assets

New tax law impacts M&A in a way you would not expect

I wanted to give you a heads up in the case you had not already seen this that the new tax law has a hidden issue related to M&A.  Since it is so new there is no Code section to refer to, but Paragraph 1504 of the new law adds to the list of assets that are excluded from the definition of capital assets.

 

Prior law excluded copyrights, literary, musical, or artistic compositions, letters or memoranda, or similar property from the definition of a capital asset if the asset is held either by the taxpayer who created the property, or a taxpayer for whom the property was produced.  Seldom in M&A do we see these assets being transferred.  The new law however changes this considerably.  The new law adds to this list patents, inventions, model or design, and a secret formula or process which is held by the taxpayer who created the property (or for whom the property was created).

The added items are encountered many time in the sale of a business.  The problem is that these items are intangibles and the value of these items have, historically been included in the portion of the purchase price that is allocated to goodwill.  Goodwill is a capital asset, and therefore subject to capital gains tax, whereas the previously mentioned items are not capital assets if the sale occurs in 2018 or later and must be excluded from goodwill value.  This give us an opportunity and creates some danger.  The opportunity is now we have another category of purchase price we can negotiate, the danger is if we do not separately state the allocation to these assets and they accidentally end up in the goodwill allocation the IRS could, upon audit make a sizable adjustment for the portion of the goodwill that they deem to be the value of these excluded items.  Fair Market Value in a sale between unrelated parties is whatever they agree upon.  If they do not agree then the IRS will have the ability to create a value.  In most cases the value of a business in excess of the value of its tangible personal or real property is considered “goodwill”.  This represents the value of the cash flow in excess of the tangible asset value.  If the business makes its money from the production of a product that has a patent or uses a secret formula then much of this excess value may actually be attributable to the patent or secret formula, which would render that portion of the purchase price subject to ordinary income tax rates and not be treated as capital gains.  If the value of these excluded assets are separately stated and the value is agreed to in the purchase agreement the IRS would have a hard time adjusting it.

The bottom line is if the business possesses any of the excluded assets it would be wise to allocate a negotiated portion of the purchase price to this class of assets.

Let me know if I can help further.

Harold F. Ingersoll, CPA/ABV/CFF, CVA, CM&AA

Partner at Atchley & Associates, LLP

How to maximize deductions for business real estate

Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.

Segregate personal property from buildings

Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phaseout if total asset acquisitions for the tax year exceed $2.03 million).

If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.

Carve out improvements from land

As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.

Convert land into a deductible asset

Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.

Another option is to purchase an “estate-for-years,” under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.

More limits and considerations

There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.

© 2017

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

9 Things to Know When Settling a Loved One’s Estate

by Joe Ben Combs, CPA

Tax Supervisor @ Atchley & Associates, LLP

 

Handling the estate of a family member or friend who has passed away can be one of the most difficult things you may be asked to do, both emotionally and logistically. You have to navigate a complex tax system, a treacherous legal system and a bureaucratic financial system all while managing relationships with beneficiaries eager for their inheritance, not to mention the task of dealing with your own personal loss.

Our team has walked many people through this process and we thought it would be helpful to share a few items that our clients often need to be reminded of.

  1. Notifications. There are a number of individuals, businesses and institutions that are impacted when someone passes away and will need to be notified. Depending on the situation, these can include the Social Security Administration, heirs, beneficiaries, creditors, financial institutions, insurance companies, and utilities providers, among others.
  2. Obtain an EIN. The employer identification number is the tax ID used by an estate or trust. This will be required to open an estate or trust bank account as well as for any tax filings.
  3. Change of address. The United States Postal Service allows you to request a change of address online at usps.com. This is important in order to avoid a pile of mail in the decedent’s mailbox which can pose a security risk but it also allows you as the person responsible for the estate to stay on top of bills and identify businesses or financial institutions with which the decedent may have had accounts.
  4. Taxes. As the personal representative, you may be responsible for filing a number of tax returns for the decedent. These might include an estate tax return (form 706) an income tax return for the estate (form 1041) and the individual’s final income tax return (form 1040) or gift tax return (form 709) as well as unfiled returns from prior years. With all of these come a host of possible tax elections and post-mortem planning opportunities that should be discussed with a tax professional. And while Texas does not have any corresponding state returns for these federal filings, many decedents will have filing obligations in other states.
  5. Search for unclaimed property. One of the primary responsibilities of the executor, administrator or trustee handling an estate is to identify, collect, value, manage, and dispose of or distribute the decedent’s assets. An often overlooked source of assets is the state itself. In Texas, the Comptroller provides a website (https://mycpa.cpa.state.tx.us/up/Search.jsp) where individuals and business can search for unclaimed property by name.
  6. Value all assets. This was alluded to above but it is worth repeating. Even if the value of a decedent’s estate is below the threshold to generate any estate tax, obtaining date-of-death values (or values as of the alternate valuation date if applicable) is crucial to ensure correct income tax reporting when that property is subsequently disposed of. This is because the basis (tax-speak for the starting point in a gain or loss calculation) of an asset gets stepped up to the date of death value and is often difficult to track down later on when the asset is sold.
  7. Disclaiming an inheritance. Many beneficiaries find it advantageous for various reasons to allow assets that they would have otherwise inherited to pass to someone else. This can be an effective post-mortem planning technique. Keep in mind however that the assets must then be distributed as if the beneficiary had predeceased the decedent. In order to be effective for tax purposes a disclaimer generally must be made within 9 months of the date of death and the original beneficiary must not have received any benefit from the disclaimed assets.
  8. IRAs. Decedents’ assets at death will often include retirement accounts, particularly IRAs. The full range of options available for handling IRAs is beyond the scope of this piece and it is often not the executor’s decision what happens to these accounts but simply keep in mind that withdrawing the funds immediately is often the least advantageous option. Consulting a CPA or financial advisor is highly recommended when making these decisions.
  9. Hire professionals. At the risk of sounding self-serving, we could not in good conscience omit this simple piece of advice. There are simply too many moving pieces and too much at stake to not at least consult with a CPA and/or attorney who is experienced in dealing with estates.

Beware of accounts deceivable

More than half of financial statement frauds involve sales and accounts receivable, according to the Committee of Sponsoring Organizations of the Treadway Commission. (COSO is a joint initiative of five private sector organizations that develops frameworks and guidance on enterprise risk management, internal control and fraud deterrence.) But why do fraudsters tend to target accounts receivable?

For accrual-basis entities, accounts receivable is typically one of the most active accounts in the general ledger. It’s where companies report contract revenue and any other sales that are invoiced to the customer (rather than paid directly in cash). The sheer volume of transactions flowing through this account helps hide a variety of scams. Here are some examples.

Fictitious sales

Sometimes fraudsters book phony sales — and receivables — to make their company’s performance appear rosier than reality. Increased sales assure stakeholders that the company is growing and building market share. They also increase profits artificially, because bogus sales generate no costs. And, overstated receivables inflate the collateral base, allowing the company to secure additional financing.

Timing differences

Unscrupulous owners or employees might manipulate cutoffs to boost sales and receivables in the current accounting period. For example, a salesperson could prematurely report a large contract sale even though material uncertainties exist. A retail chain CFO could hold the accounting period open a few extra days to boost year-end sales. Or a contractor might use aggressive percentage-of-completion estimates to boost revenues.

Lapping

Some employees divert customer payments for their personal use. Then, the fraudster applies a subsequent payment from another customer to the customer whose funds were stolen. The second customer’s account is credited by a third customer’s payment, and so on. Delayed payments continue until the fraudster repays the money, makes an adjusting journal entry or gets caught.

Know the red flags

Accounts receivable fraud can be hard to unearth. Fortunately, experienced forensic accountants know to look for such anomalies as:

  • Dramatically increased accounts receivable compared to sales or total assets,
  • Revenues increasing without a proportionate increase in cost of sales or shipping costs,
  • Deteriorating collections, and
  • Significant write-offs and returns in subsequent periods.

If something seems awry with your accounts receivable, we can help verify your outstanding balances and find holes in your internal controls system to safeguard against future scams.

© 2016