February 2017

SCENARIO #1 – Leasing vs. Selling Mineral Rights

Posted on February 27, 2017July 23, 2024 by Debra Barcuch

An owner of undeveloped or partially developed land (who also owns the mineral rights to the property) is considering whether to lease mineral rights on the undeveloped property or to sell the rights. An E&P company or other lessee wants the right to explore, drill and/or develop any minerals discovered.

If the owner leases the rights, the owner will reserve a royalty interest. For example, the owner may retain one-eighth of the interest of the minerals produced in the form of a royalty (some royalties have been as high as 25 percent in recent years for valuable holdings). The lessee will usually agree to sweeten the deal with a cash payment, commonly referred to as a lease bonus.

The owner retains the title to the minerals. The lease bonus is taxed as ordinary income as are the royalty payments once production begins. Even though the transaction is called a lease, and the lessee has a cash outlay for the lease bonus, the lease bonus is non-deductible. The lessee recovers the lease bonus cost through depletion once the property begins production.

If the minerals are not developed during the term of the lease, the lease will expire and the owner contractually regains all mineral rights and has the right to negotiate a lease with another party. However, the lessee may request to extend the lease. The payment to extend the lease, commonly referred to as a delay rental is also taxed as ordinary income by the owner. The lessee must add the delay rental cost to the cost of the lease bonus, and recovers those costs through depletion once production begins.

In the event, the lease expires, the lessee is able to deduct any unrecovered lease bonus and delay rental costs in the year of expiration.

In the rare event that the owner decides to sell the mineral rights (e.g. original owner dies and new owner prefers immediate payment), the income on the sale is treated as capital gains.

Conclusion: Even though capital gains tax rates are generally lower than ordinary income tax rates, generally the mineral interest owner will choose to lease rather than sell because the upside of the royalty far outweighs the favorable tax treatment of capital gains.

To view other scenarios and learn more about this topic, visit: Oil & Gas Update: Tax Implications of Buying and Selling Mineral Rights

The oil and gas industry has experienced booms and busts of varying lengths since the dawn of mineral exploration. The current climate for O&G suggests continued consolidation, however forecasts by industry experts anticipate the boom may be back by 2018. For any owners or buyers of mineral interests, the market may be ripe for making deals now — with a careful eye toward the tax implications of buying and selling mineral rights. No two deals are alike, and it’s important to learn the potential tax impact and the types of taxes you may be paying.

Download Now: Oil & Gas Update: Tax Implications of Buying and Selling Mineral Rights

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

Oil & Gas Update: Tax Implications of Buying and Selling Mineral Rights

Posted on February 27, 2017July 23, 2024 by Debra Barcuch

Hold ‘em or fold ‘em? It’s not a poker game. It’s the oil and gas industry.

The U.S. oil and gas industry overall may still be in a consolidation phase, but reports from industry watchers like Deloitte noted in fall 2016 that activity may pick up briskly as early as 2018. In Texas, however, the environment looks different, with more hiring and production activity in early 2017 than was seen over the last two years.

Anticipating the shift, corporate E&P activity to build up reserves has been happening in West Texas since 2015 with multi-million dollar deals in the Permian Basin and elsewhere. According to Reuters, more than $28 billion in land acquisitions were transacted in West Texas last year, more than triple those in 2015. The players include Exxon and newer E&P players like Parsley Energy.

We are familiar with the variety of scenarios in oil and gas transactions. Each deal is unique, but there are a few common scenarios worth reviewing that demonstrate how the tax law treats transactions differently. Whether you are selling, leasing or buying, now is a good time to consider your options and prepare to act at just the right time.

Following are common scenarios that can occur in oil and gas transactions and their various tax treatments. Before we introduce these scenarios, it is important to understand the types of ownership interests commonly seen in the oil and gas industry and the differences between them.

Royalty interests and over-riding royalties both collect a specified percentage of the gross revenue from the sale of oil and gas produced. Both typically are subject to severance tax that the State levies on oil and gas production. Both may also be subject to the costs of delivering the product to market (i.e. pipeline services fees), but royalty interests are normally not charged with the cost of developing the property nor are they normally charged with the cost of production and maintaining the well.
Net profits interests are a hybrid royalty that typically does not receive payment until the working interest owners have realized a pre-determined profit.
Working interests collect a specified percentage of revenue and pay their proportionate share of severance tax and the costs of delivering the product to market. However they are responsible for 100% costs of operating the well, producing the oil and gas, drilling and developing the well and maintaining the property. Clearly, the working interest owner takes virtually all of the risk in a very risky business. The tax law does provide the working interest owner with some unusual tax benefits, but those are beyond the scope of this article.

Oil and Gas Transaction Scenarios

The following scenarios are not based on any actual past or present oil and gas transaction, and the information provided does not constitute tax advice. These examples were created to more easily demonstrate the complexity and nuance of taxable or nontaxable mineral interests. Before entering into any contract, consult with your CPA or attorney. Click on any of the scenarios below to learn more about the scenario specific tax implications of buying and selling mineral rights.

SCENARIO #1 – Leasing vs. Selling Mineral Rights SCENARIO #2 – Land Owner vs. Mineral Rights Owner

SCENARIO #3 – Lessee vs. Developer

SCENARIO #4 – Sale of Proved Up vs. Undeveloped Interests

Buyer and Seller Beware

Before leasing, buying or selling mineral rights or access, players must consider the current market. Market fluctuations impact the value of the property and also the options for structuring a successful transaction. The next few years may prove very fruitful for oil and gas in Texas or show mixed results because of global market pricing pressure, the political environment or other factors.

Cornwell Jackson’s Tax team can provide guidance on the structure of land and mineral rights transactions in line with market cycles and your goals. Our team can discuss the merits of certain deals and tax treatments both short-term and long-term. Contact us with your questions.

Download Now: Oil & Gas Update: Tax Implications of Buying and Selling Mineral Rights

Factoring Uncertainty into the Value of Your Business

Posted on February 27, 2017 by Debra Barcuch

Businesses currently face numerous uncertainties in the marketplace. As President Trump and Republican congressional leaders work toward fulfilling their campaign promises, tax laws could substantially change, the estate tax could be repealed, and various laws and regulations (including the Dodd-Frank and Affordable Care Acts) could be repealed or revised. Interest rates and inflation could both rise. Economic relationships with other countries could also change. Some of these changes could be good for your business, while others could have negative effects on the value of your business.

History Lesson

Business valuation professionals are no strangers to dealing with market uncertainties — and neither are business owners and investors. The approach to valuing a business interest doesn’t change because of the uncertainties surrounding the current political environment.

Under the market and income approaches, the value of a business continues to be a function of expected economic returns and market, industry and specific company risk. These fundamentals didn’t change during other events that caused uncertainty earlier in the 21st century, such as the terrorist attacks on September 11, 2001, or the Great Recession that lasted from December 2007 to June 2009.

Key Considerations

Here are some considerations when valuing a business in today’s volatile political climate.

Public market returns. The inputs that valuators use to determine discount rates and pricing multiples are typically based, in part, on data from the public stock and bond markets. So far, public markets have reacted to the election results in a positive manner. In general, the proposed changes to taxes and business regulations are likely to lower expenses and increase cash flow for many businesses.

Company-specific risks. A factor that has changed substantially is the risk associated with specific companies and industries — and valuators face challenges as they attempt to measure these risks. For example, proposed regulatory changes might increase the value of companies that operate in the energy sector or the manufacturing sector. On the flipside, they might adversely affect the value of companies that operate in the government contracting or health care sectors.

Known (or knowable) information. Many private business valuations are prepared with a year-end effective date, because it corresponds to the cut-off date for their annual financial statements. Valuation experts can only use information known or knowable at the date of the valuation. But what did we know as of December 31, 2016?

Valuation experts constantly monitor market conditions. Realistically, at the end of 2016 and even today, there are many unknowns. The specific details of tax reforms and other regulatory proposals haven’t been fully put into effect or made into law. Since we can only speculate on what will happen in the future, business valuators must focus on the likelihood that the subject company will achieve its expected future income. The risk that a company won’t meet its financial forecasts is factored into its discount rate.

Contact a Valuation Pro

Experienced appraisers understand the importance of reacting to events that cause added uncertainty with an objective, measured response, rather than a knee-jerk response. In today’s marketplace, they understand that politicians have many divergent plans that may (or may not) be approved or take effect.

In the meantime, business owners and investors should stay calm and carry on. A valuation professional can help you stay atop the latest tax and regulatory changes and understand how they could impact your company’s expected return and risk profile in the future.

Public Markets Respond to the Election Results

Following the election and through the end of 2016 — the effective date for many private business valuations — the Standard & Poor’s 500 Composite Stock Price Index, a leading indicator of large stocks, has responded positively.

Specifically, the S&P 500 index increased from $2,139.56 on November 8, 2016, to $2,163.26 on November 9, 2016, an increase of 1.1% from the closing price on Election Day. As of December 31, 2016, the S&P 500 index had risen to $2,238.83, an increase of 4.6% compared to the closing price on Election Day.

It’s important to note that changes in the S&P 500 index aren’t exclusively tied to the election results — and sometimes the market misjudges the impact of major events. However, the performance of the S&P 500 does provide a general indication of investors’ expectations about expected economic returns and systematic risk that can assist in valuing businesses in today’s uncertain marketplace. When valuing small private firms, however, current events in the public markets can be less of a factor than estimating long-term economic income probabilities.

Republicans’ Policy Brief Explains Repeal-and-Replace Plan

Posted on February 26, 2017July 23, 2024 by Debra Barcuch

As everyone in America knows by now, President Trump and Republicans in Congress have vowed to repeal and replace the Affordable Care Act (ACA). In its place, they plan to introduce a more market-based system of health coverage.

One question many people have: How will the replacement plan help individuals without employer-provided insurance buy health coverage on the open market? A “Policy Brief” released on February 16 by U.S. House Speaker Paul Ryan (R-WI) provides some details on how Republicans hope to get this done. The main features are:

An advanceable and refundable tax credit, and
Expanded health savings accounts (HSAs).

This article explains some of the details in the document Ryan released titled, “Obamacare Repeal and Replace: Policy Brief and Resources.”

Current Premium Tax Credit

Under current law, lower-income individuals who aren’t eligible for other qualifying health coverage or “affordable” employer-sponsored insurance plans, which provide “minimum value,” are allowed to claim a refundable premium tax credit to subsidize the purchase of certain health insurance plans through a state-established American Health Benefit Exchange or through federally-facilitated Exchanges. This credit is also known as a health care affordability tax credit or premium assistance credit.

The credit generally is payable in advance directly to the insurer on the individual’s behalf, with the taxpayer reconciling the actual credit that he or she is due on a timely filed return. Alternatively, individuals can elect to purchase health insurance out-of-pocket and apply to the IRS for the credit at the end of the tax year. There are a number of complex steps involved in computing the credit.

What Are Refundable and Advanceable Tax Credits?

A refundable tax credit involves a taxpayer receiving a payment from the federal government even if the credit amount exceeds the amount the individual owes in taxes.

An advanceable tax credit provides financial help in advance of filing a tax return. The Republicans’ Policy Brief states that “advanceability is a key feature” of its tax credit proposal “because many Americans need help paying their monthly premiums. They cannot afford to wait until they file their taxes the following year to get assistance.

Proposed Universal Health Care Tax Credit

According to the Policy Brief, the Republican plan would create a new, advanceable, refundable tax credit, under a new tax code section to assist with the purchase of health insurance on the individual insurance market.

The credit would be available to all qualified individuals regardless of income, with older people receiving a higher credit amount than younger individuals, to reflect the higher cost of insurance as people age. A qualified individual would be a citizen or qualified alien who isn’t eligible for coverage through other sources, specifically through an employer or government program.

Taxpayers also would be able to receive credits for their dependents — including children up to the age of 26. (Incarcerated individuals wouldn’t be eligible for the credit.)

The credit could be used to purchase an eligible plan approved by a state and sold in the individual insurance market, including catastrophic coverage. However, the credit wouldn’t be available for plans that cover abortion.

In addition, if an employer doesn’t subsidize health care continuation coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA), an individual could use the credit to help pay unsubsidized COBRA premiums while he or she is between jobs.

If the individual doesn’t use the full value of the credit, he or she could deposit the excess amount into an HSA (see information below for more about HSAs).

ACA Penalties Would Be Repealed

The ACA penalty taxes for the individual mandate and the employer mandate would be repealed immediately. To provide relief during a transition period, Americans who are eligible for the ACA subsidy would be able to use their credit for expanded options, including currently prohibited catastrophic plans. Additionally, the ACA subsidies would be adjusted slightly to provide additional assistance for younger eligible individuals and reduce the over-subsidization that older people are receiving. Restrictions on federal funding for abortions would be included for the transition period.

HSA Rules Today

In general, eligible individuals may, subject to statutory limits, make “above-the-line” deductible contributions to an HSA. Other people (for example, family members) may also contribute on behalf of eligible individuals, and employers can, too. Eligible individuals are those who are covered under a high deductible health plan (HDHP) and aren’t covered under any other health plan that isn’t a HDHP, unless the other coverage is certain permitted insurance (for example, worker’s compensation).

For 2016 and 2017, an HDHP is a health plan with an annual deductible that isn’t less than:

$1,300 for individual coverage and
$2,600 for family coverage.

Maximum out-of-pocket expenses under the plan for 2016 and 2017 can’t exceed:

$6,550 for individual coverage and
$13,100 for family coverage.

The maximum annual HSA deductible contribution is:

$3,350 for 2016 (for family coverage, $6,750) and
$3,400 for 2017 (for family coverage, it remains $6,750).

The maximum HSA contribution is increased by an additional catch-up contribution amount (computed on a monthly basis) for individuals age 55 or older as of the last day of the calendar year who aren’t enrolled in Medicare. The catch-up contribution amount is $1,000.

Distributions from an HSA that are used exclusively to pay the qualified medical expenses of an eligible individual (account holder) or his or her spouse or dependents are excludable from gross income.

What Are “Qualified Medical Expenses?”

Qualified medical expenses are unreimbursed expenses for medical care as defined under the medical expense deduction rules. Medicine or drugs are qualified expenses only if they’re prescribed (whether or not over-the-counter) or if they are insulin. Qualified medical expenses, which must be incurred after the HSA is established, don’t include insurance premiums other than premiums for qualified long-term care insurance, COBRA and coverage while the eligible individual is receiving unemployment compensation.

Distributions not used for qualified medical expenses are subject to tax, and also are subject to an additional 20% for distributions reported on Form IRS 8853 unless they’re made after the individual attains age 65, dies or becomes disabled.

Proposed HSA Changes

The Policy Brief says Republicans want more people to be able to utilize HSAs, and expand how they and their families can use them. Specific proposals would:

Allow HSA distributions to be used for “over-the-counter” health care items.
Increase the maximum HSA contribution limit to equal the maximum out of pocket amounts allowed by law.
Allow both spouses to make catch-up contributions to the same HSA. Specifically, if both spouses are eligible for catch-up contributions and either has family coverage, the annual contribution limit that could be divided between them would include both catch-up contribution amounts. For example, they could agree that their combined catch-up amount would be allocated to one spouse to be contributed to that spouse’s HSA. In other cases, as under present law, a spouse’s catch-up contribution amount wouldn’t be eligible for division between the spouses. It would have to be made to the HSA of that spouse.
Provide that, if an HSA is established during the 60-day period beginning on the date that an individual’s coverage under a high deductible health plan begins, then the HSA would be treated as having been established on the date that such coverage begins for purposes of determining if an expense incurred is a qualified medical expense. Thus, if a taxpayer establishes an HSA within 60 days of the date that his or her coverage under a high deductible health plan begins, any distribution from an HSA used as a payment for a medical expense incurred during that 60-day period after the high deductible health plan coverage began would be excludible from gross income as a payment used for a qualified medical expense — even though the expense was incurred before the date the HSA was established.

The Republicans’ repeal-and-replace plans for the ACA still appear to be a work in progress. For example, under the Patient Freedom Act of 2017, a bill introduced by Senator Bill Cassidy (R-LA) and Senator Susan Collins (R-Maine) in January, contributions to expanded HSAs would be nondeductible. They would be set up as Roth HSAs.

However, the Policy Brief provides some clues as to what the future may hold. Stay tuned.

How S Corporations Can Save on Federal Employment Taxes

Posted on February 24, 2017 by Debra Barcuch

If you own an unincorporated small business, you may be getting fed up with high self-employment (SE) tax bills. One way to lower your SE tax liability is to convert your business to an S corporation.

SE Tax Basics

Sole proprietorship income as well as partnership income that flows through to partners (except certain limited partners) is subject to SE tax. These rules also apply to single-member limited liability companies (LLCs) that are treated as sole proprietorships for federal tax purposes and multimember LLCs that are treated as partnerships for federal tax purposes.

For 2017, the maximum federal SE tax rate of 15.3% hits the first $127,200 of net SE income. That rate includes 12.4% for the Social Security tax and 2.9% for the Medicare tax.

The rate drops after SE income hits $127,200 because the Social Security tax component goes away above the Social Security tax ceiling of $127,200 for 2017 (up from $118,500 for 2016). But the Medicare tax continues to accrue at a 2.9% rate, and then it increases to 3.8% at higher income levels because of the 0.9% additional Medicare tax. (This 0.9% tax applies to the extent that wages and SE income exceed $200,000 for singles and heads of households, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. The tax is part of the Affordable Care Act, so it likely will disappear if the ACA is repealed or replaced.)

We’ll refer to the Social Security and Medicare taxes collectively as federal employment taxes.

Example 1

Suppose your sole proprietorship is expected to generate net SE income of $200,000 in 2017. Your SE tax bill will be $21,573 [($127,200 x 15.3%) + ($72,800 x 2.9%)]. That’s a sizable amount — and it’s likely to get bigger every year due to inflation adjustments to the Social Security tax ceiling and the growth of your business.

SE Tax Reduction Strategy

To lower your SE tax bill in 2017 and beyond, consider converting your unincorporated small business into an S corporation and then paying yourself (and any other shareholder-employees) a modest salary. Distribute most (or all) of the remaining corporate cash flow to the shareholder-employee(s) as federal-employment-tax-free distributions. Here’s why this SE tax-saving strategy works.

For compensation paid to an S corporation employee in 2017, including an employee who also is a shareholder, the FICA tax rate is 7.65% on the first $127,200. This includes 6.2% for the Social Security tax and 1.45% for the Medicare tax. Above $127,200, the rate drops to 1.45% because the Social Security tax component goes away. But the 1.45% Medicare tax component continues indefinitely. At higher wage levels, S corporation employees must also pay the additional 0.9% Medicare tax. FICA tax is paid by the employee through withholding from employee paychecks.

The employer then pays in matching amounts of Social Security tax and Medicare tax (other than the additional 0.9% tax) directly to the U.S. Treasury. So the combined FICA and employer rate for the Social Security tax is 12.4%, and the combined rate for the Medicare tax is 2.9%, rising to 3.8% at higher income levels. These are the same as the SE tax rates. That’s the bad news.

The good news is that S corporation taxable income passed through to a shareholder-employee and S corporation cash distributions paid to a shareholder-employee aren’t subject to federal employment taxes. Only wages paid to shareholder-employees are subject to federal employment taxes.

This favorable federal employment tax treatment places S corporations in a potentially more favorable position than businesses that are conducted as sole proprietorships, partnerships or LLCs (if treated as sole proprietorships or partnerships for federal tax purposes).

Example 2

Assume the same facts as the previous example, except this time you operate your business as an S corporation that generates net income of $200,000 before paying your salary of $60,000. (Assume you could find somebody to do the same work for about that amount.) Only the $60,000 salary amount is subject to federal employment taxes, which amount to $9,180 ($60,000 x 15.3%). That’s significantly lower than you’d pay as a sole proprietor ($21,573).

The Caveats

This tax-saving strategy isn’t right for every business. Here’s some food for thought as you consider changing your business structure:

1. Operating as an S corporation and paying yourself a modest salary will save SE tax as long as your salary can be proven to be reasonable, albeit on the low side of reasonable. Otherwise you run the risk of the IRS auditing your business and imposing back employment taxes, interest and penalties.

However, you can help minimize the risk that the IRS will successfully challenge your stated salary amounts if you gather objective market evidence to demonstrate that outsiders could be hired to perform the same work for salaries equal to what you’re paying shareholder-employee(s).

2. A potentially unfavorable side effect of paying modest salaries to S corporation shareholder-employee(s) is that it can reduce your ability to make deductible contributions to tax-favored retirement accounts. If the S corporation maintains a Simplified Employee Pension (SEP) or traditional profit-sharing plan, the maximum annual deductible contribution for each shareholder-employee is limited to 25% of his or her salary.

So, the lower the salary, the lower the maximum contribution. However, if the S corporation sets up a 401(k) plan, paying modest salaries won’t preclude generous contributions.

3. Operating as an S corporation will require some extra administrative hassle. For example, you must file a separate federal return (and possibly a state return, too).

In addition, transactions between S corporations and shareholders must be scrutinized for potential tax consequences, including any transfers of assets from an existing sole proprietorship or partnership to the new S corporation. State-law corporation requirements, such as conducting board of directors meetings and keeping minutes, must be respected.

In most cases, these drawbacks are far less burdensome than the potential SE tax savings. Your tax advisor can help you minimize the downsides and work through the details.

Weighing the Upsides and Downsides

Converting an existing unincorporated business into an S corporation to reduce federal employment taxes can be a smart tax move under the right circumstances. That said, consult your tax advisors to ensure that all the other tax and legal implications are considered before making the switch.

Mechanics of Converting to S Corporation Status

To convert an existing sole proprietorship or partnership to an S corporation, a corporation must be formed under applicable state law and business assets must be contributed to the new corporation. Then an S election must be made for the new corporation by a separate form with the IRS by no later than March 15, 2017, if you want the business to be treated as an S corporation for calendar year 2017.

If you currently operate your business as a domestic limited liability company (LLC), it generally isn’t necessary to go through the legal step of incorporation in order to convert the LLC into an entity that will be treated as an S corporation for federal tax purposes. That’s because the IRS allows a single-member LLC or multimember LLC that otherwise meets the S corporation qualification rules to simply elect S corporation status by filing a form with the IRS. However, if you want your LLC to be treated as an S corporation for calendar year 2017, you also must complete this paperwork by no later than March 15, 2017.

Defining True Job Costs for Construction Bids

Posted on February 21, 2017July 23, 2024 by Debra Barcuch

At the heart of a profitable construction company is an accurate bidding process. An accurate bid involves much more than your expected materials or your sub-contractor and labor costs. There are also other variables to consider related to the site, the weather, the subs (or GC), customer expectations and how you expect your competitors will bid. The more you factor in those variables across all bids, the closer you can get to a bid that is competitive but will also match true costs.

Construction companies can get very efficient at estimating the expected costs per job; however, they don’t always factor in “hidden” job-related costs in developing the bid:

Labor-related benefits
Fleet vehicles (owned or rented) and maintenance
Fuel
Small tools and other job consumables
General liability insurance
Safety program

If these costs are not considered, the company is at risk for missing the expected job profit, particularly in longer-lived jobs.

Reducing Job Costs and Increasing Margins

Identify the areas where your company has historically experienced cost overruns and develop incentive plans for the project management or field supervisory team to minimize those costs. If their bonuses are tied to the following key performance indicators, it can help to improve per job realization:

Cost-effective materials sourcing
Efficient and timely use of labor
Waste reduction
Safety management
Early troubleshooting on budget or timeline concerns
Timely work in process updates
Quality standards (minor punch lists)

If you have never instituted a specific accountability program for these KPIs, develop standards for two or three and incorporate them into the next round of new work. If there is already some level of accountability in place, audit the results and look for additional areas for improvement.

When designing the incentive plan, it is important to keep parameters in place so that cost savings achieved do not come at higher costs in another category. For example, a labor savings incentive program may inadvertently incentivize the foreman to bypass safety protocols. An accident on the job will potentially result in long-term increased costs in worker’s compensation insurance (not to mention legal claims) that far outweigh the labor savings. Additionally, design the program so that any bonuses are not paid until the warranty period has run in order to assure cost savings do not come at the cost of quality.

Does your company schedule a realization meeting after every completed job? These meetings can identify jobs that provided a healthy margin as well as jobs that lost money. By reviewing past performance, you can get a better sense of where bidding and costs were not aligned, the drivers for cost overruns and even whether a project type is still worth pursuing. For these meetings to be effective, however, you have to have accurate cost reporting. When looking at past jobs in which a company made or lost money, it’s a good exercise to understand exactly what drove the costs. Even though every company at some point has experienced a freak of nature, an accident or a materials shortage, there are usually more cost drivers that the company and its management can actually control.

One of the other areas that a company can review — and this ties to a longer-term shift in the business strategy — is the type of job bid.

Conditions change, and the jobs that used to be lucrative for a company can slowly whittle away margins due to higher competition, compliance issues or threadbare budgets. At the company I served, it was determined that K-12 school construction projects had experienced tightened margins, shortened project timelines and increased competition. Shifting the segment focus to junior college improvement projects, a market segment with less competition, helped the company to improve profit margins.

Continue Reading: Balancing Overhead, Budgeting and Risk to Increase Project Profits

Cornwell Jackson’s Tax team can provide guidance on reigning in costs by reviewing your profit and loss statements, work in process and general accounting ledgers. Contact our team with your questions.

Keep Production Humming in Peak Season

Posted on February 20, 2017 by Debra Barcuch

Peak production season can be a nightmare. It’s the time you need all employees to show up consistently and pull their weight. But reality is often far removed from the ideal.

If that’s the case in your plant, you need to consider some strategies to build resilience into your staffing. Here are six tips that can help ease the strain of production peaks:

Cross-train.

Teach employees to perform various jobs. Cross-training not only ensures coverage when it’s needed, it boosts job satisfaction because staff members feel challenged. Have higher-level employees mentor trainees until they get up to speed.

Offer incentives.

Motivate the performance you want, but don’t overuse incentives. They’re ideal for addressing short-term attendance issues. Offer something in return for perfect attendance — being at work on time every day, with no doctor’s appointments or sick days. One company that goes into mandatory overtime during peak production gives employees gift certificates for dinner and a movie for two month’s perfect attendance. And at the end of the time period, the names of all the people who had perfect attendance are entered into a drawing with the prize being a Saturday off with regular pay.

Hire temps.

You can find good temporary help through staffing agencies. This strategy can be especially powerful if combined with cross-training. For example, full-time pickers who have been cross-trained can run machines or work in receiving while temps do picking. Work with two or three agencies so that you’re not dependent on just one.

Shift into overtime if necessary.

Most employees welcome the extra income from overtime. On a limited basis, overtime may be no more costly than temporary labor when you factor in training expenses.

Seek referrals.

Ask employees to refer friends and relatives. Some companies avoid hiring employees’ friends and relatives, even for temporary positions, but they can be a source of reliable help.

Tap academia.

Technical colleges or universities are often a good source for supervisory help. If your peak production times are predictable, you can arrange to hire management or logistics students as interns to assist supervisors.

Any way you look at it, gearing up for peak production in advance saves your company money, time, hassles and missed deadlines. And those advantages go to your bottom line.

In Your Handbook

Stress the importance of good attendance and punctuality in your employee handbook. Spell out that unexcused absences can result in disciplinary action or even dismissal.

Tighter Control for Purchases Made With FSA Debit Cards

Posted on February 17, 2017July 23, 2024 by Debra Barcuch

Debit card technology has simplified the use of health care flexible spending accounts (FSAs). By accessing the stored value on a debit card when making a health care purchase, an FSA participant avoids having to pay for the expense out-of-pocket and then go through a claims submission process in order to be reimbursed. Debit cards also are used in other types of self-insured medical reimbursement plans, such as health reimbursement arrangements.

As the use of debit cards and the popularity of FSAs continue to grow, some retailers are developing online pharmacies that sell only FSA-eligible products. Consumers pay for the goods using their FSA debit cards and can print a receipt at the time of purchase or wait until later. This makes it easier for FSA users to comply with IRS regulations regarding expense documentation. Internal Revenue Service rules require substantiation of expenses for which an FSA participant seeks reimbursement. For transactions conducted with a debit card, IRS rules and notices define how the basic substantiation requirements can be met without the employee having to submit documentation after the fact. When the health care expense is incurred at a provider or merchant that does not have a health care-related merchant category code — such as a grocery store, discount store or online pharmacy — the Internal Revenue Service now requires that such merchants have in place an inventory information approval system (IIAS) in order for the debit card transaction to be processed.

Most major grocery store chains, discount stores and warehouse clubs now have in-store pharmacies to offer shoppers the convenience of filling prescriptions while doing their regular shopping. Plus, over-the-counter medications and health care supplies — pain relievers, cold remedies, first-aid supplies, contact lens solutions and the like — can be paid for with FSA money. Thus, when filling a prescription or picking up an over-the-counter medication, a shopper at these types of merchants frequently will make purchases that cannot be paid for from the flexible spending account. An IIAS is intended to ensure that, in such situations, the debit card is used to pay for only those items that qualify as Tax Code Section 213 medical expenses.

How Does an IIAS Work?

Basically, such a system collects inventory control information about the items purchased and compares that data to a list of qualified medical expenses. At the time of the transaction, the system approves only the amount of the qualified medical expense for payment with the FSA card and requires the card user to pay for any remaining portion of the purchase in some other way. If an employee purchases over-the-counter medications at a grocery store along with a few food items, the IIAS validates the over-the-counter medications as qualified medical expenses, eligible to be paid from the FSA card. This information is then electronically transmitted to the debit card vendor and the employee need not submit any further substantiation on the expense (though it’s a good idea for the employee to hang on to these receipts).If a non-health care merchant does not use an IIAS, an employee’s attempt to use a debit card to pay for a purchase would be rejected by the debit card vendor. The employee would have to pay for the items out-of-pocket, and go through the FSA’s substantiation/claims submission process to receive reimbursement.

The IIAS requirement became effective beginning in 2008 for merchants such as grocery stores, discount stores, warehouse clubs and convenience stores, and for mail-order and online pharmacies. It became effective in 2009 for stores that have a “Drug Stores and Pharmacies” merchant code, but which also sell a significant number of items that would not qualify as Sec. 213 medical expenses. Drug stores and pharmacies for which 90 percent of the gross receipts in the prior taxable year were for items that would qualify as Section 213 medical expenses — including over-the-counter products that so qualify — need not have an IIAS in place in order to process debit card FSA transactions.

Since the IIAS requirement is relatively new, your employees might be encountering situations where their debit card is being rejected for valid health care purchases from a merchant they’ve successfully used the card at previously. Thus, it could be helpful to let employees know why this is happening or to check with your plan’s debit card vendor to see whether it has any communications prepared on this issue.

A Strong Offense Can Ward Off an IRS Audit

Posted on February 15, 2017 by Debra Barcuch

No one likes to be audited by the IRS. It costs time and, thus, money — even if no additional tax, interest or penalties are assessed — and it’s stressful. So, what can your dealership do to avoid an IRS audit in the first place? It’s simple: Don’t attract unfavorable IRS attention. Reviewers can’t audit every return, so they rely on key indicators to narrow the scope.

Plan “A” — Careful Preparation

To reduce your chances of being audited, you need to examine your business practices and your dealership’s return while thinking like an IRS agent. Be accurate and consistent with the information you provide, and pay special attention to:

Compensation.

Because most dealerships are family-run businesses, the IRS keeps an eye out for unreasonable compensation. Align your salaries with industry benchmarks. Accurately record hours worked, unique contributions from high-salaried employees, and any other factors that influence pay spikes to executives or officers.

Cash transactions.

The IRS is much more likely to audit businesses with frequent cash transactions. Most of these occur in your parts department. Report these transactions properly by making sure the transaction is recorded in your accounting records with a proper paper or electronic trail.

The size of business loss deductions.

Large business loss deductions are red flags to an IRS reviewer. Document each loss and keep receipts. Be able to prove your intent to make a profit, even if you’re temporarily losing money.

Travel deductions.

Keep detailed auto expense logs and be able to justify the business-use percentage. Alternatively, you can employ the standard deduction rate of 54 cents per mile driven in 2016.

Nondeductible contributions.

Contributions to political action funds aren’t deductible for income tax purposes, including the portion of your NADA and state auto dealer association dues that fund political action committees (PACs). Give your CPA the annual statements provided by your associations indicating the portion of dues that fund PACs so that the matter can be handled properly on your tax return.

Business credits.

If you think one of your dealership’s credits might come into question, attach an explanation to the documentation. Show the IRS reviewer that you understand the rules.

Meals and entertainment.

Keep receipts for any expense totaling $75 or more. Include the name and location of the meeting facility. To avoid penalties if you are audited, keep detailed descriptions of events, who attended, business relationships and business discussed.

LIFO.

Keep accurate records of your previous years’ LIFO invoices. Despite the three-year statute of limitations for auditing tax returns, your current year’s LIFO reserve can be affected by several years of built-in layers. Thus, LIFO workpapers and calculations should be kept permanently.

Related-party receivables.

Keep documentation of related-party loans. There should be a signed loan agreement between the parties with a stated interest rate. Typically loans greater than $10,000 need to have interest paid between the parties. The minimum interest rate should be the applicable federal rate in effect at the time the loan is made.

Variances.

Do a high-level review of your tax return. If items are grouped differently from the previous year, it could draw IRS attention. An example: You classified your rental vehicles as part of your property and equipment in Year 1. Now, in Year 2, you classify them as “other assets.”

Plan “B” — Professional Assistance

No one wants an IRS audit. If you are conscientious about the records you keep and wise about the tax decisions you make, you can avoid waving the red flags that might trigger one.

But if, despite your best efforts, the IRS requests an audit, enlist the help of your CPA promptly and cooperate with the agency fully. Your CPA can perform a pre-audit, which includes reviewing the more complex areas of your tax return as well as any areas singled out by the IRS.

10 Important Tax Developments for 2016 Filings

Posted on February 13, 2017 by Debra Barcuch

Several significant tax developments happened last year that may affect federal income tax returns that individual and business taxpayers file in 2017. Here’s a quick look at 10 key changes that you should be aware of during this tax season.

Uncertain Fate of Tax Extenders

In 2016, Congress adjourned without addressing numerous temporary tax provisions that were set to expire at the end of the year. Congress generally renews these “tax extenders” when they expire, but there aren’t any guarantees.

For example, Congress extended all 52 provisions that had expired after 2014 in the Protecting Americans from Tax Hikes (PATH) Act of 2015. Unlike previous tax extenders legislation, however, the PATH Act made a number of these provisions permanent. Several others were extended through 2019, while many provisions were temporarily extended for two years, through 2016.

Stay tuned for additional information on the fate of the tax extenders currently in limbo, as well as details of tax reform measures under the Trump administration and the Republican majority in Congress.

1. Stand-Alone HRAs

On December 13, 2016 — just over a month before leaving office — President Obama signed the 21st Century Cures Act into law. In addition to funding cutting-edge medical research, this new legislation allows an employer with fewer than 50 employees and no other group health insurance plan to establish Health Reimbursement Arrangements (HRAs) for its employees.

These standalone HRAs aren’t subject to certain penalties and restrictions imposed by the IRS under the Affordable Care Act (ACA). Plan ahead: The 21st Century Cures Act applies to plan years beginning after 2016.

2. ACA Reporting

Although the ACA might be repealed or modified in 2017, it’s still in effect for 2016. Under the ACA, employers must file information returns with the IRS and provide information to employees and other responsible individuals.

Recently, the IRS offered some consolation: It extended to March 2, 2017, the due date for furnishing to individuals 2016 Form 1095-B, “Health Coverage,” and 2016 Form 1095-C, “Employer-Provided Health Insurance Offer and Coverage.” This gives employers an extra 30 days to get their paperwork in order.

3. Premium Tax Credits

Taxpayers required to acquire health insurance under the ACA may qualify for premium tax credits to offset part of the cost. Although existing regulations include several favorable safe-harbor rules for determining eligibility, those rules don’t apply where an individual, with reckless disregard of the facts, provides incorrect information to a health insurance exchange.

New final regulations clarify that this provision for “reckless disregard of the facts” applies only to the conduct of the individual — not to information provided by any third parties.

4. Standard Mileage Rates

Each year, the IRS adjusts the standard mileage rates that taxpayers may use in lieu of tracking actual driving expenses. Due to lower gas prices, the rates have been reduced for 2017. The IRS recently announced that the flat rate for business driving is 53.5 cents per mile in 2017 (down from 54 cents per mile in 2016). Also, the rates for driving attributable to medical and moving purposes dropped to 17 cents per mile in 2017 (down from 19 cents per mile in 2016). Finally, the rate for charitable driving, which is set statutorily, remains at 14 cents per mile in 2017. In all cases, related tolls and parking fees can be added to the flat rate.

5. Valuations for Vehicles

Employees are taxed on the fair market value (FMV) of their personal use of company-provided vehicles. For convenience, the IRS permits FMV accounting methods based on the cents-per-mile rule (see “Standard Mileage Rates” above), as well as a fleet average value for employers with 20 or more vehicles, with the maximums updated annually.

Under a recent IRS Notice, the cents-per-mile thresholds in 2017 are $15,900 for automobiles (the same as in 2016) and $17,800 for trucks and vans (up from $17,700 for 2016). The thresholds for the fleet average rule in 2017 are $21,100 for a passenger auto (down from $21,200 for 2016) and $23,300 for a truck or van (up from $23,100 for 2016).

6. CPEOs

The IRS has now provided detailed requirements for certified professional employer organizations (CPEOs) — often called leasing companies — to remain certified. The IRS also has established procedures for suspending and revoking certification. Small businesses often contract with CPEOs to ensure compliance with workplace laws and regulations.

Under the Tax Increase Prevention Act of 2014, a CPEO may be treated as the sole employer of employees for purposes of paying and withholding employment taxes. Professional employer organizations can be certified as CPEOs effective as of January 1, 2017.

7. Delayed Refunds

A new tax law change requires the IRS to hold refunds for tax returns claiming the Earned Income tax credit or the additional child credit until at least February 15, 2017. As a result, many early filers still won’t have access to their refunds until the week of February 27 or even later.

Under the new rules, the IRS must delay the entire refund, even the portion that isn’t associated with the Earned Income tax credit or additional child credit. The IRS is advising taxpayers that the fastest way to get a refund is to file electronically and choose the direct deposit method.

8. ABLE Accounts

The Achieving a Better Life Experience (ABLE) Act of 2014 authorized special tax-favored savings accounts for individuals who are disabled before age 26. After the IRS issued regulations on this issue, individual states began rolling out ABLE accounts in 2016.

With an ABLE account, contributions aren’t tax deductible. But the amounts set aside in ABLE accounts are distributed tax-free to recipients if they’re used to pay for qualified disability expenses. Contributions to ABLE accounts may be sheltered by the annual gift tax exclusion of $14,000 for 2017 (the same as in 2016). Note, however, that if the account balance exceeds $100,000 it will impact SSI (Supplemental Security Income) eligibility.

9. Self-Certified Rollover Waivers

In general, an individual has 60 days to complete a tax-free rollover of a distribution from an Individual Retirement Account (IRA) or workplace retirement plan to another eligible retirement program. If you inadvertently miss this deadline, the distribution is usually taxable unless you obtain a waiver from the IRS. Thanks to a new ruling from the IRS in 2016, a taxpayer can self-certify that mitigating circumstances caused the failure.

For this purpose, a waiver may be allowed due to:

A distribution check being misplaced and never cashed,
Severe damage to the taxpayer’s home,
Death of a family member,
A serious illness of the taxpayer or a relative,
The taxpayer’s incarceration, or
Restrictions imposed by a foreign country.

The new rules went into effect on August 24, 2016.

Important note: Don’t forget that qualifying taxpayers may still make contributions, whether deductible or nondeductible, to a traditional IRA until the day taxes are due, without extension. They also have until Tax Day to make a nondeductible contribution to a Roth IRA for 2016. Put simply, the deadline for individuals to contribute to traditional or Roth IRAs for 2016 is April 18, 2017.

10. FBAR Reporting

Generally, a taxpayer who has over $10,000 in foreign bank accounts at any time during the year must file a Report of Financial Bank and Financial Accounts (FBAR). In the past, the filing deadline was June 30 of the following year. Now the FBAR due date has been moved to coincide with federal income tax filings.

Accordingly, 2016 FBARs must be filed electronically with the Financial Crimes Enforcement Network (FinCEN) by April 18, 2017. Also, FinCEN will grant filers missing the April 18, 2017, deadline an automatic extension until October 16, 2017.

Just a Sampling

This brief article covered just a few noteworthy tax developments in 2016. The IRS made many other changes that could affect your tax obligations, depending on your personal situation. Contact your CJ tax advisor if you have any questions.

Unlock the Potential of Your Business

Let’s Connect