Offering Summer Job Opportunities? Double-check Child Labor Laws

Spring has sprung — and summer isn’t far off. If your business typically hires minors for summer jobs, now’s a good time to brush up on child labor laws.

In News Release No. 22-546-DEN, the U.S. Department of Labor’s Wage and Hour Division (WHD) recently announced that it’s stepping up efforts to identify child labor violations in the Salt Lake City area. However, the news serves as a good reminder to companies nationwide about the many details of employing children.

Finer points of the FLSA

The Department of Labor is the sole federal agency that monitors child labor and enforces child labor laws. The most sweeping federal law that restricts the employment and abuse of child workers is the Fair Labor Standards Act (FLSA). The WHD handles enforcement of the FLSA’s child labor provisions.

The FLSA restricts the hours that children under 16 years of age can work and lists hazardous occupations too dangerous for young workers to perform. Examples include jobs involving the operation of power-driven woodworking machines, and work that involves exposure to radioactive substances and ionizing radiators.

The FLSA allows children 14 to 15 years old to work outside of school hours in various manufacturing, non-mining, non-hazardous jobs under certain conditions. Permissible work hours for 14- and 15-year-olds are:

Three hours on a school day,
18 hours in a school week,
Eight hours on a non-school day,
40 hours in a non-school week, and
Between 7 a.m. and 7 p.m.*

*From June 1 through Labor Day, nighttime work hours are extended to 9 p.m.

Just one example

News Release No. 22-546-DEN reveals the results of three specific investigations. In them, the WHD found that employers had allowed minors to operate dangerous machinery. Also, minors were allowed to work beyond the time permitted, during school hours, more than three hours on a school night and more than 18 hours a workweek.

In one case, a restaurant allowed minors to operate or assist in operating a trash compactor and a manual fryer, which are prohibited tasks for 14- and 15-year-old workers. The employer also allowed minors to work:

More than three hours on a school day,
More than 18 hours in a school week,
Past 7 p.m. from Labor Day through May 31,
Past 9 p.m. from June 1 through Labor Day, and
More than eight hours on a non-school day.

The WHD assessed the business $17,159 in civil money penalties.

Letter of the law

In the news release, WHD Director Kevin Hunt states, “Early employment opportunities are meant to be valuable and safe learning experiences for young people and should never put them at risk of harm. Employers who fail to keep minor-aged workers safe and follow child labor regulations may struggle to find the young people they need to operate their businesses.”

What’s more, as the case above demonstrates, companies can incur substantial financial penalties for failing to follow the letter of the law. Consult an employment attorney for further details on the FLSA. We can help you measure and manage your hiring and payroll costs.

Most nonprofits have some type of special event that they run during the fiscal year, whether it is an annual event or just a periodic event. Accounting and tax reporting can be tricky for these events. At most of these events, the attendee is obtaining some type of good or service (such as a dinner or entertainment) but is paying more to obtain that good or service than it is worth (because they are trying to contribute money to the nonprofit.) Therein lies the complexity. The good news is that the book and tax ramifications are similar.

Accounting for the contribution portion
Let’s start with the contribution piece. The price of admission that is above and beyond the fair value of the goods and services received is considered a contribution for both book and tax purposes. For example, let’s assume it is a dinner event and the cost of the admission ticket is $50. You could purchase the meal yourself from the caterer (or from a different caterer) for $20. The contribution for both book and tax purposes is $30 (ticket cost of $50 less fair value of goods received of $20). For both book and tax, it is irrelevant if the caterer charges the nonprofit the fair value of $20 or not.

For tax reporting purposes, that means that the fundraising event line item of revenue will be broken down into $30 of contributions and $20 of gross income from fundraising events. The $30 contribution is subject to all the same tax rules as if the person had simply written you a check for $30 and received nothing in return; that means for certain donors, you need to be able to track it separately for Schedule A or Schedule B purposes. As a nonprofit, you have a legal requirement that if the admission ticket was $75 or more, you must provide the purchaser a statement indicating the value of goods or services received. This allows them to do the math on their tax return and determine the contribution they can deduct.

For generally accepted accounting principles purposes, the same $30 is contribution revenue and the $20 is revenue from contracts with customers. The $30 of contribution revenue is recorded when the contribution becomes unconditional. That means unless there is a right of return/release and a barrier, the $30 is recorded as revenue when the ticket purchaser promises to purchase the ticket. If you are selling tickets in the year before the event, that means a portion of “event” revenue (related to contributions) is earned before the event. To “prevent” that from happening, the contribution must be conditional. There would have to be an explicit expectation that if the event did not happen, the contribution would be refundable. That is a business decision that should not be made lightly, just to fix unpleasant accounting requirements.

Accounting for the exchange portion
Now we have the remaining $20, which is gross income from fundraising events (tax) or revenue from contracts with customers (book). This amount is recognized when the event takes place. For tax purposes, this $20 is the amount listed as gross income from fundraising events in the revenue section of Form 990. It will be netted with the direct costs of the items sold/production of revenue. For the dinner, that would include the cost of the food and beverages and potentially the invitation to the dinner. It would not include advertising for the event (which is an indirect fundraising expense), nor would it include the cost of the time that the employees spend planning the event.

In general, we would expect that the net amount reported in the revenue section of Form 990 for income from fundraising would be close to break-even or a positive number (especially if the nonprofit got a discount on what they paid which is more significant than what the average individual could obtain). If instead your net income from fundraising is a large negative amount, either you have allocated expenses that are not directly related to the fundraising event, or you have not properly determined the contribution revenue (and therefore have told your donors they could take too high a tax deduction on their return).

For book purposes, that $20 is revenue from contracts with customers. It is earned when, or as, the performance obligations are performed. Typically, this will be the night of the dinner, when dinner is provided (or the person fails to come to the dinner and is not reimbursed their ticket price). Aside from a potential timing difference between recognizing contribution and revenue from contracts with customers, the non-contribution portion of the transaction has substantially more disclosures that will need to be included in the financial statements.

Accounting for auction items
Frequently these types of special events have auctions of donated items. Let’s presume that a donor provides, at no cost to the nonprofit, an item for the auction with a fair value of $5,000. Both book and tax would record that as contribution income (noncash) of $5,000 when it is unconditional. The excess of the selling price over the fair value will be a contribution in both cases. So, if it sells for $7,500, the remaining $2,500 ($7,500 less the $5,000 already accounted for) is cash contribution. If instead it sells for $3,000, there is no additional contribution ($3,000 less $5,000 is negative). For tax purposes, the lesser of the fair value ($5,000) or amount received ($3,000 or $7,500, depending on the example) is reported as gross income from fundraising events. Also, for tax purposes, the full fair value of $5,000 is an expense (regardless of the amount it was auctioned for) plus any other direct expenses (such as the cost of the auctioneer). This would result in negative net income from fundraising equal to at least the amount of the other direct expenses.

What about sponsorships?
Special events also frequently offer sponsorships. The IRS has specific rules on what can be considered contribution (and non-taxable). Those rules indicate that the sponsor pays the nonprofit with no arrangement of expectation for substantial return benefit. Substantial return benefit includes: a) advertising, b) an exclusive provider arrangement, c) providing more than a de minimus facilities, services, or other privileges to the payor or a person designated by the payor, or d) granting the payor or a person designated by the payor the right to use an intangible asset such as a trademark, patent, or logo of the nonprofit.

Advertising is defined as having qualitative or comparative language, price information, and endorsement, or an inducement to purchase, not just a logo or description of goods. The de minimus exception is set at 2% of the sponsorship agreement. In the tax realm, if the sponsorship does not meet the criteria to be a contribution, it is likely advertising and taxable income.

Generally accepted accounting principles do not have strict guidelines to differentiate between revenue from contracts with customers and contribution revenue. However, a good rule of thumb is that if it is contribution revenue for the IRS, it is contribution revenue for book purposes; if it’s not, it’s not. Do remember, for book purposes, contribution revenue is earned when it is unconditional. That is to say, when there is not both a right of return/release and a barrier. If you do not explicitly indicate in your sponsorship agreements that in the event the special event is cancelled, all sponsorships will be returned, then it is unconditional.

Other considerations in contribution revenue
Accounting and reporting for special events can be very confusing. Book and tax tend to mimic each other but aren’t always intuitive. To determine the contributions, you will take the actual amounts pledged less the fair value of what is being given, regardless of the cost. The contributions may be recorded in a period before the event takes place if they are unconditional. If the ticket price is over $75, the nonprofit is required by law to provide a receipt indicating the value of goods and services the purchaser has received, so that they can calculate the tax-deductible contributions. Sponsorships may or may not be contribution revenue, depending on the goods and services being provided in exchange for the sponsorships.

If you have questions about specific situations, please engage the Yeo & Yeo Nonprofit Services Group to help you evaluate the proper accounting and tax reporting for these special events.

Over the last year, consumer prices rose 7.9%, according to the latest data from the U.S. Bureau of Labor Statistics. The Consumer Price Index covers the prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. This is the highest 12-month increase since 1982.

Increases in the price of consumer goods will affect most businesses, sooner or later. For example, if you operate a restaurant, spikes in food prices directly affect you. If you operate a fleet of delivery vehicles, you’re already feeling the effect of rising gas prices. And manufacturers have been hit with higher energy, commodity and shipping costs.

Meanwhile, the producer price index (PPI) is up 10% over last year. This is the largest increase on record for wholesale inflation. PPI gauges inflation before it hits consumers. The U.S. Bureau of Labor Statistics reports that whole energy and food costs were up 33.8% and 13.7% in February 2022 compared to February 2021.

Inflation impacts profits. Although you might be able to absorb some temporary cost increases, at some point, you’ll probably need to raise prices to remain profitable. But, if your competitors hold out on increasing their prices, they might gain an instant competitive advantage, which could lead to turnover and reduced market share.

The decision to raise prices by how much and when depends on demand for your products or services, market trends, customer loyalty, and how long high inflation rates persist. Even if you’re able to implement a successful price increase, there’s a limit to how far you can go. Then what can you do to stay profitable?

Link Pay to Performance

The next step is taking a fresh look at your cost structure for savings opportunities to offset cost increases. Unfortunately, this may be challenging for companies that have already cut costs during the COVID-19 pandemic.

A logical starting point is payroll. It’s the largest cost category for most businesses, and many companies have been forced to raise wages to attract and retain workers during the so-called “Great Resignation.” If you’ve raised the pay for certain key positions, you’d probably expect a corresponding increase in those employees’ productivity. Review those workers’ productivity levels to determine whether there’s indeed a connection between pay and performance.

Next, evaluate whether your performance assessment process is effective. That means having clear and detailed job descriptions in place, including performance indicators and annual objectives. Performance reviews need to be performed regularly against those objectives. Document the results. Accountability for productivity is the best way to achieve it.

Optimize Staffing Levels

The performance review process can help identify opportunities to reduce headcount. How? Before giving existing workers a raise, discuss whether they’d be willing to take on additional responsibilities. These discussions could open the door to some tactical downsizing.

Also, when evaluating payroll costs, look for perks you’re providing but aren’t valued by employees. Some benefits, such as occasional free lunches and company parties, can be suspended without significant pushback from employees.

While generous health benefits are usually a good way to attract and retain employees, consider whether you might be being more generous than you’re legally required to be. For example, are you paying more to subsidize health benefits than other employers in your area?

Other Savings Opportunities

Payroll and benefits aren’t the only areas that can be scaled back to counter inflation. Consider these popular savings opportunities:

Using independent contractors. Labor laws tend to discourage companies from converting employees into freelancers. In fact, under certain conditions, the IRS may reclassify independent contractors as employees — a potentially costly scenario for a business.

However, you might be able to use contractors to augment your staff or replace workers who’ve left. Generally, using freelance help is more flexible than employing workers — you use contractors only as much as you need them, at a cost that’s negotiable.

Renegotiating service contracts. Make a list of all your service contracts. Examples include phone, Internet, software licenses, equipment leases, landscaping, cleaning, security, insurance and professional services. You can lower these costs by 1) switching to a less-expensive competitor, 2) negotiating a lower rate with your existing provider, or 3) reducing your level of service.

Downsizing your real estate. In addition to rent, mortgage interest and property taxes, real estate can represent a major expense because of maintenance, insurance and utilities. You can’t change the space your business occupies overnight — especially if you own the property. But you can evaluate your current footprint and assess how much space would be necessary if you implemented a flexible work schedule. Some workers might be able to telecommute indefinitely. Others can work from home two or three days per week and use revolving workspaces when they’re in the office.

Under the right circumstances, you could sublease some of your excess space. Or you might negotiate less square footage when your lease runs out. If your company owns its real estate, investigate whether you could sell all or part of the space. Alternatively, some businesses lower costs by moving to a less expensive location. Before you decide to relocate, however, consider how doing so would impact employees’ commutes and customers’ convenience.

Partnering with other businesses. Large groups — such as trade organizations or cooperatives — often have more collective bargaining power than individual businesses negotiating alone. By forming or joining a buying group, you’ll likely benefit from discounted supplies and services. Some groups even share certain overhead expenses, such as office equipment, administrative staff and meeting space.

Managing inventory. Over the last two years, some companies have increased their safety stock levels to mitigate supply chain disruptions and to take advantage of bulk discounts. However, businesses that carry excessive inventory levels tie up substantial working capital. They also incur significant costs, including insurance, storage, security, pilferage and obsolescence. Efficient inventory management is essential to staying profitable and maintaining cash flow in today’s inflationary conditions.

What’s Right for Your Business?

High inflation, coupled with labor shortages and supply disruptions, are creating a tenuous situation for business owners. How can you counteract these trends? Strong demand allows some companies to pass along price increases to customers — up to a limit. If high inflation rates persist, you’ll need to find more creative coping strategies. Contact your financial professional for advice on price increases and feasible cost cuts for your business.

How would you feel about taking a cross-country road trip without knowing the amount of gas in your tank, your engine’s temperature or your oil pressure? That’s why you have an instrument panel on your vehicle’s dashboard.

Your business can have a dashboard, too, that features key performance indicators (KPIs). Some metrics may be applicable to any business, while others need to be customized for your specific operating conditions. However, if they’re too complicated to create and monitor, you might veer off course or crash while staring at your dashboard.

Profitability

The bottom line on business performance is just that — the bottom line. Over the long run, profitability metrics are important for every business.

But there may be reasons to temporarily operate at a loss. Examples include start-ups breaking into new markets and low-cost producers trying to take away market share from competitors. External conditions (such as a government-mandated lockdown or a natural disaster) may also cause a business to lose money temporarily.

In most cases, businesses that are losing money have a problem that demands immediate attention. Common profitability metrics include:

Gross margin [(revenue – costs of sales) / revenue], and
EBITDA (earnings before interest, taxes, depreciation and amortization).

You can determine the optimum level of profitability for your business by researching common profit ratios for companies in your industry, geographic location and size. Also make sure that you aren’t under-investing in your business’s future.

Beware: Companies that pursue profits at all costs may suffer adverse effects. For example, employees who are spread too thin may feel overworked, leading to burnout, accidents, errors and high turnover. Likewise, companies that pay below-market wages or skimp on benefits and training may experience high turnover and difficulty recruiting skilled workers. Cuts to the marketing budget, failure to maintain equipment and postponed technology upgrades might boost current profits, but they can impair performance and value over the long run.

Employee Productivity

Personnel costs — including salaries, wages, bonuses, payroll taxes and benefits — are typically a company’s biggest expense category. Management wants to make sure the company is getting its money’s worth, especially as labor rates and health care benefit costs have gone up in recent years.

Some companies use labor cost per unit produced as a KPI. A unit may be a product or service. This KPI may be more relevant when you track it over time and see how it correlates to your bottom line, as compared to other cost categories. To illustrate, suppose your business is sufficiently profitable today (however you define that) and your labor cost per unit produced is $100. A year later, your wages remain stable, but you’ve invested in new equipment to help boost productivity. If those tools are effective, you’d expect to have a lower labor cost per unit. However, it may take some time to recoup the cost of your investment.

Alternatively, some companies measure labor time per unit produced. For example, a medical practice might calculate average time spent per patient. That approach lets you isolate the productivity rate of labor from changes in labor cost. This can provide a simpler assessment of the impact of new productivity tools.

These “tools” can also be intangible, such as skills training, that enable employees to do more without another change to their work environment. It could even include the introduction of a new department head or supervisor. By tracking changes in the labor cost or time per unit, you can assess whether the new hire is having a positive effect on productivity.

Some productivity metrics may be industry specific. For example, a clothing retailer might calculate average units or dollars for each sales transaction. Or an auto dealership might calculate vehicles sold per week for salespeople or vehicles serviced per week for technicians.

Another metric to consider is time spent on productive activities vs. administrative ones (such as meetings, filling out forms and paid leave). This KPI helps assess the cost of your “overhead” labor. For example, a law office may compute billable vs. nonbillable hours for its paralegals and junior lawyers. If the percentage of nonbillable hours increases over time it might signal a red flag, especially if accompanied by declining profitability.

Productivity can also be measured qualitatively. For example, suppose your company has a goal to improve customer satisfaction. You might ask customers to complete surveys after they purchase a product or receive a service, and then track the percentage of employees rated at different performance levels. You may decide to reward those with high scores and provide additional training to get under-performers back on track.

Other Target Areas

The rest of your dashboard should be customized based on what drives your company’s value. KPIs differ from one company to the next based on the industry and the company’s objectives. Common examples include:

Operating cash flow. Cash is king. This metric helps management evaluate how much cash is available for immediate spending needs.

Return on assets. This metric (net income / total assets) measures how effectively your company is managing its assets to generate earnings.

Asset turnover ratios. How much revenue is generated for each dollar invested in assets? You might want to look at the big picture (revenue / total assets). Or you might prefer to break it down by different categories of assets and evaluate it in terms of days (rather than the number of times an account turns over). For example, you might compute days in receivables [(average receivables / annual revenue) × 365 days] or days in inventory [(average inventory / annual cost of sales) × 365 days].

Productivity metrics also can be industry specific. For example, a hospital might be evaluated based on revenue per bed or a hotel based on revenue per room. The key when selecting KPIs is that they must be both specific and measurable.

A Custom Approach

These are just a sampling of metrics you can use. When designing your dashboard, the goal is to identify and track the most relevant KPIs. This information can help you make important tactical and strategic decisions in a timely manner to keep your business healthy in today’s volatile market conditions.

Many IT tools, including project management software, are available to help you crunch the numbers. Your financial advisor can guide you in finding the best way to measure and monitor your business performance.

The tax filing deadline for 2021 tax returns is April 18 this year. After your 2021 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations:

1. You can throw some tax records away now

You should hang onto tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return. So you can generally get rid of most records related to tax returns for 2018 and earlier years. (If you filed an extension for your 2018 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should keep certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

What about your retirement account paperwork? Keep records associated with a retirement account until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

2. Waiting for your refund? You can check on it

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.

3. If you forgot to report something, you can file an amended return

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2021 tax return that you file on April 15, 2022, you can generally file an amended return until April 15, 2025.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

We’re here year-round

If you have questions about tax record retention, your refund, or filing an amended return, contact us. We’re not just available at tax-filing time — we’re here all year!

The concept of in-kind contributions – receiving a contribution that is goods or services – has been around, and unchanged, for quite some time. FASB released a new accounting update that will not change the accounting or recognition, but will change the disclosure and presentation of many in-kind contributions. ASU 2020-07, Presentation and Disclosures by Not-for-profit Entities for Contributed Nonfinancial Assets will be effective for years beginning after June 15, 2021. This means that June 30, 2022, and later year ends will need to apply this standard.

The good news is that the accounting and recognition will not change. All the information needed for the new disclosure and presentation requirements should already be available to your organization. It just may need to be structured differently.

The presentation will now require contributed nonfinancial assets to be in a single line, separate from any contributed financial assets, in the statement of activities. FASB is not making you change the line items for all your contributions; financial contributions (cash, receivables, investments, etc.) can continue to be labeled in however many line items with whatever titles you wish. It only impacts contributed nonfinancial assets (goods, services, and use of goods). All of those contributed nonfinancial assets need to be lumped into one line item on the statement of activities, and it cannot include contributed financial assets. This may mean adding a new account to your chart of accounts and may require some reclassifications of amounts between accounts.

The disclosure portion of the standard is far more in-depth. The disclosure needs to disaggregate the contributed nonfinancial assets into categories. The categories are not specifically listed, and you may find the qualitative information useful in helping determine how to choose categories.

Each category needs to indicate the dollar amount of the contributed nonfinancial assets.
Each category also needs to indicate if it was monetized (sold for money) or utilized during the reporting period. As part of the monetization, describe any policy the organization has on monetizing certain contributions.
For those categories that were utilized, the programs or activities they were used in must be disclosed per category; this should match up to the functions listed in the statement of functional expense.
In addition, if any of the contributed nonfinancial assets have donor-imposed restrictions, those must be disclosed.
Valuation techniques and valuation inputs used to arrive at the fair value of the contributed nonfinancial assets must be described by category, as well as the principal, or most advantageous, market if the entity is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial assets in that market.

These are significantly more robust disclosures than we have ever had before for contributed nonfinancial assets. One way to show these disclosures is to have a grid format with a column for each type of information necessary; this may be the most efficient way if there are multiple categories of nonfinancial assets.

Let’s go back to the discussion of the principal, or most advantageous, market used to arrive at fair value when the organization is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial asset. This seems far-fetched, but it happens all the time in pharmaceuticals. When the pharmaceutical is donated, the fair value must be recorded. The fair value standards indicate to use the fair value in the principal market, so that is where the most sales happen. That principal market could be the U.S., for example. If there is no principal market, then the most advantageous market to the seller should be used. However, a pharmaceutical company may restrict donated pharmaceuticals to be allowed to be used in only Africa and not in the U.S. This would still require the U.S. market value (principal market) to be used even though the organization could not use the drug in the U.S. That would now need to be disclosed.

Contributed services also seem to have some additional disclosures that have been missed in the past. We know that not all contributed services meet the requirements to be recorded as revenue. However, the standards indicate that the programs and activities the contributed services were used for, and the nature and extent of those contributed services, should be disclosed. This is in addition to any revenue amounts recorded. So, if volunteers do not meet the criteria to have services recorded as revenue, the nature of those services, extent (number of volunteers or hours), and the programs they are used in should still be disclosed.

This standard is required to be retroactively implemented for all periods presented. That means, if comparative financial statements are shown, there will potentially be restatements of line items in the statement of activities for the prior year, and the disclosures must also be comparative. The person assisting in preparing the financial statements may not have all the original records necessary to determine all of this detail, and the organization may need to locate those originals for the prior year as well.

These new changes should result in more transparency across the industry. Users will now be able to see more directly the impact that contributed nonfinancial assets have on the organization and how important they are. The biggest concerns are likely to be collating the information for the prior year’s disclosures in this year of implementation and ensuring that financial contributions, such as investments, are not included incorrectly in the contributed nonfinancial assets line item and disclosures.

Operating as an S corporation may help reduce federal employment taxes for small businesses in the right circumstances. Although S corporations may provide tax advantages over C corporations, there are some potentially costly tax issues that you should assess before making a decision to switch.

Here’s a quick rundown of the most important issues to consider when converting from a C corporation to an S corporation:

Built-in gains tax

Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within 5 years after the corporation becomes an S corporation. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

Passive income

S corporations that were formerly C corporations are subject to a special tax if their passive investment income (such as dividends, interest, rents, royalties and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

LIFO inventories

C corporations that use LIFO inventories have to pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

Unused losses

If your C corporation has unused net operating losses, the losses can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

There are other factors to consider in switching from C to S status. Shareholder-employees of S corporations can’t get the full range of tax-free fringe benefits that are available with a C corporation. And there may be complications for shareholders who have outstanding loans from their qualified plans. All of these factors have to be considered to understand the full effect of converting from C to S status.

There are strategies for eliminating or minimizing some of these tax problems and for avoiding unnecessary pitfalls related to them. But a lot depends upon your company’s particular circumstances. Contact us to discuss the effect of these and other potential problems, along with possible strategies for dealing with them.

In recent years, accounting rule makers have issued guidance that requires certain items on the balance sheet to be reported at “fair value.” Here are some answers to frequently asked questions about this standard of value and how it’s measured.

What is fair value?

Under U.S. Generally Accepted Accounting Principles (GAAP), fair value is “the price that would be received to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date.” The use of the term “market participants” refers to buyers and sellers in the item’s principal market. This market is entity specific and may vary among companies.

Fair value estimates are used to report such assets as derivatives, nonpublic entity securities, certain long-lived assets, and acquired goodwill and other intangibles. These estimates specifically exclude entity-specific considerations, such as transaction costs and buyer-specific synergies.

Does fair value differ from fair market value?

Although fair value is similar to fair market value, the terms aren’t synonymous. The most common definition of fair market value is found in IRS Revenue Ruling 59-60. The IRS defines fair market value as “[T]he price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

The Financial Accounting Standards Board (FASB) chose the term “fair value” to prevent companies from applying IRS regulations or guidance and U.S. Tax Court precedent when valuing assets and liabilities for financial reporting purposes. The use of this term also shouldn’t be confused with its use in certain legal situations — for example, when valuing a business for a divorce or a shareholder buyout. Statutory definitions of fair value typically differ from the definition provided under GAAP.

How is fair value measured?

The FASB recognizes three valuation approaches: cost, income and market. It also provides the following hierarchy for valuation inputs, listed in order from most important to least important:

Quoted prices in active markets for identical assets and liabilities,
Observable inputs, including quoted market prices for similar items in active markets, quoted prices for identical or similar items in active markets, and other market data, and
Unobservable inputs, such as cash-flow projections or other internal data.

Valuation specialists are often used to estimate fair value. But ultimately, management can’t outsource responsibility for fair value estimates. Management has an obligation to understand the valuator’s assumptions, methods and models. It also must implement adequate internal controls over fair value measurements, impairment charges and disclosures.

How do auditors assess fair value measurements?

External auditors evaluate accounting estimates as part of their standard audit procedures. They may inquire about the underlying assumptions (or inputs) that were used to make estimates to determine whether the inputs seem complete, accurate and relevant.

Whenever possible, auditors try to recreate management’s estimate using the same assumptions (or their own). If an auditor’s estimate differs substantially from what’s reported on the financial statements, the auditor will ask management to explain the discrepancy. Don’t be surprised if auditors ask questions related to fair value estimates or request additional documentation to support your conclusions in today’s uncertain marketplace.

For more information

Contact us about any additional questions you may have about fair value measurements. We can help ensure that you’re meeting your financial reporting responsibilities.

If you’re an investor in mutual funds or you’re interested in putting some money into them, you’re not alone. According to the Investment Company Institute, a survey found 58.7 million households owned mutual funds in mid-2020. But despite their popularity, the tax rules involved in selling mutual fund shares can be complex.

What are the basic tax rules?

Let’s say you sell appreciated mutual fund shares that you’ve owned for more than one year, the resulting profit will be a long-term capital gain. As such, the maximum federal income tax rate will be 20%, and you may also owe the 3.8% net investment income tax. However, most taxpayers will pay a tax rate of only 15%.

When a mutual fund investor sells shares, gain or loss is measured by the difference between the amount realized from the sale and the investor’s basis in the shares. One challenge is that certain mutual fund transactions are treated as sales even though they might not be thought of as such. Another problem may arise in determining your basis for shares sold.

When does a sale occur?

It’s obvious that a sale occurs when an investor redeems all shares in a mutual fund and receives the proceeds. Similarly, a sale occurs if an investor directs the fund to redeem the number of shares necessary for a specific dollar payout.

It’s less obvious that a sale occurs if you’re swapping funds within a fund family. For example, you surrender shares of an Income Fund for an equal value of shares of the same company’s Growth Fund. No money changes hands but this is considered a sale of the Income Fund shares.

Another example: Many mutual funds provide check-writing privileges to their investors. Although it may not seem like it, each time you write a check on your fund account, you’re making a sale of shares.

How do you determine the basis of shares?

If an investor sells all shares in a mutual fund in a single transaction, determining basis is relatively easy. Simply add the basis of all the shares (the amount of actual cash investments) including commissions or sales charges. Then, add distributions by the fund that were reinvested to acquire additional shares and subtract any distributions that represent a return of capital.

The calculation is more complex if you dispose of only part of your interest in the fund and the shares were acquired at different times for different prices. You can use one of several methods to identify the shares sold and determine your basis:

First-in first-out. The basis of the earliest acquired shares is used as the basis for the shares sold. If the share price has been increasing over your ownership period, the older shares are likely to have a lower basis and result in more gain.
Specific identification. At the time of sale, you specify the shares to sell. For example, “sell 100 of the 200 shares I purchased on April 1, 2018.” You must receive written confirmation of your request from the fund. This method may be used to lower the resulting tax bill by directing the sale of the shares with the highest basis.
Average basis. The IRS permits you to use the average basis for shares that were acquired at various times and that were left on deposit with the fund or a custodian agent.

As you can see, mutual fund investing can result in complex tax situations. Contact us if you have questions. We can explain in greater detail how the rules apply to you.

The federal government is helping to pick up the tab for certain business meals. Under a provision that’s part of one of the COVID-19 relief laws, the usual deduction for 50% of the cost of business meals is doubled to 100% for food and beverages provided by restaurants in 2022 (and 2021).

So, you can take a customer out for a business meal or order take-out for your team and temporarily write off the entire cost — including the tip, sales tax and any delivery charges.

Basic rules

Despite eliminating deductions for business entertainment expenses in the Tax Cuts and Jobs Act (TCJA), a business taxpayer could still deduct 50% of the cost of qualified business meals, including meals incurred while traveling away from home on business. (The TCJA generally eliminated the 50% deduction for business entertainment expenses incurred after 2017 on a permanent basis.)

To help struggling restaurants during the pandemic, the Consolidated Appropriations Act doubled the business meal deduction temporarily for 2021 and 2022. Unless Congress acts to extend this tax break, it will expire on December 31, 2022.

Currently, the deduction for business meals is allowed if the following requirements are met:

The expense is an ordinary and necessary business expense paid or incurred during the tax year in carrying on any trade or business.
The expense isn’t lavish or extravagant under the circumstances.
The taxpayer (or an employee of the taxpayer) is present when the food or beverages are furnished.
The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact.

In the event that food and beverages are provided during an entertainment activity, the food and beverages must be purchased separately from the entertainment. Alternatively, the cost can be stated separately from the cost of the entertainment on one or more bills.

So, if you treat a client to a meal and the expense is properly substantiated, you may qualify for a business meal deduction as long as there’s a business purpose to the meal or a reasonable expectation that a benefit to the business will result.

Provided by a restaurant

IRS Notice 2021-25 explains the main rules for qualifying for the 100% deduction for food and beverages provided by a restaurant. Under this guidance, the deduction is available if the restaurant prepares and sells food or beverages to retail customers for immediate consumption on or off the premises. As a result, it applies to both on-site dining and take-out and delivery meals.

However, a “restaurant” doesn’t include a business that mainly sells pre-packaged goods not intended for immediate consumption. So, food and beverage sales are excluded from businesses including:

Grocery stores,
Convenience stores,
Beer, wine or liquor stores, and
Vending machines or kiosks.

The restriction also applies to an eating facility located on the employer’s business premises that provides meals excluded from an employee’s taxable income. Business meals purchased from such facilities are limited to a 50% deduction. It doesn’t matter if a third party is operating the facility under a contract with the business.

Keep good records

It’s important to keep track of expenses to maximize tax benefits for business meal expenses.

You should record the:

Date,
Cost of each expense,
Name and location of the establishment,
Business purpose, and
Business relationship of the person(s) fed.

In addition, ask establishments to divvy up the tab between any entertainment costs and food/ beverages. For additional information, contact your tax advisor.

Small businesses may start off using the cash-basis method of accounting. But many eventually convert to accrual-basis reporting to conform with U.S. Generally Accepted Accounting Principles (GAAP). Which method is right for you?

Cash method

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

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Normally, the preferred strategy is to postpone revenue recognition and accelerate expense payments at year end. This strategy can temporarily defer the company’s tax liability. But it makes the company appear less profitable to lenders and investors.

Conversely, if tax rates are expected to increase substantially in the coming year, it may be advantageous to take the opposite approach — accelerate revenue recognition and defer expenses at year end. This strategy maximizes the company’s tax liability in the current year when rates are expected to be lower.

Accrual method

The more complex accrual method conforms to the matching principle under GAAP. That is, companies recognize revenue (and expenses) in the periods that they’re earned (or incurred). This method reduces major fluctuations in profits from one period to the next, facilitating financial benchmarking.

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

Tax considerations

Thanks to the Tax Cuts and Jobs Act (TCJA), more companies are eligible to use the cash method for federal tax purposes than under prior law. In turn, this change has caused some small companies to rethink their method of accounting for book purposes.

The TCJA liberalized the small business definition to include those that have no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2021, the inflation-adjusted limit is $26 million. For 2022, it’s $27 million. Under prior law, the gross-receipts threshold for the cash method was only $5 million.

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

For more information

There are several viable reasons for a small business to switch to the accrual method of accounting. It can help reduce variability in financial reporting and attract financing from lenders and investors who prefer GAAP financials. But, if you’re eligible for the cash method for tax purposes, you may want to switch to that method for the simplicity and the flexibility in tax planning it provides. Contact us to discuss your options and pick the optimal method for your situation.

Yeo & Yeo, a leading Michigan-based accounting and advisory firm, is grateful for their team members, clients and communities that have made nearly a century of success possible. Yeo & Yeo is proud to celebrate its 99^th anniversary on April 1.

“We are truly honored to have clients and communities that have supported our business for 99 years,” said President & CEO Dave Youngstrom. “Today, we celebrate by reflecting on our proud past as a family-owned company and, more importantly, focusing on our future success and celebrating our partners – including our professionals and clients across Michigan.”

Since its beginnings in downtown Saginaw, Mich., in 1923, Yeo & Yeo has sustained a thriving Michigan business dedicated to building strong relationships and helping clients meet their long-term financial and business goals. Yeo & Yeo’s professionals proudly carry forward the tradition of personal service and community support begun by three generations of the Yeo family. Today Yeo & Yeo has more than 200 professionals providing accounting, tax, assurance and advisory solutions from nine offices across Michigan. Three companies – Yeo & Yeo Technology, Yeo & Yeo Medical Billing & Consulting and Yeo & Yeo Wealth Management – have also evolved to serve clients’ growing needs.

“Our ability to provide integrated solutions under one firm allows us to be a trusted advisor for our clients at a strategic level,” said Youngstrom. “We listen to our clients’ concerns that keep them up at night and passionately work to provide them with the services, resources and knowledge that give them peace of mind.”

Yeo & Yeo recognizes that the champions behind positive client experiences are its people. “We are a people-first organization committed to providing our professionals with a meaningful career, creating a fun work environment and supporting life outside of the office,” said Youngstrom. “I am grateful to our people whose dedication has helped Yeo & Yeo achieve 99 successful years in business.”

In upholding the firm’s culture of giving back, and to create more opportunities to expand its community support in the future, the firm established the Yeo & Yeo Foundation in 2020. Since its inception, the 100 percent employee-sponsored Foundation has granted over $210,000 to 120 organizations throughout Michigan.

“99 years is an incredible accomplishment that we are extremely proud of,” said Youngstrom. “As we look to the future, we are excited to create new possibilities for our people, clients and communities through innovation and growth.”

The entire team at Yeo & Yeo is proud of the firm’s legacy and looks forward to serving clients and their communities for many more years. For more information, visit yeoandyeo.com.

The clock is ticking down to the April 18 tax filing deadline. Sometimes, it’s not possible to gather your tax information and file by the due date. If you need more time, you should file for an extension on Form 4868.

An extension will give you until October 17 to file and allows you to avoid incurring “failure-to-file” penalties. However, it only provides extra time to file, not to pay. Whatever tax you estimate is owed must still be sent by April 18, or you’ll incur penalties — and as you’ll see below, they can be steep.

Failure to file vs. failure to pay

Separate penalties apply for failing to pay and failing to file. The failure-to-pay penalty runs at 0.5% for each month (or part of a month) the payment is late. For example, if payment is due April 18 and is made May 25, the penalty is 1% (0.5% times 2 months or partial months). The maximum penalty is 25%.

The failure-to-pay penalty is based on the amount shown as due on the return (less credits for amounts paid via withholding or estimated payments), even if the actual tax bill turns out to be higher. On the other hand, if the actual tax bill turns out to be lower, the penalty is based on the lower amount.

The failure-to-file penalty runs at the more severe rate of 5% per month (or partial month) of lateness to a maximum 25%. If you file for an extension on Form 4868, you’re not filing late unless you miss the extended due date. However, as mentioned earlier, a filing extension doesn’t apply to your responsibility for payment.

If the 0.5% failure-to-pay penalty and the failure-to-file penalty both apply, the failure-to-file penalty drops to 4.5% per month (or part) so the combined penalty is 5%. The maximum combined penalty for the first five months is 25%. Thereafter, the failure-to-pay penalty can continue at 0.5% per month for 45 more months (an additional 22.5%). Thus, the combined penalties can reach a total of 47.5% over time.

The failure-to-file penalty is also more severe because it’s based on the amount required to be shown on the return, and not just the amount shown as due. (Credit is given for amounts paid via withholding or estimated payments. If no amount is owed, there’s no penalty for late filing.) For example, if a return is filed three months late showing $5,000 owed (after payment credits), the combined penalties would be 15%, which equals $750. If the actual liability is later determined to be an additional $1,000, the failure-to-file penalty (4.5% × 3 = 13.5%) would also apply to this amount for an additional $135 in penalties.

A minimum failure-to-file penalty also applies if a return is filed more than 60 days late. This minimum penalty is the lesser of $435 (for returns due through 2022) or the amount of tax required to be shown on the return.

Reasonable cause

Both penalties may be excused by the IRS if lateness is due to “reasonable cause” such as death or serious illness in the immediate family.

Interest is assessed at a fluctuating rate announced by the government apart from and in addition to the above penalties. Furthermore, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can jump to 15% per month, with a 75% maximum.

Here are some of the key tax-related deadlines that apply to businesses and other employers during the second quarter of 2022. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

April 18

If you’re a calendar-year corporation, file a 2021 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004) and pay any tax due.
Corporations pay the first installment of 2022 estimated income taxes.
For individuals, file a 2021 income tax return (Form 1040 or Form 1040-SR) or file for an automatic six-month extension (Form 4868) and paying any tax due. (See June 15 for an exception for certain taxpayers.)
For individuals, pay the first installment of 2022 estimated taxes, if you don’t pay income tax through withholding (Form 1040-ES).

May 2

Employers report income tax withholding and FICA taxes for the first quarter of 2022 (Form 941) and pay any tax due.

May 10

Employers report income tax withholding and FICA taxes for the first quarter of 2022 (Form 941), if you deposited on time and fully paid all of the associated taxes due.

June 15

Corporations pay the second installment of 2022 estimated income taxes.

Major events or transactions — such as a natural disaster, a cyberattack, a regulatory change or the loss of a large business contract — may happen after the reporting period ends but before financial statements are finalized. The decision of whether to report these so-called “subsequent events” is one of the gray areas in financial reporting. Here’s some guidance from the AICPA to help you decide.

Recognition

Financial statements reflect a company’s financial position at a particular date and the operating results and cash flows for a period ended on that date. However, because it takes time to complete financial statements, there may be a gap between the financial statement date and the date the financials are available to be issued. During this period, unforeseeable events may happen in the normal course of business.

Chapter 27 of the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities classifies subsequent events into two groups:

1. Recognized subsequent events. These provide further evidence of conditions that existed on the financial statement date. An example would be the bankruptcy of a major customer, highlighting the risk associated with its accounts receivable. There are usually signs of financial distress (such as late payments or staff turnover) months before a customer actually files for bankruptcy.

2. Nonrecognized subsequent events. These reflect conditions that arise after the financial statement date. An example would be a tornado or earthquake that severely damages the business. A business usually has little or no advanced notice that a natural disaster is going to happen.

Generally, the former must be recorded in the financial statements. The latter events aren’t required to be recorded, but the details may have to be disclosed in the footnotes.

Disclosure

To decide which events to disclose in the footnotes, consider whether omitting the information about them would mislead investors, lenders and other stakeholders. Disclosures should, at a minimum, describe the nature of the event and estimate the financial effect, if possible.

In some extreme cases, the effect of a subsequent event may be so pervasive that your company’s viability is questionable. This may cause your CPA to re-evaluate the going concern assumption that underlies your financial statements.

When in doubt

If you’re unsure how to handle a subsequent event, we can help eliminate the guesswork. Contact us for more information.

On this day in history, March 23, 2020, we faced a level of disruption none of us had experienced before. Two years ago today, Michigan’s Governor issued a statewide stay-at-home order for all non-essential workers. COVID-19 and the shutdown forced all businesses to adapt to entirely new circumstances.

We quickly realized that our clients needed us more than ever, and so did our people. Our professionals are the heart behind all we do – and so many faced immense challenges on the home front. We took this responsibility very seriously and in response to the initial shutdown:

Yeo & Yeo put its critical response team into action, ensuring the safety and support of our people, clients, families and communities.
Our IT Group seamlessly supported the work-from-home transition of 200+ professionals while our HR team met the critical safety and well-being needs of our people.
Transparent and timely internal and external communications became a daily priority.

During the onset of the pandemic, into the darkest days of the state shutdown, and now in emerging stages, we at Yeo & Yeo have continually focused on supporting our people, giving them the foundation to provide outstanding care and service to our clients and communities. Here are just a few stories our people shared as they reflected on the pandemic.

“When COVID emerged in 2020, our firm acted swiftly and sent out updates regularly on how we would be adapting to a pandemic-friendly workplace. We transitioned to remote work, which I appreciated because I became a first and third-grade teacher to my two daughters, whose school shut down. We were allowed, and even encouraged, to work flexible hours to ensure we could take care of our families’ needs. The way our firm handled the pandemic was far beyond my expectations, and I will forever be grateful for that.” – Jordan Bohlinger, Senior Accountant

“I can vividly remember being in the office in March 2020 and going home thinking, ‘When am I coming back?’ Two weeks into lockdown, I had no fear anymore because I knew we would make it through. Our firm’s leadership genuinely cares about each and every employee. They made sure that we were able to effectively work from home, keep our families safe and balance our priorities.” – James Kuch, Firm Administration

“The constant communication that Yeo & Yeo leaders demonstrated was huge. I got a call nearly weekly from a leader just checking to see how I was handling things. Early in the pandemic, a random package showed up at my door. It came with a very kind note and care package that I still have to this day. I felt that employees and their morale were Yeo & Yeo’s priority during the pandemic. I felt they genuinely cared about me and my well-being and made sure that I had the resources and support I needed during the extremely challenging times.” – Marisa Ahrens, Principal

“The start of the pandemic was an uncertain time for many employees at Yeo & Yeo Technology, including myself. I was pregnant with my first child, and the firm created an opportunity for me to work from home four days a week to help put my mind at ease. There is now more flexibility for working remotely, and this option has been great for my family and me.” – Julian Braem, Yeo & Yeo Technology

“We worked tirelessly to take care of our clients. With all the federal programs that were made available, there was a lot to stay on top of so we could help our clients tap into the resources that would help sustain them. We were sending near-daily communications to keep everyone informed. I am incredibly proud of our professionals who went above and beyond to provide genuine support to our clients.” – Rebecca Millsap, Managing Principal

Reshaping the Future

Flexibility for our people. We offer hybrid and remote work plans in addition to in-office work to provide further flexibility and work-life balance for our professionals.
Open, honest and timely communication. We are committed to listening intently, responding authentically and alleviating potential challenges for our people and clients through knowledge, experience and kindness.
Technology advancement and innovation. We will continue to research and implement the most up-to-date and secure technologies for our people and our clients to communicate, collaborate and share information.
Agility for our clients. What sets us apart is our ability to adapt perfectly to the size, scope and needs of our clients. We are dedicated to remaining agile, helping clients respond to uncertainty with clarity and optimism.

Summer is just around the corner. If you’re fortunate enough to own a vacation home, you may wonder about the tax consequences of renting it out for part of the year.

The tax treatment depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Here’s the test: if you use it personally for more than the greater of 1) 14 days, or 2) 10% of the rental days, you’re using it “too much,” and you can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years. If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.

If you “pass” the personal use test (i.e., you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

As you can see, the rules are complex. Contact us if you have questions or would like to plan ahead to maximize deductions in your situation.

Typically, businesses want to delay recognition of taxable income into future years and accelerate deductions into the current year. But when is it prudent to do the opposite? And why would you want to?

One reason might be tax law changes that raise tax rates. There have been discussions in Washington about raising the corporate federal income tax rate from its current flat 21%. Another reason may be because you expect your noncorporate pass-through entity business to pay taxes at higher rates in the future, because the pass-through income will be taxed on your personal return. There have also been discussions in Washington about raising individual federal income tax rates.

If you believe your business income could be subject to tax rate increases, you might want to accelerate income recognition into the current tax year to benefit from the current lower tax rates. At the same time, you may want to postpone deductions into a later tax year, when rates are higher, and when the deductions will do more tax-saving good.

To accelerate income

Consider these options if you want to accelerate revenue recognition into the current tax year:

Sell appreciated assets that have capital gains in the current year, rather than waiting until a later year.
Review the company’s list of depreciable assets to determine if any fully depreciated assets are in need of replacement. If fully depreciated assets are sold, taxable gains will be triggered in the year of sale.
For installment sales of appreciated assets, elect out of installment sale treatment to recognize gain in the year of sale.
Instead of using a tax-deferred like-kind Section 1031 exchange, sell real property in a taxable transaction.
Consider converting your S corporation into a partnership or LLC treated as a partnership for tax purposes. That will trigger gains from the company’s appreciated assets because the conversion is treated as a taxable liquidation of the S corp. The partnership will have an increased tax basis in the assets.
For a construction company, do you have long-term construction contracts previously exempt from the percentage-of-completion method of accounting for long-term contracts? Consider using the percentage-of-completion method to recognize income sooner as compared to the completed contract method, which defers recognition of income until the long-term construction is completed.

To defer deductions

Consider the following actions to postpone deductions into a higher-rate tax year, which will maximize their value:

Delay purchasing capital equipment and fixed assets, which would give rise to depreciation deductions.
Forego claiming big first-year Section 179 deductions or bonus depreciation deductions on new depreciable assets and instead depreciate the assets over a number of years.
Determine whether professional fees and employee salaries associated with a long-term project could be capitalized, which would spread out the costs over time and push the related deductions forward into a higher rate tax year.
Purchase bonds at a discount this year to increase interest income in future years.
If allowed, put off inventory shrinkage or other write-downs until a year with a higher tax rate.
Delay charitable contributions into a year with a higher tax rate.
If allowed, delay accounts receivable charge-offs to a year with a higher rate.
Delay payment of liabilities where the related deduction is based on when the amount is paid.

In the ever-evolving landscape of the cannabis industry, finding the right path to growth and success can be a challenging endeavor. In this article, we engage in a thought-provoking Q&A session with Alex Wilson, a trusted advisor in cannabis advisory, tax, and accounting solutions. Through his valuable insights and experiences, he sheds light on various aspects of the cannabis business. From strategies for achieving growth to preparing for inevitable setbacks and the impact of vertical integration, Alex provides guidance that can benefit both established and aspiring cannabis businesses. Join us as we explore the intricate world of cannabis through the eyes of an industry advisor.

1. WHAT DO OWNERS NEED TO CONSIDER WHEN LOOKING AT GROWTH AND THE DRIVERS OF SUCCESS?

Owners who experience the most success embrace big-picture thinking as the driver of growth. In this respect, there are five steps to drive growth and, ultimately, allow owners to live the life they desire: 1. Know the value of your business and identify the drivers that affect the value. 2. Know the key performance indicators that enable you to operate your business more efficiently and effectively. 3. Have a handle on your plan and prepare yourself for setbacks. 4. Understand how your business and personal wealth support each other. 5. Have a clear vision for your business with specific, measurable objectives.

2. HOW CAN CANNABIS BUSINESSES PREPARE FOR SETBACKS?

A setback at some point is inevitable throughout the life of a business, which is why preparation is critical. Currently, we are experiencing a massive oversaturation of the market. Flower prices are dropping substantially, to the point that the product is selling at an unsustainable loss. While some businesses saw this coming and prepared, others are struggling. Having a plan for cash flow preservation, expense cuts, and pivots in operation is essential. Having a broad frame of mind is important — always considering how decisions affect your overall cash flow.

3. HOW CAN VERTICAL INTEGRATION IMPACT HOW COMPANIES EXPERIENCE THE CURRENT OVERSUPPLY ISSUE?

Vertically integrated operations, where the company can be both buyer and seller while controlling all aspects of the product, are better positioned to have a cost cushion. Those that are already vertically integrated have this advantage. If vertical integration is on the horizon for your business, the time to prepare is now. Start considering your access to capital and take stock of your trusted advisers and the resources available to you. If expanding or adding locations leads to multistate operations, it is imperative that you understand the many state requirements so you can remain compliant and adjust your business model appropriately.

4. WITH AN ABUNDANCE OF CANNABIS COMPANIES IN MICHIGAN NOW, WHAT DOES IT TAKE TO STAY AT THE FOREFRONT?

Forging new relationships and improving brand recognition can give companies the edge they need to survive. Customers will recognize a premium product and are willing to pay more, ultimately reducing the loss on the grower side. You may also find benefit in pursuing an increase in marketing efforts so your business can be in a place to earn market share and set a price that is not only sustainable but provides for growth.

5. WHAT APPROACH DOES YEO & YEO TAKE TO ADVISING CANNABIS CLIENTS?

First and foremost, we are our clients’ partners in success. We work with them to build customized, right-sized relationships that help our clients remain compliant, organized, and growing. Our clients’ goals vary, but whatever their goals are — vertical integration, preparing for M&A, adding licenses, or opening a new location — we ensure they have the information they need to make data-driven decisions and we are there to support them every step of the way.

Business transactions with related parties — such as friends, relatives, parent companies, subsidiaries and affiliated entities — may sometimes happen at above- or below-market rates. This can be misleading to people who rely on your company’s financial statements, because undisclosed related-party transactions may skew the company’s true financial results.

The hunt for related parties

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

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

Specifically, auditors look for contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s-length transactions between unrelated third parties.

For example, a spinoff business might lease office space from its parent company at below-market rates. A manufacturer might buy goods at artificially high prices from its subsidiary in a low-tax country to reduce its taxable income in the United States. Or an auto dealership might pay the owner’s daughter an above-market salary and various perks that aren’t available to unrelated employees.

Audit procedures

Audit procedures designed to target related-party transactions include:

Testing how related-party transactions are identified and coded in the company’s enterprise resource planning (ERP) system,
Interviewing accounting personnel responsible for reporting related-party transactions in the company’s financial statements, and
Analyzing presentation of related-party transactions in financial statements.

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

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With related-party transactions, communication is key. Always tell your auditors about known related-party transactions and ask for help disclosing and reporting these transactions in a transparent manner that complies with U.S. Generally Accepted Accounting Principles.