Accounting for M&As

Many buyers are uncertain how to report mergers and acquisitions (M&As) under U.S. Generally Accepted Accounting Principles (GAAP). After a deal closes, the buyer’s post-deal balance sheet looks markedly different than it did before the entities combined. Here’s guidance on reporting business combinations to help minimize future write-offs and restatements due to inaccurate purchase price allocations.

Purchase price allocations

Under GAAP, buyers must allocate the purchase price paid in M&As to all acquired assets and liabilities based on their fair values. The process starts by estimating a cash equivalent purchase price.

If a buyer pays 100% cash up front, the purchase price is already at a cash equivalent value. But the cash equivalent price is less clear if a seller accepts non cash terms, such as an earnout that’s contingent on the acquired entity’s future performance or stock in the newly formed entity.

The next step is to identify all tangible and intangible assets and liabilities acquired in the business combination. The seller’s presale balance sheet will report most tangible assets and liabilities, including inventory, equipment and payables. However, intangibles are reported only if they were previously purchased by the seller. But intangibles are usually generated internally, so they’re rarely included on the seller’s balance sheet.

Fair value

Acquired assets and liabilities are then added to the buyer’s postdeal balance sheet, based on their fair values on the acquisition date. The difference between the sum of these fair values and the purchase price is reported as goodwill.

Goodwill and other indefinite-lived intangibles — such as brand names and in-process research and development — usually aren’t amortized for GAAP purposes. Instead, companies generally must test goodwill for impairment each year. Impairment testing also is needed when certain triggering events occur, such as the loss of a key person or an unanticipated increase in competition. If a borrower reports an impairment loss, it could mean that the business combination has failed to achieve management’s expectations.

Rather than test for impairment, private companies may elect to amortize goodwill straight-line, generally over 10 years. Companies that elect this alternate method, however, must still test for impairment when certain triggering events occur.

Bottom line

A business combination is a significant transaction, so it’s important to get the accounting right from the start. We can help buyers identify intangibles, estimate fair value and allocate purchase price even when a deal’s cash-equivalent purchase price isn’t readily apparent.

© 2017

2017 Q1 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

January 31

  • File 2016 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • File 2016 Forms 1099-MISC, “Miscellaneous Income,” reporting nonemployee compensation payments in Box 7 with the IRS, and provide copies to recipients.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2016. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2016. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2016 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.

February 28

File 2016 Forms 1099-MISC with the IRS and provide copies to recipients. (Note that Forms 1099-MISC reporting nonemployee compensation in Box 7 must be filed by January 31, beginning with 2016 forms filed in 2017.)

March 15

If a calendar-year partnership or S corporation, file or extend your 2016 tax return. If the return isn’t extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.

© 2016

How entity type affects tax planning for owner-employees

Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.

Partnerships and LLCs

If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.

The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.

But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.

S and C corporations

For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.

In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).

Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.

As you can see, tax planning is extra important for owner-employees. Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of your income in 2017. Please contact us for help identifying the ideal strategies for your situation.

© 2016

Help prevent the year-end vacation-time scramble with a PTO contribution arrangement

Many businesses find themselves short-staffed from Thanksgiving through December 31 as employees take time off to spend with family and friends. But if you limit how many vacation days employees can roll over to the new year, you might find your workplace a ghost town as workers scramble to use, rather than lose, their time off. A paid time off (PTO) contribution arrangement may be the solution.

How it works

A PTO contribution program allows employees with unused vacation hours to elect to convert them to retirement plan contributions. If the plan has a 401(k) feature, it can treat these amounts as a pretax benefit, similar to normal employee deferrals. Alternatively, the plan can treat the amounts as employer profit sharing, converting excess PTO amounts to employer contributions.

A PTO contribution arrangement can be a better option than increasing the number of days employees can roll over. Why? Larger rollover limits can result in employees building up large balances that create a significant liability on your books.

Getting started

To offer a PTO contribution arrangement, simply amend your plan. However, you must still follow the plan document’s eligibility, vesting, rollover, distribution and loan terms. Additional rules apply.

To learn more about PTO contribution arrangements, including their tax implications, please contact us.

© 2016

Signs of inventory fraud

Is your inventory being stolen by dishonest employees or customers? Inventory is a prime target for fraud schemes, second only to cash. And it doesn’t always involve the physical theft of items. Here are some early warning signs that your inventory has been targeted.

Know your risk profile

Some companies are more at risk for inventory fraud than others. Obviously, service companies with minimal inventory on hand bear little risk of inventory embezzlement; instead, it’s more common among retailers, manufacturers and contractors. In general, higher-value inventory items, such as electronics or jewelry, tend to be more attractive to thieves.

Sometimes, however, the inventory account is just a convenient place to hide financial misstatement ploys, such as skimming or bogus sales. Thousands of journal entries are typically made to the inventory account, and it’s closed out to cost of sales each year. So, thieves with access to the accounting systems may bury their scams in the inventory account. Then, victim-organizations may write off discrepancies between the computerized perpetual inventory records and physical inventory counts as external pilferage, obsolescence or errors — when, in fact, it’s due to intentional manipulation of the accounting systems.

Monitor inventory metrics

If your year-end inventory counts aren’t adding up, don’t just write off the discrepancy as a cost of doing business; investigate why. You can shed light on the situation by computing various inventory ratios, including:

  • Days in inventory (average inventory divided by annual cost of sales times 365 days),
  • Gross margin (sales minus cost of sales) as a percentage of sales,
  • Inventory as a percentage of total assets,
  • Returns as a percentage of annual sales, and
  • Shipping costs as a percentage of sales.

These metrics should be consistent over time and comparable to industry benchmarks. Sudden changes require immediate action.

Catch fraud early

The median duration — from inception to detection of a fraud scam — is 18 months, according to the 2016 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners. Many victims are unaware that inventory balances are inaccurate until they’ve accrued substantial losses. Diligent managers know the signs of inventory fraud and can identify anomalies early. Contact us for help investigating a suspected inventory scam.

© 2016

Are you ready for audit season?

It’s almost audit season for calendar-year entities. A little preparation can go a long way toward facilitating the external audit process, minimizing audit adjustments and surprises, lowering your audit fees in the future and getting more value out of the audit process. Here are some ways to plan ahead.

The mindset

Before fieldwork begins, meet with your office team to explain the purpose and benefits of financial statement audits. Novice staff members may confuse financial audits with IRS audits, which can sometimes become contentious and stressful. Also designate a liaison in the accounting department who will answer inquiries and prepare document requests for auditors.

Reconciliation
Enter all transactions into the accounting system before the auditors arrive, and prepare a schedule that reconciles each account balance. Be ready to discuss any estimates that underlie account balances, such as allowances for uncollectible accounts, warranty reserves or percentage of completion.

Check the schedules to reveal discrepancies from what’s expected based on the company’s budget or prior year’s balance. Also review last year’s adjusting journal entries to see if they’ll be needed again this year. An internal review is one of the most effective ways to minimize errors and adjusting journal entries during a financial statement audit.

Work papers
Auditors are grateful when clients prepare work papers to reconcile account balances and transactions in advance. Auditors also will ask for original source documents to verify what’s reported on the financial statements, such as bank statements, sales contracts, leases and loan agreements.

Compile these documents before your audit team arrives. They may also inquire about changes to contractual agreements, regulatory or legal developments, additions to the chart of accounts and major complex transactions that occurred in 2016.
Internal controls

Evaluate internal controls before your auditor arrives. Correct any “deficiencies” or “weaknesses” in internal control policies, such as a lack of segregation of duties, managerial review or physical safeguards. Then the auditor will have fewer recommendations to report when he or she delivers the financial statements.

Value-added
Financial statement audits should be seen as a learning opportunity. Preparing for your auditor’s arrival not only facilitates the process and promotes timeliness, but also engenders a sense of teamwork between your office staff and external accountants.

© 2016

Tax Return Due Dates Change in 2017

by Nicole Oeltjen

Tax Senior at Atchley & Associates, LLP

Federal due dates for the 2016 tax returns are changing for the 2017 filing season. Don’t worry, your individual income tax return is still due April 15th and the extended due date is still on October 15th. Changes were made to business returns and other tax forms.

The new due dates apply to tax years beginning after December 31, 2015. This also applies to a business that that may have a short year return during 2016. For business that have a fiscal year end other than a calendar year end the due dates may differ slightly.

New federal due dates for a calendar year taxpayer are below:

Form                             Type                                                Due Date             Extended Due Date


1065                                 Partnership                                    March 15               September 15

1120S                               S corporation                                March 15               September 15

1040                                 Individual                                        April 15                  October 15

1041                                 Trust & Estate                                 April 15                 September 30

1120                                 C corporation                                April 15                 September 15

FinCEN Form 114        Foreign Accounts                         April 15                  October 15

990 & 990T                    Tax Exempt                                     May 15                  November 15

5500                                 Employee Benefit Plans             July 31                   October 15

 

States that have income filing requirements will be working to enact legislation to change their due dates to coincide with the federal deadlines for 2017.

 

Why the change?

Over the years more and more businesses were formed as a flow through entity-such as a partnership or S corporation-rather than a C corporation due to the tax implications. As tax law and the complexities of a partnership structure increased, additional time was needed in order for information to be gathered, prepared, and properly reviewed before filing a business tax return. Individual taxpayers were finding it difficult to file on time due to receiving a late Schedule K-1. A Schedule K-1 is the form one receives as being a partner or shareholder of a business structured as a flow through entity. The AICPA, tax professionals and business owners voiced their concerns and opinions and advocated for a change in the federal due dates. Congress passed the new legislation in 2015 to take effect for the 2017 filing season.

Tips for efficient year-end physical inventory counts

The basics

Inventory includes raw materials, work-in-progress and finished goods. Your physical inventory count also may include parts and supplies inventory. Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value.

Estimating the value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. For example, the value of work-in-progress inventory includes overhead allocations and, in some cases, may require percentage-of-completion assessments.

A moving target

The inventory count gives a snapshot of how much inventory is on hand at year end. The value of inventory is always in flux, as work is performed and items are delivered or shipped. To capture a static value, it’s essential that business operations “freeze” while the count takes place.

Usually, it makes sense to count inventory during off-hours to minimize the disruption to business operations. Larger organizations with multiple locations may be unable to count everything at once. So, larger companies often break down their counts by physical location.

Proactive planning

Planning is the key to minimizing disruptions. Before counting starts, management can:.

  • Order (or create) prenumbered inventory tags,
  • Conduct a dry run to identify roadblocks and schedule workers,
  • Assign workers to count inventory using two-person teams to prevent fraud,
  • Write off any unsalable items, and
  • Precount and bag slow-moving items.

If your company issues audited financial statements, your audit team will be present during the physical inventory count. They aren’t there to help count inventory. Instead, they’ll observe the procedures, review written inventory processes and cutoffs, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.

Beyond the count

When the inventory count is complete, it’s critical to investigate discrepancies between your computerized accounting records and physical inventory counts. We can use this information to help you evaluate how to stock items more efficiently and safeguard against future write-offs due to fraud, damage or obsolescence.

© 2016

Depreciation-related breaks offer 2016 tax savings on business real estate

Commercial buildings and improvements generally are depreciated over 39 years, which essentially means you can deduct a portion of the cost every year over the depreciation period. (Land isn’t depreciable.) But enhanced tax breaks that allow deductions to be taken more quickly are available for certain real estate investments:

1. 50% bonus depreciation. This additional first-year depreciation allowance is available for qualified improvement property. The break expired December 31, 2014, but has been extended through 2019. However, it will drop to 40% for 2018 and 30% for 2019. On the plus side, beginning in 2016, the qualified improvement property doesn’t have to be leased.

2. Section 179 expensing. This election to deduct under Sec. 179 (rather than depreciate over a number of years) qualified leasehold-improvement, restaurant and retail-improvement property expired December 31, 2014, but has been made permanent.

Beginning in 2016, the full Sec. 179 expensing limit of $500,000 can be applied to these investments. (Before 2016, only $250,000 of the expensing election limit, which also is available for tangible personal property and certain other assets, could be applied to leasehold-improvement, restaurant and retail-improvement property.)

The expensing limit is subject to a dollar-for-dollar phaseout if your qualified asset purchases for 2016 exceed $2,010,000. In other words, if, say, your qualified asset purchases for the year are $2,110,000, your expensing limit would be reduced by $100,000 (to $400,000).

Both the expensing limit and the purchase limit are now adjusted annually for inflation.

3. Accelerated depreciation. This break allows a shortened recovery period of 15 years for qualified leasehold-improvement, restaurant and retail-improvement property. It expired December 31, 2014, but has been made permanent.

Although these enhanced depreciation-related breaks may offer substantial savings on your 2016 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules. In some situations — such as if in the future your business could be in a higher tax bracket or tax rates go up — the normal depreciation deductions could be more valuable.

For more information on these breaks or advice on whether you should take advantage of them, please contact us.

© 2016

Installment sales offer both tax pluses and tax minuses

Whether you’re selling your business or acquiring another company, the tax consequences can have a major impact on the transaction’s success or failure.

Consider installment sales, for example. The sale of a business might be structured as an installment sale if the buyer lacks sufficient cash or pays a contingent amount based on the business’s performance. And it sometimes — but not always — can offer the seller tax advantages.

Pluses

An installment sale may make sense if the seller wishes to spread the gain over a number of years. This could be especially beneficial if it would allow the seller to stay under the thresholds for triggering the 3.8% net investment income tax (NIIT) or the 20% long-term capital gains rate.

For 2016, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately) will owe NIIT on some or all of their investment income. And the 20% long-term capital gains rate kicks in when 2016 taxable income exceeds $415,050 for singles, $441,000 for heads of households and $466,950 for joint filers (half that for separate filers).

Minuses

But an installment sale can backfire on the seller. For example:

  • Depreciation recapture must be reported as gain in the year of sale, no matter how much cash the seller receives.
  • If tax rates increase, the overall tax could wind up being more.

Please let us know if you’d like more information on installment sales — or other aspects of tax planning in mergers and acquisitions. Of course, tax consequences are only one of many important considerations.

© 2016