Month: July 2016

Stay in Touch With Your Accountant Even After Your Tax Return is Filed

Tap your CPA’s knowledge and experience

As your business grows so do the complexities of complying with the regulations and requirements that may apply to you and your business. Your accountant is available to assist with accounting and compliance issues. In a business environment where these rules and regulations are constantly changing you want to be sure you are covered. Make sure you keep the lines of communication open throughout the year and take advantage of all the knowledge and expertise your accountant has to offer. The added value from keeping in touch with your accountant could extend well beyond tax services.

How is your business actually doing?

COMPLIANCE conceptIf you are familiar with basic accounting and maintain your own set of books, but can’t seem to make sense of the reports your accounting software is producing it may be time to sit down with your accountant. This is a great way to analyze how your business is actually doing. Your accountant is well versed in what your cash flow and finances are comprised of and could be an extremely useful resource when it comes to planning your future, setting goals, and assuring growth.

Consider outsourcing your bookkeeping

Success and growth may mean that more time and focus is needed with daily operations. The accounting and tax rules and regulations that become applicable are also more complicated than what you may have seen in the past. Allowing your accountant to take charge of the bookkeeping tasks allows you to focus on managing your business and creates a relationship where there is constant communication.

Together, you can develop a strategic plan for the future while discussing aspects of your business that may need change or attention. The conversations and accuracy of the financial reports will provide you with an accurate understanding of your businesses profitability and allow for accurate projections to be made which results in an easier tax filing season.

Ask questions

You should be asking your CPA questions about the financial aspects of your business that you may not be familiar with and would like to learn more about. These conversations can lead to you feeling more comfortable and confident while making informed decisions to assure a successful business.

Stay in touch

Your accountant can offer the proper guidance needed to make you consider all possible outcomes, consequences, or opportunities that may arise when making business decisions. Keeping them informed about any significant changes is imperative to avoid negative repercussions when it comes to accounting or compliance issues. Be sure to stay proactive in keeping your accountant apprised of decisions regarding your personal finances, business engagements, and any other significant changes in your life. With expertise in many different areas, your accountant can offer you insight and support even after you’ve filed your tax return.

Additional resources

If you haven’t yet found the CPA that’s right for you, check out the post, “How to Choose the Right Accountants.”  The post, “Does Your Small Business Need Help with Bookkeeping Tasks” can help you decide if outsourcing these important tasks is right for your small or mid-size business.

Understanding IRS Rules for Self-Rentals

Owner or renter – or both? 

Tax effects of self rentalsSelf-rental is an arrangement in which a business and property that it rents are both owned by the same person(s). It is common for a taxpayer to own an operating business and also own the accompanying real estate. That person has to materially participate in the operating company for the self rental rules to apply. If the operating company is an entity that the owner(s) actively participate in on a day-to-day basis, in most cases the owner(s) would be considered to materially participate in that activity.

Additional details on material participation can be found in Internal Revenue Service  Publication 925.

The passive activity loss rules

As discussed in my blog post, Passive Loss Limitations in Rental Real Estate, the IRS Code generally prohibits taxpayers from deducting passive activity losses against other income, including salaries, interest, dividends, and income from nonpassive activities. Generally, a passive activity loss can only be used to offset other passive income.

The IRS considers most business activities to be nonpassive if a taxpayer materially participates in the business.  One of the exceptions to this rule is rental real estate. Rental real estate activities are generally considered passive regardless of level of participation.

Trapped losses

Passive losses can only offset other passive income. Assuming a taxpayer incurs a loss on the rental of property to a business in which he or she materially participates, absent any other passive income during the year, the loss will not be deductible. However, the loss is carried forward to future tax years to offset income from the activity.

If there are unused passive losses from the activity when the property is sold, such suspended losses from that activity are recognized in the year of disposition.

How self-rental rules can apply

What does it all mean? Here’s an example to help you understand how the rules apply:

A taxpayer owns a warehouse which is rented by his distribution company that he materially participates in as owner and president. During the year the rental warehouse incurs a loss of $50,000, while the distribution company has $50,000 of income.

Does the $50,000 of losses incurred by the warehouse offset the $50,000 of profits from the distribution company?

No. Because the property was essentially rented to himself (i.e., to a business in which he materially participated), the self-rental rules apply. In the case of a self-rental, income is treated as nonpassive and loss is treated as passive. The self-rental rule characterizes the $50,000 of rental loss as passive which cannot offset the nonpassive income from the distribution company.

If you are currently involved in a self-rental or are considering this transaction, there are methods whereby you can avoid or reduce the disadvantageous tax effect of the self-rental rule. Contact me at 201.655.7411 or [email protected] and I can help you understand which methods are most advantageous to you.

A Few Considerations Before Acquiring a Small Business

 

Whether you are buying a retail store, a franchise, or a service business, your due diligence and valuation process is not much different than that employed in purchasing a multi-million-dollar business.

The three main things you want to know when you’re considering purchasing a small business are:

  1. What is the amount and timing of money you expect the business to generate in the future?
  2. When you are ready to sell the business, how much will you be able to sell it for?
  3. What is the risk that items 1 and 2 will not occur as expected?

business valuationAs evident from these questions, the thing to focus on is the future. Although the seller will certainly focus on past performance, what happened twenty, ten, or five years ago is of little significance; you want to know what will happen in the future.

It is not uncommon for small business buyers and sellers to agree on a price based on an industry “rule of thumb” formula such as three times net income or 80% of gross revenue. Unfortunately, rules of thumb are nothing more than old wives’ tales.  Every business is unique and no business should be purchased based on a formula purported to be applicable to an entire industry.

Sometimes a buyer thinks that he or she is buying a business, but they are really buying a job. On the most basic level, the value of a business is based on the amount of money you can earn above and beyond the value of the services you provide to the business.  For example, if you earn $100,000 per year as an employee and you have the opportunity to purchase the business where you are employed, the purchase would make sense only if it gave you the opportunity to increase your earnings. Investing in a business is risky.  If you purchased the business and continued to earn the same $100,000, you would not receive any return for taking the risk, and would be better off investing your money elsewhere.

Get professional advice before buying a small business

Professional advisors understand the issues; know the questions to ask and procedures to employ to help you understand the business you are considering and what it is worth. The earlier in the process that you get professional advice, the better off you are.  Even if you just ask your CPA to look at the last few years’ tax returns of the business and offer comments and questions, you will save a lot of time and money, and get unbiased advice from an experienced professional.

For more about understanding how to value a business you’re considering purchasing, read “Why You Need a Business Valuation.

Choosing The Right Accounting Software

Get the Accounting Software Your Small Business Needs to Succeed

If you are looking for an accounting system for a small business you may want to start by reviewing the features included in prepackaged solutions such as QuickBooks or Xero. These are relatively inexpensive and can be set up and functioning quickly with some user training.

Businesswoman working on laptop.Depending upon the version purchased, these packages will offer the user the ability to perform basic bookkeeping functions such as

  • Creating estimates and invoices
  • Syncing bank or credit card accounts
  • Printing checks
  • Reconciling bank accounts
  • Exporting data to Excel
  • Maintaining a General Ledger
  • Providing basic financial reports such as Balance Sheet and Profit & Loss statements.

If not offered in the basic versions, more advanced features may include preparation and printing of 1099’s, payroll, inventory tracking, time & billing, budgets, and enhanced financial reporting. In addition to the pre-packaged accounting software, there are many add-on applications that can automate many business processes.  For example, applications are available to provide point of sale solutions, enhanced inventory management, paperless bill-pay processes, employee expense/reimbursement processing and sales tax automation. There are even CRM and document management add-on applications available to help manage and grow your business.

Do your homework before buying accounting software

Not every app will integrate with every software package or version so it is important to do your homework. And if remote access is important to you, many packages offer both cloud-based and desktop versions of their software. Be sure to compare the features offered in each since certain functionality may be available in one and not the other.

It is also important that the system you use for your business provide an audit trail and the ability to lock down closed accounting periods. These functions will protect the integrity of the data and limit unauthorized posting or deletion of data.

Accounting software for a growing business

So what do you do when you believe you have outgrown the small business packaged software solutions such as QuickBooks or Xero?

First, be certain that it is the accounting software that you have outgrown and not your operational software. For example, a large volume distributor may have intricate inventory management, markup and costing operational needs that are best managed through industry-specific operational software. If this is your dilemma, then it is not only necessary to evaluate the accounting functions of the software; most often, the operational functionality will take the lead in the selection process.

Although they are getting better, we often see excellent industry-specific operational systems that lack functionality and integrity on the accounting and financial reporting side. In these circumstances, it is important to determine if the benefits of operational reporting outweigh the accounting functionality. If so, some customized software enhancements may be needed at additional cost. These operational and accounting software packages will be much more costly than packaged software and require significant training for all users. Most often it is recommended to run a new system simultaneously with the prior system until the integrity of the data can be tested and trusted.

In either scenario your accountant should be able to help you in the software selection process. He or she should understand your business operations, user needs and reporting requirements and be able to offer valuable insight in your selection process. Your accounting software should allow you to process transactions efficiently and provide financial reporting that will help your business be more profitable.

If you have questions about choosing the right accounting software for your small business, KRS CPAs can help. Give me a call at 201.655.7411 or email me at [email protected]

Investor vs. Dealer

Purchasing real estate assets? This post explains what you need to know about the important distinction between real estate investor and dealer for tax purposes.

A real estate developer is taxed differently than a real estate investor. Real estate investors purchase real estate with the intention of holding properties and gaining financial return. Typically, real estate dealers acquire and sell real estate as part of their everyday business.

career or new opportunity concept, business backgroundA real estate professional who is involved in buying real estate with the intention of selling for a profit in a short time frame, or flipping is usually considered a dealer. Contractors and builders who build houses and commercial structures, and subsequently sell the finished property to customers are also considered dealers.

A question that arises often is whether a real estate developer who purchases properties (sometimes raw land or an outdated property) and makes improvements should be considered an investor or a dealer. Real estate developers are usually treated as dealers by the IRS because they are in the business of buying and selling real estate. However, if the developers work on individual and sporadic long-term projects, they may be able to take a position they should be taxed as investors.

Why does it matter to real estate professionals?

When a real estate investor sells property that has been owned for more than one year, gain on the sale is taxed at the favorable long term capital gains rates, currently 15% or 20% depending upon income (plus the 3.8% net investment income tax, if applicable).

When real estate dealers sell their properties, those properties are considered inventory and any gains are taxed at the dealers’ ordinary income tax rates. Currently, Federal ordinary income tax rates can be as high as 39.6%.

The Internal Revenue Code offers general guidelines regarding activities that reach the level of a trade or business. However, Internal Code does not provide specific guidance regarding real estate activities. Consequently, court cases have been the primary source for defining what level of activity determines a trade or business in real estate development and, therefore, the nature of the income.

The main factor in determining if a taxpayer is a real estate investor or a dealer is his or her intent with respect to the property. The mere fact that an individual holds a piece of property for a short period of time does not automatically cause him or her to be a dealer. Often an individual purchases real estate with the intent of holding it for investment purposes, but sells it earlier due for financial or economic reasons.

Consider the Winthrop Factors

A case often cited when determining dealer vs. investor status is United States v. Winthrop. In determining whether the gain from sales was ordinary or capital in nature the court relied on a series of facts and circumstances in the Winthrop case. These have become commonly referred to as the “Winthrop Factors.”

Subsequent court cases have enumerated the following 9 Winthrop Factors:

  1. The purpose for which the property was initially acquired
  2. The purpose for which the property was subsequently held
  3. The extent of improvements made to the property
  4. The number and frequency of sales over time
  5. The extent to which the property has been disposed of
  6. The nature of the taxpayer’s business, including other activities and assets
  7. The amount of advertising/promotion, either directly or through a third party
  8. The listing of the property for sale through a broker
  9. The purpose of the held property at time of sale; the classification as an investor or dealer is determined on a property-by-property basis.

Talk to your tax professional

With such a wide disparity between the maximum capital gains tax rate of 20% (plus the net investment income tax 3.8%) and the tax rate on ordinary income of 39.6%, it is important to consult your tax advisor regarding newly acquired real estate assets and established investments.

Structuring a Business Sale to Minimize Income Taxes

Many of the considerations in structuring a business sale are dependent upon the type of entity that operates the business.

For the purposes of this post, we will limit our discussion to sales of businesses operating in the corporate form, either as S or C corporations.

Tax Advice Puzzle Shows Taxation Irs HelpIn a business sale, the seller prefers to sell the stock representing the business ownership, but the buyer prefers to purchase the assets of the corporation. The seller wants a stock sale because it generates a capital gain, taxed at a 20% rate.  The buyer prefers to purchase the assets because the full purchase price is allocated to the assets purchased, creating tax deductions for depreciation and amortization.  In a stock purchase, the buyer steps into the seller’s shoes, receiving no tax benefit from the price paid until the business is sold.  This issue is usually resolved by compromise, sometimes involving a price adjustment.

C corporation vs. S corporation asset sales

There is a significant difference between an asset sale by a C corporation and an asset sale by an S corporation. Sale by a C corporation results in double tax because the selling corporation is taxed on the gain on the asset sale, and the shareholders are taxed on the distribution to them by the corporation.  Sale by an S corporation that has been an S corporation for at least five years preceding the sale is subject to only one level of tax.  Because S corporations are pass-through entities that do not pay federal income tax, the entire gain is passed through to the shareholders for inclusion on their personal income tax returns.

If your business operates as a C corporation and you are contemplating sale, you should consider making an S corporation election.  This will allow you to avoid a double tax, but only if the corporation has been an S corporation for at least five years prior to the sale.  If the five-year requirement is not met, the S election will be disregarded for purpose of the sale and the sale will generally be treated as having been made by a C corporation.

In certain circumstances, a sale transaction can be structured in which the seller is taxed at favorable capital gains rates and the buyer receives ordinary deductions for a large part of the purchase price. This would occur if seller had personal goodwill, such as customer or supplier relationships not owned by the corporation.  In this structure, the seller would recognize capital gain and the purchaser would deduct the price paid for the goodwill over fifteen years.

Learn more about selling a business

For more information on this, see my article which may be accessed using the following link: http://krscpas.com/wp-content/uploads/2016/02/Business-Sales-and-Personal-Goodwill-G-Shanker.pdf

This article is intended to present general concepts in structuring the sale of a business. If you are considering the sale of a business, you should contact a qualified CPA for specific advice.