Anderson ZurMuehlen Blog

Put Your Income Statement to Good Use

By midyear, most businesses that follow U.S. Generally Accepted Accounting Principles (GAAP) have issued their year-end financial statements. But how many have actually used them to improve their business operations in the future? Producing financial statements is more than a matter of compliance — owners and managers can use them to analyze performance and find ways to remedy inefficiencies and anomalies. How? Let’s start by looking at the income statement.

Benchmarking performance

Ratio analysis facilitates comparisons over time and against industry norms. Here are four ratios you can compute from income statement data:

1. Gross profit. This is profit after cost of goods sold divided by sales. This critical ratio indicates whether the company can operate profitably. It’s a good ratio to compare to industry statistics because it tends to be calculated on a consistent basis.

2. Net profit margin. This is calculated by dividing net income by sales and is the ultimate scorecard for management. If the margin is rising, the company must be doing something right. Often, this ratio is computed on a pretax basis to accommodate for differences in tax rates between pass-through entities and C corporations.

3. Return on assets. This is calculated by dividing net income by the company’s total assets. The return shows how efficiently management is using its assets.

4. Return on equity. This is calculated by dividing net profits by shareholders’ equity. The resulting figure tells how well the shareholders’ investment is performing compared to competing investment vehicles.

For all four profitability ratios, look at two key elements: changes between accounting periods and differences from industry averages.

Plugging profit drains

What if your company’s profitability ratios have deteriorated compared to last year or industry norms? Rather than overreacting to a decline, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of a macroeconomic trend.

If the industry is healthy, yet a company’s margins are falling, management may need to take corrective measures, such as:

  • Reining in costs,
  • Investing in technology, and/or
  • Looking for signs of fraud.

For example, if an employee is colluding with a supplier in a kickback scam, direct materials costs may skyrocket, causing the company’s gross profit to fall.

Playing detective

For clues into what’s happening, study the main components of the income statement: gross sales, cost of sales, and selling and administrative costs. Determine if line items have fallen due to company-specific or industrywide trends by comparing them to public companies in the same industry. Also, monitor trade publications, trade associations and the Internet for information. Contact us to discuss possible causes and brainstorm ways to fix any problems.

©2017

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Seasonal business? Optimize your operating cycle

Every business has some degree of ups and downs during the year. But cash flow fluctuation OKs are much more intense for seasonal businesses. So, if your company defines itself as such, it’s important to optimize your operating cycle to anticipate and minimize shortfalls.

A high-growth example

To illustrate: Consider a manufacturer and distributor of lawn-and-garden products such as topsoil, potting soil and ground cover. Its customers are lawn-and-garden retailers, hardware stores and mass merchants.

The company’s operating cycle starts when customers place orders in the fall — nine months ahead of its peak selling season. So the business begins amassing product in the fall, but curtails operations in the winter. In late February, product accumulation continues, with most shipments going out in April.

At this point, a lot of cash has flowed out of the company to pay operating expenses, such as utilities, salaries, raw materials costs and shipping expenses. But cash doesn’t start flowing into the company until customers pay their bills around June. Then, the company counts inventory, pays remaining expenses and starts preparing for the next year. Its strategic selling window — which will determine whether the business succeeds or fails — lasts a mere eight weeks.

The power of projections

Sound familiar? Ideally, a seasonal business such as this should stockpile cash received at the end of its operating cycle, and then use those cash reserves to finance the next operating cycle. But cash reserves may not be enough — especially for high-growth companies.

So, like many seasonal businesses, you might want to apply for a line of credit to avert potential shortfalls. To increase the chances of loan approval, compile a comprehensive loan package, including historical financial statements and tax returns, as well as marketing materials and supplier affidavits (if available).

More important, draft a formal business plan that includes financial projections for next year. Some companies even project financial results for three to five years into the future. Seasonal business owners can’t rely on gut instinct. You need to develop budgets, systems, processes and procedures ahead of the peak season to effectively manage your operating cycle.

Distinctive challenges

Seasonal businesses face many distinctive challenges. Please contact our firm for assistance overcoming these obstacles and strengthening your bottom line.

Contact us for more information.

©2017

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How to Shape Up Your Working Capital

Working capital — current assets minus current liabilities — is a common measure of liquidity. High liquidity generally equates with low risk, but excessive amounts of cash tied up in working capital may detract from growth opportunities and other spending options, such as expanding to new markets, buying equipment and paying down debt. Here are some recent working capital trends and tips for keeping your working capital in shape.

Survey says

Working capital management among U.S. companies has been relatively flat over the last four years, excluding the performance of oil and gas companies, according to the 2016 U.S. Working Capital Survey published by consulting firm REL and CFO magazine. The overall results were skewed somewhat because oil and gas companies increased their inventory reserves to take advantage of low oil prices, thereby driving up working capital balances for that industry.

The study estimates that, if all of the 1,000 companies surveyed managed working capital as efficiently as do the companies in the top quartile of their respective industries, more than $1 trillion of cash would be freed up from receivables, inventory and payables.

Rather than improve working capital efficiency, however, many companies have chosen to raise cash with low interest rate debt. Companies in the survey currently carry roughly $4.86 trillion in debt, more than double the level in 2008. As the Federal Reserve Bank increases rates, companies will likely look for ways to manage working capital better.

Efficiency initiatives

How can your company decrease the amount of cash that’s tied up in working capital? Best practices vary from industry to industry. Here are three effective exercises for improving working capital:

Expedite collections. Possible solutions for converting receivables into cash include: tighter credit policies, early bird discounts, collection-based sales compensation and in-house collection personnel. Companies also can evaluate administrative processes — including invoice preparation, dispute resolution and deposits — to eliminate inefficiencies in the collection cycle.

Trim inventory. This account carries many hidden costs, including storage, obsolescence, insurance and security. Consider using computerized inventory systems to help predict demand, enable data-sharing up and down the supply chain, and more quickly reveal variability from theft.

Postpone payables. By deferring vendor payments, your company can increase cash on hand. But be careful: Delaying payments for too long can compromise a firm’s credit standing or result in forgone early bird discounts.

From analysis to action

No magic formula exists for reducing working capital, but continuous improvement is essential. We can help train you on how to evaluate working capital accounts, identify strengths and weaknesses, and find ways to minimize working capital without compromising supply chain relationships.

 

Contact us for more information.

©2017

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Create a Strong System of Checks and Balances

 

The Securities and Exchange Commission (SEC) requires public companies to evaluate and report on internal controls over financial reporting using a recognized control framework. Private companies generally aren’t required to use a framework for the oversight of internal controls, unless they’re audited, but a strong system of checks and balances is essential for them as well.

A critical process

Reporting on internal controls is an ongoing process, not a one-time assessment, that’s affected by an entity’s board of directors or owners, management, and other personnel. It’s designed to provide reasonable assurance regarding the effectiveness and efficiency of operations, the reliability of financial reporting, compliance with applicable laws and regulations, and safeguarding of assets.

A strong system of internal controls helps a company achieve its strategic and financial goals, in addition to minimizing the risk of fraud. At the most basic level, auditors routinely monitor the following three control features. These serve as a system of checks and balances that help ensure management directives are carried out:

1. Physical restrictions. Employees should have access to only those assets necessary to perform their jobs. Locks and alarms are examples of ways to protect valuable tangible assets, including petty cash, inventory and equipment. But intangible assets — such as customer lists, lease agreements, patents and financial data — also require protection using passwords, access logs and appropriate legal paperwork.

2. Account reconciliation. Management should confirm and analyze account balances on a regular basis. For example, management should reconcile bank statements and count inventory regularly.

Interim financial reports, such as weekly operating scorecards and quarterly financial statements, also keep management informed. But reports are useful only if management finds time to analyze them and investigate anomalies. Supervisory review takes on many forms, including observation, test counts, inquiry and task replication.

3. Job descriptions. Another basic control is detailed job descriptions. Company policies also should call for job segregation, job duplication and mandatory vacations. For example, the person who receives customer payments should not also approve write-offs (job segregation). And two signatures should be required for checks above a prescribed dollar amount (job duplication).

Controls assessment

Is your company’s internal control system strong enough? Even if you’re not required to follow the SEC’s rules on assessing internal controls, a thorough system of checks and balances will help your company achieve its goals. Company insiders sometimes lack the experience or objectivity to assess internal controls. But our auditors have seen the best — and worst — internal control systems and can help evaluate whether your controls are effective.

Contact us for more information.

©2017

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3 Financial Statements You Should Know

Successful business people have a solid understanding of the three financial statements prepared under U.S. Generally Accepted Accounting Principles (GAAP). A complete set of financial statements helps stakeholders — including managers, investors and lenders — evaluate a company’s financial condition and results. Here’s an overview of each report.

1. Income statement

The income statement (also known as the profit and loss statement) shows sales, expenses and the income earned after expenses over a given period. A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product.

Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.

2. Balance sheet

This report tallies the company’s assets, liabilities and net worth to create a snapshot of its financial health. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Net worth or owners’ equity is the extent to which the book value of assets exceeds liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your liabilities exceeds the value of the assets, your net worth will be negative.

Public companies may provide the details of shareholders’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.

3. Cash flow statement

This statement shows all the cash flowing into and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

Although this report may seem similar to an income statement, it focuses solely on cash. It’s possible for an otherwise profitable business to suffer from cash flow shortages, especially if it’s growing quickly.

Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. To remain in business, companies must continually generate cash to pay creditors, vendors and employees. So watch your statement of cash flows closely.

Ratios and trends

Are you monitoring ratios and trends from your financial statements? Owners and managers who pay regular attention to these three key reports stand a better chance of catching potential trouble before it gets out of hand and pivoting, when needed, to maximize the company’s value.

Contact us for more information.

©2017

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Don’t Make Hunches – Crunch the Numbers

 

Some business owners make major decisions by relying on gut instinct. But investments made on a “hunch” often fall short of management’s expectations.

In the broadest sense, you’re really trying to answer a simple question: If my company buys a given asset, will the asset’s benefits be greater than its cost? The good news is that there are ways — using financial metrics — to obtain an answer.

Accounting payback

Perhaps the most common and basic way to evaluate investment decisions is with a calculation called “accounting payback.” For example, a piece of equipment that costs $100,000 and generates an additional gross margin of $25,000 per year has an accounting payback period of four years ($100,000 divided by $25,000).

But this oversimplified metric ignores a key ingredient in the decision-making process: the time value of money. And accounting payback can be harder to calculate when cash flows vary over time.

Better metrics

Discounted cash flow metrics solve these shortcomings. These are often applied by business appraisers. But they can help you evaluate investment decisions as well. Examples include:

Net present value (NPV). This measures how much value a capital investment adds to the business. To estimate NPV, a financial expert forecasts how much cash inflow and outflow an asset will generate over time. Then he or she discounts each period’s expected net cash flows to its current market value, using the company’s cost of capital or a rate commensurate with the asset’s risk. In general, assets that generate an NPV greater than zero are worth pursuing.

Internal rate of return (IRR). Here an expert estimates a single rate of return that summarizes the investment opportunity. Most companies have a predetermined “hurdle rate” that an investment must exceed to justify pursuing it. Often the hurdle rate equals the company’s overall cost of capital — but not always.

A mathematical approach

Like most companies, yours probably has limited funds and can’t pursue every investment opportunity that comes along. Using metrics improves the chances that you’ll not only make the right decisions, but that other stakeholders will buy into the move. Please contact our firm for help crunching the numbers and managing the decision-making process.

©2017

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Financial Survival Tips for Recent College Graduates

Graduation can be one of the most exciting — and intimidating — times in your life. You’re officially an adult, and with that new-found independence comes financial responsibilities. No pressure, but the decisions you make today about spending and saving can mean the difference between struggling for the rest of your life and building a solid financial future.

Here’s a list of important questions to consider as you start your journey:

1. Where Should You Live?

Depending on where you want to live and how much you earn, you probably can’t move into your dream home right away. The cost of a studio in a big city could potentially get you a huge place out in the country. Your location of choice is tied to many variables — job, family and personal preferences.

To avoid overspending, be realistic about how much you can afford. As a rule of thumb, roughly one-third of your net monthly take-home pay should be used to finance the place you live. If your starting income is modest, you’ll likely pay a higher percentage for housing.

If you decide to rent, always read the entire lease before signing on the dotted line. Find out such details as how long the lease lasts, whether it includes utilities and if there are any fees for terminating the lease early.

If you’ve already saved up money for a down payment, consider buying a condo or single family home. Interest rates are near historic lows. And the sooner you purchase, the quicker you start building equity and claiming tax benefits that come with owning a home.

If you can find a roommate, you’ll have extra money for other living expenses, such as furniture and bills for phone, cable TV and Internet access. Also, don’t forget renter’s insurance to cover your personal belongings in the event of a theft, fire, flood or other disaster. Alternatively, consider the upsides of living with your parents for a little while longer. (See “The Boomerang Generation” at right.)

2. How Much Should You Save Each Month?

No one wants to live paycheck to paycheck. Doing so can lead to significant stress if you lose your job, become disabled or incur a major expense (like a medical bill or car repair). It’s smart to set aside a predetermined amount from each paycheck that goes directly into savings. This amount should be separate from your retirement savings (see below).

Keeping a separate savings account will help prevent you from thinking that this amount is part of your disposable income. As a rule of thumb, you should try to build a “rainy day fund” that equals three to six months of net monthly take-home pay. When the unexpected strikes, you’ll be glad you saved.

3. Why Should You Begin Saving for Retirement Now?

It may seem premature to think about retirement when you start your first real job. But you can amass a large nest egg by saving small amounts when you’re young, because your contributions have time to compound. Plus, any money you put into tax-deferred accounts lowers your taxes in the year you contribute. (Income taxes will be due when you eventually withdraw funds from these accounts, however.)

If your employer offers a retirement plan, such as a 401(k) plan, sign up as soon as possible. Also, find out if your employer makes “matching contributions.” This means the employer adds in a percentage, say 25% or 50%, for every dollar you contribute. Besides employer-provided plans, there are many other retirement planning tools. For example, Roth and traditional IRAs may be beneficial, depending on your personal situation.

As an added bonus, you may be able to borrow from a 401(k) account or take money from an IRA, without paying an early withdrawal penalty, for several reasons, including the purchase of a first home.

4. Do You Need to Buy (or Finance) a Car?

After putting money toward living expenses, savings and retirement, new graduates need to budget for another essential: transportation. Again, you might not be able to afford your dream car right away. Moreover, a car may not be a necessity, especially if you live and work in a city with reliable public transportation.

If you decide to buy a car, consider saving money with a used car. Another way to save money is to look for a car loan with the lowest possible interest rate by:

    • Checking your credit. Consider a co-signer if your credit rating isn’t very good or if you haven’t established any credit rating yet.

 

  • Shopping around for interest rates at your bank, credit union and various car dealerships. Try to get quotes from at least three different sources.

If you finance a vehicle through the dealership (because it’s convenient) and later find a lower rate elsewhere, you can pay off the original loan with the lower rate loan. Just make sure the original loan doesn’t include any prepayment penalties. Some homeowners even use home equity loans to finance their vehicles, because the interest is generally tax deductible.

5. What Types of Insurance Do You Need?

Graduation is a good time to make critical decisions about auto, health and life insurance coverage.

Most new graduates get their health insurance coverage through an employer. If you’re unemployed or your employer doesn’t provide coverage, you may be allowed to stay on your parents’ policy for a few more years (until you turn 26). This is likely to hold true even if the Affordable Care Act (ACA) is repealed, as that provision was retained in the bill to repeal the ACA, which stalled in the House earlier this year.

If you can’t get coverage through a parent’s health insurance provider, you need to consider other ways to comply with the ACA’s individual mandate — or you’ll face the shared responsibility penalty. Nonexempt U.S. citizens and legal residents will generally owe this penalty if they fail to have minimum essential coverage for themselves and their dependents for any particular month. Coverage options for the unemployed include:

    • Certain government sponsored programs (such as Medicare, Medicaid, and the Children’s Health Insurance Program),

 

    • Plans obtained on the individual market,

 

    • Certain grandfathered group health plans, and

 

  • Certain other coverage specified by the U.S. Department of Health and Human Services in coordination with the IRS.

There are a number of exceptions to the penalty, such as the one for eligible lower-income individuals and the one for some people whose existing health insurance plans were canceled.

Also consider obtaining life insurance. If you sign up when you’re young and healthy, the rates are generally less expensive. Depending on your needs later in life, as well as health issues that can creep up over time, the cost could rise significantly in the future.

6. How Can Discretionary Spending Help You Build Credit?

Any money that’s left over from your paycheck is available for discretionary items, such as vacations, dining out, pets, clothing and personal pampering. Credit cards can be a convenient way to pay for discretionary items, and, as an added bonus, they often accrue rewards points that can be redeemed in the future.

If you don’t already have a credit card, sign up for one to help build credit. But resist the temptation to spend beyond your means. Always pay off your credit cards in full monthly — or you’ll likely incur high interest rates on any unpaid balances. Interest-free financing offers (for, say, a mattress or an appliance) can be another way to save money and build credit, but you must pay off the balance in full before the deal expires — or you’ll incur high interest charges from the original purchase date.

Need Help?

As soon as you graduate, it’s important to establish relationships with tax, business and legal advisors. During your career, you’ll likely need help from experienced professionals who can assist you as your needs evolve. By initiating these relationships now, you’ll know whom to contact when help is needed.

©2017

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10 Simple (and Fun) Ways to Cut Taxes This Summer

It’s already starting to feel like summer in many parts of the country. But the forecast for Washington remains unclear as officials continue to discuss various tax-related issues.

No matter what happens in Washington, don’t get stuck in a holding pattern yourself. Give some attention to business and personal tax planning this summer. Here are 10 ideas that combine tax planning with summertime fun.

1. Entertain top business clients. You may be eligible to write off 50% of the cost of business meals and entertainment if you entertain clients before or after a substantial business discussion. For instance, after you hammer out a business deal, you might treat a client to a round of golf and then dinner and drinks. The 50% limit applies to all the qualified expenses, including the amounts you pay for the client, yourself and your significant others.

2. Throw a company picnic. You can generally deduct the cost of a picnic, barbecue or similar get-together. Not only will such an event provide your workers an opportunity to relax and socialize, but the 50% limit on meals and entertainment expense deductions also won’t apply. There is one caveat: The benefit must be primarily for your employees, who are not “highly compensated” under tax law. Otherwise, expenses are deductible under the regular business entertainment rules.

3. Donate household items to charity. Are you planning to clean out the garage, attic or basement this summer? If so, you’ll probably find household goods — such as clothing and furniture — that you don’t want or need anymore. Consider donating these items to charity. Assuming they’re still in good condition, you may take a charitable deduction on your 2017 personal tax return based on the current fair market value of any donated items. Use an online guide or consult your tax professional for valuations.

4. Send the kids to day camp. Parents who need to work may decide to send young children to summer day camp while school is out. Assuming certain requirements are met, the cost may qualify for a dependent care credit. Generally, the maximum credit is $600 for one child and $1,200 for two or more kids. Note that specialty day camps for athletics or the arts qualify for this break, but overnight camp doesn’t qualify. (Remember, tax credits lower your tax liability dollar for dollar, unlike deductions, which lower the amount of income that’s taxed.)

5. Buy an RV or boat. If you take out a loan to purchase a recreational vehicle (RV) or boat for personal use this summer, the vehicle or vessel may qualify as a second home for federal income tax purposes. In other words, you may be eligible to write off the interest on the loan as mortgage interest on your personal tax return.

The IRS says that any dwelling place qualifies as a second home if it has sleeping space, a kitchen and toilet facilities. Therefore, the interest paid to buy an RV or boat that meets these requirements is tax-deductible under the mortgage interest rules. This deduction is available for interest paid on a combined total of up to $1 million of mortgage debt used to acquire, build or improve a principal residence and a second residence. Interest on additional home equity debt of up to $100,000 may also be deductible.

6. Minimize vacation home use. Federal tax law allows you to deduct expenses related to renting out a vacation home to offset the rental income you receive. With summer already underway, you’ve probably worked out a rental schedule for your vacation home, but remember that you can’t deduct a loss if your personal use of the home exceeds the greater of 14 days or 10% of the time the home is rented out. If you expect to experience a loss, watch your personal use to ensure you remain below the 14-day or 10% limit. Other rules, however, might still limit your loss deduction.

7. Rent out your primary residence. Do you live in an area where a summertime event — such as a major golf tournament, arts festival or marathon — will be held? If you rent out your home for no more than two weeks during the year, you don’t have to comply with the usual tax rules. In other words, you don’t have to report the rental income — it’s completely tax-free — but you can’t deduct rental-based expenses either.

8. Take advantage of business travel. Suppose you’re required to go on a business trip this summer. You can write off much of your travel expenses as long as the trip’s primary purpose is business-related — even if you indulge in some vacationing. For instance, if you spend the business week in meetings and the weekend sightseeing, the entire cost of your airfare plus business-related meals, lodging and local transportation is deductible within the usual tax law limits. Just don’t deduct any personal expenses you incur.

9. Support a recent graduate. If your child just graduated from college, this is probably the last year you can claim a dependency exemption for him or her. However, you must provide more than half of the child’s annual support to qualify for the $4,050 exemption.

To clear the half-support threshold, consider giving the graduate a generous graduation gift, such as a car to be used on the first job. Doing so will provide your child with a practical gift, as well as possibly helping you clear the support threshold required to claim a dependency exemption. Unfortunately, dependency exemptions may be reduced for high-income taxpayers. Consult a tax professional about this tax issue before purchasing a major graduation gift. It could impact the amount you’re willing to spend.

10. “Go fishing” for deductions. The IRS won’t allow you to claim deductions for an “entertainment facility,” such as a boat or hunting lodge. But you can still write off qualified out-of-pocket entertainment expenses, subject to the 50% limit. For example, if you take a client out on your boat, no depreciation deduction is allowed — but you may be eligible to write off the 50% of the costs of boat fuel, food and drinks, and even the fish bait, if you qualify under the usual business entertainment rules.

More Tips Available

These tips show that tax planning doesn’t have to be tedious. Whether you decide to ship the kids off to day camp or take the plunge of buying a boat, summer tax planning can actually be fun — and your tax advisor may have other creative ideas. With the proper planning, you can bask in the sun and tax-saving opportunities all summer long.

©2017

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Real Estate Investor vs. Professional: Why It Matters

Income and losses from investment real estate or rental property are passive by definition — unless you’re a real estate professional. Why does this matter? Passive income may be subject to the 3.8% net investment income tax (NIIT), and passive losses generally are deductible only against passive income, with the excess being carried forward.

Of course the NIIT is part of the Affordable Care Act (ACA) and might be eliminated under ACA repeal and replace legislation or tax reform legislation. But if/when such legislation will be passed and signed into law is uncertain. Even if the NIIT is eliminated, the passive loss issue will still be an important one for many taxpayers investing in real estate.

“Professional” requirements

To qualify as a real estate professional, you must annually perform:

  • More than 50% of your personal services in real property trades or businesses in which you materially participate, and
  • More than 750 hours of service in these businesses.

Each year stands on its own, and there are other nuances. (Special rules for spouses may help you meet the 750-hour test.)

Tax strategies

If you’re concerned you’ll fail either test and be subject to the 3.8% NIIT or stuck with passive losses, consider doing one of the following:

Increasing your involvement in the real estate activity. If you can pass the real estate professional tests, the activity no longer will be subject to passive activity rules.

Looking at other activities. If you have passive losses from your real estate investment, consider investing in another income-producing trade or business that will be passive to you. That way, you’ll have passive income that can absorb some or all of your passive losses.

Disposing of the activity. This generally allows you to deduct all passive losses — including any loss on disposition (subject to basis and capital loss limitations). But, again, the rules are complex.

Also be aware that the IRS frequently challenges claims of real estate professional status — and is often successful. One situation where the IRS commonly prevails is when the taxpayer didn’t keep adequate records of time spent on real estate activities.

If you’re not sure whether you qualify as a real estate professional, please contact us. We can help you make this determination and guide you on how to properly document your hours.

©2017

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Operating Across State Lines Presents Tax Risks – Or Possibly Rewards

 

It’s a smaller business world after all. With the ease and popularity of e-commerce, as well as the incredible efficiency of many supply chains, companies of all sorts are finding it easier than ever to widen their markets. Doing so has become so much more feasible that many businesses quickly find themselves crossing state lines.

But therein lies a risk: Operating in another state means possibly being subject to taxation in that state. The resulting liability can, in some cases, inhibit profitability. But sometimes it can produce tax savings.

Do you have “nexus”?

Essentially, “nexus” means a business presence in a given state that’s substantial enough to trigger that state’s tax rules and obligations.

Precisely what activates nexus in a given state depends on that state’s chosen criteria. Triggers can vary but common criteria include:

  • Employing workers in the state,
  • Owning (or, in some cases even leasing) property there,
  • Marketing your products or services in the state,
  • Maintaining a substantial amount of inventory there, and
  • Using a local telephone number.

Then again, one generally can’t say that nexus has a “hair trigger.” A minimal amount of business activity in a given state probably won’t create tax liability there. For example, an HVAC company that makes a few tech calls a year across state lines probably wouldn’t be taxed in that state. Or let’s say you ask a salesperson to travel to another state to establish relationships or gauge interest. As long as he or she doesn’t close any sales, and you have no other activity in the state, you likely won’t have nexus.

Strategic moves

If your company already operates in another state and you’re unsure of your tax liabilities there — or if you’re thinking about starting up operations in another state — consider conducting a nexus study. This is a systematic approach to identifying the out-of-state taxes to which your business activities may expose you.

Keep in mind that the results of a nexus study may not be negative. You might find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state (if you don’t already have it) by, say, setting up a small office there. If all goes well, you may be able to allocate some income to that state and lower your tax bill.

The complexity of state tax laws offers both risk and opportunity. Contact us for help ensuring your business comes out on the winning end of a move across state lines.

 

©2017

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