Ratio Analysis: Extracting Actionable Data From Your Financials

What do you do with your financial statements when your auditor delivers them? Resist the temptation to just file them away — they’re more than an exercise in compliance. With a little finagling, you can calculate key financial ratios from line items in your company’s financial statements. These metrics provide insight into historical trends, potential areas for improvement and how the business is likely to perform in the future.

Financial ratios are generally grouped into the following four principal categories:

1. Operating

Operating ratios — such as the gross margin or earnings per share — evaluate management’s performance and the effects of economic and industry forces. Operating ratios can illustrate how efficiently a company is controlling costs, generating sales and profits, and converting revenue to cash.

This analysis shouldn’t stop at the top and bottom of the income statement. Often, it’s useful to look at individual line items, such as returns, rent, payroll, owners’ compensation, interest and depreciation expense.

2. Asset management

Asset management ratios gauge liquidity, which refers to the ability of a company to meet current obligations. Commonly used liquidity ratios include:

Current ratio, or the ratio of current assets to current liabilities,
Quick ratio, which only considers assets that can be readily liquidated, such as cash and accounts receivable,
Days in receivables outstanding, which estimates the average collection period for credit sales, and
Days in inventory, which estimates the average time it takes to sell a unit of inventory.

It’s also important to consider long-term assets, such as equipment, with the total asset turnover. This ratio tells how many dollars in revenue a company generates from each dollar invested in assets. Management must walk a fine line with 1) efficient asset management, which aims to minimize the amount of working capital and other assets on hand, and 2) satisfying customers and suppliers, which calls for flexible credit terms, ample safety stock and quick bill payment.

3. Coverage

Coverage ratios measure a company’s capacity to service its debt. One commonly used coverage ratio is times interest earned, which measures a firm’s ability to meet interest payments and indicates its capacity to take on additional debt. Another is current debt coverage, which can be used to measure a company’s ability to repay its current debt.

Before a company that already has significant bank debt seeks further financing, it should calculate its coverage ratios. Then it should consider what message management sends to potential lenders.

4. Leverage

Leverage ratios can indicate a company’s long-term solvency. The long-term debt-to-equity ratio represents how much debt is funding company assets.

For example, a long-term debt-to-equity ratio of five-to-one indicates that the company requires significant debt financing to run operations. This may translate into lower returns for shareholders and higher default risk for creditors. And, because the company needs to make considerable interest payments, it has less cash to meet its current obligations.

Basis of comparison

Ratios mean little without appropriate benchmarks. Comparing a company to its competitors, industry averages and its own historical performance provides perspective on its current financial health. Contact us to help select relevant ratios to include in your analysis. We can help you create a scorecard from your year-end financial statements that your in-house accounting team can recreate throughout the year using preliminary financial numbers.

Because the federal gift and estate tax exemption amount currently is $12.06 million, fewer people need life insurance to provide their families with the liquidity to pay estate taxes. But life insurance can still play an important part in your estate plan, particularly in conjunction with charitable remainder trusts (CRTs) and other charitable giving strategies.

Home for highly appreciated assets

CRTs are irrevocable trusts that work like this: You contribute property to a CRT during your life or upon your death and the trust makes annual distributions to you or your beneficiary (typically, your spouse) for a specified period of time. When that period ends, the remainder goes to a charity of your choice.

These instruments may be useful when you contribute highly appreciated assets, such as stock or real estate, and want to reduce capital gains tax exposure. Because the CRT is tax-exempt, it can sell the assets and reinvest the proceeds without currently triggering the entire capital gain. Another benefit is that, if you opt to receive annual distributions from your trust, that income stream generally will be taxed at a lower rate than other income using a formula that combines ordinary taxable income, tax-exempt income, capital gains and other rates.

Here’s where life insurance comes in. Because CRT assets eventually go to charity — usually after both you and your spouse have died — you won’t have as much to leave to your children or other heirs. A life insurance policy can replace that “lost” wealth in a tax advantaged way.

Charities as beneficiaries

CRTs are ideal for philanthropically minded individuals. But there are other ways to use life insurance to fund charitable gifts and enjoy tax benefits. You might, for example, transfer your policy to a nonprofit organization and take a charitable income tax deduction (subject to certain limitations) for it. If you continue to pay premiums on the policy after the charity becomes its owner and beneficiary, you can take additional charitable deductions.

Another scenario is to just name a charity as your policy’s beneficiary. Because you retain ownership, you can’t take charitable income tax deductions during your life. But when you die, your estate will be entitled to an estate tax charitable deduction.

Wealth replacement tool

Life insurance can be used to replace wealth in many circumstances — not only when you’re donating to charity. For instance, if you’ve decided to forgo long term care (LTC) insurance and pay any LTC-related expenses (such as home nursing services or care in a nursing facility) out of pocket, you may not have as much to leave your heirs. Life insurance can help ensure that you provide your family with an inheritance.

Multiple benefits

Federal estate tax liability may no longer be a concern if your estate is valued at less than $12.06 million. But, depending on your goals, life insurance can help you make charitable gifts, leave money to your heirs and realize tax advantages. We can explain the types of policies that might be appropriate for estate planning purposes.

Is your manufacturing company on the cutting edge? It’s important to keep pace with the competition, especially if you’re trying to carve out a niche in a new marketplace. Fortunately, federal tax law allows manufacturers to claim a generous tax credit for qualified research expenses. The credit generally offsets income tax liability on a dollar-for-dollar basis.

Now there’s some extra tax incentive: The Inflation Reduction Act (IRA) expands the ability of qualified small businesses to use research credits to offset federal payroll tax instead of income tax.

The pre-IRA credit

The research credit is intended to encourage spending on research activities by both established firms and start-up companies. Generally, the credit equals the sum of 20% of the excess of qualified research expenses for the year over a base amount. (Other special rules may apply.)

For this purpose, the base amount is a fixed-base percentage (not to exceed 16%) of average annual receipts from a U.S. trade or business, net of returns and allowances, for the four years prior to the year of claiming the credit. It can’t be less than 50% of the annual qualified research expenses. In other words, the minimum credit is equal to 10% of qualified research expenses (50% rule x 20% credit).

Alternatively, a manufacturing company can claim a “simplified credit” of 14% of the amount by which its qualified research expenses for the year exceed 50% of its average qualified research expenses for the preceding three tax years.

The credit is available only for qualified expenses. The expenses must:

Meet the definition of a “research and experimentation expenditure” established by the tax code, and
Relate to research undertaken for the purpose of discovering information that’s technological in nature and the application of which is intended to be useful in developing a new or improved business component.

Also, substantially all of the activities of the research must constitute elements of a process of experimentation that relates to a new function or improved performance, reliability or quality.

Special payroll tax offset

Initially, the research credit was intended to offset only income tax liability. However, the Protecting Americans from Tax Hikes (PATH) Act created an alternate scenario. For tax years beginning after 2015, a qualified small business can use the credit to offset its employer share of the Social Security, or FICA, tax up to an annual limit of $250,000. This is beneficial for businesses that are just getting off the ground and have little or no taxable income.

To qualify as a small business, a manufacturer must have less than $5 million in annual gross receipts (annualized over 12 months for a business that started in the current year). Furthermore, the business can have had gross receipts for only the last five years. Thus, in effect, a business just starting can claim the payroll tax offset for a maximum of five years. Under interim guidance from the IRS, “gross receipts” are defined as the sum of total sales, amounts received for services and income from investments (including interest income).

The IRA expansion

The IRA authorizes an offset for a qualified small business against the 1.45% Medicare portion of federal payroll tax, up to an annual limit of $250,000. When combined with the PATH Act provision, this gives manufacturers the potential for a total maximum payroll offset of $500,000.

For 2022, the employer share of the Social Security tax is equal to 6.2% of an employee’s wages up to a base amount of $147,000. In contrast, the 1.45% Medicare tax portion applies to all wages. So even though it’s only at 1.45% tax, the ability to offset against Medicare tax could provide significant tax savings.

Bear in mind that this provision isn’t effective until tax years beginning after 2022. You’ll have to wait until you file your company’s 2023 tax return — in 2024 — before you can take advantage of the full offset.

Also, the credit can’t exceed the tax imposed for any calendar quarter, with any unused amounts of the credit being carried forward. Some start-up firms with small staffs may have to realize their 2023 tax benefits over the course of several years.

Moving forward

Manufacturers could benefit from the research credit by carefully navigating these basic rules. And now the IRA opens up more favorable tax opportunities to smaller manufacturers. The IRS is expected to issue guidance on the expanded research credit, as well as revised tax forms for 2023. If you have questions, contact us. We can help your manufacturing company maximize the tax benefits available for qualified research activities.

In most companies, employees need a user identity to access work-related hardware and software. Privileges to use certain applications or open certain files usually are provided to workers based on their department, role and level of authority. Over their tenure, employees might accumulate various privileges they no longer need. For example, someone who once worked in accounting might retain the ability to make journal entries even after transferring to the legal department. Unfortunately, dishonest employees could use their privileges for nefarious purposes.

Best practices

Privileged users sometimes use their access to perpetrate fraud, intellectual property theft or sabotage. And they don’t always act alone. Third parties, such as competitors, could try to recruit privileged users to steal trade secrets. Or employees could collude with hackers to compromise a company’s network.

To prevent such incidents, your organization needs to keep close tabs on employee access. Follow these best practices:

Identify the privileges needed for each role. List the access privileges required for each job and review current employee access to ensure workers have only the privileges they need. If in doubt regarding the need for access to certain applications, err on the side of caution and remove them. Managers can reinstate privileges on a case-by-case basis if they decide someone needs greater access.

Monitor user activity. Observe how employees use their privileges. If, for example, an employee accesses customer data from another city, check to see if there’s a business reason for doing so. If someone in sales creates a journal entry, find out whether that task falls within his or her current role and if a manager has approved it.

Establish an “upgrading” process. Although managers should make any decisions about upgrading an employee’s privileges, use technology to help standardize and track requests and approvals. For sensitive applications, such as those that house customer and financial data, consider requiring two levels of approval to elevate a user’s privileges.

Remove dormant accounts. When employees leave your organization, their access privileges should be deleted immediately. If a previously inactive account becomes active, block access until you have time to research why it has come back to life.

Potentially severe consequences

If employees or third parties abuse privileged access to your network, the consequences could be severe and long-lasting. Your organization must continually monitor privileges to ensure they’re used only to perform legitimate work. Contact us to discuss fraud-proofing your network and business.

Growing up, I had a mentor through Youth for Christ. He had a huge impact on my life and is still someone I can go to today. I wanted to be a similar resource for students, so when I moved to Mount Pleasant for college, I started volunteering for Central Michigan Youth for Christ (CMYFC), and I’ve been a mentor for roughly seven years.

Meg Warner Once a week during the school year, I volunteer with high school students. We meet up and play games and discuss how their school and family life is going. As a CPA, I’ve been able to help students answer personal finance questions. I’ve also helped some fill out their application for Federal Student Aid and file tax returns. It’s really rewarding to teach kids and help empower them.

Especially today, I think it is increasingly easy for people to isolate themselves, which is why organizations like CMYFC are so important. They give kids resources and people who can help them by providing a listening ear and advice. Everyone who volunteers through CMYFC goes above and beyond to care for the students so they can feel loved and seen. It is a great organization to be a part of.

I give back because I want to help students feel loved and seen.

You and your small business are likely to incur a variety of local transportation costs each year. There are various tax implications for these expenses.

First, what is “local transportation?” It refers to travel in which you aren’t away from your tax home (the city or general area in which your main place of business is located) long enough to require sleep or rest. Different rules apply if you’re away from your tax home for significantly more than an ordinary workday and you need sleep or rest in order to do your work.

Costs of traveling to your work location

The most important feature of the local transportation rules is that your commuting costs aren’t deductible. In other words, the fare you pay or the miles you drive simply to get to work and home again are personal and not business miles. Therefore, no deduction is available. This is the case even if you work during the commute (for example, via a cell phone, or by performing business-related tasks while on the subway).

An exception applies for commuting to a temporary work location that’s outside of the metropolitan area in which you live and normally work. “Temporary,” for this purpose, means a location where your work is realistically expected to last (and does in fact last) for no more than a year.

Costs of traveling from work location to other sites

On the other hand, once you get to the work location, the cost of any local trips you take for business purposes is a deductible business expense. So, for example, the cost of travel from your office to visit a customer or pick up supplies is deductible. Similarly, if you have two business locations, the costs of traveling between them is deductible.

Recordkeeping

If your deductible trip is by taxi or public transportation, save a receipt if possible or make a notation of the expense in a logbook. Record the date, amount spent, destination and business purpose. If you use your own car, note miles driven instead of the amount spent. Note also any tolls paid or parking fees and keep receipts.

You’ll need to allocate your automobile expenses between business and personal use based on miles driven during the year. Proper recordkeeping is crucial in the event the IRS challenges you.

Your deduction can be computed using:

A standard mileage rate (58.5¢ per business mile driven between Jan. 1 and June 30, 2022, and 62.5¢ per business mile driven between July 1 and Dec. 31, 2022) plus tolls and parking, or
Actual expenses (including depreciation, subject to limitations) for the portion of car use allocable to the business. For this method, you’ll need to keep track of all costs for gas, repairs and maintenance, insurance, interest on a car loan and any other car-related costs.

Employees versus self-employed

From 2018 – 2025, employees, may not deduct unreimbursed local transportation costs. That’s because “miscellaneous itemized deductions” — a category that includes employee business expenses — are suspended (not allowed) for 2018 through 2025. However, self-employed taxpayers can deduct the expenses discussed in this article. But beginning with 2026, business expenses (including unreimbursed employee auto expenses) of employees are scheduled to be deductible again, as long as the employee’s total miscellaneous itemized deductions exceed 2% of adjusted gross income.

Mastercard has new rules for recurring transactions that entities must be aware of. Implementation of these rules has been delayed several times; currently, the rules are expected to take effect on March 21, 2023, for nonprofits. The rules essentially apply to any recurring transactions that are automatically charged to customers’ or donors’ Mastercard. Refer to Mastercard’s Transaction Processing Rules.

These are Mastercard’s terms and conditions. Therefore, if an entity accepts payment from Mastercard, it must follow these terms and conditions. For transactions from other credit card companies, such as Visa or Discover, the Mastercard terms and conditions do not apply. However, state laws may have similar requirements that an entity may be subject to. It also may be easier to structure the electronic systems to be the same regardless of the payment vendor.

These rules appear to be designed to assist the consumer and reduce chargebacks. Most consumers have some type of “subscription” that automatically “renews” or charges a credit card on a periodic, often monthly, basis. These rules are designed to make it easier for the consumer to cancel that subscription or renewal. Although the letter of the rules discusses ongoing and/or periodic delivery of physical products or digital goods, Mastercard’s FAQs indicate that recurring donations are also considered in this rule.

The rules start at the initiation of the transaction and so would apply to newly initiated transactions. When the entity obtains the Mastercard credentials for payment, they must disclose the price that will be billed and the billing frequency to their customer. The entity must clearly and prominently (i.e., no burying in the fine print) display the subscription terms on payment and order summary web pages. During the initiation, the entity must capture the cardholder’s affirmative acceptance of the subscription terms. It specifically states that a link to another website or expanding a message to scroll down does not satisfy this requirement. This may require a change in how website orders are confirmed. In addition, immediately after completing the subscription order, the entity must send their customer, through electronic communications, the subscription terms and clear instructions for how to cancel the subscription. Think of this as an email or a text message that the customer can keep.

In addition to initiation rules, there are rules for the subsequent transactions. These rules take effect on the date the changes in transaction processing rules take effect; that means if someone initiated a transaction in the year 2019 and is still doing that transaction, these rules will apply to the transactions processed starting on March 21, 2023. Each time a transaction (payment) occurs, the entity must provide the customer with a transaction receipt through electronic means, and it must include instructions for canceling the subscription. It also goes on to say the entity must provide an “online or electronic cancellation method (similar to unsubscribing from email messages or any other electronic method) or clear instructions for how to cancel that are easily accessible online (such as a “Manage Subscription” or a “Cancel Subscription” link on the merchant’s home page).” Some entities have inquired whether this requires the ability to unsubscribe online without having to call, or if the instructions can include calling a phone number to cancel; Mastercard has not clarified this.

There are also notification requirements for infrequent billings. For subscriptions where the billing is less frequent than every six months (180 days), the entity must send an electronic reminder about the billing at least 7 days, and no more than 30 days, before the next billing date. The reminder must include the subscription terms and how to cancel the subscription. It also cannot be part of marketing communications. Think of this as a reminder that amounts will be charged so the customer can stop the charges before they occur.

If your entity has recurring subscriptions/donations, ensure that you familiarize yourself with these rules in detail and the specific dates they take effect, which may be different for nonprofits. These rules apply to Mastercard transactions; other laws could also be applicable, and other credit card companies might have or add similar rules. Clearly, changes may need to be made to your electronic notices of payment. Most importantly, it needs to be easy for customers to see how to unsubscribe; this may involve changes to the website itself. Some payment portals have already made changes to comply with these rules, while others may require work on the entity’s part to do so.

When one business is sold to another, the buyer often asks for a determination letter to help assure that the seller’s 401(k) plan is qualified. The seller must then request such a letter from the IRS, but availability is restricted under certain rules. Assuming the 401(k) in question is an individually designed, single-employer plan, here’s some background on requesting a determination letter.

Evolving rules

The rules governing determination letter requests for individually designed plans have changed considerably over the years. At one time, requests could be made whenever a plan was restated or materially amended. Then, to limit submissions, the IRS adopted a cyclical remedial amendment system under which plans were typically submitted for a determination letter every five years.

In 2017, the IRS further narrowed the circumstances in which individually designed plans can request determination letters. The rules now allow individually designed 401(k) plans to be submitted for a determination letter only in one of the following circumstances:

The plan hasn’t been submitted previously,
The plan is being terminated,
A limited determination is requested regarding whether a partial termination has occurred, or
The plan has recently merged with the plan of a previously unrelated entity.

Keep in mind that additional rules may apply.

Limits to the letters

If a seller’s individually designed plan has received a favorable determination letter in the past, and it hasn’t recently merged with another plan, the seller could be unable to request the kind of determination letter the buyer wants. The seller might be able to request a determination as to whether a partial termination occurred, but that limited basis for seeking a determination letter wouldn’t allow the seller to provide the buyer with a determination regarding the current plan document.

In addition, determination letters affirm only that the form of the plan satisfies the applicable qualification requirements. Because the IRS reviews only the plan document, not plan administration, the determination letter wouldn’t offer a buyer any assurance regarding operation of the plan.

So, even if a seller is able to obtain a determination letter, it should anticipate having to demonstrate to the buyer that the plan’s operation satisfies the qualification rules and adheres to the plan document’s provisions. One example is by providing results of nondiscrimination testing.

Many details to consider

Special determination letter submission procedures apply for individually designed multiple employer plans. And different determination letter submission standards apply to plans that use a pre-approved plan document.

As you can see, there are many details to consider. We can answer questions and provide further information about the IRS rules for qualified retirement plans such as 401(k)s.

Whether the economic climate is stable or volatile, one thing never changes: the need to protect your assets from risk. Hazards may occur as a result of factors entirely outside of your control, such as the stock market or the economy. It’s even possible that dangers lie closer to home, including the behavior of your heirs and creditors. In any case, it’s wise to consider taking steps to mitigate potential peril. One such step is to set up a trust.

Make sure it’s irrevocable

A trust can be a great way to protect your assets — but it must become the owner of the assets and be irrevocable. That is, you as the grantor can’t modify or terminate the trust after it has been set up. This is the opposite of a revocable trust, which allows the grantor to modify the trust.

Once you transfer assets into an irrevocable trust, you’ve effectively removed all of your rights of ownership to the assets and the trust. The benefit is that, because the property is no longer yours, it’s unavailable to satisfy claims against you.

Placing assets in a trust won’t allow you to sidestep responsibility for any debts or claims that are already outstanding at the time you fund the trust. There may also be a substantial “look-back” period that could negate the protection that would otherwise be provided.

Consider a spendthrift trust

If you’re concerned about what will happen to your assets after they pass to the next generation, you may want to consider a “spendthrift” trust. Despite the name, a spendthrift trust does more than just protect your heirs from themselves. It can protect your family’s assets against dishonest business partners or unscrupulous creditors.

The trust also protects loved ones in the event of relationship changes. For example, if your son divorces, his spouse generally won’t be able to claim a share of the trust property in the divorce settlement.

Several trust types can be designated as a spendthrift trust — you just need to add a spendthrift clause to the trust document. This type of clause restricts a beneficiary’s ability to assign or transfer his or her interests in the trust, and it restricts the rights of creditors to reach the trust assets. But a spendthrift trust won’t avoid claims from your own creditors unless you relinquish any interest in the trust assets.

Bear in mind that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it’s possible for government agencies to reach the trust assets to, for example, satisfy a delinquent tax debt.

You can gain greater protection against creditors’ claims if you give your trustee more discretion over trust distributions. If the trust requires the trustee to make distributions for a beneficiary’s support, for example, a court may rule that a creditor can reach the trust assets to satisfy support-related debts. For increased protection, give the trustee full discretion over whether and when to make distributions. You’ll need to balance the potentially competing objectives of having the access you want and preventing others from having access against your wishes.

Secure your assets

Obviously, you can choose from many types of trusts, depending on your particular circumstances. Talk to us to help you determine which type of trust is best for you going forward.

When I was in college, I saw people struggling to get food. I had some free time and decided I wanted to spend it volunteering at the local food pantry to help those in need.

Wilcox - Aid in Milan I started volunteering at Aid in Milan and, for the next few years, spent nearly every Friday packing food. It was a small, local food pantry when I first started there. Now, they have updated facilities and offer programs for different occasions like Christmas and back-to-school to help those in need.

The staff and volunteers at Aid in Milan really care about the people who come through. They offer personalized options to fit everyone’s needs. If someone has a dietary restriction, certain foods can be substituted. If someone is having a tough time, the staff puts extra items in their food box. I am proud to support Aid in Milan. It is a great organization that provides a valuable service to those living in our small, rural community.

I give back because I want to support those who are struggling with hunger.

IRS audit rates are historically low, according to a recent Government Accountability Office (GAO) report, but that’s little consolation if your return is among those selected to be examined. Plus, the IRS recently received additional funding in the Inflation Reduction Act to improve customer service, upgrade technology and increase audits of high-income taxpayers. But with proper preparation and planning, you should fare well.

From tax years 2010 to 2019, audit rates of individual tax returns decreased for all income levels, according to the GAO. On average, the audit rate for all returns decreased from 0.9% to 0.25%. IRS officials attribute this to reduced staffing as a result of decreased funding. Businesses, large corporations and high-income individuals are more likely to be audited but, overall, all types of audits are being conducted less frequently than they were a decade ago.

There’s no 100% guarantee that you won’t be picked for an audit, because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare in advance. On an ongoing basis you should systematically maintain documentation — invoices, bills, cancelled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all records in one place.

Audit targets

It also helps to know what might catch the attention of the IRS. Certain types of tax-return entries are known to involve inaccuracies so they may lead to an audit. Here are a few examples:

Significant inconsistencies between tax returns filed in the past and your most current return,
Gross profit margin or expenses markedly different from those of other businesses in your industry, and
Miscalculated or unusually high deductions.

Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee’s salary that’s much higher or lower than those at similar companies in his or her location may catch the IRS’s eye, especially if the business is structured as a corporation.

If you receive a letter

If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.

Many audits simply request that you mail in documentation to support certain deductions you’ve claimed. Only the strictest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited email or text messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)

The tax agency doesn’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. Collect and organize all relevant income and expense records. If anything is missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.

If you’re audited, our firm can help you:

Understand what the IRS is disputing (it’s not always clear),
Gather the specific documents and information needed, and
Respond to the auditor’s inquiries in the most effective manner.

The IRS normally has three years within which to conduct an audit, and an audit probably won’t begin until a year or more after you file a return. Don’t panic if the IRS contacts you. Many audits are routine. By taking a meticulous, proactive approach to tracking, documenting and filing your company’s tax-related information, you’ll make an audit less painful and even decrease the chances you’ll be chosen in the first place.

Accounting Standards Codification Topic 842, Leases, requires organizations to report the full magnitude of their long-term lease obligations on their balance sheets — a historic first. For private companies and nonprofits, the changes take effect this year. Public entities adopted the rules in 2019. While the Financial Accounting Standards Board (FASB) conducts its post-implementation review of the new-and-improved lease standard, the guidance is concurrently being adopted by private organizations.

A major issue that has surfaced relates to leases under common control. In a surprise move, the FASB voted on September 21 to propose changes to address stakeholder concerns.

Practical expedient for related-party leases

Topic 842 requires an organization to account for a lease that’s under common control on the basis of the legally enforceable provisions. Problems arose for private companies because some don’t have written documentation of related-party leases, and they’re confused about what’s “legally enforceable.”

FASB members unanimously agreed to propose a practical expedient for private entities to simplify the guidance for determining whether a lease exists for arrangements between entities under common control. A practical expedient is an accounting workaround with a simpler approach to arriving at the same answer as the initial rule.

The proposal specifies that entities would only consider the written terms and conditions when determining whether a lease exists, and the classification and accounting for that lease. Entities wouldn’t be required to determine whether those written terms and conditions are legally enforceable. Moreover, if no written terms and conditions exist, an entity would apply Topic 842 to any verbal or implicit terms and conditions. If no lease exists, other rules would apply.

Clarity on leasehold improvements

An affiliated issue that came up during the FASB’s review of Topic 842 is how to handle the treatment of leasehold improvements when there’s a verbal related-party transaction. In many cases, the life of the related-party lease could substantially differ from the actual life of the underlying lease asset.

The term “leasehold improvement” generally refers to changes, buildouts or upgrades to real property made by a commercial tenant. For example, you might paint, update lighting, install new carpet or make repairs to a space.

FASB members voted 4-3 to propose an amendment to Topic 842 that would specify that leasehold improvements associated with leases between entities under common control be “amortized by the lessee over the useful life of the improvements (regardless of the lease term) as long as the lessee continues to use the underlying asset.” If the lessee stops using the leased asset, it would then be “accounted for as a transfer between entities under common control.”

To be clear, if approved, this change would apply to both public and private entities. Public companies already implemented the updated standard in 2019.

It’s important to note that three FASB members dissented to proposing changes to leasehold improvement rules. The dissenters said that they didn’t have enough information to vote to propose changes for public companies and were uncertain about any secondary or indirect implications of the proposal. The members who were in favor of the proposal indicated that public companies would largely be unaffected by the changes. Their leases tend to be arm’s length, written agreements, regardless of whether the lessors are third parties or under common control.

Stay tuned

Since the updated lease guidance was issued in 2016, it has been deferred twice and amended five times. Once these two last-minute proposals are issued, there will be a 45-day comment period. In the meantime, private organizations must continue pushing forward with adopting the updated guidance for 2022. Contact us for help onboarding the changes, including any amendments for leases under common control.

Employers have been advised for years to beware of “presenteeism” and its often slow-developing negative effects on an organization. Obviously, a regularly absent employee isn’t getting much work done. But someone who repeatedly shows up unwell — the definition of presenteeism — tends to accomplish less, produce substandard work and might even hurt the performance of co-workers.

An employee who works in an office or other facility and comes in physically ill could literally sicken other staff members. This has become a particularly acute problem during the COVID-19 pandemic. But presenteeism can be more subtle and hard to spot when it involves mental illness, major stress or burnout. These issues can develop slowly and be hard to detect until they become major problems.

Promote your benefits

“We offer paid time off for illness” is a common response to presenteeism. Paid sick days do generally help resolve incidences of physical ailment or injury. However, they often fail to adequately address struggles with mental illness, burnout, and stressors such as divorce or financial struggles. Some supervisors might raise an eyebrow at those taking a “mental health day,” so sufferers end up coming in to work when they really need a day off.

How can you help? If you sponsor a health care plan, it likely offers coverage for mental health and substance use disorder services, including behavioral health treatment. Be sure employees are aware of this.

Also, reinforce with staff that you’ll honor the sick-day provisions spelled out in your employee manual for all types of ailments (physical, mental and psychological). Train supervisors to support employees’ well-being, which includes encouraging team members to take time off when necessary.

Encourage healthy work habits

Another common cause of presenteeism is the perceived notion that workers must put in excessive overtime to prove themselves. Some organizations still operate under an “old school” culture that says working extra shifts or even 24/7 when salaried will make the boss happy and lead to quicker raises and promotions.

Many supervisors assume that an absent employee automatically means productivity is plummeting. Conversely, if someone is always “burning the midnight oil” and skipping vacations, productivity must be soaring. But these assumptions aren’t always true — they must be supported by a thorough, objective and analytical performance evaluation process.

You can prevent this cause of presenteeism by strongly encouraging, if not strictly enforcing, paid time off. Communicate to employees your concerns about overworking and remind them to take advantage of the time off that they’ve earned. (Doing so can also deter fraud.)

Don’t forget telecommuters

Many of today’s employers face an even bigger challenge spotting and addressing presenteeism because so many people work from home, where showing up (logging in) unwell is incredibly easy. Be sure to train supervisors to check in regularly with telecommuters and watch for signs of burnout. We can help you track and analyze data points related to productivity that may raise a red flag of presenteeism in progress.

When President Biden signed the Inflation Reduction Act (IRA) into law in August, most of the headlines covered the law’s climate change and health care provisions. But the law also enhances an often overlooked federal tax break for qualifying small businesses.

The IRA more than doubles the amount a qualified business can potentially claim as a research and development (R&D) tax credit to offset its payroll tax for tax years starting after 2022 — to a maximum of $2.5 million over five years. The credit allows a qualified business to leverage the substantial R&D tax benefit even if it has little to no income tax liability, potentially freeing up significant cash flow.

Background on the pre-IRA credit

The Protecting Americans from Tax Hikes (PATH) Act created a permanent incentive for eligible start-up companies to pursue R&D activities within the United States. The Section 41 tax credit for qualifying in-house and contract research activities already existed, but early-stage companies that hadn’t yet incurred income tax liability couldn’t take advantage of it.

The PATH Act revised the Sec. 41 credit to allow taxpayers to elect to apply up to $250,000 of the credit against their share of the Social Security, or FICA, tax for their employees, rather than against income tax. The revision became effective for tax years that began after Dec. 31, 2015.

The payroll tax election is available to taxpayers with 1) gross receipts of less than $5 million for the tax year, and 2) no gross receipts for any tax year more than five years prior to the end of the current tax year. The latter requirement essentially limits the payroll tax credit to start-up companies. If the taxpayer had a tax year of less than 12 months, the gross receipts must be annualized for a full year.

Be aware that not all research is eligible. To qualify for the credit, the research must be:

Performed to eliminate technical uncertainty about the development or improvement of a product or process, including computer software, techniques, formulas and inventions,
Undertaken to discover information that’s technological in nature (meaning based on physical, biological, engineering or computer science principles),
Intended for use in developing a new or improved business product or process, and
Elements of a process of experimentation relating to a new or improved function, performance, reliability or quality.

Qualifying research expenses include wages for employees involved with the research, supplies to conduct it and amounts paid for the use of computers. They also include 65% of the amounts paid or incurred for contractors.

The credit equals the smallest amount of 1) the current year Sec. 41 credit, 2) an elected amount not exceeding $250,000, or 3) the general business credit carryforward for the tax year (before application of the payroll tax credit for the year). Note that the general business credit carryforward limit doesn’t apply to S corporations or partnerships.

The IRA expansion

Under the PATH Act, a qualified small business could elect to apply its R&D credit against only the 6.2% Social Security tax. Beginning with the 2023 tax year, eligible businesses will be allowed to apply an additional $250,000 against their 1.45% Medicare tax liability.

While the total maximum credit is now $500,000, that amount is bifurcated. You can apply no more than $250,000 against each prong of payroll tax liability — FICA and Medicare, respectively.

As under the PATH Act, you can claim the credit for no more than five years. Existing aggregation rules, which treat related entities as a single taxpayer for purposes of determining gross receipts, also continue to apply. Any credit is allocated among the entities, but each entity must make the election separately.

Claiming the credit

You can make a payroll tax credit election by having us complete the appropriate portion of Form 6765, “Credit for Increasing Research Activities,” and submit it with your income tax return. To then claim the credit, complete Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities” and attach it to your employment tax return.

You can apply the credit to offset payroll tax no earlier than the first quarter after you file the return reporting the election. The credit can’t exceed the amount of tax imposed for any calendar quarter. Unused amounts can be carried forward.

What if you were eligible for the R&D credit previously but didn’t claim it because you were unaware of it or for another reason? The IRS recently tightened the requirements to claim a refund of the R&D credit.

To be considered sufficient, a refund claim must:

Identify all the business products and processes to which the Sec. 41 research credit claim relates for the relevant year.
For each business product and process, identify all research activities performed, all individuals who performed each research activity and all of the information each individual sought to discover.
Provide the total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses for the claim year. (This may be done using Form 6765.)

These so called “items of information” must be submitted when the refund claim is filed, along with a declaration signed under penalty of perjury verifying their accuracy. If your refund claim is deemed deficient, you’ll receive a letter providing 45 days to cure the deficiency.

More to come

The IRS is expected to issue guidance on the expanded small business R&D tax credit, as well as revised tax forms for 2023. Contact us if you think you may qualify, now or in the past.

When the pandemic hit about two and a half years ago, thousands of employees suddenly found themselves working from home. In many cases, this meant turning to personal devices to access their work email, handle documents and perform other tasks. Even before COVID, more and more businesses were allowing employees to use their own phones, tablets and laptops to get stuff done.

By now, many companies have established firm bring-your-own-device (BYOD) policies. Other businesses, however, have taken a more informal approach, allowing their policies to evolve with minimal documentation. Whichever camp your company falls into, it’s a good idea to regularly review and, if necessary, formalize your BYOD policy.

Key questions

A comprehensive BYOD policy needs to anticipate a multitude of situations. What if a voluntary or involuntary termination occurs? What if a device is lost, shared or recycled? What if it’s infected by a virus or malware? How about if a device is synced on an employee’s home cloud? Other key questions to address include:

Who pays the bill? Payment policies vary widely. For example, an employer might pay for an unlimited data plan for employees. Any charges above that amount are the employee’s responsibility.

Who owns an employee’s cell phone number? This is a big deal for salespeople and service representatives — especially if they leave to work for a competitor. Customers may continue to call a rep’s cell phone, leading to lost sales for your business.

Are employees properly password-protecting their devices? A policy should require employees to not only use passwords, but also implement two-factor authentication if feasible. In addition, users need to set up their devices to lock if left idle for more than a few minutes.

Legal ramifications

A BYOD policy needs to address the fact that using a personal device for work inevitably opens the door for an employer to access personal information, such as text messages and photos. State that the company will never intentionally view protected items on a device, such as privileged communications with attorneys, protected health information or complaints against the employer that are permitted under the National Labor Relations Act.

In case your business becomes involved in a lawsuit, its data retention policies should address how data is stored on mobile devices and gathered during litigation. Keep in mind that Rule 34 of the Federal Rules of Civil Procedure covers all devices, including personal ones that access a company’s network.

Financial impact

Formalizing your BYOD policy should involve spelling it out in a written user’s agreement that all participants must sign. Consult a qualified attorney in drafting such an agreement. Contact us for help assessing the tax and financial impact of allowing employees to use personal devices vs. buying technology assets and providing them to your workforce.

Business travel has been picking up again this year. If your manufacturing company has recently resumed travel to visit key customers and suppliers — or is planning to soon — it’s a good time to review the tax rules for deducting domestic business travel expenses.

The basics

An employer may deduct an employee’s “ordinary and necessary” expenses for travel away from home on business. Travel expenses are ordinary and necessary if they’re business-related, reasonable under the circumstances, and not “lavish or extravagant.” Unfortunately, there’s no bright-line definition of lavish or extravagant.

Generally, travel is considered away from home if:

It requires an employee to be away from the general area of his or her tax home for substantially longer than an ordinary day’s work, and
The employee can’t reasonably be expected to meet the demands of the work activities without sleep.

Typically, an employee’s tax home is the general vicinity (city and surrounding suburbs) of his or her regular place of business. Special rules apply for employees who work in multiple locations, don’t have a fixed place of business (for example, because they’re on the road most of the time), or are on temporary assignment away from their regular place of business.

Traveling away from home doesn’t necessarily require an overnight stay. Let’s say you drive to a city four hours away, meet with clients and prospects all day, and then catch a few hours of sleep at a hotel before driving back at 10 p.m. Because it would be unreasonable to expect you to make the round trip in one day without rest, you’re considered to be traveling away from home for tax purposes.

Travel deductions

So, what can employers deduct? Deductible travel expenses include, but aren’t limited to:

Transportation expenses, such as air, rail or bus fares, or the costs of operating and maintaining a car,
Taxi fares or other local transportation expenses,
Baggage charges,
Hotel or other lodging expenses,
Meal expenses (subject to the rules discussed below),
Dry cleaning and laundry expenses, and
Telephone or computer rental expenses.

To substantiate these expenses, employees must keep credit card receipts, canceled checks, bills or other adequate records for all lodging, as well as other travel expenses greater than $75. (Note that some employers require documentation of all expenses.) These records should show the amount, date, place and essential character of the expense.

Meal deductions

Ordinarily, business meals are 50% deductible. However, under the Consolidated Appropriations Act, otherwise eligible business meals provided by a restaurant (including carryout) are 100% deductible through the end of 2022.

Employers can deduct the cost of meals employees eat alone when traveling. You’re also permitted to take a deduction for meals if 1) a business owner or employee is present, 2) the meal is provided to a business contact (such as a customer, prospect, consultant or vendor), 3) the meal serves an ordinary and necessary business purpose, and 4) the meal isn’t lavish or extravagant.

Entertainment expenses aren’t deductible. But employers may deduct the cost of food or beverages provided during an entertainment activity if they’re purchased separately or stated separately on a receipt or invoice.

Allocation of business and pleasure expenses

If you have employees who travel in the United States primarily for business but also spend some time on personal activities, you can deduct the full cost of their airfare or other transportation to and from the destination. However, lodging, meal and other qualified business expenses are deductible only for the business portion of the trip.

Typically, a trip is considered primarily for business if the employee spends more time on business activities than on personal activities — for example, if the employee spends five days at business meetings followed by a weekend at the beach. If a trip is primarily for pleasure, travel expenses aren’t deductible, although employers may still write off otherwise deductible expenses for business activities during the stay.

Revisit your expense policies

The rules for deducting travel and other business expenses are complex. Instead of deducting actual travel expenses, some businesses simplify the process by providing employees with allowances for lodging, meal and incidental expenses based on federal per-diem rates. Contact us for if you need clarification on business expense rules.

Each year, the Yeo Young Professionals group hosts a firm-wide service initiative. As the Yeo Young Professionals service chair for the Yeo & Yeo Foundation, I am leading this year’s service project to benefit Making Strides Against Breast Cancer.

Richardson Making Strides Participating in Making Strides walks has always been important for our employees. I was invited to the walks from the first year I joined the firm. Seeing our employees’ passion and hearing about their personal connections to the organization inspired me to make it our main event this year.

The Making Strides movement raises life-saving funds for breast cancer patients, survivors, thrivers, and caregivers. To show our support of the movement, all Yeo & Yeo employees have been encouraged to bring their friends and families to Making Strides walks across Michigan. Yeo & Yeo teams will participate in six walks – Making Strides of the Great Lakes Bay Region, Ann Arbor, Lansing, Oakland and Macomb Counties, and West Michigan. Our YPs will also do fundraising activities leading up to the walks and volunteering.

It has been a blast helping to coordinate the teams. I am excited to lead the Young Professionals service project and support such a great cause.

I give back because I want to offer a collective service opportunity to everyone at Yeo & Yeo.

Any form of identity theft can be costly, unsettling, and take months — sometimes years — to fully recover from and repair. But tax-related identity theft can be particularly disturbing because it involves the IRS, about which many people already harbor suspicion and anxiety. Although the IRS has taken significant steps in recent years to help minimize the occurrence of tax-related identity theft, this type of fraud continues to occur. Here’s how to avoid becoming a victim.

Individuals and businesses are vulnerable

If criminals use your information to file an income tax return to claim your refund, the first notification of fraud you receive may be a denial of your return. Tax returns are identified via Social Security numbers (SSNs) and the IRS won’t accept two returns with the same taxpayer identity. Thieves make a point of filing as early as possible to get a jump on the legitimate taxpayer.

Tax-related identity theft isn’t limited to personal returns. Business identity theft can occur when a fraud perpetrator uses an Employer Identification Number (EIN) associated with your business to file a return. In either case, if the IRS receives a fraudulent request for a refund, it could issue it to the criminal via direct deposit or check.

4 red flags

Often, the IRS is responsible for uncovering tax-related identity fraud when confronted with the problem of two separate returns. But you also should be on the lookout for red flags, for example:

Your return is rejected. The most unambiguous indication of tax-related identity theft is when the IRS rejects your return based on a duplicate SSN or EIN. You may learn this immediately if you e-file your return.
The IRS notifies you. When the IRS discovers a suspicious tax return, it will contact the affected taxpayer through the mail. If you receive a letter indicating a problem, the IRS may ask you to complete a form to prove your identity. The IRS might also notify you that there’s a new online account in your name or that someone has taken over your existing account.
You’re asked to pay additional taxes. To trigger a refund payment, criminals often submit fictitious information to the IRS. If the agency conducts a review and learns that the return associated with your SSN or EIN contains incorrect amounts (usually after a return is processed), it may ask you for more money. The IRS could notify you that you owe additional tax, that it’s withholding a future refund or that it plans to take collection actions.
IRS records are incorrect. Criminals often invent sources of income to appear legitimate to the IRS and facilitate a refund. If, for example, the IRS issues an EIN you didn’t request, a criminal may be using your business’s identity to submit fraudulent returns.

How to report fraud

If it appears your tax-related identity has been stolen, your need to complete IRS Form 14039, Identity Theft Affidavit as soon as possible. The IRS then will assign your case to one of its employees who’s trained to help identity-theft victims. The employee will determine the scope of the fraud, make any necessary corrections to IRS records and assign to you a personal identification number to prevent criminals from using your SSN or EIN to file returns in the future.

You may also need to notify your state’s tax authority. Although less prevalent (because refunds generally are smaller), it’s possible someone could use your SSN or EIN to file a fake state tax return.

Prevent it from happening in the first place

Of course, the best defense against tax-related identity theft is offense. File early before a potential scammer can file a fraudulent return in your name. Ensure that your computer is well-protected from viruses, malware and other hacker weapons and watch out for phishing emails. Also take advantage of the ID.me program. After you verify your identity, you can use your ID.me account to securely communicate with the IRS and various other government agencies.

If you suspect you’ve become a victim of fraud or have questions about protecting your own or your business’s identity, contact us.

In today’s tough job market and economy, the Work Opportunity Tax Credit (WOTC) may help employers. Many business owners are hiring and should be aware that the WOTC is available to employers that hire workers from targeted groups who face significant barriers to employment. The credit is worth as much as $2,400 for each eligible employee ($4,800, $5,600 and $9,600 for certain veterans and $9,000 for “long-term family assistance recipients”). It’s generally limited to eligible employees who begin work for the employer before January 1, 2026.

The IRS recently issued some updated information on the pre-screening and certification processes. To satisfy a requirement to pre-screen a job applicant, a pre-screening notice must be completed by the job applicant and the employer on or before the day a job offer is made. This is done by filing Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit.

Which new hires qualify?

An employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:

Qualified members of families receiving assistance under the Temporary Assistance for Needy Families (TANF) program,
Qualified veterans,
Qualified ex-felons,
Designated community residents,
Vocational rehabilitation referrals,
Qualified summer youth employees,
Qualified members of families in the Supplemental Nutritional Assistance Program (SNAP),
Qualified Supplemental Security Income recipients,
Long-term family assistance recipients, and
Long-term unemployed individuals.

Other rules and requirements

There are a number of requirements to qualify for the credit. For example, there’s a minimum requirement that each employee must have completed at least 120 hours of service for the employer. Also, the credit isn’t available for certain employees who are related to or who previously worked for the employer.

There are different rules and credit amounts for certain employees. The maximum credit available for the first-year wages is $2,400 for each employee, $4,000 for long-term family assistance recipients, and $4,800, $5,600 or $9,600 for certain veterans. Additionally, for long-term family assistance recipients, there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit of $9,000 over two years.

For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth employees is $1,200 per employee.

A beneficial credit

In some cases, employers may elect not to claim the WOTC. And in limited circumstances, the rules may prohibit the credit or require an allocation of it. However, for most employers hiring from targeted groups, the credit can be beneficial. Contact us with questions or for more information about your situation.

The popularity of telehealth grew exponentially when the COVID-19 pandemic hit in the spring of 2020. Many people have now returned to in-person appointments with their physicians, though virtual visits remain a convenient option under some circumstances.

The situation has motivated many employers to formally offer telehealth as an employee benefit. As a result, a common question arises: Is such a benefit subject to the Employee Retirement Income Security Act (ERISA)?

Key definition

The answer is generally yes. Telehealth, sometimes also referred to as telemedicine, is typically offered under a group health plan — which is indeed governed by ERISA if sponsored by a private sector employer. Even if telehealth is offered separately from the employer’s group health plan, the benefit can still be subject to the law if it’s considered all or part of an ERISA welfare benefit plan.

In general, an ERISA welfare benefit plan is a plan, fund or program established or maintained by an employer to provide employees with ERISA-listed benefits. Let’s break down each element as it relates to telehealth and whether the benefit would be subject to ERISA:

A plan, fund or program. An arrangement that provides “one-off” benefits and, thus, doesn’t require an “ongoing administrative scheme” might not be considered a plan, fund or program subject to ERISA. But it’s difficult to imagine a telehealth benefit that wouldn’t involve ongoing administration, so this element would likely be met.

Established or maintained by an employer for its employees. If an employer explicitly offers telehealth as a health care benefit, this element would probably be met.

Provides ERISA-listed benefits. Medical benefits are among those listed in ERISA. As telehealth is clearly medical care, this element would likely be met.

DOL safe harbor

Under a regulatory safe harbor issued by the U.S. Department of Labor, certain group insurance arrangements are exempt from ERISA even if they provide ERISA-listed benefits. An arrangement is exempt under this safe harbor if the following requirements are met:

The employer makes no contributions.
Participation is completely voluntary.
The employer doesn’t endorse the arrangement and its involvement is limited to permitting the insurer to publicize the program and collecting and remitting insurance premiums.
The employer receives no consideration for collecting and remitting premiums other than reasonable compensation.

A voluntary employee-pay-all telehealth benefit offered by a third party, with employer involvement limited to the permitted activities set forth in the safe harbor, probably wouldn’t be an ERISA plan.

Rules to follow

If your organization’s telehealth benefit does fall under the purview of ERISA, which is likely the case, you’ll need to ensure the benefit complies with the applicable rules. These include having a plan administrator, following claims and appeals procedures, and providing a summary plan description. Our firm can help you assess the costs of any benefits you offer or are considering, including the impact of ERISA compliance.