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Author: Red Spot Design2

Year-end Capital Expenditures for Manufacturers – Eligible for Bonus Depreciation in 2015?

Posted on by Red Spot Design2

If you are part of the plant production management team, you are always looking for ways to increase throughput and lower maintenance down times. Of course, one of the go-to year-end capital expenditures strategies is to utilize a CAPEX budget in Q4 to purchase machines, equipment, or do a significant retrofit of existing equipment.

In addition to the return on assets analysis requested by the CEO and CFO, you also have to predict an elusive variable of “the potential tax savings implication in 2015.”

Unfortunately, answering this question has become a variable that might be best handicapped by Vegas and not by a production manager.

 

The bad news.

There is no definite bright line that will allow you to know with a high degree of certainty if the Sec. 179 dollar limit for expensing will be $25,000 or $500,000 in 2015.

There is also not a definite way to know if 50% bonus depreciation is available or unavailable by the end of the year 2015.

 

The good news and current status.

In July 2015, the Senate Finance Committee voted to extend bonus depreciation and the enhanced section 179 deduction through 2016. The full Senate has not indicated if or when it will act on this legislation and the House is not scheduled to act on extender legislation until late 2015. However, if passed this will create planning certainty for 2 years.

In addition, in September, the House Ways and Means Committee passed HR 2510, a bill by Congressman Pat Tiberi (R-Ohio) that proposes to go a step further and make 50% bonus deprecation a permanent part of the tax law and not part of a sun setting extender that has to be renewed annually.

There is considerable support for this bill from a strong ally, Representative Paul Ryan. Ryan wields considerable influence in the house as both Chairman of the House Way and Means Committee and as the newly elected Speaker of the House. Ryan has publicly supported the bonus depreciation incentive and its impact on investing in making manufacturers and businesses more productive.

As House Ways and Means Chairman Paul Ryan (R-Wis.) put it at today’s markup, “H.R. 2510 is about small-business people refurbishing their store or manufacturers buying new equipment. They aren’t earning income. They’re investing in our country. They’re investing in our children. They’re creating jobs. This is exactly what our tax code should support.”

So staying fluid and flexible is the name of the game. We are advising our clients to not rely on bonus for 2015, but we give it our personal handicap score of somewhere north of 60% chance of passage over the next 30-40 days before Congress adjourns for the holidays.

 

Maximizing deductions for a year-end acquisition.

(This is an example from the Congressional Research Center using 2014 tax rules and regulations since we do not yet have the new regulations for 2015.)

In the case of assets that were eligible for both bonus and section 179 expensing allowances, a taxpayer may recover their cost in the following order. The Section 179 expensing allowance would be taken first, lowering the taxpayer’s basis in the asset by that amount. The taxpayer then could apply the bonus depreciation allowance to the remaining basis amount, further reducing their basis in the property. Finally, the taxpayer was allowed to claim a depreciation allowance under the MACRS for any remaining basis, using the double-declining balance method.

A simple example from a 2014 acquisition illustrates how this procedure might work. Assume that a company made an acquisition of a new CNC laser cutter system at a total cost of $700,000. Such a purchase qualified for both the Section 179 expensing and bonus depreciation allowances for that year. Therefore, it was permitted to recover that cost for federal tax purposes as follows:

  • First, the company could take a Section 179 expensing allowance of $500,000 on its federal tax return for that year, lowering its basis in the property to $200,000 ($700,000 -$500,000).
  • Then it could claim a bonus depreciation allowance of $100,000 ($200,000 x 0.5), further lowering its basis to $100,000 ($200,000 -$100,000).
  • Next, the company was allowed a deduction for depreciation under the MACRS on the remaining $100,000. Given that the MACRS recovery period for laser cutters is five years and five-year property is depreciated using the double-declining-balance method, the company could claim an additional depreciation allowance equal to 20% of $100,000, or $20,000, using the half-year convention. ( this presumes no mid-quarter convention issues)
  • The company could recover the remaining basis of $80,000 ($100,000 -$20,000) by taking MACRS depreciation deductions over each of the next five years at rates of 32%, 19.2%, 11.52%, 11.52%, and 5.76%, respectively. ( this presumes no mid-quarter convention issues)
  • Thus, the company was able to write off nearly 89% of the cost of the CNC laser cutter in the same year it was purchased and placed in service.

 

Key Points to Remember for Year-end Planning

This is not an all-inclusive list – instead key points to remember before pulling the trigger on any capital expenditure before year-end.

  • Only 50% of cost is eligible for bonus depreciation
  • Bonus is not available for USED equipment
  • Not all states acknowledge or utilize bonus depreciation or Sec. 179
  • Newly constructed or original use property with a recovery period of 20 years or less (real or personal), qualified leasehold improvements, certain computer software, and water utility property is eligible for bonus depreciation. The only new property is eligible for bonus depreciation; used property is not eligible.
  • Qualified leasehold improvements are generally bonus eligible if made under a lease to the interior portion of a building occupied by a tenant and placed in service more than three years after the building was first placed in service.

We generally advise our manufacturing clients during year-end tax planning to avoid making long-term decisions based on tax allowances, but it can be a strong incentive due to the significant cash flow savings in March when the final year-end tax bill is tabulated.

If your current tax advisor hasn’t talked to you this year about bonus deprecation, LIFO, cost segregation or R&D credits and how they could impact your business in 2015 and 2016, then let us help. We’re tax experts.

 

Blog post written by: Gary Jackson, CPA, Tax and Consulting Partner

Federal Agencies Turn Up the Heat on Worker Classification

Posted on by Red Spot Design2

The federal government is always on the lookout for businesses that improperly classify workers as independent contractors rather than employees. But the heat was recently turned up even more.

The issue of worker classification has many tax and benefit implications. And it continues to be problematic for employers.

Your Responsibilities

If a worker is an employee, you generally must withhold federal income tax and the employee’s share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer’s share of Social Security and Medicare taxes, pay federal unemployment tax, file federal payroll tax returns and follow lots of other burdensome IRS and DOL rules.

You may also have to pay state and local unemployment and worker compensation taxes and comply with more rules and regulations.

In addition, employees may be eligible for fringe benefits such as health insurance, retirement plans and paid vacations.

If a worker is an independent contractor and you pay him or her $600 or more during the year, you must issue a Form 1099-MISC to the individual and the IRS to report what you paid.

If you incorrectly treat a worker who is actually an employee as an independent contractor, your company could be assessed unpaid payroll taxes plus interest and penalties. It also could be liable for employee benefits that should have been provided but weren’t, including significant penalties under federal laws. In addition, businesses with misclassified workers also generally owe taxes and penalties to their states.

During 2015, both the IRS and the U.S. Department of Labor’s Wage and Hour Division (WHD) issued communications to employers about employee classification.

The IRS issued a Fact Sheet reminding employers “to correctly determine whether workers are employees or independent contractors.” The tax agency and courts generally take the stand that workers are independent contractors if they meet specific criteria focusing on the amount of control they have over their jobs.

The WHD, on the other hand, issued an “Administrator’s Interpretation” stating that worker classification isn’t just about control. Rather, the focus is “whether the worker is economically dependent on the employer or in business for him or herself.”

The WHD added that “most workers are employees” under the broad definitions of the Fair Labor Standards Act (FLSA).

The two federal agencies are working together and with states to tackle misclassification.

Many businesses prefer to classify workers as independent contractors to lower costs, even if it means having less control over workers’ day-to-day activities. Federal and state government agencies have always cracked down on businesses that classify workers as independent contractors to evade taxes or sidestep providing benefits. Now there’s another reason to focus on worker classifications: Employers may treat individuals as independent contractors to avoid health insurance obligations that involve employee headcounts under the Affordable Care Act.

Note: Be aware that a worker or a business can file a form with the IRS to ask for a determination about classification. Disgruntled former workers may file the form to show that a business improperly denied employee benefits by classifying them as independent contractors. Businesses should consult with their tax advisers before filing this form because it may alert the IRS to worker classification issues — and inadvertently trigger an employment tax audit.

Here’s the rub for your business: If you incorrectly classify an employee as an independent contractor, your company could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren’t, including significant penalties under federal laws.

That doesn’t mean that you shouldn’t use independent contractors. You just have to be careful to handle the relationships properly. A written contract can help support a worker’s independent contractor status. But that’s no guarantee.

The determination traditionally boils down to this: A worker is an independent contractor if you have little or no control over the way he or she gets the job done. For example, do you set the hours, provide equipment and require the worker to come to your facilities? These are only some of the questions that need to be asked. The bottom line is that if you provide substantial day-to-day supervision, the worker is probably an employee.

Worker classification is a complex issue. Contact us if you have questions about the status of an individual or the filing of 1099 forms. We can help.

Robotics Finds a Place in Construction

Posted on by Red Spot Design2

When you think of robots, you likely conjure up images of C3P0 and R2D2 in “Star Wars,” the cyborgs from the “Terminator” or, closer to reality, the high-tech machines in auto factories.

And now, as costs decline and availability increases, robots are slowly showing up on construction jobs and may soon become commonplace.

It’s About Safety

In the construction industry danger lurks everywhere, whether crews are working on homes or installing girders on skyscrapers. Safety issues are paramount; there are inherent risks every step of the way toward completion of a project.

As a result, industry leaders continually look for ways to promote greater safety, streamline processes and improve efficiency. Enter robots.

According to Inside Unmanned Systems, a magazine that analyzes technology and related developments in construction and other industries, the trend toward robotics in construction can be traced back to the 1990s. At that time, a large Japanese company spent significant amounts of money to develop robots for use in construction. But it had limited success. Consequently, the firm shifted its emphasis to demolition and developed robots that could crush concrete and cut through steel reinforcements.

Improved Demolition Robots

An improved wave of demolition robots recently entered the marketplace. Utilizing new technology, a robot can scan a building, plan for its demolition and essentially flatten it — all without any significant human interaction.

One of the latest innovations is the ERO Concrete Recycling Robot from Sweden. Using water pressure, it separates concrete from rebar and other debris, makes cement slurry, and sends it off to be packed and shipped to concrete precast stations for reuse.

However, these systems can’t autonomously sense, think and act on their own. So the question remains: Can robots be used as independent construction workers?

Taking the Next Step

Many in the construction industry believe that the answer is “yes.” Notably, they point to three new robotic systems:

  1. The Semi-Automated Masonry (SAM) system, developed by Construction Robotics, is generating considerable buzz. SAM is a bricklaying robot that is designed to work with a mason. As the robotic system lifts and places mortared bricks, the mason concentrates on site setup, tooling joints, finishing and quality. SAM can lay roughly 230 bricks an hour and can handle varying brick sizes without difficulty. The machine is being used in the construction of a new high school at The Lab School in Washington, D.C.
  2. FlexBrick, a robotic assembly process for nonstandard brickwork. Developed by ROB

Technologies AG of Switzerland, this device has been licensed to Keller AG Ziegeleien, a Swiss company specializing in structural systems, façades, interiors and tunnels. The machine currently is being used to construct a façade for a winery and three residential blocks in Switzerland, a wall for a stadium in Manchester, England, and acoustically active wall panels for a concert hall in Frankfurt, Germany. ROB Technologies has also rolled out a prefabrication system for masonry façades that is designed to handle every brick differently.

  1. A tiling machine developed by ROB Technologies in partnership with research program Future Cities Laboratory. Future Cities is a part of the Singapore-ETH Centre for Global Environmental Sustainability. The prototype has been tested at a public housing construction site in Singapore. This machine can lay tiles two to three times faster than humans and can increase productivity four-fold because it can work 24/7. FLC says it expects to have a semi-autonomous robotic tiling machine “on the shelves” by the end of 2015. It’s also collaborating with two other partners on a new version of the machine.

Boosting Human Strength

And, of course, there’s the potential of exoskeletons. For an image of a robotic exoskeleton, think of Robert Downey’s “Iron Man” suit or Sigourney Weaver stepping into a power loader in “Aliens.” Exoskeletons are mobile frameworks worn a bit like a suit. They significantly augment a person’s strength.

One exoskeleton is being developed by Ekso Bionics of Richmond, California. It has an unpowered frame that allows it to be used all day (an earlier version could be used only for limited amounts of time due to battery life).

The Ekso product allows the user to lift power tools as if they weigh nothing at all. Similar exoskeletons may be able to be worn by workers in construction jobs that involve extensive lifting, standing and squatting.

As the construction industry grows, the need for innovation and automation increases. With advances in robotics and exoskeleton suits, the industry is likely to become safer and more efficient. Even firms with modest objectives might consider how they could put robotics to good use.

Are you Manufacturing an R&D Credit in your Manufacturing Operation?

Posted on by Red Spot Design2

The leaders of the manufacturing clients that populate our firm’s client base are by their very nature – innovators. Innovators that are constantly experimenting, refining processes, and trying to determine how to do things better, faster, and cheaper. In particular they are interested in how to create innovations that can bring long-term value to their organizations and their customers.

This value creation from innovation creates jobs and is the main reason that the R&D credit exists in our tax code. So why aren’t more middle market manufacturers claiming this credit? – It seems to me that is likely for one of the four reasons explained below:

  1. Lack of Knowledge

Many manufacturers are third or fourth generation businesses, which could mean a third or fourth generation CPA relationship that may have not kept pace with innovation and current tax law and regulatory changes. Another possibility is that perhaps many years ago you re- engineered your own company tax returns to be performed by an internal department that gets no reward for taking any risks or innovating with new ideas. Sorry to be that blunt, but if the shoe fits- at least take a look at it.

  1. Fear, YES I said Fear

A fear that claiming any credit or incentive is jumping the shark with the IRS and certainly most of my manufacturing clients have enough scrutiny and regulations, that they certainly aren’t prone to invite more regulatory oversight unnecessarily. The fear thing, well it’s natural and is developed in all of us to govern behavior and preserve our lives, so we are by nature created with this emotion for a reason. That being said, this isn’t a fight or flight situation. So it should not freeze us like Elsa from Frozen (blatant Disney grandkid reference) in a business situation that can be assessed, measured, reasoned, and controlled to benefit our company and the families that work in it. Remember, middle market manufacturers create most of the jobs in your respective communities. So our government is helping you help them, which should not be a reason for fear.

  1. Cost/Benefit Uncertainty

This seems to be the main reason that clients don’t embrace the credit. To combat this, our firm has aligned with several engineering firms and specialty tax consulting firms that specifically do an upfront cost/benefit analysis to help clients assess the credit, do a rough estimate, and propose a plan to file and claim the credits. Generally, a rough estimate of the tax benefit can be attained before you start spending any consulting dollars with us or one of our specialists. If you are a Texas manufacturer- beginning in 2014 you also get to add to the analysis a bonus of a 5% credit against your Texas Franchise tax or margin tax on your gross margin. This can be used to offset up to 50% of your franchise tax in any year. Even my smaller manufacturers are seeing significant Texas credits in 2014 and 2015. Also, once you build the model you can repeat it in future years.

  1. Ignorance of the Law

Many leaders of manufacturing firms come from an engineering background, and they just want to know how things work before they dive in. They want to understand what it takes to qualify and how the credit is calculated. So to help with this natural curiosity- here is an example of the basic calculation of the Alternative Simplified Credit:

It’s the sum of your qualified expenses in the current year less (the average of the three years previous qualified expenses multiplied by 50%), which gives you the amount subject to the credit multiplied by 14% to get the actual credit amount.

Assuming you spent $280,000 of qualified activities costs( which is really easy to accumulate if you have any engineers and other smart guys on your management team, ( see the qualifiers below ) in 2014, and the average of your three prior years was say $100,000, then the delta would be $180,000 of qualified expense multiplied by 14% which equals $25,200. If you add the Texas credit to the federal credit that’s an additional $9,000 resulting in$34,200 in tax savings in one year. Better than a poke in the eye with a sharp stick.

So what kind of qualified expenses qualify- I found this great summation of the rules written for manufacturers in this article written by FreedMaxick CPA’s, a New York State firm that does quite a bit of R&D credit work. Here’s their summary and examples of the four qualifiers for the credit.

Four-Part R&D Credit Qualifier Test per FreedMaxick CPA’s:

  1. Permitted PurposeThe activity must result in a new or improved process, function, product, performance, reliability, quality, or significant reduction in cost. Probably the most common type of activity overlooked by companies regarding these specific criteria involves significant improvements made to production-line operations. A very common example of this sort of improvement would be the updating of production-line capabilities by a manufacturer that ultimately improved efficiency, increased production capacity, and eventually yielded an overall reduction in costs. An example of this type of activity would be a company that manufactures heavy equipment, and relied upon a labor-intensive approach to production. If that company were to implement improvements in its manufacturing process, by way of automation or some other means that required investment in new equipment for the plant floor, then it’s very possible that the costs associated with the implementation of the new production process could be eligible for the R&D tax credit.
  1. Elimination of UncertaintyWere the activities conducted and intended to eliminate uncertainty concerning the development or improvement of a product? This criterion specifically involves the identification of information that is uncertain at the onset of the project or activity. Such uncertainty can relate to the capability of the product, the method used to produce it, or the appropriate design of the product. The examples that we typically encounter when consulting with clients in this arena deal with issues such as: Will the new or improved manufacturing process integrate with our current system, on any level? Will our new product development meet the customer specifications? Will the potential benefits outweigh the potential risks? Or will the new or improved product or activity even work?
  1. Technical in NatureDoes the research fundamentally rely on the principals of, engineering, physical or biological science, or computer science? This criterion is usually a fairly easy one to deal with. What it really does is eliminate the soft sciences from the formal definition of technology. In other words, products or activities that are predicated upon literary, historical or social sciences do not qualify for the R&D Tax Credit. In all of our experiences, this technology criterion has never been an issue when performing an R&D study for a manufacturing company.
  1. Process of ExperimentationDoes the activity involve developing one or more hypotheses for specific design decisions, testing and analyzing those hypotheses, and refining and discarding the hypotheses? A key factor regarding the Process of Experimentation hurdle was recently crystallized, when Treasury Regulations changed the wording to evaluation of one or more alternatives. Previous language defined the process as evaluation of more than one alternative.

So now that you know the rules, you can quantify and control the risk, and you can rest assured you are in the fairway not in the rough. So, now it’s time to see if you have created enough innovation recently to qualify for the credit.

Alright then, my innovative bunch of manufacturers, we have one more year of certainty with the R&D credit and we have the ability to amend and claim up to three years of credits until you slide past your extended filing deadline. So as part of your yearend planning, capital expenditure budgeting, and tax forecasting for 2015 and projecting for 2016, please consider the R&D credit and look at the improvements you made to your business in 2014 and 2015. You more likely than not manufactured an R&D credit along with that bazillion widgets you produced for ACME Industries last year!

To find out more about R&D credits and other tools in the manufacturing tool box, or if you would just like to talk some things over about your manufacturing business, contact Gary Jackson, CPA at Cornwell Jackson, PLLC.

Blog post written by: Gary Jackson, CPA, Tax and Consulting Partner

Internal Controls for Small Businesses

Posted on by Red Spot Design2

‘Internal controls’ – accountants love to throw the phrase around and tell you just how important it is to have them.  They’ll tell you that without them your financial information will be inaccurate, your accounting practices inefficient, and in all likelihood your employees will steal from you. Hearing this may worry you, and in all honesty, it should. Accountants don’t just say these things to scare you. In our experience, it is absolutely the truth.

Accordingly, the accounting profession will gladly help you create procedures to reduce your risk. One of the most basic of these procedures is to make sure that you have one person create invoices for customers, another collects payments and creates deposits, another person take them to the bank, and a third person reconcile the accounts. By using this structure, each person’s work is verified by another person, which drastically reduces the likelihood of errors or theft. The same process works for vendor payments: you can have one person enter invoices, another person processes the payments, and yet another approves the payments.

Easy, right? Actually, the methods are quite simple. However, if you own or manage a business with less than five or six people in just your accounting department, this setup is all but useless. Many, if not most of you reading this have one or less dedicated accounting staff, much less an entire dedicated team. Fortunately, a very large segment of the accounting profession is dedicated to small and medium sized business that have been developing processes that can be tailored to your needs.

Let’s take the first example, which involves invoicing clients, collecting payments, and getting their payments into the bank. The reason the profession tries to separate these duties is that, in theory, an unscrupulous employee could create an invoice, receive the payment, then route the funds to his or her accounts rather than the business. Then, the invoice is deleted from the system, and no one ever notices.

For a small business, the combination of technology and management and owner oversight can effectively combat this scenario. Most modern accounting software packages can create warnings when an invoice number is missing or out of sequence. There are also several solutions available for making deposits. First, you can request your customers pay you electronically using a credit card or an online service provider. Additionally, you can use an electronic check reader from your bank to electronically deposit all checks immediately upon receipt, rather than taking any of them to the bank. For those in cash heavy industries, many banks will provide you with on-site lockboxes in which the cash can be immediately inserted and deposited. The bank then makes this cash available to you and will periodically come by to pick up the funds from your location.

The final step involves oversight from either the owner, a supervisor, a third party, or a combination of those parties. Any one of those individuals must be able to check the system warnings for invoice numbers that are out of sequence. They can then review the accounts receivable aging reports to confirm customer balances. Finally, the bank account should be reconciled by one of these individuals. By utilizing this streamlined process, a small business or medium size business can protect itself with the same policies and procedures as a large accounting department.

One very important idea should be sticking out to you while reading this; the internal control system described above still requires the people (or person) in your organization to do their job honestly and effectively. That is why the last step – oversight – is crucial to the power of the control system. Without it, people can simply skip steps or worse, work together to circumvent the controls.

That means the supervisor must be someone that understands what the end result should be. In this example, he or she should be able to quickly scan an invoice listing noting anything out of sequence. This person should also be able to trace a customer’s transaction from the invoice to collecting payment and depositing it into the bank. It should also be someone that does not have an incentive to circumvent the system.

The owner is a somewhat obvious choice for the supervisor role. The trade-off for the owner performing this duty is the loss of time and energy available to grow the business. If, however, it is not in the business’ best interest for the owner to supervise this duty, another person must be chosen. This could be a separate executive level employee within the organization. An outside party such as your external CPA could step in to perform this function at the end of each month as he or she works with you and your accounting staff to close the books.

There is a definite need for strong internal controls for businesses of all sizes. We have only explored an accounts receivable and deposits scenario today, but we will continue to explore different examples in the future. All businesses – big and small – need effective internal controls. Continue checking in with us, as we’ll continue providing real life solutions custom tailored for small and medium businesses.

SBA (7a) Loans: How they Work and What you Need to Know

Posted on by Red Spot Design2

Need a Loan for Your Business? As a company grows, inevitably it will need to partner with a bank to provide long-term financing and additional working capital. Over the years, I have been involved with many clients that struggle to get traditional financing. The response that my clients usually get upon applying for credit is “we like the business model, but it is just ‘not’ the right fit for the bank.” After applying to five different banks, it is quite possible to receive five different reasons for not being a good fit. Maybe it was a ratio, type of industry, or the type of collateral that triggered the rejection. Whatever it may be, the bank says to come back in six months and we can look at it again; the only problem is that many small businesses might not have six months to wait and reapply.

There is a solution for companies that are operating at a profit but don’t have a significant amount of equity built up. Recently, I have worked with a client that is being forced out of bank. While they are current on the payment terms for loans outstanding at his bank, the business incurred some significant losses in 2013 due to a change in the business model that would allow the company to make more money in the future. The company funded the losses by a loan provided by a minority investor. Despite the fact that the minority investor with deep pockets guaranteed the loan, the bank downgraded the loan internally, froze the line of credit, and required the owners to pay down the line of credit by 40%. From that point, the bank was unsure of its next step, since the client’s company started making money in 2014 and is doing fantastic in 2015. So my client and I kept meeting with his banker on a quarterly basis for a quarterly renewal/extension of the loan. Each meeting they just nicely asked for us to pay down the line of credit more and more to squeeze as much cash out of the company as possible. The main problem with that was he was growing and his inventory and receivables were going up which required more cash.

No problem, right? Just go down the street to a new bank and get the better treatment that your company deserves. The only problem with my client was he did not fit in the “traditional lending” platform primarily for not having two full years of net income. For most banks, if you’re not in the black for two years it is difficult to pass the loan committee review.

So who did we turn to for help? Believe it or not- our very own government. Most people don’t know that the Small Business Administration was established to assist small business owners by providing resources and programs to benefit the community. They have a loan program called the SBA 7(a) loan that, in certain cases, makes securing a loan a lot easier for qualifying businesses. Qualifying businesses vary by industry and may be defined as a small business based on either revenue size or the number of employees.

The SBA 7(a) loan program is not a loan directly from the SBA. Instead, the SBA guarantees loans underwritten by traditional lenders. Lenders have to qualify with the SBA to provide these loans and there a several types of certified lending programs they fall under depending on the circumstances of the applicant. These programs vary slightly, however, under the standard 7(a) process lenders submit a full application package to the SBA when they request an SBA guaranty. The SBA confirms the originating lender’s credit decision with its own analysis of the application, which typically takes five to ten business days.

There are some advantages for banks to lend under the 7(a) loan program:

  1. It helps banks serve customers that don’t meet the standards of a conventional loan, which allows them to generate new revenues they wouldn’t otherwise be able to generate.
  2. It reduces the bank’s portfolio risks due to the SBA guaranty
  3. Due to the SBA guaranty, it lowers a lender’s risk weighting for meeting capital requirements.

The SBA 7(a) loan program provides an 85% guaranty for loans of $150,000 or less and a 7% guarantee for larger loans. The amount of the guaranty is reduced to 75% as the size of the loans decreases. The maximum SBA 7(a) loan amount is $5 million.

In addition to the revenue and/or employee headcount guidelines, there are additional eligibility requirements for businesses applying for loans under these programs such as:

  1. Operate for profit
  2. Be engaged in, or propose to do business in, the United States or its possessions
  3. Have reasonably invested equity
  4. Use alternative financial resources, including personal assets, before seeking financial assistance
  5. Use the funds for a sound business purpose
  6. Not be delinquent on any existing debt obligations to the U.S. government

There are certain business types that are ineligible because of the activities they conduct such as:

  1. Lenders such as banks and finance companies
  2. Real estate development
  3. Life insurance companies
  4. Multi-level marketing companies
  5. Government owned entities
  6. Churches
  7. Promotion of sexually oriented products or services
  8. Oil and gas exploration

The SBA 7(a) program was established to encourage longer term financing. There are various factors to the actual term assigned to a loan, however, maximum loan maturities have been established: 25 years for real estate, up to 10 years for equipment, and generally 7 years for working capital. Applicants can request interest-only payments during the start-up and expansion phases to allow the business time to generate income before it starts making full loan payments.

The SBA expects every 7(a) loan to be fully secured, but may not decline a request to guarantee a loan if the only unfavorable factor is insufficient collateral, provided all available collateral is offered.

There are two types of costs related to 7(a) loans. These are loan origination fees and interest charges. The loan origination fees vary based on the size of the loan and range from 0.25% of the guaranteed portion of the loan to 3.5% on loans of more than $700,000. There is also an additional fee of 0.25% on any guaranteed portion of more than $1 million.

All interest rates vary depending on the negotiations between the bank and the applicant, however, the rates are subject to the SBA maximums. The rates can also be either fixed or variable. The maximum rate is composed of a base rate and an allowable spread which will be no more than 2.25% for loans with a maturity less than 7 years. For loans longer than 7 years, the maximum rate will be 2.75%.

Like most other traditional loans, there is a loan application checklist that is very thorough which tends to be one of the slightly negative elements of an SBA 7(a) loan. One of the most common challenges an applicant may face is the ability to provide financial statements that are current within 90 days of the application ‘and’ 3 years of historical financial statements. In addition, an applicant is required to provide a 2 year cash flow projection with an attached written explanation as to how you expect to achieve this projection.  From my experience and from conversions with SBA lenders, this is one of the most common pitfalls an applicant may face when trying to get SBA loans. The most likely cause of the lack of reliable financial information is due to the owner being more focused on growing the business than on the quality of the financial statement preparation. They typically rely on a back office that is spread too thin with administrative duties and getting their billings out on time.

That is where can help. Not only can we help you produce timely and accurate financial information, we can help increase the value of your company by helping you improve your core administrative process. The first step is to begin automating your processes. You also need to develop processes to make your business smarter and more efficient to reduce costs and increase productivity. Here are some examples:

  • Eliminate cumbersome and time consuming manual tasks such as: data entry, envelope stuffing, filing and check runs
  • Pay bills online at a fraction of the time it takes to process and sign checks
  • Automate customer collections
  • Stop opening mail by having the vendor emails sent directly into the accounting software
  • Reduce human error and increase accuracy with automated software
  • Improve internal controls to reduce the risk of fraud
  • Improve timely reporting of financial results
  • Improve collaboration of your limited resources

Free up your resources to focus on your team and customers which will ultimately help you grow the company and have the peace of mind that your company is operating in a smarter and more profitable way. Go and Grow can help you put the processes in place and become your back office at a much lower cost with better controls.

Blog post written by: Scott Bates, Audit and Business Services Partner

Disparate Impact: The Other, Other Supreme Court Decision, and What it Means for the Real Estate World

Posted on by Red Spot Design2

The Supreme Court of the United States recently ruled on a case that may have a profound impact on a number of Americans.  No, not that one, or that one.  We’re talking about the case Texas Department of Housing and Community Affairs v. The Inclusive Communities Project (ICP).  Not quite the sizzle of other recent cases, but the effect it could have on businesses involved in real estate and mortgage lending is significant.  The ruling in this case held that disparate impact claims are recognized under the Fair Housing Act.  Unless you’ve been following this case closely, you probably don’t know what disparate impact is or what the significance of it is (until recently I counted myself in that group as well).  Let’s start by defining disparate impact and understanding how it applies to housing.

What is Disparate Impact?

The Fair Housing Act “prohibits discrimination in the sale, rental, and financing of dwellings, and in other housing-related transactions based on race, color, national origin, religion, sex, familial status, and disability”.  The simple interpretation of this is that it is illegal to intentionally discriminate against (or have policies that discriminate against) a person when it comes to housing.  Disparate impact is the idea that a policy can have a discriminatory effect even if it wasn’t created with an intent to discriminate.  Simply, it is the theory that an individual or organization can be held liable for unintentional discrimination when it comes to housing or mortgage lending.  This means that if someone can show statistical evidence of discrimination against a protected class, they can bring an anti-discrimination lawsuit against your business.  You then have to prove in a court of law that there is an important business objective to the policy that is causing the disparate impact.  If that sounds like guilty until proven innocent to you, then you have a good understanding of the new ruling.

Can you give me an example?
Laurie Goodman, director of the Housing Finance Policy Center gives a good explanation as it relates to the mortgage industry:

“You can only hold a business responsible for what they can control. For example, if a lender applies uniform underwriting standards to all applicants, it will likely result in more mortgage denials for black and Hispanic applicants than for white applicants, because there is a difference in income, wealth and credit experience between the groups. Businesses certainly have a responsibility to support, and at the minimum, not to stand in the way of government programs that push for greater equality of opportunity. But that is different than the disparate impact doctrine, which could hold the private sector guilty of discrimination if their policies resulted in a differential impact on different racial and ethnic groups, despite the fact that these groups have differences in income, wealth and credit experience.”

So let’s be reasonable.

If someone brought a disparate impact suit for the above reason, the mortgage lender could show that there is an important business objective to requiring a minimum credit score in determining whether an applicant is eligible for a loan.  It would be easy to show historical data proving a higher rate of default for customers with lower credit scores which negatively affects the profitability of the business.  The business could feel confident they would win this suit, but the issue is the fact that they would have to defend that suit in the first place, and that is what has business owners nervous.  One more example is the case of Magner v. Gallagher.  In this case, Multi-family property owners in the city of St. Paul argued that the city’s housing code which requires that landlords to maintain minimum maintenance standards for all structures and premises for basic equipment and facilities for light, ventilation, heating and sanitation; for safety from fire; for crime prevention; for space, use and location; and for safe and sanitary maintenance of all structures and premises caused them to raise rents and decrease the number of units available to African-American tenants (which were the majority of people renting their properties currently).  A district court granted a summary judgement for the City (Magner), but the Eighth Circuit held the respondents (Gallagher) should be allowed to proceed to trial because they presented sufficient evidence of a disparate impact on African-Americans.  Yes, the court just ruled that policies put in place to require landlords to maintain adequate living standards in their apartments in St. Paul were discriminatory under disparate impact.  This case was later settled, but it just goes to show how crazy disparate impact cases could be.  A policy whose sole goal was to provide better and safer living conditions for tenants could be made illegal because it theoretically discriminated against the tenants it was trying to help.

So now what?

No one is really sure.  It could turn out to not really be that big of a deal, or we could see a flood of lawsuits.  It is possible that if you own an apartment complex in a neighborhood that is 20% African-American, and only 5% of your tenants are African-American, then you could be slapped with a disparate impact lawsuit.  In the case that was before the Supreme Court, it was concluded that disparate impact was established based on the fact that the Housing Department approved low-income housing credits for 49.7% of units in neighborhoods that were 90 – 100% non-Caucasian while it only approved credits for 37.4% of units in neighborhoods that were 90 – 100% Caucasian.  The ICP asserted that the allocation of these credits caused “continued segregated housing patterns by its disproportionate allocation of tax credits, granting too many credits for housing in predominantly black inner-city areas and too few in predominantly white suburban neighborhoods”.  You can’t be sued on statistics alone, there has to be some evidence to suggest that the statistical discrepancy is caused by a policy you have in place.  That being said, the lack of evidence does not preclude someone from filing a disparate impact suit, it just means the case will be dismissed if the party bringing the suit can’t prove that “a challenged practice caused or predictably will cause a discriminatory effect”.  All we know for sure is that the boundaries of this law and its definitions will most likely be tested in the courts over the next few years.  If anything, it should be interesting.

If you would like to learn more about how this topic might affect your business, please contact Gary Jackson, CPA at Gary.Jackson@cornwelljackson.com or call 972.202.8000.

What’s All The Hubbub About Captive Insurance Companies?

Posted on by Red Spot Design2

Why are we hearing more about Captive Insurance Companies at happy hours, networking deals and professional conferences? Well, it’s simple… people are more open now to new ideas to lessen their tax burden than they were in 2011.

It doesn’t take an Ivy League education to figure out that out of the top 5% of taxable income earners in America – (the vast majority being hard working successful business owners like you) have watched their effective tax rate increase from the low 30’s to an effective rate of almost 40% in the last couple of years. Between our wars in Iraq and Afghanistan, and the “sucking sound” created by promises in the Affordable Care Act – there is no relief in sight from these higher tax rates in the foreseeable future.

Regardless of the reasons or your political persuasion, – John or Jane business owner operating in North Texas, whether in a growing service business, a construction company, a small manufacturer, or a franchisee with 10 dry cleaners, are getting taxed… and taxed hard.

When these business owners become tax “stunned” they become both more creative, more resilient, and more receptive to ideas to help them save on their tax bill. When that occurs certain ideas that were previously reserved for a few (the fortune 500 or fortune 1000 size companies)…. start having traction with middle market companies that may have revenues of 10MM to 200MM, have a strong cash flow, or a fairly predictable earnings history year over year.

So, enough about the why. How do captives work for the common business owner? What does he need to be aware of?  Where is the sizzle in the steak? And finally… What risks do you need to avoid if you are a 5%-er that wants to explore Captives?

 

How They Work

The operating or income producing company (your company) forms a captive and basically pays annual premiums to ensure against risks and pays the premiums to a newly formed insurance company that you own and/or control…

By paying premiums of $500K and you will receive a $500K deduction. Your insurance company receives the $500,000, pays $70k to $100k in operating expenses, small claims settlements and maintenance costs, and assuming no major claims occur- your insurance company makes a profit of around $400K per year.

A specific code section and available election under Sec. 831b, available only to small closely held captives with premiums of less than $1.2 MM annually, keeps the captive from having to pay tax on the premiums it receives at the insurance company level, and it only has to pay tax on its investment earnings.

Meaning, you are getting a deduction for 500K, and your captive is not paying tax on the $400K on the other side.

If your business does this for ten years with no major claims- then your insurance company and its owners has amassed $4,000,000 inside the insurance company which they can dividend or liquidate at 20 to 24% tax rates to the owners of the Captive (you and your family).

If you and your spouse’s net worth exceeds 10MM, you can also, with careful planning, set up your Captive ownership outside of your estate, saving your family an additional 50% of that 4 million in estate taxes that can be passed on to your heirs instead of the IRS.  Over ten years you have likewise saved $2,000,000 in your operating company from ten years of getting $200,000 a year in tax benefit (500,000 x 40%).

In other words, you are getting a 40% deduction and accumulating wealth on a deferred tax advantaged basis over time, which lets you accumulate faster and achieve greater returns.

So friends that’s where the SIZZLE in the steak comes from – the tax rate arbitrage and the estate planning you can accomplish by having your kids own the shares of the captive. Keeping your captive outside of your estate makes for a nifty tax advantaged structure for building wealth transfer to future generations.

 

So, that’s The Good News. What’s the Downsides- or Things to Avoid?

  1. First and foremost – illegitimate or thinly veneered promoters that are selling captives as promoted tax shelters versus an experienced risk management insurance company or Captive management company that operates in the fairway and will advise you correctly on insurable risks and doing it right, with real actuaries that have been doing this a long time.
  2. Insuring faux (not legitimate) or real risks inside your company. For example, anti-terrorism insurance for a small group of doctors versus real risks like malpractice.
  3. Not evaluating your liquidity needs, knowing what is reasonably possible regarding funding of premiums, and how realistic it will be annually to manage your premium levels and payments. While it is possible to change your risks that you cover to toggle or increase or decrease your premiums actuarially, it may reduce the efficacy of your insurance company.
  4. Making sure under your accounting method you can properly deduct the premiums, kind of a bad deal if you go through all this and then remember your cash basis business has to write a 500K check by 12/31 and it doesn’t have the funds to make this happen.
  5. IRS scrutiny- Captives primarily because of the promoters mentioned in #1 above have received a jaundiced eye by our friends at the IRS, and captives even made the dirty dozen list published by the IRS annually for targeted tax scams.
  6. So there are some of our clients that would not be comfortable with this kid of exposure legitimate or not , and then there are some clients that are ok with it because they have done the right things by having the right kind of advisors and captive operators that don’t deal in the fringe element.
  7. Claims- if your captive is legitimate – you will have claims and occasionally some of those could be expensive. How your operating company manages its risks as well as how your Captive manages its reserves and risk can be a difference maker in this area.

 

So If This Is Something You Want To Explore Further, What Are Your Steps?

First, a business owner through his insurance company, financial advisor, or CPA is referred in to a company that can help him form and organize a new Captive Insurance Company and manage its operations going forward.

The CPA works with the captive management company, the business management team, their existing insurance agents or risk manager to come up with a team approach to risk management and evaluate the overall feasibility of using a Captive as a part of the overall risk management plan of the business.

A captive insurance company is a fully licensed insurance company owned by the business or the business owners. It is a unique entity and is a standalone insurance company with policies, policy holders, risks, claims, and a license to do business in various domiciles – some domestic and some off shore.

What does this cost – well of course it varies – but the set up seems to run somewhere between $50K and $70K – with some variability to this figure if you use a domestic captive (with higher initial capital formation requirement), or a foreign captive that may have less stringent initial capitalization requirements.

Done well, a CIC strategy can be a great tool for tax-advantaged risk management and wealth preservation- the veritable combo pack that most of us are looking for. To learn more about it contact Gary Jackson or Cornwell Jackson’s strategic alliances and advisors in this area.

Blog post written by: Gary Jackson, Tax and Advisory Partner

My CPA Conference at Disneyworld

Posted on by Red Spot Design2
disneyLast month, I packed the family up and we jetted to Orlando for a fully deductible summer family vacation.  Now, of course, it was technically a fully deductible continuing education conference as far as IRS rules go.  It was the perfect setting for my 8 and 11-year-old kids.  The plan was for my wife and mother-in-law to go to all the Disney parks while I was in class learning about new accounting rules and trends in the accounting industry.  In fact, that is exactly what happened, and luckily I was able to stay over a couple of extra days to be with them at the Disneyworld parks.

I found the classes very interesting as a significant portion of the content covered the powerful impact of technology changes that are having a dramatic impact to our firm and our clients by increasing efficiencies that increase the bottom line.  The opportunity for our clients is to reduce their back office overhead cost by outsourcing these processes.  I left the conference motivated by the fact that our firm can truly help our clients more than ever before and that we are becoming the accounting and business services firm of the future.

Before heading home, it was off to Disneyworld to take on all the fun Orlando has to offer.  We arrived at the park as it opened for the day.  It was already hot and humid in the morning. So, I was not sure how much fun it would be.  We hit the ground running and made the most of our day despite the heat.  By halfway through the day I began to become increasingly impressed with the park operations.  Everything we experienced was very intentional, meaning there was going to be NO accidental fun.  Every detail of our experience we extremely well thought-out from the beginning until the end of every ride, theme, and experience.  I realized Disney was one of the most efficient engines I had ever seen in a business operation.  I may have learned some great things at the conference, but it was not until I took in Disney that I got the most eye-opening lesson on intentional profitable operations.

Its culture is built around the term ‘plus it’ which was used by Walt Disney to continuously further improve projects whether it be a film, TV show, or park.  I kept thinking to myself, what if our firm and our clients could actually create such an efficient economic engine and how awesome it would be to witness the results on a daily basis.  As business owners, we strive to reap the rewards of our hard work.  For example, we tend to buy the most highly engineered vehicles on the market.  But when it comes to our business operations we cut corners on engineering of our operations and then use prayer and hope that our employees will get-‘er-done using some sort of R&I (resourcefulness and intuition) to provide our services to our customers.

From the time you step off the plane in Orlando, you enter the kingdom so to speak.  You will notice how clean the airport and shuttles are at the influence of Disney.  You can begin your experience with the Disney Magic Band to express check-in, and unlock your hotel room as you arrive without having to wait in line for check-in.  The Magic Band allows you to charge and purchase food and items and connects you to the Disney photo pass and fast pass.  You fast pass to the front of the line and when your attraction ride is over you just wave it on over a reader for your picture that was taken during the attraction ride and it can be purchased anytime later so you don’t have to spend time cutting into your family fun.

I can only image the planning and strategy that goes into the delivery of an attraction on a Disney property.  Each attraction is developed to have a purpose and their customers are entertained from the end of the line all the way through the end of the ride.  The characters are controlled through an extensive network of digital animation that provides a consistent repeatable experience for its customers.  As you walk from one attraction to another it is apparent that the park is very clean and there is plenty of space to walk around.  It utilizes a system of utilidors that allows personnel, retail goods, and supplies to be moved through underground tunnels.  There is another underground system that uses compressed air to collect and transfer trash off the property.

Being an accountant, I thought I would put their financial statements to the test.  I downloaded their last Annual Report filed with the SEC to get to their bottom line.  Is all this worth it I was wondering.  Well, Disney’s year over year growth ‘and’ net profit was in the billions.  Their profit was 15% of gross revenue.  Now that is a well-oiled machine!

So my conference was a success in a way that I did not expect.  I arrived to learn from all the experts in our industry.  There were numerous vendors, subject matter experts, and consultants that wanted to share their knowledge with all the CPA’s and accountants from across the country.  They covered areas of technical rule changes, operations, marketing, and management.  Outside of the technical rule changes, there existed a collaborative effort through over 100 courses with varying topics to cover and talk about concepts that can have a positive impact on efficiencies for our clients.  Better said there was a tremendous amount of talking.  But in the end I witnessed actual efficiencies live in action at Disneyworld that turned into the best lesson I got at the conference.

As a business owner can you imagine having a highly engineered engine running your business?  What if you had a process that ran itself and provided you information in real time to make course corrections?  You take your stress home from work.  Work can be more stressful if it relies heavily on employees who do it the best way they can which is their way and not THE way.  THE way is your strategic way that allows you to work less and make much more money.  Then you can enjoy the financial freedom on your terms and be a happier leader at home and at work.

Now not everyone can throw off a billion dollar bottom line but why not try to get the most out of your business.  Take the first step and create a Disney culture of ‘plus-it’ to move the needle on your business.  The first step is to begin automating your processes. You also need to develop processes to make your business smarter and more efficient to reduce costs and increase productivity. Here are some examples:

  • Eliminate cumbersome and time consuming manual tasks such as: data entry, envelope stuffing, filing and check runs
  • Pay bills online at a fraction of the time it takes to process and sign checks
  • Automate customer collections
  • Stop opening mail by having the vendor emails sent directly into the accounting software
  • Reduce human error and increase accuracy with automated software
  • Improve internal controls to reduce the risk of fraud
  • Improve timely reporting of financial results
  • Improve collaboration of your limited resources

Let ‘your’ team use their business experience which is not as much dependent on technology to help your employees and customers which will ultimately help you grow the company and have the peace of mind that your company is operating in a smarter and more profitable way. Go and Grow can help you put the processes in place and become your back office at a much lower cost with better controls.

Small Business Reprieve on Health Premium Reimbursement Plans

Posted on by Red Spot Design2

Historically, companies that wanted their employees to be protected with health coverage, but didn’t want the hassle of having a company health plan, could simply give employees an amount of money sufficient to reimburse them for the cost of buying the coverage (or some portion of it). As long as the individuals provided evidence that they used those funds for health coverage, the dollars were excludable from taxable income for the employees.

Alternatively, companies could just pay the premiums directly to the insurance carrier.

However, back in November 2014, the Department of Labor (DOL) declared that companies reimbursing employees for medical care instead of offering a health care plan is the equivalent of having a health plan and is subject to the Affordable Care Act (ACA). And since those reimbursement arrangements failed to meet ACA requirements in two ways — that is, the condition that group health plans have no annual limits on benefits, and that no co-pay for certain preventive health services must be paid — they were ruled to be noncompliant with the law.

Per Employee Penalty

This DOL ruling reiterated 2013 guidance from the IRS. The kicker: Beginning in 2014, companies with such reimbursement arrangements in place would be subject to a $36,500 penalty per employee.

The only remedy offered by the DOL was for companies to gross up those contributions (that is, add to them enough money to cover the tax liability employees would incur as a result of receiving the payments), plus make it clear to employees that they could do whatever they wanted with all of the money they received. In other words, they would not be required to use it to pay for health coverage.

The IRS’s latest ruling, Notice 2015-17, which the tax agency says is in sync with the most recent DOL policy on the matter, gives everyone time to catch their breath.

Specifically, small businesses with reimbursement plans in place will not be penalized unless they maintain them beyond June 30 of this year. Small businesses are also off the hook for having to file Form 8928, which is the form that covers failures to satisfy group health plan requirements. Originally, that form would have been required with companies’ 2014 tax returns.

The reprieve also applies to plans that help retirees pick up the tab for Medicare Part B and D premiums.

Employees with S Corp Stock

Employees who own at least 2 percent of their employers’ stock (if the company is an S corp) are treated differently. Such employees were required to report the premium reimbursement payments as income on their 1040s, even though the payments were not subject to payroll tax. But those same employees could also take a deduction equal to the amount of that income, leaving them tax neutral.

In IRS Notice 2015-17, the tax agency warns that it and the DOL “are contemplating publication of additional guidance on the application of the market reforms to a 2 percent shareholder-employee healthcare arrangement.” Until then, however, the companies are off the hook. So, too, are the employees who will continue to be allowed to deduct that income as self-employed health insurance premiums.

Notice 2015-17 reconciles the IRS with a position the DOL had taken earlier — that is, declaring reimbursement plans as merely taxable payments to employees doesn’t prevent them from being deemed health plans. That means the only way to help employees secure health coverage without having a bona fide health plan is to just give each employee a raise and hope they will use it to buy their own health coverage. (Keep in mind, small businesses with fewer than 50 employees and full-time equivalents are not required to provide health plans under the ACA.)

The guidance also made it clear that the ACA’s market reforms, as they pertain to this issue, don’t extend to arrangements covering only a single employee (regardless of whether that employee is a 2 percent-or-more shareholder). That means if you own your company and aren’t an employee, but you have one employee and want to reimburse that person for the cost of buying individual coverage, you won’t be subject to any penalties.

Monthly Health Allowances

Meanwhile, the entrepreneurial spirit of America is at work to help small businesses that just want to help employees pay for individual coverage, but don’t want to run afoul of the IRS and DOL. One benefits company offers a web-based defined contribution arrangement it calls “Individual Health Reimbursement for Small Business.” It gives employees access to a “monthly health allowance.” However, companies considering such arrangements should consult legal counsel for an opinion as to whether the plan would pass muster with the IRS and DOL.

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