IRS, Treasury Announce Families of 88% of Children in the U.S. to Automatically Receive Monthly Payment of Refundable Child Tax Credit

WASHINGTON – The Internal Revenue Service and the U.S. Department of the Treasury announced today that the first monthly payment of the expanded and newly-advanceable Child Tax Credit (CTC) from the American Rescue Plan will be made on July 15. Roughly 39 million households—covering 88% of children in the United States—are slated to begin receiving monthly payments without any further action required.

IRS and Treasury also announced the increased CTC payments will be made on the 15^th of each month unless the 15^th falls on a weekend or holiday. Families who receive the credit by direct deposit can plan their budgets around receipt of the benefit. Eligible families will receive a payment of up to $300 per month for each child under age 6 and up to $250 per month for each child age 6 and above.

The American Rescue Plan increased the maximum Child Tax Credit in 2021 to $3,600 for children under the age of 6 and to $3,000 per child for children between ages 6 and 17. The American Rescue Plan is projected to lift more than five million children out of poverty this year, cutting child poverty by more than half.

Households covering more than 65 million children will receive the monthly CTC payments through direct deposit, paper check, or debit cards, and IRS and Treasury are committed to maximizing the use of direct deposit to ensure fast and secure delivery. While most taxpayers will not be required to take any action to receive their payments, Treasury and the IRS will continue outreach efforts with partner organizations over the coming months to make more families aware of their eligibility.

Today’s announcement represents the latest collaboration between the IRS and Bureau of the Fiscal Service—and between Treasury and the White House American Rescue Plan Implementation Team—to ensure help quickly reaches Americans in need as they recover from the COVID-19 pandemic. Since March 12, the IRS has also distributed approximately 165 million Economic Impact Payments with a value of approximately $388 billion as a part of the American Rescue Plan.

Additional information for taxpayers on how they can access the Child Tax Credit will be available soon on at IRS.gov/childtaxcredit2021.

In recent years, the accounting rules for certain balance sheet items have transitioned from historical cost to “fair value.” Examples of assets that may currently be reported at fair value are asset retirement obligations, derivatives and intangible assets acquired in a business combination. Though fair value may better align your company’s financial statements with today’s market values, estimating fair value may require subjective judgment.

GAAP definition

Under U.S. Generally Accepted Accounting Principles (GAAP), fair value is “the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.” Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, explains how companies should estimate the fair value of assets and liabilities by using available, quantifiable market-based data.

Topic 820 provides the following three-tier valuation hierarchy for valuation inputs:

Quoted prices in active markets for identical assets or liabilities,
Information based on publicly quoted prices, including older prices from inactive markets and prices of comparable stocks, and
Nonpublic information and management’s estimates.

Fair value measurements, especially those based on the third level of inputs, may involve a high degree of subjectivity, making them susceptible to misstatement. Therefore, these estimates usually require more auditor focus.

Auditing estimates

Auditing standards generally require auditors to select one or a combination of the following approaches to substantively test fair value measurements:

Test management’s process. Auditors evaluate the reasonableness and consistency of management’s assumptions, as well as test whether the underlying data is complete, accurate and relevant.

Develop an independent estimate. Using management’s assumptions (or alternate assumptions), auditors come up with an estimate to compare to what’s reported on the internally prepared financial statements.

Review subsequent events or transactions. The reasonableness of fair value estimates can be gauged by looking at events or transactions that happen after the balance sheet date but before the date of the auditor’s report.

Outside input

Measuring fair value is outside the comfort zone of most in-house accounting personnel. Fortunately, an outside valuation expert can provide objective, market-based evidence to support the fair value of assets and liabilities. Contact us for more information.

“Sales tax” is a phrase that fills many nonprofits with dread, especially when they try to determine whether or not to collect or remit it. The rules last changed in 2018. However, in December 2020, the Michigan Department of Treasury issued Revenue Administrative Bulletin (RAB) 2020-25, without any fanfare, which “clarifies” some things that may change how nonprofits operate.

Exemption for the first $10,000 of sales

Fundraising sales tend to be the biggest sales tax question in the nonprofit world. In Michigan, 501(c)(3), (4), and (19) have some leeway with fundraising sales. Those entities with total sales at retail of $25,000 or less can claim exemption from sales tax on the first $10,000 of sales. The exemption does not apply if the nonprofit already specifically collected the sales tax; all sales tax collected must be remitted. But if the nonprofit was going to do algebra to determine what amount of the gross price was sales tax versus sales price, they do not need to remit taxes on the first $10,000 as long as they keep total sales at retail below $25,000. Once $25,000 is met, all retail sales are taxable (subject to standard sales tax rules).

New developments – who carries the risk?

This RAB goes on to explain several nuances that may be different from how things have operated in the past. The RAB gives several examples where a nonprofit (a school in the example, but it could be any 501(c)(3), or (4)) purchases goods from a for-profit to sell for fundraising purposes. Whether or not these sales are considered sales at retail for the nonprofit or the for-profit is dependent on the entity bearing the risk. If the nonprofit simply takes orders on the front end (through the nonprofit itself or volunteers, including students) and then uses the orders to purchase the fundraising items from the for-profit, the nonprofit has no risk. In that case, the for-profit is the one making the sale because the for-profit is fulfilling the orders. Yes, the school pays the for-profit, but there is no risk to the nonprofit since they only ordered what they had sold. The for-profit must collect and remit the sales tax on the transaction; the nonprofit does not remit sales tax on the transaction.

If instead the nonprofit purchases the goods first, and after purchasing the goods enlists volunteers to sell them, now the nonprofit bears the risk that they may not sell all the items. The sale at retail is the nonprofit’s sale at retail; thus, the amounts are subject to sales tax collection and remittance by the nonprofit but could meet the nonprofit exemption described above. Similarly, suppose a nonprofit school operates their cafeteria themselves. In that case, meals sold to students are not taxable, but if the nonprofit outsources to a for-profit (who really makes the sales to the students), they are taxable.

What is not subject to exemption?

What is not subject to the exemption on the first $10,000 of sales at retail? If a 501(c)(19) sells tangible personal property that is not for the purpose of raising funds for the benefit of an active duty service member or a veteran, that is a taxable transaction for sales tax. However, fundraising by the 501(c)(19) that is for the benefit of the active duty or veterans would be subject to the exemption using the same rules as a 501(c)(3) or (4). In addition, non-fundraising retail sales (such as a gift shop at a nonprofit) are all taxable.

The RAB goes on to explain the tax base for retail sales as well. Just because the nonprofit paid sales tax on a purchase they made from the vendor does not cover their requirement for the nonprofit to charge sales tax on the sale. For example, if a nonprofit pays $10 for a t-shirt and sells it at $15, the nonprofit should not pay any sales tax when purchasing the t-shirt for $10 and should claim a resale exemption. Then the nonprofit would charge the final customer sales tax on the $15. If the nonprofit mistakenly paid tax on the $10 shirt, they still must remit on the $15 of sales and then request a refund on the $10 shirt.

Prepared food at events

Many fundraising events have prepared food. In determining the amount of sales tax required to be remitted, the nonprofit first must determine if the food is part of the fundraising event (not an optional payment and not separately stated) or if it is a separate deliverable (such as a cash bar that is optional to purchase.) If it is a separate deliverable, the nonprofit must remit sales tax on the sales and not simply pay sales tax when purchasing the food from the vendor. If the food is part of the fundraising event, there are two options. If they pay fair value to a vendor for the food, they can pay sales tax to the vendor and have the sales tax requirements complete; this only applies to prepared food sales at fundraising events. Otherwise, the taxable amount is the total fundraising event fee, unless the client can substantiate a lower fair value of the food (in which case the food’s fair value is the taxable amount). Note that in no case do they look at the cost of the food, but rather the fair value. If the event has a $25 admission fee and provides dinner with a fair value of $20, but the food was donated, $20 of the $25 is still subject to sales tax (the fair value).

Auctions and raffles

Auctions and raffles are other areas that can be confusing. If the entity is a 501(c)(3) or (4), then the taxable amount of the auction item is the lesser of the fair value or the proceeds received. However, other entities, including 501(c)(19) entities, must pay sales tax on the proceeds received, regardless of the fair value. The RAB also indicates raffle proceeds are not subject to sales tax, but if the nonprofit purchases a good to be raffled, the nonprofit owes use tax on that purchase. Donated items for the raffle have no use tax requirement (although for the auction, they have a sales tax requirement).

Sales tax license

Generally, nonprofit organizations making retail sales are required to obtain a sales tax license, even if they expect to meet the exemption. The RAB clarifies that a nonprofit entity that makes retail sales at two or fewer events in a calendar year does not have to obtain a sales tax license or register for use tax. Instead, the nonprofit may report and remit tax on Form 3421 Sales Tax Return for Special Events or Form 5089 Concessionaire’s Sales Tax Return.

Conclusion

Nonprofit sales tax has always been – and will always be – complex in the State of Michigan. However, this new RAB changes certain areas, especially fundraisers where the nonprofit does not have the risk, and prepared food sales where the nonprofit sells the food separately. Make sure your nonprofit is calculating sales tax correctly.

For more information, refer to the Treasury’s Revenue Administrative Bulletin 2020-25, Sales and Use Tax Treatment of Nonprofit Entities. Contact your Yeo & Yeo professional if you need assistance.

Management must formally adopt a budget to adhere to the law.

The legislative body must pass a budget for the general fund and each special revenue fund to comply with the Uniform Budget Manual issued by the Michigan Department of Treasury.

Treasury requires that specific requirements be reflected in local governments’ budgets. Although this may sound like a daunting task, adopting and monitoring the budget helps guide decision-making, all while meeting requirements set by the State. In this article, you will find how a budget can help your government and which approach may be best according to your needs.

Budgetary requirements of a local government

State the total mills to be levied and the purpose for each millage levied (truth in budgeting act).
Include amounts appropriated for expenditures and amounts to meet liabilities for the ensuing fiscal year in each fund.
Include estimated revenues by source in each fund for the ensuing fiscal year.
Be consistent with the Uniform Chart of Accounts issued by the State Treasurer (or by the Michigan Department of Education for school districts, intermediate school districts and public school academies).
The budgeted expenditures, including an accrued deficit, shall not exceed budgeted revenues, including available surplus and the proceeds from bonds or other obligations issued under the Fiscal Stabilization Act (Act 80 of 1981 MCL 141.1001).

The budget is sometimes viewed as tedious work when really it is management’s greatest tool.

The budget serves several vital functions for the government, such as a planning, control and communication, and it can also be a motivational tool.

More detailed benefits of proper budgeting procedures include:

A means of opening your eyes to the ongoing and future needs of the government
A control over frivolous spending and waste of government resources
A means to identify and project shortfalls in revenues
A tool to assist leadership in making sound decisions

Budget-to-actual activities should be shared with the finance or other committees regularly, and management must always have the most recent board-approved budget reflected in their financial reporting system. If the correct budget is not reflected in the financial reporting system, how can finance appropriately monitor activities within the budget? This can result in a deficiency in internal controls and noncompliance.

Which budgeting methodology is best for your local government?

Line item budget – identifies expenditures into groupings such as salaries, professional services, insurance, postage, etc. Preparation is simple, but this method makes it difficult to determine if goals are achieved or if programs are adequately funded.
Program budget – identifies expenditures by program accompanied by a narrative description of the services to be provided. Each program budget must detail line item amounts. Slightly more complex in nature, program budgets allow for the program itself to be evaluated.
Program performance budget – identifies the relationship between the dollars spent and units of service performed to determine a cost per unit. This approach is useful in measuring the success of a program but is typically avoided as difficulties arise in allocating unit costs appropriately. Like all the other budget approaches, line-item allocations of costs are necessary.
Management by objectives budget – identifies the specific programs or objectives to be accomplished during the budget year. This approach will allow management to establish target dates and costs for specific objectives and provide a means for the legislative body to measure the performance of the various departments and the management structure.
Zero-based budget – a method in which each department administrator must justify every dollar of their respective budget during each budget cycle.

When correctly approving and adhering to a sound budget, expect deviations from the respective budget. The budget is a benchmarking tool and will rarely equate to actual outcomes of the government’s ongoing activities. However, the legislative body must amend the budget as soon as a deviation is apparent to comply with Treasury guidelines. The budget should be dynamic and represent the financial needs and projections of the government at any point in time and should be amended not only at fiscal year-end.

Contact your Yeo & Yeo professional if you need assistance with your government entity’s budget process.

It’s been an interesting year, to say the least. School districts have been affected dramatically by the pandemic regarding virtual learning, safety protocols and funding. The 2020/2021 audit season is approaching quickly, and preparing for an audit year that had so many changes and uncertainties can be nerve-wracking. Below are some tips to help with your 2020/2021 audit preparation:

1. Identify your federal funds. New funding was pouring in during the year. Identifying for your auditor which revenues and expenses were federal will be essential. Preparing an accurate schedule of expenditures of federal awards (SEFA) will be more important than ever before. Some of these new funding sources may need to be tested for the single audit, so providing correct information up-front will result in the proper programs being tested. Also, if you are providing your auditor with a preliminary SEFA before year-end, correctly estimating expenditures through the end of the year will be very important as well.

2. Document changes in key controls. Many districts had periods during the year where administrative staff were working remotely. Perhaps procedures for your internal controls had to change as a result. Were invoices being approved electronically rather than via signature? Were individuals being paid even though they weren’t working their full FTEs? Documenting changes to your processes and controls in your main transaction cycles because of COVID-19 will be imperative for auditors to evaluate and assess your internal control structure during the audit.

3. Avoid double-dipping. With COVID-19 funding added on top of usual funding sources, a significant emphasis will be placed on verifying that expenditures were not “double-dipped” between grants. Some of the COVID-19 grants allowed for expenditures to be charged back from the 2019/2020 year. Auditors may be looking to verify that those expenditures weren’t first charged to one federal grant during 2019/2020 and then charged to a COVID-19 grant in 2020/2021. Make sure expenditures journaled to COVID-19 grants were not charged elsewhere and are clearly identified and supported.

4. Analyze Budgets. Budgeting hasn’t been easy. In many cases, school districts have had to create various scenarios for the budgets. Changing factors regarding virtual learning, funding cuts, new funding, allowable expenditures, and allowable periods for expenditures have made budgeting a constant concern. Be sure to evaluate the budget to actual results closely towards year-end. Districts will need to make the necessary amendments to keep from incurring expenditures in excess of budgets.

5. Prepare for GASB 84. School districts had the option in 2019/2020 to implement or delay the adoption of GASB 84. If you are one of those districts that delayed, implementation will need to occur in 2020/2021. Districts will be required to evaluate their fiduciary funds and determine whether student activity funds are now special revenue funds based on whether the district has administrative or direct involvement. Those deemed special revenue funds will be moved, and a new fund (Fund 29) must be set up on the district’s books. Don’t forget that this new fund also requires a budget.

Properly preparing for these items will result in a more successful audit in the upcoming year. Yeo & Yeo’s Education Services Group is here to help with questions or concerns you have about the audit or other matters.

For businesses, so much has changed over the past year or so. The COVID-19 pandemic hit suddenly and companies were forced to react quickly — sending many employees home to work remotely and making myriad other tweaks and revisions to their processes.

Understandably, you may not have fully documented all the changes you’ve made. But you should; and among the ideal places to do so is in your employee handbook. Now that optimism is rising for a return to relative normalcy, why not look at your handbook with fresh eyes and ensure it accurately represents your company’s policies and procedures.

Legal considerations

Among the primary reasons companies create employee handbooks is protection from legal challenges. Clearly written HR policies and procedures will strengthen your defense if an employee sues. Don’t wait to test this theory in court: Ask your attorney to review the legal soundness of your handbook and make all recommended changes.

Why is this so important? A supervisor without a legally sound and updated employee handbook is like a coach with an old rulebook. You can’t expect supervisors or team members to play by the rules if they don’t know whether and how those rules have changed.

Make sure employees sign a statement acknowledging that they’ve read and understood the latest version of your handbook. Obviously, this applies to new hires, but also ask current employees to sign a new statement when you make major revisions.

Motivational language

Employee handbooks can also communicate the total value of working for your company. Workers don’t always appreciate the benefits their employers provide. This is often because they, and maybe even some managers, aren’t fully aware of those offerings.

Your handbook should express that you care about employees’ welfare — a key point to reinforce given the events of the past year. It also should show precisely how you provide support.

To do so, identify and explain all employee benefits. Don’t stop with the obvious descriptions of health care and retirement plans. Describe your current paid sick time and paid leave policies, which have no doubt been transformed by federal COVID relief measures, as well as any work schedule flexibility and fringe benefits that you offer.

Originality and specificity

One word of caution: When updating their handbooks, some businesses acquire a “best in class” example from another employer and try to adopt it as their own. Doing so generally isn’t a good idea. That other handbook’s tone may be inappropriate or at least inconsistent with your industry or organizational culture.

Similarly, be careful about downloading handbook templates from the Internet. Chances are you’ll have no idea who wrote the original, let alone if it complies with current laws and regulations.

Document and guide

Your employee handbook should serve as a clearly written document for legal purposes and a helpful guide for your company’s workforce. Our firm can help you track your employment costs and develop solutions to any challenges you face.

Before the COVID-19 pandemic hit, the number of people engaged in the “gig” or sharing economy had been growing, according to several reports. And reductions in working hours during the pandemic have caused even more people to turn to gig work to make up lost income. There are tax consequences for the people who perform these jobs, which include providing car rides, delivering food, walking dogs and providing other services.

Bottom line: If you receive income from freelancing or from one of the online platforms offering goods and services, it’s generally taxable. That’s true even if the income comes from a side job and even if you don’t receive an income statement reporting the amount of money you made.

Basics for gig workers

The IRS considers gig workers as those who are independent contractors and conduct their jobs through online platforms. Examples include Uber, Lyft, Airbnb and DoorDash.

Unlike traditional employees, independent contractors don’t receive benefits associated with employment or employer-sponsored health insurance. They also aren’t covered by the minimum wage or other protections of federal laws and they aren’t part of states’ unemployment insurance systems. In addition, they’re on their own when it comes to retirement savings and taxes.

Pay taxes throughout the year

If you’re part of the gig or sharing economy, here are some tax considerations.

You may need to make quarterly estimated tax payments because your income isn’t subject to withholding. These payments are generally due on April 15, June 15, September 15 and January 15 of the following year. (If a due date falls on a Saturday or Sunday, the due date becomes the next business day.)
You should receive a Form 1099-NEC, Nonemployee Compensation, a Form 1099-K or other income statement from the online platform.
Some or all of your business expenses may be deductible on your tax return, subject to the normal tax limitations and rules. For example, if you provide rides with your own car, you may be able to deduct depreciation for wear and tear and deterioration of the vehicle. Be aware that if you rent a room in your main home or vacation home, the rules for deducting expenses can be complex.

Keeping records

It’s important to keep good records tracking income and expenses in case you are audited by the IRS or state tax authorities. Contact us if you have questions about your tax obligations as a gig worker or the deductions you can claim. You don’t want to get an unwanted surprise when you file your tax return.

President Biden recently announced his $1.8 trillion American Families Plan (AFP), the third step in his Build Back Better policy initiative. The announcement followed the previous releases of the proposed $2.3 trillion American Jobs Plan and the Made in America Tax Plan. These plans propose major investments in various domestic initiatives, such as expanded tax credits for families, offset with tax increases on high-income individual taxpayers and corporations.

Proposed tax changes for the wealthy

The AFP would reverse many of the provisions in 2017’s Tax Cuts and Jobs Act and other parts of the tax code that benefit higher-income taxpayers. These taxpayers could be hit by changes to the following:

Individual tax rates. The plan proposes to return the tax rate for the top income bracket to Obama administration levels, going from the current 37% to 39.6%. It’s not clear whether the income tax brackets will be adjusted. For 2021, the top tax rate begins at $523,601 for single taxpayers and $628,301 for married taxpayers filing jointly.

Capital gains and qualified dividend income. For those with income of more than $1 million in a tax year, the AFP would tax long-term capital gains and qualified dividend income as ordinary income — in other words, at 39.6%. Long-term capital gains currently are taxed at a maximum rate of 20% (effectively 23.8%, when combined with the net investment income tax), depending on taxable income and filing status.

Net investment income tax (NIIT). This tax applies to net investment income to the extent that a taxpayer’s modified adjusted gross income (MAGI) exceeds $200,000 for single tax filers, $250,000 for joint filers and $125,000 for married taxpayers filing separately. If a taxpayer meets the applicable MAGI threshold and has net investment income, the amount of NIIT liability is 3.8% of the lesser of 1) the amount by which the MAGI exceeds the threshold or 2) the net investment income.

The AFP proposes to broaden the NIIT by applying it to all types of income greater than $400,000, rather than only investment income. On top of the hike in capital gains, these taxpayers would face a tax of 43.4% at the federal level. With state and local capital gains taxes, high-income individuals could face an overall capital gains tax rate that tops 50%.

Stepped-up basis. Under existing law, the income tax basis of an inherited asset is the asset’s fair market value at the time of the deceased’s death, not the deceased’s original cost for it. This is referred to as “stepped-up basis.” As a result of this rule, the gain on appreciated assets isn’t subject to taxation if the heir disposes of the assets at death.

To reduce the incentive to hold appreciated assets until after death — rather than subjecting them to capital gains taxes — the AFP imposes limits on stepped-up basis. Specifically, it ends the practice for gains that exceed $1 million, or $2.5 million per couple when combined with existing real estate exemptions. The Biden administration has indicated that it would carve out exceptions for property donated to charities and family-owned businesses and farms.

Carried interest. A “carried interest” is a hedge fund manager’s contractual right to a share of a partnership’s profits. Currently, it’s taxable at the capital gains rate if certain conditions are satisfied. The Biden administration would tax carried interests at ordinary tax rates.

Like-kind exchanges. Also known as Section 1031 exchanges, like-kind exchanges allow a taxpayer to defer the recognition of a gain on the exchange of real property held for use in a business or for investment if the property is exchanged solely for similar property. The AFP would end such deferrals for gains of more than $500,000.

Tax relief for individuals and families

While the AFP would increase the tax liability of high-net-worth individuals, it’s also designed to help those less well off. It would do so through a variety of tools, including the following:

Child Tax Credit (CTC). The American Rescue Plan Act (ARPA), passed in March 2021, temporarily increased the CTC from $2,000 to $3,000 for eligible taxpayers for each child age six through 17, with credits of $3,600 for each child under age six. It also makes the credit fully refundable in most cases.

The current $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers, and it’s generally refundable up to $1,400 per qualifying child. The ARPA continues the typical phaseout treatment for the first $2,000 of the credit in 2021 but applies a separate phaseout for the increased amount — $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers. Under the ARPA, the U.S. Treasury Department will make monthly advance payments for the CTC beginning in July and running through December 2021, based on taxpayers’ most recently filed tax returns.

The AFP would extend these CTC increases through 2025 and make the credit fully refundable on a permanent basis. The proposed extension would include the regular advance payments from the U.S. Treasury Department.

Child and dependent care tax credit. The ARPA expands this credit for 2021. Taxpayers can claim a refundable 50% credit for up to $8,000 in care expenses for one child or dependent and up to $16,000 in expenses for two or more children or dependents — making the credit ultimately worth up to $4,000 or $8,000. It begins phasing out when household income levels exceed $125,000; for households with income over $400,000, the credit can be reduced below 20%.

The AFP would leave this increase in place permanently. Families with an income between $125,000 and $400,000 would receive a partial credit.

Health insurance tax credit. The ARPA also increases the availability and the amount of premium tax credits (PTCs) under the Affordable Care Act (sometimes referred to as ACA subsidies or cost-sharing), retroactive to January 1, 2021. It extends PTCs to anyone who receives, or was approved to receive, unemployment benefits in 2021. It also limits the amount that anyone who obtains insurance through the federal or state marketplaces must pay for premiums to 8.5% of their MAGI — regardless of their income. The AFP would make this expansion permanent.

Corporate tax proposals

In addition to the individual tax proposals, the Biden administration has proposed a swath of changes in the taxation of businesses. For example, the AFP would make permanent the limit on excess business loss deductions.

The Made in America Tax Plan contains many more provisions relevant to businesses. Among other things, it proposes to raise the corporate tax rate to 28%, the midpoint between the 21% rate enacted during the Trump administration and the Obama administration level of 35%. The plan also proposes several changes to international taxation rules, including raising the tax rate on global intangible low-taxed income to 21%.

The Made in America Tax Plan would also impose a 15% minimum tax on book income (as opposed to the income reported on corporate tax returns) on large companies that report high profits with little or no taxable income. Note, too, that Treasury Secretary Janet Yellen has stated that the United States is working with other countries to set a global minimum tax rate.

The American Jobs Plan, on the other hand, provides several tax incentives and other support for businesses. For example, it would provide $52 billion to promote domestic manufacturing and $31 billion for small business programs to expand access to credit, venture capital, and research and development funding. It proposes targeted credits related to clean energy generation and storage and expanding the Section 45Q carbon credit. And it would provide an expanded credit for employers that provide workplace childcare facilities.

IRS-related proposals

In a recent study, the IRS found that the top 1% of individual taxpayers failed to report 20% of their income and failed to pay nearly $175 billion in taxes owed annually. The Biden administration proposes providing the IRS with the resources and information it needs to address the “tax gap” (that is, the difference between the tax owed by taxpayers and the amount that’s actually paid on time).

The AFP calls for a significant boost in the funding of IRS tax enforcement — $80 billion over 10 years, which, on an annual basis, nearly doubles the agency’s 2021 enforcement budget. The closer scrutiny would focus on large corporations, partnerships and wealthy individuals. It also would require financial institutions to report information on balances and account flows to better track earnings from investment and business activities. The Biden administration has stated that the enforcement efforts won’t target households with less than $400,000 in annual income.

The path forward

The Biden administration and the slim Democratic majority in Congress have already demonstrated with the ARPA their willingness to use the budget reconciliation process to pass fiscal policy legislation on a majority basis in the U.S. Senate. That approach, however, requires unanimous Democratic support.

Moderate Democrats in Congress could demand the trimming of certain proposals regarding tax increases or reject them altogether (for example, the higher taxes on investment income and changes to the step-up in basis). We’ll keep you up to date on the provisions that survive and any that might be added during negotiations, such as an elimination of the limit on the state and local tax deduction.

Many businesses use independent contractors to help keep their costs down. If you’re among them, make sure that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be a costly error.

It can be complex to determine whether a worker is an independent contractor or an employee for federal income and employment tax purposes. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.

On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).

What are the factors the IRS considers?

Who is an “employee?” Unfortunately, there’s no uniform definition of the term.

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.

Note: Section 530 doesn’t apply to certain types of workers.

Should you ask the IRS to decide?

Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.

It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.

If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.

“Tax day” is just around the corner. This year, the deadline for filing 2020 individual tax returns is Monday, May 17, 2021. The IRS postponed the usual April 15 due date due to the COVID-19 pandemic. If you still aren’t ready to file your return, you should request a tax-filing extension. Anyone can request one and in some special situations, people can receive more time without even asking.

Taxpayers can receive more time to file by submitting a request for an automatic extension on IRS Form 4868. This will extend the filing deadline until October 15, 2021. But be aware that an extension of time to file your return doesn’t grant you an extension of time to pay your taxes. You need to estimate and pay any taxes owed by your regular deadline to help avoid possible penalties. In other words, your 2020 tax payments are still due by May 17.

Located in a combat zone

Military service members and eligible support personnel who are serving in a combat zone have at least 180 days after they leave the combat zone to file their tax returns and pay any tax due. This includes taxpayers serving in Iraq, Afghanistan and other combat zones.

These extensions also give affected taxpayers in a combat zone more time for a variety of other tax-related actions, including contributing to an IRA. Various circumstances affect the exact length of time available to taxpayers.

Outside the United States

If you’re a U.S. citizen or resident alien who lives or works outside the U.S. (or Puerto Rico), you have until June 15, 2021, to file your 2020 tax return and pay any tax due.

The special June 15 deadline also applies to members of the military on duty outside the U.S. and Puerto Rico who don’t qualify for the longer combat zone extension described above.

While taxpayers who are abroad get more time to pay, interest applies to any payment received after this year’s May 17 deadline. It’s currently charged at the rate of 3% per year, compounded daily.

We can help

If you need an appointment to get your tax return prepared, contact us. We can also answer any questions you may have about filing an extension.

Many companies are continuing to struggle financially during the COVID-19 pandemic. If cash is tight, what can your business do to shorten its cash cycle? The answer could lie in your outstanding accounts receivable. Here are five strategies to help convert receivables into cash ASAP.

1. Apply for a line of credit. A line of credit can help bridge the “cash gap” between making a sale and getting paid. Often credit lines are collateralized by unpaid invoices, just like equipment and property are pledged for conventional term loans. Banks typically charge fees and interest for securitized receivables.

Each financial institution sets its own rates and conditions. Typically, these arrangements provide immediate loans for up to 90% of the value of an outstanding debt and are repaid as customers pay their bills.

2. Encourage early payment. Your company may be able to expedite collections if customers are given a financial incentive to pay their bills early. For example, you might give a 3% discount to customers who pay with 14 days of receiving their invoices. Online and autopayment options often work in tandem with these discounts.

3. Consider factoring. This option allows companies to monetize their unpaid — but not yet delinquent — receivables. Here, receivables are sold to a third-party factoring company for immediate cash.

Costs associated with receivables factoring can be much higher than those for collateral-based loans. And factoring companies are likely to scrutinize the creditworthiness of your customers. But selling receivables for upfront cash may be advantageous, especially for smaller businesses, because it reduces the burden on accounting staff and saves time.

4. Renegotiate with customers. Before you write off stale receivables that are more than 90 days outstanding, call the customer and ask what’s going on. Sometimes you might be able to negotiate a lower amount or installment payments — which might be better than a write-off if your customer is facing bankruptcy.

5. Focus on collections. Some small companies haven’t historically needed to dedicate specific resources to collections, because customers have generally paid in a timely matter. However, if significant collection issues have built up during the pandemic, it may be time to pick a customer service rep to be in charge of making collections calls. For more serious issues, you might prefer hiring a seasoned, in-house collections professional or reaching out to an external commission-based collection agency.

If slow-to-pay customers are adversely affecting your company’s cash flow, contact us. We’ve helped many businesses implement creative solutions to convert receivables into fast cash.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that A.J. Licht, CPA, has earned the Certified Construction Industry Financial Professional (CCIFP) credential. Licht joins an exclusive group of 1,150 professionals nationwide who have met the Institute of Certified Construction Industry Financial Professionals’ rigorous standards in the practice of construction financial management.

“I have devoted much of my career to serving clients in the construction industry,” Licht said. “The CCIFP credential formally recognizes my expertise in construction accounting and further equips me to help my clients strengthen their financial position and achieve their business goals.”

The CCIFP designation raises the standards for construction financial professionals by giving special recognition to those who demonstrate skill and proficiency in their field. To attain the certification, an applicant must serve in a professional financial role for a construction contractor or an accounting and/or financial service provider to the industry and pass a comprehensive exam. The CCIFP exam covers accounting and reporting, income recognition, budgeting and planning, risk management, taxes, human resources, legal issues and information technology. In addition, certified professionals must complete continuing education requirements.

Licht is a senior manager and leader of the firm’s Construction Services Group. He is a member of the Associated Builders & Contractors Greater Michigan Chapter, the Home Builders Association of Saginaw, and the Construction Industry CPAs/Consultants Association. In addition to his work at Yeo & Yeo, Licht is a member of the Saginaw Valley Young Professionals Network and the Saginaw Valley State University Stevens Center for Family Business.

During the pandemic, many employees have postponed using their allotted paid time off until COVID-related restrictions are lifted and safety concerns subside. This situation has caused an increase in accruals for certain employers. Here’s some guidance to help evaluate whether your company is required to report a liability for so-called “compensated absences” and, if so, how to estimate the proper amount.

Balance sheet effects

Compensated absences include:

Paid vacation,
Paid holidays,
Paid sick leave, and
Other forms of time off earned by employment.

Accruals for compensated absences are classified as other liabilities on companies’ balance sheets. The liability also creates a deferred tax asset equal to the accrual times the effective tax rate, because companies can’t deduct paid time off until it’s actually paid under U.S. tax law.

When to book an accrual

Before quantifying the compensated absences liability, review your company’s policies and procedures related to paid time off. Does your company allow employees to accumulate unused paid time off, beyond year end, for use in future years? Does the company provide vesting rights to accumulated paid time off balances that require payout after employment is terminated? If you answered “yes” to either question, you may be required to record a compensated absences accrual.

Specifically, under U.S. Generally Accepted Accounting Principles (GAAP), employers should accrue a liability for an employee’s right to receive compensation for a future absence if these four conditions are met:

The employee has earned the right to time off, but they’ve not taken that time off.
The employee’s rights accumulate or vest.
It’s probable that employees will exercise their rights to paid time off, triggering payment.
The employer can reasonably estimate the amount of benefits the employee will receive.

You also must consider applicable laws in the states and countries where your employees live. In some cases, these laws may supersede your company’s policies and practices.

Calculating the accrual

For an employee who’s paid hourly, the compensated absences liability equals the hourly pay rate times the number of hours per day times accumulated days off. The hourly rate includes benefits and employer taxes your company will incur while the employee isn’t at work.

The calculation for a salaried employee involves dividing annual compensation (including benefits and employer taxes) by the number of days worked per year to arrive at the employee’s daily pay rate. This amount is then multiplied by the accumulated days off.

You must also adjust the accrual for the probability that employees will fail to exercise their rights to accumulated time off. Often employers support this adjustment with historical data on how employees have behaved in the past.

Hidden costs

Mounting paid time off accruals have brought accounting issues related to compensated absences to the forefront. While companies don’t want to report higher liabilities, there’s also an intangible cost to consider: When employees forego time off, their well-being often suffers, which can lead to lower productivity and increased turnover. We can help you comply with the financial reporting requirements under GAAP, as well as brainstorm ways to remind employees about the importance of maintaining a healthy work-life balance.

Many businesses provide education fringe benefits so their employees can improve their skills and gain additional knowledge. An employee can receive, on a tax-free basis, up to $5,250 each year from his or her employer for educational assistance under a “qualified educational assistance program.”

For this purpose, “education” means any form of instruction or training that improves or develops an individual’s capabilities. It doesn’t matter if it’s job-related or part of a degree program. This includes employer-provided education assistance for graduate-level courses, including those normally taken by an individual pursuing a program leading to a business, medical, law or other advanced academic or professional degree.

Additional requirements

The educational assistance must be provided under a separate written plan that’s publicized to your employees, and must meet a number of conditions, including nondiscrimination requirements. In other words, it can’t discriminate in favor of highly compensated employees. In addition, not more than 5% of the amounts paid or incurred by the employer for educational assistance during the year may be provided for individuals who (including their spouses or dependents) who own 5% or more of the business.

No deduction or credit can be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.

Job-related education

If you pay more than $5,250 for educational benefits for an employee during the year, he or she must generally pay tax on the amount over $5,250. Your business should include the amount in income in the employee’s wages. However, in addition to, or instead of applying, the $5,250 exclusion, an employer can satisfy an employee’s educational expenses, on a nontaxable basis, if the educational assistance is job-related. To qualify as job-related, the educational assistance must:

Maintain or improve skills required for the employee’s then-current job, or
Comply with certain express employer-imposed conditions for continued employment.

“Job-related” employer educational assistance isn’t subject to a dollar limit. To be job-related, the education can’t qualify the employee to meet the minimum educational requirements for qualification in his or her employment or other trade or business.

Educational assistance meeting the above “job-related” rules is excludable from an employee’s income as a working condition fringe benefit.

Student loans

In addition to education assistance, some employers offer student loan repayment assistance as a recruitment and retention tool. Recent COVID-19 relief laws may provide your employees with tax-free benefits. Contact us to learn more about setting up an education assistance or student loan repayment plan at your business.

President Biden’s proposals for individual taxpayers were outlined in an April 28 address to Congress and in an 18-page fact sheet released by the White House. The “American Families Plan” contains tax breaks for low- and middle-income taxpayers and tax increases on those “making over $400,000 per year.”

Here’s a summary of some of the proposals.

Extended tax breaks

Extend the Child Tax Credit (CTC) increases in the American Rescue Plan Act (ARPA) through 2025 and make the credit permanently fully refundable. The ARPA made several changes to the CTC for 2021. For example, it expanded the credit for eligible taxpayers from $2,000 to $3,000 per child ages six and above, and $3,600 per child under age six. It also made 17-year-olds eligible to be qualifying children for the first time and made the credit fully refundable. It also provides for monthly advance payments of the credit that will be paid from July through December 2021.

The American Families Plan would make permanent the full refundability of the CTC, while extending the other expansions of it through 2025. “The credit would also be delivered regularly,” the fact sheet states, meaning that monthly payments would continue to families rather than waiting until tax season to claim the credit.

Permanently increase the Child and Dependent Care Credit. The ARPA increased the amount of the credit for many taxpayers and made it refundable. The American Families Plan would make these changes permanent.

Extend expanded Affordable Care Act tax credits for premiums. The ARPA expanded the premium credit that’s available to many people enrolled in an exchange-purchased qualified health plan, which in effect, lowers plan premiums for them. This expansion applies to 2021 and 2022. The American Families Plan would make the premium reductions permanent.

Make the Earned Income Tax Credit (EITC) expansion for childless workers permanent. The ARPA made changes that roughly tripled the EITC for childless workers for 2021. The American Families Plan would make the changes permanent.

Tax increases

Increase the top tax rate to 39.6%. The proposed plan would restore the top tax bracket to what it was before the 2017 Tax Cuts and Jobs Act, returning it to 39.6% from 37%. This would apply to taxpayers in the top 1%.

Increase the capital gains tax for “households making over $1 million.” They would pay the same 39.6% rate on all income, rather than the current maximum 20% tax rate on long-term capital gains. (Short-term capital gains from investments held less than one year currently are taxed at the top individual tax rate of 37%.)

Reduce the “step-up in basis” at death for some taxpayers. The proposed plan would end the practice of stepping up the basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions) at death and would tax the gains if the property isn’t donated to charity. The fact sheet states that this “will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.”

Revise the taxation of carried interest. The proposed plan would close the carried interest loophole so that hedge fund partners will pay ordinary income rates on their income.

Cut back the rule for like-kind exchanges. President Biden would like to eliminate the Section 1031 like-kind exchange rule with respect to gains greater than $500,000 on real estate exchanges.

Make the excess business loss rules permanent. Under the tax code, for noncorporate taxpayers in tax years beginning after December 31, 2020, and before January 1, 2026, any “excess business loss” of a taxpayer for the tax year is disallowed. The American Families Plan would make this rule permanent.

Close loopholes in the 3.8% net investment income tax. Certain unearned income of high-income individuals, estates and trusts is subject to a surtax of 3.8%. The fact sheet states that the application of this provision is “inconsistent across taxpayers due to holes in the law” and proposes to “apply the taxes consistently to those making over $400,000.”

A challenging road ahead

These are only some of the proposals in the American Families Plan. Keep in mind that for any of these proposals to become reality, President Biden’s plan would have to be approved by Congress and that will be challenging. No matter what lies ahead, we can help you implement planning strategies to keep your tax bill as low as possible.

In a society increasingly conscious of well-being, with the costs of health care benefits remaining high, many businesses have established or are considering employee wellness programs. The Centers for Disease Control and Prevention (CDC) has defined these programs as “a health promotion activity or organization-wide policy designed to support healthy behaviors and improve health outcomes while at work.”

Yet there’s a wide variety of ways to design and operate a wellness program. How can you ensure yours fulfills objectives such as reducing absenteeism and controlling benefits costs? Build it on a solid foundation.

Pandemic changes

Clearly, many business owners believe in wellness programs. Well before the COVID-19 pandemic, a 2017 study of 3,000 worksites by the CDC and researchers at the University of North Carolina found that almost 50% of those employers offered some type of health promotion or wellness program.

Since the pandemic hit, the focus of many wellness programs has begun to shift away from physical health to overall well-being. This means helping employees with improving their mental health, managing their finances and adjusting to remote work. (Some research has found that wellness programs don’t significantly improve short-term physical health or medical outcomes.)

Total leadership commitment

Whether it’s an existing wellness program or one you’re just starting, ask yourself a fundamental question: Who will champion our program? The answer should be: leaders at every level.

If a business takes a “top down” approach to wellness — that is, it’s essentially mandated for everyone by ownership — the program will likely struggle. Likewise, if a single middle manager or ambitious employee tries to lead the effort alone, while the rest of management looks on lackadaisically, the effort probably won’t meet its objectives.

Successful wellness programs are driven by total management buy-in — from the C-suite to middle management to leaders in every department.

Cultural alignment

A wellness program needs to be a natural and appropriate extension of your company’s existing culture. If it feels forced or “tone deaf,” employees may ignore the program or reflexively push back against it rather than approach it enthusiastically or simply with an open mind.

For example, if your business culture tends to be low-key and you engage a wellness vendor (such as a speaker) who shows up with a loud, flamboyant presentation, your staff may not appreciate what you’re trying to accomplish. Your wellness program’s materials and content should match the tenor and feel of your existing internal communications.

Ultimately, look to establish a “culture of wellness” at your company. For businesses that have never emphasized (or perhaps even discussed) healthy habits and lifestyles, doing so can present a great challenge. Be patient and persistent, bearing in mind that a cultural shift of this nature takes time.

Risks vs. benefits

These are just some of the foundational elements of an employee wellness program to bear in mind. We can help you estimate the costs and assess the risks vs. benefits of establishing or revising such a program.

The May 17 deadline for filing your 2020 individual tax return is coming up soon. It’s important to file and pay your tax return on time to avoid penalties imposed by the IRS. Here are the basic rules.

Failure to pay

Separate penalties apply for failing to pay and failing to file. The failure-to-pay penalty is 1/2% for each month (or partial month) the payment is late. For example, if payment is due May 17 and is made June 22, the penalty is 1% (1/2% 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 through 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.

For example, if your payment is two months late and your return shows that you owe $5,000, the penalty is 1%, which equals $50. If you’re audited and your tax bill increases by another $1,000, the failure-to-pay penalty isn’t increased because it’s based on the amount shown on the return as due.

Failure to file

The failure-to-file penalty runs at a more severe rate of 5% per month (or partial month) of lateness to a maximum of 25%. If you obtain an extension to file (until October 15), you’re not filing late unless you miss the extended due date. However, a filing extension doesn’t apply to your responsibility for payment.

If the 1/2% 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 total combined penalty is 5%. The maximum combined penalty for the first five months is 25%. After that, the failure-to-pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties could reach 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. So 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 tax liability is later determined to be an additional $1,000, the failure to file penalty (4.5% × 3 = 13.5%) would also apply for an additional $135 in penalties.

A minimum failure to file penalty will also apply if you file your return more than 60 days late. This minimum penalty is the lesser of $210 or the tax amount required to be shown on the return.

Reasonable cause

Both penalties may be excused by IRS if lateness is due to “reasonable cause.” Typical qualifying excuses include death or serious illness in the immediate family and postal irregularities.

As you can see, filing and paying late can get expensive. Furthermore, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can reach 15% per month, with a 75% maximum. Contact us if you have questions or need an appointment to prepare your return.

Are you wondering whether alternative energy technologies can help you manage energy costs in your business? If so, there’s a valuable federal income tax benefit (the business energy credit) that applies to the acquisition of many types of alternative energy property.

The credit is intended primarily for business users of alternative energy (other energy tax breaks apply if you use alternative energy in your home or produce energy for sale).

Eligible property

The business energy credit equals 30% of the basis of the following:

Equipment, the construction of which begins before 2024, that uses solar energy to generate electricity for heating and cooling structures, for hot water, or heat used in industrial or commercial processes (except for swimming pools). If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in calendar year 2023; and, unless the property is placed in service before 2026, the credit rate is 10%.
Equipment, the construction of which begins before 2024, using solar energy to illuminate a structure’s inside using fiber-optic distributed sunlight. If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%.
Certain fuel-cell property the construction of which begins before 2024. If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%.
Certain small wind energy property the construction of which begins before 2024. If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%.
Certain waste energy property, the construction of which begins before January 1, 2024. If construction began in 2020, the credit rate is 26%, reduced to 22% for construction beginning in 2023; and, unless the property is placed in service before 2026, the credit rate is 0%.
Certain offshore wind facilities with construction beginning before 2026. There’s no phase-out of this property.

The credit equals 10% of the basis of the following:

Certain equipment used to produce, distribute, or use energy derived from a geothermal deposit.
Certain cogeneration property with construction beginning before 2024.
Certain microturbine property with construction beginning before 2024.
Certain equipment, with construction beginning before 2024, that uses the ground or ground water to heat or cool a structure.

Pluses and minuses

However, there are several restrictions. For example, the credit isn’t available for property acquired with certain non-recourse financing. Additionally, if the credit is allowable for property, the “basis” is reduced by 50% of the allowable credit.

On the other hand, a favorable aspect is that, for the same property, the credit can sometimes be used in combination with other benefits — for example, federal income tax expensing, state tax credits or utility rebates.

There are business considerations unrelated to the tax and non-tax benefits that may influence your decision to use alternative energy. And even if you choose to use it, you might do so without owning the equipment, which would mean forgoing the business energy credit.

As you can see, there are many issues to consider. We can help you address these alternative energy considerations.

Yesterday, Governor Whitmer formally extended the city income tax filing and payment deadline to May 17, 2021, to align with state and federal filing deadlines.

Like the state and federal filings, taxpayers who have yet to file their city returns will not be subject to interest and penalties during the extension period.

The extended filing and payment due date is automatic. Taxpayers do not need to file any additional forms or contact their city to qualify.

Visit Yeo & Yeo’s Tax Resource Center for useful links, tax guides, tax articles on our blog, webinars, podcasts and more. Please contact your Yeo & Yeo tax professional with questions or concerns.

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

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

Identify assets and liabilities

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

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

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

Determine the price

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

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

Allocate fair value

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

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

Make accounting a forethought, not an afterthought

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