Management Letters: Follow Up On Your Auditor’s Recommendations

Maintaining the status quo in today’s volatile marketplace can be risky. To succeed, businesses need to “level up” by being proactive and adaptable. But some managers may be unsure where to start or they’re simply out of new ideas.

Fortunately, when audited financial statements are delivered, they’re accompanied by a management letter that suggests ways to maximize your company’s efficiency and minimize its risk. These letters may contain fresh, external perspectives and creative solutions to manage supply chain shortages, inflationary pressures and other current developments.

Auditing standards

Under Generally Accepted Auditing Standards, auditors must communicate in writing about material weaknesses or significant deficiencies in internal controls that are discovered during audit fieldwork. A material weakness is defined as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.”

Significant deficiencies are generally considered less severe than material weaknesses. A significant deficiency is “a deficiency, or a combination of deficiencies, in internal control that is … important enough to merit attention by those charged with governance.”

Auditors may unearth less severe weaknesses and operating inefficiencies during the course of an audit. Although reporting these items is optional, they’re often included in the management letter. The write-up for each deficiency includes an observation (including a cause, if observed), financial and qualitative impacts, and a recommended course of action.

From compliance to business improvement

Audits should be more than just an exercise in compliance. Management letters summarize lessons learned during audit fieldwork on how to improve various aspects of the company’s operations.

For example, a management letter might report a significant increase in the average accounts receivable collection period from the prior year. Then the letter might provide cost-effective suggestions on how to expedite collections, such as implementing early-bird discounts and using electronic payment systems to enable real-time invoices and online payment. Finally, the letter might explain how improved collections would potentially boost operating cash flow and decrease write-offs for bad debts.

When you review the management letter, remember that your auditor isn’t grading your performance. The letter is designed to provide advice based on best practices that the audit team has learned over the years from working with other clients.

Observant auditors may comment on a wide range of issues they encounter during the course of an audit. Examples — beyond internal controls — include cash management, operating workflow, control of production schedules, capacity issues, defects and waste, employee benefits, safety, website management, technology improvements and energy consumption.

Take your audit to the next level

Always take the time to review the management letter that’s delivered with your audited financial statements — don’t just file it away for a later date. Too often, the same talking points are repeated year after year. Proactive managers recognize the valuable insights these letters contain, and they contact us to discuss how to implement changes as soon as possible.

The April tax filing deadline has passed, but that doesn’t mean you should push your taxes out of your mind until next year. Here are three tax-related actions that you should consider taking in the near term (if you filed on time and didn’t file for an extension).

Retain the requisite records

Depending on the specific issue, the IRS has years to audit your tax return so it’s critical to maintain the records you may need to defend yourself. You generally need to keep the documents that support your income, deductions and credits for at least three years after the tax-filing deadline. (Note that no time limit applies to how long the IRS has to pursue taxpayers who don’t file or file fraudulent returns.)

Essential documentation to retain may include:

Form W-2, “Wage and Tax Statement,”
Form 1099-NEC, “Nonemployee Compensation,” 1099-MISC, “Miscellaneous Income,” and 1099-G, “Certain Government Payments,”
Form 1098, “Mortgage Interest Statement,”
Property tax payments,
Charitable donation receipts,
Records related to contributions to and withdrawals from Section 529 plans and Health Savings Accounts, and
Records related to deductible retirement plan contributions.

Hold on to records relating to property (including improvements to property) until the period of limitations expires for the year in which you dispose of the property. You’ll need those records to calculate your gain or loss.

Plan for your 2022 taxes

You should be collecting the documentation you’ll need for next year’s tax filing deadline on an ongoing basis. Keep up-to-date records of items such as charitable donations and mileage expenses.

In addition, this is a good time to reassess your current tax withholding to determine if you need to update your Form W-4, “Employee’s Withholding Certificate.” You may want to increase withholding if you owed taxes this year. Conversely, you might want to reduce it if you received a hefty refund. Changes also might be in order if you expect to experience certain major life changes, such as marriage, divorce, childbirth or adoption this year.

If you make estimated tax payments throughout the year, consider reevaluating the amounts you pay. You might want to increase or reduce the payments on account of changes in self-employment income, investment income, Social Security benefits and other types of nonwage income. To preempt the risk of a penalty for underpayment of estimated tax, consider paying at least 90% of the tax for the current year or 100% of the tax shown on your prior year’s tax return, whichever amount is less.

When it comes to strategies to reduce your 2022 tax bill, recent downturns in the stock market may have some upside. If you have substantial funds in a traditional IRA, this could be a ripe time to convert them to a Roth IRA. Roth IRAs have no required mandatory distributions, and distributions are tax-free. You must pay income tax on the fair market value of the converted assets, but, if you convert securities that have fallen in value or you’re in a lower tax bracket in 2022, you could pay less in taxes now than you would in the future. Moreover, any subsequent appreciation will be tax-free.

The market downturn could provide loss-harvesting opportunities, too. By selling poorly performing investments before year end, you can offset realized taxable gains on a dollar-for-dollar basis. If you end up with excess losses, you generally can apply up to $3,000 against your ordinary income and carry forward the balance to future tax years.

If you itemize deductions on your tax return, you also might consider “bunching” expected medical expenses into 2022 to increase the odds that you can claim the medical and dental expense deduction. You’re allowed to deduct unreimbursed expenses that exceed 7.5% of your adjusted gross income. If you expect to have, for example, a knee replacement surgery next winter, accelerating it (and all of the follow-up appointments and physical therapy) into this year could put you over the 7.5% threshold.

Respond to an IRS question or audit

You might have no choice but to continue thinking about your taxes if you receive a tax return question or audit letter from the IRS (and you would be notified only by a letter — the IRS doesn’t initiate inquiries or audits by telephone, text or email). Such letters can be alarming, but don’t assume the worst.

It’s important to remember that receiving a question or being selected for an audit doesn’t always mean you’ve tripped up somehow. For example, your tax return could have been flagged based on a statistical formula that compares similar returns for deviations from “norms.”

Further, if selected, you’re most likely going to undergo a correspondence audit; these audits account for more than 70% of IRS audits. They’re conducted by mail for a single tax year and involve only a few issues that the IRS anticipates it can resolve by reviewing relevant documents. According to the IRS, most audits involve returns filed within the last two years.

If you receive notification of a correspondence audit, you and your tax advisor should closely follow the instructions. You can request additional time if you can’t submit all documentation requested by the specified deadline. It’s advisable to submit copies instead of original documents, and each page of documentation should be marked with your name, Social Security number and the tax year under scrutiny.

Don’t ignore the letter. Doing so will eventually lead to the IRS disallowing the item(s) claimed and issuing a Notice of Deficiency (that is, a notice that a balance is due). You’ll then have 90 days to petition the U.S. Tax Court for review.

While correspondence audits are by far the most common, you could be selected for an office audit (in an IRS office) or field audit (at the taxpayer’s place of business). These are more intensive, and you should consult a tax professional with expertise in handling these types of exams.

Stay ahead of the game

Tax planning is an ongoing challenge. We can help you take the necessary steps to minimize your filing burden, your tax liability and the risk of bad results if you’re ever flagged for an audit.

If you donate valuable items to charity, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions. If you donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:

Get a “qualified appraisal,”
Receive the qualified appraisal before your tax return is due,
Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
Include other information with the return, and
Maintain certain records.

Keep these definitions in mind. A qualified appraisal is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An appraisal summary is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.

While courts have allowed taxpayers some latitude in meeting the “qualified appraisal” rules, you should aim for exact compliance.

The qualified appraisal isn’t submitted separately to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.

Failure to comply with the requirements

The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.

Exceptions to the requirement

A qualified appraisal isn’t required for contributions of:

A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
publicly traded securities for which market quotations are “readily available,” and
qualified intellectual property, such as a patent.

Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:

Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
Publicly traded securities for which market quotations aren’t “readily available.”

More than one gift

If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.

The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your contribution planning.

The coronavirus pandemic has brought about several new funding streams that your organization may have received. If so, you will likely need to give more consideration to audit and compliance requirements than you have given attention to in previous years. Your organization may even be subject to a single audit for the first time, which could be a daunting process to go through if you are unprepared. Following are some special considerations to think about.

Will you need a single audit? If you expended more than $750,000 of federal funds, you’ll likely need one (however, more on this below). In basic terms, this a more intensive audit that requires additional reporting outside of your basic financial statement audit. The single audit will communicate:
1. an opinion as to whether you have complied with all material compliance requirements of your major federal programs,
2. any noncompliance that was noted specific to other laws, regulations, and grant agreements,
3. any internal control deficiencies over compliance or financial reporting that were noted during the audit, and
4. an opinion as to the accuracy of the schedule of federal awards’ expenditures in relation to your financial statements as a whole.

Your auditor will need to perform a great deal of additional testing to complete this reporting and increased effort to prepare will be required on your part. You should make a single audit determination and let your auditor know as soon as possible, so both parties will have enough notice to plan and prepare for the single audit.

If a single audit is needed, a new statement called the schedule of expenditures of federal awards (SEFA) will be required. Your auditor will need an accurate schedule well in advance of the audit to communicate which grants will be selected as major programs, meaning the grants that the single audit will give the most attention to. If you have never prepared this schedule before, you may wish to reach out to your auditor for guidance.
Some of the pandemic funding is not subject to a single audit. Ensure you are familiar with which funding is and is not subject to a single audit for proper reporting on the SEFA. This point is crucial because it could be the difference between having or not having a single audit in the first place.
Provider Relief Funds are unique funding in that although the funds are received (and possibly expended) in one period, they are not reportable until a future period. This can directly affect your schedule of expenditures of federal awards. Additionally, special audit requirements may apply. If you receive any of this funding, you should become familiar with compliance and reporting requirements.

All expenditures must be reported separately, by grant, in your general ledger. For example, if you have Federal Grant A and Federal Grant B, you will need a way to associate how much of all costs, such as salaries, are charged to each grant. This is ideally accomplished with separate accounts or separate grant codes within the accounting system. The separation is essential to demonstrate you are not charging the same expenditures to multiple grants or ‘double-dipping.’
Regardless of whether you need a single audit or not, as a recipient of federal funding, you should have a written procedures manual in addition to your policies that are specific to federal grants. It is important to understand that policies and procedures are two very different things. Your procedures manual should cover all compliance areas applicable to your grants, such as allowable costs and activities, reporting, earmarking, etc. The manual should be specific to your organization and in sufficient detail to document and demonstrate proper procedures, in addition to guiding employees responsible for compliance. The manual is especially important in the event of a changeover in the CFO or compliance officer position.

Ensure you are familiar with both the specific requirements of your grant and the Uniform Guidance (UG), which is outlined in the Code of Federal Regulations at 2 CFR 200. UG is the streamlined and consolidated guidance that governs all federal awards issued on or after December 26, 2014. A great deal of the single audit is focused on compliance with UG.

Contact Yeo & Yeo’s Nonprofit Services Group or your auditor if you think you may need a single audit for the first time or if you need help with any of the special considerations above.

The IRS has begun mailing notices to businesses, financial institutions and other payers that filed certain returns with information that doesn’t match the agency’s records.

These CP2100 and CP2100A notices are sent by the IRS twice a year to payers who filed information returns that are missing a Taxpayer Identification Number (TIN), have an incorrect name or have a combination of both.

Each notice has a list of persons who received payments from the business with identified TIN issues.

If you receive one of these notices, you need to compare the accounts listed on the notice with your records and correct or update your records, if necessary. This can also include correcting backup withholding on payments made to payees.

Which returns are involved?

Businesses, financial institutions and other payers are required to file with the IRS various information returns reporting certain payments they make to independent contractors, customers and others. These information returns include:

Form 1099-B, Proceeds from Broker and Barter Exchange Transactions,
Form 1099-DIV, Dividends and Distributions,
Form 1099-INT, Interest Income,
Form 1099-K, Payment Card and Third-Party Network Transactions,
Form 1099-MISC, Miscellaneous Income,
Form 1099-NEC, Nonemployee Compensation, and
Form W-2G, Certain Gambling Winnings.

Do you have backup withholding responsibilities?

The CP2100 and CP2100A notices also inform recipients that they’re responsible for backup withholding. Payments reported on the information returns listed above are subject to backup withholding if:

The payer doesn’t have the payee’s TIN when making payments that are required to be reported.
The individual receiving payments doesn’t certify his or her TIN as required.
The IRS notifies the payer that the individual receiving payments furnished an incorrect TIN.
The IRS notifies the payer that the individual receiving payments didn’t report all interest and dividends on his or her tax return.

Do you have to report payments to independent contractors?

By January first of the following year, payers must complete Form 1099-NEC, “Nonemployee Compensation,” to report certain payments made to recipients. If the following four conditions are met, you must generally report payments as nonemployee compensation:

You made a payment to someone who isn’t your employee,
You made a payment for services in the course of your trade or business,
You made a payment to an individual, partnership, estate, or, in some cases, a corporation, and
You made payments to a recipient of at least $600 during the year.

Contact us if you receive a CP2100 or CP2100A notice from the IRS or if you have questions about filing Form 1099-NEC. We can help you stay in compliance with all rules.

Financial statements tell only part of the story. Investors, lenders and other stakeholders who know how to identify red flags of impending problems can protect their own financial interests. Additional due diligence may be needed to uncover these issues. For instance, stakeholders might need to talk to management, visit the company’s website and compute financial benchmarks using the company’s most recent financial statement. Here’s what to look for.

Employees who jump ship

Employee turnover — at all levels — often precedes weak financial results. One obvious reason is that company insiders are often the first to know when trouble is brewing. For example, if the plant manager’s innovative ideas are frequently denied due to lack of funds or if employees hear shareholders bickering over the company’s strategic direction, they may decide to seek greener pastures.

The reverse happens, too. If certain key people leave the company, it may cause revenue or productivity to nosedive. Given time and sufficient effort, most established companies can recover from the loss of a key person.

Another reason for high employee turnover may be layoffs. Companies that can’t meet payroll may need to shed costs and dole out pink slips.

Employee turnover can also be a vicious cycle. Top performers in an organization may respond to perceived financial problems by moving to healthier competitors. That leaves behind the weaker performers, who must train new hires on the company’s operations. Finding and training new workers can be time-consuming and costly, compounding the borrower’s financial distress.

Working capital concerns

Working capital is the difference between a company’s current assets and liabilities. Monitoring key turnover ratios can help gauge whether the company is managing its short-term assets and liabilities efficiently.

When accounts receivable turnover slows dramatically, it could signal weakened collection efforts, stale accounts or even fraud. For example, a company that’s desperate to boost revenue might solicit business with customers that have poor credit. Or one of a company’s major customers might be underperforming and it’s trickling down the supply chain.

Likewise, beware of deteriorating inventory turnover. Similar to receivables, a buildup of inventory on a borrower’s balance sheet could signal inefficient asset management. Certain product lines may be obsolete and require inventory write-offs. Or a new plant manager might overestimate the amount of buffer stock that’s needed in the warehouse. It might even forewarn of fraud or financial misstatement.

Changing market conditions

External factors may affect a company’s financial performance, but the effects vary from company to company. For instance, some companies permanently closed when the economy shut down during the COVID-19 pandemic, while others pivoted and prospered.

Today, business performance may be adversely impacted by geopolitical pressures, rising interest rates, supply chain shortages and inflation. Stakeholders should continue to monitor financial results closely in these volatile conditions.

Extra assurance

When a company shows signs of financial distress, stakeholders should encourage management to supplement its year-end financial statements with interim reports or engage a CPA to perform targeted agreed-upon procedures. Doing so can help the company assess risk, identify problems and brainstorm corrective measures, if needed. Contact us for more information.

Like many people, you may have dreamed of turning a hobby into a regular business. You won’t have any tax headaches if your new business is profitable. But what if the new enterprise consistently generates losses (your deductions exceed income) and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses.

By contrast, if the new enterprise isn’t affected by the hobby loss rules because it’s profitable, all otherwise allowable expenses are deductible on Schedule C, even if they exceed income from the enterprise.

Note: Before 2018, deductible hobby expenses had to be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

Avoiding a hobby designation

There are two ways to avoid the hobby loss rules:

Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing or racing horses).
Run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.

How can you prove you have a profit-making objective? You should run the venture in a businesslike manner. The IRS and the courts will look at the following factors:

How you run the activity,
Your expertise in the area (and your advisors’ expertise),
The time and effort you expend in the enterprise,
Whether there’s an expectation that the assets used in the activity will rise in value,
Your success in carrying on other activities,
Your history of income or loss in the activity,
The amount of any occasional profits earned,
Your financial status, and
Whether the activity involves elements of personal pleasure or recreation.

Recent court case

In one U.S. Tax Court case, a married couple’s miniature donkey breeding activity was found to be conducted with a profit motive. The IRS had earlier determined it was a hobby and the couple was liable for taxes and penalties for the two tax years in which they claimed losses of more than $130,000. However, the court found the couple had a business plan, kept separate records and conducted the activity in a businesslike manner. The court stated they were “engaged in the breeding activity with an actual and honest objective of making a profit.” (TC Memo 2021-140)

Contact us for more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do to avoid a tax challenge.

What are the tax consequences of selling property used in your trade or business?

There are many rules that can potentially apply to the sale of business property. Thus, to simplify discussion, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year. (There are different rules for property held primarily for sale to customers in the ordinary course of business; intellectual property; low-income housing; property that involves farming or livestock; and other types of property.)

General rules

Under the Internal Revenue Code, your gains and losses from sales of business property are netted against each other. The net gain or loss qualifies for tax treatment as follows:

1) If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.

2) If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income (in other words, none of the rules that limit the deductibility of capital losses apply).

Recapture rules

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules — that is, rules under which amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of as long-term capital gain.

Section 1245 Property

“Section 1245 Property” consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually, real property that performs specific functions). If you sell Section 1245 Property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.

Section 1250 Property

“Section 1250 Property” consists, generally, of buildings and their structural components. If you sell Section 1250 Property that was placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% as adjusted for the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% as adjusted for the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules may apply to Section 1250 Property, depending on when it was placed in service.

As you can see, even with the simplifying assumptions in this article, the tax treatment of the sale of business assets can be complex. Contact us if you’d like to determine the tax consequences of specific transactions or if you have any additional questions.

AmazonSmile is an accessible, no-cost fundraising opportunity operated by Amazon.com that can help supplement the existing charitable contributions a nonprofit organization receives. The process is simple and it all starts with Amazon.com customers. Customers interested in participating are required to select a charitable organization before making purchases. The AmazonSmile Foundation will then donate 0.5 percent of eligible purchases to the charitable organization of the customer’s choosing. AmazonSmile provides a database of almost one million charitable organizations from GuideStar.com, so your organization may already be able to participate!

Your charitable organization only needs to do two things to maximize the benefit from AmazonSmile.

1. Register to ensure your charitable organization’s information is accurate and to receive the donations that AmazonSmile collected.

2. Make your volunteers and contributors aware of the AmazonSmile program through social marketing or other advertising so they can associate your charitable organization with any Amazon.com purchases they make. There is no cost to the customer nor to the charitable organization for using the service, which makes it a very economical way to embrace existing donors into further supporting your organization.

Go to org.amazon.com for more information and to register. If you have questions, please contact your Yeo & Yeo Non-Profit professional.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Megan LaPointe, CPP, Lead Payroll Specialist, has met the requirements of the Certification Board of the American Payroll Association and earned the Certified Payroll Professional (CPP) accreditation. A CPP is a specialist in payroll processing and administration.

“The CPP credential is considered the mark of excellence for payroll professionals,” said Christine Porras, CPP, Payroll Services Group leader. “Megan’s achievement demonstrates our professionals’ commitment to expanding Yeo & Yeo’s level of expertise in providing outsourced payroll and consulting services for Michigan businesses.”

All CPPs must pass a rigorous exam and demonstrate knowledge of core payroll concepts, the Fair Labor Standards Act, employment taxes, compensation and benefits, employee and employer forms, voluntary and involuntary deductions, methods and timing of pay, reporting, compliance, internal controls and accounting principles.

Megan LaPointe, a graduate of Northwood University, holds a bachelor’s degree in accounting. She joined Yeo & Yeo in 2015, and is the Lead Payroll Specialist, based in the firm’s Saginaw office. Her areas of expertise include processing payroll, preparing quarterly and annual payroll returns, and payroll audits. Megan is a member of the American Payroll Association – Great Lakes Bay Chapter.

Is your business ready to seek funding from outside investors? Perhaps you’re a start-up that needs money to launch as robustly as possible. Or maybe your company has been operating for a while and you want to pivot in a new direction or just take it to the next level.

Whatever the case may be, seeking outside investment isn’t as cut and dried as applying for a commercial loan. You need to wow investors with your vision, financials and business plan.

To do so, many businesses today put together a “pitch deck.” This is a digital presentation that provides a succinct, compelling description of the company, its solution to a market need, and the benefits of the investment opportunity. Here are some useful guidelines:

Keep it brief, between 10 to 12 short slides. You want to make a positive impression and whet investors’ interest without taking up too much of their time. You can follow up with additional details later.

Be concise but comprehensive. State your company’s mission (why it exists), vision (where it wants to go) and value proposition (what your product or service does for customers). Also declare upfront how much money you’d like to raise.

Identify the problem you’re solving. Explain the gap in the market that you’re addressing. Discuss it realistically and with minimal jargon, so investors can quickly grasp the challenge and intuitively agree with you.

Describe your target market. Include the market’s size, composition and forecasted growth. Resist the temptation to define the market as “everyone,” because this tends to come across as unrealistic.

Outline your business plan. That is, how will your business make money? What will you charge customers for your solution? Are you a premium provider or is this a budget-minded product or service?

Summarize your marketing and sales plans. Describe the marketing tactics you’ll employ to garner attention and interact with your customer base. Then identify your optimal sales channels and methods. If you already have a strong social media following, note that as well.

Sell your leadership team. Who are you and your fellow owners/executives? What are your educational and business backgrounds? Perhaps above everything else, investors will demand that a trustworthy crew is steering the ship.

Provide a snapshot of your financials, both past and future. But don’t just copy and paste your financial statements onto a few slides. Use aesthetically pleasing charts, graphs and other visuals to show historical results (if available), as well as forecasted sales and income for the next several years. Your profit projections should realistically flow from historical performance or at least appear feasible given expected economic and market conditions.

Identify your competitors. What other companies are addressing the problem that your product or service solves? Differentiate yourself from those businesses and explain why customers will choose your solution over theirs.

Describe how you’ll use the funds. Show investors how their investment will allow you to fulfill your stated business objectives. Be as specific as possible about where the money will go.

Ask for help. As you undertake the steps above — and before you meet with investors — contact our firm. We can help you develop a pitch deck with accurate, pertinent financial data that will capture investors’ interest and help you get the funding your business needs.

Adding a new partner in a partnership has several financial and legal implications. Let’s say you and your partners are planning to admit a new partner. The new partner will acquire a one-third interest in the partnership by making a cash contribution to it. Let’s further assume that your bases in your partnership interests are sufficient so that the decrease in your portions of the partnership’s liabilities because of the new partner’s entry won’t reduce your bases to zero.

Not as simple as it seems

Although the entry of a new partner appears to be a simple matter, it’s necessary to plan the new person’s entry properly in order to avoid various tax problems. Here are two issues to consider:

First, if there’s a change in the partners’ interests in unrealized receivables and substantially appreciated inventory items, the change is treated as a sale of those items, with the result that the current partners will recognize gain. For this purpose, unrealized receivables include not only accounts receivable, but also depreciation recapture and certain other ordinary income items. In order to avoid gain recognition on those items, it’s necessary that they be allocated to the current partners even after the entry of the new partner.

Second, the tax code requires that the “built-in gain or loss” on assets that were held by the partnership before the new partner was admitted be allocated to the current partners and not to the entering partner. Generally speaking, “built-in gain or loss” is the difference between the fair market value and basis of the partnership property at the time the new partner is admitted.

The most important effect of these rules is that the new partner must be allocated a portion of the depreciation equal to his share of the depreciable property based on current fair market value. This will reduce the amount of depreciation that can be taken by the current partners. The other effect is that the built-in gain or loss on the partnership assets must be allocated to the current partners when partnership assets are sold. The rules that apply here are complex and the partnership may have to adopt special accounting procedures to cope with the relevant requirements.

Keep track of your basis

When adding a partner or making other changes, a partner’s basis in his or her interest can undergo frequent adjustment. It’s imperative to keep proper track of your basis because it can have an impact in several areas: gain or loss on the sale of your interest, how partnership distributions to you are taxed and the maximum amount of partnership loss you can deduct.

Contact us if you’d like help in dealing with these issues or any other issues that may arise in connection with your partnership.

In today’s volatile economy, many businesses and nonprofits have been required to write down the value of acquired goodwill on their balance sheets. Others are expected to follow suit — or report additional write-offs — in 2022. To the extent that goodwill is written off, it can’t be recovered in the future, even if the organization recovers. So, impairment testing is a serious endeavor that usually requires input from your CPA to ensure accuracy, transparency and timeliness.

Reporting goodwill

Under U.S. Generally Accepted Accounting Principles (GAAP), when an organization merges with or acquires another entity, the acquirer must allocate the purchase price among the assets acquired and liabilities assumed, based on their fair values. If the purchase price is higher than the combined fair value of the acquired entity’s identifiable net assets, the excess value is labeled as goodwill.

Before lumping excess value into goodwill, acquirers must identify and value other identifiable intangible assets, such as trademarks, customer lists, copyrights, leases, patents or franchise agreements. An intangible asset is recognized apart from goodwill if it arises from contractual or legal rights — or if it can be sold, transferred, licensed, rented or exchanged.

Goodwill is allocated among the reporting units (or operating segments) that it benefits. Many small private entities consist of a single reporting unit. But large conglomerates may be composed of numerous reporting units.

Testing for impairment

Organizations must generally test goodwill and other indefinite-lived intangibles for impairment each year. More frequent impairment tests might be necessary if other triggering events happen during the year — such as the loss of a key person, unanticipated competition, reorganization or adverse regulatory actions.

In lieu of annual impairment testing, private entities have the option to amortize acquired goodwill over a useful life of up to 10 years. In addition, the Financial Accounting Standards Board recently issued updated guidance that allows private companies and not-for-profits to delay the assessment of the goodwill impairment triggering event until the first reporting date after that triggering event. The change aims to reduce costs and simplify impairment testing related to triggering events.

Writing down goodwill

When impairment occurs, the organization must decrease the carrying value of goodwill on the balance sheet and reduce its earnings by the same amount. Impairment charges are a separate line item on the income statement that may have real-world consequences.

For example, some organizations reporting impairment losses may be in technical default on their loans. This situation might require management to renegotiate loan terms or find a new lender. Impairment charges also raise a red flag to investors and other stakeholders.

Who can help?

Few organizations employ internal accounting staff with the requisite training to measure impairment. Contact us for help navigating this issue and its effects on your financial statements.

Spring has sprung — and summer isn’t far off. If your business typically hires minors for summer jobs, now’s a good time to brush up on child labor laws.

In News Release No. 22-546-DEN, the U.S. Department of Labor’s Wage and Hour Division (WHD) recently announced that it’s stepping up efforts to identify child labor violations in the Salt Lake City area. However, the news serves as a good reminder to companies nationwide about the many details of employing children.

Finer points of the FLSA

The Department of Labor is the sole federal agency that monitors child labor and enforces child labor laws. The most sweeping federal law that restricts the employment and abuse of child workers is the Fair Labor Standards Act (FLSA). The WHD handles enforcement of the FLSA’s child labor provisions.

The FLSA restricts the hours that children under 16 years of age can work and lists hazardous occupations too dangerous for young workers to perform. Examples include jobs involving the operation of power-driven woodworking machines, and work that involves exposure to radioactive substances and ionizing radiators.

The FLSA allows children 14 to 15 years old to work outside of school hours in various manufacturing, non-mining, non-hazardous jobs under certain conditions. Permissible work hours for 14- and 15-year-olds are:

Three hours on a school day,
18 hours in a school week,
Eight hours on a non-school day,
40 hours in a non-school week, and
Between 7 a.m. and 7 p.m.*

*From June 1 through Labor Day, nighttime work hours are extended to 9 p.m.

Just one example

News Release No. 22-546-DEN reveals the results of three specific investigations. In them, the WHD found that employers had allowed minors to operate dangerous machinery. Also, minors were allowed to work beyond the time permitted, during school hours, more than three hours on a school night and more than 18 hours a workweek.

In one case, a restaurant allowed minors to operate or assist in operating a trash compactor and a manual fryer, which are prohibited tasks for 14- and 15-year-old workers. The employer also allowed minors to work:

More than three hours on a school day,
More than 18 hours in a school week,
Past 7 p.m. from Labor Day through May 31,
Past 9 p.m. from June 1 through Labor Day, and
More than eight hours on a non-school day.

The WHD assessed the business $17,159 in civil money penalties.

Letter of the law

In the news release, WHD Director Kevin Hunt states, “Early employment opportunities are meant to be valuable and safe learning experiences for young people and should never put them at risk of harm. Employers who fail to keep minor-aged workers safe and follow child labor regulations may struggle to find the young people they need to operate their businesses.”

What’s more, as the case above demonstrates, companies can incur substantial financial penalties for failing to follow the letter of the law. Consult an employment attorney for further details on the FLSA. We can help you measure and manage your hiring and payroll costs.

Most nonprofits have some type of special event that they run during the fiscal year, whether it is an annual event or just a periodic event. Accounting and tax reporting can be tricky for these events. At most of these events, the attendee is obtaining some type of good or service (such as a dinner or entertainment) but is paying more to obtain that good or service than it is worth (because they are trying to contribute money to the nonprofit.) Therein lies the complexity. The good news is that the book and tax ramifications are similar.

Accounting for the contribution portion
Let’s start with the contribution piece. The price of admission that is above and beyond the fair value of the goods and services received is considered a contribution for both book and tax purposes. For example, let’s assume it is a dinner event and the cost of the admission ticket is $50. You could purchase the meal yourself from the caterer (or from a different caterer) for $20. The contribution for both book and tax purposes is $30 (ticket cost of $50 less fair value of goods received of $20). For both book and tax, it is irrelevant if the caterer charges the nonprofit the fair value of $20 or not.

For tax reporting purposes, that means that the fundraising event line item of revenue will be broken down into $30 of contributions and $20 of gross income from fundraising events. The $30 contribution is subject to all the same tax rules as if the person had simply written you a check for $30 and received nothing in return; that means for certain donors, you need to be able to track it separately for Schedule A or Schedule B purposes. As a nonprofit, you have a legal requirement that if the admission ticket was $75 or more, you must provide the purchaser a statement indicating the value of goods or services received. This allows them to do the math on their tax return and determine the contribution they can deduct.

For generally accepted accounting principles purposes, the same $30 is contribution revenue and the $20 is revenue from contracts with customers. The $30 of contribution revenue is recorded when the contribution becomes unconditional. That means unless there is a right of return/release and a barrier, the $30 is recorded as revenue when the ticket purchaser promises to purchase the ticket. If you are selling tickets in the year before the event, that means a portion of “event” revenue (related to contributions) is earned before the event. To “prevent” that from happening, the contribution must be conditional. There would have to be an explicit expectation that if the event did not happen, the contribution would be refundable. That is a business decision that should not be made lightly, just to fix unpleasant accounting requirements.

Accounting for the exchange portion
Now we have the remaining $20, which is gross income from fundraising events (tax) or revenue from contracts with customers (book). This amount is recognized when the event takes place. For tax purposes, this $20 is the amount listed as gross income from fundraising events in the revenue section of Form 990. It will be netted with the direct costs of the items sold/production of revenue. For the dinner, that would include the cost of the food and beverages and potentially the invitation to the dinner. It would not include advertising for the event (which is an indirect fundraising expense), nor would it include the cost of the time that the employees spend planning the event.

In general, we would expect that the net amount reported in the revenue section of Form 990 for income from fundraising would be close to break-even or a positive number (especially if the nonprofit got a discount on what they paid which is more significant than what the average individual could obtain). If instead your net income from fundraising is a large negative amount, either you have allocated expenses that are not directly related to the fundraising event, or you have not properly determined the contribution revenue (and therefore have told your donors they could take too high a tax deduction on their return).

For book purposes, that $20 is revenue from contracts with customers. It is earned when, or as, the performance obligations are performed. Typically, this will be the night of the dinner, when dinner is provided (or the person fails to come to the dinner and is not reimbursed their ticket price). Aside from a potential timing difference between recognizing contribution and revenue from contracts with customers, the non-contribution portion of the transaction has substantially more disclosures that will need to be included in the financial statements.

Accounting for auction items
Frequently these types of special events have auctions of donated items. Let’s presume that a donor provides, at no cost to the nonprofit, an item for the auction with a fair value of $5,000. Both book and tax would record that as contribution income (noncash) of $5,000 when it is unconditional. The excess of the selling price over the fair value will be a contribution in both cases. So, if it sells for $7,500, the remaining $2,500 ($7,500 less the $5,000 already accounted for) is cash contribution. If instead it sells for $3,000, there is no additional contribution ($3,000 less $5,000 is negative). For tax purposes, the lesser of the fair value ($5,000) or amount received ($3,000 or $7,500, depending on the example) is reported as gross income from fundraising events. Also, for tax purposes, the full fair value of $5,000 is an expense (regardless of the amount it was auctioned for) plus any other direct expenses (such as the cost of the auctioneer). This would result in negative net income from fundraising equal to at least the amount of the other direct expenses.

What about sponsorships?
Special events also frequently offer sponsorships. The IRS has specific rules on what can be considered contribution (and non-taxable). Those rules indicate that the sponsor pays the nonprofit with no arrangement of expectation for substantial return benefit. Substantial return benefit includes: a) advertising, b) an exclusive provider arrangement, c) providing more than a de minimus facilities, services, or other privileges to the payor or a person designated by the payor, or d) granting the payor or a person designated by the payor the right to use an intangible asset such as a trademark, patent, or logo of the nonprofit.

Advertising is defined as having qualitative or comparative language, price information, and endorsement, or an inducement to purchase, not just a logo or description of goods. The de minimus exception is set at 2% of the sponsorship agreement. In the tax realm, if the sponsorship does not meet the criteria to be a contribution, it is likely advertising and taxable income.

Generally accepted accounting principles do not have strict guidelines to differentiate between revenue from contracts with customers and contribution revenue. However, a good rule of thumb is that if it is contribution revenue for the IRS, it is contribution revenue for book purposes; if it’s not, it’s not. Do remember, for book purposes, contribution revenue is earned when it is unconditional. That is to say, when there is not both a right of return/release and a barrier. If you do not explicitly indicate in your sponsorship agreements that in the event the special event is cancelled, all sponsorships will be returned, then it is unconditional.

Other considerations in contribution revenue
Accounting and reporting for special events can be very confusing. Book and tax tend to mimic each other but aren’t always intuitive. To determine the contributions, you will take the actual amounts pledged less the fair value of what is being given, regardless of the cost. The contributions may be recorded in a period before the event takes place if they are unconditional. If the ticket price is over $75, the nonprofit is required by law to provide a receipt indicating the value of goods and services the purchaser has received, so that they can calculate the tax-deductible contributions. Sponsorships may or may not be contribution revenue, depending on the goods and services being provided in exchange for the sponsorships.

If you have questions about specific situations, please engage the Yeo & Yeo Nonprofit Services Group to help you evaluate the proper accounting and tax reporting for these special events.

Over the last year, consumer prices rose 7.9%, according to the latest data from the U.S. Bureau of Labor Statistics. The Consumer Price Index covers the prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. This is the highest 12-month increase since 1982.

Increases in the price of consumer goods will affect most businesses, sooner or later. For example, if you operate a restaurant, spikes in food prices directly affect you. If you operate a fleet of delivery vehicles, you’re already feeling the effect of rising gas prices. And manufacturers have been hit with higher energy, commodity and shipping costs.

Meanwhile, the producer price index (PPI) is up 10% over last year. This is the largest increase on record for wholesale inflation. PPI gauges inflation before it hits consumers. The U.S. Bureau of Labor Statistics reports that whole energy and food costs were up 33.8% and 13.7% in February 2022 compared to February 2021.

Inflation impacts profits. Although you might be able to absorb some temporary cost increases, at some point, you’ll probably need to raise prices to remain profitable. But, if your competitors hold out on increasing their prices, they might gain an instant competitive advantage, which could lead to turnover and reduced market share.

The decision to raise prices by how much and when depends on demand for your products or services, market trends, customer loyalty, and how long high inflation rates persist. Even if you’re able to implement a successful price increase, there’s a limit to how far you can go. Then what can you do to stay profitable?

Link Pay to Performance

The next step is taking a fresh look at your cost structure for savings opportunities to offset cost increases. Unfortunately, this may be challenging for companies that have already cut costs during the COVID-19 pandemic.

A logical starting point is payroll. It’s the largest cost category for most businesses, and many companies have been forced to raise wages to attract and retain workers during the so-called “Great Resignation.” If you’ve raised the pay for certain key positions, you’d probably expect a corresponding increase in those employees’ productivity. Review those workers’ productivity levels to determine whether there’s indeed a connection between pay and performance.

Next, evaluate whether your performance assessment process is effective. That means having clear and detailed job descriptions in place, including performance indicators and annual objectives. Performance reviews need to be performed regularly against those objectives. Document the results. Accountability for productivity is the best way to achieve it.

Optimize Staffing Levels

The performance review process can help identify opportunities to reduce headcount. How? Before giving existing workers a raise, discuss whether they’d be willing to take on additional responsibilities. These discussions could open the door to some tactical downsizing.

Also, when evaluating payroll costs, look for perks you’re providing but aren’t valued by employees. Some benefits, such as occasional free lunches and company parties, can be suspended without significant pushback from employees.

While generous health benefits are usually a good way to attract and retain employees, consider whether you might be being more generous than you’re legally required to be. For example, are you paying more to subsidize health benefits than other employers in your area?

Other Savings Opportunities

Payroll and benefits aren’t the only areas that can be scaled back to counter inflation. Consider these popular savings opportunities:

Using independent contractors. Labor laws tend to discourage companies from converting employees into freelancers. In fact, under certain conditions, the IRS may reclassify independent contractors as employees — a potentially costly scenario for a business.

However, you might be able to use contractors to augment your staff or replace workers who’ve left. Generally, using freelance help is more flexible than employing workers — you use contractors only as much as you need them, at a cost that’s negotiable.

Renegotiating service contracts. Make a list of all your service contracts. Examples include phone, Internet, software licenses, equipment leases, landscaping, cleaning, security, insurance and professional services. You can lower these costs by 1) switching to a less-expensive competitor, 2) negotiating a lower rate with your existing provider, or 3) reducing your level of service.

Downsizing your real estate. In addition to rent, mortgage interest and property taxes, real estate can represent a major expense because of maintenance, insurance and utilities. You can’t change the space your business occupies overnight — especially if you own the property. But you can evaluate your current footprint and assess how much space would be necessary if you implemented a flexible work schedule. Some workers might be able to telecommute indefinitely. Others can work from home two or three days per week and use revolving workspaces when they’re in the office.

Under the right circumstances, you could sublease some of your excess space. Or you might negotiate less square footage when your lease runs out. If your company owns its real estate, investigate whether you could sell all or part of the space. Alternatively, some businesses lower costs by moving to a less expensive location. Before you decide to relocate, however, consider how doing so would impact employees’ commutes and customers’ convenience.

Partnering with other businesses. Large groups — such as trade organizations or cooperatives — often have more collective bargaining power than individual businesses negotiating alone. By forming or joining a buying group, you’ll likely benefit from discounted supplies and services. Some groups even share certain overhead expenses, such as office equipment, administrative staff and meeting space.

Managing inventory. Over the last two years, some companies have increased their safety stock levels to mitigate supply chain disruptions and to take advantage of bulk discounts. However, businesses that carry excessive inventory levels tie up substantial working capital. They also incur significant costs, including insurance, storage, security, pilferage and obsolescence. Efficient inventory management is essential to staying profitable and maintaining cash flow in today’s inflationary conditions.

What’s Right for Your Business?

High inflation, coupled with labor shortages and supply disruptions, are creating a tenuous situation for business owners. How can you counteract these trends? Strong demand allows some companies to pass along price increases to customers — up to a limit. If high inflation rates persist, you’ll need to find more creative coping strategies. Contact your financial professional for advice on price increases and feasible cost cuts for your business.

How would you feel about taking a cross-country road trip without knowing the amount of gas in your tank, your engine’s temperature or your oil pressure? That’s why you have an instrument panel on your vehicle’s dashboard.

Your business can have a dashboard, too, that features key performance indicators (KPIs). Some metrics may be applicable to any business, while others need to be customized for your specific operating conditions. However, if they’re too complicated to create and monitor, you might veer off course or crash while staring at your dashboard.

Profitability

The bottom line on business performance is just that — the bottom line. Over the long run, profitability metrics are important for every business.

But there may be reasons to temporarily operate at a loss. Examples include start-ups breaking into new markets and low-cost producers trying to take away market share from competitors. External conditions (such as a government-mandated lockdown or a natural disaster) may also cause a business to lose money temporarily.

In most cases, businesses that are losing money have a problem that demands immediate attention. Common profitability metrics include:

Gross margin [(revenue – costs of sales) / revenue], and
EBITDA (earnings before interest, taxes, depreciation and amortization).

You can determine the optimum level of profitability for your business by researching common profit ratios for companies in your industry, geographic location and size. Also make sure that you aren’t under-investing in your business’s future.

Beware: Companies that pursue profits at all costs may suffer adverse effects. For example, employees who are spread too thin may feel overworked, leading to burnout, accidents, errors and high turnover. Likewise, companies that pay below-market wages or skimp on benefits and training may experience high turnover and difficulty recruiting skilled workers. Cuts to the marketing budget, failure to maintain equipment and postponed technology upgrades might boost current profits, but they can impair performance and value over the long run.

Employee Productivity

Personnel costs — including salaries, wages, bonuses, payroll taxes and benefits — are typically a company’s biggest expense category. Management wants to make sure the company is getting its money’s worth, especially as labor rates and health care benefit costs have gone up in recent years.

Some companies use labor cost per unit produced as a KPI. A unit may be a product or service. This KPI may be more relevant when you track it over time and see how it correlates to your bottom line, as compared to other cost categories. To illustrate, suppose your business is sufficiently profitable today (however you define that) and your labor cost per unit produced is $100. A year later, your wages remain stable, but you’ve invested in new equipment to help boost productivity. If those tools are effective, you’d expect to have a lower labor cost per unit. However, it may take some time to recoup the cost of your investment.

Alternatively, some companies measure labor time per unit produced. For example, a medical practice might calculate average time spent per patient. That approach lets you isolate the productivity rate of labor from changes in labor cost. This can provide a simpler assessment of the impact of new productivity tools.

These “tools” can also be intangible, such as skills training, that enable employees to do more without another change to their work environment. It could even include the introduction of a new department head or supervisor. By tracking changes in the labor cost or time per unit, you can assess whether the new hire is having a positive effect on productivity.

Some productivity metrics may be industry specific. For example, a clothing retailer might calculate average units or dollars for each sales transaction. Or an auto dealership might calculate vehicles sold per week for salespeople or vehicles serviced per week for technicians.

Another metric to consider is time spent on productive activities vs. administrative ones (such as meetings, filling out forms and paid leave). This KPI helps assess the cost of your “overhead” labor. For example, a law office may compute billable vs. nonbillable hours for its paralegals and junior lawyers. If the percentage of nonbillable hours increases over time it might signal a red flag, especially if accompanied by declining profitability.

Productivity can also be measured qualitatively. For example, suppose your company has a goal to improve customer satisfaction. You might ask customers to complete surveys after they purchase a product or receive a service, and then track the percentage of employees rated at different performance levels. You may decide to reward those with high scores and provide additional training to get under-performers back on track.

Other Target Areas

The rest of your dashboard should be customized based on what drives your company’s value. KPIs differ from one company to the next based on the industry and the company’s objectives. Common examples include:

Operating cash flow. Cash is king. This metric helps management evaluate how much cash is available for immediate spending needs.

Return on assets. This metric (net income / total assets) measures how effectively your company is managing its assets to generate earnings.

Asset turnover ratios. How much revenue is generated for each dollar invested in assets? You might want to look at the big picture (revenue / total assets). Or you might prefer to break it down by different categories of assets and evaluate it in terms of days (rather than the number of times an account turns over). For example, you might compute days in receivables [(average receivables / annual revenue) × 365 days] or days in inventory [(average inventory / annual cost of sales) × 365 days].

Productivity metrics also can be industry specific. For example, a hospital might be evaluated based on revenue per bed or a hotel based on revenue per room. The key when selecting KPIs is that they must be both specific and measurable.

A Custom Approach

These are just a sampling of metrics you can use. When designing your dashboard, the goal is to identify and track the most relevant KPIs. This information can help you make important tactical and strategic decisions in a timely manner to keep your business healthy in today’s volatile market conditions.

Many IT tools, including project management software, are available to help you crunch the numbers. Your financial advisor can guide you in finding the best way to measure and monitor your business performance.

The tax filing deadline for 2021 tax returns is April 18 this year. After your 2021 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations:

1. You can throw some tax records away now

You should hang onto tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return. So you can generally get rid of most records related to tax returns for 2018 and earlier years. (If you filed an extension for your 2018 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should keep certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

What about your retirement account paperwork? Keep records associated with a retirement account until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

2. Waiting for your refund? You can check on it

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.

3. If you forgot to report something, you can file an amended return

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2021 tax return that you file on April 15, 2022, you can generally file an amended return until April 15, 2025.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

We’re here year-round

If you have questions about tax record retention, your refund, or filing an amended return, contact us. We’re not just available at tax-filing time — we’re here all year!

The concept of in-kind contributions – receiving a contribution that is goods or services – has been around, and unchanged, for quite some time. FASB released a new accounting update that will not change the accounting or recognition, but will change the disclosure and presentation of many in-kind contributions. ASU 2020-07, Presentation and Disclosures by Not-for-profit Entities for Contributed Nonfinancial Assets will be effective for years beginning after June 15, 2021. This means that June 30, 2022, and later year ends will need to apply this standard.

The good news is that the accounting and recognition will not change. All the information needed for the new disclosure and presentation requirements should already be available to your organization. It just may need to be structured differently.

The presentation will now require contributed nonfinancial assets to be in a single line, separate from any contributed financial assets, in the statement of activities. FASB is not making you change the line items for all your contributions; financial contributions (cash, receivables, investments, etc.) can continue to be labeled in however many line items with whatever titles you wish. It only impacts contributed nonfinancial assets (goods, services, and use of goods). All of those contributed nonfinancial assets need to be lumped into one line item on the statement of activities, and it cannot include contributed financial assets. This may mean adding a new account to your chart of accounts and may require some reclassifications of amounts between accounts.

The disclosure portion of the standard is far more in-depth. The disclosure needs to disaggregate the contributed nonfinancial assets into categories. The categories are not specifically listed, and you may find the qualitative information useful in helping determine how to choose categories.

Each category needs to indicate the dollar amount of the contributed nonfinancial assets.
Each category also needs to indicate if it was monetized (sold for money) or utilized during the reporting period. As part of the monetization, describe any policy the organization has on monetizing certain contributions.
For those categories that were utilized, the programs or activities they were used in must be disclosed per category; this should match up to the functions listed in the statement of functional expense.
In addition, if any of the contributed nonfinancial assets have donor-imposed restrictions, those must be disclosed.
Valuation techniques and valuation inputs used to arrive at the fair value of the contributed nonfinancial assets must be described by category, as well as the principal, or most advantageous, market if the entity is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial assets in that market.

These are significantly more robust disclosures than we have ever had before for contributed nonfinancial assets. One way to show these disclosures is to have a grid format with a column for each type of information necessary; this may be the most efficient way if there are multiple categories of nonfinancial assets.

Let’s go back to the discussion of the principal, or most advantageous, market used to arrive at fair value when the organization is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial asset. This seems far-fetched, but it happens all the time in pharmaceuticals. When the pharmaceutical is donated, the fair value must be recorded. The fair value standards indicate to use the fair value in the principal market, so that is where the most sales happen. That principal market could be the U.S., for example. If there is no principal market, then the most advantageous market to the seller should be used. However, a pharmaceutical company may restrict donated pharmaceuticals to be allowed to be used in only Africa and not in the U.S. This would still require the U.S. market value (principal market) to be used even though the organization could not use the drug in the U.S. That would now need to be disclosed.

Contributed services also seem to have some additional disclosures that have been missed in the past. We know that not all contributed services meet the requirements to be recorded as revenue. However, the standards indicate that the programs and activities the contributed services were used for, and the nature and extent of those contributed services, should be disclosed. This is in addition to any revenue amounts recorded. So, if volunteers do not meet the criteria to have services recorded as revenue, the nature of those services, extent (number of volunteers or hours), and the programs they are used in should still be disclosed.

This standard is required to be retroactively implemented for all periods presented. That means, if comparative financial statements are shown, there will potentially be restatements of line items in the statement of activities for the prior year, and the disclosures must also be comparative. The person assisting in preparing the financial statements may not have all the original records necessary to determine all of this detail, and the organization may need to locate those originals for the prior year as well.

These new changes should result in more transparency across the industry. Users will now be able to see more directly the impact that contributed nonfinancial assets have on the organization and how important they are. The biggest concerns are likely to be collating the information for the prior year’s disclosures in this year of implementation and ensuring that financial contributions, such as investments, are not included incorrectly in the contributed nonfinancial assets line item and disclosures.

Operating as an S corporation may help reduce federal employment taxes for small businesses in the right circumstances. Although S corporations may provide tax advantages over C corporations, there are some potentially costly tax issues that you should assess before making a decision to switch.

Here’s a quick rundown of the most important issues to consider when converting from a C corporation to an S corporation:

Built-in gains tax

Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within 5 years after the corporation becomes an S corporation. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

Passive income

S corporations that were formerly C corporations are subject to a special tax if their passive investment income (such as dividends, interest, rents, royalties and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

LIFO inventories

C corporations that use LIFO inventories have to pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

Unused losses

If your C corporation has unused net operating losses, the losses can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

There are other factors to consider in switching from C to S status. Shareholder-employees of S corporations can’t get the full range of tax-free fringe benefits that are available with a C corporation. And there may be complications for shareholders who have outstanding loans from their qualified plans. All of these factors have to be considered to understand the full effect of converting from C to S status.

There are strategies for eliminating or minimizing some of these tax problems and for avoiding unnecessary pitfalls related to them. But a lot depends upon your company’s particular circumstances. Contact us to discuss the effect of these and other potential problems, along with possible strategies for dealing with them.