Internal Controls: Segregation of Duties in Small Nonprofits

Nonprofit organizations have a responsibility to be good stewards of the resources they’re given. The commitment of the Board of Directors and leadership to ethical behavior sets the tone for the entire organization. Emphasizing the importance of integrity from the top down creates an environment where internal controls will be most effective. The reality is that nonprofit organizations are continually asked to do more with fewer resources. Often the organizations are driven by volunteers looking to improve their communities, serve a need, and do some good in the world. Many times, nonprofit organizations are understaffed, and the concept of segregation of duties seems daunting, if not impossible. It’s imperative for nonprofits of all sizes to protect themselves and ensure they can continue their good works well into the future.

Let’s look at ways a small nonprofit organization can do that.

What is segregation of duties?

What, exactly, does segregation of duties mean? It’s one of those accounting jargon terms that non-accountants might not fully understand. To put it simply, it is the system of checks and balances an organization puts in place to separate who is responsible for recording, authorizing or approving, and who has access to the related asset. Ideally, multiple people would be involved so that one person is not responsible for multiple functions.

Take, for example, a volunteer parent who is treasurer of the parent-teacher organization. That parent sits at the bake sale table, accepting cash from paying customers. The parent also deposits the money into the bank account, reconciles the bank statement, and records all the transactions in a spreadsheet to provide as the treasurer’s report. This parent and the organization have both left themselves open to the possibility of error or inappropriate or fraudulent actions. For both the individual and the organization to protect themselves, it is important to separate the steps in the organization’s revenue process.

How can a small nonprofit segregate key duties?

The difficulty for many nonprofits and other small organizations is the lack of people who can be used to spread the various steps of the process. Management must consider all the possible people involved with the organization who could help perform the functions, assigning duties to volunteers and members of the Board of Directors to augment the various duties. Also consider outsourcing some functions to an independent third party, like a CPA.

See recommendations for How to Segregate Duties in Smaller Organizations in a two-person, three-person and four-person office.

Hiring additional staff or finding suitable volunteers may be difficult, if not impossible. It is important for management to consider the processes and procedures that are particular to their organization and assess where they are at risk. If separating duties is not practical or cost-effective, or if the risk is low, then alternate options should be considered. Management must balance their approach to include different types of controls. The goal is to reduce the risk of error or fraud.

Watch the budget, and implement expense policies and procedures

Using a budget can be an important step for nonprofit organizations. The overall objectives of the budget should be set by the Board or management at the beginning of the process. Then the organization should set a revenue budget and receive input from program directors to set the expense budgets. The proposed expense budgets and the revenue budget should be analyzed together and brought into the desired relationship, based on the overall objectives set by the Board and/or management. Management should provide consistent, meaningful review and monitor the progress throughout the year through variance reports and determine corrective action, if necessary.

By using a budget, the organization can give the authority to approve expenses that are within budget to the program directors while requiring specific authorization for checks written over a certain dollar amount, or for certain types of transactions, like a wire transfer of any amount. No one should be permitted to sign a check payable to themselves. Expense reimbursements to management should be approved by a Board member.

Use software to restrict access

The features of the accounting software should be used to help separate duties by restricting access to certain areas of the software and donor database. Management should also restrict physical access to assets. For example, a church may collect an offering during a service that is immediately put into a locked safe until it can be counted by two or more people, and then put into a sealed deposit bag and taken to the bank.

Numerous solutions are available to protect nonprofit organizations when the Board of Directors and management insist on high standards of ethics and integrity. The trick is finding the combination of controls that are right for each organization, including segregation of duties, ensuring that the individuals and the organization are both protected. That’s where Yeo & Yeo can help. Our professionals can assess the internal controls in place and provide suggestions for improvement tailored to your organization.

Has your organization accepted noncash donations? Chances are you have, and chances are you don’t have a gift acceptance policy in writing. While it may be hard to say “no, thank you” to well-meaning donors, there are times when that is exactly what you should do. A gift acceptance policy can help prevent unintended hardships related to noncash donations in several ways.

A policy can help you communicate to your donors why certain gifts are unacceptable. Maybe they are in contradiction with your values, or they come with added expenses (like property tax on land). It can also help staff members by providing guidance and wording to use when communicating with donors. In addition, the policy can state what the organization will do with certain donations. For example, a donation of stock will be sold within ten days. To be effective, the gift acceptance policy must be shared with donors and staff alike. Adopt yours today.

Check Out Our eBook on Creating Policies for Your Nonprofit

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The audit process, and review of financial statements, can be a bit overwhelming for you as an elected official if you don’t have a strong financial background. Here are five tips to help you wrap your arms around this task.

1. Look through last year’s audited financial statements.

Ask for a copy of the previous year’s financial statements and look through them. Especially take time to read the Management Discussion & Analysis section (MD&A). The MD&A is a great overview in layman terms as to what happened during that year, as well as expectations and projections for the future. The audited financial statements can also be found on the Michigan Department of Treasury’s website at www.michigan.gov/treasury.

2. Ask about the various funds that exist at your municipality.

Besides the general fund, which is the government’s basic operating fund, most municipalities utilize various other funds. The number of funds can vary significantly from one government to another. Unlike a private business, where all funds are accounted for as a single entity, governmental accounting is tracked through separate funds that balance in and of themselves. The accountant, bookkeeper or Chief Financial Officer will be able to give you an overview of the types of funds and, more importantly, the purpose of each fund.

3. Understand the internal controls in place at your municipality.

Internal controls are a series of events or methods put in place by the municipality to ensure the integrity of accounting and financial information. It is also a process of applying management policies throughout the entire entity. It is very important that internal controls are documented to provide an audit trail, and it is management’s responsibility to establish and maintain the internal controls. This will give you an understanding of the flow of information into and out of the municipality.

Organizations with a limited number of staff need to work especially hard to maintain the segregation of duties. Tasks must be delegated to different people to ensure no single individual is in a position where they could authorize, record, and be in custody of a financial transaction and the resulting asset.

4. Review the Budget to Actual Report often.

The Budget to Actual Report is a useful tool for decision-making, which is a responsibility of the elected officials. The budget is the “best guess” of how much money will come into the government and how much will go out each fiscal year. The budget should be updated throughout the year as events and circumstances change the government’s original “best guess.” It is a state law that the local unit’s actual expenditures are within the amounts authorized in the budget.

5. Ask questions about the draft financial statements and or audit process.

Ask questions when you aren’t sure of something or need clarification. The audited financial statements are the responsibility of management. Therefore, having a good understanding of the statements, schedules, and footnotes is required. Please speak up during the exit conference or draft meeting and ask questions. Your auditors love to talk numbers and internal control processes and procedures.

If you would like specific training related to understanding the audit process and or financial statements, please contact us.

Join David Jewell, CPA and Danielle Cary, CPA in a comprehensive overview of the impact of Tax Reform on individuals and families, and planning strategies for 2018 and beyond.

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You’ve worked hard to get your business off the ground. Business is good— so good that you’re ready to trade up from your leased space and build your own building. You’ve met with the bank and they’ve given you preliminary approval on a loan package. But the bank representative says she needs to see your financial statements before she can finalize your loan.

You know that timely, accurate and understandable financial statements are necessary to gauge how well your business has performed and to assess the strength of its financial position. You know that they are the foundation upon which you make important business decisions.

Over the last several years, virtual currency has become increasingly popular. Bitcoin is the most widely recognized form of virtual currency, also commonly referred to as digital, electronic or crypto currency.

While most smaller businesses aren’t yet accepting bitcoin or other virtual currency payments from their customers, more and more larger businesses are. And the trend may trickle down to smaller businesses. Businesses also can pay employees or independent contractors with virtual currency. But what are the tax consequences of these transactions?

Bitcoin 101

Bitcoin has an equivalent value in real currency and can be digitally traded between users. It also can be purchased with real currencies or exchanged for real currencies. Bitcoin is most commonly obtained through virtual currency ATMs or online exchanges.

Goods or services can be paid for using “bitcoin wallet” software. When a purchase is made, the software digitally posts the transaction to a global public ledger. This prevents the same unit of virtual currency from being used multiple times.

Tax impact

Questions about the tax impact of virtual currency abound. And the IRS has yet to offer much guidance.

The IRS did establish in a 2014 ruling that bitcoin and other convertible virtual currency should be treated as property, not currency, for federal income tax purposes. This means that businesses accepting bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received, measured in equivalent U.S. dollars.

When a business uses virtual currency to pay wages, the wages are taxable to the employees to the extent any other wage payment would be. You must, for example, report such wages on your employees’ W-2 forms. And they’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date received by the employee.

When a business uses virtual currency to pay independent contractors or other service providers, those payments are also taxable to the recipient. The self-employment tax rules generally apply, based on the fair market value of the virtual currency on the date received. Payers generally must issue 1099-MISC forms to recipients.

Finally, payments made with virtual currency are subject to information reporting to the same extent as any other payment made in property.

Deciding whether to go virtual

Accepting bitcoin can be beneficial because it may avoid transaction fees charged by credit card companies and online payment providers (such as PayPal) and attract customers who want to use virtual currency. But the IRS is targeting virtual currency transactions in an effort to raise tax revenue, and it hasn’t issued much guidance on the tax treatment or reporting requirements. So bitcoin can also be a bit risky from a tax perspective.

To learn more about tax considerations when deciding whether your business should accept bitcoin or other virtual currencies — or use them to pay employees, independent contractors or other service providers — contact us.

Tuesday, June 12, 2018
11:30 AM – 12:30 PM EST

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The “Tax Cuts & Jobs Act” (TCJA), the first major tax code overhaul in over 30 years, made sweeping changes to the tax code that impact nearly every American. The new law favorably reduces marginal tax brackets and rates. It also eliminates or limits many popular tax deductions. It’s highly recommended that all taxpayers familiarize themselves with the tax law changes and begin developing a plan for its potential impact. Concerned about tax reform’s impact on your personal tax situation?

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

TOPICS:

Overview of the new tax rates and brackets
In-depth analysis of changes to itemized deductions
Opportunities for planning to maximize the benefit of the new rules

PRESENTERS:

David Jewell, CPA, Principal
Leader, Tax Services Group
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Danielle Cary, CPA, Principal
Leader, State & Local Tax Services Group
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A security upgrade is necessary for all connections used by QuickBooks Desktop, 2015 and later. After May 31, 2018, you will need to meet certain system requirements to access Intuit services. It is highly recommended to consider all of your services and how the new system requirements will affect them. If these requirements are not met, critical services including–but not limited to–the following will be impacted:

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Follow these steps to ensure greater security and stability with TLS 1.2, an internet security protocol. If you want to learn more about TLS 1.2, click here.

Make sure the QuickBooks Desktop version you are using is updated to the latest release.
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If the TLS 1.2 Readiness tool indicates failure, you should review the details here to take the necessary steps.

For more information, please view this QuickBooks article. Contact your Yeo & Yeo professional for additional assistance.

Today many employees receive stock-based compensation from their employer as part of their compensation and benefits package. The tax consequences of such compensation can be complex — subject to ordinary-income, capital gains, employment and other taxes. But if you receive restricted stock awards, you might have a tax-saving opportunity in the form of the Section 83(b) election.

Convert ordinary income to long-term capital gains

Restricted stock is stock your employer grants you subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it.

At that time, you pay taxes on the stock’s fair market value (FMV) at your ordinary-income rate. The FMV will be considered FICA income, so it also could trigger or increase your exposure to the additional 0.9% Medicare tax.

But you can instead make a Sec. 83(b) election to recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

The Sec. 83(b) election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly. With ordinary-income rates now especially low under the Tax Cuts and Jobs Act (TCJA), it might be a good time to recognize such income.

Weigh the potential disadvantages

There are some potential disadvantages, however:

You must prepay tax in the current year — which also could push you into a higher income tax bracket or trigger or increase the additional 0.9% Medicare tax. But if your company is in the earlier stages of development, the income recognized may be relatively small.
Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or sell it at a decreased value. However, you’d have a capital loss in those situations.
When you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8% net investment income tax.

It’s complicated

As you can see, tax planning for restricted stock is complicated. Let us know if you’ve recently been awarded restricted stock or expect to be awarded such stock this year. We can help you determine whether the Sec. 83(b) election makes sense in your specific situation.

It’s not uncommon for businesses to sometimes generate tax losses. But the losses that can be deducted are limited by tax law in some situations. The Tax Cuts and Jobs Act (TCJA) further restricts the amount of losses that sole proprietors, partners, S corporation shareholders and, typically, limited liability company (LLC) members can currently deduct — beginning in 2018. This could negatively impact owners of start-ups and businesses facing adverse conditions.

Before the TCJA

Under pre-TCJA law, an individual taxpayer’s business losses could usually be fully deducted in the tax year when they arose unless:

The passive activity loss (PAL) rules or some other provision of tax law limited that favorable outcome, or
The business loss was so large that it exceeded taxable income from other sources, creating a net operating loss (NOL).

After the TCJA

The TCJA temporarily changes the rules for deducting an individual taxpayer’s business losses. If your pass-through business generates a tax loss for a tax year beginning in 2018 through 2025, you can’t deduct an “excess business loss” in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

Your aggregate business income and gains for the tax year, and
$250,000 ($500,000 if you’re a married taxpayer filing jointly).

The excess business loss is carried over to the following tax year and can be deducted under the rules for NOLs.

For business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes, the new excess business loss limitation rules apply at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on the owner’s personal federal income tax return for the owner’s tax year that includes the end of the entity’s tax year.

Keep in mind that the new loss limitation rules apply after applying the PAL rules. So, if the PAL rules disallow your business or rental activity loss, you don’t get to the new loss limitation rules.

Expecting a business loss?

The rationale underlying the new loss limitation rules is to restrict the ability of individual taxpayers to use current-year business losses to offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains.

The practical impact is that your allowable current-year business losses can’t offset more than $250,000 of income from such other sources (or more than $500,000 for joint filers). The requirement that excess business losses be carried forward as an NOL forces you to wait at least one year to get any tax benefit from those excess losses.

If you’re expecting your business to generate a tax loss in 2018, contact us to determine whether you’ll be affected by the new loss limitation rules. We can also provide more information about the PAL and NOL rules.

If you own a business and have a child in high school or college, hiring him or her for the summer can provide a multitude of benefits, including tax savings. And hiring your child may make more sense than ever due to changes under the Tax Cuts and Jobs Act (TCJA).

How it works

By shifting some of your business earnings to a child as wages for services performed, you can turn some of your high-taxed income into tax-free or low-taxed income. For your business to deduct the wages as a business expense, the work done must be legitimate and the child’s wages must be reasonable.

Here’s an example: A sole proprietor is in the 37% tax bracket. He hires his 20-year-old daughter, who’s majoring in marketing, to work as a marketing coordinator full-time during the summer. She earns $12,000 and doesn’t have any other earnings.

The father saves $4,440 (37% of $12,000) in income taxes at no tax cost to his daughter, who can use her $12,000 standard deduction (for 2018) to completely shelter her earnings. This is nearly twice as much as would have been sheltered last year, pre-TCJA, when the standard deduction was only $6,350.

The father can save an additional $2,035 in taxes if he keeps his daughter on the payroll as a part-time employee into the fall and pays her an additional $5,500. She can shelter the additional income from tax by making a tax-deductible contribution to her own traditional IRA.

Family taxes will be cut even if an employee-child’s earnings exceed his or her standard deduction and IRA deduction. Why? The unsheltered earnings will be taxed to the child beginning at a rate of 10% instead of being taxed at the parent’s higher rate.

Avoiding the “kiddie tax”

TCJA changes to the “kiddie tax” also make income-shifting through hiring your child (rather than, say, giving him or her income-producing investments) more appealing. The kiddie tax generally applies to children under age 19 and to full-time students under age 24. Before 2018, the unearned income of a child subject to the kiddie tax was generally taxed at the parents’ tax rate.

The TCJA makes the kiddie tax harsher. For 2018-2025, a child’s unearned income will be taxed according to the tax brackets used for trusts and estates, which for 2018 are taxed at the highest rate of 37% once taxable income reaches $12,500. In contrast, for a married couple filing jointly, the 37% rate doesn’t kick in until their taxable income tops $600,000. In other words, children’s unearned income often will be taxed at higher rates than their parents’ income.

But the kiddie tax doesn’t apply to earned income.

Other tax considerations

If your business isn’t incorporated or a partnership that includes nonparent partners, you might also save some employment tax dollars. Contact us to learn more about the tax rules surrounding hiring your child, how the kiddie tax works or other family-related tax-saving strategies.

The Tax Cuts and Jobs Act (TCJA) introduced a flat 21% federal income tax rate for C corporations for tax years beginning in 2018 and beyond. Under prior law, profitable C corporations paid up to 35%. This change has caused many business owners to ask: What’s the optimal choice of entity for my start-up business?

Choosing the Optimal Business Structure

Under prior tax law, conventional wisdom was that most small and midsize businesses should be set up as sole proprietorships, or so-called “pass-through entities,” including:

Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
Partnerships,
LLCs treated as partnerships for tax purposes, and
S corporations.

View our Tax Reform Pass-through Deduction Flowchart.

The big reason that pass-through entities were popular was that income from C corporations is potentially taxed twice. First, the C corporation pays entity-level income tax. And then, corporate shareholders pay tax on dividends and capital gains. The use of pass-through entities avoids the double taxation issue, because there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, the new 21% corporate federal income tax rate helps level the playing field between C corporations and pass-through entities.

This issue is further complicated by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction of up to 20% on qualified business income (QBI). (See “QBI Deductions for Pass-Through Businesses” at right.)

There’s no universal “right” answer when deciding how to structure your business to minimize taxes. The answer depends on your business’s unique situation and your situation as an owner. Here are three common scenarios and choice-of-entity implications to help you decide what’s right for your start-up venture.

1. Business Generates Tax Losses

If your business consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. So, it probably makes sense to operate as a pass-through entity. Then, the losses will pass through to your personal tax return (on Schedule C, E, or F, depending on the type of entity you choose).

2. Business Distributes All Profits to Owners

Let’s suppose your business is profitable and pays out all of its income to the owners. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. After paying the flat 21% federal income tax rate at the corporate level, the corporation pays out all of its after-tax profits to its shareholders as taxable dividends eligible for the 20% maximum federal rate.

So, the maximum combined effective federal income tax rate on the business’s profits — including the 3.8% net investment income tax (NIIT) on dividends received by shareholders — is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax rate on the dividends, which are reduced by the corporate level tax [(20% + 3.8%) x (100% – 20%)]. While you would still have double taxation here, the 39.8% rate is lower than it would have been under prior law.

Results with a pass-through entity. For a pass-through entity that pays out all of its profits to its owners, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the self-employment (SE) tax (whichever applies). This example assumes that, if the SE tax applies, the additional 0.9% Medicare tax on high earners increases the rate for the Medicare tax portion of the SE tax to 3.8%.

If you can claim the full 20% QBI deduction, the maximum federal income tax rate is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a pass-through entity is probably the way to go if significant QBI deductions are available. If not, it’s basically a toss-up. But operating as a C corporation may be simpler from a tax perspective.

3. Business Retains All Profits to Finance Growth

Let’s suppose your business is profitable, but it socks away all of its profits to fund future growth strategies. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. In this example, we’re going to assume that retained profits increase the value of the corporation’s stock dollar-for-dollar, and that shareholders eventually sell the shares and pay federal income tax at the maximum 20% rate for long-term capital gains.

The maximum effective combined federal income tax rate on the venture’s profits is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax on gain that is reduced to reflect the 21% corporate tax [(20% + 3.8%) x (100% – 21%)]. While you would still have double taxation here, the 39.8% rate is better than it would have been under prior law. Plus, shareholder-level tax on stock sale gains is deferred until the stock is sold.

If the corporation is a qualified small business corporation (QSBC), the 100% gain exclusion may be available for stock sale gains. If so, the maximum combined effective federal income tax rate on the venture’s profits can be as low as 21%. Ask your tax advisor if your venture is eligible for QSBC status.

Results with a pass-through entity. Under similar assumptions for a pass-through entity, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). That’s slightly higher than the 39.8% rate that applies with the C corporation option.

However, here’s the key difference: For a pass-through entity, all taxes are due in the year that income is reported. With a C corporation, the shareholder-level tax on stock sale gains are deferred until the shares are sold.

If you can claim the full 20% QBI deduction, the maximum effective rate for a pass-through entity is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income that is reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a C corporation is probably the way to go if the corporation is a QSBC. If QSBC status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level. If you expect to be eligible for the full 20% QBI deduction, pass-through entity status might be preferred. Discuss this issue with your tax advisor to evaluate all of the pros and cons.

Other Related Issues to Consider

Business owners can use a variety of strategies to help lower their tax bills, and those strategies may vary depending on the type of entity you choose. Before deciding on the optimal business structure for your start-up, here are some other issues to consider.

Deductions for capital expenditures. For the next few years, C corporations and pass-through entities will be able to deduct 100% of the cost of many types of fixed assets, thanks to the TCJA’s generous Section 179 rules, which are permanent, and the 100% first-year bonus depreciation deduction, which is generally available for qualifying property placed in service between September 28, 2017, and December 31, 2022.

These changes under the new tax law may significantly reduce the federal income tax hit on a capital-intensive business over the next few years. However, reducing pass-through income with these favorable first-year depreciation rules will also reduce allowable QBI deductions.

Deductions for “reasonable” compensation. Closely held C corporations have historically sought to avoid double taxation by paying shareholder-employees as much as possible in deductible salaries, bonuses and fringe benefits. However, salaries, bonuses and benefits must represent reasonable compensation for the work performed.

For 2018 through 2025, this strategy is a bit more attractive because the TCJA’s rate reductions for individual taxpayers mean that most shareholder-employees will pay less tax on salaries and bonuses. In addition, any taxable income left in the corporation for tax years beginning in 2018 and beyond will be taxed at only 21%. Finally, C corporations can provide shareholder-employees with some tax-free fringe benefits that aren’t available to pass-through entity owners.

S corporations have historically tried to do the reverse. That is, they’ve attempted to minimize salaries paid to shareholder-employees to reduce Social Security and Medicare taxes. The IRS is aware of this strategy, so it’s important to pay S corporation shareholder-employees reasonable salaries to avoid IRS challenges.

The TCJA makes this strategy even more attractive for many businesses, because it maximizes the amount of S corporation income that’s potentially eligible for the QBI deduction. Guaranteed payments to partners (including LLC members treated as partners for tax purposes) and reasonable salaries paid to S corporation shareholder-employees do not count as QBI. But S corporation net income (after deducting salaries paid to shareholder-employees) does qualify as QBI.

Appreciating assets. If your business owns real estate, certain intangibles and other assets that are likely to appreciate, it’s still generally inadvisable to hold them in a C corporation. Why? If the assets are eventually sold for substantial profits, it may be impossible to get the profits out of the corporation without double taxation.

In contrast, if appreciating assets are held by a pass-through entity, gains on sale will be taxed only once at the owner level. The maximum rate will generally be 23.8% or 28.8% for real estate gains attributable to depreciation.

Spin-offs. A major upside for pass-through entities is the QBI deduction. But the disallowance rule for service businesses may wipe out QBI deductions for certain types of businesses, such as medical practices and law firms, that are set up as pass-through entities.

However, a spin-off might allow you to take a partial QBI deduction. How? If you can spin off operations that don’t involve the delivery of specified services into a separate pass-through entity, income from the spin-off may qualify for the QBI deduction.

The IRS hasn’t yet issued guidance on this strategy. Plus, the QBI deduction is scheduled to expire after 2025, unless Congress extends it. So, making big changes to create QBI deductions may not be worth the trouble. Talk to your tax advisor before attempting a spin-off.

Need Help?

The TCJA has far-reaching effects on business taxpayers. Contact your tax advisor to discuss how your business should be set up on opening day to lower its tax bill over the long run.

For simplicity, this article focuses on start-ups. If you own an existing business and wonder whether your current business structure still makes sense, many of the same principles apply. But the tax rules and expense for converting from one type of entity to another add another layer of complexity. Discuss your concerns with a tax pro who can help you with the ins and outs of making a change.

Audits have a stigma that leads people to believe that audits (and the auditors) are only a requirement to check off the annual business cycle. Hopefully, you have a great relationship with your auditor that allows the audit process to go smoothly. Once the financial statements have been released, the audit submitted to the State, and the Board or Council presentation completed, you’re ready to kick those auditors to the curb and tackle the next priority. We can hardly blame you! However, auditors have much more potential than just completing the annual audit that you could harness to benefit your organization year round.

Risk-Based Auditing

First, our audit teams take a risk-based approach to developing and customizing each client’s audit. What does that mean? We gather historical and current information about the organization, interview employees, members of management and members of the Board or Council, and then use that information to brainstorm possible ways things could go wrong in your organization. After our brainstorming session, the customized audit plan is developed accordingly. The audit plan can incorporate areas where the organization could benefit from further efficiency, or areas where management or the Board or Council has additional concerns. Here are some examples:

If the organization routinely has issues with getting all employees to timely submit credit card receipts, we can focus attention to this area. Our testing will likely result in a recommendation that provides management with leverage for initiating change. If management can say the auditors are looking at an area, employees are more likely to comply.
If bank accounts aren’t being reconciled as timely throughout the year as the manager would like, he/she can ask the auditor to review the reconciliation completion dates without having to be the bad guy.

These and many other areas of organizations can be improved by being an active participant in your audit.

Institutional Knowledge

Second, auditors have a significant amount of institutional knowledge. Many of my clients have been with me more than five years and I know their organization well, maybe better than most within their organization. When moving into the future, take advantage of that historical knowledge. Auditors can help with long-term analysis, in some cases projections of where the organization is heading, and can help your organization avoid taking a path that was already traveled which resulted in a less than desirable outcome. Helping the organization move in the right direction makes everyone feel like a winner.

Credibility

Another area in which auditors can be used is to gain creditability. For example, when there are new members of management or new members of the Finance Committee, those new members are trying to get up to speed, and in some cases challenge the establishment while having little to no history of the organization. Auditors can explain the hurdles that were faced, describe how the organization has grown and dealt with issues in the past, and work to support the qualifications and work of members of management. In some cases, we have even provided Board or Council training related to financial statements or internal controls. Auditors are generally well respected and knowledgeable; use that to your advantage.

Interim Help

Lastly, when an organization experiences turnover in management and staff, or there are large projects that no one has time to complete, your auditor might be the answer. As previously mentioned, in many cases auditors know your organization and internal controls better than most in your organization. With that knowledge, auditors can help you design controls to cover the organization in the interim and can even do certain types of projects that don’t include management functions. Sometimes this can keep the organization from falling woefully behind while they look to replace lost team members, or help move projects off of the to-do list and keep the organization moving forward.

These ideas are just the tip of the iceberg. The main point is that we are your auditors all year long, not just at the time of the audit. We want to hear from our clients and are always willing to go the extra mile to help out when we can.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Christopher M. Sheridan, CPA, has achieved the Certified Valuation Analyst (CVA) credential, awarded by the National Association of Certified Valuators and Analysts (NACVA).

“This is a great achievement for Chris as a professional,” says David Schaeffer, Managing Principal of Yeo & Yeo’s Saginaw office. “He joins our growing business valuation group of three CVAs across the firm.”

A CVA is the premier accreditation for CPAs. Adding a CVA designation along with Chris’ efforts as a member of Yeo & Yeo’s Litigation Support , Valuation and Fraud & Forensics Services Group, allows him the ability to provide sound and reliable business valuation services for attorneys and successful business owners. Yeo & Yeo provides business valuations for privately held businesses and business owners as part of success planning, and as part of business strategy to more efficient business growth.

Chris is a senior accountant and a member of Yeo & Yeo’s Manufacturing Services Group. He holds additional memberships with the MICPA’s Manufacturing Task Force, the Great Lakes Bay Manufacturers Association, the Michigan Manufacturers Association and the National Association of Certified Valuators and Analysts.

In many parts of the country, summer is peak season for selling a home. If you’re planning to put your home on the market soon, you’re probably thinking about things like how quickly it will sell and how much you’ll get for it. But don’t neglect to consider the tax consequences.

Home sale gain exclusion

The U.S. House of Representatives’ original version of the Tax Cuts and Jobs Act included a provision tightening the rules for the home sale gain exclusion. Fortunately, that provision didn’t make it into the final version that was signed into law.

As a result, if you’re selling your principal residence, there’s still a good chance you’ll be able to exclude up to $250,000 ($500,000 for joint filers) of gain. Gain that qualifies for exclusion also is excluded from the 3.8% net investment income tax.

To qualify for the exclusion, you must meet certain tests. For example, you generally must own and use the home as your principal residence for at least two years during the five-year period preceding the sale. (Gain allocable to a period of “nonqualified” use generally isn’t excludable.) In addition, you can’t use the exclusion more than once every two years.

More tax considerations

Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, as long as you owned the home for at least a year. If you didn’t, the gain will be considered short-term and subject to your ordinary-income rate, which could be more than double your long-term rate.

Here are some additional tax considerations when selling a home:

Tax basis. To support an accurate tax basis, be sure to maintain thorough records, including information on your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed based on business use.

Losses. A loss on the sale of your principal residence generally isn’t deductible. But if part of your home is rented out or used exclusively for your business, the loss attributable to that portion may be deductible.

Second homes. If you’re selling a second home, be aware that it won’t be eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 exchange. Or you may be able to deduct a loss.

A big investment

Your home is likely one of your biggest investments, so it’s important to consider the tax consequences before selling it. If you’re planning to put your home on the market, we can help you assess the potential tax impact. Contact us to learn more.

When it comes to financial statements, you can engage your CPA to perform varying levels of service, from a compilation, to a review, to an audit. Learn the situations when each may be appropriate for your nonprofit.

To first understand what level of service is most appropriate for your situation, you need to understand the differences among the three.

A compilation is the most basic of the three levels of financial statement services your CPA can perform. In a compilation, your CPA is required to read the financial statements and consider whether those financial statements are free of obvious material misstatements based on the reporting framework presented (for example, generally accepted accounting principles, U.S. GAAP). The CPA, however, is not required to provide any assurance on the financial statements and therefore does not verify the accuracy or completeness of the information or obtain any evidence supporting the financial statement line items.

A review, on the other hand, is a level of service where the CPA provides a limited assurance on the accuracy of the financial statements. In a review, the CPA obtains an understanding of an organization’s operations and accounting practices and principally relies on applying analytical procedures and inquiries of management to determine if any material modifications should be made to the financial statements. This ensures that the financial statements are presented in accordance with the reporting framework presented (for example, U.S. GAAP).

An audit is the highest level of independent assurance that can be obtained on an organization’s financial statements. During an audit, your CPA obtains an understanding of internal controls, assesses fraud risks and corroborates amounts and disclosures included in your financial statements. The intent is to issue an opinion to provide reasonable (but not absolute) assurance on the accuracy of the financial statements in accordance with the reporting framework presented. Additionally, as part of the audit, your CPA will communicate any deficiencies identified in internal controls.

Although an audit is the most comprehensive level of service and the highest level of independent assurance you can obtain on your financial statements, it does not mean it is always the best option for an organization. In some cases, especially for smaller organizations, an audit will likely be cost prohibitive and result in more service than what an organization needs.

In Michigan, to comply with the state’s solicitation requirements, nonprofits are required to undergo an annual audit when they receive more than $525,000 in contributions (excluding any government grants). They are required to have a review performed when contributions (excluding any government grants) are between $275,000 and $525,000. Beyond these requirements, certain grantors or donors may impose audit or review requirements as a condition of receiving their funding. This is frequently the case for organizations that receive federal grants over particular dollar thresholds.

Outside of these circumstances, there is not a one-size-fits-all answer to determine the level of assurance needed on an organization’s financial statements. Each organization’s situation, including number of funding sources, complexity of operations, level of monitoring, and accounting practices, should be taken into account when determining the level of service to have performed on the financial statements. Lastly, just because you have one level of service performed one year does not mean you can’t have a different level of service in another. It is a common practice in the association industry (where there are frequently no outside requirements to undergo an audit) to have an audit performed every three years, with a review performed in the off years.

For a more in-depth information about financial statement services, refer to Yeo & Yeo’s Guide to Financial Statement Services: Compilation, Review and Audit.

If you have questions about what level of service is right for your organization, your Yeo & Yeo advisor would be pleased to help guide you and your nonprofit board through the decision-making process.

Many of the manufacturers we speak with express their concern about finding younger talent – or sometimes just available talent – in the manufacturing workforce. Since the recession a few years back, most manufacturing plants have been running leaner, and the manufacturing job force has not been appealing for the younger generation. Also, our culture promotes the mindset that the only way to be successful in a career is to attend college and earn a degree rather than learn a skilled trade. These circumstances have left a huge void in the manufacturing workforce, especially in the need for younger talent. Most manufacturers are concerned that when their machinists retire, they won’t have replacements in place who are educated enough to perform the same tasks.

Delta College and Mid Michigan Community College have addressed this problem head-on by creating an accelerated CNC program to train and prepare applicants with the proper knowledge and skills to excel in this field. The program addresses the two major problems in regards to this topic by attracting the younger generations and offering a viable solution to those who do not want to obtain the traditional college degree.

One great thing about this program is that it is local. Most of the graduates are local residents who plan to find a job locally. The colleges are an excellent resource to find trained talent who want to enter the manufacturing workforce. The students will already have the training and expertise to start working immediately, with a background that could propel them into more advanced machining.

If you are experiencing similar issues with finding younger, trained talent, look no further than our back yard!

A conflict of interest policy is essential to have in place for both governance (board of directors) and management to mitigate personal interests from competing with those of the nonprofit. Such a policy is so significant that it is one of only a handful of policies the IRS requires organizations to report on their Form 990, whether or not the policy has been adopted.

A conflict of interest policy should be written and should identify the organization’s process to identify conflicts of interest, as well as the process to oversee any conflicts of interest. A typical component of a conflict of interest policy is the annual completion of a conflict of interest disclosure form, and review of the forms at a board meeting.

Now is as good a time as any to ensure your nonprofit has adopted and is staying up to date with its conflict of interest policy.

Check Out Our eBook on Creating Policies for Your Nonprofit

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Yeo & Yeo CPAs & Business Consultants is pleased to announce that Brian Dixon, CPA, has achieved the Advanced Single Audit Certification from the American Institute of CPAs (AICPA).

The certification is reserved for auditors with a minimum of seven years of experience planning, performing, reviewing, and reporting single audits in accordance with the latest Uniform Guidance requirements. The Advanced Single Audit exam covers topics such as internal controls over compliance, compliance testing, and audit sampling, among others.

Dixon is a Principal and leads the firm’s Audit Services Group. He has over 20 years of accounting and audit experience with specialization in the nonprofit and healthcare sectors, and proven expertise in single audits of federal awards.

Yeo & Yeo is an industry leader serving Governments, Nonprofit and Education entities throughout Michigan.

Internal Controls: Segregation of Duties in Small Nonprofits

Check Out Our eBook on Creating Policies for Your Nonprofit

View our Tax Reform Pass-through Deduction Flowchart.

1. Business Generates Tax Losses

2. Business Distributes All Profits to Owners

3. Business Retains All Profits to Finance Growth

For a more in-depth information about financial statement services, refer to Yeo & Yeo’s Guide to Financial Statement Services: Compilation, Review and Audit.

Check Out Our eBook on Creating Policies for Your Nonprofit

Read more information about the Advance Single Audit Certification here.