Month: June 2016

How to Choose the Right Accountants

Tips for choosing an accountant for your business or family

Businessman showing a superhero suit underneath dollar symbolLet’s face it, to be called a certified public accountant (CPA) one must have a certain educational background as well as proven knowledge (i.e., by passing a rigorous exam). We believe CPAs have the business acumen that allows them to prepare basic financial reports and tax returns. You may also expect your CPA to fill the role of business consultant to help you achieve certain business and personal results.

How do you know if a CPA is right for you?

You can start by asking the following questions:

  1. How many years of (corporate, partnership, individual, estate) tax experience do you have?
  2. If I use you/your firm, who will prepare my tax returns? Who will be working on my account?
  3. Do you hold any advanced degrees? What associations are you a member of?
  4. What if I am audited? Will you represent me? What are the additional costs?
  5. Will you review prior years tax returns at no additional charge?
  6. Do you have expertise in my industry or with a specific issue relevant to my facts and circumstances (i.e. stock options, government contracts, tax credits, etc.)?
  7. How do you bill for your services/what will you charge?
  8. What if I need accounting or bookkeeping help? Do you offer these services?
  9. What if I need a loan or credit line? How can you help me?
  10. If I decide to use you, what should I expect?

These basic questions should spark conversation that will not only provide you with the assurance that the CPA is qualified, but it should also provide insight as to how the CPA can help your business or family. This conversation should allow you to evaluate how the CPA can educate you and how the CPA will collaborate with you to help you achieve your goals. The CPA should be focused on understanding your needs and clearly communicating how his or her skills and expertise will help meet those needs.

Most CPAs will tell you they meet many of their new clients through referrals from existing clients or from other professional service providers such as attorneys, bankers and investment advisors. Other business owners, family and friends are also good sources to seek out for accountant recommendations. If you are unlucky finding a CPA through referral, you can try your state’s CPA society as it will likely have a directory of its members. You can also check the CPA firm’s website and partner profiles for services offered, industries served and other specific expertise.

All CPAs are NOT all the same

The industries CPAs specialize in and the services they offer will vary according to firm size and partner/staff expertise. At KRS, for example, we provide full-service accounting, tax planning and preparation, business office processing and business valuation services to businesses. We also offer family office services, individual tax planning and preparation, and estate accounting and tax preparation to our individual clients.

If you have questions about choosing the right accountant for your family or business, I’d be happy to help. Contact me at [email protected] or 201.655.7411.

Accounting Methods for Construction Contractors

 

For construction contractors, there are more options for accounting methods than those available to other business taxpayers due to the unique nature of construction activities and the inherent imprecision that can arise in measuring profit at different points in time during a construction contract. The IRS provides several steps for construction contractors to follow when determining which accounting method is appropriate.

Concept of construction and design.Cash method – under the cash method, revenues and expenses are recognized based upon receipt and disbursement of funds. Contractors are generally eligible for the cash method of accounting, if they have $10 million or less in gross receipts annually for each of the past three years.

Accrual method – under the accrual method, revenue is generally recognized when all the events have occurred that fix the right to receive the income, and the amount of the income can be determined with reasonable accuracy (i.e., as billing invoices are issued). Expenses are deductible when all events have occurred that establish the fact of the liability, the amount can be determined with reasonable accuracy, and economic performance has occurred.

Completed-contract method (CCM) – under the completed contract method, no profit is recognized on a construction contract until completion of the contract.

Although the completed-contract method allows you to defer taxes on your income, it prevents you from deducting losses on unprofitable jobs until the contract ends. It can also push taxpayers into higher tax brackets by bunching income into a single year.

Percentage of completion method (PCM) – the percentage of completion method is a variation of the accrual method, where revenue recognition is measured not by a reference to billing but rather by applying an estimate of relative completion of a contract to the overall contract value. To determine how much income to report for each contract, calculate your project completion factor by dividing deductible project costs for that year by the total estimated cost to complete the project. For example, if you spent $100,000 on a project that will cost $1 million to complete, your project is 10% complete. Multiply that 10% factor by the contract’s total value to determine how much income to report.

Choosing the right accounting method

The choice of accounting method can have an important impact on tax-related disbursements. Effective tax planning relies heavily on the concept of deferring the payment of tax. Construction contractors and their advisors need to consider the optimal method under their specific circumstances provide the greatest benefit.

If you have questions about the accounting method you should be using for your construction firm, contact me at [email protected] or 201.655.7411.

Valuation Considerations in Selling a Business

 

The most important tool in helping evaluate cash flow and risk is good accounting records. If the business has five or more years of good accounting records, the buyer’s perception of risk is reduced, because the records will tell the story of the company’s cash flow, and make it easier to project future cash flow.

Price and Value balance conceptIt is unlikely that any single action will result in a significant increase in cash flow, but the here are some areas where improvement may be achieved:

Expense Reductions – Review your financial statements line by line. Can the company operate with less payroll?  Fewer vehicles?  Can you reduce your space and related rent expense?

Have employee contributions to health insurance costs kept up with rising premiums?  I once assisted with a business sale in which the owner’s mantra was “find an expense reduction or become one.”  Every dollar that is added to the bottom line may increase the value of the business.

Revenue Increases – Can the customer base be expanded?   How will the company’s market share be affected by a price increase?  What about a price decrease?  Can the company take on new product lines?

Accounts Receivable – Can customer payments be accelerated? Money that is not in accounts receivable will be in your bank account, available for the business to use.  For example, a business that has $10 million of annual sales will gain approximately $385,000 of cash by reducing its average collection period by 14 days.

Inventory – Are you carrying obsolete or slow moving inventory? If so, it should be sold at a discount to reduce inventory and raise cash.  This step is also necessary so that prospective buyers of the business will have an accurate picture of normal inventory levels.

Common risk factors

Although different businesses may have different risks factors, some risks are common to all businesses. In evaluation of risk, we identify factors that may cause cash flow to not be received in the amounts expected and when expected. Following are some risks common to many businesses:

Customer Concentration – Is the business dependent on sales to one or a few customers? What would happen if one or more of those customers were lost?

Supplier Concentration – Are business operations dependent upon one supplier? If that supplier ceased to exist, could it be replaced?

Key Employees – Do the key employees have employment agreements and/or non-compete agreements? If not, and they went to work for a competitor, would the business suffer?

Obsolescence – Are your products or the processes used to produce your products approaching obsolescence, or are you updating your products and processes to stay competitive?

To understand the value of the business and how to increase it, a business owner considering selling should have the business valued. This will help him understand the factors that drive the value of the business.  If this is done long before the contemplated sale, this will give the owner and management team more time to make the changes necessary to increase the value of the business.

For more about business valuation, read the posts, “Why You Need a Business Valuation,” and “Goodwill and Your Business.” Also visit the KRS Business Valuation and Litigation Support page.

Who’s Really in Control of Your Internal Controls?

As a small business grows beyond its owner or owners, a system of internal controls becomes necessary. We would all like to believe that our business assets are safe from unscrupulous employees and that the financial information we use to make critical business decisions is free from errors and omissions. However, without a system of internal controls, there is little possibility that even the most innocent error or omission will be detected.

Vote equalityInternal controls are the checks and balances that are in place to at least provide a fighting chance that errors, omissions, duplications and misappropriations will be detected and avoided. They can apply to many different aspects of the business.

For example a business can have internal controls over financial processes, IT applications and systems, as well as over human resources. My focus is on accounting and financial internal controls that a small business can put into place immediately without breaking the bank.

The 10 internal controls you need

Ten internal control procedures businesses of all sizes can immediately put into place:

  1. Separate the check writing and check signing responsibilities among two or more individuals. If using online bill pay, keep account passwords secure and only with those authorized to make the online payment.
  2. Have a person who is independent from the check writing or accounts receivable responsibilities open the mail. When opening mail, immediately endorse and stamp checks “for deposit only” and list checks on a log before turning them over to the person responsible for depositing receipts. Periodically reconcile the incoming check log against deposits. Small offices can have the business owner open all mail and populate the check log.
  3. Require paychecks to be distributed by a person other than the one authorizing or recording payroll transactions or preparing payroll checks. Have employees sign for their paycheck and periodically inspect signatures against employee files. Many fictitious employee schemes have been found through “surprise” in person paycheck distributions.
  4. Reconcile bank accounts monthly. Ideally these reconciliations should be done by an independent person who doesn’t have bookkeeping responsibilities or check signing responsibilities. If you don’t have the personnel to segregate these duties, make sure the reconciliation is adequately reviewed by another person or by the organization’s independent CPA.
  5. As part of the reconciliation process, periodically examine cancelled checks to ensure that checks are in sequence, payees are recognized, endorsements are appropriate and signatures are valid.
  6. Set account limits on company credit card use and require employees to submit original receipts for all purchases. Examine credit card statements and receipts each month to ensure charges are business related and authorized.
  7. Compare financial results against budgets, forecasts and prior year results. This comparison should be done monthly and any inconsistencies or variances should be investigated.
  8. Avoid time lags between approval and processing since falsifications can occur after the approval of the transaction. After approval the document should not be returned to the preparer.
  9. Limit access to assets such as inventory, petty cash and equipment. Periodically count the assets and compare the results to the underlying accounting records.
  10. Develop formal policies and procedures for purchasing. Separate the purchasing function from the requisitioning, shipping, and receiving functions. Include the verification of goods and services received to the contract or purchase order and invoice.

Protecting against fraudulent activity

Internal controls are not only needed to help protect a business against fraud or misappropriation by bad employees. They are used to detect innocent errors, duplications or omissions.

Once a business determines formal internal controls are needed it shouldn’t delay in establishing these procedures and protocols; as we all know, the longer the delay in implementing a process the more difficult the buy-in for change.

In the end management is ultimately responsible for the organization’s internal controls. Be aware that any system will be hard pressed to prevent or detect fraudulent activity through employee collusion. A good system of control will help to prevent what could be costly errors and omissions as well as discourage deliberate misappropriation of organizational assets.

If you have questions about setting up internal controls for your business, contact me at 201.655.7411 or [email protected]

Considerations in Buying a Business

 

I have helped many clients purchase businesses, and probably advised just as many to walk away from deals.  What makes a deal good and what are the important factors in evaluating the purchase of a business?  If you are considering purchasing a business, your goal should be to minimize the risk that you will overpay for the business.

businessman looking to successBuying a business is an investment decision, no different than buying stock in a publicly traded company. When investing in public company, you consider two factors; how much can you expect to receive in dividends and what do you expect the stock price to be when you sell.  Not all stocks pay dividends, but absolutely no sane person would purchase stock in a company if they expected the share price to go down during their period of ownership.

It is the same when you buy a business. The important factors are how much income will be available for distribution to you (the dividend) and how much will the business be worth when you are ready to sell (the share price).  The problem is, there is usually more uncertainty (risk) in a private business than in a public company.  As a purchaser, what can you do to understand and minimize the risk?

Consider the risk

Accounting records tell the story of a business, and speak for themselves. If the business does not have good accounting records that go back at least five years, that is risk.  The more explanations and stories that are needed to support the accounting records, the greater the risk.  I always tell clients that they should only pay for what the seller can prove.  As far as we are concerned, if income isn’t reflected on the books and reported on the tax returns, it does not exist.

Concentration risk is another important consideration. If the business is economically dependent upon a single customer or a few customers, a single product supplier, or a few key employees, the future of the business is risky.  What would the business look like if the important customer was no longer a customer, the single supplier could no longer supply product, or some key employees went to work for a competitor?  Could the business continue profitable operations if one or more of these events occurred?

More than a salary

If you buy a business and the only thing you get is a salary for working there, you are not buying a business, you are buying a job. Take the emotion out of your decision. You would be better off getting a job somewhere else and not putting your investment at risk. However, if you expect the business to grow, allowing you to receive more money in the future, and eventually sell the business for more than you paid, that is a different story and should be your goal.

I have touched on a few of the many things that must be considered in the purchase of a business. Before you buy any business, you should conduct thorough due diligence, which is usually performed by CPAs and attorneys experienced in business purchase and sale transactions.  This will help you understand the business, its risks, and provide the information that will allow you to estimate the value of the business.

If you’re buying a business and have questions about the risks involved, contact me at 201.655.7411 or [email protected]

Foreign Withholding of Income Tax on Real Estate Transactions

Whether a person is considered a “U.S. person” or “non-U.S. person” will determine which income is subject to federal income tax. This also determines withholdings on that income, which may include earnings from real estate trade/business, passive rental income or sale of property.

Basic Rules

Foreign WithholdingNon-U.S. persons are subject to income tax only on their U.S. source income (income earned within the United States). According to the Internal Revenue Service, most types of U.S. source income paid to a foreign person are subject to a withholding tax of 30 percent, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty.

What’s a U.S. or Non-U.S. Person?  A U.S. person includes citizens and residents of the United States. For income tax purposes, U.S. residents include green card holders or other lawful permanent residents who are present in the United States. A person is also a U.S. resident if he has a “substantial presence” in the States.

A non-U.S. /foreign person, or nonresident alien (NRA) includes (but is not limited to) a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person. You can read more on these definitions here.

Withholdings on real estate ventures

If you are a non-U.S. person it is important to consult with tax and/or legal counsel to determine if you are subject to withholding. Below are several situations that could require U.S. withholding with respect to real estate.

  • Trade or business – A non-U.S. person is considered to be engaged in a U.S. trade of business if they regularly undertake activities such as developing, operating and managing real estate. If this is the case, the income is not subject to withholding; rather, the non-U.S. person files an income tax return and computes their applicable tax.
  • Passive rental income – Income from a rental property is typically considered passive income (refer to my previous blog on Passive Activity Losses for details). Rental income is subject to a 30 percent withholding tax unless it is reduced under an income tax treaty. The 30 percent withholding rate is applied to the gross rents and is reported on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding.
  • Sale of property – The Foreign Investment in Real Property Act (FIRPTA) requires a FIRPTA withholding tax of 10 percent of the amount realized on the disposition of all U.S. real property interests by a foreign person. A purchaser of U.S. real property interest from a foreign investor is considered the transferee and also the withholding agent. The transferee must find out if the transferor is a foreign person. If the transferor is a foreign (non-U.S.) person and the transferee fails to withhold, the buyer may be held liable for the tax.

Withholding on foreign partners in a partnership

In addition to filing an annual partnership tax return (Form 1065), if a partnership has taxable income that is effectively connected with a U.S. trade or business, it is required to withhold on income that is allocated to its foreign partners.

The withholding rate for effectively connected income that is allocable to foreign partners is 39.6 percent for non-corporate foreign partners and 35 percent for corporate foreign partners (2016 withholding rates). There are tax treaties with many countries that can reduce the withholding requirements and these should be reviewed.

Note that withholding is calculated on taxable income, not distributions of cash. A partnership needs to be aware before distributing cash to foreign partners that there may be a withholding obligation.

Are you a non-U.S. person with real estate interests in the United States? Or, are you a U.S. citizen or resident working or investing in real estate? I can answer your questions regarding tax issues around passive income losses and other real estate financial considerations; contact me at [email protected] or (201) 655-7411.