Category: Tax Services

Posted on Jul 21, 2016

If your dealership’s new car sales are putting a smile on your face and your used car and service departments are merrily humming along, you might think now’s the time to give yourself a hefty — and perhaps overdue — pay increase.

But before you compensate yourself for the amount you believe you deserve, take stock: The IRS is in the business of scrutinizing top executives’ salaries, bonuses and distributions or dividends. Various stakeholders also may be examining your self-compensation decisions. Here are some factors to consider before setting your new pay.

What’s the Right Balance?

Let’s start with the basics. Your compensation is obviously affected by the amount of cash in your dealership’s bank account. But just because your financial statements report a profit, it doesn’t necessarily mean you’ll have cash available to pay owner-employees a higher salary or large bonus or make annual distributions. Net income and cash flows aren’t synonymous.

Other business objectives — such as buying new equipment, repaying debt and sprucing up your showroom — vie for your kitty. So, it’s a balancing act between owner-employees’ compensation on the one hand and capital expenditures, expansion plans and financing goals on the other.

What if Your Dealership Is a C-Corporation?

If you operate as a C corporation, your dealership’s income is taxed twice. First, it’s taxed at the corporate level. Then, it’s taxed again at the personal level as you draw dividends — an obvious disadvantage to those owning this corporation type.

C corporation owner-employees might be tempted to classify all the money they take out as salaries and bonuses, which the company can deduct, to avoid the double tax on dividends. But the IRS is wise to this strategy. It is on the lookout for excessive compensation to owner-employees and may reclassify above-market compensation as dividends, potentially resulting in additional income tax as well as interest and penalties.

The IRS also may monitor a C corporation’s accumulated earnings. Generally similar to retained earnings on your balance sheet, accumulated earnings measure the buildup of undistributed earnings. If these earnings get too high and can’t be justified for such things as a planned expansion, the IRS may assess a tax on them.

What about S-Corporations?

S corporations, limited liability companies and partnerships are examples of flow-through entities, which aren’t taxed at the entity level. Instead, income flows through to the owners’ personal tax returns, where it’s taxed at the individual level.

Dividends (typically called “distributions” for flow-through entities) are tax-free to the extent that an owner has tax basis in the business. Simply put, basis is a function of capital contributions, net income and owners’ distributions. Distributions in excess of basis are subject to ordinary income tax, but they’re not subject to payroll taxes.

So, the IRS has the opposite concern with flow-through entities: Agents are watchful of owner-employees who underpay themselves to minimize payroll taxes. If the IRS thinks you’re downplaying salary in favor of payroll-tax-free distributions, it may reclassify some of your distributions as salary. In turn, while your income taxes won’t change, you’ll owe more in payroll taxes — plus any interest and penalties due.

Do You Reflect the Market?

Above- or below-market compensation raises a red flag to the IRS, and that’s definitely undesirable. Not only will the agency evaluate your compensation expense — possibly imposing extra taxes, penalties and interest — but a zealous IRS auditor might turn up other challenges to your records.

What’s more, it might cause a domino effect, drawing attention in the states where you do business. Many state and local governments face budget shortages and are hot on the trail of the owner-employee compensation issue.

Who Else Might be Concerned?

Other parties may have a vested interest in how much you’re getting paid, too. Lenders, franchisors and minority shareholders might think you’re impairing future growth by paying yourself too much.

If a silent owner, factory representative or lender, for instance, decides your showroom looks shabby and sees flat sales, your salary expense and dividends might become the subject of debate.

Here Comes the Judge

If you or your dealership is involved in a lawsuit, the courts might impute reasonable (or replacement) compensation expense. This is common in divorces and minority shareholder disputes. The amount a court prescribes for compensation affects business value, which, in turn, affects damages awards and asset distributions. In divorce, reasonable compensation also affects child support and alimony awards.

When a court imputes reasonable compensation, it typically considers compensation studies and other factors that include salary history, responsibilities, experience, geographic location and the dealership’s performance.

Are You Being Prudent?

One of the major advantages of being a dealership owner is having a big say in all manner of decisions. But when it comes to your compensation, make sure you’re being prudent. Otherwise, you may find yourself in hot water with the IRS and others who have an interest in your business.

 

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Posted on Jul 20, 2016

Warning. The execution phase of succession planning requires singleness of purpose. Within the first 90 days of succession planning, you will likely find issues and gaps with your plan or personal retirement plan — items that need tending. Don’t let these issues become a distraction to your ultimate goal of developing a clear and actionable succession plan! To stay focused during this phase, use the following questions to keep your plan on track.

  • Who will help you execute and monitor the plan?
  • What are the gaps and issues?
  • How can you prioritize fixing the gaps and issues?
  • What if all doesn’t go as planned?

Maintaining Deadlines

Succession planning for small businesses can be accomplished within 210 days if you don’t let these issues become a hindrance. But often, business owners feel that they have to have every detail figured out before they can execute. Not so. For example, you may have:

  • Wills that need updating based upon new tax laws
  • Missing non-compete agreements with some of your key management
  • A woefully inadequate disability policy based on the level of income needed
  • Your personal investment portfolio performing below average (e.g. 1 percent rate of return when it needs to be at least 5 percent)
  • Legal entity structure changes needed to pay less tax upon sale
  • Unaddressed estate tax problems

Rather than diving into one rabbit hole after another to tackle each of these somewhat complex issues, document each one and prepare a to-do list. In the check-in meeting with your advisors, share the list and prioritize it. This process will help you move along the path of creating a well-written succession plan while scheduling the action items that will support smart execution of your plan down the road.

Now it’s time to meet with your advisors, which can include your lawyer, CPA, financial advisor, board and/or board of advisors and leadership team. Give them an outline of your progress over the past 90 days, your discoveries and expected next steps. It is important to discuss the following in this meeting:

  • Plan A and Plan B – Plan A is your preferred scenario for transitioning out of the business. However, things can change in year one, three or five…requiring a back-up plan. Discuss your preferences and potential changes that could require shifting from Plan A to Plan B. This will keep you on the same page with your advisors and help you prepare logically and emotionally for that shift if necessary.
  • Your list of gaps, issues and problems for Plan A — let your advisors weigh in on these and other issues they foresee.
  • Your list of gaps, issues and problems for Plan B — again, gather advisor feedback and any additional foreseeable issues that may be different than in Plan A.

Do not let the blind spots or additional issues brought up in this meeting distract you from the ultimate goal of creating a plan. Obstacles can be overcome in most scenarios by taking them one step at a time. Right now, you are simply gathering feedback and advice. Don’t give up even if the issues seem insurmountable. Stay in control of the process.

Name a Quarterback

When I say that business owners should stay in control of execution, I mean that owners are the ultimate decision makers in the transition of their businesses. However, that doesn’t mean trying to handle every detail. You are still trying to run a business! Instead, place a chief advisor in charge of facilitating discussion and outlining next steps. This advisor can be accountable for research, scheduling the next check-in meeting and coordinating feedback from other advisors.

Some business owners prefer their CPA in this role (like a succession planning quarterback) while others choose their attorney or financial advisor. Just make sure it’s a trusted relationship that you believe will keep things moving forward in a timely way and bring about the best results. By choosing a quarterback, you can avoid your own blind spots in the planning process as well as soften the emotional impact of certain decisions.

For example, many small business owners avoid setting up an emergency management plan. This plan provides a designated leader or leaders to operate the business in the event of an owner’s incapacitation. Because buy/sell agreements are only engaged if the owner dies, an emergency management plan fills that gap if the authorized person is in a coma or otherwise disabled. Designated leaders are given limited legal power to make financial or other important business decisions and operate the business on behalf of stakeholders such as family members. You can even include incentives for key people to stay and see the business through a set time period until transition or succession decisions can be made.

Now that you have organized your advisory team (including your quarterback), determined your Plan A and Plan B and received feedback on gaps and issues, it’s time to assemble all the documents and create a timetable and strategy around communication with family and key employees/managers.

Continue reading for the last phase in Succession Planning: Phase III – Communication: Establishing Timing and Deliverables for Your Succession Plan

For more information on guiding your small business through succession planning, talk to the tax team at Cornwell Jackson.

Gary Jackson, CPA, is the lead tax partner in Cornwell Jackson’s business succession practice as has led or assisted in hundreds of succession and sales transactions. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services such as succession planning to management teams and business leaders across North Texas. 

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Posted on Jul 18, 2016

Roth IRA Accounts

Does your employer offer a 401(k), 403(b) or governmental 457 plan? If so, you may be able to set up a designated Roth account through your company’s plan. Then your Roth account will be allowed to receive designated Roth contributions that are taken out of your salary through so-called “salary-reduction contributions.” Here’s more on how this strategy works, why it may be advantageous for certain taxpayers and how new IRS regulations add greater flexibility to allocating distributed after- and pre-tax amounts.

Designated Roth Account Basics

Unlike regular salary-reduction contributions, designated Roth contributions don’t reduce your taxable salary. Instead, the tax advantage comes later when you are allowed to take distributions from your designated Roth account without owing any federal income tax. These tax-free amounts are referred to as qualified distributions.

The catches to receiving tax-free qualified distributions are twofold: First, the Roth account must have been open for more than five years. Second, you must have reached age 59½ or become disabled before taking distributions from your Roth account.

The five-year period is deemed to begin on the first day of the year in which you make your first designated Roth account contribution. For example, if you made your first contribution anytime in 2014, the five-year period is deemed to have started on January 1, 2014. In this scenario, you can receive tax-free qualified distributions anytime after December 31, 2018, as long as you’re at least 59½ or disabled. If you die, your heirs can receive tax-free qualified distributions as long as the five-year requirement has been met.

Important note: Setting up a Roth account makes the most sense if you believe you’ll pay the same or higher tax rates during your retirement years.

Treatment of Designated Roth Account Distributions

At some point, you may want to direct designated Roth account distributions to multiple destinations — say, to one or more taxable accounts and one or more tax-favored accounts — using tax-free rollovers. These transactions can be executed using the 60-day rollover rule or via direct rollovers where money is transferred directly between accounts. Favorable IRS rules generally allow you to allocate after-tax (tax-free) amounts from nondeductible contributions and pretax (taxable) amounts from deductible contributions and account earnings to the various destinations to achieve the best tax results.

The IRS recently issued an amended final regulation to eliminate a previous requirement affecting some Roth account transactions. That requirement mandated that a disbursement from a designated Roth account that was directly rolled over into a Roth IRA or another designated Roth account be treated as a separate distribution from any amount simultaneously paid directly to the account owner (you). When such mandatory separate distribution treatment applied, the pretax and after-tax amounts included in the designated Roth account disbursement had to be allocated pro rata to each separate distribution.

The following example illustrates how the now-eliminated rule that required distributions from designated Roth accounts to be treated separately could lead to unfavorable tax results.

Example 1: Old rule for designated Roth account distributions. A 50-year-old woman owns a Roth IRA. She also has a $50,000 balance in a designated Roth account set up through her employer’s 401(k) plan. The designated Roth account balance consists of $30,000 of after-tax dollars (from nondeductible contributions to the account) and $20,000 of pretax dollars (from account earnings). Therefore, 60% of the account balance ($30,000/$50,000) is after-tax money and 40% ($20,000/$50,000) is pretax money.

The woman quits her job and arranges for a $50,000 disbursement to close out the designated Roth account. This is not a qualified designated Roth account distribution, because she’s not age 59½, disabled or dead. So, if she puts the entire $50,000 into a taxable account with a bank or brokerage firm (or straight into her pocket), the woman will owe federal income tax on the $20,000. She’ll probably owe the dreaded 10% early distribution penalty on the $20,000 and any applicable state income taxes, too.

What if, instead, she chose to put $30,000 of the $50,000 into a taxable account (or her pocket) and rolled over the remaining $20,000 into a Roth IRA using a direct transfer? Under the old separate distribution rule, the woman was required to treat the $30,000 that she didn’t roll over as consisting of $18,000 of after-tax money (60%) and $12,000 of pretax money (40%). Similarly, the $20,000 that she directly rolled over into her Roth IRA was deemed to consist of $12,000 of after-tax money (60%) and $8,000 of pretax money (40%).

As you can see, the unfavorable separate distribution rule would have resulted in the woman owing taxes on the $12,000 of pretax money that’s deemed to have gone into her taxable account (or pocket). She also might have owed the 10% penalty tax and state income tax on the $12,000.

New IRS Guidance on Designated Roth Account Distributions

Fortunately, under a recently amended IRS regulation, separate distribution treatment is no longer required when part of a disbursement from a designated Roth account is directly rolled over tax-free into one or more eligible retirement accounts and part is sent to the account owner.

Now, you can follow the taxpayer-friendly rules to allocate after-tax and pretax amounts between the destinations to achieve the best tax results. The following example illustrates how the new guidance adds greater flexibility to allocating distributed after- and pretax amounts.

Example 2: New, more flexible rule for designated Roth distributions. Now that the separate distribution rule no longer applies, the woman in the previous example has a more tax-favorable option for allocating her distributions. Pursuant to IRS Notice 2014-54, she can treat the $30,000 that was transferred into the taxable account (or her pocket) as consisting entirely of after-tax (tax-free) dollars, and she can treat the $20,000 that was directly rolled over into her Roth IRA as consisting entirely of pretax dollars.

Under the new guidance, she would owe no federal income tax on the designated Roth account disbursement and no 10% early-distribution penalty or state income taxes. In addition, she’ll be eligible to take the $20,000 out of her Roth IRA through tax-free qualified Roth distributions once she reaches age 59½ (or becomes disabled).

Effective Date

The amended final regulation applies to distributions from designated Roth accounts that are made on or after January 1, 2016. However, you can also elect to follow the favorable amended final regulation for distributions that were made on or after September 18, 2014, and before January 1, 2016. For more information about how the new guidance applies to your Roth accounts, contact your tax adviser.

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Posted on Jul 15, 2016

QCD

You can make cash donations to IRS-approved charities out of your IRA using so-called “qualified charitable distributions” (QCDs). This strategy may be advantageous for high-net-worth individuals who have reached age 70 1/2. It expired at the end of 2014, but QCDs were made permanent for 2015 and beyond under the Protecting Americans from Tax Hikes (PATH) Act of 2015.

To take maximum advantage of this strategy for 2016, you’ll need to replace some or all of this year’s IRA required minimum distributions (RMDs) with tax-advantaged QCDs. Here are more details.

QCD Basics

QCDs can be taken out of traditional IRAs, and they’re exempt from federal income taxes. In contrast, other traditional IRA distributions are taxable (either wholly or partially depending on whether you’ve made any nondeductible contributions over the years).

Unlike regular charitable donations, QCDs can’t be claimed as itemized deductions. That’s OK, because the tax-free treatment of QCDs equates to a 100% deduction — because you’ll never be taxed on those amounts. Additionally, you don’t have to worry about any of the restrictions that apply to itemized charitable write-offs under the federal tax code.

A QCD must meet the following requirements:

  • It must be distributed from an IRA.
  • The distribution can’t occur before the IRA owner or beneficiary reaches age 70 1/2.
  • It must meet the IRS requirements for a 100% deductible charitable donation. If you receive any benefits that would be subtracted from a donation under the regular charitable deduction rules — such as free tickets to an event — the distribution can’t be a QCD. This is an important pitfall to watch out for.
  • It must be a distribution that would otherwise be taxable. A distribution from a Roth IRA can meet this requirement if it’s not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs is generally not advisable for reasons explained later.

Important note: You can also use the QCD strategy on an IRA inherited from the deceased original account owner if you’ve reached age 70 1/2.

Annual Limit

There’s a $100,000 limit on total QCDs for any one year. But if you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit, for a combined total of $200,000.

Tax-Saving Advantages

QCDs offer several potential tax-saving advantages:

  1. They’re not included in your adjusted gross income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based rules. For example, a higher AGI can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible and more of your investment income to be hit with the 3.8% net investment income tax. QCDs are also exempt from the rule that says your itemized charitable write-offs can’t exceed 50% of your AGI. (Any itemized charitable deductions that are donations disallowed by the 50%-of-AGI limitation can be carried forward for up to five years.)
  2. They qualify as RMDs if they’re taken from traditional IRAs. So, you can arrange to donate all or part of your 2016 RMDs (up to the $100,000 limit) that you would otherwise be forced to receive before year end and pay taxes on.
  3. They reduce your taxable estate, though this is less of an issue for most folks now that the federal estate tax exemption has been permanently increased. (The inflation-adjusted exemption for 2016 is $5.45 million.)

In addition, suppose you’ve made nondeductible contributions to one or more of your traditional IRAs over the years. If so, your IRA balances consist of a taxable layer (from deductible contributions and account earnings) and a nontaxable layer (from those nondeductible contributions). QCDs are treated as coming first from the taxable layer. Any nontaxable amounts remain in your accounts. In subsequent tax years, those nontaxable amounts can be withdrawn tax-free by you or your heirs.

QCDs from Roth IRAs

Should you make QCDs from Roth IRAs? Generally, the answer is no. That’s because you (and your heirs) can withdraw funds from a Roth IRA without owing federal income taxes. The catch is that at least one of your Roth accounts must have been open for five years or more.

Also, for original account owners (as opposed to account beneficiaries), Roth IRAs aren’t subject to the RMD rules until after you die. The bottom line: It’s generally best to leave your Roth balances untouched rather than taking money out for QCDs, because the tax rules for Roth IRAs are so favorable.

Plan Ahead

The QCD strategy can be a smart tax move for high-net-worth individuals over 70 1/2 years old. If you’re interested in this opportunity, don’t wait until year end to act. Summer is time for mid-year tax planning, including arranging with your IRA trustee or custodian for QCDs to replace your 2016 RMDs.

Could QCDs Work for You?

High-net-worth senior citizens who can afford to donate money from their retirement accounts may benefit tax-wise from taking qualified charitable distributions (QCDs) if they match at least one of these profiles:

1. You don’t itemize deductions. Only people who itemize benefit tax-wise from regular charitable donations. Using QCDs provides a way for people who don’t itemize to gain a tax benefit from making charitable donations.

2. You itemize, but part of your charitable deduction would be phased out based on your adjusted gross income (AGI) or delayed by the 50%-of-AGI restriction.

3. You want to avoid being taxed on required minimum distributions (RMDs) that you must take from your IRAs.

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Posted on Jul 14, 2016

Product Liability for Manufacturers

The limits of product liability are not always easy to define. But in one case, the Nebraska Supreme Court helped identify the limits by ruling that two manufacturers aren’t liable for harm caused by the criminal acts of others — even if their product’s failure led to the harm.

The court ruled that Ford Motor Co. and Bridgestone/Firestone were not liable for the death of a 19-year-old college student who was murdered by a man who offered her a ride after she had a flat tire.

“We have found no authority recognizing a duty on the part of the manufacturer of a product to protect a consumer from criminal activity at the scene of a product failure where no physical harm is caused by the product itself.”
– Nebraska Supreme Court

There was no allegation that the young woman sustained any injury as a result of the tire failure itself. Instead, the student’s parents charged negligence on the part of the manufacturers, claiming that the malfunctioning Firestone tire on their daughter’s Ford Explorer set in motion a chain of events that culminated in her murder. They argued that the manufacturers knew — or should have known — of the potential for criminal assault after the breakdown of a Ford Explorer.

The court disagreed, invoking the legal concept of “proximate cause.” Under the law, it is generally not enough to show that an event would not have happened if it weren’t for another prior event. Liability generally lies with the last negligent or intentional act that leads to the harm. In this case, that act was committed by the murderer because he shot the young woman.

The court responded: “Assuming the truth of these allegations, the most that can be inferred is that Ford and Firestone had general knowledge that criminal assaults can occur at the scene of a vehicular product failure. However, it is generally known that violent crime can and does occur in a variety of settings, including the relative safety of a victim’s home.”

The court made its decision even though the federal government had found the tires on the woman’s Ford Explorer to be unsafe. Millions of ATX, ATX II and Wilderness AT tires have been recalled after it was determined that they are prone to losing their treads at high speeds. The plaintiffs argued that their daughter might not have driven alone, early in the morning, if she had known of the tire’s tendency to blow out. The court did not find this argument persuasive. (Stahlecker v. Ford Motor Co., 266 Neb. 601, 08/08/03)

While this case does express a principle that protects companies from liability from unforeseeable criminal acts, it should not be interpreted as a blanket protection from liability in all cases of criminal behavior by third parties.

A variation: A different set of circumstances could lead to a different outcome. For example, imagine a situation where a man tries to use a jack supplied by the automaker to change a flat tire. The design of the jack requires that the car be close to the edge of the road. The man is then struck by a drunk driver and killed.

This is a scenario where the automaker could be held liable for its negligent design of the jack, even though the criminal act of the drunk driver was the ultimate cause of the man’s death.

The difference: In this hypothetical case, the court could determine that the automaker should have foreseen the possibility that an accident might occur.

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Posted on Jul 11, 2016

Phase I – Assessment

Because your business is probably your largest asset — and because it also is probably your largest single source of income — your decision-shaping and calendar of events for your plan are going to be built around assessing alternatives to preserve the asset, nurture the asset, monetize the asset or liquidate the asset for optimum results for you, your family and the business. Some of the questions you should ask as you begin the journey of planning your succession are:

  • What is your business really worth?
  • What do you really need in retirement?
  • How does ownership translate into retirement assets?
  • Who will step into the ownership role(s)?
  • What’s your Plan A and Plan B scenario?
  • What will you do next?
  • What is your timetable for fully transitioning out?

So, what is your business really worth? If you’ve never had a formal or even informal valuation of your business, now is the time to schedule it. You will need a reasonable estimated value of your business — and an honest assessment of after-tax available cash to you in the event of a sale. You need a valuation regardless of whether you desire to sell to a third party or to your management team, or create an ESOP, family gifting or charitable gifting options.

There are formal valuations and there are informal valuations. For the purposes of succession planning, most small business owners simply need a valuation professional to determine an estimation of value within $100,000. Don’t try to calculate the value online with a low-end, do-it-yourself tool. All of your decisions going forward derive from this number, so it pays to consult a professional.

Once you have a clear estimation of value, you will want to visit with your investment advisor or financial planner to assess your personal finances, current and post retirement cash flow, retirement goals and sources of cash flow up to your official retirement date. In my experience with succession planning, this process will take at least three separate meetings in order to:

  • Determine what you want to do in retirement
  • Assess the lifestyle you want to maintain
  • Incorporate the vision of the next successful chapter of your life into the succession plan

During this discussion, you may want to decide how much, if any, you want to continue working in the business. Independent of any valuation or legacy issues you carry, what would be a fair amount for you to be compensated in a less than full-time position at the company? What are the primary areas where you could add value to the business on a continuing basis?

Establish Plan A and Plan B

This decision, of course, hinges on the most likely acquirer of your business. You will need to rank on a 10-point scale the likelihood and viability of a sale or transfer to:

  • Your own family members
  • Your current management team or business partners
  • Your employees taking ownership stake through an ESOP
  • A strategic buyer
  • A private equity firm

Whichever option gets the highest ranking, call that “Plan A.” But call the second highest option “Plan B.” We’ll talk more about why having two options for potential owners are important in the execution phase of succession planning.

In addition to ranking a potential successor or outside buyer, you will need to obtain and review all of the following agreements and legal documents. You may find during this process that there are documents you don’t have and will need to create.

  • Will and estate documents
  • Emergency management plan – who gets the keys if you are temporarily out of commission
  • Shareholder agreements, often called buy/sell agreements
  • Bylaws or operating agreement of the business itself – voting, officers, classes of stock, etc.

The final piece of your Phase I Assessment is to target a specific year that will be the year of your exit — no matter what form that takes.

As you assess your current situation, including decisions around successors and timelines, your CPA should support you with a clear picture of cash flow, debt and proper entity structures. Your CPA can also help you assess certain buy-out scenarios that may involve selling to internal stakeholders, courting an external buyer or creating an ESOP. Rely on your CPA to weigh the pros and cons of your Plan A and Plan B to ensure that they are viable choices.

Once your first 90 days of planning are completed, you should begin to understand where the gaps lie in order to set the timeline for succession planning execution. Review each step that has been accomplished so far with your advisory team. Most of all, congratulate yourself for moving toward a viable plan for your business transition.

To continue reading about succession planning, read: Phase II – Sharing and Executing the Succession Plan

For more information on guiding your small business through succession planning, talk to the tax team at Cornwell Jackson.

Gary Jackson, CPA, is the lead tax partner in Cornwell Jackson’s business succession practice as has led or assisted in hundreds of succession and sales transactions. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services such as succession planning to management teams and business leaders across North Texas. 

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Posted on Jul 11, 2016

SB Blog Cover 1200pxNumerous tax breaks have been retroactively expanded for 2015 and beyond — or, in some cases, been made permanent — under the Protecting Americans from Tax Hikes (PATH) Act of 2015. Now that the dust from the new law has settled, small business owners can plan ahead with these 5 mid-year tax strategies inspired by the recent legislation.

5 Tax Breaks for Small Businesses

1. Buy equipment. The PATH Act preserves both the generous limits for the Section 179 expensing election and the availability of bonus depreciation. These breaks generally apply to qualified fixed assets, including equipment or machinery, placed in service during the year. For 2016, the maximum Sec. 179 deduction is $500,000, subject to a $2,010,000 phaseout threshold. Without the PATH Act, the 2016 limits would have been $25,000 and $200,000, respectively. The higher amounts are now permanent and subject to inflation indexing.

Additionally, for 2016 and 2017, your business may be able to claim 50% bonus depreciation for qualified costs in excess of what you expense under Sec. 179. Bonus depreciation is scheduled to be reduced to 40% in 2018 and 30% in 2019 before it expires on December 31, 2019.

2. Improve your premises. Traditionally, businesses must recover the cost of building improvements straight-line over 39 years. But the recovery period has been reduced to 15 years for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. This tax break was reinstated and made permanent by the PATH Act.

If you qualify and your premises need remodeling, you can recoup the costs much faster than you could without this special provision. Keep in mind that some of these expenses might be eligible for bonus depreciation.

3. Ramp up research activities. After years of uncertainty, the research credit has been made permanent under the PATH Act. For qualified research expenses, the credit is generally equal to 20% of expenses over a base amount that’s essentially determined using a historical average of research expenses as a percentage of revenues. There’s also an alternative computation for companies that haven’t increased their research expenses substantially over their historical base amounts.

Research activities must meet these criteria to be considered “qualified”:

  • The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
  • There must be an intention to eliminate uncertainty.
  • There must be a process of experimentation. In other words, there must be a trial and error process.
  • The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.

Effective starting in 2016, a small business with $50 million or less in gross receipts may claim the credit against its alternative minimum tax (AMT) liability. In addition, a start-up company with less than $5 million in gross receipts may claim the credit against up to $250,000 in employer Federal Insurance Contributions Act (FICA) taxes.

4. Issue more stock. Does your business need an influx of capital? If so, consider issuing qualified small business stock (QSBS). As long as certain requirements are met (for example, at least 80% of your corporate assets must be actively used for business purposes) and the investor holds the stock for at least five years, 100% of the gain from a subsequent sale of QSBS will be tax-free to the investor — making such stock an attractive investment opportunity. The PATH Act lifted the QSBS acquisition deadline (December 31, 2014) for this tax break, essentially making the break permanent.

5. Hire workers from certain “target groups.” Your business may claim the Work Opportunity credit for hiring a worker from one of several “target groups,” such as food stamp recipients and certain veterans. The PATH Act revives the credit and extends it through 2019. It also adds a new category: long-term unemployment recipients.

Generally, the maximum Work Opportunity credit is $2,400 per worker, but it’s higher for workers from certain target groups. In addition, an employer may qualify for a special credit, with a maximum of up to $1,200 per worker for 2016, for employing disadvantaged youths from Empowerment Zones or Enterprise Communities in the summer.

New transitional rules give an employer until June 30, 2016, to claim the Work Opportunity credit for applicable wages paid in 2015.

Midyear Small Business Tax Planning Meeting

We’re almost half way through the tax year. Summer is a great time for small businesses to get a jump start on tax planning. Contact your Cornwell Jackson tax adviser to estimate your expected tax liability based on year-to-date taxable income and devise ways to reduce your tax bill in 2016 and beyond.

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Posted on Jul 5, 2016

Individual Tax Breaks from PATH ActNumerous tax breaks have been retroactively expanded for 2015 and beyond — or, in some cases, been made permanent — under the Protecting Americans from Tax Hikes (PATH) Act of 2015. Now that the dust from the new law has settled, individuals can plan ahead with these 5 mid-year tax strategies inspired by the recent legislation.

5 Tax Breaks for Individuals

1. Consider tax breaks for college students. If you have a child in college this year, you may be eligible for tax benefits. The PATH Act makes the American Opportunity credit permanent and extends the tuition and fees deduction through 2016. Both of these breaks are subject to phaseouts based on income level. For each student, you may claim either the American Opportunity credit or the tuition and fees deduction, but not both. Thus, while it is possible to claim the credit and the deduction in the same year, you may not claim both for the same student. If your income is too high to take one of these breaks, your child might be eligible.

The PATH Act also permanently treats computers, computer equipment, software and Internet service as qualified expenses for Section 529 savings plans, so distributions for this purpose are tax-free. Summer planning can help maximize your tax benefits for costs incurred for the fall semester.

2. Shop for a new car. If you itemize deductions on your federal income tax return, you can generally deduct state and local income taxes paid for the year. As an alternative, however, you may claim a deduction for state and local sales taxes. This option — which has been permanently extended by the PATH Act — is generally beneficial to taxpayers in locales with low or no state or local income taxes. But it can also benefit taxpayers who make large purchases during the year, regardless of where they live.

The sales tax deduction is determined based on actual receipts or an IRS table that lists amounts for each state. If you opt to use the IRS table, you can add on the actual sales tax paid for certain “big-ticket items,” such as cars or boats. If you’re in the market for a new vehicle, remember this alternate tax deduction.

3. Transfer IRA funds directly to charity. After you turn age 70½, you must take required minimum distributions (RMDs) from your traditional IRAs, whether you want to or not. These RMDs are taxable in the tax year they’re received.

Under a provision made permanent by the PATH Act, if you’re age 70½ or older, you may transfer up to $100,000 directly from your IRA to a charity without any tax consequences. In other words, you can’t claim a charitable deduction for these transfers, but the payouts aren’t taxable either — even if they’re used to satisfy your RMD. Act sooner rather than later to avoid year-end scrambling. Keep in mind that this is a per person benefit. Although both spouses may individually transfer up to $100,000 from an IRA to a charity, one spouse cannot “borrow” the other spouse’s $100,000 to make a $200,000 transfer.

4. Gift property to a charity. Real estate owners can deduct the value of “conservation easements” made to a charity that preserve the property in its original condition. Charitable deductions for long-term capital gains property (appreciated property that’s been held more than one year) are generally limited to 30% of the taxpayer’s adjusted gross income (AGI). Any excess may be carried forward for up to 15 years.

Under enhancements made permanent by the PATH Act, the deduction threshold is raised to 50% of AGI (100% for farmers and ranchers) for conservation easements. Any excess may still be carried forward for up to 15 years. One catch, however, is that all such conservation donations must be made in perpetuity.

5. Install energy-saving equipment. Are you dreading the summer heat? It may be time to install a central air conditioning system. There are various requirements to qualify for the credit. First, the home must be your main home. Also, while the credit is generally equal to 10% of the cost of qualified energy-saving improvements, there is a lifetime credit limit of $500. Thus, if you’ve claimed the credit in a prior year, your current-year credit will be reduced accordingly. Other special dollar limits may apply. It’s available for a wide range of items from central air to insulation.

The PATH Act extended the residential energy credit only through 2016. So, it’s important to act before this tax-saving opportunity expires. (It may be extended again, but there are no guarantees.)

Midyear Individual Tax Planning Meeting

We’re almost half way through the tax year. Summer is a great time for individuals to get a jump start on tax planning. Contact your Cornwell Jackson tax adviser to estimate your expected tax liability based on year-to-date taxable income and devise ways to reduce your tax bill in 2016 and beyond.

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Posted on Jul 2, 2016

Scenic high way

You Can “Manufacture” a Succession Plan in Months,
Enjoy it for Years.

As a longtime CPA in the Dallas area, I have worked with a lot of family-owned and closely held small business owners, particularly in manufacturing and distribution companies. If you are among the small and medium-sized business owners who are age 50 or older, that gives most of you a window of 10 years or less to fully execute a business transition or succession plan. Fortunately, creating the actual succession plan can take less than one year. This whitepaper can be your accounting starter kit or template for a fruitful business transition. Use it to support a healthier business and a more secure retirement. Your future begins…now.

As a business owner, you have always forged your own path, but at the height of your leadership lies the big question: What’s next?

Succession planning is like a nagging incompletion in the back of your mind. You have plenty of reminders from your attorney, your CPA, your spouse and maybe even your children. You know you need to face it, but inertia sets in. It all feels so complex, so overwhelming, and so FINAL.

WP Download - Succession PlanningOne day, you overhear a conversation on the golf course (or at your favorite restaurant). “Poor Fred. After 40 years, the only thing he can do is liquidate when he finally decides to call it quits. It’s too bad…”

If you don’t have a plan, someone or something will create the plan for you. Due to the unfortunate lack of business succession planning, only about 30 percent of successful family businesses survive into the second generation, according to The Family Firm Institute. A survey of advisors through the Financial Planners Association also found that only 30 percent of their clients had a written succession plan — even though 78 percent of clients planned to fund their retirements through a business sale.

Really? A Succession Plan in Seven Months?

In our experience, about 80 percent of business succession planning can be developed in seven months. Some plans take more time, some less, but the average timetable is about 210 days.

Step one: declare your commitment to create a plan. Share this commitment with your three closest advisors. This team usually includes your attorney, your CPA and your investment advisor, but it could also include your banker, your CFO and/or members of your leadership team. This team will keep you accountable for the planning process by organizing meetings and asking important questions. Planning is divided into three phases:

PHASE I – 90 days of Assessment – facing the unknowns

  • What is your business really worth?
  • What do you really need in retirement?
  • How does ownership translate into retirement assets?
  • Who will step into the ownership role(s)?
  • What’s your Plan A and Plan B scenario?
  • What will you do next?
  • What is your timetable for fully transitioning out?

PHASE II – 90 days of Execution – sharing the plan and getting feedback

  • Who will help you execute and monitor the plan?
  • What are the gaps and issues?
  • How can you prioritize fixing the gaps and issues?
  • What if all doesn’t go as planned?

PHASE III – 30 days of Communication – establishing timing and deliverables

  • How will you communicate the plan to leaders, clients, employees, family?
  • What can reinforce buy-in and cooperation?
  • What contracts and documents must be in place?
  • What is the exact timetable and launch?

To dive deeper into each phase of planning a succession plan for your business, click on the links below to read more on each phase.

Phase I – Assessment: Facing the Unknowns of Succession Planning
Phase II – Execution: Sharing Your Succession Plan
Phase III – Communication: Establishing Timing and Deliverables for Your Succession Plan

 

For more information on guiding your small business through succession planning, talk to the tax team at Cornwell Jackson.

GJ HeadshotGary Jackson, CPA, is the lead tax partner in Cornwell Jackson’s business succession practice as has led or assisted in hundreds of succession and sales transactions. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services such as succession planning to management teams and business leaders across North Texas. 

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Posted on Jun 24, 2016

Congress 1200pxLate last year, Congress passed the Protecting Americans from Tax Hikes (PATH) Act, reviving and extending several key provisions that directly or indirectly affect construction businesses.

The changes help bring more certainty and permanency to year-end income tax planning. They also provide more opportunities to use credits and incentives to ease your company’s tax burden. Here’s an overview of seven PATH breaks to consider:

  1. Section 179 expensing. Under this provision of the Internal Revenue Code, you can choose to currently deduct the cost of qualified property placed in service during the year. For 2016, a generous maximum deduction of $500,000 is permanently preserved and will be indexed for inflation in later years.

When the total cost of the property exceeds $2 million, however, the deduction is phased out on a dollar-for-dollar basis. The $2 million threshold will also be indexed after 2016. Also, the deduction can’t exceed your business income for the year.

This provision gives contractors plenty of leeway. It doesn’t matter when during the year you place qualified new or used equipment or machinery into service. You can wait until late in the year and still benefit from the full year deduction.

  1. Bonus depreciation. The law also provides a complementary tax break for the cost of acquiring business property. For qualified new — but not used — property placed in service during 2016, you can claim a 50% bonus depreciation for any cost remaining after the Section 179 election. Unlike the Section 179 provision, however, bonus depreciation isn’t permanent. It will be phased out under the following schedule:
  • 50% through 2017,
  • 40% in 2018, and
  • 30% in 2019.

After 2019, bonus depreciation will expire, unless it’s extended again.

The PATH Act also enhances bonus depreciation by accelerating the use of alternative minimum tax (AMT) credits that may be claimed in place of bonus depreciation. This increases the amount of unused AMT credits that may be used; modifies the rules to include qualified investment property; and permits bonus depreciation for certain trees, vines and plants bearing fruits or nuts. As with the Sec. 179 deduction, property may be placed in service at year end.

  1. Building improvements. Usually it takes 39 years to recoup the cost of business building improvements, though deductions may be front-loaded under complicated rules. The PATH Act makes permanent a faster straight-line write-off period of 15 years for:
  • Qualified leasehold improvement property — any improvement to an interior portion of a nonresidential building made more than three years after the building was placed in service,
  • Qualified restaurant property — any Section 1250 property that’s a building (new or existing) or improvement to a building if more than 50% of the square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals, and
  • Qualified retail improvement — any improvements to an interior portion of nonresidential real estate more than three years after the building was placed in service, as long as it’s a retail establishment where goods are sold to the public.

The ability to claim faster write-offs may spur property owners into contracting with construction companies.

  1. Energy-efficient buildings. The PATH Act extends several incentives for energy improvements. One tax break that may indirectly benefit contractors is the deduction for energy-efficient buildings, which was extended through 2016.

A tax deduction of $1.80 per square foot is available to owners of new or existing buildings who make energy-based improvements either to the HVAC, hot water or interior lighting systems, or the building’s envelope. The modifications must trim the building’s total energy and power cost by 50% or more when compared to certain minimum standards.

In addition, a deduction of $0.60 per square foot may be claimed by building owners where individual lighting, building envelope or heating and cooling systems meet levels that would reasonably contribute to an overall building savings of 50% if additional systems were installed.

The deduction is available mainly to building owners, though tenants may be eligible. This may turn into a good selling point to prospective clients who can claim the tax benefits. But keep in mind that the deduction is currently scheduled to expire after this year.

  1. Work Opportunity Tax Credit (WOTC). A construction company may qualify for a tax credit for hiring workers from several target groups. Technically, the WOTC expired after 2014, but it was reinstated for 2015 and extended through 2019. The PATH Act also added a new target group of long-term unemployment beneficiaries, beginning in 2016.

Generally, the maximum WOTC is $2,400 for each full-time worker from a target group. In addition, if your business needs extra help during the summer, it may qualify for a special maximum credit of $750 per worker for hiring certain youths from empowerment zones or enterprise communities.

Now is a good time to hire workers who will qualify for either the regular credit or the special summertime credit. What’s more, transitional rules allow you to claim the WOTC for qualified workers for 2015. But you must act fast: The deadline is June 30, 2016.

  1. Research credit. This credit generally equals 20% of the excess of qualified research expenses for the year over a base amount. Your construction business may claim a simplified credit equal to 14% of the amount by which qualified expenses exceed 50% of the average for the three preceding tax years.

The PATH Act permanently preserves the research credit with a couple of important enhancements that take effect in 2016:

  • A qualified small business (one with $50 million or less in gross receipts) may claim the credit against AMT liability, and
  • A qualified startup (one with less than $5 million in gross receipts) may claim the credit against up to $250,000 in FICA taxes annually for up to five years.

The credit is especially valuable to construction companies that also do design work. Check with your tax adviser to see whether your costs will qualify.

  1. Qualified small business stock. If you invest in qualified small business stock (QSBS) in your company, the tax law allows you to exclude 100% of any gain from the sale of the QSBS after five years as long as certain other requirements are met. This now-permanent tax break is a powerful incentive for contractors to invest in their own businesses. It may also be an advantageous method of securing more working capital from outside investors. (The QSBS tax break isn’t limited to business owners.)

For more information on how your firm can benefit from these tax breaks, consult with your advisers.

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