Saturday, 31 March 2012 23:19

How social media is used in litigation

It’s often said that once something is posted to the Internet, it’s hard to get rid of it — no matter how many times you press the delete button. With the prevalence of social media in today’s society, this is something to consider. Once you post a picture on Facebook or tweet something in Twitter, it will stay there, in some form. And you never know how that personal information you posted online will come back to haunt you — especially in court.

“A great deal of valuable information about individuals and corporations can be determined from what people put on their social media sites such as Twitter, Facebook, LinkedIn and blogs,” says Rebekah Smith, CFFA, CPA, CVA, director of financial advisory services at GBQ Consulting LLC.

Smart Business spoke with Smith about the role social media plays in litigation and what you need to know about social media’s use in litigation.

What role does social media play in litigation, mainly in the financial realm?

People typically think about divorce cases where social media was used to uncover some type of personal behavior. While it is true that social media can be extremely helpful for attorneys in a divorce case as one method for proving certain actions of one party or the other, a forensic accountant can also use social media for financial purposes. For example, Facebook pictures or Tweets may be used as evidence of non-disclosed assets or a certain lifestyle. We have used social media in cases to determine if a debtor was hiding assets from a creditor, to obtain someone’s education, work history and current career direction, and frequently for research on a corporation or individual.

How has this changed over the last 10 years?

Dramatically! Ten years ago the only ‘social media’ was blogs, but unless you knew the name of a person’s blog, or it was easy to find, personal blogs were pretty hard to uncover. LinkedIn and Facebook did not even exist 10 years ago. LinkedIn popped up in 2003 and Facebook did not launch until 2004 and neither really gained major popularity until later. Twitter was the last to start in 2006. So 10 years ago, none of these resources were available to forensic accountants and attorneys when they were conducting their investigations. Now, it is standard protocol to see if the individual has a Facebook, Twitter, LinkedIn, or blog page where one can conduct some research.

How much, and to what extent, can your personal online footprint be used in litigation?

It partially depends on the type of litigation. In general, the more personal the litigation and the more personal information someone puts on their social media site(s), the more valuable it can be. For example, in a case regarding whether an individual was hiding assets from a creditor, social media was used to determine that the individual had a child who had recently purchased a very expensive piece of property in a different state. After running down that lead, it was determined that the property had been purchased with the funds from the individual under investigation, unveiling a common scheme of hiding  assets in relatives’ names.

We have also used Facebook as evidence of someone’s lifestyle when doing a lifestyle analysis in a fraud investigation. This involves looking at the lifestyle someone leads and comparing it to the known available monies (i.e. salary) to see if there is a gap in spending versus earnings, which could be an indicator of fraud.

What about your business’s online footprint?

In a fraud case, social media can be used to track down certain individuals and identify the parties related to the potential fraud. Sometimes, as part of researching a company and trying to understand what the company does, we will search social media sites. Many times in a shareholder dispute or a ‘business divorce’ people have motivation to either pump up the value of the business or depress it depending on whether they are the seller or buyer. Often times while scouring social media, you will find statements the company has issued which confirm or contradict self-serving statements made by the parties during litigation.

What are key things you need to understand about the use of social media in litigation?

It used to be that it was the exception to check social media sites as part of litigation, but it has become more and more routine. A recent article described the ways that social media was used, which even included jury research. If you think about people’s status updates on their Facebook pages, a lot can be gleaned about a potential juror’s political or social affiliations, which might make them more or less attractive jurors.

Jurors are Facebooking and Tweeting about juries they are on and judges are trying to monitor social media to make sure jurors aren’t disobeying their orders to not discuss a case. Recently in Florida, a man was kicked off a jury for ‘friending’ the plaintiff on Facebook. Unfortunately, the judge didn’t take too kindly to the fact that the juror allegedly posted his excitement about getting kicked off the jury and has now called for a hearing to determine if the actions rise to the level of contempt of court, which carries a potential fine and jail time.

Rebekah Smith, CFFA, CPA, CVA, is director of financial advisory services at GBQ Consulting LLC. Reach her at (614) 947-5300 or

Insights Accounting & Consulting is brought to you by GBQ Partners LLC

Published in Columbus
Wednesday, 31 August 2011 20:02

How to develop a buy-sell agreement

Companies should not only have a plan outlining how they conduct business, but also covering what happens if one of the owners leaves the company. A buy-sell agreement outlines who may purchase an owner’s shares, how the value of the shares will be determined, and the terms of a purchase. It’s important for any business with more than one shareholder to have a buy-sell agreement as a critical element to succession planning and to ensure continuity when a shareholder leaves.

“Buy-sell agreements ensure that shareholders are treated fairly when they leave a business, and that they will ‘know the rules of the game before they play’ — i.e., know when and how their shares will be bought out when they leave, how the company will deal with other shareholders leaving, etc.,” says Brian Bornino, CBA, CFA, CPA/ABV, director of valuation services at GBQ Consulting LLC. “It is crucial to have an agreement in place before a triggering event, since these events often cause disputes and friction, which can make the process very problematic.”

Smart Business spoke with Bornino about what you need to understand about buy-sell agreements and why valuation plays a critical role in administering these agreements.

What are some key items business leaders need to understand about buy-sell agreements?

  • You have to have one.
  • Regularly, shareholders should ‘play out’ the agreement to see what would happen if someone left so there are no surprises.
  • Review the agreement occasionally.
  • Shareholders should consider funding future buyouts triggered by the buy-sell agreement with life insurance.
  • Valuation is perhaps the most critical part of a buy-sell agreement, and independent valuations are highly advisable for administering these agreements.

How does valuation come into play with buy-sell agreements?

Valuation is probably the most critical part of a buy-sell agreement. Knowing how to value the shares of a departing shareholder is critical — and is often a huge ‘unknown’ for shareholders. While some agreements establish a formula, there are many flaws with formulas and they often produce unintended and irrational results. Formulas should never be used if the shareholders’ intentions are to buy shareholders out at fair market value; rather, independent valuations should be performed. A simple formula cannot encompass all of the complex factors that are involved in a proper business valuation.

There are many different ways that valuations are used in buy-sell agreements.  Sometimes a value is established annually. Sometimes a value is only established when there is a triggering event. In these cases, sometimes ‘each side’ gets a valuation and there might even be a third ‘tie-breaker’ valuation if the two valuations are not sufficiently close.

The best practice is to have valuations completed regularly and communicated to all shareholders — and to do this before a triggering event. Although there are costs associated with this approach, the benefits far outweigh the costs since valuation is, by far, the most common element of disputes with buy-sell agreements. Shareholders will appreciate knowing the value before there is a triggering event, as it provides comfort and certainty.

Also, knowing the value of the shares allows the company to plan for repurchases and perhaps fund them with life insurance. Additionally, it is much easier to value a company before a triggering event, because shareholders are getting along and generally agree on the business’s future prospects, which are important to a valuation. After a triggering event, valuation becomes much more difficult because shareholders begin ‘jockeying for position’ and advocating higher or lower values based on their own best interest. In these cases, the valuator has to sort through both sides of the story — i.e., two completely different sets of projections regarding the business’s prospects — and do their best to come up with a reasonable answer. Not to mention, as a shareholder’s ownership interest in their business is often their most valuable asset, doesn’t it make sense to know what it is worth before the shareholder leaves?

How can you ensure that you have a well-crafted agreement?

Have the agreement reviewed by both an attorney and a business valuation expert. Many agreements are deficient, particularly with regard to the valuation language. Valuation formulas should almost always be avoided. Also, the valuation language should be clear as to whether valuation discounts apply, as this is often the source of confusion and disputes.

Valuation discounts apply when assessing the fair market value of a noncontrolling ownership interest in a privately held company. Since these discounts can be quite large — often 20 to 40 percent — it is important for everyone to understand whether these discounts should be applied to the company’s value when determining the value of the shares pursuant to the agreement. If the agreement is silent on whether discounts apply, disputes can arise.

Ultimately, it is important for all shareholders to understand what happens when shares are to be purchased, and all advisers should be on the same page as the shareholders.

What are the risks and benefits associated with buy-sell agreements?

The biggest risk is not having one. Other risks are having a nebulous, confusing agreement, an ill-conceived approach to valuing shares, such as a valuation formula, or having to sell a business when a shareholder leaves.

The benefits include shareholder comfort and certainty, the ability to plan for repurchases and business continuity.

Buy-sell agreements are truly an example of when an ounce of prevention is worth a pound of cure. It is much easier to ‘do it right’ ahead of time than deal with costly and disruptive disputes later.

Brian Bornino, CBA, CFA, CPA/ABV, is director of valuation services at GBQ Consulting LLC. Reach him at (614) 947-5212 or

Published in Columbus

When preparing your company’s financial statement, it may seem all too easy to lie about your numbers to make your company seem more successful — especially in this tough economy. Whether you’re tempted to manipulate your statements to hit a personal performance goal, receive a bonus, keep the bank from calling a loan, or to inflate a purchase price, it’s all considered financial statement fraud.

“Financial statement frauds impact closely held companies as well,” says Rebekah Smith, CFFA, CPA, CVA, director of financial advisory services with GBQ Consulting LLC. “They can be a less obvious fraud, such as deferring revenues or expense in a different time period to give the appearance of consistent earnings or growth. Or it can be a more complex scheme where the business overstates revenues by recording false revenues.”

Smart Business spoke with Smith about the signs that point to financial statement fraud and how to stop it from happening in your company.

How many businesses are impacted by fraud?

The Association of Certified Fraud Examiners reports on fraud trends every other year. In the 2010 report, only 5 percent of fraud cases they studied were financial statement fraud. However, financial statement fraud was responsible for the largest losses, representing 68 percent of the dollars studied. When financial statement fraud does occur, it generally has a significant impact on a business.

What are some signs to look for if you think someone is committing financial statement fraud?

The signs vary and you must consider the motive of the person who is most likely to commit the fraud. For example, in a situation where the person would benefit from the financials appearing to be better than actual performance, key indicators could potentially include:

? Unexplained revenue or sales growth without a corresponding increase in cash flow.

? Increased sales and an unexplained increased days outstanding sales (the measurement for the number of days it takes to convert revenues to cash).

? A sudden, unexplained increase in revenue without a corresponding increase in expected expenses.

On the other hand, consider someone who is trying to buy out a partner or is going through a divorce; his or her motives might be different and thus the indicators would be different as well:

? An unexplained decline in the business while the rest of the industry is still performing.

? A sudden unexplained increase in expenses without a corresponding increase in revenue.

Who typically commits financial statement fraud?

Unfortunately, the profile of a person who commits financial statement fraud tends to be a trusted employee of the company who generally has long tenure and is part of the management team. Perpetrating a fraud requires the ability to circumvent internal controls and trust is an element that helps a fraudster enact his or her scheme. Individuals that commit frauds are generally financially minded and clever individuals. The complexity of the scheme sometimes requires that the individual be well versed in financial and operational matters to understand how to successfully circumvent internal controls.

What steps do you need to take if financial statement fraud has been committed?

It is important to secure any evidence that might be susceptible to being destroyed. Too many times the first instinct is to confront the individual who allegedly perpetrated the fraud and, next thing you know, documents are missing. Once documents and evidence is sure, you should contact your lawyer and, if necessary, ask for assistance from a forensic accountant. Pulling together a qualified, experienced team to help through the process will make prosecution and recovery easier.

What items can you put in place to prevent financial statement fraud from happening in your company?

Reviewing your company’s internal controls and policies and procedures is first and foremost. Sometimes due to the size of the organization or financial constraints, you cannot achieve perfect segregation of duties amongst your management and accounting and financial staff. However, a careful study of your policies can reveal the areas where you are most vulnerable and your internal controls can be designed to minimize the risk of a fraud.

Do you think financial statement fraud is on the rise or decline?

Unfortunately, coming out of tough economic times, the trend will likely be an increase in the number of frauds that are discovered in the next few years. Businesses faced incredible pressure to perform over the last two years and financial statement fraud takes time to uncover. On average, financial statement fraud goes on for 27 months before it’s uncovered. So it may be 2012 or 2013 before some 2009 and 2010 frauds are uncovered.

REBEKAH SMITH, CFFA, CPA, CVA, is the director of financial advisory services at GBQ Consulting LLC. Reach her at (614) 947-5300 or

Published in Columbus

Over the last several years, companies have continued to file for bankruptcy protection at growing rates as a result of struggling markets and economic conditions. The good news is that bankruptcy can be a viable option for turning a company around if the proper time and planning is invested.

But how do you know if your company is headed for bankruptcy? Beth A. Savage, CPA, the director of financial advisory services with GBQ Consulting LLC, says there are several indicators that can put  financial strain on companies and possibly lead to a bankruptcy filing.

“Significant declines in sales, trouble managing cash flow, strained relationships with vendors, and limited or no access to capital can heighten a company’s financial distress and, thus, result in a bankruptcy filing,” says Savage.

Smart Business spoke with Savage about the steps you need to take when considering a bankruptcy filing and how to prepare your company and employees for bankruptcy.

What are some key things you need to be aware of regarding bankruptcy?

First, most companies wait too long to file for Ch. 11 bankruptcy protection. Management often does not want to believe that the financial crisis is as bad as it is. This is common in every industry and in every size company. Management needs to take a true look at the company’s financial position, not what they hope it will be. This involves understanding sales forecasts, financial projections, current cash position of the company, and what access to additional capital the company has, including refinancing options to improve liquidity. The challenge is that the further a company goes down the path of financial decline, typically, the fewer the options.

It would be the equivalent of someone spending all the money in their checking and savings and then liquidating all other assets including 401(k), and then saying, OK, now I need help. The time to do it is when you still have some options and financing opportunities available. In fact, bankruptcy is only one of the options that a company can utilize for a successful turnaround. Today, we see less true Ch. 11 turnarounds than in the past; instead many Ch. 11 filings ultimately involve a sale, potentially a Section 363 transaction selling the company or certain assets of the company. A new surviving entity is created from the sale of assets and then the remaining components of the business are liquidated, often through the creation of a Liquidating Trust. Other business turnaround options include an out-of-court restructuring plan that could involve a refinancing, possibly tied to selling certain subsidiary companies or divesting certain operations to streamline the business.

What is involved with filing for bankruptcy?

Management should contact an attorney who is familiar with corporate bankruptcy proceedings, as well as a financial adviser, as soon as possible. An attorney and a financial adviser can advise the company on its options and what makes sense for the business.

A Ch. 11 filing typically allows the company (referred to as ‘Debtor in Possession’) to do the following to restructure its business operations, which are true advantages to filing:

  • Negotiate and acquire financing/loans on more favorable terms.
  • Reject certain leases and cancel business contracts. Debtors in Possession are protected from other litigation against the business through an automatic stay.
  • Vendors that continue to do business with companies operating in bankruptcy have more assurance that they will be paid for their post-petition goods and services than if they continued to do business with the company without the Ch. 11 filing.

How do you prepare your company and employees for bankruptcy?

There’s a lot of work that has to be done behind the scenes. The communication strategy is absolutely critical to the success of the turnaround. Management should communicate expectations and timelines to employees, business partners, vendors and others with the intent being to clearly explain how the filing is most likely to affect them. In most cases, it’s also helpful to explain the reason why you’re taking this step to file — so you can restructure the company and return the business to financial health. That’s the most important thing to emphasize.

What preparations can you make to get the company out of bankruptcy in the future?

When companies begin to see a significant decline in financial performance, one of the challenges is that this information may not be coming quickly enough for management to react. More erosion of the business can occur before management reacts. Accurate and real-time management reporting and a good business plan are paramount for the financial improvement of the company.

What are the risks and benefits associated with filing for bankruptcy?

Bankruptcy still has a certain stigma to it, but, in reality, when handled professionally and executed with good information, a Ch. 11 bankruptcy filing can be the best thing to enable the company to turn around. It just depends on the factors that are involved with the business. It also depends on the marketplace. Some business models are just not going to succeed no matter what turnaround they attempt.

Beth A. Savage, CPA, is the director of financial advisory services at GBQ Consulting LLC. Reach her at or (614) 947-5297.

Published in Columbus
Saturday, 30 April 2011 21:01

How to improve your SOX 404 audits

The Sarbanes-Oxley Act of 2002 introduced major changes to the regulation of financial practices and corporate governance. Much debate ensued about whether smaller companies and their external auditors would also have to follow SOX. Thus, a lighter version of SOX was introduced in 2007.

“This was the go-ahead to take a top-down approach and focus on the larger risks,” says Tom Powers, CPA, director, assurance and business advisory services, GBQ Partners LLC.

Smart Business spoke with Powers about some of the lessons learned from SOX and how to increase efficiency during SOX audits.

What are some lessons that companies have learned from SOX?

Before diving into the control risk matrix for purchase-to-pay or order-to-cash cycles with 10, 15 or 20 controls, visit with the controller, CFO and other upper management and ask the simple question: ‘How do you know when there is a material error in your monthly, quarterly or annual financial statements?’

It may have been a while since you’ve heard what happens, because Jane approves the general ledger account distribution or Joe makes sure all invoices were prepared for all shipments sent out. Yes, these are important process level controls to help run your business, but may not be what management is ‘banking on’ to catch the material mistake that prevents the material weakness. Typically, management has a number of analysis, comparisons, trend reports or other dashboards that send up the red flags. Think about putting more effort into understanding and testing those more powerful controls and less time and effort into the nitty-gritty process level controls.

How can you increase SOX efficiency?

It’s time to think about internal audit getting back to performing operational reviews and special projects on targeted areas to identify value. You need to turn over SOX to process level owners. One tool that is helpful to increase operating effectiveness is to create a dashboard — a spreadsheet that lists your company’s key controls, along with the individual responsible for performing or reviewing the control procedure, with check-off boxes for each month or quarter.

Sort the overall dashboard by individual and create a one- or two-page dashboard for each individual. Have them post it at their cubicle or desk to constantly serve as a reminder of the responsibilities required to be completed each month or quarter. Have the individuals complete the periodic dashboard initialing each periodic performance box and submit those to designated corporate accounting personnel who reviews and takes actions when the boxes are not checked off.

A number of deficiencies occur simply because people forget. The individual dashboard serves as a friendly reminder of to-do’s, increases accountability and provides a place for people to positively indicate that they have performed the control procedure, especially if there is not a paper trail.

What are some risks to be aware of with SOX?

The first is evaluating the design of internal controls. The second is promoting the idea that, in general, the implementation of effective internal controls and/or processes could provide the company with increased processing efficiencies and potential cost savings. Never mind SOX, how much time and money could a company save if management knew they could take proactive steps to implement key controls around significant processes?

In 2004, how many companies had to test the same key controls multiple times before the operation of control appeared effective? How much more time and how many more resources did it take for the company to perform this undertaking?

What effect can SOX have on your existing procedures?

Existing policies and procedures serve as building blocks for SOX process documentation and define employees’ roles and responsibilities. Once you have identified significant SOX processes, documentation begins with evaluating those policies and procedures. The SOX documentation process is the most practical time to recommend ways to update any outdated or inadequate policies and procedures to avoid future pitfalls.

How do the SAS 70 User Control Considerations affect SOX?

User-access reviews, segregation of duties, checklists, policies and procedures, and entity-level controls remain internal to an organization. What happens when a company outsources functions or relies on an outside vendor to provide core and/or support services that management relies on to support the assertion that the financial statements are fairly presented in accordance with GAAP?

Management should consider the activities of any service organization it uses when assessing its own internal controls over financial reporting. These rules are covered in SAS 70, which spells out how an external auditor should assess the internal controls of the service provider used by the company it is auditing. Obtaining a SAS 70 Type II report from the service provider constitutes acceptable documentation and will allow a company to properly evaluate the operating effectiveness of controls at the service organization.

A Type II report includes the external auditor’s opinion on the fairness of the presentation of the service provider’s description of its controls and how well suited the controls are to achieve the specified control objectives. It also includes the auditor’s opinion on whether the controls were operating effectively during the period under review.

The hard part of management’s assessment is an evaluation of recommended user control considerations, which are recommended by the service provider for companies to have in place to support the achievement of the service provider’s control objectives.

Tom Powers, CPA, is the director of assurance and business advisory services at GBQ Partners LLC. Reach him at or (614) 947-5215.

Published in Columbus

When you purchase an item, you may not think twice about handing over your credit card. But with credit card fraud and identity theft happening to more than 10 million Americans each year, you need to make sure your information is secure.

The Payment Card Industry Data Security Standards (PCI-DSS), put into place in 2008, are a group of 12 broad rules, 61 processes and 148 sub-processes that define what companies accepting credit card transactions need to do in order to protect the security of cardholders’ information.

“Businesses are required to demonstrate their compliance, depending upon the quantity of credit card transactions they process, and the nature of the technology they use to process those transactions,” says Michael R. Dickson, CPA, CISA, CISM, director, Business Technology Group, GBQ Partners LLC.

If you’re a large merchant (Level 1), you’ll be required to submit to a third-party assessment of your PCI compliance. Smaller organizations (Levels 2-4) may engage a third party to assist them in completing the annual self-assessments and quarterly security scans.

Smart Business spoke with Dickson about the PCI-DSS and how to make sure your company is compliant with these standards.

How does PCI-DSS affect businesses?

The major credit card issuers developed the standards. Their vested interest in securing cardholder data and the merchants who use their cards is to reduce fraud and prevent financial losses. Initially, each of these institutions developed their own standards. They were all similar and aimed at protecting the privacy of user information, but they had their own specific way of communicating and enforcing these rules. PCI-DSS was designed to be adaptable to all brand institutions, so a business can be confident that, if they’re following these particular standards, they are in compliance with all bank rules.

The qualified assessments or self-assessments required for compliance give information about your organization and how you conduct business with your customers. The requirements are based on your size, the nature of your technology, and how you actually process cards.


What are some key things you need to understand about being PCI-DSS compliant?

Non-compliance has consequences. Many businesses, especially smaller ones, take a rather casual approach to compliance. Oftentimes, someone in the IT department will print off a form, check a bunch of boxes to say they are in compliance with the requirements, but don’t go into detail of how they do it. The business owner then signs the form without really understanding what the requirements are, and how well their organization is doing to meet the requirements. There’s a big risk for companies that take shortcuts. Consequences include potentially huge fines and the costs of notification, not to mention the damage to a company’s reputation and revenue stream that can result from a breach in customer credit card security.

More than 38 states have laws protecting consumers from data and privacy breaches and PCI compliance is the de facto standard for best practice in credit card protections.

There are no proactive enforcement mechanisms, unless a brand merchant chooses to react to a filing that has been submitted because they think it’s substandard.

If your merchant is not satisfied with the quality of your filings, and generally deems you to be a higher risk than its other customers, it may require a third -party assessment, or may even re-negotiate your fee structure or revoke your right to process credit card transactions through its institution. The biggest risk of non-compliance is if you have a breach and someone gains access to your information, or someone inside your organization sells or publishes it. The cost of dealing with lawsuits, insurance claims, canceled accounts and a damaged reputation can and will be significant.

How do you become compliant?

The first thing you have to do is determine what level of merchant you are. If you process less than 20,000 e-commerce transactions a year, you would be considered a Level 4 merchant, and can report annually on a self-assessment questionnaire. The criteria get tougher as you go up. A Level 1 merchant processes over six million transactions a year, and is required to engage a third party to complete the compliance assessment workpapers.

The second step is to perform an assessment of your technology environment to see how it measures up with a list of PCI specifications. Again, there are 12 high-level requirements, 61 different key processes, and 148 specific inquiries relating to those processes. For each of the requirements, it is advisable to have documentation of how your organization complies with each requirement. This documentation should be detailed enough to clearly explain the technologies that are in use, but it also should be clear and concise so executive management who must sign an attestation of compliance can understand what the requirements are, and what specific solutions your company has implemented to address the inquiry/risk. For each requirement for which you don’t have a procedure or technology in place to mitigate the risk, you are required to demonstrates knowledge of the specification you’re not performing, and explain why the other things (i.e. compensating controls) you’re doing meet the same objective. Ultimately your bank will determine if you’re in compliance or not. It wants to see if you’ve designed new processes and procedures, or that you’ve implemented the procedure that didn’t exist.

What are the benefits of compliance?

Your systems and data will be safe and secure, you’ll have a low risk of any adverse consequences occurring, and the customers’ trust you’ve built up over the years won’t be shattered in an instant by a careless lack of attention to detail when securing your card-holder data computing environment.

Michael R. Dickson, CPA, CISA, CISM, is the director of the Business Technology Group at GBQ Partners LLC. Reach him at (614) 947-5259 or

Published in Columbus

With all of the debate surrounding the new health care law and its impact on business, another major issue promises to rear its head in the next few years — taxation of capital gains. Although Congress extended the Bush era cuts for another two years in December, the issue of capital gains promises to be at the forefront of political deliberation for months to come.

Tax is currently charged on capital gains, or the profits realized on the sale of a non-inventory asset that was purchased at a lower price. Almost anything owned for investment purposes or personal use are considered capital assets for income tax purposes.

“The most common capital gains are realized from the sale of stocks, bonds, precious metals and real property,” says Dennis R. Mowrey, the director of tax and business advisory services at GBQ Partners LLC.

Smart Business spoke with Mowrey about capital gains tax and some of the tax changes expected in the future.

What are some new updates with capital gains tax?

The special tax rates on long-term gains and qualified dividends expire on December 31, 2012. Starting in 2013, the tax rate on long-term gains will be 20 percent, or 10 percent for those in the 15 percent tax bracket.

Also starting in 2013, the distinction between ordinary and qualified dividends will disappear, and all dividends will be subject to the ordinary tax rates. Capital gains income will also be subject to an additional 3.8 percent Medicare tax in 2013.

What are some key things you need to understand about capital gains?

Tax rates that apply to net capital gains are generally lower than the tax rates that apply to other income. For 2010 through 2012, the maximum capital gains rate for most people is 15 percent. There are some special factors that apply to lower-income individuals, which can reduce their capital gains rates.

If your total capital losses exceed your capital gains, the excess can be deducted on your tax return and be used to reduce other income, but you are limited to an annual amount of $3,000, or $1,500 if you are married filing separately.

How are capital gains taxed, and how does this impact business?

Capital gains and losses are classified as long term and short term, depending on how long you hold the property before you sell it. Your capital gain or loss is long term if you hold the property for more than one year. Your capital gain or loss is short term if you hold it one year or less.

Long-term gains are subject to a more favorable tax rate than short-term gains. Rates for long-term gains in 2010 started at 0 percent for those in the lowest income tax bracket and topped out at 15 percent. Rates for short-term gains started at 10 percent and topped out at 35 percent. There are special rates for collectibles and the sale of certain small business stock.

A lot of times, businesses will provide dividends to their shareholders. Dividends are classified as ordinary or qualified. Qualified dividends are taxed at a 15 percent rate.

To be eligible as a qualified dividend, the dividend must meet the following two criteria:

• The dividend has to be from a domestic corporation or a qualifying foreign corporation.

• The stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

What special rules apply to capital gains inherited or received as gifts?

People often end up owning real estate and other property when the original owner has given that property to them. Transfers of property given before the original owner dies are gifts. The recipient of a gift does not pay any taxes or report any income when the gifted property is received. Capital gains or losses on property received as a gift are calculated with respect to the original owner’s basis in the property. When property is given, the recipient receives both the property and the property’s basis. The recipient also receives the donor’s holding period in the property for determining whether a gain is long term or short term.

Why is it important to keep good records of your capital gains and losses?

Your records help determine your capital gains and losses. Keeping good records is mandatory to be able to document and calculate the correct rates for your tax returns.

This includes making sure all items are dated, as this matters for calculating what type of gain you have — either short term or long term.

Dennis R. Mowrey is the director of tax and business advisory services at GBQ Partners LLC. Reach him at (614) 947-5273 or

Published in Columbus