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Dice with the letters L O S S stacked on piles of coins which are decreasing.  Delaware Business CPA

If your business is a limited liability company (LLC) or a limited liability partnership (LLP), you know that these structures offer liability protection and flexibility as well as tax advantages. But they once also had a significant tax disadvantage: The IRS used to treat all LLC and LLP owners as limited partners for purposes of the passive activity loss (PAL) rules, which can result in negative tax consequences. Fortunately, these days LLC and LLP owners can be treated as general partners, which means they can meet any one of seven “material participation” tests to avoid passive treatment. 

The PAL rules

The PAL rules prohibit taxpayers from offsetting losses from passive business activities (such as limited partnerships or rental properties) against nonpassive income (such as wages, interest, dividends and capital gains). Disallowed losses may be carried forward to future years and deducted from passive income or recovered when the passive business interest is sold.

There are two types of passive activities: 1) trade or business activities in which you don’t materially participate during the year, and 2) rental activities, even if you do materially participate (unless you qualify as a “real estate professional” for federal tax purposes).

The 7 tests

Material participation in this context means participation on a “regular, continuous and substantial” basis. Unless you’re a limited partner, you’re deemed to materially participate in a business activity if you meet just one of seven tests:

  1. You participate in the activity at least 500 hours during the year.
  2. Your participation constitutes substantially all of the participation for the year by anyone, including nonowners.
  3. You participate more than 100 hours and as much or more than any other person.
  4. The activity is a “significant participation activity” — that is, you participate more than 100 hours — but you participate less than one or more other people yet your participation in all of your significant participation activities for the year totals more than 500 hours.
  5. You materially participated in the activity for any five of the preceding 10 tax years.
  6. The activity is a personal service activity in which you materially participated in any three previous tax years.
  7. Regardless of the number of hours, based on all the facts and circumstances, you participate in the activity on a regular, continuous and substantial basis.

The rules are more restrictive for limited partners, who can establish material participation only by satisfying tests 1, 5 or 6.

In many cases, meeting one of the material participation tests will require diligently tracking every hour spent on your activities associated with that business. Questions about the material participation tests? Contact us.

 

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Red stamp letters - ExpiredMost of the talk about possible tax legislation this year has focused on either wide-sweeping tax reform or taxes that are part of the Affordable Care Act. But there are a few other potential tax developments for individuals to keep an eye on.

Back in December of 2015, Congress passed the PATH Act, which made a multitude of tax breaks permanent. However, there were a few valuable breaks for individuals that it extended only through 2016. The question now is whether Congress will extend them for 2017. 

An education break

One break the PATH Act extended through 2016 was the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction was capped at $4,000 for taxpayers whose adjusted gross income (AGI) didn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI didn’t exceed $80,000 ($160,000 for joint filers).

You couldn’t take the American Opportunity credit, its cousin the Lifetime Learning credit and the tuition deduction in the same year for the same student. If you were eligible for all three breaks, the American Opportunity credit would typically be the most valuable in terms of tax savings.  
But in some situations, the AGI reduction from the tuition deduction might prove more beneficial than taking the Lifetime Learning credit. For example, a lower AGI might help avoid having other tax breaks reduced or eliminated due to AGI-based phaseouts.  

Mortgage-related tax breaks

Under the PATH Act, through 2016 you could treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. The deduction phased out for taxpayers with AGI of $100,000 to $110,000. 

The PATH Act likewise extended through 2016 the exclusion from gross income for mortgage loan forgiveness. It also modified the exclusion to apply to mortgage forgiveness that occurs in 2017 as long as it’s granted pursuant to a written agreement entered into in 2016. So even if this break isn’t extended, you might still be able to benefit from it on your 2017 income tax return.

Act now

Please check back with us for the latest information. In the meantime, keep in mind that, if you qualify and you haven’t filed your 2016 income tax return yet, you can take advantage of these breaks on that tax return. The deadline for individual extended returns is October 16, 2017.

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We are proud to recognize our dedicated staff and announce the following promotions: 

Chris Erisman

Christopher D. Erisman, CPA has been promoted to Senior Manager. Chris has been with the firm for more than a decade and is focused on audit, review, and compilation engagements in a variety of industries including privately-held companies, and not-for-profit organizations. He is a graduate of the University of Delaware.

 

 

Anne Lane

Anne R. Lane, CPA, MST has been promoted to Senior Manager. Anne has worked in various leadership positions including working in The Netherlands before coming home to Delaware. Her primary focus is tax, specializing in tax planning strategies and compliance for businesses. She is also involved in strategic tax planning and research projects, and supervising staff development and training. She is a graduate of Colorado State University.

 

 

Chris Smith

Christopher A. Smith, CPA has been promoted to Manager. With more than a decade of public accounting experience, Chris prepares and reviews Federal and multi-state income tax filings for individuals, corporations, and partnerships. He enjoys working with business owners to help grow their businesses. He is a graduate of the University of Delaware. 

 

 

Phil Winnington

Philip A. Winnington, CPA has been promoted to Senior Manager. Phil has been with Gunnip & Company since 2002, and uses his experience in auditing, accounting, and consulting to a varied mix of clients, including a specialization in large commercial enterprises. He is a graduate of Villanova University.

 

 

 

 

 

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From the time a business opens its doors, the owner is told “cash is king.” It may seem to follow that having a very large amount of cash could never be a bad thing. But, the truth is, a company that’s hoarding excessive cash may be doing itself more harm than good.

Liquidity overload
What’s the harm in stockpiling cash? Granted, an extra cushion helps weather downturns or fund unexpected repairs and maintenance. But cash has a carrying cost — the difference between the return companies earn on their cash and the price they pay to obtain cash.

For instance, checking accounts often earn no interest, and savings accounts typically generate returns below 2% and in many cases well below 1%. Most cash hoarders simultaneously carry debt on their balance sheets, such as equipment loans, mortgages and credit lines. Borrowers are paying higher interest rates on loans than they’re earning from their bank accounts. This spread represents the carrying cost of cash.

A variety of possibilities
What opportunities might you be missing out on by neglecting to reinvest a cash surplus to earn a higher return? There are a variety of possibilities. You could: 

  • Acquire a competitor (or its assets). You may be in a position to profit from a competitor’s failure. When expanding via acquisition, formal due diligence is key to avoiding impulsive, unsustainable projects. 
  • Invest in marketable securities. As mentioned, cash accounts provide nominal return. More aggressive businesses might consider mutual funds or diversified stock and bond portfolios. A financial planner can help you choose securities. Some companies also use surplus cash to repurchase stock — especially when minority shareholders routinely challenge the owner’s decisions.
  • Repay debt. This reduces the carrying cost of cash reserves. And lenders look favorably upon borrowers who reduce their debt-to-equity ratios.

Optimal cash balance
Taking a conservative approach to saving up cash isn’t necessarily wrong. But every company has an optimal cash balance that will help safeguard cash flow while allocating dollars for smart spending. Our firm can assist you in identifying and maintaining this mission-critical amount.
 

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Auditor IndependenceAuditor independence is still a hot topic among investors and lenders even though the financial crisis of 2008 was nine years ago. Here’s an overview of the independence guidance from the Securities and Exchange Commission (SEC). These rules apply specifically to public companies, but auditors of private companies are typically held to the same (or similar) standards. 

Independence guidelines

External auditors are supposed to be “independent” of their audit clients — both in appearance and in fact. This may seem like common sense. But there’s sometimes confusion about the rule, causing the SEC to file auditor independence cases on a regular basis. These enforcement actions generally fall into three broad categories:

  1. Auditors who provide prohibited nonaudit services to audit clients,
  2. Auditors who enter into prohibited employment (or employment-like) arrangements with audit clients, and 
  3. Auditors (or associated entities) with prohibited financial ties to audit clients (or their affiliates).

To avoid independence-related enforcement actions, it’s important for auditors and their clients to respect the auditor independence guidance. Audit clients generally include companies whose financial statements are being audited, reviewed or otherwise attested — and any affiliates of those companies.

Four questions

Unsure whether an assignment violates the auditor independence guidance? Consider these questions:

  1. Does it create a mutual or conflicting interest?
  2. Does it put the auditor in a position of auditing his or her own work?
  3. Does it result in the auditor acting as a member of management or an employee of its audit client?
  4. Does it put the auditor in a position of being the client’s advocate?

Affirmative answers may indicate possible independence issues. The SEC applies these factors on a fact-sensitive, case-by-case basis. Examples of prohibited nonaudit services for public audit clients include bookkeeping, financial information systems design, valuation services, management functions, legal services and expert services unrelated to the audit.

The auditor independence guidance applies to audit firms, covered people in those firms and their immediate family members. The concept of “covered people” extends beyond audit team members. It may include individuals in the firm’s chain of command who might affect the audit process, as well as other current and former partners and managers. 

Independence is universal

CPAs are public watchdogs — we protect the interests of not only public company investors but also private company shareholders and financial institutions that lend money to companies of all sizes. Our auditors are committed to maintaining independence in order to provide accurate and reliable financial statements that stakeholders can count on. If you have concerns about auditor independence issues, please contact us to discuss them.

The sweeping new revenue recognition standard goes into effect soon. But many companies are behind on implementing it. Whether your company is public or private, you can’t afford to delay the implementation process any longer.

5 steps

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, requires companies following U.S. Generally Accepted Accounting Principles (GAAP) to use a principles-based approach for recognizing revenues from long-term contracts. Under the new guidance, companies must follow five steps when deciding how and when to recognize revenues:

1. Identify a contract with a customer. 

2. Separate the contract’s commitments.

3. Determine the transaction price. 

4. Allocate a price to each promise. 

5. Recognize revenue when or as the company transfers the promised good or service to the customer, depending on the type of contract.

In some cases, the new guidance will result in earlier revenue recognition than in current practice. This is because the new standard will require companies to estimate the effects of sales incentives, discounts and warranties.

Changes coming

The new standard goes into effect for public companies next year. Private companies have a one-year reprieve.

The breadth of change that will be experienced from the new standard depends on the industry. Companies that currently follow specific industry-based guidance, such as software, real estate, asset management and wireless carrier companies, will feel the biggest changes. Nearly all companies will be affected by the expanded disclosure requirements.

Some companies that have already started the implementation process have found that it’s more challenging than they initially expected, especially if the company issues comparative statements. Reporting comparative results in accordance with the new standard requires a two-year head start to ensure all of the relevant data is accurately collected.

Reasons for procrastination 

Why are so many companies dragging their feet? Reasons may include:

  • Lack of funding or staff,
  • Challenges interpreting the standard’s technical requirements, and
  • Difficulty collecting data.

Many companies remain uncertain how to prepare their accounting systems and recordkeeping to accommodate the changes, even though the FASB has issued several amendments to help clarify the guidance. In addition, the AICPA’s FinREC has published industry-specific interpretive guidance to address specific implementation issues related to the revenue recognition standard. 

Got contracts?

We’ve already helped other companies start the implementation process — and we’re ready to help get you up to speed, too. Contact us for questions on how the new revenue recognition standard will impact your financial statements and accounting systems. 

 
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The American Institute of Certified Public Accountants (AICPA) has clarified its guidance on pro forma compilations. Here’s an explanation of when the new Statement on Standards for Accounting and Review Services (SSARS) applies and what your CPA now expects from you when performing these nontraditional attestation services. 

Overview

SSARS 22 applies when an accountant has been engaged to perform a compilation engagement on pro forma financial information. Unlike forecasts or projections that reflect prospective financial results, pro forma financial information shows what the historical financial statements would have looked like had a transaction or event — such as a business combination, disposition of a business line or change in capitalization — occurred at an earlier date. 

The new guidance explains that a compilation engagement on pro forma financial information is often undertaken as a separate engagement. But it can also be done in conjunction with a compilation, a review or an audit of financial statements. 

Expectations for clients

When compiling pro forma statements, what do we expect from you? Under SSARS 22, the company’s management must 1) provide written acknowledgment that it accepts full responsibility for the preparation and fair presentation of the pro forma financial information in accordance with the applicable financial reporting framework, and 2) include (or make readily available) the following in any document containing the pro forma financial information:

  • Your company’s financial statements for the most recent year,
  • A summary of significant assumptions,
  • Interim period historical financial information, if interim period pro forma financial information is presented, and
  • In the case of a business combination, the relevant historical financial information for the significant constituent parts of the combined entity.

Financial statements and historical interim financial information are deemed to be “readily available” if a third party can obtain them without any further action by the entity. For example, historical interim financial information on a company’s website may be considered readily available. However, information that’s available upon request isn’t considered readily available.

Additionally, pro forma financial information must be based on historical financial statements that have been compiled, reviewed or audited. Moreover, the new standard requires you to ask your CPA for permission before including the compilation report in any document containing pro forma financial information that indicates that a compilation has been performed on such information. 

Up and running

SSARS 22 is effective for compilation reports on pro forma financial information dated on or after May 1, 2017. We understand these fundamental changes and have updated our practices to comply with the new guidance. Contact us for help compiling your pro formas.

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All charitable donations aren’t created equal — some provide larger deductions than others. And it isn’t necessarily just how much or even what you donate that matters. How the charity uses your donation might also affect your deduction. 

Take vehicle donations, for example. If you donate your vehicle, the value of your deduction can vary greatly depending on what the charity does with it. 

Determining your deduction

You can deduct the vehicle’s fair market value (FMV) if the charity:

  • Uses the vehicle for a significant charitable purpose (such as delivering meals-on-wheels to the elderly),
  • Sells the vehicle for substantially less than FMV in furtherance of a charitable purpose (such as a sale to a low-income person needing transportation), or
  • Makes “material improvements” to the vehicle.

But in most other circumstances, if the charity sells the vehicle, your deduction is limited to the amount of the sales proceeds. 

Getting proper substantiation

You also must obtain proper substantiation from the charity, including a written acknowledgment that:

  • Certifies whether the charity sold the vehicle or retained it for use for a charitable purpose,
  •  Includes your name and tax identification number and the vehicle identification number, and
  • Reports, if applicable, details concerning the sale of the vehicle within 30 days of the sale.

For more information on these and other rules that apply to vehicle donation deductions — or deductions for other charitable gifts — please contact us. 

 

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