If you’ve acquired, constructed or improved a building in the last three years, you may want to consider a cost segregation study. A cost segregation study identifies and reclassifies personal property assets (nonstructural elements, exterior land improvements and indirect construction costs) to shorten the depreciation time for taxation purposes, which reduces current income tax obligations.
Analysis of capital expenditures is used to determine appropriate asset classifications. Cost segregation identifies building costs and reclassifies them to permit a shorter, accelerated method of depreciation for certain building costs. Costs for nonstructural elements (wall coverings, carpet, accent lighting, portions of the electrical system) and exterior site improvements (sidewalks and landscaping) can often be depreciated over five, seven or 15 years.
“Cost segregation studies can be very beneficial,” says Kevin Lovins, CPA, a tax shareholder with Briggs & Veselka Co. “Tax depreciation deduction is accelerated, which reduces income taxes and increases cash flow. It should be noted, however, that income taxes are only deferred, not eliminated.”
Also, component costs are usually not easily identifiable and the IRS will not allow a taxpayer to estimate the components.
Smart Business asked Lovins about cost segregation studies, how to conduct one and why they are so helpful in today’s economy.
What problems can a company face when acquiring, purchasing or improving real estate property?
When the individual component costs of a building are unavailable, the costs are generally classified as a 27.5- or 39-year property. The acceleration of depreciation expense is missed when the entire costs of a building is classified this way. Generally, the individual component costs of acquiring, constructing or improving a building are not readily available. When purchasing a building, the cost is usually just a lump-sum amount. Since depreciation expense is missed, taxes are accelerated and cash flow is negatively impacted.
How does a cost segregation study work?
Usually, an accountant and an engineer will analyze architectural drawings, mechanical and electrical plans and other blueprints to segregate the structural and general building electrical and mechanical components from those linked to personal property. The study also allocates ‘soft costs,’ such as architect and engineering fees, to all components of the building. While the building itself and any structural components are required to be depreciated over 27.5 or 39 years, parts of a building, including tangible personal property and land improvements, may qualify for an accelerated deprecation method over a much shorter recovery period (five, seven or 15 years). A cost segregation study identifies costs eligible for accelerated depreciation method over a shorter recovery period. By identifying costs eligible for accelerated tax depreciation expense, current taxes are reduced, which improves cash flow. Taxes are only deferred, not eliminated.
What are the benefits?
Cost segregation studies are performed by trained tax and engineering professionals.
The professionals separate the individual cost components by analyzing the construction drawings and methods and applying their knowledge of the internal revenue code, revenue rulings and court cases. A cost segregation study not only identifies the component parts of a building, but also substantiates the allocation of cost of a building among the individual components.
In addition to providing tax relief, a cost segregation study can benefit businesses by maximizing tax savings by adjusting the timing of deductions. When an asset’s life is shortened, depreciation expense is accelerated and tax payments are decreased during the early stages of a property’s life. This, in turn, releases cash for investment opportunities or current operating needs.
A cost segregation study also creates an audit trail. Improper documentation of cost and asset classifications can lead to an unfavorable audit adjustment. A properly documented cost segregation helps resolve IRS inquiries at the earliest stages.
Finally, taxpayers can capture immediate retroactive savings on property added since 1987. Previous rules, which provided a four-year, catch-up period for retroactive savings, have been amended to allow taxpayers to take the entire amount of the adjustment in the year the cost segregation study is completed. This opportunity to recapture unrecognized depreciation in one year presents an opportunity to perform retroactive cost segregation analyses on older properties to increase cash flow in the current year.
What can go wrong if a cost segregation study isn’t done?
If a taxpayer does not obtain a cost segregation study from a qualified professional, the taxpayer may not be able to substantiate his or her tax position upon challenge from the Internal Revenue Service (IRS). The IRS does not allow the taxpayer to estimate the individual component costs.
KEVIN LOVINS, CPA, is a tax shareholder with Briggs & Veselka Co. Reach him at firstname.lastname@example.org or (713) 667-9147.
Just about any employer can see the value of sick days. Besides helping your employees get healthy, they keepsick employees away from everyone else on your staff, ensuring that the illness doesn’t spread. But, sick days are sometimes abused or misused, and an employer always has to be conscious of the bottom line, which begs the question: How many sick days should employees get, and which employees should get them?
A current piece of legislature being kicked around Ohio is the Healthy Families Act, which would require employers of 25 or more people to allow full-time employees to earn seven mandatory paid sick days a year. Part-time employees would also be protected on a prorated basis. Employees and their spouses, children and parents (including in-laws) could use these sick days to recuperate from injuries or illnesses, obtain preventive care, or get medical treatments.
The Ohioans for Healthy Families, a statewide coalition of citizens and organizations, is strongly behind the act, and they’re currently gathering support in an effort to get the proposal on the November ballot. On the other hand, many employers the ones who are aware of the act, anyway are wary of handing out a full week of sick days, particularly for nonfull-time employees.
“Several business groups are rallying together to defeat this act, but many business owners don’t even know this is going on,” says Leah Pappas, an attorney in the government relations practice group at Calfee, Halter & Griswold LLP. “It’s not that companies want to deny employees sick time, but seven full days for all employees part-time, full-time, half-time, whatever can get to be very expensive.”
Pappas adds that the problem is twofold. With large companies, the bigger the staff, the bigger the expense. With smaller companies, many of them only or mostly hire part-time employees specifically because they can’t afford to pay for sick time. Thus, all businesses are afraid of what mandatory sick days could mean to the bottom line and, in some cases, the companies’ future.
Smart Business spoke with Pappas and W. Eric Baisden, a partner in the labor and employment group at Calfee, Halter & Griswold LLP, about the Healthy Families Act, what it will mean to your business if passed and what employers can do about it.
What are the main things business owners need to know about the proposed Healthy Families Act?
As written, the act allows employees to begin accruing the paid sick leave immediately upon hire and to use it after 90 days of employment. Leave could be taken in the smallest increments possible. And, unless foreseeable, an employer only needs to provide oral or written notice of need for this leave ‘as soon as practicable.’ Employers may not penalize employees for utilizing their paid sick leave. Supporting medical documentation could only be required if the leave exceeds three days. Employees may not be penalized for availing themselves of this entitlement. Thus, an employee could arrive for work several hours late and simply indicate that he or she was sick. The employee must be provided paid leave without suffering any adverse consequences. This is just one example of what could cause employers concern above and beyond the cost they may face in being required to provide seven paid sick days.
If the Healthy Families Act is passed, how will Ohio businesses be affected?
Ohio would be the first state to adopt such a leave law. Ohio is currently struggling to remain competitive and to attract new industry. Adding additional financial burdens, which on the surface seem attractive, only makes it harder for Ohio to remain competitive and to bring new jobs to the state. Businesses will be required to adopt the leave provided for by the act possibly even in addition to existing leave policies available to employees. This will be especially difficult for start-up businesses with very little room to absorb additional costs.
Can an employer see any benefits from the Healthy Families Act?
The purported purpose of the proposal is an attractive one. However, most responsible employers currently offer a variety of leave to employees, which provides flexibility and recognizes legitimate reasons to be away from work. Horror stories of employees being terminated for legitimate absences are typically overblown and based on an incomplete story. Employers do not want to lose productive employees and most are empathetic to personal and family emergencies.
What should business owners do now, before the Healthy Families Act is passed?
Business owners need to review their current leave policies since they will not be able to make any changes after the effective date of the act. Business owners should consult with their employment counsel to determine whether any modifications to sick leave and time-off policies are necessary. Additionally, business owners should consider getting the message out to their employees why the act would cause hardships for the company. Business owners should also consider becoming active in groups working to defeat this measure. <<
LEAH PAPPAS is an attorney in the government relations practice group at Calfee, Halter & Griswold LLP. Reach her at (614) 621-7007 or LPappas@Calfee.com. W. ERIC BAISDEN is a partner in the labor and employment group at Calfee, Halter & Griswold LLP. Reach him at (614) 621-7752 or EBaisden@Calfee.com.
Partner, labor and employment group
Calfee, Halter & Griswold LLP
The use of partnership equity compensation is a growing trend. Using equity in a partnership or a limited liability company (LLC) to compensate and incentivize executives and other service providers involves giving them either a “capital interest” or a “profits interest” in the entity, according to J. Troy Terakedis, an attorney at law with Calfee, Halter & Griswold LLP. The type of interest received will impact the federal income taxes of the recipient.
“Over the last several years there has been an increased focus on structuring equity compensation arrangements in the partnership and LLC contexts,” says Terakedis. “Thus, it’s important to understand these arrangements so the recipient of the interest is not surprised with unexpected taxes.”
Smart Business spoke with Terakedis about partnership equity compensation arrangements and the federal income tax considerations related to such agreements.
Why are we seeing an increase in partnership equity compensation arrangements?
The reason for this increase is due in large part to more companies being formed as a partnership or an LLC (taxed as a partnership). These non-corporate entities enjoy both tax and non-tax advantages over corporations. Another reason is a resurgence of companies wanting to incentivize management teams by compensating them with equity interests. This gives management the ability to participate in the success of the company, and better aligns management’s interests with those of the company’s owners.
What’s different about these arrangements?
IRC Section 83 governs the tax consequences of a transfer of property to a service provider. In general, property (e.g., stock in a corporation) issued in connection with the performance of services is taxable to the recipient as ordinary income in the first year the property is transferable or not subject to a substantial risk of forfeiture. The amount included in income is the fair market value of the property less any amount paid for such property. Any future appreciation in the value is taxed at capital gains rates when the property is sold. But, it was unclear how IRC Section 83 would apply to partnership interests. There was debate as to whether partnership interests were property and, if so, how such interests were to be valued. The IRS clarified how it would tax compensatory partnership interests with two Revenue Procedures: Rev. Proc. 93-27, 1993-2 C.B. 343 and Rev. Proc. 2001-43, 2001-2 C.B. 191.
What do those Revenue Procedures mean?
They recognized that there are two types of partnership interests: ‘capital interests’ and ‘profits interests.’ A capital interest gives the holder a share of the proceeds if, immediately upon receipt, the partnership’s assets were sold at fair market value, all partnership liabilities were satisfied, and the proceeds were distributed in a complete liquidation of the partnership.
A profits interest is any interest that is not capital interest. A profits interest only entitles the recipient to income and appreciation in the partnership that arises after the date the interest is issued. The time to test whether the interest is a capital interest or profits interest is at the time of issuance, even if the interest is subject to forfeiture. If the interest is a profits interest, then an executive or service provider will not be taxed on the receipt of the interest. IRC Section 83 will not apply to the receipt of a profits interest, but will apply to the receipt of a capital interest. This is beneficial to the recipient of a profits interest because they do not have to pay for the profits interest and they are not taxed on its receipt. This treatment is not available if the equity interest is stock or a capital interest.
Are there any other rules?
In May 2005, the IRS issued Notice 2005-43, 2005-43 IRB 1, and proposed Treasury regulations (Reg. 05346-03), which would make Rev. Proc. 93-27 and Rev. Proc. 2001-43 obsolete. If adopted, the issuance of a partnership interest in exchange for services will be subject to IRC Section 83, regardless of whether the partnership interest is a capital interest or a profits interest. The proposed rules would permit the amount which must be included as ordinary income by the recipient of the partnership interest to be based on ‘liquidation value’ rather than ‘fair market value’ if a special election is made by the partnership. Generally, use of liquidation value will result in a lesser amount being taxed to the recipient of a profits interest. The proposed rules are complex and address many other aspects of compensatory partnership interests. It is not expected that these rules will be finalized in 2008 and, until they are, Rev. Proc. 93-27 and Rev. Proc. 2001-43 will continue to apply.
What problems can arise from these arrangements and the taxation of them?
The biggest problem is when the partnership interest issued is really a capital interest and not a profits interest. Then, the executive or service provider receiving the interest will be taxed on its value. Thus, the partnership agreement must be carefully drafted so the interest is properly characterized as a profits interest. Moreover, since it is expected that the proposed rules will eventually be finalized, it’s necessary to make provisions for electing the use of liquidation value so the expectations of the company and the executive or service provider can be realized.
J. TROY TERAKEDIS is an attorney at law with Calfee, Halter & Griswold LLP. Reach him at (614) 621-7757 or JTerakedis@Calfee.com.
In today’s high-paced, technology-driven market, the way companies do business is ever-evolving. Buying and selling isn’t ust done face to face anymore. Business is done in a variety of ways and through several different channels. Savvy businesses are marketing their companies in ways never before imagined via e-marketing campaigns or programs, search engine optimization (SEO), pay-per-click, e-mails, banner ads, Webinars, blogs, RSS feeds, podcasts and Internet television. All of this is in addition to traditional methods, such as print, mail order, public relations, billboards, radio and television.
It’s a lot to keep track of, and if you’re not on top of things, your marketing dollars may end up going down the drain. Thus, companies are searching for a holistic way to manage a broad range of communication vehicles to various target audiences. The search has lead to the advent of integrated marketing communications (IMC).
According to Dick Brooks, director of the Center for Integrated Marketing Communications at San Diego State University, IMC is designed to make all aspects of marketing communications work together as a unified force, rather than each aspect working alone in isolation. IMC creates a unified look and message for all elements of a marketing campaign, leading to less headaches for companies and their marketing teams and, more importantly, more money to the bottom line.
Smart Business spoke with Brooks about why IMC is important in today’s market and what companies can do to implement it.
Why has IMC grown in importance?
The number of media tools has grown exponentially over the years, giving marketers a vast range of opportunities to send their messages to their target audiences. But, it’s difficult to sort out what vehicles will best reach your audiences in the most appropriate ways. A younger consumer will have different media consumption behaviors than a baby boomer, so you need to know the needs and wants of your target audiences, then get the right message to them via the appropriate vehicle, and you need to do it all while staying within your marketing budget. All of this has led to the need for a good IMC program.
What are the challenges of IMC?
A big challenge comes when the various people who take ownership in different media silos compete with one another. For instance, one group may be in charge of media advertising, while another is in charge of the Web site. Both have their own individual ideas and creative directions, so they don’t want to change. This happens constantly. It gets further complicated when a marketer employs different agencies to do different functions. It’s usually easier to get your own people on the same page versus those from different companies. Either way, though, the result is inconsistency of messages, using the wrong vehicles to reach the wrong audiences and the improper allocation of marketing dollars.
How can these challenges be overcome?
The solution has to come from the top down, with a mindset that all marketing ventures are going to be managed holistically, with the appropriate tools delivering the appropriate messages to the appropriate audiences. Also, someone needs to be in charge of the entire process, which is why we’re seeing the creation of a new position: manager of IMC. Knowing what to use, when to use it and how much to spend can be a major challenge. A manager of IMC can look at the big picture and ensure this is being accomplished.
What should a company look for in a manager of IMC?
Most importantly, the person needs to have incredible people skills. He or she will have to negotiate through all the various communication silos and the egos that go with them. Bringing all of this together, while staying in budget, takes an expressive, understanding and influential person. The person also needs to have license from above to make all this happen. He or she also needs to have the ability to help train all parties involved and keep them on the same page. Obviously, the individual needs to be knowledgeable, skilled and trained in the range of tools available as well as adept at being able to translate a creative platform that describes the target audiences and the messages to be delivered.
What does the future hold for IMC?
The importance of IMC is growing rapidly as we speak, and it will continue to do so for many years. The key is figuring out the best way to implement IMC. With that, top management wants accountability it wants to know exactly where its communication dollars are going. Right now, we can measure individual aspects, such as the impact of a banner ad or a podcast, but we need a better way to measure the synergistic effect of an entire campaign. The holistic effect is still difficult to quantify, so there will be more efforts in the future to improve that. The interest in the marketplace for IMC is great, and with the cost of communication increasing practically every day, the bottom line is screaming for a measurement of performance.
DICK BROOKS is a clinical professor of marketing and director of the Center for Integrated Marketing Communications at San Diego State University. Reach him at (619) 594-4713 or email@example.com.
In today’s ultracompetitive job market, it’s hard to find a good fit. It’s difficult for applicants to find a good job, and it can be equally difficult for companies to find good employees. If both sides are looking for similar qualities, shouldn’t it be easier to find common ground?
“Finding the right candidates can be easy, if a company knows what it’s looking for and how to attract it,” says Deborah Phillips, chief administrative officer of Priority Health. “It’s worth the effort because having quality people in your company will help you secure better financial results. Smart companies know they must find, develop and keep the people who keep them competitive.
“Securing the right human talent is essential. Identifying and developing high performers for future leadership positions as well as developing effective planning methods to ensure that you have strong leaders in the pipeline are key to a company’s future. The best way to sustain continued growth is to increase the number of people in the leadership pipeline who can intelligently look at the business and find ways to accelerate your performance.”
Smart Business spoke to Phillips about strategies to attract and retain the best and brightest.
How do you define ‘high performers’?
High performers are people who are eager to get ahead and who have the skills to move themselves forward. They are committed to meeting or exceeding customer expectations, have a positive attitude, excellent communication skills, and a strong desire to contribute. They have an aptitude for continuous learning, enthusiasm for the organization and their role in the organization, and the ability to transfer knowledge to ensure the success of others. High performers are not happy until the job is done and goals are met. They are solution focused, they accept accountability, and they demonstrate emotional maturity. Finally, they are technically competent. They have exceptional industry or business knowledge, think organizationally, and rapidly bring new skills and information into use. High performers are people you know will be the future of your company.
What are strategies to recruit them?
In most cases, the best candidates are not looking for positions, so to locate these hard-to-find candidates you have to work harder and smarter to find them.
Finding, recruiting and screening candidates can be a very time-consuming process, and it can be expensive if you make a mistake. Utilizing outside recruiting specialists who understand your business, networking with colleagues and encouraging employee referrals are ways companies can effectively find good applicants without wasting valuable time and money. Technology (Web sites, Internet postings, resume searches, blogs, etc.) is also an effective tool.
Companies can also try calling contacts or just cold-calling prospective recruits. If you know what you’re looking for and your reputation is solid, letting people know in a very direct way that you’re interested in them can pay off.
What are strategies to retain them?
If a company wants to keep high performers, it needs to create a culture that attracts the best and brightest. You don’t want your company to be a steppingstone for employees; you want it to be a place where employees want to stay.
Again, smart companies have a succession management and leadership development program in place for their high performers. High performers, or high potentials, demand a development program. Do not develop a list of high potentials if you do not have the resources to develop the program.
What are strategies to develop them?
Stay involved. Develop a clear set of standards and objectives about what it takes to succeed in the organization, and ensure there is a clear connection between what you require of your leaders and how you can win in the marketplace. Define the ‘critical experiences’ required to be a high performer, i.e., what experiences are necessary to prepare the employee for the future role? Plan for outside coaches. If you don’t have the skills internally to develop the individual or don’t have the time, you risk losing the high performer. Create individual development plans. Remember, one size does not fit all! Include critical timelines, action steps, metrics and measures of the program. Teach business acumen. Ensure that your high performers are well grounded in the business.
Finally, make sure you involve the high performer in the development plan. Remember, more than anything else, high performers thrive on challenges. If you keep them stimulated, it’s a win-win: They’re more likely to stay, and your company will continue to benefit from their efforts.
DEBORAH PHILLIPS is the chief administrative officer of Priority Health. Reach her at (616) 464-8135 or firstname.lastname@example.org.
A hot topic in the accounting world centered on the audit reform standards that the American Institute of Certified Public Accountants (AICPA) issued in March, 2006. The standards (SAS 104 through SAS 111), commonly known as the risk assessment standards (RAS), are effective for this year’s calendar year-end audits. They were designed to improve the audit process, requiring auditors to perform risk assessments for each client, while tailoring audit procedures to address specifically identified risks.
According to Andy Kuntz, a CPA with Briggs & Veselka Co. in Houston, the primary objective of the standards is to improve the auditors’ application of the risk model, through a more in-depth understanding of the entity and its environment, including its internal control and, ultimately, an improved linkage between the risks and the nature, timing and extent of audit procedures.
“The objective was a more rigorous and consistent audit process regardless of the size or type of entity being audited,” says Kuntz. “Many have drawn the parallel between RAS and private companies and SOX [Sarbanes-Oxley Act] and public companies.”
Smart Business spoke with Kuntz about the new standards, what they mean, what challenges they’ll present and how companies can overcome those challenges.
What are some changes companies can expect to see as a result of the new standards?
First, more thorough information must be assembled on the nature of your company and its industry and environment in order to identify risks. Significantly more work will need to be performed on internal controls, as well. In the past, our professional standards permitted us to obtain a basic knowledge of the internal controls, and then assess control risk at the maximum level. Now, we are required to obtain a more thorough understanding of the internal control structure, evaluate if controls are designed appropriately and determine if those controls are implemented. Then we have an option as to whether we want to perform specific tests of internal controls or to perform substantive tests. However, we are required to test controls if substantive procedures alone are not sufficient to reduce risk.
Additional changes that companies will notice in future audits are the types of audit evidence being acquired. Historically, an auditor may have simply asked someone in the accounting department to describe a process or an internal control. The RAS clearly indicate that inquiry alone is no longer sufficient. Auditors will now be asking for you to document your internal controls and other procedural items. Additionally, under the new standards, auditors are required to perform walk-throughs of certain transaction flows and corroborate information learned via inquiry with additional procedures.
Private entities can also anticipate different types of communication during the course of the audit. Engagement letters, which are essentially contracts between auditors and companies, will have revised language. Auditors will also communicate some additional information with respect to known and likely misstatements identified during the course of the audit. Private companies can also anticipate receiving additional comments from auditors with respect to issues or weaknesses in their internal control structures.
The RAS will require more time in preparing for and executing the audit. The audit will likely take longer, which could translate to higher fees, especially if proactive steps are not taken to document internal controls and ensure they have been implemented effectively.
What can a company do to prepare for the changes?
Management needs to understand that auditing private companies is a whole new ballgame now. Companies have to be proactive when it comes to these changes, and that should start with a meeting with your auditor. Other steps may include:
- Document your existing controls and ensure they are implemented as documented.
- Consider testing controls, and formally documenting the testing procedures performed, and share this information with your auditor.
- Evaluate your accounting department to see if the existing infrastructure is sufficient based on the size and complexity of the organization.
- Look at credit agreements to see what covenants are in place and whether there is a requirement to provide correspondence from your auditor related to internal controls and other matters. Many believe the new standards will result in additional auditor comments and potentially more severe comments which could lead to covenant violations and events of default.
- Finally, determine if an audit is the most appropriate service. In certain cases where an audit is not needed for an upcoming exit strategy, companies have negotiated to reduce the requirement from a financial statement audit to a financial statement review, which are not currently subject to the RAS.
Your company can save time, money and potentially improve the overall control structure by taking these steps now.
ANDY KUNTZ, CPA, is a principal in the Audit Department at Briggs & Veselka Co. in Houston. Reach him at (713) 667-9147 or email@example.com.