How to navigate the state sales tax landscape after the Wayfair decision

As e-commerce grows, states have become increasingly unhappy with how sales and use taxes are collected on remote retailers. A recent U.S. Supreme Court decision, South Dakota v. Wayfair Inc., however, dramatically changed the landscape for sales tax nexus, and the obligation to file and report taxes.

“It’s not Armageddon, but you may need to start filing in a handful or more states in the coming years,” says Mike Feiszli, managing director of state and local tax at BDO USA, LLP.

Smart Business spoke with Feiszli about what’s next for companies.

What’s the background on the Wayfair case?

Nearly 30 states created non-standardized statutes with economic nexus standards for sales tax. They sought to get around the nexus standard that a remote seller needs a substantial physical presence within the state to be subject to that state’s sales tax laws and reporting requirements, which the Supreme Court reaffirmed with the 1992 case, Quill v. North Dakota.

In 2016, South Dakota decided that a retailer that sells $100,000 of tangible personal property or services, or completes 200 transactions, has enough business activity to be subject to its sales tax law. The law was challenged by Wayfair and two other internet sellers in the South Dakota courts, with the lower level courts holding for Wayfair, due to the Supreme Court precedent. The Supreme Court was petitioned by the state and decided in June, 5-4, in favor of the state. It reversed Quill, finding that physical presence is an incorrect interpretation of the commerce clause and isn’t required for substantial nexus. It didn’t define what the nexus standard should be — leaving that to a stalled Congress — but it does consider South Dakota’s economic standard to be reasonable.

Have other states reacted yet?

Some states already had standards similar to South Dakota, and many of those became effective over the summer. About a dozen other laws will become effective soon. If a state had an economic nexus standard prior to Wayfair, the Supreme Court didn’t encourage retroactive enforcement. A few states, Ohio and California, for example, have higher nexus limits than South Dakota, while Pennsylvania has a nexus standard of $10,000. Many states, including Ohio, will likely start aligning more closely with South Dakota’s law.

What does this mean for businesses?

To any business owner not currently registered in multiple jurisdictions in the U.S., be aware that the landscape has changed. It’s no longer a matter of whether you have a salesperson or warehouse in a jurisdiction. If you have a certain amount of sales or transactions, states probably have, or will have soon, a law in place that will require you to register and start reporting sales and charging sales tax.

If your company believes it only has exempt sales or that because it only provides services, Wayfair won’t affect its business, that’s not necessarily the case. States will look at gross receipts that are sold into the state and expect you to register once you hit a threshold. You’ll need, at a minimum, to begin filing returns and reporting sales activity. You will also need to document exempt sales and keep exemption or resale certificates, while remembering that state’s rules vary on exemptions as well as acceptable documentation. If proper documentation isn’t kept and you’re audited, those sales could become invalidated and you as the seller may be on the hook for tax that likely should have been the purchaser’s burden.

There will certainly be a compliance cost to the court’s decision.

So, what needs to occur now? You need to do a self-analysis. States won’t immediately know you’re over because they’re not geared up for this change either — as much as they wanted this decision. However, they can and will eventually find out through audits of the purchases of your customers in their state and by cooperating with other states or governmental agencies.

Your tax adviser can help you determine the pressure points, the aggressive states, who is likely to be auditing companies soon and who is not. It’s like any business decision — go through the analysis, determine where you have issues and then decide on a plan that fits your risk tolerance and budget.

What else is important to know about the Wayfair’s long-term impact?

There are many unanswered questions, like how the decision affects international business. At some point, these cost burdens will likely be reflected in prices, and brick and mortar stores may find themselves on a more level playing field with internet businesses. As tax laws change, you’ll also want to keep an eye on whether this affects income tax or other state and local tax compliance in other jurisdictions.

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Why EBITDA matters in M&A

Business leaders are used to the scrutiny of audits, but that doesn’t compare to the fine-toothed comb of due diligence before a sale. A transaction team has a tighter scope, says Ross Vozar, managing director of Transaction Advisory Services at BDO USA, LLP.

EBITDA, or earnings before interest, taxes, depreciation and amortization, is a typical business metric. Generally speaking, the value of a company is a multiple of that EBITDA, based upon the industry you’re in. But buyers don’t want to pay for a non-recurring event and sellers don’t want to be penalized for a one-time expense.

“There needs to be clear expectations on both sides. When these aren’t identified upfront, it can slow down or kill a deal,” Vozar says. “There can be hard feelings, because one party feels like the other is hiding something.”

To avoid confusion, sellers are hiring transaction teams to get a credibly backed and true value on the business before they put the company on the market. This “sell-side quality of earnings” provides a clear understanding of sustainable earnings that supports valuation in a M&A process.

Smart Business spoke with Vozar about the difference between reported EBITDA and adjusted EBITDA and how it impacts value.

How might EBITDA change?

Let’s say a company that manufactures roofing products has an EBITDA of $10 million. The industry multiple is six times EBITDA, so the business owner expects the business to be worth $60 million. The owner settles on a buyer. However, during due diligence, the buyer performs a quality of earnings analysis on that $10 million EBITDA, which in part seeks to understand how the company earns that $60 million value — who are the customers and what is recurring and non-recurring income.

The year prior, several hurricanes hit the southeastern U.S. This company, which sells its roofing products through Home Depot, sees sales spike in that region. The quality of earning analysis determines $1 million of income isn’t sustainable; it’s from a non-recurring event when people replaced roofs. The EBITDA is adjusted from its reported number, and value drops to $54 million. The problem is that the seller expected to get $60 million.

What are other areas that commonly cause EBITDA to be adjusted during a transaction?

Depending on the size of the business, sometimes owner personal expenses are charged to the company. Sellers want to identity those because going forward the business will not incur those types of expenses, which will increase EBITDA.

Another item that will be missed in reported EBITDA are professional fees. For example, a $100,000 legal settlement was correctly reported, but the accompanying $25,000 in professional legal fees could be buried in another line item. Both expenses are non-recurring and can be taken out.

An area to watch is self-insurance reserves used for workers’ compensation and health insurance, which fluctuate. Certain large claims could be justified as non-recurring.

In the case of audited financial statements, some expenses and incomes may be below an auditor’s scope and, as such, aren’t adjusted as part of the audit. Typically, the concept of scope isn’t used in a quality of earnings and the threshold of significance is lower. When multiples of EBITDA are used, a $100,000 item, for example, may impact valuation by $600,000. It needs to be correctly recorded and classified.

Also, most income statements have an ‘other income and expense’ line item that is either a catch-all or kept separate to identify the amounts as non-operating. Other income and expense needs to be scrutinized to understand if these items are, in fact, non-operating or non-recurring in nature.

What else do business owners need to know?

Hire the right adviser, or risk being left in the dark. These kinds of transactions aren’t familiar to many successful business owners. They don’t understand how reported and adjusted EBITDA differ. Instead, they rely on key advisers to point them in the right direction — and that doesn’t always happen.

It’s worth the cost, time and effort to hire a transaction professional. Northeast Ohio is undergoing the most robust transaction environment of the past 10 years. Buyers and sellers both need a clear understanding of a company’s financial history, in order to consummate a transaction.

Insights Accounting is brought to you by BDO USA, LLP

How do you stack up to the risks of big manufacturers?

Manufacturers are up against coalescing forces of technological disruption, economic uncertainty, globalization and trade upheaval — all of which will shape the manufacturing industry of tomorrow. Today, that means a wide array of business risks to identify, evaluate and build into business strategy.

But there’s also ample reason for optimism. New orders, employment and inventories reflect stability, and with the installation of a new administration vocally committed to boosting U.S. manufacturing competitiveness, momentum seems to be building.

Smart Business spoke with Tina Salminen, assurance partner at BDO USA, LLP, about the 2017 BDO Manufacturing RiskFactor Report, which examines risk factors in the most recent 10-K filings of the largest 100 publicly traded U.S. manufacturers.

How much are politics playing into companies’ risk profiles?

Even with the Trump administration’s stated focus on regulatory reprieve, the feasibility and speed of potential reform is still murky. There’s hope in the industry that a solid level of balance will be reinstated between the greater good some regulations seek and the high costs of compliance.

One in five manufacturers mentioned the 2016 U.S. general election and its associated changes in their filings. As businesses wait to see how campaign rhetoric will play out in enacted policies, manufacturers seem to be feeling uncertainty around economic priorities and spending.

One key promise was repealing the Dodd-Frank Wall Street Reform and Consumer Protection Act. In early May, the House Financial Services Committee voted to send the Financial CHOICE Act, which would rollback significant pieces of Dodd-Frank, to the House floor, where the bill passed in early June. Its fate in the Senate, however, remains unclear.

More than a third of the respondents say the effects of climate change are a threat to their business, but regulatory standards aimed at addressing those concerns bring their share of challenges. At the same time, nearly all reported that environmental regulations are a risk.

What about international politics, like Brexit?

The United Kingdom’s Brexit vote in June spurred global shockwaves, and 30 percent of filers mentioned this vote in their filings. Almost all (94 percent) of manufacturers say their international operations and sales face threats this year, with the combined forces of protectionist trade and immigration measures, rising commodity costs and sharpening international currency risks.

Where do manufacturers stand on the next wave of manufacturing, connectivity?

Many are unsure of how to staff the industrial revolution that’s underway — and speeding up. With connectivity comes technology risk, too. Cybersecurity broke into manufacturers’ top five risks this year, with 96 percent citing potential security breaches in their filings. That’s a 50 percent jump from just four years ago.

Another critical question is how to fund the unprecedented innovation and change in the industry. The National Association of Manufacturers reports that 93 percent of manufacturers are positive about their own company’s outlook, up from 57 percent last year, and marking an all-time high for their survey. Hurdles remain, however, as capital availability is uncertain and the Federal Reserve will likely raise rates sooner rather than later. This spurred a 31 percent jump in mentions of interest rates in recent manufacturers’ filings.

What’s your advice for local companies in light of these findings?

Local manufacturing companies should remain cautiously optimistic, despite international volatility, market disruptions and uncertainty of potential reform under the new administration. Manufacturers should thoughtfully embrace the opportunities to enhance technology and refine products and processes through the development of sound business plans under an administration that remains focused on revitalizing manufacturing in the U.S.

Insights Accounting is brought to you by BDO USA, LLP

Make your company more attractive to buyers with a tax election

Sellers of middle-market companies are increasingly engaging advisers to perform sell-side due diligence before they go to the market. Part of the due diligence process involves evaluating tax structuring opportunities, including tax elections that deliver a step up in the basis of the assets for the buyer.

“Sophisticated buyers have understood this for a long time. Now, sellers are starting to appreciate a buyer’s desire for this, so they want to get out in front of it,” says Dave Godenswager, senior manager, Transaction Advisory Services at BDO USA, LLP.

Smart Business spoke with Godenswager about how deal structure impacts a company’s tax expectations during a sale.

What do you mean by tax elections that step up tax basis?

There are two ways to buy a business. A stock acquisition — easier to document from a legal standpoint and an advantage for certain customer contracts — is where a new owner purchases the stock or units of the business. In an asset acquisition, the assets of the business are sold to the buyer while the selling entity remains intact. In some cases, a stock transaction can be treated as a sale of the assets for tax purposes.

If a buyer purchases assets, or has the ability to treat the transaction as if he or she purchased assets, the buyer may be able to amortize the purchase price for up to 15 years, which in turn lowers the buyer’s future tax costs. This tax shield is compelling for private equity firms in particular because they typically want to hold a company for five to 10 years and are focused on the company’s cash position.

Buyers have historically keyed in on this, and middle-market sellers can use these techniques to make their company more attractive and marketable. They also can look at this when going to market, asking, ‘Is there a possibility we can monetize this or use it as a negotiating point?’

How does a seller know whether or not this is possible for his or her company?

Generally, as a seller, before going to market you want to consider your company’s tax profile to understand potential tax exposures and opportunities. You want to be in a position to say, ‘Yes, we’ve identified this and we’re taking certain steps.’ During due diligence, advisers can help determine if there is an opportunity to implement certain pre-closing reorganizational steps. For instance, consideration may be given to a Section 338(h)(10) or 336(e) election or perhaps an F reorganization, such that the seller is able to deliver a step up in the tax basis of the assets to the buyer.

Since many middle-market organizations are taxed as flow-through entities — S Corporations, limited liability companies or partnerships — they are uniquely positioned to deliver some of these tax benefits.

How important is this in today’s market?

It’s been a seller’s market — with few high-quality companies on the market, private equity firms are chasing the same deals. While the deal space is still hot for sellers, there is uncertainty about tax reform and what a potential border adjustment tax could mean for businesses. Understanding structuring opportunities gives the seller a better chance to get a transaction closed.

What else do sellers need to know?

Sellers want to understand and express the deal structure to the buyer before signing the letter of intent. Some structures may result in incremental taxes, and therefore sellers need to be clear with buyers that they intend to be compensated for these tax costs. Often, buyers are willing to do this because the tax benefits are compelling.

It’s also important to have an adviser who understands the structuring nuances in order to calculate an accurate gross-up payment. Historically, sophisticated buyers have had that, but sellers are realizing they need to make sure they are getting adequately compensated since incremental taxes could include recognizing ordinary income, built-in gains tax for S Corporations and certain entity-level taxes. Sellers also need to be focused on potential accounting method changes and the impact of deferred revenue as a result of the transaction.

The tax opportunities may not change the legal form of the deal, but there are certain provisions that will need to be tailored in the purchase agreement. It is a nice benefit that sellers can present to buyers to become more attractive in the market.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Are you prepared for the changes to revenue recognition and leases?

“The Financial Accounting Standard Board (FASB) was busy during 2016. A total of 20 accounting updates and amendments were issued, and two of the 20 are either impacting our clients now or will so in the next couple of years,” says Seán N. Kilbane, a director of Assurance at BDO USA, LLP. “If our businesses aren’t talking about the board’s changes to revenue recognition and leases, they ought to.”

Smart Business spoke with Kilbane about changes to revenue recognition and leases.

What’s important for business owners to understand about revenue recognition?

The new revenue recognition standards will take effect in 2019 for most midsize companies, and next year for publicly traded businesses. No particular industry is immune from adopting the new standard, as FASB’s goal was to offer a greater level of comparability across all industries and to minimize differences in the way in which revenue is recognized.

For many businesses, this will impact the timing and pattern of revenue recognition. For others, especially where industry specific guidance was followed, the changes could be significant and will require careful planning.

The basic premise of the new standard is to record revenue when customers obtain control over the goods and services that are provided to them, rather than when simply ‘earned.’

The new standard requires companies to identify their customer contracts, and such contracts can take many forms. After figuring out what contracts they have, businesses must assess what distinct items they have to either deliver, produce or provide services for, and for which of those distinct deliverables the customer benefits from — either if sold on their own or in a combination with other deliverables, such as construction materials together with labor for a build out of space. Businesses then determine the price of the overall contract and allocate that price to each of those distinct deliverables. Once these performance obligations are satisfied, they can recognize the revenue.

Business leaders should familiarize themselves with the new standard and evaluate the impacts on each revenue stream. They should also be aware of trickle-down effects. Businesses need to ascertain what this may mean for complying with EBITDA and other financial performance-based covenants, the income tax implications and what effects this may have on their internal control environment.

The best advice in anticipation of these changes is to act now. Businesses need to consider the various transition methods that the FASB has prescribed, look into training for finance personnel and monitor any additional updates. Their financial experts can help assist all lines of business through this transition.

How are leases changing under FASB’s updates?

This mainly impacts lessees —  companies that lease property or equipment — but has less sweeping implications for lessors, such as landlords.

For small and midsize companies, beginning in 2020, lessees will be required to bring long-term leases onto their balance sheet, by recognizing the right to use the leased asset and establishing a liability to capture the present value of the future lease payments. For shorter termed leases, lessees can make a policy election to treat their leases similarly to how operating leases are currently accounted for — that is without capitalizing, and by recognizing expense evenly over the life of the lease agreement.

Each lease under the new code will need to be categorized as a financed or operating lease, depending on how much control is asserted over the asset now or will be at the end of the lease. This categorization matters, as it impacts the pattern of expense recognition and where to point cash flows in financial statements.

It’s important to be proactive, to develop a plan and consider the impacts with lenders and other stakeholders, especially since new assets and liabilities will be presented, which can significantly change a company’s financial ratios. Also, businesses should consider whether their software can handle the new complexities of lease accounting.

Again, the right advisers can help, regardless of complexity, with either an assessment of current system needs or with a new system implementation.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

How the restaurant industry’s sales are stacking up

Each quarter, BDO USA, LLP compiles the operating results of publicly traded restaurant companies in order to help restaurants benchmark. In its most recent report, same-store sales through the third quarter decreased, mainly due to increased competition and declining foot traffic.

“The Northeast Ohio market has seen a similar decrease in same-store sales as the national market,” says Adam Berebitsky, tax partner and co-leader of the National Restaurant Practice at BDO USA, LLP.

While BDO’s study uses publicly traded restaurant company information, Berebitsky believes the private sector probably saw a similar decrease in its same-store sales.

Smart Business spoke with Berebitsky about trends in the restaurant industry.

What’s going on with same-store restaurant sales and profit margins?

Publicly held restaurant companies saw same-store sales decreases of 0.1 percent through the third quarter. This deceleration may be attributed to the widening pricing gap between grocery stores and restaurants, and subsequent shifts in consumers’ attitudes toward dining out. Also during the third quarter, pending labor regulations fueled uncertainty around workforce compensation among restaurant operators.

The fast casual segment has fallen into this decline, which is different from the growth reported in fiscal year 2015. Chipotle’s 24.9 percent decrease, for example, works against the average as the brand strives to restore its reputation and customer base by dedicating dollars to marketing and offering more promotions.

The two public restaurant sectors still reporting positive same-store sales are the pizza segment, where Domino’s is leading the charge, and the quick-serve segment.

While same-store sales remain a concern, declining commodity costs is a reason for optimism, most notably higher beef supplies. Lower commodity prices can be a double-edged sword, though. The savings generated for restaurants are also available to consumers through less expensive groceries.

In this highly competitive market, restaurants are reluctant to raise prices to combat declining sales. Price increases also won’t overcome the reduced foot traffic.

Where do things stand with labor costs?

Labor costs increased across all segments for the third consecutive quarter — most significantly in the fast casual segment.

The recent election has quieted some fears about regulated labor costs, especially since President-elect Trump’s nominee for Secretary of Labor is fast-food executive Andrew Puzder and the new Department of Labor overtime rules are suspended as a result of a recent Texas court ruling.

Despite this, labor concerns still exist due to a possible localized minimum wage hike, low unemployment — which means restaurant owners may have to pay higher wages to find workers — and rising health insurance costs. Many restaurants will have to return to the drawing board to identify strategies for reducing labor costs.

How do you think the restaurant market will perform, looking ahead?

As we head into the new year with an increasingly saturated market and labor regulation uncertainty, restaurants need to be more creative, such as utilizing technology to drive sales and provide quicker, more efficient ways to deliver food to the consumers at either the restaurant or their homes.

Despite the results through the third quarter, restaurant valuations continue to be strong and many speakers at the November Restaurant Finance & Development Conference were bullish on the industry’s outlook. Economic conditions remain healthy and consumer confidence trends upward post-election, suggesting the restaurant sector may benefit. Investments in emerging brand concepts continue to be strong throughout the country.

Businesses need to use lessons learned from 2016 to adapt their strategies for 2017. By keeping their finger on the pulse of consumer preferences and behaviors, as well as the competitive landscape, restaurants can ensure they’re cooking up and delivering offerings that meet consumers’ — and investors’ — evolving needs.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Retail marketers keep holiday optimism in check, survey finds

NEW YORK ― Chief marketing officers at U.S. retailers are cautious heading into the holiday season, though those at larger chains are a bit more optimistic about their prospects, according to a survey conducted by BDO USA.

Chief marketing officers expect holiday sales to rise 2.9 percent this year, a less rosy view than the 3.5 percent rise a group of CMOs predicted during the firm’s 2010 survey.

“It kind of confirmed my belief that the holiday sales were going to be tepid – positive, but not very strong,” said Doug Hart, partner in BDO’s retail and consumer product practice.

Most retailers have kept their holiday season inventory purchases about the same as last year, as they attempt to anticipate how a high unemployment rate and other economic issues will affect spending.

Retailers do not want a repeat of the 2008 holiday season, when shoppers cut back and chains that ordered too many goods had to slash prices, hitting margins, to sell them.

Sixty-five percent said their chain’s inventory purchases have stayed about the same, up from 52 percent last year.

Inventory decisions were likely impacted by the weak consumer confidence numbers over the summer, which is when most chains have to make their final calls on holiday purchases to ensure they have time for goods to arrive from overseas.

Inventory levels are expected to be up by just 0.7 percent this holiday season, down from the 2.8 percent increase that was projected in 2010.

“They’re a little bit more cautious,” said Hart, noting that CMOs often have a brighter view than executives such as chief financial officers. “The fact that these guys are certainly not optimistic is a good benchmark for where the inventory purchases are going.”

Overall, 48 percent of those surveyed anticipate their holiday season sales will stay about the same, 41 percent expect their sales to rise and 11 percent see a decline.

Among CMOs from some of the biggest retailers, just 33 percent see their sales staying about the same, while 67 percent are calling for sales at their chains to rise. No CMOs from the large chains expect their sales to fall.