Businesses have been given more time to prepare for changes in the way they account for expenses related to tangible property, but it might be advantageous to get an early start.
The U.S. Department of the Treasury issued temporary regulations that were to be effective in 2012, but the Treasury and IRS revised the effective date to Jan. 1, 2014. Final regulations that include the new effective date are expected in 2013.
“The regulations focus primarily on whether an expenditure is for immediately deductible repairs and maintenance or for capital improvements that must be depreciated over time. An expenditure on tangible property can be a current deduction if it’s considered incidental in nature and doesn’t add to the value of the property or prolong its useful life,” says Tom Tyler, partner at Crowe Horwath LLP.
“The temporary regulations are of particular interest to businesses with significant amounts of brick-and-mortar properties or to machinery-intensive businesses,” he says.
Smart Business spoke with Tyler about the regulations and what businesses should do to prepare for the change.
Should businesses act now or wait for final regulations?
The IRS announced the change to the effective date on Nov. 20, 2012. The revised date covers tax years beginning on or after Jan. 1, 2014. However, taxpayers can early-adopt the regulations for their 2012 and/or 2013 tax years. The early adoption allowance is an acknowledgement on the Treasury’s part that taxpayers might have already expended resources in order to adopt the temporary regulations. Taxpayers still can apply the temporary regulations as long as they file an accounting method change if the final regulations turn out to be different.
Potential corporate tax reform also could affect decisions regarding tangible property. Because of that, it’s advisable to evaluate the effects of the final regulations now, regardless of whether you’re going to adopt them in advance of the required date.
Is the final version expected to vary much from the temporary regulations?
There were sections of the temporary regulations that generated a lot of feedback from taxpayers and practitioners, and the Treasury likely will incorporate that feedback into the final regulations. For example, there is a new de minimis rule that exempts certain acquisitions from capitalization. If it’s under a certain threshold dollar amount, a taxpayer can deduct the purchase price of the property for tax purposes as long as it follows a written expense policy and has an applicable financial statement. Under the rule, the amount paid and expensed must be less than or equal to the greater of 0.1 percent of gross receipts for income tax purposes or 2 percent of the total depreciation and amortization expense for the tax year.
Treasury officials have suggested the de minimis rule might be expanded to taxpayers without audited financial statements, and they may revise the way the ceiling limitation is computed. Temporary regulations regarding dispositions and safe harbor for routine maintenance also are likely to be revised.
What steps should businesses take now?
Don’t hold off on implementation plans; instead, proceed while bearing in mind the effect of potential revisions. If the de minimis rule is expanded but retains the written policy requirement, businesses should establish a written capitalization policy for financial reporting purposes by the first day of the tax year they want to apply those rules.
Additionally, taxpayers might need to file an accounting method change if the final regulations differ from the temporary ones, even if no changes are made to the deductions claimed under the temporary regulations.
Taxpayers should weigh the pros and cons of the options outlined by the Treasury and IRS to determine the most advantageous approach. Those options are:
- Adopt the final regulations in 2014 with their 2014 tax return.
- Early adopt the final regulations with their 2012 or 2013 tax return.
- Adopt temporary regulations with their 2012 or 2013 tax return with the possibility of filing a second method change to adopt the final regulations for the 2014 tax year.
Tom Tyler is a partner at Crowe Horwath LLP. Reach him at (214) 777-5250 or email@example.com.
Insights Accounting is brought to you by Crowe Horwath LLP
The recent accessibility of oil and gas in the Utica Shale rock formation, located throughout much of Eastern Ohio, will have a major impact on businesses and individuals alike. New businesses will be coming to the state due to the drilling, and companies currently here will likely see increased business.
As a result, companies should be considering the state and local tax ramifications of these operations in Ohio.
“Many businesses coming into the state may not have done work in Ohio before,” says Anthony Ott, CPA, senior manager, state and local tax services with GBQ Partners LLC. “For the first time, they will be subject to Ohio’s state and local tax structure, which does have some nuances that differ from other states.”
Smart Business spoke with Ott about how to prepare for the increased business and the resulting tax ramifications.
What are a few key state and local tax focus areas for businesses impacted by the shale boom?
Ohio is one of the few states that allows municipalities to enforce their own income taxes, which creates a very burdensome compliance process.
Owners of land leased for drilling will likely receive upfront lease bonuses, as well as royalty payments once the well is active and producing. This could produce a much larger municipal income tax liability for these individuals, depending on where they live. They may also be required to make estimated payments for municipal income tax, creating a new level of complexity.
It’s also very problematic for businesses to properly comply, especially those coming from out of state that are not familiar with the municipal taxing structure. Ohio utilizes a 12-day entrant rule — if you operate in a given taxing municipality for 12 days during any given year, you’re responsible for withholding and paying municipal income tax in those locations. Businesses with mobile work forces have to track the location of employees and property to apportion their income in Ohio to the correct municipality. This becomes difficult when you have crews working all over the state.
Ohio also imposes sales tax on certain services such as temporary employment. So, if businesses are utilizing temporary help and other taxable services, they will have an impact on the profitability of their jobs.
How do severance and real property taxes apply?
The severance tax is the hot topic right now. With the mid-biennium budget review, Gov. John Kasich proposed certain changes that would increase the tax above its current level and use the additional funds collected to provide an income tax credit to Ohio individuals.
The legislation would establish two categories of wells — hydraulically fractured horizontal wells and conventional wells — and tax each differently. If this legislation passes, it will raise the complexity for companies, particularly those with hydraulically fractured horizontal wells, given the opportunity to use a reduced rate for the first two years while they recoup costs associated with construction of the well.
The real property, or ad valorem tax, allows county auditors to value the oil and gas reserves for producing wells and assign a value for real property tax purposes. The value is determined based on an annual return filed with the county auditor.
What about the Commercial Activity Tax?
Ohio’s CAT is unlike the income/franchise taxes levied in many other states. In essence, it is a tax on a business’s gross receipts. The CAT’s unique requirements around what items are included in gross receipts and how receipts are sourced will have an impact on both businesses and individuals participating in the industry.
What is the overall risk of not understanding and complying with Ohio’s taxing structure?
The risk is that a company operating in the state fails to comply with all the statutory tax requirements. This could lead to an audit by the state or municipality, and the business would likely be subject to the tax assessment and associated penalties and interest.
What are some of the opportunities for companies participating in the boom?
The state and local tax impact can increase dramatically as the associated revenue dollars and investment rise. Depending on the project, there may be opportunities for incentives from the state and local jurisidictions that may help offset some of those increased costs. These may include incentives and tax credits for job creation, capital expenditures, training, etc.
Ohio law also provides a sales tax exemption related to items directly used in the production of oil and gas. I would encourage industry participants, as well as service providers, to fully understand what qualifies for the exemption in order to take full advantage and possibly reduce the overall dollar investment required.
How can companies stay up to date on these issues?
Participants in the industry should keep a keen eye on the severance tax legislation. The Ohio Oil and Gas Association is very active in this area and is a good resource for members of the industry to stay informed.
Regarding current Ohio taxes, businesses and individuals alike should review the structure and consult with a state and local tax professional to better understand how it will apply. Each industry segment, as well as the ancillary service businesses, will be impacted differently.
There are also many opportunities to attend informational seminars specifically related to these issues.
Anthony Ott, CPA, is a senior manager, state and local tax services at GBQ Partners LLC. Reach him at (614) 947-5311 or firstname.lastname@example.org.
Insights Accounting & Consulting is brought to you by GBQ Partners LLC
Business owners need to be aware of the tax implications of recent federal legislation, including President Obama’s extension of former President Bush’s tax cuts and changes to the estate tax exemption.
“There are a lot of potential advantages on the plate, but there are also a lot of unknowns,” says Mona Sarkar, J.D. MTax, a Vice President, Client Advisor and Wealth Team Manager for FirstMerit Bank. “Some things have changed and some have stayed the same.”
Smart Business spoke with Sarkar about how to prepare for the implications.
What has changed and what has stayed the same?
On one hand, the new legislation extended tax cuts with regard to dividends, capital gains and rates on ordinary income, for another two years — through the end of 2012. On the other, the estate tax situation was modified.
Over the past decade, the estate tax had an increasing exemption amount, which peaked in 2009 at $3.5 million, with a maximum tax rate of 45 percent. In 2010, there was no federal estate tax. Legislators then passed a $5 million exemption and a maximum estate tax rate of 35 percent for 2011 and 2012. In addition, the lifetime gift-giving exemption was capped at $1 million, while the estate tax exemption continued to increase.
Now, the new estate tax exemption and the gift tax exemption are the same. Someone can pass away with an estate of $5 million and pass federal estate tax-free to beneficiaries, or they could literally give away $5 million of assets during their lifetime and pay no gift tax. It’s an either/or for the next two years.
The real question now is will the higher estate tax exemption be made permanent or will it revert to lower previous levels? As a result, you have a two-year window of advantages capped with uncertainty.
What should businesses expect over the next two years?
There is a drumbeat of concern about taxes wiping out a lifetime’s worth of building a business. The people pushing to make the estate tax exemption permanent say it will save the American small business.
Small business owners are saying ‘If my spouse and I each have a $5 million exemption, that will ensure our business passes on to the next generation without having to be sold to pay taxes.’ I expect there will be an attempt to make it permanent prior to the national election in 2012.
What do business owners need to know about the changes in the estate tax exemption?
There are business owners with a succession plan in place, who have already given away $1 million of stock in their business, but were kept from giving any more because they would be paying out-of-pocket on gift taxes.
Now, they have the opportunity to re-examine their plan. They’re able to make larger gifts or pass the business down to the next generation, without extraneous tax penalties.
Most estate planners are educating their clients as to what’s currently possible in the given environment. Our job is to be sure the consumer is educated as to the possibilities, so they’re able to make an informed decision Not everything in life can be driven by taxes, but it’s important to be aware of the tax situation.
As we get closer to the end of 2012, push will come to shove. Depending on whether lawmakers are considering making the changes permanent or if they are facing pushback, people will either sit back or there will be a race to accomplish major gifts in the last quarter of 2012.
How should existing estate plans be handled?
People should look at the documents they have in place, just to make sure that if something were to happen between now and 2012, or if in fact the new exemptions became permanent, their estate plan still works the way it’s intended.
While the documents fit at the time they were created, the current estate tax situation could turn that plan into a mess if it isn’t managed carefully.
If you have a document that is more than five years old, we recommend talking to your attorney to find out if it still works. Many factors can impact an estate plan: premarital agreements in the case of second marriages or children from previous marriages, etc. So when there are major changes in exemption amounts, like we’ve seen this year, it’s critical to examine your plan to make sure it still works.
While you may not want to engage in any major gift-giving now, you still have to make sure that if something happened to you tomorrow, you would still get the right result.
It’s a two-sided coin — on one hand it could impact your plan if you do nothing, and on the other hand, are there advantages you should take because of the exemption?
What other tax implications should businesses consider?
The income tax part of it simply extended the tax cuts that were already in place in terms of dividends, capital gains and ordinary income rates overall. To the extent that those were allowed to expire, you would have higher income taxes paid on dividends and capital gains and higher overall income tax brackets for ordinary income.
In terms of real actual revenue dollars, the estate tax is not a big item in the federal budget. Income taxes, capital gains taxes, and taxes on dividends are a much bigger concrete number. While they are not as high in any given situation, there are more people paying them.
Also, for anyone inheriting from an estate or beneficiary of estate for someone who passed away in 2010, there are elections that can be made. Talk to your attorney about it.
Mona Sarkar, J.D. MTax, is a Vice President, Client Advisor and Wealth Team Manager for FirstMerit Bank. Reach her at 1-888-384-6388 or Mona.Sarkar@firstmerit.com.
When determining what entity type is best for your organization, you need to consider several factors, and working with an outside adviser can help avoid trouble down the road, says Steven H. Gross, CPA, a partner with Skoda Minotti.
“A limited liability company (LLC) often makes the most sense, as it provides the most flexibility, but there are other options to consider,” says Gross. “Even with an LLC, you need to determine the best way to be taxed.”
Smart Business spoke with Gross about how to make the best choice to lessen your tax burden and avoid common tax traps.
What types of entity structures can businesses choose from?
The most common options are a C corporation, an S corporation, partnerships and, as mentioned above, an LLC.
A corporation (S or C) is a separate legal entity. C corporations are tax paying entities, that is, they pay taxes on their taxable income just as individuals pay taxes on their taxable income. A C corporation can make a distribution to its shareholders, which may be taxed as a dividend. These dividends are not deductible to the corporation, but taxed, at least until 2013, at a favorable tax rate to the recipient. Depending on the tax situation of the individual and the corporation, paying some dividends may result in less taxes paid by the corporation and individual combined.
An S corporation is also a separate legal entity but generally is not a tax-paying entity for federal tax purposes. An advantage of an S corp. is that its profits are taxed to the shareholders, not the corporation itself; therefore the double taxation that exists in a C corp. is eliminated. Another advantage is that the amount of profits taxed to the shareholders is subject to self-employment tax. Since S corp. profits are not subject to self-employment tax, you can manage your self-employment taxes better than in a C corp. In an S corp., profits and losses have to be allocated to the shareholders in the same percentages, as ownership and distributions cannot be disproportionate.
Another entity structure option is an LLC. Generally, a multi-member LLC will be taxed as a partnership. An LLC filing a partnership return is not a tax-paying entity and the profits and losses flow through to the members in a similar manner to an S corp. Members of an LLC can elect to have the entity taxed as an S corp. or a C corp.
What are some benefits of an LLC?
An LLC that is treated as a partnership allows its members to avoid the double taxation and higher income tax of a corporation while, at the same time, retaining limited liability and other favorable attributes of a corporation.
An LLC, unlike an S corp., has the ability to specially allocate items of income, loss, deduction or credit, so long as the allocations have substantial economic effect.
Note that, even if an LLC is treated as a partnership for federal income tax purposes, an LLC may also be treated as a corporation and be subject to franchise taxes under state law.
What are some benefits of an S corporation?
As stated before, shareholders of an S corp. do not pay self-employment tax on the flow-through profits.
An S corp. with only one shareholder still files a separate return, unlike a single member LLC. A single member LLC is a disregarded entity for federal tax purposes and all of the business income and expenses are reported on Schedule C of the individual’s income tax return.
Disposition of an ownership interest in an S corp. at a loss may yield an ordinary loss under I.R.C. Sec. 1244, while disposition of an LLC ownership interest generally yields a capital loss.
What are some common tax traps businesses fall into?
When you have flow-through entities, you have basis issues when it comes to losses. If you meet certain criteria, those losses can be deducted on your tax return. However, individuals often think that if they are incurring losses in their pass-through entity, they can deduct those losses on their individual income tax returns when, in fact, they do not have basis to take the losses.
Another trap in the C corp. arena is charitable contributions. Contributions made in a C corp. are only deductible to the extent that they don’t exceed modified net income by 10 percent. Any excess contributions can be carried forward for up to five years. If a C corp. is running at a loss, the shareholder may want to consider making the donation personally.
How do you determine the right choice for your business?
Business owners need to seek advice on what would be the best choice in their particular situation. Sit down with an adviser, determine the pros and cons and weigh the options.
The issues can be very confusing and difficult to get your arms around. These are intricate tax issues and you would be best served by sorting through your options with an experienced professional.
Steven H. Gross, CPA, is a partner with Skoda Minotti. Reach him at (440) 449-6800 or email@example.com.
You may think that because you have a will, all of your assets will go where you intended. But if those assets aren’t properly titled, it doesn’t matter what your will says, because the title on the assets supersedes a will and other legal documents, says Tom Kotick, CPA, CFP®, associate director in tax at SS&G.
“Say, for example, an account is joint tenancy with rights of survivorship,” says Kotick. “Then, by law, after your death, the asset will go to the other joint owner, even if you’ve indicated in your will that you want that money to go to your child. The law looks at how that asset is titled, and that governs where it goes.”
Smart Business spoke with Kotick about how to make sure that your assets end up where you intended.
Where do people err with titling assets?
People often get tripped up with life-changing events, for example, when they get married or divorced, if there is a death, or the birth of a child. The biggest areas of risk are assets that pass via beneficiary designation, typically IRAs, 401(k)s, life insurance and annuity products. Those are considered contractual agreements with those companies, and when you set them up, you designate a beneficiary.
A single individual may name his or her parents as the beneficiary, but not update the beneficiary after getting married. As a result, the provider will pass that money on to the designated beneficiary, even if your will or trust says otherwise. Any time you experience a life-changing event, you should do an overall review of your estate planning, and a key component of that is asset titling.
In addition, you should pay close attention to asset titling as you set up new accounts or acquire additional assets, or if there is a sizable shift in your net worth. What may have made sense when you had half-a-million dollars may not make sense if you now have $2 million.
What would you say to those who say they trust their family to make sure assets go to their intended recipients?
That sounds good in theory, but the only way to guarantee those assets transfer to the intended beneficiary is to make sure they are correctly titled. A parent may feel that all the children get along just fine, but there could be rifts.
Also, money and finances can be a very uncomfortable discussion for families, so if you can properly title your assets and your family doesn’t need to have those tough discussions, everyone is better off.
In addition, if you, as a parent, make one person the beneficiary of assets with the idea that the child will distribute them according to your will, you create another problem. If that child inherits an asset and gives it to someone else, he or she has now made a gift for gift tax purposes. Generally speaking, every person can give every other person up to $13,000 annually. This year and in 2012, there is a $5 million gift tax exclusion individuals can use to gift assets. But to the extent your child does so, he or she is eating into the $5 million gift exclusion and would have less exemption to pass assets to that child’s own heirs tax free.
Is there any way to get around it after the fact if assets haven’t been properly titled?
One way is with a qualified disclaimer. For example, if you have an account titled ‘transfer on death’ to your brother and you pass away, the account legally goes to him. But if he doesn’t want it, or doesn’t need it, and he wants it to go to your heirs, he can execute a qualified disclaimer, essentially saying ‘thanks, but no thanks,’ and that asset will pass as if he predeceased you. The asset becomes part of the estate and transfers based on your will. The risk of planning with disclaimers is that one, the individual has to agree to not accept the property; two, there is a timeline for executing the disclaimer; and three, the individual disclaiming the property must not have received any benefit from that property, for example, withdrawing funds from the account.
How can having assets properly titled speed up the process and keep matters private?
Having assets properly titled speeds up the process as it will minimize the need for any post-death planning by your advisers and can help avoid the probate process. Any assets passing by way of your will are subject to probate, which is a very public process and can take time. If assets pass through the county probate court, the details become public record anyone can access.
On the other hand, with asset titling tools including ‘payable on death’ and ‘transfer on death,’ assets transfer directly and avoid the probate process, keeping the transfer private and avoiding the expense inherent to the probate process.
How can outside experts help ensure that you get it right?
Working with an outside expert can help you determine if your plan is still appropriate given any tax law changes. Also, having that periodic review forces you to consider your family situation. Have family dynamics changed? Is the plan in place still a good plan? Without reviewing the plan every so often, it’s easy to overlook those things.
Finally, as you are titling your assets, if you are also creating a will or a trust, work with an attorney to make sure everything is titled correctly and that assets really will transfer the way that you want them to.
Tom Kotick, CPA, CFP®, is an associate director in tax at SS&G. Reach him at (330) 668-9696 or TKotick@SSandG.com.
Nexus is a Latin word for a common tie or a connection, and, in today’s business environment, it is also a key term in determining the tax jurisdiction that applies to state business taxes.
Because of the interconnected nature of our economy today, the discussion of state tax nexus has clear implications for many business owners. They often find themselves operating in multistate environments but may lack the expertise and the means to limit their tax liability and audit risk.
And as a result of that lack of technical expertise, business owners may find themselves stymied by a state tax nexus questionnaire, says Timothy A. Dudek, a director of tax strategies at Kreischer Miller in Horsham, Pa., and chair of the firm’s State and Local Tax group.
“Nexus questionnaires are not to be taken lightly,” says Dudek. “Incorrect responses on the company’s part to what can be very confusing questions — questions that prompt only yes or no answers — may give rise to unsuspecting and irreversible results. This, then, leads to being subject to the multitude of taxes within each jurisdiction.”
Smart Business spoke with Dudek about how to approach a nexus questionnaire and how to proceed should your business receive one.
Why would a business receive a nexus questionnaire?
In the current economic landscape, more and more states are feeling the impact of the budget crunch. In an effort to increase revenue, states are sending nexus questionnaires to out-of-state businesses that they suspect may be underreporting and underpaying taxes in their jurisdiction. Choosing to ignore these questionnaires may be dangerous for a business, as these states may take steps to impose arbitrary assessments and force companies to then defend themselves, ultimately resulting in a lot of professional fee expense for the business.
How do state and local taxing jurisdictions obtain their mailing list of companies to target?
It’s not too difficult to reason how they get the names of companies that may be liable for some type of tax liability within their jurisdiction. State auditors research potential business links such as customs reports, FAA logs, boating registries and realty transfer transactions.
Other revenue officials may roam trade shows and business centers, peruse telephone directories and websites and watch bridge crossings to target companies whose names are not already listed on the state database. Advanced technology allows for interdepartmental inquiries within each given state, with wage tax systems interacting with corporate tax systems.
Lastly, because of state tax compacts (information sharing agreements) signed among a number of neighboring states, the audit of one company leads to information about another company, and so on.
What types of taxes are subject to these inquiries?
While the list of taxes that are subject to these inquiries would be beyond the purview of this article, it’s essentially any tax or fee that can be imposed under that state’s taxing ordinance. This would encompass everything from corporate income and franchise taxes to unclaimed property reporting to sales and use taxes to wage taxes.
What danger do these questionnaires pose to businesses that are not familiar with them?
The answer is twofold. First, a company needs to understand the concept of nexus, which is defined differently for the different types of taxes involved. Companies may or may not be subject to state taxes based on a variety of state tax concepts, such as physical presence, constitutional nexus, economic nexus, affiliate nexus, agency nexus, or Public Law 86-272, which addresses the circumstances under which a multistate business may owe state income taxes.
Second, the questions asked on the nexus questionnaire can be quite broad in nature. A company may think that the response to a particular question should be a simple ‘yes.’ However, a more accurate answer may be, ‘Yes, except for … ’ In other words, if a company answers ‘yes’ to a particular question without providing further explanation of that answer, it becomes easier for the state to conclude that the company has nexus. Being able to provide a further explanation may provide a solid basis for concluding that the company does not have nexus.
Because of that it is a very good idea for companies to review their answers with their state tax professional before returning the questionnaire to the state. Once submitted to the state, it becomes extremely difficult to retract answers that were originally given in good faith but that were incorrectly submitted.
What other factors should companies be aware of regarding nexus questionnaires?
Companies should continuously assess their operations in any state or local jurisdiction where they do business. If you find that you have established state tax nexus, the law requires you to register in those jurisdictions and begin paying taxes.
However, before you register, if there is a possibility that state tax liabilities may have existed for your business in earlier years, first talk to a state tax professional about your options. There may be voluntary disclosure, amnesty or exemption programs that your business can utilize to resolve its tax requirements.
Timothy A. Dudek is a director of tax strategies at Kreischer Miller in Horsham, Pa., and chair of the firm’s State and Local Tax group. Reach him at (215) 441-4600 or firstname.lastname@example.org.
Although the economy might be showing signs of recovery, business owners continue to look at ways to keep costs down, and one of the most common costs that business owners look to reduce is professional fees, says Marc Newman, CPA, assurance manager at SS&G.
“A key element to reducing professional fees is to ensure audit engagements are efficient for both the accounting firm and the business. Although efficiency can be gained on audits in different ways, one of the most important is constant communication throughout the year,” says Newman.
“Throughout the year, the auditor and business owner should consult on all significant transactions to ensure the transactions are properly reflected in the financial statements and that the transaction makes business sense.”
Smart Business spoke with Newman about the steps you can take to help lower the cost of your annual audits.
What can a company do internally to help lower costs?
Understand the need for financial statements and what is driving the requirement to have an audit. An audit provides the highest level of assurance on the company’s financial statements but can be expensive to conduct. Engage your firm to assist in negotiating an acceptable lower level of assurance on your financial statements, such as a review or compilation, which are both less in scope and fees than an audit.
If an audit is the only acceptable level of assurance, having an active role in the audit process can have a significant impact on the cost. Establish an internal level of materiality to determine which transactions or accounts could have significance to users of the financial statements. Once an internal level has been established, the company should gather all relevant documents which support accounts or transactions over materiality to include in a financial close and reporting package. This will not only enhance internal controls but can also reduce the amount of documentation subsequently requested by the auditor, thus saving the auditor time.
Establish controls to safeguard the company’s assets and prevent and detect errors in its financial statements. If a company can properly design and implement an effective internal control environment, the auditor can test the company’s controls to determine whether or not the auditor can rely on the company’s controls and potentially reduce the amount of substantive audit procedures the auditor would have to perform.
Consult and communicate on all significant and material transactions throughout the year. This will ensure all significant transactions are properly reflected and disclosed in the financial statements and whether the transaction makes business sense. For example, if a lifestyle center is in the processes of refinancing its maturing debt, or a real estate developer is looking to acquire a new track of land, there are specific accounting and reporting requirements that dictate how these transactions are to be recorded and disclosed. Identifying the proper accounting treatment prior to commencement of field work can reduce the amount of time the auditor would incur in proposing adjustments or disclosures to properly reflected the transaction within the financial statements.
A properly staffed accounting department is vital to controlling audit fees and providing owners and the auditor with current and accurate financial information on a timely basis. It allows the company the ability to properly design and implement an effective internal control environment while establishing acceptable accounting procedures and policies.
How can the bid process affect costs when a company is looking to change firms?
Typically, companies will issue a request for proposal every three to four years. Although fees are always a consideration, it is important to recognize that the lowest bid is not necessarily the best for the company, and could lead to an increase in audit fees. There is a true cost in changing accounting firms. The successor firm will have to invest a considerable amount of time gaining an understanding of the company’s controls, the environment in which it operates, and its accounting policies and procedures. Also, consider the efficiencies that have been gained from the years of experience and knowledge with your current accounting firm. Companies should consider the accounting firm’s expertise, reputation and existing client base before selecting an auditor.
How can a business choose the best firm for its needs?
Consider the industry expertise within the accounting firm. Some CPA firms have niche practice areas that better understand certain industries, which not only can help with specific problem solving, but can help save time.
Look at a firm that focuses on retaining employees to achieve a low turnover in its staff. Continuity of the audit engagement team plays a significant role in keeping audit fees stable from year to year.
In the future, will your business require additional professional services beyond the traditional tax and assurance services, such as payroll processing, retirement and medical plan design and administration, or wealth management? Consider the capacity of the accounting firm. Does the accounting firm have sufficient staff to meet deadlines?
Consider what technology the accounting firm has in place. How easy is it to transfer and receive documents? A portal allows a company the ability to transfer large amounts of data quickly and securely through the Internet, thus adding efficiency to the audit process.
Finally, understand how the culture and the mission of the accounting firm compares to the company’s culture and mission.
MARC NEWMAN, CPA, is an assurance manager at SS&G. Reach him at MNewman@SSandG.com or (440) 248-8787.
In last month’s article, the concept of Tax Risk Management (TaxRM) was introduced. TaxRM is an enterprisewide process that is affected by a company’s board of directors, management and/or other personnel, and is designed to minimize tax liabilities and maximize compliance, each within the guidelines of tax laws.
Having provided a definition of TaxRM, this article focuses on elements of TaxRM processes and how they can identify opportunities associated with an organization’s strategy, operations and processes.
“TaxRM is most effective when it is treated as a component of the organization’s overall enterprise risk management (ERM) process,” says Walter M. McGrail, JD, CPA, a senior manager at Cendrowski Selecky PC. “TaxRM should be a key element of every business’s ERM process.”
Smart Business spoke with McGrail about the types of tax risks that exist and how TaxRM processes can help mitigate those risks.
What is the function of TaxRM processes?
When professionals think about tax risks, they generally think of audits and financial reporting issues. TaxRM is about much more than these elements. Among other things, a TaxRM process should quantify the impact and likelihood of tax risks, manage tax risks to a level commensurate with the organization’s stated TaxRM strategy and quantify the benefits associated with proper tax strategy implementation. The last point is a central element of TaxRM: Proper tax strategy implementation can assist an organization in maximizing its after-tax earnings available to shareholders.
What types of tax risks exist?
Profitable organizations pay numerous taxes, including corporate income, sales, excise, payroll and withholding taxes. These taxes arise from decisions made in accordance with an organization’s strategy, operations and processes.
Tax risks are present within each of these elements due to uncertainty in the decision-making process and tax law changes. Among other things, tax risks might pertain to uncertainties in the application of tax law to numerous areas of the business; financial reporting decisions; acquisitions and divestitures; and asset purchases and sales.
Nearly every decision made by a for-profit corporation involves tax implications, and hence, tax risk. With some corporations paying upward of 40 percent of their profits in income taxes, the ramifications of tax risks can be highly significant and can negatively affect a business’s after-tax cash flow.
However, mitigation of tax risks can present numerous benefits to businesses while maximizing tax compliance.
Can you give specific examples of how TaxRM processes can identify opportunities associated with an organization’s strategy, operations and processes?
Let’s suppose an organization has a documented strategy stating that it wants to become a market leader in its industry. In order to achieve this goal, the organization must grow organically or acquire outside firms to increase its market share.
In some instances, the purchase of an external firm may provide significant tax benefits. For instance, if the acquisition is optimally structured from a tax standpoint, the target’s existing tax loss carry forwards may be preserved within the entity post acquisition. TaxRM processes can also help guide organizational managers in their operational and process-level decision-making. For example, if an organization requires new machinery for manufacturing processes, leasing equipment may provide significant tax benefits when compared with capital expenditures associated with the purchase of a machine. However, the lease versus buy decision will hinge on numerous business-specific factors; it is not always optimal to lease equipment.
What are some prevalent risks that TaxRM processes can mitigate?
Business transactions, including asset acquisitions and divestitures, often present significant tax risks and opportunities for businesses. Involvement of the tax function or an external tax adviser in examining these transactions can yield significant benefits to the organization and potentially improve its profitability. This involvement might also save the business significant costs by ensuring a transaction is structured optimally from a tax standpoint.
For example, in some instances, business owners may desire to change the classification of their organization. If an organization that is taxable as a corporation elects to be classified as a partnership, this election will generally be treated as a full liquidation of the existing corporation and a subsequent formation of a new partnership. This classification change could thus cause the organization to realize harmful tax consequences, both immediately and in the future.
Involvement of the tax function or an external tax adviser in such decision-making can help managers make decisions in the best interests of the organization and maximize the after-tax cash flows of the business.
How can an organization achieve maximum benefits from a TaxRM process?
Again, in order to be most effective, a TaxRM process should be integrated into an organization’s ERM process. In this manner, tax risks can be evaluated simultaneously with other business risks, and the tax benefits and costs of an organization’s strategy, operations and processes can be regularly evaluated. Integrating TaxRM into the organization’s ERM process also signals to employees the importance the organization has placed on TaxRM. If employees can tangibly discern the organization’s emphasis on TaxRM, it is likely that they themselves will place greater emphasis on examining tax risks in their decision-making processes.
Walter M. McGrail, JD, CPA, is a senior manager at Cendrowski Selecky PC. Reach him at (248) 540-5760 or email@example.com, or visit www.cendsel.com.
In the past two months, we have defined tax risk management (TaxRM), discussed the optimal structure of TaxRM processes and provided examples of tax risks. More specifically, TaxRM is an enterprisewide process that is effected by a company’s board of directors, management and/or other personnel, and is designed to minimize tax liabilities and maximize compliance, each within the guidelines of tax laws. TaxRM processes are most effective when they are treated as a component of the organization’s overall enterprise risk management (ERM) process. Typical risks mitigated by TaxRM processes might pertain to uncertainties in the application of tax law to numerous areas of the business, financial reporting decisions, acquisitions and divestitures, and asset purchases and sales.
In this month’s article, Smart Business sat down with Walter M. McGrail, JD, CPA, a senior manager at Cendrowski Corporate Advisors LLC, to discuss how risks can be identified and prioritized in TaxRM processes.
“Prioritization of tax risks is an essential component of TaxRM processes. It may directly impact the effectiveness of a business’s tax function,” says McGrail.
What are some prevalent tax risks?
Many tax risks exist for any organization; however, one of the largest risks an organization faces is the risk of proper tax compliance. IRS audits are costly, time consuming events. The risk of an IRS audit should be mitigated by an organization’s TaxRM process. While TaxRM processes are seemingly the domain of the tax department, tax professionals are dependent on data from outside the tax department. For instance, tax managers must understand the basis of information presented in a business’s financial statements, including the derivation of GAAP-based accounting estimates. Without such an understanding, a tax professional may improperly prepare tax-basis financial statements, increasing the likelihood of an IRS audit. Furthermore, tax professionals should bear in mind that there exists no standard of materiality in the event of a tax audit. Unlike audits of GAAP-basis financial statements, where a threshold of materiality governs the audit, every item in a tax-basis financial statement is material. This is a significant, often overlooked tax risk that organizations must assess and mitigate.
How should tax risks be identified?
One way to promote tax risk identification is through risk workshops. In these workshops, participants from various levels of the organization jointly voice their concerns regarding prevalent tax risks. Workshop participants must possess a personality that affords them the ability to freely voice their concerns. If participants do not possess this personality, the workshop will not optimally identify risks.
Additionally, risk identification in workshops requires participants to identify foundational risks rather than superficial risks or effects of risks. For example, workshop participants might enumerate ‘poor tax compliance’ as a risk. However, poor tax compliance is a consequence of risk realization, not a foundational risk itself.
Poor tax compliance might be caused by the receipt of inaccurate information from a business’s operations. Going a step further, a lack of accurate information might be caused by an outdated IT system, a lack of an appropriate data entry policy, or a poorly executed but well-intentioned data entry policy, among other things.
In any event, it is essential for participants to identify foundational risks in order to properly analyze and mitigate them and the exposure associated with these risks.
How should tax risks be analyzed?
Once identified, tax risks should be quantified along two dimensions, impact and likelihood, before a detailed analysis of the risks is performed. The impact of a risk denotes the consequences of its realization. For instance, if a risky event is realized, this realization may cause the business to be subject to tax-related interest and penalties.
Furthermore, while the realization of tax risks will generally have a negative impact on the business’s after-tax earnings, numerous spillover effects may also occur. These spillover effects may include degradation in the business’s revenue, profits, reputation with customers and reputation with suppliers. It is important to include spillover effects when quantifying the impact of tax-related risks.
The likelihood of a risk is the probability or chance that it may occur. Likelihood is a function of the business’s internal environment, including the tone at the top set by management and the board of directors; business’s organizational structure; chain of communication; assignment and authority of responsibility; human resources policies and practices; and the culture of risk awareness present at the organization. It is also a function of the controls designed to mitigate the likelihood of risky events, including the implementation of risk assessment and monitoring policies.
Lastly, the likelihood of risky events is dependent on the business’s external environment, including its susceptibility to regulatory changes and shifts in its competitive landscape.
What types of tax risks should businesses prioritize?
Businesses should prioritize high impact/high likelihood tax risks, as these risks present the greatest exposure to the organization. High impact/high likelihood risks may be known to the organization due to their frequency of occurrence, but they must be properly mitigated to ensure the business does not suffer frequent, severe consequences. High impact/low likelihood risks, including ‘Black Swan’ events are also of high importance. A business is often highly vulnerable to such risks as employees may be unfamiliar with their occurrence, and proper ways to mitigate these risks in the event they arise.
Walter M. McGrail, JD, CPA, is a senior manager at Cendrowski Corporate Advisors. Reach him at (866) 717-1607 or firstname.lastname@example.org, or visit www.cca-advisors.com.