Red Spot Design2, Author at The CJ Group

Communication: Establishing Timing and Deliverables for Your Succession Plan – Phase III

Posted on July 30, 2016 by Red Spot Design2

When I work with small business owners, particularly family-owned businesses in manufacturing and distribution, succession planning is stalled because of a lack of communication. Owners don’t want to face the sometimes tough conversations around who will take over the business and what that will mean for family members, employees or customer relationships. Before beginning the final phase of building your succession plan, consider the following questions:

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?

Usually, I try an objective process of elimination. If there are family members in the business, I ask if any are interested — and able — to operate the company. Based on the owner’s responses, we take a look at other scenarios such as a leveraged buy-out or ESOP arrangement. And finally, we look at the potential for selling to an outside buyer (e.g. private equity, competitor, affiliated vendor).

Based on the owner’s selection of a Plan A and Plan B succession scenario, we have to plan communication with family and management. The depth and detail of communication is directly related to how significant each family member’s or management leader’s role will be in Plan A or Plan B. The smaller the role, the less detailed you will be in communication. Key topics of discussion may or may not include:

How your buyout or retirement will be handled and impact on the business operationally and financially going forward
How the plan will affect each stakeholder in particular – who will be offered stock or ownership
How you are dealing with family members not involved in the business — helping them understand that the business is like any other stock in their portfolio
Your planned date of exit
Getting feedback on their concerns

There may be some hard conversations. This is where you can seek help from your advisory team to guide the conversation. For example, I’ve seen situations in which a child thinks the parent will bring him into the business, but the child doesn’t have any experience or education. You may also have one child already working in the business and another who isn’t. The parents want to be fair to both children, but it’s not necessarily the best decision to hand the reins of the company to both.

The same conversations must be discussed with management. Depending on the details of Plan A and Plan B, you want to avoid a mass exodus of skilled management. Therefore, discussions of transition should also include compensation of key employees to support retention and timely — rather than sudden — exits.

Set up the Timetable and Deliverables

The final timetable is of utmost importance so that you can address issues and gaps in your plan, properly structure your exit and leave the company in good hands.

Let’s say, for example, you have seven years to exit. In year three, you may arrange to step out of the CEO role and take on a support role of transitioning relationships and training management. Making such transitions over time is usually best to preserve customer relationships and value of the business.

Owners must also set up a timetable for addressing and solving issues and gaps in the plan. Perhaps you need to restructure entities for a better tax position upon sale. You may have outstanding debt and collections that need cleaning up. You will need to schedule a valuation to determine the true value (or estimation of value) of all company assets. You will also need to revisit your organizational chart to determine hiring of key management and/or transition of management.

The last 30 days of your succession planning involve reviewing your written Plan A and Plan B, establishing a timetable to address gaps and issues, and ensuring that many documents are updated and in place. Some of the key documents in a succession plan can include the following:

A one page executive summary succession Plan A and Plan B in writing
A management emergency plan
Shareholder agreements – buy /sell
Review of wills and estate plan documents
Purchase price formula or method with discounts and terms
Final proforma balance sheet, income statement and cash flow

Remember, you are not alone in this planning. Rely on your designated succession planning quarterback, such as your CPA, to keep everyone on your advisory team informed and involved. You will be amazed at the sense of relief after handling a critical piece in business ownership — that is, how to leave your business in good hands.

For more information on guiding your small business through succession planning, download the whitepaper: Do You Need a Succession Planning Starter Kit?

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.

DOL Announces Increased Civil Penalties for Violations of Federal Laws

Posted on July 30, 2016 by Red Spot Design2

DOL Announces Increased Civil Penalties for Violations of Federal Laws

The Department of Labor recently issued final rules that will increase the civil penalties assessed to employers for violating various federal laws. The higher penalties are part of a law passed last year and are scheduled to begin with those assessed after August 1, 2016. This article explains why the penalties are increasing and some of the new amounts.

Penalties Going Up for Violations Related to Employment of Temporary Non-immigrant Workers

The DOL issued two interim final rules that will increase civil penalties for violations related to the employment of temporary non-immigrant workers under the H-1B and H-2B visa programs.

Descriptions and Penalties

H-1B visa program. The H-1B visa is used by U.S. employers to hire foreign workers in areas of specialized knowledge or technical expertise, such as scientists, engineers, or computer professionals. American employers that apply for the visa must prove there are no qualified U.S. workers that could fill the positions, and must ensure that the H-1B visa holders are paid the same as their U.S. counterparts.

The following H-1B visa program penalties are increasing August 1, 2016:

1. The civil penalty for violations pertaining to strikes, lockouts, displacement of U.S. workers, notification, misrepresentation of material facts, etc. is going from $1,000 to $1,782;

2. The civil penalty for willful violations pertaining to wages, working conditions, misrepresentation of material facts, etc. is increasing from $5,000 to $7,251; and

3. The civil penalty for each willful violation that caused the displacement of a U.S. worker is rising from $35,000 to $50,758 per violation.

H-2B visa program. This visa program allows American employers who meet specific regulatory requirements to bring foreign nationals to the U.S. to fill temporary non-agricultural jobs. There are civil penalties on employers for violations including those related to wages, impermissible deductions, prohibited fees and expenses, and improper refusal to employ or hire U.S. workers.

Effective August 1, 2016, the related civil penalty is increasing from $10,000 to $11,940 per violation.

Background Information

On November 2, 2015, Congress passed the Federal Civil Penalties Inflation Adjustment Act Improvements Act of 2015. It directed federal agencies to adjust civil penalties for inflation each year. Agencies were instructed to determine the last time civil penalties were increased and publish interim final rules to adjust penalties for inflation from that date. The amount of increase can’t exceed 150% of the existing penalty amount.

A DOL Fact Sheet explains that penalties are imposed on employers to encourage greater compliance. “These penalties, however, are less effective when they haven’t been raised for decades to keep up with inflation,” the DOL states. Recognizing this, Congress passed a law in 1990 directing agencies to adjust their civil monetary penalties to keep up with inflation, defining a civil monetary penalty as a penalty for a specific amount or maximum amount set by federal law that is assessed or enforced by a federal agency.

“But a low cap on these increases together with complicated rounding rules kept many penalties from accomplishing Congress’s stated goal of keeping up with inflation over time,” the DOL adds.

Furthermore, some agencies, such as the Occupational Safety and Health Administration (OSHA), were exempt from the 1990 law, so the agency’s penalties haven’t increased since 1990. That’s why Congress passed the Inflation Adjustment Act in 2015 to begin annually adjusting penalties using a more straightforward method than the 1990 law.

DOL Civil Penalties

The DOL will increase more than 20 civil penalty amounts, effective with civil penalties assessed after August 1, 2016, with associated violations that occurred after November 2, 2015. For example:

Minimum wage and overtime. The civil penalty for repeated or willful violation of the minimum wage and overtime provisions in the FLSA will increase from $1,100 to $1,894 per violation.

Child labor. The civil penalty for violations will increase from $11,000 to $12,080.

FMLA. The civil penalty for willful violation of the requirement that employers post and keep on their premises a notice about the FMLA and the procedures that employees may use to file complaints will increase from $110 to $163.

OSHA Penalties

OSHA’s maximum penalties, which were last adjusted in 1990, will increase by 78%. In addition, going forward, the agency will adjust its penalties for inflation each year based on the Consumer Price Index.

Serious violations. The top OSHA penalty for serious violations will increase from $7,000 to $12,471 and its top penalty for willful or repeated violations will rise from $70,000 to $124,709.

Other Agencies and Laws

This article only covers some of the increased penalties. For example, under the Employee Retirement Income Security Act, there will be several higher penalties for violations including:

Failure to furnish documents to certain employees, former participants and beneficiaries;
Failure to maintain records; and
Failure (or refusal) to file an annual report on Form 5500.

There will also be increased penalties assessed on some employers by the Employee Benefits Security Administration, Mine Safety & Health Administration and under the Office of Workers’ Compensation Programs. In addition, the DOL (along with the Department of Homeland Security) has adjusted penalties associated with the H1B and H2B temporary guest worker program (see right-hand box).

Click here for a chart showing all of the penalty adjustments.

This article only lists some of the increased penalties employers may face. For more information about your company’s situation, consult with your employee benefits adviser or employment attorney.

Manufacturer’s Operating Report Knowledge Can Be Golden

Posted on July 28, 2016 by Red Spot Design2

Your dealership likely prepares and sends operating reports to your manufacturer every month. How you use the reports beyond sending them to the factory can have a big impact on your dealership’s profitability.

Here are three ideas for using your monthly operating report as a tool to stay on track as the year progresses.

1. Keep an Eye on Revenue.

Every manufacturer’s report is different, but yours likely contains, in some format, a summary of that month’s operating revenue. These figures can quickly tell you which departments are the moneymakers and which lag behind expectations.

Let’s say that the current month’s operating report for a dealership shows that it brought in the following in gross revenues: $2 million in new car sales, $750,000 in used car sales, $140,000 in parts sales, $61,000 in service income and $56,000 in body shop income.

You also can see how income from your store’s various departments compare with the prior month, as well as a year ago, the dealership’s projected budget, benchmarks and so on. Let’s assume that you projected $2.25 million in new car sales for the current month. With sales coming in at only $2 million, you are concerned that first quarter sales are off to a slow start and, thus, choose to move up by several weeks a new car sales promotion you had planned to run in two months.

Another example involves gross revenue versus turnover. Take Dealer A, who buys a vehicle for $20,000, holds it for 90 days and finally sells it making a $3,000 gross profit. Many dealers would be pleased with this outcome. But let’s also consider Dealer B, who spends the same $20,000, sells the vehicle in 30 days but only achieves a 10 percent profit margin or $2,000 gross profit. The difference is that Dealer B does three times the sales in the same 90 days, doubling his total gross income compared to Dealer A.

There are many other ways to use your operating report to analyze front-end operations.

2. Figure Out the Reasons Behind the Numbers.

When you analyze the back end of your operations, for example, you’ll look at income and expenses in the service, parts and body shop departments.

Let’s say that you have a gross profit of $33,000 in the service department. This alarms your manufacturer, because it’s less than 55 percent of your monthly service sales and shows that your gross profit percentage has slipped from the target of 65 percent. But it shouldn’t be a major concern if the reason for the shortfall is that the department was busier than usual refurbishing used cars for sale next month — and profits for that venture won’t start showing up until the following month.

3. Consider other Benchmarks.

Monthly operating reports are also a way for you to measure your dealership’s performance against more complex benchmarks. Consider, for instance, the concept of “service absorption.” This is defined as the sum of total parts, service and body shop gross profits divided by the sum of total fixed expenses plus dealer salary plus parts, service and body shop sales expense. (If your report doesn’t have this category, you could calculate it from the other data provided.)

Let’s say that your store’s benchmark range for service absorption is 85 to 100 percent, but your current operating report shows your store coming in at 83.8 percent for the month. This figure is only slightly below the bottom of your benchmark range. Nonetheless, you might want to take steps to lower expenses or bump up revenue for the next month to be sure your store is in the benchmark range.

Achieving a service absorption of 85 percent or higher will give you a competitive advantage over your competition, because the new and used departments only need to cover 15 percent or less of your dealership’s total fixed expenses. Thus, you can afford to take less gross profit on an individual sale.

Knowledge Can Be Golden

By studying your manufacturer’s operating reports, you can arrive at countless insights, from your day supply of vehicles to the gross profit per technician to determine an adequate employee count in the back end. All of this knowledge can be golden, because it helps you recognize strengths, pinpoint weaknesses and set goals for the rest of the year. Don’t let it go unnoticed.

Professional Service KPIs: Know Your Numbers, Define Value

Posted on July 27, 2016July 23, 2024 by Red Spot Design2

A well-managed PSO anticipates change with the right key performance indicators — helping leaders look ahead instead of always over their shoulders. Whether PSOs are considering M&A, structuring pricing or forecasting capacity, it comes down to numbers.

Every service organization should have a list of key performance indicators (KPIs) that measure how well the business is doing. KPIs will be different for every organization, but in general PSOs should look at the following five:

Annual Revenue per Billable Consultant – Total revenue divided by the number of billable consultants — this should minimally equal one to two times the fully loaded cost of the consultant
Annual Revenue per Employee – Total revenue divided by the total number of employees (billable and nonbillable) – this should be close two times the fully loaded cost per person
Billable Utilization – Calculated by dividing the total billable hours by 2,000 (the average utilization per employee) – this KPI is central to profitability and signals the need to expand or contract the workforce
Project Overrun – Percent of budgeted cost to actual cost – consistent project overruns eat into profits and signal inefficient project governance
Profit Margin – Calculated as revenue that remains after paying for the direct costs of delivering a project (payroll, transportation, materials, etc.) – can be fixed-price or not to exceed price or related to hourly time and expense.

Because they sell knowledge and service, PSOs realize revenue growth and profits mainly by leveraging people effectively. Time is truly money in a PSO. Not every minute can be billed, and many PSOs support nonbillable activities such as volunteering to enhance their team culture. However, the ratio of billable activities must be high enough to achieve per person revenue goals and margins. By the same token, nonbillable employees must be a smaller percentage of the overall employment base compared to billable employees.

Effective KPIs are monitored and reviewed regularly. This can happen during senior leadership team or sales meetings, but the emphasis is on regular review. The biggest squeak gets the grease, and leaders must commit to change before they will see it in their organizations.

Here are some of the ways that PSOs can improve the five primary KPIs:

Leveraging senior-level professionals for high-level consulting and project oversight
Delegating project management and technical services to mid-level professionals
Right-pricing engagements
Defining and focusing on ‘A’ clients
Increasing efficiency of project delivery through processes, productization and automation
Outsourcing nonbillable or repetitive tasks that relate to running the organization

Such methods sound like common sense in theory, but we are still dealing with people. Depending on the size of the organization, prioritize which methods to pursue first that would make the biggest impact on profits.

Do you have low-profit clients that need to be transitioned to another service provider?
Do you have senior professionals unaware of tasks they could delegate (or unwilling)?
Are your processes inefficient because they are tailored too much for each client, and therefore impossible to delegate?
Are you underpricing your services or underestimating the actual time it will take to deliver them?
Are you sacrificing client service in the pursuit of new business?

Every PSO experiences these challenges. Being aware of them is the first step to discussing solutions to eliminate them.

In any event, one of the simplest ways to boost KPIs is to limit the time that owners and senior staff spend working in the business rather than on it. This relates to all of those time-consuming administrative, financial and operational tasks that must be done, but could be done more efficiently and cost-effectively by someone else — allowing professionals to focus on billable client work.

At Cornwell Jackson, our tax and business services teams have worked with clients for many years to optimize back-office functions, but also assist with business strategy and planning. We have supported PSOs in determining the best KPIs, the optimal level of staffing and timely introduction of accounting tools and processes that enhance their growth. For more information on how your PSO can face today’s growth challenges head-on with a qualified outsourced relationship, contact us.

Mike Rizkal, CPA is a partner in Cornwell Jackson’s Audit and Attest Service Group. In addition to providing advisory services to privately held, middle-market businesses, Mike oversees the firm’s ERISA practice, which includes annual audits of approximately 75 employee benefit plans. Contact him at mike.rizkal@cornwelljackson.com.

The Financial Rewards of Buying a College Condo for Your Kid’s University Housing

Posted on July 25, 2016 by Red Spot Design2

Photo Credit: Claire L. Evans, Flickr

With real estate prices recovering in many markets, it might make sense to buy a condo where your child can live during college. He or she can live there while attending school, and you can avoid “throwing away” money on dorm costs or rent for an apartment. If you buy a place that has extra space, you also can rent it to your child’s friend(s) to offset some of the ownership costs.

Additionally, you may be able to sell the condo for a gain after the four or five (or maybe even six) years that it takes for your son or daughter to graduate. A gain may be even more likely if you have more than one child — and you can persuade a younger child to attend the same college as an older sibling. Here are some tax issues to consider before you buy a condo near campus.

Rules about Deducting College Condo Ownership Costs

The federal income tax rules generally prevent you from deducting losses from owning and renting out a residence to a family member. But an exception applies when you rent at market rates to the family member who uses the property as his or her principal home. This loophole is open to you if you buy a condo and rent it out to your college kid (and any roommates) at market rates.

As long as you charge market rent, you can — subject to the passive activity loss (PAL) rules explained later — deduct the mortgage interest and write off all the other operating expenses, including utilities, insurance, association fees, security monitoring, cleaning, maintenance and repairs. As a bonus, you can depreciate the cost of the structure (but not the land) over 27.5 years, even if its market value is increasing.

Where will your cash-strapped college student get the money to pay you market rent for the condo? The same place he or she would get the cash to pay for a dorm room or apartment rent. You can gift your child up to $14,000 annually without any adverse federal tax consequences. If you’re married, you and your spouse, combined, can give up to $28,000. Your child can then use that money to write monthly rent checks back to you.

For recordkeeping purposes, your child should send checks that say “rent” on the memo line. It’s also helpful for you to open a separate checking account to handle rental income and expenses. Taking these steps will minimize problems with the IRS if you get audited.

Key point: Even if you don’t charge your child market rent for the condo, you can still deduct the property taxes. Designate the condo as your second home, and then you can also deduct the interest on up to $1.1 million of combined mortgage debt on your main home and the condo as an itemized deduction on your personal tax return (subject to the phaseout rule for high-income folks that normally applies to these deductions).

Watch Out for PAL Rules

The condo is likely to generate tax losses after you consider depreciation deductions. If so, the PAL rules generally apply. The fundamental concept is simple: You can deduct PALs only to the extent you have passive income from other sources, such as positive taxable income from other rental properties or gains from selling them.

A special exception allows you to deduct up to $25,000 of annual PALs from rental real estate provided:

Your adjusted gross income before the real estate loss is less than $100,000, and
You “actively participate” in the rental activity.

Active participation means you’re making management decisions, such as approving tenants, signing leases and authorizing repairs.

If you qualify for this exception, you won’t need any passive income to claim a deductible rental loss of up to $25,000 annually. However, if your adjusted gross income (AGI) is between $100,000 and $150,000, the special exception gets proportionately phased out. If your AGI exceeds $150,000 and you have no passive income, you can’t currently deduct any passive rental real estate losses. Fortunately, any unused losses will be carried forward to future tax years, and you can deduct them when you sell the condo.

Expect More Tax Benefits When You Sell

When you sell a rental property that you’ve owned for more than a year, the profit — the difference between sales proceeds and the tax basis of the property after subtracting depreciation — is a long-term capital gain.

For most folks, the maximum federal tax rate on long-term gains is 15%. But if you are in the top federal bracket, the maximum rate is 20%. Higher-income taxpayers may also owe the 3.8% net investment income tax on rental property gains. Also be aware that, if you’re in the 25% regular income tax bracket or above, part of the gain — the amount equal to your cumulative depreciation write-offs — is taxed at a maximum federal rate of 25%.

Finally, remember those carryover passive losses that we talked about earlier? You get to use them to shelter all or part of the gain from selling the place.

Act Quickly but Not Hastily

While the idea of buying a college condo can be attractive purely from a tax perspective, it makes sense only if you expect to make money on the investment. If you can buy relatively low now and sell high later, you’ll come out ahead. But if you don’t expect to be able to make a profit on a future sale, you may be better off simply paying for your child to live in a dorm or apartment.

The start of school is just around the corner, so act fast if you think this investment opportunity will work for you. Before you meet with a realtor, contact your tax professional for more information.

Compensation Matters: Determining Your Own Pay

Posted on July 21, 2016 by Red Spot Design2

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.

Small Employers Get 7-Day Safe Harbor for 401k Deposits

Posted on July 20, 2016 by Red Spot Design2

Photo Credit: Julian Pett, Flickr

Small employers* now have added certainty in knowing their time frame for transmitting employee 401(k) contributions to the plan. Compliance with deadlines is important, because holding on to employee contributions too long constitutes a prohibited transaction that could result in penalties. The U.S. Department of Labor’s establishment of a safe harbor period eases up the rules and can help small employers avoid this dilemma.

What a Difference a Day Makes

Why is it so important that employee contributions be deposited into the appropriate plan on time? Employees don’t see the activity involved in moving their money. They tend to assume that their contributions are deposited into the plan on the day you withhold it from their paychecks. As the saying goes, “timing is everything,” especially in a volatile stock market. Employees who believe their investments were harmed by a delayed deposit could sue for a breach of fiduciary duty.

The DOL has long required that amounts withheld from an employee’s paycheck — such as elective deferrals to a 401(k) plan — must be transmitted to the plan on the earliest reasonable date.

In the case of a pension plan (including 401(k) plans), the DOL had set an outside limit of the 15th business day of the month following the month in which such amounts would have been available to the employee.
In the case of welfare plans, the outside limit is 90 days from the withholding.

Despite setting these outside limits, if an audit should occur, the DOL will look for the earliest date by which the contributions could have been transmitted to the plan. If the agency determines that this date is earlier than the outside limit, it will be the earlier date that applies. In some cases this may be just a few business days.

For employers, the difficulty is in adhering to the earliest-reasonable-date rule. After that time, employee amounts are considered plan assets and holding onto them is a prohibited transaction.

Since January 14, 2010, small employers have been granted a little breathing room. As long as the employee contributions are deposited into the plan within seven business days of the date they are withheld from the employee’s paycheck, they will be deemed to be handled in a timely manner. This is true even if the amounts are deposited in an account of the plan, but not yet credited to specific participants. This is the seven-day safe harbor rule, and it can apply even if the funds could have been deposited earlier, therefore, employers can use this rule to avoid prohibited transaction violations of the general rule.

The safe harbor rule can be used for 401(k) elective contributions as well as for participant contributions to any plan, or for participant loan repayments.

Is the Safe Harbor Rule Optional?

The simple answer is yes. Even if small employers deposit the funds after seven business days, they may still rely on the general rule to avoid a prohibited transaction — assuming the money was transferred as soon as possible.

Also, the safe harbor is applied on a deposit-by-deposit basis. So, an employer can miss the seven-day window for a particular pay period and instead use the earliest-reasonable-date approach and may then use the seven-day safe harbor for subsequent payroll periods.

If a small employer misses the seven-day safe harbor date and also misses the earliest reasonable date, penalties are calculated from the earliest date contributions could have been deposited, not from the safe harbor date.

Why did the DOL issue the safe harbor rule? They did it to address concerns from employers and advisers about the previous rules and the uncertainty they brought. Also, the DOL admitted that it was expensive and time consuming to pursue violations. We devote “significant enforcement resources to cases involving delinquent employee contributions, and the vast majority of applications under the Department’s Voluntary Fiduciary Correction Program involve delinquent employee contribution violations,” a DOL spokesperson said. With the safe harbor, small employers will be able to make timely deposits and rest assured they are within the law.

*For this purpose, small employers are defined as having fewer than 100 plan participants, determined at the beginning of the plan year.

Execution: Sharing Your Succession Plan – Phase II

Posted on July 20, 2016 by Red Spot Design2

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.

Cybersecurity Awareness Month: Protect Valuable Assets

Posted on July 19, 2016July 23, 2024 by Red Spot Design2

cybersecurity

Our world is more interconnected than ever before. The Internet has become an integral part of everyone’s business and personal lives. But along with Web-based opportunities come risks of breaches and associated losses. The U.S. Department of Homeland Security has launched a series of education seminars this October as part of National Cybersecurity Awareness Month. The goals are to raise awareness about cybersecurity and to increase the U.S. resiliency against the threat of a cyber incident. Here, we reveal findings from two recent studies that underscore the importance of protecting your business against data breaches.

Sobering Statistics

The second-quarter 2015 Duke University / CFO Magazine Global Business Outlook survey revealed that approximately four out of five U.S. companies had experienced at least one serious outside hacking attempt to steal, make public or change important data in the last year. Breach rates were even higher among European companies (92%) and those with fewer than 1,000 employees (85%). In the third-quarter 2015 Global Business Outlook survey, data security once again made the list of top 10 CFO concerns.

A recent claims study by NetDiligence, a cyber risk assessment and data breach services provider for the insurance industry, reports that the average cost of a cyber breach in 2015 was nearly $674,000. But the NetDiligence dataset includes some claims that haven’t yet been paid, and it estimates that the average cost could rise to $1.1 million, assuming self-insured retentions are met.

Most of these claims involved losses of records containing personal identifiable information (45%), followed by payment card information (27%) and personal health care information (14%). Nearly a third of the incidents involved hackers. The health care and financial services industries accounted for the most claims (21% and 17%, respectively). But the largest claim overall occurred in the retail industry.

Preventive Measures

What steps has your company taken to minimize data breach risks? The first step in any cybersecurity plan is identifying your “crown jewels,” the data that’s most valuable to your organization. Depending on your industry, that might be trade secrets, financial data or customer data, for example. Focus most of your attention on making these assets more secure. Doing so requires an understanding of who has access to your most valuable intellectual property assets, including employees and third-party vendors.

Protecting against cyber threats is an ongoing chore that requires buy-in from everyone in your organization. The most common data security technique reported by CFOs in the Global Business Outlook survey was installing new software (64% of respondents). In addition, approximately one-third of respondents plan to train employees about breach prevention, install updated IT hardware or hire a data security firm to review their protocols.

Other ways to beef up your company’s cybersecurity measures include:

Installing the latest software, hardware or application updates on every device as soon as they’re released by the manufacturer. Doing so can help thwart hackers who troll for patches and updates to exploit the latest system vulnerabilities. Nimble hackers can then use these vulnerabilities to steal data before businesses have a chance to install the fix.
Limiting the number of devices connected to the Internet and minimize off-site risks. For example, consider limiting which employees can work from home. It’s also important to educate employees about the risks of cyber breaches and to install encryption software on devices that link to external networks. Employees who take devices out of the office expose your company’s data to less-than-secure home networks and public hotspots that provide wireless Internet access.
Fortifying your defenses against losses from breaches with cyber liability insurance. Professional and general business liability insurance policies generally don’t cover losses related to a hacking incident. Cyber liability insurance can cover a variety of risks, depending on the scope of the policy. It typically protects against liability or losses that come from unauthorized access to your company’s electronic data and software.

Instead of purchasing a standalone cyber liability policy, you can add a cyber liability endorsement to your errors and omissions policy. Not surprisingly, the coverage through the endorsement isn’t as extensive as the coverage in a standalone policy.

Business owners and managers should carefully read their policies to understand what types of incidents are specifically excluded from coverage. And, remember, no type of cyber liability insurance is a suitable replacement for sound cybersecurity policies and procedures. Other well-resourced preventive measures can also reduce your premiums for cyber insurance.

Year-End Planning

National Cybersecurity Awareness Month is a perfect time to launch an educational program for your employees about these risks and preventive measures. If you’re unsure where to start, forensic accountants are familiar with ways to identify and reduce costly cyber breach risks. Giving some extra attention to cybersecurity before year end will help your business start off 2016 on the right foot.

New IRS Guidance for Designated Roth Accounts

Posted on July 18, 2016 by Red Spot Design2

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.

Unlock the Potential of Your Business

Let’s Connect