Category: Article

Maintaining a healthy inventory of products to sell is always a balancing act, and it usually involves a lot of trial and error when your business is young. If you’re selling unique products that you’ve created yourself, it’s not so hard. You make one, you sell it, and your inventory is gone.

It gets trickier if you’re mass-producing the same item or buying items in bulk or wholesale. How many will you be able to sell? Your first estimates may be wildly off base. You take those early losses and try to make better buying decisions. You want to have enough products in stock that you don’t have to turn away sales, but you also don’t want to tie up a lot of money in excess inventory that isn’t moving.

As a business manager, you must learn on your own where that sweet spot is for every item you stock. It can take months or even years. QuickBooks Online can’t make those buying decisions for you, but it can warn you when you’re running low and when you have too much on hand that isn’t selling so well.

Here are several ways to improve that delicate balance.

Turn on the inventory tracking options

Click the gear icon in the upper right and scroll down to Sales on the Account and Settings page. In the Product and services section, make sure all of the options are set to On (we’ll get to price rules later). Be sure to click Done when you’re finished.

Detail matters on inventory product records

We’ve described the process of creating inventory item records before. You click the gear icon in the upper right corner and select Lists | Products and services. Click New in the upper right and Inventory in the panel that slides out from the right. You’re only required to complete three fields here: Name, Initial quantity on hand, and As of date. This allows you to include those item records in transactions. QuickBooks Online will subtract items when you sell them and keep your inventory level current.

The Reorder point field is very important. When the inventory level for that product drops to the number you specify, QuickBooks Online will let you know. In fact, when your cursor is on the QTY (quantity) field in an invoice, the three numbers pictured above will appear in a pop-out window (Quantity on PO automatically appears in the record based on your current purchase orders). Be sure you pay attention to this information when you’re selling products.

Set up flexible pricing

There may be times when you want to temporarily lower the price of a product or products because they’re just not selling. Maybe it’s a seasonal issue, and you expect that sales will pick up later. You can use QuickBooks Online’s Price rules. This tool allows you to discount certain products for a specified period.

Let’s say you’re overstocked on fountain pumps, and you want to discount them for a month to see if you can reduce your inventory level. Click the gear icon in the upper right again and select Lists | All lists | Price Rules. Click Create a rule and give it a Rule name. Price rules apply to all products and all customers by default. So, you’d leave Customer | All customers as is. Scroll down under Products and services and click Select individually. Under Price adjustment method, select Fixed amount. Choose Decrease by and 12, and in the next two fields, then No rounding. Enter the Start date and End date (optional).

Click +Add product or service, then click the down arrow in the field under Products in the lower half of the screen. Scroll down to Fountain Pump and select it. Your Adjusted Price should appear in that column. Click Apply rule, and then save it. This price will appear automatically when you create an invoice, though you can override it or delete it on the Price Rules page.

Use the site’s inventory reports

As you might imagine, QuickBooks Online offers excellent templates for inventory reports that you should be running on a regular basis. We talked about how the site alerts you to low stock levels when you’re creating invoices. But you should study the big picture on occasion. These reports are:

Inventory valuation summary. Transactions for each inventory item, and how they affect quantity on hand, value, and cost.

Inventory valuation detail. The quantity on hand, value, and average cost for each inventory item.

Physical inventory worksheet. Your inventory items, with space to enter your physical count so you can compare to the quantity on hand in QuickBooks Online. QuickBooks Online allows you to adjust inventory levels, but this should be done with great care.

You can also visit the Products & Services page, which displays a detailed profile of each item. If you’re low on stock or completely out, you’ll see that information at the top of the page.

We can’t advise you on the inventory levels you should be maintaining. Over time, this will become easier to gauge. But we’re here if you have questions about the mechanics of inventory management or any other element of QuickBooks Online.

© 2024 KraftCPAs PLLC

Divorce entails difficult personal issues, and taxes might not seem like a priority during that difficult process.

However, several concerns may need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are six financial issues that, if left unaddressed, can make the divorce proceedings even more traumatic:

Personal residence sale: In general, if a couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (if they’ve owned and used the home as their principal residence for two of the previous five years). If one former spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect this tax exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

Pension benefits: A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a qualified domestic relations order (QDRO). This gives one former spouse the right to share in the pension benefits of the other and taxes the former spouse who receives the benefits. Without a QDRO, the former spouse who earned the benefits will still be taxed on them even though they’re paid out to the other former spouse.

Filing status: If you’re still married at the end of the year, but in the process of getting divorced, you’re still treated as married for tax purposes. A financial advisor can help you determine how to file your 2024 tax return — as married filing jointly or married filing separately. Some separated individuals may qualify for head of household status if they meet the requirements.

Alimony or support payments: For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the former spouse making them. And the alimony payments aren’t included in the gross income of the former spouse receiving them. The rules are different for divorce or separation agreements executed before 2019. This was a change made in the Tax Cuts and Jobs Act. However, unlike some provisions of the law that are temporary, the repeal of alimony and support payment deduction is permanent.

Child support and child-related tax return filing: No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying former spouse (or taxable to the recipient). You and your ex-spouse will also need to determine who will claim your child or children on your tax returns to claim related tax breaks.

Business interests: If certain types of business interests are transferred in connection with divorce, care should be taken to make sure tax attributes aren’t forfeited. For example, interests in S corporations may result in suspended losses (losses that are carried into future years instead of being deducted in the year they’re incurred). When these interests change hands in a divorce, the suspended losses may be forfeited. If a partnership interest is transferred, a variety of more complex issues may arise involving partners’ shares of partnership debt, capital accounts, built-in gains on contributed property, and other complex issues.

A range of tax challenges

These are just some of the issues you may have to cope with if you’re getting a divorce. In addition, you may need to adjust your income tax withholding, and you should notify the IRS of any new address or name change. There are also estate planning considerations that an advisor can help resolve.

© 2024 KraftCPAs PLLC

 

Are you buying a business that will have one or more co-owners? Or do you already own one fitting that description? If so, consider installing a buy-sell agreement, which can be a big help in three ways:

• Transform your business ownership interest into a more liquid asset.
• Prevent unwanted ownership changes.
• Avoid hassles with the IRS.

Agreement basics

There are two basic types of buy-sell agreements: Cross-purchase agreements and redemption agreements (sometimes called liquidation agreements).

A cross-purchase agreement is a contract between you and the other co-owners. Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the remaining co-owners if a triggering event, such as a death or disability, occurs.

A redemption agreement is a contract between the business entity and its co-owners (including you). Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the entity if a triggering event occurs.

Triggering events

You and the other co-owners specify the triggering events you want to include in your agreement. You’ll certainly want to include obvious events like death, disability, and attainment of a stated retirement age. You can also include other events that you deem appropriate, such as divorce.

Valuation and payment terms

Make sure your buy-sell agreement stipulates an acceptable method for valuing the business ownership interests. Common valuation methods include using a fixed per-share price, an appraised fair market value figure, or a formula that sets the selling price as a multiple of earnings or cash flow.

Also ensure the agreement specifies how amounts will be paid out to withdrawing co-owners or their heirs under various triggering events.

Life insurance to fund the agreement

The death of a co-owner is perhaps the most common, and catastrophic, triggering event. You can use life insurance policies to form the financial backbone of your buy-sell agreement.

In the simplest case of a cross-purchase agreement between two co-owners, each co-owner purchases a life insurance policy on the other. If one co-owner dies, the surviving co-owner collects the insurance death benefit proceeds and uses them to buy out the deceased co-owner’s interest from the estate, surviving spouse or other heir(s). The insurance death benefit proceeds are free of any federal income tax, so long as the surviving co-owner is the original purchaser of the policy on the other co-owner.

However, a seemingly simple cross-purchase arrangement between more than two co-owners can get complicated, because each co-owner must buy life insurance policies on all the other co-owners. In this scenario, you may want to use a trust or partnership to buy and maintain one policy on each co-owner. Then, if a co-owner dies, the trust or partnership collects the death benefit proceeds tax-free and distributes the cash to the remaining co-owners. They then use the money to fund their buyout obligations under the cross-purchase agreement.

To fund a redemption buy-sell agreement, the business entity itself buys policies on the lives of all co-owners and then uses the death benefit proceeds buy out deceased co-owners.

Specify in your agreement that any buyout that isn’t funded with insurance death benefit proceeds will be paid out under a multi-year installment payment arrangement. This gives you (and any remaining co-owners) some breathing room to come up with the cash needed to fulfill your buyout obligation.

Create certainty for heirs

If you’re like many business co-owners, the value of your share of the business comprises a big percentage of your estate. Having a buy-sell agreement ensures that your ownership interest can be sold by your heir(s) under terms that you approved when you set it up. Also, the price set by a properly drafted agreement establishes the value of your ownership interest for federal estate tax purposes, thus avoiding possible IRS hassles.

As a co-owner of a valuable business, having a well-drafted buy-sell agreement in place is pretty much a no-brainer. It provides financial protection to you and your heir(s) as well as to your co-owners and their heirs. The agreement also can help ward off hassles with the IRS over estate taxes.

© 2024 KraftCPAs PLLC

With the estate tax exemption amount at $13.61 million for 2024, it would be tempting to brush off concerns over federal taxes. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it.

But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Congress could act to extend the higher amount or institute a new amount.

For now, at least, here are strategies to consider based on the current exemption amount.

Using the annual exclusion 

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility 

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

© 2024 KraftCPAs PLLC

Selling property that’s used in your trade or business isn’t as simple as signing on the dotted line. In fact, there are many complex rules that can apply to the sale.

To use a common example, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year.

Different rules can apply for property held primarily for sale to customers in the ordinary course of business, intellectual property, low-income housing, property that involves farming or livestock, and other types of property.

Basic rules

Under tax law, your gains and losses from sales of business property are netted against each other. The tax treatment is as follows:

1. If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. In other words, none of the rules that limit the deductibility of capital losses apply.

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. Under these rules, amounts are treated as ordinary income, rather than capital gain, because of previous ordinary loss or deduction treatment.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of long-term capital gain.

Different types of property

Under the Internal Revenue Code, different provisions address different types of property. For example:

Section 1245 property. This consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually real property that performs specific functions). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.

Section 1250 property. In general, this consists of buildings and their structural components. If you sell Section 1250 property that’s placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% plus the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% plus the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules apply to, respectively, Section 1250 property that you placed in service before 1987 but after 1980 and Section 1250 property that you placed in service before 1981.

As you can see, even based on the simple assumptions described here, the tax treatment of the sale of business assets can be complex. Consult an advisor to work through potential sticking points before the sale.

© 2024 KraftCPAs PLLC

Creating a comprehensive and actionable succession plan is rarely easy for business owners, but there are ways to go about succession planning in a slow, methodical manner that can make it relatively easier. In fact, it may strengthen the plan you eventually devise.

Lay down a foundation

Among the best ways to begin building the framework of your succession plan is to determine what you’ve got. You know you own a business, but how much is it worth, and what are its primary value drivers?

To determine these things, you can engage a qualified valuation expert familiar with your industry. Even if retirement is years or decades away, a valuation can provide fascinating and useful insights about your company that may inspire key strategic moves.

In addition, clearly outline your projected date and goals for retirement. That is, do you intend to retire outright or gradually retire by moving to a part-time schedule? Some business owners step down but keep a seat on the board of directors. You can pave your own road, but make sure that your plan is clear and followed.

Be sure to consider all stakeholders when thinking about succession planning. Discuss the topic with, as appropriate and applicable, your spouse and family members — particularly those involved in the business — as well as fellow business owners and your leadership team. Give them an opportunity to provide input and listen carefully to what they say.

You’ll also need to choose the best method to transfer ownership of the company, whether through a sale, stock gift, buy-sell agreement, trust, or other option. It’s also wise to address retirement and estate planning — how will your succession plan help fund your retirement and provide for your family and/or heirs?

Evaluate your business plan

Another important step is reviewing and revising your business plan to incorporate an eventual ownership succession. A business plan is essentially a baseline for monitoring progress and keeping the company on track. The targets laid out in the plan should serve as performance goals, and regular reviews of the plan can help determine whether the business is meeting those goals.

The plan should also define the responsibilities of each executive and manager. Your company’s succession depends on the leadership team’s ability to understand and carry out the financial and marketing objectives of the business plan.

This includes setting up a program to identify potential successors who are willing and able to take over — whether they be family members, employees or third parties — and to develop their abilities and transfer knowledge to them. Training can include industry certification courses, leadership workshops, and business management classes, as well as day-to-day mentoring and job shadowing.

Form an outside team

Perhaps the most straightforward way to make succession planning easier is to form a team of qualified, objective outside advisors to guide you through the process. Your advisory team should include a CPA, attorney, and qualified valuation expert. Many contractors also meet with business consultants or brokers, insurance experts, and estate planning advisors.

These experts can help you fine-tune the many minute details of your succession plan. When the time comes for you to step down, they can guide you through the execution process to minimize the financial risks and tax consequences of, say, activating a buy-sell agreement you’ve established with other owners.

Dream it, build it

It’s important to note that succession plans aren’t only for future retirees. There may be other callings, business ventures or life circumstances that eventually motivate you to step down from the helm of your company. A solid succession plan, laid out well in advance, can help preserve the legacy of the business you’ve worked so hard to build.

© 2024 KraftCPAs PLLC

Having your financial statements prepared by an external accountant provides a level of assurance to your company, lenders, and stakeholders – but exactly how much assurance might be up to you.

Assurance, simply put, refers to the level of understanding that your statements are reliable, accurate, and in conformity with U.S. Generally Accepted Accounting (GAAP) principles. Higher levels of assurance require more in-depth procedures – and often more time.

Here’s how the levels of assurance measure up.

Compilations and prepared statements

Compiled financial statements provide no assurance that they have no material misstatements or that they don’t require material changes to meet GAAP standards. Here, an accountant simply arranges the data provided by the company into a financial statement format that conforms to GAAP (or another framework). Footnote disclosures and cash flow information are optional in compiled financial statements.

Under the AICPA’s Statement on Standards for Accounting and Review Services (SSARS) No. 21, compilation reports are one paragraph long, unless the company follows a special-purpose framework (such as income tax basis or cash basis). In those cases, an extra paragraph is needed.

Another service that provides no assurance is prepared financial statements, which follows many of the same guidelines as compiled financials. The basic difference: Preparation statements don’t require the CPA to include a report. Instead, they simply contain a disclaimer on every page that no level of assurance has been provided. Prepared financial statements are often used by owners who formerly relied on management-use-only financial statements, which were eliminated under SSARS 21.

Reviewed statements

Reviews provide limited assurance that the statements are free from material misstatement and conform to GAAP. They start with internal financial data. Then, the accountant applies analytical procedures to identify unusual items or trends in the financial statements. He or she will also inquire about any anomalies and evaluate the company’s accounting policies and procedures.

Reviewed statements require footnote disclosures and a statement of cash flows. But the accountant isn’t required to evaluate internal controls, conduct testing and confirmation procedures, or physically inspect assets.

SSARS 21 calls for review reports to contain emphasis-of-matter (and other-matter) paragraphs when CPAs encounter significant disclosed or undisclosed matters that are relevant to stakeholders.

Audited statements

Audits are commonly considered the ultimate level of assurance in financial reporting. They provide reasonable assurance that the statements are free from material misstatement and conform to GAAP.

A lot of work goes into preparing audited financial statements. In addition to performing analytical procedures and conducting inquiries, auditors:

• Evaluate internal controls
• Verify information with third parties (such as customers and lenders)
• Observe inventory counts
• Physically inspect assets
• Assess other forms of substantive audit evidence

Public companies are required by the Securities and Exchange Commission to have their financial statements audited. In addition, many lenders require larger private companies to be audited. Nonprofit and governmental bodies also are often required to be audited regularly.

Fraud considerations

While audits aren’t required for every business, they can be an effective antifraud control, according to “Occupational Fraud 2024: A Report to the Nations” published by the Association of Certified Fraud Examiners (ACFE). There’s no level of assurance that provides an absolute guarantee against material misstatement or fraud. But the recent ACFE survey found that external audits are associated with a 52% reduction in fraud losses and a 50% reduction on the duration of fraud schemes.

The survey also revealed that only 59% of small victim-organizations (those with fewer than 100 employees) had audited financial statements, compared to an audit rate of 91% for larger victim-organizations. External audits may help detect fraud and deter would-be fraudsters who perceive that outsiders are reviewing their work.

Choosing the right level

When deciding which service to obtain for your business, consider three key factors:

1. The complexity of your business and its risk profile
2. The abilities of your in-house personnel to accurately report financial results that conform to GAAP
3. The expectations of your stakeholders

Though larger companies have more sophisticated finance and accounting departments, the nature of their transactions and their reliance on outside financing often necessitate an audit.

Time for a change?

Business owners and managers may decide to change their level of assurance over time. For example, a growing business might upgrade from a review to an audit to attract public company buyers or obtain more favorable financing terms. Or a stable midsize firm might decide to downgrade from an audit to a review, and then hire their accountant to perform certain agreed-upon procedures to evaluate high-risk accounts on a quarterly basis.

© 2024 KraftCPAs PLLC

If you’re a philanthropic person who’s also obligated to take required minimum distributions (RMDs) from a traditional IRA, you may want to consider a tax-saving strategy that involves making a qualified charitable distribution (QCD).

How it works

To reap the possible tax advantages of a QCD, you make a cash donation to an IRS-approved charity out of your IRA. This method of transferring IRA assets to charity leverages the QCD provision that allows IRA owners who are age 70½ or older to direct up to $105,000 of their IRA distributions to charity in 2024. For married couples, each spouse can make QCDs for a possible total of $210,000. When making QCDs, the money given to charity counts toward your RMDs but doesn’t increase your adjusted gross income (AGI) or generate a tax bill.

Keeping the donation amount out of your AGI may be important for several reasons. When distributions are taken directly out of traditional IRAs, federal income tax of up to 37% in 2024 will have to be paid. State income taxes may also be owed. That tax is avoided with a QCD. Here are some other potential benefits of a QCD:

1. It can help you qualify for other tax breaks. For example, having a lower AGI can reduce the threshold for itemizers who can deduct medical expenses, which are only deductible to the extent they exceed 7.5% of AGI.

2. You can avoid rules that can cause some or all of your Social Security benefits to be taxed, and some or all of your investment income to be hit with the 3.8% net investment income tax.

3. It can help you avoid a high-income surcharge for Medicare Part B and Part D premiums, which kick in if AGI is over certain levels.

Keep in mind that you can’t claim a charitable contribution deduction for a QCD not included in your income. Also keep in mind that the age after which you must begin taking RMDs is now 73, but the age you can begin making QCDs is 70½.

To benefit from a QCD for 2024, you must arrange for a distribution to be paid directly from the IRA to a qualified charity by December 31, 2024. You can use QCDs to satisfy all or part of the amount of your RMDs from your IRA. For example, if your 2024 RMDs are $20,000 and you make a $10,000 QCD, you’d have to withdraw another $10,000 to satisfy your 2024 RMDs.

© 2024 KraftCPAs PLLC

Business plans aren’t only for young companies seeking initial financing. They can also help established companies make strategic decisions and communicate with lenders and investors when they seek new capital infusions. Here’s an overview of specific items a comprehensive business plan should address, including historical and prospective financial statements.

Devising a detailed plan

Formal business plans usually are composed of six sections:

1. Executive summary
2. Business description
3. Industry and marketing analysis
4. Management team description
5. Implementation plan
6. Financials

A comprehensive business plan can be useful for internal planning, but it can also be used for external purposes. For example, it’s an essential part of the loan application process for start-ups and when a company needs financing for a major capital expenditure. A high-growth business might present its business plan to prospective investors, joint venture partners, or buyers. Lenders and creditors also might request one if a business is restructuring or teetering on the edge of bankruptcy.

While the length of business plans varies, they needn’t be long-winded. For a small business, the executive summary shouldn’t exceed one page, and the maximum number of pages should generally be fewer than 40.

Using historical results to predict the future

Business planning tells where the company is now — and where management expects it to be in three, five, or 10 years. Management’s goals should be realistic and measurable. So, most plans include a “financials” section to show how the company will achieve its goals.

For established businesses, this section starts with historical financial results (typically the past two years’ income statements, balance sheets, and cash flow statements). These reports show the company’s track record for generating profits and operating cash flow, managing working capital and assets, repaying debts, and paying dividends to shareholders.

Historical financial results can be used to identify key benchmarks that management wants to achieve over the long run. These assumptions drive forward-looking financial forecasts that show how much capital the company will need, how it plans to use those funds, and when it expects to repay loans or provide returns to investors.

For example, suppose a company that had $10 million in sales in 2023 expects to double that figure over a three-year period. How will the company get from Point A ($10 million in 2023) to Point B ($20 million in 2026)? Many roads may lead to the desired destination.

Let’s say the management team decides to double sales by hiring four new salespeople and acquiring the assets of a bankrupt competitor. These assumptions will drive the forecasted income statement, balance sheet, and cash flow statement.

When forecasting the income statement, management makes assumptions about variable and fixed costs. Direct materials are generally considered variable. Salaries and rent are generally fixed. But many fixed costs can be variable over the long term. Consider rent: Once a lease expires, management might relocate to a different facility to accommodate changes in size.

Balance sheet items — receivables, inventory, payables, and so on — are generally expected to grow in tandem with revenue. Cash flow forecasts are a critical part of a company’s plan. Management may make assumptions about its minimum cash balance, and then debt increases or decreases to keep the balance sheet balanced. For instance, a company might use a line of credit to fund any cash shortfalls that take place as it grows.

Seeking external guidance

Comprehensive business planning can be a complex, time-consuming endeavor, especially when it comes to pulling together reliable financial forecasts. However, lenders and investors tend to be critical of financials that are prepared in-house. CPA-prepared historical and forecasted financial statements can lend credibility to a company’s business plan — and offer fresh perspectives and market-based support for management’s assumptions.

© 2024 KraftCPAs PLLC

Choosing the right business entity has many implications, including the amount of your tax bill. The most common business structures are sole proprietorships, partnerships, limited liability companies, C corporations, and S corporations.

There are times when a business can benefit by switching from one entity type to another. In particular, S corporations can provide substantial tax benefits over C corporations in some circumstances, but there are potentially costly tax issues to consider before making the decision to convert from a C corporation to an S corporation.

Here are four considerations:

1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

Other issues to explore

These are only some of the factors to consider when switching a business from C to S status. For example, shareholder-employees of S corporations can’t get all the tax-free fringe benefits that are available as a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors must be considered to understand the implications of converting from C to S status.

© 2024 KraftCPAs PLLC

A growing number of companies are reporting significant goodwill impairment write-offs amid uncertain market conditions and rising interest rates.

In just the first quarter of 2024, for example, Walgreens recognized a $12.4 billion pretax impairment loss. That’s compared to a total of $82.9 billion among 353 public companies in 2023.

As additional public and private companies are expected to follow suit this year, is your business at risk? Let’s review the current accounting rules for measuring impairment losses.

The basics

Goodwill is an intangible asset that may be linked to such things as a company’s customer loyalty or business reputation. Many companies have internally developed goodwill that isn’t reported on their balance sheets. However, if goodwill is acquired through a merger or acquisition, it may be reported on the buyer’s financial statements.

The value of goodwill is determined by deducting, from the cost to buy a business, the fair value of tangible assets, identifiable intangible assets, and liabilities obtained in the purchase. It reflects the premium the buyer of a business pays over its fair value.

Investors are interested in tracking goodwill because it enables them to see how a business combination fares in the long run. In accounting periods after the acquisition date, acquired goodwill must be monitored for impairment. That happens when market conditions cause the fair value of goodwill (an indefinite-lived intangible asset) to fall below its cost.

Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.

Two sets of rules

The accounting rules for measuring and reporting impairment have been modified several times over the years, leading to some confusion among business owners, investors, and other stakeholders. Notably, different rules apply to public companies than private entities.

Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheets can’t amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.

Testing should also happen for all entities whenever a “triggering event” occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition, or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s an economic downturn that causes the parent company or the acquired business to lose value.

The Financial Accounting Standards Board (FASB) has granted private companies some practical expedients to simplify the subsequent accounting of goodwill and other intangibles. Specifically, Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, gave private companies that follow GAAP the option to amortize acquired goodwill over a useful life of up to 10 years.

The test that private businesses must perform to determine whether goodwill has lost value was also simplified in 2014. Instead of automatically testing for impairment every year, private companies are required to test only when there’s a triggering event.

The FASB proposed changing the accounting rules for public companies. Its proposal would have given public companies the option to amortize goodwill over a useful life of up to 10 years. However, after reviewing public comments and holding roundtable discussions, the FASB decided to table the proposal in 2022.

© 2024 KraftCPAs PLLC

Do you invest in mutual funds? Or maybe you’re interested in putting money into them? If so, you’re part of a large group. According to the Investment Company Institute, 116 million individual U.S. investors owned mutual funds in 2023. But despite their widespread use, the tax rules involved in selling mutual fund shares can be complex.

Review the basic rules

Let’s say you sell appreciated mutual fund shares that you’ve owned for more than one year. The resulting profit will be a long-term capital gain. As such, the maximum federal income tax rate will be 20%, and you may also owe the 3.8% net investment income tax. However, most taxpayers will pay a tax rate of only 15%, and some may even qualify for a 0% tax rate.

When a mutual fund investor sells shares, gain or loss is measured by the difference between the amount realized from the sale and the investor’s basis in the shares. One challenge is that certain mutual fund transactions are treated as sales even though they might not be thought of as such. Another problem may arise in determining your basis for shares sold.

A sale may unknowingly occur

It’s obvious that a sale occurs when an investor redeems all shares in a mutual fund and receives the proceeds. Similarly, a sale occurs if an investor directs the fund to redeem the number of shares necessary for a specific dollar payout.

It’s less obvious that a sale occurs if you’re swapping funds within a fund family. For example, you surrender shares of an income fund for an equal value of shares of the same company’s growth fund. No money changes hands, but this is considered a sale of the income fund shares.

Another example is when investors write checks on their funds. Many mutual funds provide check-writing privileges to their investors. Although it may not seem like it, each time you write a check on your fund account, you’re making a sale of shares.

Figuring the basis of shares 

If an investor sells all shares in a mutual fund in a single transaction, determining basis is relatively easy. Simply add the basis of all the shares (the amount of actual cash investments), including commissions or sales charges. Then, add distributions by the fund that were reinvested to acquire additional shares and subtract any distributions that represent a return of capital.

The calculation is more complex if you dispose of only part of your interest in the fund and the shares were acquired at different times for different prices. You can use one of several methods to identify the shares sold and determine your basis:

First-in, first-out. The basis of the earliest acquired shares is used as the basis for the shares sold. If the share price has been increasing over your ownership period, the older shares are likely to have a lower basis and result in more gain.

Specific identification. At the time of sale, you specify the shares to sell. For example, “sell 100 of the 200 shares I purchased on June 1, 2020.” You must receive written confirmation of your request from the fund. This method may be used to lower the resulting tax bill by directing the sale of the shares with the highest basis.

Average basis. The IRS permits you to use the average basis for shares that were acquired at various times and that were left on deposit with the fund or a custodian agent.

© 2024 KraftCPAs PLLC