liability. Amounts previously shown as liabilities in Agency funds as owed to individuals or outside entities will now be shown as part of net position in the Custodial funds. An exception to this is taxes collected for other governments; those will be shown as liabilities just as they have been in the past.

The Statement of Changes in Fiduciary Net Position shows all additions and deductions (different terminology than revenues and expenditures in governmental funds) to or from net position of the funds. In the past, Agency funds were not included in the Statement of Changes in Fiduciary Net Position, but this will now be required for the new Custodial funds.

Additions and deductions should also be presented “disaggregated by source,” which means that more details about the sources and uses of the funds will need to be presented than was done in the past, such as additions broken down by contribution source, investment type, type of tax collected and deductions broken down by type of disbursement, administrative expense, type of tax remitted, etc. An exception to the disaggregation requirement is for resources normally held for three months or less (such as property taxes). Those can be shown in two lines as collected for and distributed to other governments.

With the effective date of this standard being what it is, we still have time to analyze, learn, and plan for implementation. Additionally, we expect specific guidance to be forthcoming from the GASB, GFOA, and MGFOA to help with implementing this standard. The GASB expects to issue an implementation guide including this standard in 2019. For now, we can focus on educating ourselves on the standard and starting to analyze how it might affect each of our unique situations.

Yeo & Yeo is here to help. Please don’t hesitate to reach out to your Yeo & Yeo professional with questions on this standard. We will be happy to assist you.

The Office of Management and Budget (OMB) released a memorandum on June 20, 2018, which modifies the thresholds used for purchases utilizing the micro-purchase method and the simplified acquisition method for all federal agencies. The micro-purchase threshold has been increased from $3,500 to $10,000, and the simplified acquisition threshold has been increased from $100,000 to $250,000.

Technically the increase is not effective until it is implemented in the Federal Acquisition Regulation (FAR) at 48 CFR Subpart 2.1; however, OMB is granting an exception and allowing recipients to utilize the higher thresholds in advance of the revision. Even though the exception has been authorized, organizations must still follow their internal purchasing policies.

To take advantage of these increased thresholds, we recommend that those entities that receive federal dollars take the time to review their procurement policy.

• Some organizations include in their policy the actual dollar amount that should be utilized when making purchases using the two methods discussed above. Those organizations should revise their policies and procedures to include the higher threshold.
• Other organizations may have indicated that they follow 48 CFR Subpart 2.1 with the thought that it would eliminate the hassle of updating the policy in the future to agree with current approved thresholds. As this increase is not technically written into that code yet, it is our recommendation to revise the policy to indicate that the organization will utilize the higher of the amounts listed in 48 CFR Subpart 2.1 or amounts approved by memorandums issued by the OMB.

If you have implementation questions, please contact your trusted advisor at Yeo & Yeo.

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

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 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 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 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, inventory, employees or property) was necessary to establish substantial nexus. As a result, some 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 transactions 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 sales to all of your out-of-state customers. You’ll be required to collect such taxes only if the particular state requires it. Many 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

The recent tariff battles between the United States and other countries like China, Canada, and the European Union are beginning to affect commodity prices. Increased U.S. tariffs on steel and aluminum have caused these countries to enact retaliatory tariffs on other products including commodities, which is proving to be another threat to the already suffering farm commodity prices. While the full impact of these tariffs on the commodity markets will not be known for some time since the first round of U.S. tariffs was implemented on July 6, the Trump administration is already looking for ways to help farmers offset the potential market declines.

One way to do that would be to utilize the Commodity Credit Corporation (CCC). The CCC, which is a division of the USDA, reportedly can borrow up to $30 billion from the Treasury Department and extend that money to various farm sectors. The CCC could offer support through numerous means including loans, commodity purchases, payments or other operations.

Another option for assistance to farmers affected by these price reductions is called Section 32. This section was part of the fiscal year 2018 March omnibus budget which removed earlier restrictions on the CCC’s activities. This change would enable to CCC to better support prices of agricultural goods.

While these scenarios are just beginning to play out, many questions remain. One important question is, when will these funds be made available to farmers and for how long will they last? There are also many concerns in the industry as to whether or not these type of subsidies are good for the farmers or if the subsidies will merely serve to ‘kick the can down the road’ and put farmers in more debt in the long run.

Yeo & Yeo’s Agribusiness Services Group is closely monitoring the tariff battles between the United States and other countries. We are watching the opportunities available for farmers to offset the potential market declines. If you have questions, reach out to your Yeo & Yeo advisor or me.

Exit planning is a topic many business owners seem to shy away from. Many know at some point they will eventually come to this, but sometimes it can be too late, or not properly executed for the owner to receive the maximum benefits of a well-thought-out exit strategy. Many owners are so occupied with managing and running day-to-day operations, they often don’t make the time to sit down and come up with a strategic plan for exiting the business, or passing the business on. When the time eventually comes, sometimes it is too late to maximize value for both the seller and the business itself.

The Exit Planning Institute says that 70 to 80 percent of businesses put on the market end up not selling. This can be caused by a variety of reasons, but the most common is the value owners place on the business. Ninety-five percent of merger and acquisition professionals believe that business owners have unrealistic expectations when it comes to selling their business. That is why a business valuation can be the most important step in the process. The business owner can not only be educated on the value of the business, but also the factors that make up the value. It is important that owners are educated on the factors that generate value. This will help them reconcile the valuation number and the number they originally assumed. Knowing the correct factors like risk percentages, discounts, and normalization adjustments can help owners understand everything that needs to be considered in the sale of the business.

After this step has been completed, owners can determine what the next step will be in the process. They will need to determine the cash flow effects a sale would have on their tax situation and their lifestyle, and potentially plan for retirement, or decide if it would be better for them to wait a few more years. They can continue to receive a salary and earnings from the company, and sell in a few years, or decide to grow the business to achieve a higher sales value in the future. Becoming educated on the factors that impact the valuation can help owners determine changes in the business to create a higher sales value in the future.

Attaining a business valuation is the first, and possibly the most important, step in the exit planning process. Sometimes owners wait too long, and do not receive the maximum benefits they could have received if the process had been planned earlier.

If you would like to discuss the factors that impact the valuation of your business, contact Yeo & Yeo.

One of the top manufacturing trends today is “Green Manufacturing.” Green manufacturing can be applied in two aspects. First, using renewable energy systems and clean-technology equipment. Second, reducing pollution and waste by minimizing the use of natural resources, recycling, reducing emissions, and reusing waste.

This initiative has become popular over the past few years, and continues to gain interest by consumers. Manufacturers in particular are usually portrayed negatively in the public’s eye in relation to environmental issues. The rolling smokestacks, environmental waste dumping, and inefficient depletion of natural resources are all stigmas typically associated with manufacturers. Even though these perceptions are not always true, it is something that has been associated with the “image” of manufacturing plants.

Green manufacturing has the benefit of not only setting your company aside from this negative perception, but also saving you “green” in the process. Going green can result in reduced costs and higher efficiency. Companies can better utilize the raw materials they have, cutting down on any excess waste, and even use that waste efficiently in other processes. Companies that can find renewable resources will not be dependent on supply and demand pricing of non-renewable resources. This can help keep costs more controlled, and not as susceptible to the swing in market prices.

Consider different ways to manage energy use in your facility:

• Simply replacing lighting with energy-efficient products and controls can reduce energy consumption by up to 50 percent
• Electric motors are responsible for almost 70 percent of all energy consumed in industrial applications. Energy efficient motors and drives can contribute a 30 percent energy savings with a seven-month return on investment.
• Heating and cooling costs can be reduced by as much as 25 percent by operating the system efficiently.
• Renewable sources of energy to power the facility can be a great long-term savings resource.

Tax credits for certain energy-saving property investments are available. There is a 30 percent credit for solar, fuel cells, and small wind asset purchases. A 10 percent tax credit is available for geothermal, micro turbines, and combined heat and power assets. To be eligible, you must own or have built the equipment, equipment must be placed into service the year you take the credit, and the equipment must meet specific performance and quality standards.

Green manufacturing not also has savings benefits, but a competitive advantage that can be used in marketing efforts. Becoming a green manufacturer can be a great reputation boost and create a positive perception about your company with consumers. Green companies can also become more competitive in government contracts; many contracts are available only to green businesses. Green purchasing companies may also only do business with green manufacturing companies. Going green can create numerous sales opportunities that would not be available otherwise.

An investment policy is an important policy to ensure that excess cash is being invested in a manner appropriate for the organization. It starts with the objectives of the investments; why is excess cash being invested in the first place? The objectives of the investments, in conjunction with the overall availability of financial resources, should help the organization determine its risk tolerance.

Once the organization has determined its risk tolerance, the policy should indicate what types of investments are acceptable for the organization. Different investments have different levels of risk and different levels of liquidity that need to be considered. In addition, in creating the policy, take into account the taxability of the investment and the level of IRS reporting required. For example, foreign investments may have additional reporting requirements that can include penalties of $10,000 if they are not filed appropriately. In creating the policy, the organization may also want to consider how particular investment types, such as alternative investments, impact the cost of obtaining audited or reviewed financial statements. After delineating acceptable investments, most policies will include an asset allocation range to ensure diversification of assets.

Finally, the investment policy should include responsibilities for designated board or management members to oversee the investment process. It is not acceptable to simply hire out the investment management without providing oversight.

This new standard puts all entities, regardless of industry, into the same framework for recognizing revenue. It is a “simple” five-step process.

1. Identify the contract with a customer.
2. Identify the performance obligations.
3. Determine the transaction price.
4. Allocate the transaction price to performance obligations.
5. Recognize revenue for the performance obligation when (or as) the customer obtains control of the good or service.

It sounds logical and easy, but there are many things to consider.

Step 1 – Identify the contract with a customer.

This has a few potential impacts on different types of nonprofits. Both parties have to approve and commit to the transaction before there is a contract. In the medical field in nonprofits, this could change the timing of when a contract is deemed to occur. The patient who is unconscious cannot commit to a transaction. Also imbedded in this is the concept of the collection being probable of all amounts the organization is entitled to. Nonprofits give discounts, based on ability to pay, and the probability of collection is based on the discounted amount, not the gross amount. Depending on the timing of when that discount is determined, the service may be provided before the collection of the discounted amount is probable.

If a wholly unperformed contract can be terminated without any penalty, then it is not considered a contract yet, either. For example, if there is a withdrawal period at a university and the student can get a full refund of tuition if they withdraw during the first week, then there is no contract until after that first week is complete.

If a contract doesn’t exist, no revenue can be recorded until a contract is considered to exist. Even if cash is received, if it is not probable that all amounts the organization is entitled to will be collected, then there is no contract, and therefore no revenue! For many organizations this will not change anything, but for others it will create more significant changes in revenue timing.

Step 2 – Identify the performance obligations.

For some organizations, especially membership organizations, this may be a lot of work. What are the goods or services, whether explicitly listed or implicitly promised, that the member gets when they purchase membership? For a zoo or a fitness center, this would include the obligation to “stand ready,” so it is the obligation to be open on all the days they say they will be. For an association, this might include the discounts the member gets when attending association trainings. If there is a loyalty program so that after seven purchases of a ride, the eighth is free, that is a material right and a performance obligation.

What are all the goods and services the customer expects to receive or the organization is obligated to provide? Especially for those membership organizations, this may be an extensive list. Once the list is determined, then consider whether each good or service is distinct, that the customer can benefit from it by itself or with other readily available resources. Those that are not distinct are bundled until the bundle is distinct.

Step 3 – Determine the transaction price.

For some organizations this is the list or contract price. For other organizations, such as those that have a sliding scale, the transaction price is the amount the entity expects to be entitled to, so it is the sliding scale price. If there are bonuses, penalties, contingencies, or price concessions, this transaction price can get harder to calculate. This price also includes any “nonrefundable advances,” as those are not separate transactions.

Step 4 – Allocate the transaction price to the performance obligations.

You have a potentially long list of performance obligations and you have a single transaction price. The transaction price has to be allocated to each of the performance obligations based on the stand-alone selling price, or the fair value, of each performance obligation. If there is only one performance obligation, this is straightforward. But for something like an association where membership dues provide access to a large number of performance obligations, this got a lot more difficult. Also, if there is a “nonrefundable advance,” remember that is part of what is being allocated amongst all of the performance obligations; it’s not recognized up front.

Step 5 – Recognize revenue for the performance obligation when (or as) the customer obtains control of the goods and services.

In step four, you found the price per performance obligation, and now whenever the performance obligation is performed, the revenue is recognized. That could result in differences in timing of revenue.

For example, the local chamber of commerce is a membership organization. As part of your membership you can attend the monthly networking events, except they have no networking events in June, July, and August. So the networking event revenue is not recognized 1/12 per month, but rather 1/9 per month for each month except June, July, and August. Depending on the fiscal year end and the dues year end, this could change the timing of revenue. Also included in that membership is a ticket to the gala event. That performance obligation occurs when the gala event occurs, at a point in time, so the revenue related to that is all recognized on the date of the gala event and not 1/12 per month.

Let’s say the organization has a buy seven and get the eighth free loyalty program and the selling price of each of the first seven is $10 each. Now when each of the first seven are purchased, something less than $10 is recognized, because a portion of that $10 is the right to obtain the eighth item free, and that performance obligation has not been fulfilled until the eighth item is obtained for free or the loyalty program expires!

Let’s say you have the zoo membership with the obligation to stand ready, or be open normal hours. If the zoo is open year-round, 1/12 per month works, but if the zoo is only open April through October, now revenue is 1/7 per month for the seven months the zoo is open.

This new revenue recognition standard sounds simplistic, based on the five steps, but will actually require a lot of thought and effort to determine if there are changes to revenue accounting, for financial statement purposes. There are no easy answers to say these types of organizations will have changes and these other types will not. It comes down to the specific transactions of each organization, and each organization will need to go through the process. In addition, the financial statement footnotes that will be required essentially disclose each of the five steps, so there are no shortcuts in the process. Your Yeo & Yeo team would be happy perform an engagement to assist you in determining the impact of this standard on your organization’s revenue recognition.

Would you rather pay taxes now or a year from now? With the new Tax Cuts and Jobs Act passed in December 2017, small to medium-size contractors have a huge opportunity to defer paying taxes on the income earned on projects that are in progress as of the end of the year. Who wouldn’t want to hold onto their money as long as they can and invest that money into business operations to grow their business? How can this be accomplished? It is as easy as selecting the completed contract method for tax treatment of your long-term contracts. Under the new tax laws, many more construction contractors are eligible to use this method.

In order to be eligible, the taxpayer must have less than $25 million in annual gross receipts averaged over the last three tax years (up from $10 million previously). For instance, if a company had $22 million (2015), $24 million (2016), and $26 million (2017) in gross receipts, the taxpayer is still eligible to use the completed contract method for 2018, as the average annual gross receipts is $24 million.

When recognizing income under the completed contract method, the taxpayer does not need to include the earnings (revenues less expenses) attributed to those projects that are to be completed within two years from the date work begins and also are not “substantially complete” – the stage of completion where the project is fit for occupancy and use for its intended purpose. However, under the percentage of completion method, you would have to pay tax on earnings on all contracts in progress during the year.

For example, a contractor with $9 million in costs associated with projects in progress at the end of the year with estimated earnings to date of $1 million would pay tax of $370,000 (assuming flow-through entity in the highest tax bracket). Under the completed contract method, this income and tax recognition would be deferred for tax purposes, along with the resulting tax, until the contract is substantially complete the following year.

While deferring income and tax is a great opportunity, it also comes with its own challenges and all aspects and effects should be considered. For instance, while deferring payment of $370,000 in tax and investing in the business operations is a huge advantage for cash flow purposes, having the funds necessary to pay that tax the following year is something that needs to be planned for. Under this method, the cash flow and operation cycle of completion of the project does not always match the tax cycle, which can lead to issues with having the necessary funds to pay the tax associated with the earnings. The completed contract method can also lead to large swings from year to year depending on the size of contracts completed carried from one year to the next and completed the following year, resulting in a low tax liability one year and a very large tax liability the following year when the contracts are completed.

With the proper planning and awareness of both the advantages and disadvantages of this method, this tax strategy can be properly implemented to take advantage of holding onto your tax dollars as long as possible to invest in your business. For help with planning for the changes in 2018 and guidance on the impact of the new tax laws on your business, please reach out to me or another member of Yeo & Yeo’s Construction Services Group.

Because donations to charity of cash or property generally are tax deductible (if you itemize), it only seems logical that the donation of something even more valuable to you — your time — would also be deductible. Unfortunately, that’s not the case.

Donations of time or services aren’t deductible. It doesn’t matter if it’s simple administrative work, such as checking in attendees at a fundraising event, or if it’s work requiring significant experience and expertise that would be much more costly to the charity if it had to pay for it, such as skilled carpentry or legal counsel.

However, you potentially can deduct out-of-pocket costs associated with your volunteer work.

The basic rules

As with any charitable donation, for you to be able to deduct your volunteer expenses, the first requirement is that the organization be a qualified charity. You can use the IRS’s “Tax Exempt Organization Search” tool (formerly “Select Check”) at https://www.irs.gov/charities-non-profits/tax-exempt-organization-search to find out.

Assuming the charity is qualified, you may be able to deduct out-of-pocket costs that are:

• Unreimbursed,
• Directly connected with the services you’re providing,
• Incurred only because of your charitable work, and
• Not “personal, living or family” expenses.

Supplies, uniforms and transportation

A wide variety of expenses can qualify for the deduction. For example, supplies you use in the activity may be deductible. And the cost of a uniform you must wear during the activity may also be deductible (if it’s required and not something you’d wear when not volunteering).

Transportation costs to and from the volunteer activity generally are deductible, either the actual cost or 14 cents per charitable mile driven. But you have to be the volunteer. If, say, you drive your elderly mother to the nature center where she’s volunteering, you can’t deduct the cost.

You also can’t deduct transportation costs you’d be incurring even if you weren’t volunteering. For example, if you take a commuter train downtown to work, then walk to a nearby volunteer event after work and take the train back home afterwards, you won’t be able to deduct your train fares. But if you take a cab from work to the volunteer event, then you potentially can deduct the cab fare for that leg of your transportation.

Volunteer travel

Transportation costs may also be deductible for out-of-town travel associated with volunteering. This can include air, rail and bus transportation; driving expenses; and taxi or other transportation costs between an airport or train station and wherever you’re staying. Lodging and meal costs also might be deductible.

The key to deductibility is that there is no significant element of personal pleasure, recreation or vacation in the travel. That said, according to the IRS, the deduction for travel expenses won’t be denied simply because you enjoy providing services to the charitable organization. But you must be volunteering in a genuine and substantial sense throughout the trip. If only a small portion of your trip involves volunteer work, your travel expenses generally won’t be deductible.

Keep careful records

The IRS may challenge charitable deductions for out-of-pocket costs, so it’s important to keep careful records. If you have questions about what volunteer expenses are and aren’t deductible, please contact us.

© 2018

For small businesses, managing payroll can be one of the most arduous tasks. Adding to the burden earlier this year was adjusting income tax withholding based on the new tables issued by the IRS. (Those tables account for changes under the Tax Cuts and Jobs Act.) But it’s crucial not only to withhold the appropriate taxes — including both income tax and employment taxes — but also to remit them on time to the federal government.

If you don’t, you, personally, could face harsh penalties. This is true even if your business is an entity that normally shields owners from personal liability, such as a corporation or limited liability company.

The 100% penalty

Employers must withhold federal income and employment taxes (such as Social Security) as well as applicable state and local taxes on wages paid to their employees. The federal taxes must then be remitted to the federal government according to a deposit schedule.

If a business makes payments late, there are escalating penalties. And if it fails to make them, the Trust Fund Recovery Penalty could apply. Under this penalty, also known as the 100% penalty, the IRS can assess the entire unpaid amount against a “responsible person.”

The corporate veil won’t shield corporate owners in this instance. The liability protections that owners of corporations — and limited liability companies — typically have don’t apply to payroll tax debts.

When the IRS assesses the 100% penalty, it can file a lien or take levy or seizure action against personal assets of a responsible person.

“Responsible person,” defined

The penalty can be assessed against a shareholder, owner, director, officer or employee. In some cases, it can be assessed against a third party. The IRS can also go after more than one person. To be liable, an individual or party must:

1. Be responsible for collecting, accounting for and remitting withheld federal taxes, and
2. Willfully fail to remit those taxes. That means intentionally, deliberately, voluntarily and knowingly disregarding the requirements of the law.

Prevention is the best medicine

When it comes to the 100% penalty, prevention is the best medicine. So make sure that federal taxes are being properly withheld from employees’ paychecks and are being timely remitted to the federal government. (It’s a good idea to also check state and local requirements and potential penalties.)

If you aren’t already using a payroll service, consider hiring one. A good payroll service provider relieves you of the burden of withholding the proper amounts, taking care of the tax payments and handling recordkeeping. Contact us for more information.

© 2018

“Going green” at home — whether it’s your principal residence or a second home — can reduce your tax bill in addition to your energy bill, all while helping the environment, too. The catch is that, to reap all three benefits, you need to buy and install certain types of renewable energy equipment in the home.

Invest in green and save green

For 2018 and 2019, you may be eligible for a tax credit of 30% of expenditures (including costs for site preparation, assembly, installation, piping, and wiring) for installing the following types of renewable energy equipment:

• Qualified solar electricity generating equipment and solar water heating equipment,
• Qualified wind energy equipment,
• Qualified geothermal heat pump equipment, and
• Qualified fuel cell electricity generating equipment (limited to $500 for each half kilowatt of fuel cell capacity).

Because these items can be expensive, the credits can be substantial. To qualify, the equipment must be installed at your U.S. residence, including a vacation home — except for fuel cell equipment, which must be installed at your principal residence. You can’t claim credits for equipment installed at a property that’s used exclusively as a rental.

To qualify for the credit for solar water heating equipment, at least 50% of the energy used to heat water for the property must be generated by the solar equipment. And no credit is allowed for solar water heating equipment unless it’s certified for performance by the nonprofit Solar Rating & Certification Corporation or a comparable entity endorsed by the state in which your residence is located. (Keep this certification with your tax records.)

The credit rate for these expenditures is scheduled to drop to 26% in 2020 and then to 22% in 2021. After that, the credits are scheduled to expire.

Document and explore

As with all tax breaks, documentation is key when claiming credits for green investments in your home. Keep proof of how much you spend on qualifying equipment, including any extra amounts for site preparation, assembly and installation. Also keep a record of when the installation is completed, because you can claim the credit only for the year when that occurs.

Be sure to look beyond the federal tax credits and explore other ways to save by going green. Your green home investments might also be eligible for state and local tax benefits, subsidized state and local financing deals, and utility company rebates.

To learn more about federal, state and local tax breaks available for green home investments, contact us.

© 2018

TAX REFORM:

Are you maximizing your tax savings yet?

This tax filing season is the first under the Tax Cuts and Jobs Act (TCJA), a major overhaul of the tax code that went into effect at the beginning of 2018. While many changes took effect for the 2018 tax year, a few go into effect in 2019 including elimination of the individual mandate under the Affordable Care Act. The corporate changes are permanent, while the majority of the individual changes are set to expire at the end of 2025.