5 Ways to Take Action on Accounts Receivable

No matter the size or shape of a business, one really can’t overstate the importance of sound accounts receivable policies and procedures. Without a strong and steady inflow of cash, even the most wildly successful company will likely stumble and could even collapse.

If your collections aren’t as efficient as you’d like, consider these five ways to improve them:

1. Redesign your invoices. It may seem superficial, but the design of invoices really does matter. Customers prefer bills that are aesthetically pleasing and easy to understand. Sloppy or confusing invoices will likely slow down the payment process as customers contact you for clarification rather than simply remit payment. Of course, accuracy is also critical to reducing questions and speeding up payment.

2. Appoint a collections champion. At some companies, there may be several people handling accounts receivable but no one primarily focusing on collections. Giving one employee the ultimate responsibility for resolving past due invoices ensures the “collection buck” stops with someone. If budget allows, you could even hire an accounts receivable specialist to fill this role.

3. Expand your payment options. The more ways customers can pay, the easier it is for them to pay promptly. Although some customers still like traditional payment options such as mailing a check or submitting a credit card number, more and more people now prefer the convenience of mobile payments via a dedicated app or using third-party services such as PayPal, Venmo or Square.

4. Get acquainted (or reacquainted) with your customers. If your business largely engages in B2B transactions, many of your customers may have specific procedures that you must follow to properly format and submit invoices. Review these procedures and be sure your staff is following them carefully to avoid payment delays. Also, consider contacting customers a couple of days before payment is due — especially for large payments — to verify that everything is on track.

5. Generate accounts receivable aging reports. Often, the culprit behind slow collections is a lack of timely, accurate data. Accounts receivable aging reports provide an at-a-glance view of each customer’s current payment status, including their respective outstanding balances. Aging reports typically track the payment status of customers by time periods, such as 0–30 days, 31–60 days, 61–90 days and 91+ days past due.

With easy access to this data, you’ll have a better idea of where to focus your efforts. For example, you can concentrate on collecting the largest receivables that are the furthest past due. Or you can zero in on collecting receivables that are between 31 and 60 days outstanding before they get any further behind.

Need help setting up aging reports or improving the ones you’re currently running? Please let us know — we’d be happy to help with this or any aspect of improving your accounts receivable processes.

Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.

For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.

A trader vs. an investor

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:

The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

Profit in the short term

So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.

Throughout the pandemic, the government has strived to lessen the impact on employers. Through various pieces of legislation, credit and grant programs have emerged. One such relief program, the Employee Retention Credit, provides refundable credits to employers. And thanks to year-end legislation, employers who participated in the Paycheck Protection Program also became eligible to receive the ERC. Read more about how to qualify and claim the credit.

The interaction between various pandemic programs and other factors raises questions about how to account for the credit. Let’s take a closer look at GAAP reporting and considerations for nonprofit organizations.

Accounting for the ERC under US GAAP

Nonprofit entities following US GAAP must account for the credit under ASC Subtopic 958-605 as a nonexchange transaction with a governmental entity that is accounted for as a conditional contribution. Organizations must consider the circumstances as of the period end date. Certain conditions must be met to claim the credit, for example, a decline in gross receipts and incurring qualified payroll and health care costs. When an organization has a PPP loan, eligible expenses cannot be used for both PPP forgiveness and the ERC (in other words, no double-dipping). The same holds for other government grants in which a nonprofit organization participates. Management must carefully allocate specific wages between the programs to ensure expenses are used only once.

If the conditions for eligibility are met as of the period end date, then the credit would be recorded as grant revenue under Subtopic 958-605 and reflected as a refund receivable or reduction of payroll tax liabilities. On the statement of cash flows, the change in refund receivable and/or reduction in payroll tax liabilities would be reflected in cash flows from operating activities. Required disclosures include the accounting method used, significant terms of the credit program, relevant information about the line items and amounts included in the financial statements, and the conditions that have not been substantially met (if applicable).

Subsequent events

Organizations that received the PPP loan were originally not eligible to receive the ERC under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was passed in March 2020. However, the Consolidated Appropriates Act of 2021, which passed in late December 2020, later enabled PPP loan recipients to also claim the ERC. Newly eligible employers can retroactively claim the credit by filing amended Form 941 returns for 2020. Organizations with a 12/31/20 fiscal year-end or later should reflect the subsequently claimed credit as of the financial statement date if the financial statements haven’t been issued yet.

Suppose financial statements were already issued before claiming the refundable credit. In that case, management must assess the facts and circumstances to determine the appropriate way to reflect the change on the next financial statements. The change in prior period information would be considered a change in estimate. If the estimate was made in good faith, then the financial statements can reflect the change on a prospective basis. If the organization missed information readily available to them when the estimate was made, a prior period adjustment would be appropriate.

The fraud triangle was introduced by Donald Cressey in the 1970s. Those who lead nonprofit organizations should understand this model for explaining the factors that cause someone to commit fraud – it’s still relevant today.

An individual must feel pressure, something that makes them feel a financial burden that they can’t share. For example, this could be unexpected medical bills or a gambling problem. The individual must recognize an opportunity to use their position to ease their financial pressure and not get caught. Nobody else is looking or double-checking, and they have access to the organization’s assets. Most people don’t think of themselves as bad people, so they find ways to rationalize or justify their actions. They might tell themselves, “I’m just borrowing it; I’ll pay it back,” or “I work so hard for this organization, they owe me.

Organizations don’t have control over the pressure an employee is facing or whether or not the employee can rationalize their decisions. However, they can reduce the opportunity that employee has by implementing appropriate internal controls.

Contact Yeo & Yeo for help with implementing fraud prevention and detection measures in your nonprofit organization.

The Fraud Triangle

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Bradley DeVries, CPA, CAE, has been promoted to managing principal of the firm’s Lansing office.

DeVries succeeds Mark Perry, CPA, who has served as the managing principal of the Lansing office for more than 18 years, since 2003. While Perry is stepping down as office managing principal, he will remain an active member of the principal group helping to mentor and foster future leadership. He will continue to dedicate his time and expertise in providing audit, accounting and tax services for the firm’s real estate, nonprofit and government clients.

“I am grateful for Mark’s continued dedication to the firm and excited for Brad to lead the Lansing office as managing principal,” said president & CEO Thomas Hollerback. “Brad is a talented professional and a strong leader who is committed to helping Yeo & Yeo’s clients succeed.”

In his new role, DeVries is responsible for the day-to-day operations at Yeo & Yeo’s Lansing office, including office growth, personnel and client care. His expertise spans audit, consulting and tax services for nonprofit organizations, affordable housing agencies, trade associations and real estate entities. He is a member of the firm’s Nonprofit, Audit and Real Estate Services Groups. As a Certified Association Executive, DeVries provides clients with in-depth expertise in nonprofit and association management.

DeVries joined Yeo & Yeo in 2005 and was named principal in 2019. He is a member of the Michigan Society of Association Executives and the Michigan Nonprofit Association. He has authored numerous articles and presented at several conferences, including, most recently, the 2021 Michigan Society of Association Executives’ Operations Conference. He is a graduate of Leadership Lansing.

There’s a harsh tax penalty that you could be at risk for paying personally if you own or manage a business with employees. It’s called the “Trust Fund Recovery Penalty” and it applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages.

Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is aggressive in enforcing the penalty.

Wide-ranging penalty

The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a wide range of people involved in a business.

Here are some answers to questions about the penalty so you can safely avoid it.

What actions are penalized? The Trust Fund Recovery Penalty applies to any willful failure to collect, or truthfully account for, and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation’s officers, directors and shareholders under a duty to collect and pay the tax as well as a partnership’s partners, or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under some circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to pay them but instead make payments to creditors and others, you become a responsible person.

Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken entirely on his or her own after the penalty is paid. It isn’t part of the IRS collection process.

What’s considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due the government is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to take care of the job yourself can be treated as the willful element.

Never borrow from taxes

Under no circumstances should you fail to withhold taxes or “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions about making tax payments.

During the COVID-19 pandemic, school districts received monetary relief from the federal government, but local businesses and communities also helped by donating materials such as personal protective equipment (PPE). How should a school district’s financial records reflect the donated materials received?

Treat the donated PPE similarly to donated commodities. GASB 33 and N50 Nonexchange Transactions in GASB’s Codification of Governmental Accounting and Financial Reporting Standards offer guidance on recording donated materials. The PPE should be recognized as revenue in the school district’s governmental fund statements in the period when all applicable eligibility requirements are met and the resources are available. The school district should record the expenditures following its supplies policy – either as supplies inventory or an expenditure when the revenue is recognized.

The school district should have documentation for how it determined the revenue it recognizes. Maintain records for the quantity of PPE received as accurately as possible – counts performed by the school district or lists provided by the donor are the best documentation to have available. Additionally, the school district should have a basis for valuing the PPE received. If the donor did not provide the value, the school district could use the market prices of similar PPE at the time of donation.

School districts should also maintain records and disclose any donated PPE the donor purchased with federal sources. Disclose the amount of donated federal PPE as a separate footnote in the Schedule of Expenditures of Federal Awards (SEFA) at the fair market value of time of receipt. The amount will not be considered for determining single audit thresholds and is not required to be audited as a major program.

We continue to receive many questions related to accounting for the 2021 school year, and we are here to help you navigate those challenges. Please reach out to your Yeo & Yeo professionals for assistance.

During the past year and a half, many government entities have experienced significant turnover in several positions. Some governments are left scrambling to continue with day-to-day operations while trying to find qualified applicants to fill vacant positions.

Unexpected events and uncertainties about the future make planning for turnover more important than ever, given the changes the pandemic has brought about in the workplace. Governments can take several steps to prepare for turnover and ensure that all duties will be covered during employee vacations, medical leaves, etc. Consider the following measures and create a plan to ensure that your government can continue to run smoothly, no matter what obstacles present themselves.

Accounting procedures are imperative to a well-functioning government. These are considered the “how” when performing accounting functions (cutting checks, processing payroll, etc.). While most government accounting personnel know what their duties are, these day-to-day accounting procedures are often left undocumented in a manual. While it is crucial to have the policies required by state laws approved by the council or board – such as a credit card acceptance policy and electronic transaction policy – it is just as important to document the complete procedures for actually processing transactions. Accounting procedures should be written for each key transaction cycle, typically those include disbursements, receipts, and payroll, to ensure that the day-to-day transactions are being processed and recorded correctly in the event of turnover. Further, it is recommended that these procedures be reviewed and updated frequently to reflect changes in the procedures that result from gaining efficiencies or changes in the software.

Once accounting procedures have been well documented, cross-train employees to ensure that all key transaction cycles are covered in the event of turnover and cover vacations or medical leave. Even during holidays, payroll will still need to be processed and checks cut. Cross-training allows employees to take time off without the government suffering as their duties have been well documented, and other departments have been trained to handle the processing of the transactions.

While cross-training is essential, it is also important to consider segregation of duties when determining which employees will cover which key transaction cycles in the event of vacations, turnover, etc. For example, the signer of the checks should not prepare the checks.

Well-documented accounting procedures and cross-training are very useful tools to ensure that the government’s operations can continue during interruptions such as turnover. However, management and the council or board should also know when to ask for external help. The pandemic has resulted in individuals retiring or taking different positions, which can adversely affect operations at the governments if they were responsible for many duties. Combined with a lack of documented procedures, this can cause the government to get behind on day-to-day transactions and annual audits, which may result in increased monitoring by the state and potentially the withholding of funding. Oversight by management and the council or board is necessary as a lack of timely financial reports can indicate that things are falling behind. Limited consulting services are often available through your audit firm, such as cash to accrual entries for audit preparation, capital asset tracking, etc. Discussion with your external auditor is always a good starting place as they work closely with firms that can assist with the day-to-day processing of transactions without impairing their independence.

Agility — or the ability to react quickly — is essential to surviving and thriving in today’s competitive landscape. Though agile techniques were originally used in the realm of software development, this concept has many applications in the modern business world, including how companies approach their internal audits. Here’s an overview of agile auditing and why many internal audit teams are jumping on the bandwagon.

The basics

Whereas a traditional audit requires extensive planning, fieldwork and reporting, an agile audit moves at a faster pace. An agile audit also allows the audit team to continually refocus their attention and efforts where they’re needed the most.

Agile auditing relies on the following key concepts:

Audit backlogs. The audit team keeps a backlog of reviewed and approved audit programs. As the environment evolves, the audit team can add, remove or reprioritize audit programs within the backlog. This dynamic approach ensures that the audit team focuses on the most pressing issues — and minimizes the likelihood that they’ll waste time on an issue from a previous audit plan that’s no longer relevant.

User stories. Auditors create user stories that are made up of:

A user,
An action, and
An outcome.

Each story corresponds to a unit of work related to the audit. The user is the individual responsible for performing critical tasks related to the story. The action is what the user must do to generate a desired outcome.

For example, a retailer (the user) wants to process credit card payments from customers online (the action), so they can order online (the outcome). Creating a story provides the audit team with an understanding of the user’s requirements and the desired outcome.

Audit sprints. With a story defined, the audit team can deliver their work in sprints. Each sprint is normally completed in one to four weeks. Sprints may include defined tasks and regular check-ins with stakeholders. A sprint has a planning phase and daily “scrums,” which are short meetings with the audit team and stakeholders. Items on the daily agenda include:

Yesterday’s progress,
The game plan for today, and
Potential challenges to completing the sprint.

Each sprint concludes with the delivery of preliminary results to stakeholders. Reviewing the results of each sprint gradually over the course of the audit helps minimize surprises when the final audit report is submitted to stakeholders.

Benefits abound

Agile auditing facilitates more frequent and timelier communications between auditors and stakeholders. This can lead to more robust partnerships and improvements in the accuracy and integrity of audit team’s findings. More frequent communication also allows the audit team and the business to identify and resolve problems quickly.

Contact us for more information. We can help you decide whether you’re ready to transition to a more agile auditing approach and, if so, guide your internal audit team through the implementation process.

As mitigation measures related to COVID-19 ease, it will be interesting to see which practices and regulatory changes taken in response to the pandemic remain in place long-term. One of them might be relief from a sometimes-inconvenient requirement related to the administration of 401(k) plans.

A virtual solution

In IRS Notice 2021-40, the IRS recently announced a 12-month extension of its temporary relief from the requirement that certain signatures be witnessed “in the physical presence” of a 401(k) plan representative or notary public.

The original relief, which appeared in IRS Notice 2020-42, was provided primarily to facilitate plan loans and distributions under the CARES Act. However, the relief could be used during 2020 for any signature that, under regulations, had to be witnessed in the physical presence of a plan representative or notary public. This included required spousal consents. The relief was subsequently extended through June 30, 2021, under IRS Notice 2021-03.

Under the notices, signatures witnessed remotely by a plan representative satisfy the physical presence requirement if the electronic system uses live audio-video technology and meets four requirements established under the original relief:

Live presentation of a photo ID,
Direct interaction,
Same-day transmission, and
Return with the representative’s acknowledgment.

Signatures witnessed by a notary public satisfy the physical presence requirement if the electronic system for remote notarization uses live audio-video technology and is consistent with state-law requirements for a notary public.

Comments requested

As mentioned, IRS Notice 2021-40 further extends the relief — subject to the same conditions — through June 30, 2022. The notice also requests comments regarding whether permanent modifications should be made to the physical presence requirement. Comments are specifically requested regarding:

The costs and other effects of the physical presence requirement and its temporary waiver,
Whether the relief has resulted in fraud, coercion or other abuses,
How the witnessing requirements are expected to be fulfilled as the pandemic abates,
What procedural safeguards should be instituted if the physical presence requirement is permanently modified, and
Whether permanent relief should use different procedures for witnessing by plan representatives or notary publics.

Comments should be submitted by September 30, 2021.

More information

Going forward, the need for a signature may often relate to spousal consents. If your business recently established a 401(k), the plan may be designed to limit or even eliminate the need for spousal consents.

However, plans that offer annuity forms of distribution are still subject to the spousal consent rules. And other 401(k) plans must require spousal consent if a married participant wants to name a nonspouse as primary beneficiary. Feel free to contact our firm for more information on the latest IRS guidance addressing employee benefits.

What is the Advance Child Tax Credit?

The American Rescue Plan Act (ARPA) increased the 2021 child tax credit from $2,000 to $3,000 for qualifying children ages 6 to 17 and $3,600 for qualifying children under age 6. This credit is fully refundable, and the IRS will begin sending automatic payments on July 15 to eligible recipients. The amount of the payments, known as the Advance Child Tax Credit, will be your total estimated 2021 Child Tax Credit divided by 12, which is $250 per month for the $3,000 credit and $300 per month for the $3,600 credit. There will be six monthly payments, and the IRS will send Letter 6419 in January 2022, which will show the total amount of Advance Child Tax Credit payments you received.

The Child Tax Credit begins to be reduced to $2,000 per child if your modified AGI in 2021 exceeds:

$150,000 if married and filing a joint return or if filing as a qualifying widow or widower;
$112,500 if filing as head of household; or
$75,000 if you are a single filer or are married and filing a separate return.

The Child Tax Credit won’t begin to be reduced below $2,000 per child until your modified AGI in 2021 exceeds:

$400,000 if married and filing a joint return; or
$200,000 for all other filing statuses.

What are the tax return implications of the Advance Child Tax Credit?

Like the Stimulus payments issued in 2020 and 2021, the amount of the credits you received will need to be reconciled on your 2021 tax return. The difference, however, is that overpayments of the Advance Child Tax Credit will need to be repaid. The IRS estimate of the credit is based on your 2020 tax return or your 2019 tax return if 2020 has not been filed. If your circumstances have changed for 2021, you can update your information on the IRS website so that they have the most accurate information. Keep in mind that the refund you would typically receive will be reduced by the Advance Child Tax Credit amount you receive. Also, if your normal refund is less than the Advance Child Tax Credit you received, then you could end up owing.

Reasons you may want to opt out of the Advance Child Tax Credit payments

You may want to opt out of the advance payments if your 2021 tax situation varies significantly from your 2020 tax return filing. This could include an increase in income over the thresholds or a decrease in the number of children you will be claiming. For example, divorced parents that alternate who claims a child every other year may want to opt out to avoid a surprise tax bill for the 2021 tax year. You can opt out by going to the IRS website. You can opt out of the program three days before the first Thursday of the month of payment. This means you would have had to opt out by June 28 to avoid the first payment, but you can still opt out of future payments. If you choose to opt out after receiving a few payments, the IRS will still send you Letter 6419 in January to reconcile the credit on your tax return. Your total refund will be reduced by the amount of the payments you received. The IRS will later update the Opt Out Tool to allow taxpayers to update their income estimates and dependent details.

For more information, refer to the IRS’s website pages:

Also refer to Yeo & Yeo’s article, Here Come the Child Tax Credit Payments: What You Need to Know.

The first advance payments under the temporarily expanded child tax credit (CTC) will begin to arrive for nearly 39 million households in mid-July 2021 — unless, that is, they opt out. Most eligible families won’t need to do anything to receive the payments, but you need to understand the implications and why advance payments might not make sense for your household even if you qualify for them.

Understanding the CTC, then and now

The CTC was established in 1997. Unlike a deduction, which reduces taxable income, a credit reduces the amount of taxes you owe on a dollar-for-dollar basis. While some credits are limited by the amount of your tax liability, others, like the CTC, are refundable, which means that even taxpayers with no federal tax liability can benefit. Historically, the CTC has been only partially refundable in that the refundable amount was limited to $1,400.

The American Rescue Plan Act (ARPA) significantly expands the credit, albeit only for 2021. Specifically, the ARPA boosts the CTC from $2,000 to $3,000 per child ages six through 17, with credits of $3,600 for each child under age six. Plus, the CTC is now fully refundable. It also affords taxpayers the opportunity to take advantage of half of the benefit in 2021, rather than waiting until tax time in 2022.

Note, however, that there are limits to eligibility. The $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers, and this continues under the ARPA — for the first $2,000. A separate phaseout applies for the increased amount: $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers.

Receiving advance payments

The ARPA directed the U.S. Treasury Department to begin making monthly payments of half of the credit in July 2021, with the remaining half to be claimed in 2022 on 2021 tax returns. For example, a household that’s eligible for a $3,600 CTC will receive $1,800 ($300 in six monthly payments) in 2021 and would claim the balance of $1,800 on the 2021 return. The payments will be made on the 15th of each month through December 2021, except for August, when they’ll be paid on August 13.

To qualify for advance payments, you (and your spouse, if filing jointly) must have:

Filed a 2019 or 2020 tax return that claims the CTC or provided the IRS with information in 2020 to claim a stimulus payment,
A main home in the United States for more than half of the year or file a joint return with a spouse who has a U.S. home for more than half of the year,
A qualifying child who’s under age 18 at the end of 2021 and who has a valid Social Security number, and
Earned less than the applicable income limit.

If the IRS has your bank information, you’ll receive the payments as direct deposits.

Because the IRS will base the payments on your 2020 tax return (or, if not yet available, your 2019 return), it’s possible that you could receive excess payments over the amount you actually qualify for in 2021. In that case — unlike excess stimulus payments — you’ll be required to repay the excess. The IRS will either deduct the amount from your 2021 refund or add it to the amount you owe.

Opting out

The IRS will automatically enroll taxpayers for advance payments, but it’s also providing an online portal at irs.gov where taxpayers can opt out. You might consider opting out if, for example, you were near the income limits in 2019 or 2020, expect to earn more in 2021, and want to avoid excess payments. Be aware that couples filing jointly must both opt out, otherwise the spouse who doesn’t will receive half of the joint payment.

It’s not only a change in expected income that could lead to excess payments; it’s also a change in the number of dependents. For example, divorced couples who share joint custody may alternate the years in which they claim their children as dependents for CTC purposes. If 2021 is your former spouse’s year, consider opting out (your former spouse won’t receive the advance payments based on his or her 2020 tax return but, if eligible, can claim the credit on the 2021 return). Parents of children who will turn age 18 in 2021 also should consider opting out.

The deadline to opt out of the first payment was June 28, 2021, but you can still opt out for future payments.

Estimating — and reducing — 2021 income

When deciding whether to opt out, you can estimate your 2021 income using multiple methods. You could simply look at your modified adjusted gross income on your most recent tax return. You also could project your income for the year and reduce it by the standard deduction (for 2021, it’s $12,550 for individual taxpayers and $25,100 for married couples filing jointly).

If you estimate that your income will be near the eligibility threshold but want to receive the advance payments, you can take measures to reduce your income before year end. You might, for example, increase your 401(k) plan contributions (the contribution limit for 2021 is $19,500). Taxpayers with high deductible health plans and health savings accounts (HSAs) can similarly reduce their income with contributions. The HSA contribution limits for 2021 are $3,600 for individual health plans and $7,200 for family health plans.

Beyond 2021

The expanded CTC is available only for 2021 as of now. President Biden has indicated that he’d like to extend it through at least 2025, and some Democratic lawmakers hope to make it permanent. But it’ll be challenging to pass a bill to make either of these proposals happen. We’ll keep you informed about any developments that could affect your tax planning.

Read our additional CTC resources:

The IRS just released its audit statistics for the 2020 fiscal year and fewer taxpayers had their returns examined as compared with prior years. But even though a small percentage of returns are being chosen for audit these days, that will be little consolation if yours is one of them.

Latest statistics

Overall, just 0.5% of individual tax returns were audited in 2020. However, as in the past, those with higher incomes were audited at higher rates. For example, in 2020, 2.2% of taxpayers with adjusted gross incomes (AGIs) of between $1 million and $5 million were audited. Among the richest taxpayers, those with AGIs of $10 million and more, 7% of returns were audited in 2020.

These are among the lowest percentages of audits conducted in recent years. However, the Biden administration has announced it would like to raise revenue by increasing tax compliance and enforcement. In other words, audits may be on the rise in the coming years.

Prepare in advance

Even though fewer audits were performed in 2020, the IRS will still examine thousands of returns this year. With proper planning, you may fare well even if you’re one of the unlucky ones.

The easiest way to survive an IRS examination is to prepare in advance. On a regular basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items reported on your tax returns.

It’s possible you didn’t do anything wrong. Just because a return is selected for an audit doesn’t mean that an error was made. Some returns are randomly selected based on statistical formulas. For example, IRS computers compare income and deductions on returns with what other taxpayers report. If an individual deducts a charitable contribution that’s significantly higher than what others with similar incomes report, the IRS may want to know why.

Returns can also be selected if they involve issues or transactions with other taxpayers who were previously selected for audit, such as business partners or investors.

The government generally has three years within which to conduct an audit, and often the exam won’t begin until a year or more after you file your return.

Complex vs. simple returns

The scope of an audit depends on the tax return’s complexity. A return reflecting business or real estate income and expenses will obviously take longer to examine than a return with only salary income.

An audit may be conducted by mail or through an in-person interview and review of records. The interview may be conducted at an IRS office or may be a “field audit” at the taxpayer’s home, business, or accountant’s office.

Important: Even if you’re chosen for an audit, an IRS examination may be nothing to lose sleep over. In many cases, the IRS asks for proof of certain items and routinely “closes” the audit after the documentation is presented.

Don’t go it alone

It’s advisable to have a tax professional represent you at an audit. A tax pro knows the issues that the IRS is likely to scrutinize and can prepare accordingly. In addition, a professional knows that in many instances IRS auditors will take a position (for example, to disallow certain deductions) even though courts and other guidance have expressed contrary opinions on the issues. Because pros can point to the proper authority, the IRS may be forced to concede on certain issues.

If you receive an IRS audit letter or simply want to improve your record-keeping, we’re here to help. Contact us to discuss this or any other aspect of your taxes.

Are you eligible to take the deduction for qualified business income (QBI)? Here are 10 facts about this valuable tax break, referred to as the pass-through deduction, QBI deduction or Section 199A deduction.

It’s available to owners of sole proprietorships, single-member limited liability companies (LLCs), partnerships and S corporations. It may also be claimed by trusts and estates.
The deduction is intended to reduce the tax rate on QBI to a rate that’s closer to the corporate tax rate.
It’s taken “below the line.” That means it reduces your taxable income but not your adjusted gross income. But it’s available regardless of whether you itemize deductions or take the standard deduction.
The deduction has two components: 20% of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate; and 20% of the taxpayer’s combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.
QBI is the net amount of a taxpayer’s qualified items of income, gain, deduction and loss relating to any qualified trade or business. Items of income, gain, deduction and loss are qualified to the extent they’re effectively connected with the conduct of a trade or business in the U.S. and included in computing taxable income.
QBI doesn’t necessarily equal the net profit or loss from a business, even if it’s a qualified trade or business. In addition to the profit or loss from Schedule C, QBI must be adjusted by certain other gain or deduction items related to the business.
A qualified trade or business is any trade or business other than a specified service trade or business (SSTB). But an SSTB is treated as a qualified trade or business for taxpayers whose taxable income is under a threshold amount.
SSTBs include health, law, accounting, actuarial science, certain performing arts, consulting, athletics, financial services, brokerage services, investment, trading, dealing securities and any trade or business where the principal asset is the reputation or skill of its employees or owners.
There are limits based on W-2 wages. Inflation-adjusted threshold amounts also apply for purposes of applying the SSTB rules. For tax years beginning in 2021, the threshold amounts are $164,900 for singles and heads of household; $164,925 for married filing separately; and $329,800 for married filing jointly. The limits phase in over a $50,000 range ($100,000 for a joint return). This means that the deduction reduces ratably, so that by the time you reach the top of the range ($214,900 for singles and heads of household; $214,925 for married filing separately; and $429,800 for married filing jointly) the deduction is zero for income from an SSTB.
For businesses conducted as a partnership or S corporation, the pass-through deduction is calculated at the partner or shareholder level.

As you can see, this substantial deduction is complex, especially if your taxable income exceeds the thresholds discussed above. Other rules apply. Contact us if you have questions about your situation.

Public Act 3 of 2021 (HB 4048), signed by the Governor on March 9, 2021, released 43.6% of ESSER II Formula funds, approved a portion of ESSER II and GEER II Discretionary funds, and appropriated State Aid funds for other programs.

Districts have had questions regarding the timing of the grant approval (award notification) of the 43.6% of ESSER II Formula funds; however, these funds have been approved in the last two weeks, and your district should have received its Grant Award Notification (GAN).

A couple of items to watch:

The award date: If you received your GAN, you can record this revenue in fiscal year 2021. (The GAN must be dated June 30 or before to be recorded in FY 2021).
The award amount: Some districts applied for more than 43.6% of funds. Before approval, the Department of Education corrected the amount to be at or below 43.6%.
New allowable costs opened up: The 43.6% of ESSER II Formula funds [Section 11r (2)] has increased from 12 to 15 allowable areas. Among the expanded allowable uses are, “purchases of educational technology (including hardware, software, connectivity, assistive technology, and adaptive equipment) for students that aids in regular and substantive educational interaction between students and their classroom instructors, including students from low-income families and children with disabilities.”

The most recent accounting guidance from the Michigan Department of Education can be found on MDE’s website.

Contact your Yeo & Yeo professional if you need assistance.

Many types of businesses — such as homebuilders and manufacturers — turn raw materials into finished products for customers. Production is a continuous process. So, any work that’s been started but isn’t yet completed before the end of the accounting period is reported as work in progress (WIP) under U.S. Generally Accepted Accounting Principles (GAAP).

The value of WIP relies on management’s estimates. Auditors often give special attention to these estimates during fieldwork. Here’s what to expect during a financial statement audit.

Inventory 101

Inventory is classified as a current asset on the balance sheet under GAAP. There are three types of inventory:

1. Raw materials. These are tangible inputs that have been received from suppliers but haven’t yet been worked with. For example, a construction firm may have a supply of lumber and drywall in a warehouse that counts as raw materials.

2. Work in progress. This term refers to partially finished products at various stages of completion. Items classified as WIP still require further work, processing, assembly and/or inspection. It includes raw materials, labor and overhead allocations.

3. Finished goods. These items are fully complete. They may be ready for customers to purchase or, in the case of custom products, available for delivery or title transfer to customers.

Standard vs. job costing

When a company produces large volumes of the same product, management allocates costs as each phase of the production process is completed. This is known as standard costing. For example, if a production process involves eight steps, the company might allocate 50% of its costs to the product once the fourth stage is completed.

On the other hand, when a company produces unique products — such as the construction of a factory or made-to-order parts — a job costing system is typically used to allocate materials, labor and overhead costs as incurred.

Most experienced managers use realistic estimates, but inexperienced or dishonest managers may inflate WIP values. This can make a company appear healthier than it really is by overstating the value of inventory at the end of the period and understating cost of goods sold during the current accounting period.

Eye on WIP

Auditors focus significant effort on analyzing how companies quantify and allocate their costs. Under standard costing, companies typically record inventory (including WIP) at cost, and then recognize revenue once they sell finished goods. The WIP balance grows based on the number of steps completed in the production process. Auditors analyze the methods used to quantify a product’s standard costs, as well as how the company allocates the costs corresponding to each phase of production.

Conversely, with job costing, revenue recognition happens based on the percentage-of-completion or completed-contract method. Auditors analyze the process to allocate materials, labor and overhead to each job. In particular, they test to ensure that costs assigned to a particular product or project correspond to that job.

Get it right

Under both methods, accounting for WIP affects the balance sheet and the income statement. We can help determine whether your company’s WIP estimates are reasonable and whether your accounting practices comply with the recent changes to the revenue recognition rules for long-term contracts, if applicable. Contact us for more information.

The Employee Retention Tax Credit (ERTC) is a valuable tax break that was extended and modified by the American Rescue Plan Act (ARPA), enacted in March of 2021. Here’s a rundown of the rules.

Background

Back in March of 2020, Congress originally enacted the ERTC in the CARES Act to encourage employers to hire and retain employees during the pandemic. At that time, the ERTC applied to wages paid after March 12, 2020, and before January 1, 2021. However, Congress later modified and extended the ERTC to apply to wages paid before July 1, 2021.

The ARPA again extended and modified the ERTC to apply to wages paid after June 30, 2021, and before January 1, 2022. Thus, an eligible employer can claim the refundable ERTC against “applicable employment taxes” equal to 70% of the qualified wages it pays to employees in the third and fourth quarters of 2021. Except as discussed below, qualified wages are generally limited to $10,000 per employee per 2021 calendar quarter. Thus, the maximum ERTC amount available is generally $7,000 per employee per calendar quarter or $28,000 per employee in 2021.

For purposes of the ERTC, a qualified employer is eligible if it experiences a significant decline in gross receipts or a full or partial suspension of business due to a government order. Employers with up to 500 full-time employees can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as explained below, employers with more than 500 full-time employees can only claim the ERTC with respect to employees that don’t perform services.

Employers who got a Payroll Protection Program loan in 2020 can still claim the ERTC. But the same wages can’t be used both for seeking loan forgiveness or satisfying conditions of other COVID relief programs (such as the Restaurant Revitalization Fund program) in calculating the ERTC.

Modifications

Beginning in the third quarter of 2021, the following modifications apply to the ERTC:

Applicable employment taxes are the Medicare hospital taxes (1.45% of the wages) and the Railroad Retirement payroll tax that’s attributable to the Medicare hospital tax rate. For the first and second quarters of 2021, “applicable employment taxes” were defined as the employer’s share of Social Security or FICA tax (6.2% of the wages) and the Railroad Retirement Tax Act payroll tax that was attributable to the Social Security tax rate.
Recovery startup businesses are qualified employers. These are generally defined as businesses that began operating after February 15, 2020, and that meet certain gross receipts requirements. These recovery startup businesses will be eligible for an increased maximum credit of $50,000 per quarter, even if they haven’t experienced a significant decline in gross receipts or been subject to a full or partial suspension under a government order.
A “severely financially distressed” employer that has suffered a decline in quarterly gross receipts of 90% or more compared to the same quarter in 2019 can treat wages (up to $10,000) paid during those quarters as qualified wages. This allows an employer with over 500 employees under severe financial distress to treat those wages as qualified wages whether or not employees actually provide services.
The statute of limitations for assessments relating to the ERTC won’t expire until five years after the date the original return claiming the credit is filed (or treated as filed).

Among the only certainties of business technology is that it will continue changing. One consequence of this is a regular need for companies to undertake IT projects such as developing custom software or upgrading network infrastructure.

Much like a physical construction job, IT projects often look eminently feasible on “paper” but may get bogged down in a gradual expansion of parameters (“scope creep”), missed deadlines and disagreements. As a result, more and more resources are consumed, and the budget is eventually blown.

One potential solution to keeping IT projects on schedule and within budget is to follow an approach called the critical path method (CPM).

The basic concept

CPM is a scheduling technique used to calculate a project’s duration and illustrate how schedules are affected when certain variables change. It identifies the “critical path,” which is the most efficient sequence of scheduled activities that determines when a project can be completed. Any delay in the critical path slows down the job.

In many cases, some tasks won’t affect other activities and can be pushed back without pushing out the planned completion date. Other tasks can be performed in parallel with the primary steps. However, each task that lies on the critical path must be completed before any later tasks can begin.

Visualizing success

CPM breaks an IT project into several manageable activities and displays them in a flow or Gantt chart showing the “activity sequence” (the order in which tasks must be performed). It then calculates the project timeline based on the estimated duration of each task.

For smaller projects, this can be done on a virtual or physical whiteboard. The project manager draws a diagram with circles that represent activities/time durations and — where one activity cannot begin until another is completed — connecting those circles with arrows to show the necessary order of primary job tasks. The completed diagram will reveal arrow paths indicating activity sequences and how long it will take to complete them.

Helpful software

For larger, more complex IT projects that may have multiple critical paths and overlapping, interconnected activities, creating charts by hand can be time consuming and difficult. CPM software makes the process faster, easier and less prone to human error. When things are constantly changing — particularly at the beginning or end of a project — these applications allow far easier updating of the analysis and production of new charts.

Plan and execute

CPM isn’t a silver bullet for every slow-moving, budget-busting IT project. But it’s helped many companies plan and execute technology initiatives. We can help you identify the costs of — and establish reasonable budgets for — any IT projects you’re considering.

Married couples may not be able to save as much as they need for retirement when one spouse doesn’t work outside the home — perhaps so that spouse can take care of children or elderly parents. In general, an IRA contribution is allowed only if a taxpayer earns compensation. However, there’s an exception involving a “spousal” IRA. It allows contributions to be made for nonworking spouses.

For 2021, the amount that an eligible married couple can contribute to an IRA for a nonworking spouse is $6,000, which is the same limit that applies for the working spouse.

IRA advantages

As you may know, IRAs offer two types of advantages for taxpayers who make contributions to them.

Contributions of up to $6,000 a year to an IRA may be tax deductible.
The earnings on funds within the IRA are not taxed until withdrawn. (Alternatively, you may make contributions to a Roth IRA. There’s no deduction for Roth IRA contributions, but, if certain requirements are met, distributions are tax-free.)

As long as the couple together has at least $12,000 of earned income, $6,000 can be contributed to an IRA for each, for a total of $12,000. (The contributions for both spouses can be made to either a regular IRA or a Roth IRA, or split between them, as long as the combined contributions don’t exceed the $12,000 limit.)

Boost contributions if 50 or older

In addition, individuals who are age 50 or older can make “catch-up” contributions to an IRA or Roth IRA in the amount of $1,000. Therefore, for 2021, for a taxpayer and his or her spouse, both of whom will have reached age 50 by the end of the year, the combined limit of the deductible contributions to an IRA for each spouse is $7,000, for a combined deductible limit of $14,000.

There’s one catch, however. If, in 2021, the working spouse is an active participant in either of several types of retirement plans, a deductible contribution of up to $6,000 (or $7,000 for a spouse who will be 50 by the end of the year) can be made to the IRA of the nonparticipant spouse only if the couple’s AGI doesn’t exceed $125,000. This limit is phased out for AGI between $198,000 and $208,000.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Ali Barnes, CPA, has achieved the Certified Government Financial Manager (CGFM) credential, awarded by the Association of Government Accountants (AGA).

“The CGFM credential is considered the mark of excellence in financial management for federal, state and local government,” said Jamie Rivette, CPA, CGFM, Principal and Government Services Group leader. “Ali’s achievement demonstrates our professionals’ commitment to expanding our level of expertise and providing audit, accounting and consulting services for Michigan governmental entities.”

The CGFM credential exemplifies competency in governmental accounting, auditing, financial reporting, internal controls and budgeting. It recognizes the specialized knowledge and experience required to be an effective government financial manager.

Barnes is the managing principal of Yeo & Yeo’s Alma office and provides audit services, with an emphasis on government entities, schools, nonprofit organizations and employee retirement benefit plans. She joined Yeo & Yeo in 2007 and is a member of the firm’s Audit Services Group, Pension Services Group and Government Services Group.

In the community, Barnes serves on the board of directors and finance committee for the Gratiot County Community Foundation. She is also board treasurer for the Alma Police Athletic League and serves on the finance committee for Girls on the Run.