July 2016

Execution: Sharing Your Succession Plan – Phase II

Posted on July 20, 2016 by Debra Barcuch

Warning. The execution phase of succession planning requires singleness of purpose. Within the first 90 days of succession planning, you will likely find issues and gaps with your plan or personal retirement plan — items that need tending. Don’t let these issues become a distraction to your ultimate goal of developing a clear and actionable succession plan! To stay focused during this phase, use the following questions to keep your plan on track.

Who will help you execute and monitor the plan?
What are the gaps and issues?
How can you prioritize fixing the gaps and issues?
What if all doesn’t go as planned?

Maintaining Deadlines

Succession planning for small businesses can be accomplished within 210 days if you don’t let these issues become a hindrance. But often, business owners feel that they have to have every detail figured out before they can execute. Not so. For example, you may have:

Wills that need updating based upon new tax laws
Missing non-compete agreements with some of your key management
A woefully inadequate disability policy based on the level of income needed
Your personal investment portfolio performing below average (e.g. 1 percent rate of return when it needs to be at least 5 percent)
Legal entity structure changes needed to pay less tax upon sale
Unaddressed estate tax problems

Rather than diving into one rabbit hole after another to tackle each of these somewhat complex issues, document each one and prepare a to-do list. In the check-in meeting with your advisors, share the list and prioritize it. This process will help you move along the path of creating a well-written succession plan while scheduling the action items that will support smart execution of your plan down the road.

Now it’s time to meet with your advisors, which can include your lawyer, CPA, financial advisor, board and/or board of advisors and leadership team. Give them an outline of your progress over the past 90 days, your discoveries and expected next steps. It is important to discuss the following in this meeting:

Plan A and Plan B – Plan A is your preferred scenario for transitioning out of the business. However, things can change in year one, three or five…requiring a back-up plan. Discuss your preferences and potential changes that could require shifting from Plan A to Plan B. This will keep you on the same page with your advisors and help you prepare logically and emotionally for that shift if necessary.
Your list of gaps, issues and problems for Plan A — let your advisors weigh in on these and other issues they foresee.
Your list of gaps, issues and problems for Plan B — again, gather advisor feedback and any additional foreseeable issues that may be different than in Plan A.

Do not let the blind spots or additional issues brought up in this meeting distract you from the ultimate goal of creating a plan. Obstacles can be overcome in most scenarios by taking them one step at a time. Right now, you are simply gathering feedback and advice. Don’t give up even if the issues seem insurmountable. Stay in control of the process.

Name a Quarterback

When I say that business owners should stay in control of execution, I mean that owners are the ultimate decision makers in the transition of their businesses. However, that doesn’t mean trying to handle every detail. You are still trying to run a business! Instead, place a chief advisor in charge of facilitating discussion and outlining next steps. This advisor can be accountable for research, scheduling the next check-in meeting and coordinating feedback from other advisors.

Some business owners prefer their CPA in this role (like a succession planning quarterback) while others choose their attorney or financial advisor. Just make sure it’s a trusted relationship that you believe will keep things moving forward in a timely way and bring about the best results. By choosing a quarterback, you can avoid your own blind spots in the planning process as well as soften the emotional impact of certain decisions.

For example, many small business owners avoid setting up an emergency management plan. This plan provides a designated leader or leaders to operate the business in the event of an owner’s incapacitation. Because buy/sell agreements are only engaged if the owner dies, an emergency management plan fills that gap if the authorized person is in a coma or otherwise disabled. Designated leaders are given limited legal power to make financial or other important business decisions and operate the business on behalf of stakeholders such as family members. You can even include incentives for key people to stay and see the business through a set time period until transition or succession decisions can be made.

Now that you have organized your advisory team (including your quarterback), determined your Plan A and Plan B and received feedback on gaps and issues, it’s time to assemble all the documents and create a timetable and strategy around communication with family and key employees/managers.

Continue reading for the last phase in Succession Planning: Phase III – Communication: Establishing Timing and Deliverables for Your Succession Plan

For more information on guiding your small business through succession planning, talk to the tax team at Cornwell Jackson.

Gary Jackson, CPA, is the lead tax partner in Cornwell Jackson’s business succession practice as has led or assisted in hundreds of succession and sales transactions. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services such as succession planning to management teams and business leaders across North Texas.

Cybersecurity Awareness Month: Protect Valuable Assets

Posted on July 19, 2016July 23, 2024 by Debra Barcuch

cybersecurity

Our world is more interconnected than ever before. The Internet has become an integral part of everyone’s business and personal lives. But along with Web-based opportunities come risks of breaches and associated losses. The U.S. Department of Homeland Security has launched a series of education seminars this October as part of National Cybersecurity Awareness Month. The goals are to raise awareness about cybersecurity and to increase the U.S. resiliency against the threat of a cyber incident. Here, we reveal findings from two recent studies that underscore the importance of protecting your business against data breaches.

Sobering Statistics

The second-quarter 2015 Duke University / CFO Magazine Global Business Outlook survey revealed that approximately four out of five U.S. companies had experienced at least one serious outside hacking attempt to steal, make public or change important data in the last year. Breach rates were even higher among European companies (92%) and those with fewer than 1,000 employees (85%). In the third-quarter 2015 Global Business Outlook survey, data security once again made the list of top 10 CFO concerns.

A recent claims study by NetDiligence, a cyber risk assessment and data breach services provider for the insurance industry, reports that the average cost of a cyber breach in 2015 was nearly $674,000. But the NetDiligence dataset includes some claims that haven’t yet been paid, and it estimates that the average cost could rise to $1.1 million, assuming self-insured retentions are met.

Most of these claims involved losses of records containing personal identifiable information (45%), followed by payment card information (27%) and personal health care information (14%). Nearly a third of the incidents involved hackers. The health care and financial services industries accounted for the most claims (21% and 17%, respectively). But the largest claim overall occurred in the retail industry.

Preventive Measures

What steps has your company taken to minimize data breach risks? The first step in any cybersecurity plan is identifying your “crown jewels,” the data that’s most valuable to your organization. Depending on your industry, that might be trade secrets, financial data or customer data, for example. Focus most of your attention on making these assets more secure. Doing so requires an understanding of who has access to your most valuable intellectual property assets, including employees and third-party vendors.

Protecting against cyber threats is an ongoing chore that requires buy-in from everyone in your organization. The most common data security technique reported by CFOs in the Global Business Outlook survey was installing new software (64% of respondents). In addition, approximately one-third of respondents plan to train employees about breach prevention, install updated IT hardware or hire a data security firm to review their protocols.

Other ways to beef up your company’s cybersecurity measures include:

Installing the latest software, hardware or application updates on every device as soon as they’re released by the manufacturer. Doing so can help thwart hackers who troll for patches and updates to exploit the latest system vulnerabilities. Nimble hackers can then use these vulnerabilities to steal data before businesses have a chance to install the fix.
Limiting the number of devices connected to the Internet and minimize off-site risks. For example, consider limiting which employees can work from home. It’s also important to educate employees about the risks of cyber breaches and to install encryption software on devices that link to external networks. Employees who take devices out of the office expose your company’s data to less-than-secure home networks and public hotspots that provide wireless Internet access.
Fortifying your defenses against losses from breaches with cyber liability insurance. Professional and general business liability insurance policies generally don’t cover losses related to a hacking incident. Cyber liability insurance can cover a variety of risks, depending on the scope of the policy. It typically protects against liability or losses that come from unauthorized access to your company’s electronic data and software.

Instead of purchasing a standalone cyber liability policy, you can add a cyber liability endorsement to your errors and omissions policy. Not surprisingly, the coverage through the endorsement isn’t as extensive as the coverage in a standalone policy.

Business owners and managers should carefully read their policies to understand what types of incidents are specifically excluded from coverage. And, remember, no type of cyber liability insurance is a suitable replacement for sound cybersecurity policies and procedures. Other well-resourced preventive measures can also reduce your premiums for cyber insurance.

Year-End Planning

National Cybersecurity Awareness Month is a perfect time to launch an educational program for your employees about these risks and preventive measures. If you’re unsure where to start, forensic accountants are familiar with ways to identify and reduce costly cyber breach risks. Giving some extra attention to cybersecurity before year end will help your business start off 2016 on the right foot.

New IRS Guidance for Designated Roth Accounts

Posted on July 18, 2016 by Debra Barcuch

Roth IRA Accounts

Does your employer offer a 401(k), 403(b) or governmental 457 plan? If so, you may be able to set up a designated Roth account through your company’s plan. Then your Roth account will be allowed to receive designated Roth contributions that are taken out of your salary through so-called “salary-reduction contributions.” Here’s more on how this strategy works, why it may be advantageous for certain taxpayers and how new IRS regulations add greater flexibility to allocating distributed after- and pre-tax amounts.

Designated Roth Account Basics

Unlike regular salary-reduction contributions, designated Roth contributions don’t reduce your taxable salary. Instead, the tax advantage comes later when you are allowed to take distributions from your designated Roth account without owing any federal income tax. These tax-free amounts are referred to as qualified distributions.

The catches to receiving tax-free qualified distributions are twofold: First, the Roth account must have been open for more than five years. Second, you must have reached age 59½ or become disabled before taking distributions from your Roth account.

The five-year period is deemed to begin on the first day of the year in which you make your first designated Roth account contribution. For example, if you made your first contribution anytime in 2014, the five-year period is deemed to have started on January 1, 2014. In this scenario, you can receive tax-free qualified distributions anytime after December 31, 2018, as long as you’re at least 59½ or disabled. If you die, your heirs can receive tax-free qualified distributions as long as the five-year requirement has been met.

Important note: Setting up a Roth account makes the most sense if you believe you’ll pay the same or higher tax rates during your retirement years.

Treatment of Designated Roth Account Distributions

At some point, you may want to direct designated Roth account distributions to multiple destinations — say, to one or more taxable accounts and one or more tax-favored accounts — using tax-free rollovers. These transactions can be executed using the 60-day rollover rule or via direct rollovers where money is transferred directly between accounts. Favorable IRS rules generally allow you to allocate after-tax (tax-free) amounts from nondeductible contributions and pretax (taxable) amounts from deductible contributions and account earnings to the various destinations to achieve the best tax results.

The IRS recently issued an amended final regulation to eliminate a previous requirement affecting some Roth account transactions. That requirement mandated that a disbursement from a designated Roth account that was directly rolled over into a Roth IRA or another designated Roth account be treated as a separate distribution from any amount simultaneously paid directly to the account owner (you). When such mandatory separate distribution treatment applied, the pretax and after-tax amounts included in the designated Roth account disbursement had to be allocated pro rata to each separate distribution.

The following example illustrates how the now-eliminated rule that required distributions from designated Roth accounts to be treated separately could lead to unfavorable tax results.

Example 1: Old rule for designated Roth account distributions. A 50-year-old woman owns a Roth IRA. She also has a $50,000 balance in a designated Roth account set up through her employer’s 401(k) plan. The designated Roth account balance consists of $30,000 of after-tax dollars (from nondeductible contributions to the account) and $20,000 of pretax dollars (from account earnings). Therefore, 60% of the account balance ($30,000/$50,000) is after-tax money and 40% ($20,000/$50,000) is pretax money.

The woman quits her job and arranges for a $50,000 disbursement to close out the designated Roth account. This is not a qualified designated Roth account distribution, because she’s not age 59½, disabled or dead. So, if she puts the entire $50,000 into a taxable account with a bank or brokerage firm (or straight into her pocket), the woman will owe federal income tax on the $20,000. She’ll probably owe the dreaded 10% early distribution penalty on the $20,000 and any applicable state income taxes, too.

What if, instead, she chose to put $30,000 of the $50,000 into a taxable account (or her pocket) and rolled over the remaining $20,000 into a Roth IRA using a direct transfer? Under the old separate distribution rule, the woman was required to treat the $30,000 that she didn’t roll over as consisting of $18,000 of after-tax money (60%) and $12,000 of pretax money (40%). Similarly, the $20,000 that she directly rolled over into her Roth IRA was deemed to consist of $12,000 of after-tax money (60%) and $8,000 of pretax money (40%).

As you can see, the unfavorable separate distribution rule would have resulted in the woman owing taxes on the $12,000 of pretax money that’s deemed to have gone into her taxable account (or pocket). She also might have owed the 10% penalty tax and state income tax on the $12,000.

New IRS Guidance on Designated Roth Account Distributions

Fortunately, under a recently amended IRS regulation, separate distribution treatment is no longer required when part of a disbursement from a designated Roth account is directly rolled over tax-free into one or more eligible retirement accounts and part is sent to the account owner.

Now, you can follow the taxpayer-friendly rules to allocate after-tax and pretax amounts between the destinations to achieve the best tax results. The following example illustrates how the new guidance adds greater flexibility to allocating distributed after- and pretax amounts.

Example 2: New, more flexible rule for designated Roth distributions. Now that the separate distribution rule no longer applies, the woman in the previous example has a more tax-favorable option for allocating her distributions. Pursuant to IRS Notice 2014-54, she can treat the $30,000 that was transferred into the taxable account (or her pocket) as consisting entirely of after-tax (tax-free) dollars, and she can treat the $20,000 that was directly rolled over into her Roth IRA as consisting entirely of pretax dollars.

Under the new guidance, she would owe no federal income tax on the designated Roth account disbursement and no 10% early-distribution penalty or state income taxes. In addition, she’ll be eligible to take the $20,000 out of her Roth IRA through tax-free qualified Roth distributions once she reaches age 59½ (or becomes disabled).

Effective Date

The amended final regulation applies to distributions from designated Roth accounts that are made on or after January 1, 2016. However, you can also elect to follow the favorable amended final regulation for distributions that were made on or after September 18, 2014, and before January 1, 2016. For more information about how the new guidance applies to your Roth accounts, contact your tax adviser.

IRA Charitable Donations: An Alternative to Taxable Required Distributions

Posted on July 15, 2016 by Debra Barcuch

QCD

You can make cash donations to IRS-approved charities out of your IRA using so-called “qualified charitable distributions” (QCDs). This strategy may be advantageous for high-net-worth individuals who have reached age 70 1/2. It expired at the end of 2014, but QCDs were made permanent for 2015 and beyond under the Protecting Americans from Tax Hikes (PATH) Act of 2015.

To take maximum advantage of this strategy for 2016, you’ll need to replace some or all of this year’s IRA required minimum distributions (RMDs) with tax-advantaged QCDs. Here are more details.

QCD Basics

QCDs can be taken out of traditional IRAs, and they’re exempt from federal income taxes. In contrast, other traditional IRA distributions are taxable (either wholly or partially depending on whether you’ve made any nondeductible contributions over the years).

Unlike regular charitable donations, QCDs can’t be claimed as itemized deductions. That’s OK, because the tax-free treatment of QCDs equates to a 100% deduction — because you’ll never be taxed on those amounts. Additionally, you don’t have to worry about any of the restrictions that apply to itemized charitable write-offs under the federal tax code.

A QCD must meet the following requirements:

It must be distributed from an IRA.
The distribution can’t occur before the IRA owner or beneficiary reaches age 70 1/2.
It must meet the IRS requirements for a 100% deductible charitable donation. If you receive any benefits that would be subtracted from a donation under the regular charitable deduction rules — such as free tickets to an event — the distribution can’t be a QCD. This is an important pitfall to watch out for.
It must be a distribution that would otherwise be taxable. A distribution from a Roth IRA can meet this requirement if it’s not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs is generally not advisable for reasons explained later.

Important note: You can also use the QCD strategy on an IRA inherited from the deceased original account owner if you’ve reached age 70 1/2.

Annual Limit

There’s a $100,000 limit on total QCDs for any one year. But if you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit, for a combined total of $200,000.

Tax-Saving Advantages

QCDs offer several potential tax-saving advantages:

They’re not included in your adjusted gross income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based rules. For example, a higher AGI can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible and more of your investment income to be hit with the 3.8% net investment income tax. QCDs are also exempt from the rule that says your itemized charitable write-offs can’t exceed 50% of your AGI. (Any itemized charitable deductions that are donations disallowed by the 50%-of-AGI limitation can be carried forward for up to five years.)
They qualify as RMDs if they’re taken from traditional IRAs. So, you can arrange to donate all or part of your 2016 RMDs (up to the $100,000 limit) that you would otherwise be forced to receive before year end and pay taxes on.
They reduce your taxable estate, though this is less of an issue for most folks now that the federal estate tax exemption has been permanently increased. (The inflation-adjusted exemption for 2016 is $5.45 million.)

In addition, suppose you’ve made nondeductible contributions to one or more of your traditional IRAs over the years. If so, your IRA balances consist of a taxable layer (from deductible contributions and account earnings) and a nontaxable layer (from those nondeductible contributions). QCDs are treated as coming first from the taxable layer. Any nontaxable amounts remain in your accounts. In subsequent tax years, those nontaxable amounts can be withdrawn tax-free by you or your heirs.

QCDs from Roth IRAs

Should you make QCDs from Roth IRAs? Generally, the answer is no. That’s because you (and your heirs) can withdraw funds from a Roth IRA without owing federal income taxes. The catch is that at least one of your Roth accounts must have been open for five years or more.

Also, for original account owners (as opposed to account beneficiaries), Roth IRAs aren’t subject to the RMD rules until after you die. The bottom line: It’s generally best to leave your Roth balances untouched rather than taking money out for QCDs, because the tax rules for Roth IRAs are so favorable.

Plan Ahead

The QCD strategy can be a smart tax move for high-net-worth individuals over 70 1/2 years old. If you’re interested in this opportunity, don’t wait until year end to act. Summer is time for mid-year tax planning, including arranging with your IRA trustee or custodian for QCDs to replace your 2016 RMDs.

Could QCDs Work for You?

High-net-worth senior citizens who can afford to donate money from their retirement accounts may benefit tax-wise from taking qualified charitable distributions (QCDs) if they match at least one of these profiles:

1. You don’t itemize deductions. Only people who itemize benefit tax-wise from regular charitable donations. Using QCDs provides a way for people who don’t itemize to gain a tax benefit from making charitable donations.

2. You itemize, but part of your charitable deduction would be phased out based on your adjusted gross income (AGI) or delayed by the 50%-of-AGI restriction.

3. You want to avoid being taxed on required minimum distributions (RMDs) that you must take from your IRAs.

The Limits of Product Liability

Posted on July 14, 2016July 22, 2024 by Debra Barcuch

Product Liability for Manufacturers

The limits of product liability are not always easy to define. But in one case, the Nebraska Supreme Court helped identify the limits by ruling that two manufacturers aren’t liable for harm caused by the criminal acts of others — even if their product’s failure led to the harm.

The court ruled that Ford Motor Co. and Bridgestone/Firestone were not liable for the death of a 19-year-old college student who was murdered by a man who offered her a ride after she had a flat tire.

“We have found no authority recognizing a duty on the part of the manufacturer of a product to protect a consumer from criminal activity at the scene of a product failure where no physical harm is caused by the product itself.”– Nebraska Supreme Court

There was no allegation that the young woman sustained any injury as a result of the tire failure itself. Instead, the student’s parents charged negligence on the part of the manufacturers, claiming that the malfunctioning Firestone tire on their daughter’s Ford Explorer set in motion a chain of events that culminated in her murder. They argued that the manufacturers knew — or should have known — of the potential for criminal assault after the breakdown of a Ford Explorer.

The court disagreed, invoking the legal concept of “proximate cause.” Under the law, it is generally not enough to show that an event would not have happened if it weren’t for another prior event. Liability generally lies with the last negligent or intentional act that leads to the harm. In this case, that act was committed by the murderer because he shot the young woman.

The court responded: “Assuming the truth of these allegations, the most that can be inferred is that Ford and Firestone had general knowledge that criminal assaults can occur at the scene of a vehicular product failure. However, it is generally known that violent crime can and does occur in a variety of settings, including the relative safety of a victim’s home.”

The court made its decision even though the federal government had found the tires on the woman’s Ford Explorer to be unsafe. Millions of ATX, ATX II and Wilderness AT tires have been recalled after it was determined that they are prone to losing their treads at high speeds. The plaintiffs argued that their daughter might not have driven alone, early in the morning, if she had known of the tire’s tendency to blow out. The court did not find this argument persuasive. (Stahlecker v. Ford Motor Co., 266 Neb. 601, 08/08/03)

While this case does express a principle that protects companies from liability from unforeseeable criminal acts, it should not be interpreted as a blanket protection from liability in all cases of criminal behavior by third parties.

A variation: A different set of circumstances could lead to a different outcome. For example, imagine a situation where a man tries to use a jack supplied by the automaker to change a flat tire. The design of the jack requires that the car be close to the edge of the road. The man is then struck by a drunk driver and killed.

This is a scenario where the automaker could be held liable for its negligent design of the jack, even though the criminal act of the drunk driver was the ultimate cause of the man’s death.

The difference: In this hypothetical case, the court could determine that the automaker should have foreseen the possibility that an accident might occur.

Top Business Challenges for Professional Service Organizations

Posted on July 13, 2016July 23, 2024 by Debra Barcuch

Professional Service Organizations (PSO) often deal in Human Capital (i.e. they sell time), which creates pressure to manage quickly but not always effectively. Even as they advise business owners, leaders in a PSO neglect many of the same operational and financial issues in their own organizations. Before client service and profits begin to decline, PSO leaders must identify their operational inefficiencies and decide if they have the resources internally or externally to address them. A well-managed PSO anticipates change with the right key performance indicators — helping leaders look ahead instead of always over their shoulders.

Professional service organizations historically can be a scattered and distracting place. Imagine all of these intelligent individuals — lawyers, accountants, engineers or architects — selling their knowledge and time. As owner and employee numbers increase, the business model is prone to inconsistencies and neglect without an executive leadership team that focuses a percentage of time on running the business.

Some of the common operational inefficiencies we’ve seen in PSOs include:

Aging accounts receivables
Lack of tax planning
Internal control and compliance issues
Inadequate investment in technology (i.e outdated)
Misalignment between marketing strategy and the business plan
Reactive recruitment

One of the solutions in PSOs is to assign a partner or shareholder to certain areas of the business: technology, marketing, HR, recruitment, etc. However, lack of knowledge in these increasingly specialized areas can result in minor errors at best and legal issues at worst. Before going too far down that road, leaders need to take time and really assess the organization’s capacity to manage these areas of the business internally — or if outside expertise is necessary as well as valuable.

Top Business Challenges for PSOs

Distinguishing one professional service from another is dependent on the owners’ ability to communicate value. When you sell an intangible service or knowledge, value is hard to pin down. It requires market research on your target audiences, their service needs, how your competition communicates value and why your existing clients say they choose your organization. Failure to take a hard look at value makes it difficult to sell, let alone attract talent or manage service expectations.

And these are some of the top challenges for PSOs to sustain good margins and avoid commodity price pressure. Even before the recession, PSOs were looking at ways to perform projects with fewer on-site visits, more milestones built in, use of more subcontractors and the ability to efficiently deliver measurable results. Clients are more likely than in the past to put a cap on spending and demand tangible deliverables that match PSO fees.

According to an annual survey of top-performing PSOs across the US by SPI Research, the most profitable PSOs are more specialized in their service offerings and/or they concentrate on high-growth segments where they are often the market leader. A significant portion of business comes through referrals thanks to their market leading reputation, and they have created a transparent culture of communication that attracts clients and employees.

According to the 2016 SPI Research survey, top-performing PSOs averaged net profits of just over 20 percent while average firms reported net revenues of 14.9%. Interestingly, the top PSOs referenced in the survey are incorporating some level of technology consulting in their practices.

Technology Is Partial Solution

PSOs have two challenges when addressing technology needs: operational and client focused. A 2016 survey by Computer Economics showed that PSOs were more likely to budget for operational IT spending — upgrades of existing IT — than investment in new IT solutions through capital outlay. One possible explanation is the migration of many organizations to cloud technology.

When considering IT investment, it is important to look at internal as well as external investments. Demonstrating up-to-date technology is a primary recruiting tool because younger professionals prefer to work in organizations that leverage technology for efficiency (e.g. workflow, remote work, databases). The right technology investment can also help PSOs measure performance (e.g. CRM, web analytics, marketing automation, financial reporting).

In addition, technology is a selling point for clients in terms of delivering services cost-effectively, helping them translate historic data into smart business decisions and also forecast opportunities (e.g. portals, accounting software, point of sale systems, time and billing, enterprise systems).

However, new technology investment can only augment staffing, attract clients and increase revenue when it is aligned with the business strategy. Too many organizations invest in a software solution or peddle it to their clients without fully developing a strategy around its value — or providing staff training to use it effectively. Moreover, growth can delay timely investment in software or even cloud-based applications that can support efficient back-office functions.

Getting back to basics, PSOs must assess their vision and assign leaders to each area of the organization: finance, operations and marketing. Then they must name and prioritize their goals:

Increase productivity
Control cost
Attract and retain talented people
Solve complex business issues
Provide outstanding client service
Financial and tax compliance
Managing technology and future investments to stay competitive

How should finance, operations and marketing align to support these goals?

Seek New Business Opportunities

One goal not mentioned yet is the development of new business opportunities. Successful PSOs are not only expanding services with existing clients, but also adding new clients. The most successful PSOs surveyed by SPI Research derived more than 20 percent of revenue from new clients. At the same time, they kept employee headcount growth lower than revenue growth through a larger sales pipeline and efficient resource management. While the slowest-growing organizations reported higher profitability, the danger was in neglecting new business opportunities in favor of short-term profits.

In a 2015 blog post, SPI Research cautioned PSOs from discounting, as survey respondents noted a prevalence of longer sales cycles and fewer winning proposals when the PSO offered price concessions. The promise of future work rarely made up for the loss in margin because clients that demanded discounting already perceived the service as a commodity.

Other ways of expanding business can happen by positioning the PSO as a leader in a particular industry vertical, thereby elevating the sophistication of the service or consulting offered. We have also seen PSO growth through M&A.

M&A activity in PSOs can include a “horizontal merger” in which firms within the same industry merge in order to add capacity and clients as well as expand geographically. PSOs can also explore product extension mergers by aligning or acquiring complimentary services such as an engineering firm adding general contractor services or a law firm adding collections services. Of course, such mergers must occur within the legal limits of the industries involved, and there are additional costs associated with M&A.

At Cornwell Jackson, our tax and business services teams have worked with clients for many years to optimize back-office functions, but also assist with business strategy and planning. We have supported PSOs in determining the best KPIs, the optimal level of staffing and timely introduction of accounting tools and processes that enhance their growth. For more information on how your PSO can face today’s growth challenges head-on with a qualified outsourced relationship, contact us.

Mike Rizkal, CPA is a partner in Cornwell Jackson’s Audit and Attest Service Group. In addition to providing advisory services to privately held, middle-market businesses, Mike oversees the firm’s ERISA practice, which includes annual audits of approximately 75 employee benefit plans. Contact him at mike.rizkal@cornwelljackson.com.

Assessment: Facing the Unknowns of Succession Planning – Phase I

Posted on July 11, 2016 by Debra Barcuch

Phase I – Assessment

Because your business is probably your largest asset — and because it also is probably your largest single source of income — your decision-shaping and calendar of events for your plan are going to be built around assessing alternatives to preserve the asset, nurture the asset, monetize the asset or liquidate the asset for optimum results for you, your family and the business. Some of the questions you should ask as you begin the journey of planning your succession are:

What is your business really worth?
What do you really need in retirement?
How does ownership translate into retirement assets?
Who will step into the ownership role(s)?
What’s your Plan A and Plan B scenario?
What will you do next?
What is your timetable for fully transitioning out?

So, what is your business really worth? If you’ve never had a formal or even informal valuation of your business, now is the time to schedule it. You will need a reasonable estimated value of your business — and an honest assessment of after-tax available cash to you in the event of a sale. You need a valuation regardless of whether you desire to sell to a third party or to your management team, or create an ESOP, family gifting or charitable gifting options.

There are formal valuations and there are informal valuations. For the purposes of succession planning, most small business owners simply need a valuation professional to determine an estimation of value within $100,000. Don’t try to calculate the value online with a low-end, do-it-yourself tool. All of your decisions going forward derive from this number, so it pays to consult a professional.

Once you have a clear estimation of value, you will want to visit with your investment advisor or financial planner to assess your personal finances, current and post retirement cash flow, retirement goals and sources of cash flow up to your official retirement date. In my experience with succession planning, this process will take at least three separate meetings in order to:

Determine what you want to do in retirement
Assess the lifestyle you want to maintain
Incorporate the vision of the next successful chapter of your life into the succession plan

During this discussion, you may want to decide how much, if any, you want to continue working in the business. Independent of any valuation or legacy issues you carry, what would be a fair amount for you to be compensated in a less than full-time position at the company? What are the primary areas where you could add value to the business on a continuing basis?

Establish Plan A and Plan B

This decision, of course, hinges on the most likely acquirer of your business. You will need to rank on a 10-point scale the likelihood and viability of a sale or transfer to:

Your own family members
Your current management team or business partners
Your employees taking ownership stake through an ESOP
A strategic buyer
A private equity firm

Whichever option gets the highest ranking, call that “Plan A.” But call the second highest option “Plan B.” We’ll talk more about why having two options for potential owners are important in the execution phase of succession planning.

In addition to ranking a potential successor or outside buyer, you will need to obtain and review all of the following agreements and legal documents. You may find during this process that there are documents you don’t have and will need to create.

Will and estate documents
Emergency management plan – who gets the keys if you are temporarily out of commission
Shareholder agreements, often called buy/sell agreements
Bylaws or operating agreement of the business itself – voting, officers, classes of stock, etc.

The final piece of your Phase I Assessment is to target a specific year that will be the year of your exit — no matter what form that takes.

As you assess your current situation, including decisions around successors and timelines, your CPA should support you with a clear picture of cash flow, debt and proper entity structures. Your CPA can also help you assess certain buy-out scenarios that may involve selling to internal stakeholders, courting an external buyer or creating an ESOP. Rely on your CPA to weigh the pros and cons of your Plan A and Plan B to ensure that they are viable choices.

Once your first 90 days of planning are completed, you should begin to understand where the gaps lie in order to set the timeline for succession planning execution. Review each step that has been accomplished so far with your advisory team. Most of all, congratulate yourself for moving toward a viable plan for your business transition.

To continue reading about succession planning, read: Phase II – Sharing and Executing the Succession Plan

For more information on guiding your small business through succession planning, talk to the tax team at Cornwell Jackson.

Five Mid-year Small Business Tax Planning Moves Inspired by the PATH Act

Posted on July 11, 2016July 23, 2024 by Debra Barcuch

SB Blog Cover 1200px Numerous tax breaks have been retroactively expanded for 2015 and beyond — or, in some cases, been made permanent — under the Protecting Americans from Tax Hikes (PATH) Act of 2015. Now that the dust from the new law has settled, small business owners can plan ahead with these 5 mid-year tax strategies inspired by the recent legislation.

5 Tax Breaks for Small Businesses

1. Buy equipment. The PATH Act preserves both the generous limits for the Section 179 expensing election and the availability of bonus depreciation. These breaks generally apply to qualified fixed assets, including equipment or machinery, placed in service during the year. For 2016, the maximum Sec. 179 deduction is $500,000, subject to a $2,010,000 phaseout threshold. Without the PATH Act, the 2016 limits would have been $25,000 and $200,000, respectively. The higher amounts are now permanent and subject to inflation indexing.

Additionally, for 2016 and 2017, your business may be able to claim 50% bonus depreciation for qualified costs in excess of what you expense under Sec. 179. Bonus depreciation is scheduled to be reduced to 40% in 2018 and 30% in 2019 before it expires on December 31, 2019.

2. Improve your premises. Traditionally, businesses must recover the cost of building improvements straight-line over 39 years. But the recovery period has been reduced to 15 years for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. This tax break was reinstated and made permanent by the PATH Act.

If you qualify and your premises need remodeling, you can recoup the costs much faster than you could without this special provision. Keep in mind that some of these expenses might be eligible for bonus depreciation.

3. Ramp up research activities. After years of uncertainty, the research credit has been made permanent under the PATH Act. For qualified research expenses, the credit is generally equal to 20% of expenses over a base amount that’s essentially determined using a historical average of research expenses as a percentage of revenues. There’s also an alternative computation for companies that haven’t increased their research expenses substantially over their historical base amounts.

Research activities must meet these criteria to be considered “qualified”:

The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
There must be an intention to eliminate uncertainty.
There must be a process of experimentation. In other words, there must be a trial and error process.
The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.

Effective starting in 2016, a small business with $50 million or less in gross receipts may claim the credit against its alternative minimum tax (AMT) liability. In addition, a start-up company with less than $5 million in gross receipts may claim the credit against up to $250,000 in employer Federal Insurance Contributions Act (FICA) taxes.

4. Issue more stock. Does your business need an influx of capital? If so, consider issuing qualified small business stock (QSBS). As long as certain requirements are met (for example, at least 80% of your corporate assets must be actively used for business purposes) and the investor holds the stock for at least five years, 100% of the gain from a subsequent sale of QSBS will be tax-free to the investor — making such stock an attractive investment opportunity. The PATH Act lifted the QSBS acquisition deadline (December 31, 2014) for this tax break, essentially making the break permanent.

5. Hire workers from certain “target groups.” Your business may claim the Work Opportunity credit for hiring a worker from one of several “target groups,” such as food stamp recipients and certain veterans. The PATH Act revives the credit and extends it through 2019. It also adds a new category: long-term unemployment recipients.

Generally, the maximum Work Opportunity credit is $2,400 per worker, but it’s higher for workers from certain target groups. In addition, an employer may qualify for a special credit, with a maximum of up to $1,200 per worker for 2016, for employing disadvantaged youths from Empowerment Zones or Enterprise Communities in the summer.

New transitional rules give an employer until June 30, 2016, to claim the Work Opportunity credit for applicable wages paid in 2015.

Midyear Small Business Tax Planning Meeting

We’re almost half way through the tax year. Summer is a great time for small businesses to get a jump start on tax planning. Contact your Cornwell Jackson tax adviser to estimate your expected tax liability based on year-to-date taxable income and devise ways to reduce your tax bill in 2016 and beyond.

Non-Compete Agreements: Finding the Right Balance

Posted on July 6, 2016 by Debra Barcuch

Non-compete agreements have long been a staple of executive employment contracts. Today, however, they’re becoming increasingly common even in lower-level jobs. According to the Wall Street Journal, a steady rise in litigation over non-competes “largely reflects the increased usage of non-compete arrangements among lower-level staffers, along with employees’ greater mobility and access to sensitive information.”

It might seem like overkill to require a non-compete agreement with employees below the executive level. However, an individual’s ability to damage your business by going to work for a competitor will grow over time — assuming the employee gains responsibility and knowledge that could help a competitor. If you don’t secure a non-compete agreement at the beginning of an employment relationship, you’ll probably need to jump through an extra hoop to make it legally enforceable later on.

State Law Rules

State law governs non-compete agreements, and some of the rules vary from one state to the next. In an extreme case, California generally doesn’t recognize the validity of these agreements at all.

Federal courts may also sometimes get involved. One federal court recently weighed in on a case and upheld a common principle — the need for an employee to receive “consideration” (some form of compensation) in exchange for accepting a non-compete agreement.

Ordinarily, being offered a job is deemed to be adequate consideration in itself. However, if an employee has already been working for a while, simply being allowed to keep the job might not be deemed adequate consideration. That’s how the U.S. District Court in Hawaii came down on the issue in the case of The Standard Register Co. v. Keala (No. 14-00291 JMS-RLP).

“Numerous courts have held that where an employee has already been hired, continued at-will employment, standing alone, is insufficient consideration for a non-competition agreement,” the court held, and denied the employer’s request for a temporary restraining order against former employees.

Is the Agreement Enforceable?

One possibility for “consideration” in that situation might have been a bonus or a promotion. However, courts aren’t always predictable in what they’ll uphold. Here are other key facets of a non-compete agreement that courts examine:

Does it protect a legitimate business interest? For example, let’s say you claim that an employee possesses sensitive information which could harm you if it fell into a competitor’s hands. Unless there’s evidence that you made a real effort to protect the secrecy of that information, a court may decide your stated business interest isn’t legitimate.

What is the duration of the agreement? Courts are sympathetic to the idea that people need to earn a living. Therefore, they often frown on agreements that restrict former employees for periods longer than, for example, six months. But “reasonable” limits vary by circumstances and courts.

What are the geographic parameters? A court will try to determine reasonableness here based on the size of your market. If you don’t have many competitors beyond a certain distance, such as a 10-mile radius, you wouldn’t be able to justify an agreement based on a 50-mile radius. Again, there’s considerable variability in this parameter.

What activity is prohibited? The broader the scope of the prohibition, the less likely the agreement is to be enforceable. The most “reasonable” restriction in the eyes of the majority of courts is against soliciting your customers.

Red Pencil, Blue Pencil

If a court reviews a non-compete agreement and finds fault with it, there are three possible outcomes — depending on the state. The most restrictive standard is known as the “red pencil” rule. It requires the invalidation of an entire agreement even if only one provision is flawed. Nebraska takes the position, and South Carolina, Virginia and Wisconsin generally do as well.

Under the less draconian “blue pencil” standard, courts are allowed to invalidate specific provisions of an agreement, while leaving other ones standing. Arizona, Connecticut, Indiana, Maryland, Montana and North Carolina generally take that approach.

The best scenario is “reformation,” which is permitted in approximately 30 states. This is where the court can actually rewrite the agreement to allow it to be as faithful as possible to the employer’s original intent, but only to the extent permissible by law. That way, you might win a partial victory if you’re still allowed to restrict the former employee’s activities, even if not as thoroughly as you’d hoped.

Not all states fall into such tidy categories, and their positions evolve. Wherever you’re located, you will need to consult with a qualified attorney to draft a non-compete agreement that will hold up to local scrutiny.

Also, many job applicants will take a dim view of a requirement to sign this type of contract. With that in mind, you’ll need to balance your eagerness to hire a particular applicant with the consideration you’re willing to offer to make the agreement more palatable. Otherwise, the non-compete agreement could be a deal breaker.

Consult your Cornwell Jackson adviser for more information.

Is the Manufacturing Renaissance Over? Time Will Tell

Posted on July 5, 2016 by Debra Barcuch

CNC LPG cutting with sparks close up

The U.S. manufacturing sector has rebounded and seems poised for more growth.

But is the revival as real as some have characterized? A number of recent reports have described the resurgence in manufacturing as a modest rebound rather than a boom. Even more compelling, some suggest the renaissance is over. This article takes a closer look at where the industry stands at midpoint 2016.

The Bright Side

Let’s start with the good news. Approximately 900,000 jobs were added to the U.S. manufacturing sector between 2010 and 2016. There’s no denying the positive impact of that growth. However, after taking a brutal beating before that, some recovery had to be expected. By most standards, the improvement was modest.

Plus, a true return to more manufacturing activity in the United States, sometimes called “reshoring,” should be backed by other data, including increased productivity in consumer goods. Although the nation has been importing more vehicles than it has been exporting for several decades (with Japanese and German automakers dominating the market) some traditionally strong sectors have eroded, including airplanes, medical equipment and semiconductors. Also, other longstanding areas of growth (oil and gas, mining and construction equipment) have slowed considerably.

Studies of U.S. manufacturing activity have produced a mixed bag of conflicting results:

Boston Consulting Group, which helped popularize the concept of reshoring, has said that a number of top manufacturing executives are considering bringing back production from China. Thirty-one percent of respondents to the group’s fourth annual survey of senior manufacturing executives at companies with at least $1 billion in annual revenues said that their companies are most likely to add production capacity in the United States within five years for goods sold in the nation, while 20% said they are most likely to add capacity in China.
A.T. Kearney, however, says its U.S. Reshoring Index suggests that reshoring is an aberration, not a trend. That index tracks actual U.S. manufacturing and import data. Kearney also notes that industries trying to avoid rising labor costs in China have been moving production to other Asian countries rather than back to the United States, a trend that is unlikely to reverse anytime soon. Countries in Southeast Asia, including India, have literally hundreds of millions of workers available in largely untapped pools. This is clearly apparent in activities such as clothing and furniture production. Another development affecting manufacturing is “nearshoring” on the North American continent, particularly in Mexico where labor costs are low.
Information Technology and Innovation Foundation (ITIF), a nonpartisan think tank, suggests that the so-called renaissance doesn’t exist. It notes that the real manufacturing value added, which it says is the best measure of U.S. manufacturing, was still 3.2% below 2007 levels in early 2015, despite GDP growth of 5.6%. Among other “myth-busters,” the ITIF report, The Myth of America’s Manufacturing Renaissance: The Real State of U.S. Manufacturing, illustrates that wages in China are estimated to be just 12% of average U.S. wages in 2015, global shipping costs are back to normal after falling by 93% in a six-month period in 2009 and U.S. productivity isn’t increasing faster than that of other industrialized countries. And it is actually growing much slower than China and South Korea.

Clearly these results suggest that the so-called renaissance has been highly overrated.

The Current Landscape

The economic outlook for manufacturing darkened somewhat in June. The sharp drop in hiring prompted the Federal Reserve to keep interest rates steady. The manufacturing sector lost 10,000 jobs and it showed job losses in three of the four most recent months. Year-over-year growth in manufacturing employment has been negative for three months in a row. The numbers have led some observers to suggest the end of any post-recessionary manufacturing resurgence.

What’s the reason for the turnabout? The Bureau of Labor Statistics published its Job Openings and Labor Turnover Survey the same week as the jobs report suggesting that jobs weakness in manufacturing may be the result of a lack of labor supply rather than lack of demand. In April, job openings in the industry jumped to a 15-year high while the ratio of manufacturing job openings to manufacturing job hires hit a record, suggesting that employers are having trouble finding quality workers to fill open positions. In the meantime:

Layoffs remain relatively low, with fewer reported this cycle than at any point during the previous cycle,
Manufacturing wage growth outpaced overall wage growth over the past manufacturing year, and
The unemployment rate for manufacturing workers has been comparable to the three years leading into the most recent recession, when the economy was stronger.

All of this seems to indicate that the manufacturing sector is healthy.

What can manufacturers do about increased labor costs due to a shortage of qualified workers? One possibility is to increase overtime hours for workers on the payroll. Alternatively, if output from existing workers is nearing its limit, wages may be increased to attract new-hires from other sectors, even if this slightly dilutes the bottom line. Other solutions, such as locking in output and sacrificing the potential for growth, may be more difficult to swallow.

Final Word

Whether you believe that the manufacturing renaissance is over, or you aren’t convinced that any revival was particularly robust or even existed, shouldn’t discourage your firm from its main focus. Stick to the fundamentals that your company has relied on: Remain diligent but retain enough flexibility in operations so your firm will be able to adapt quickly, if needed.

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