Category: Article

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

The Tax Cuts and Jobs Act (TCJA) was signed into law in 2017 and generally took effect at the start of 2018. It brought sweeping changes to tax regulations for both individuals and businesses.

But many of its provisions aren’t permanent. In fact, some of the most important ones are scheduled to expire after 2025. Although the outcome of the November election is expected to affect the fate of many expiring provisions, now’s still a good time for business owners to read up on the impending tax law changes and plan for their potential impact.

Key provisions at risk

Essentially, if no significant tax legislation is passed by late 2025, many of the law’s provisions will return to pre-TCJA levels. Key individual provisions scheduled to expire December 31, 2025, include:

• The top individual income tax rate on ordinary income, which will return to 39.6% (up from 37% currently)
• The standard deductions for individuals, which will return to lower pre-TCJA levels after being roughly doubled under the TCJA
• The gift and estate tax exemptions, which will drop to $5 million (though indexed for inflation) from the current $13.61 million

Other provisions that may be felt by business owners include:

The Section 199A deduction for many “pass-through” entities. Under this provision, owners of sole proprietorships and eligible pass-through entities (most partnerships and S corporations) may qualify for a deduction of up to 20% of qualified business income (QBI). It’s a substantial tax break that’s intended to put pass-through entities on more equal footing tax-wise with C corporations eligible for the flat 21% corporate tax rate, which isn’t scheduled to expire.

Business income for pass-through entities is taxed according to ordinary individual income tax rates. And unless Congress acts to extend the QBI deduction, it won’t be available after 2025, potentially substantially increasing tax liability for these entities.

Employer credit for paid family and medical leave. Under the TCJA, eligible employers that continue to pay wages while employees are on qualified family and medical leave may be able to claim a tax credit calculated as a percentage of wages paid while on leave. This credit won’t be available after 2025 unless Congress acts to extend it.

Accelerated depreciation. Under bonus depreciation, eligible companies can immediately deduct a certain percentage of the cost of qualifying asset purchases in the year those assets are placed in service. This has been a particularly useful tax break for construction businesses, which must regularly invest in heavy equipment and vehicles. Unfortunately, it’s being phased out.

The TCJA initially raised bonus depreciation’s deductible percentage to a full 100%. But it fell to 80% in 2023 and then to 60% this year. It’s scheduled to continue decreasing annually to 40% for 2025 and 20% for 2026 before vanishing in 2027. After 2026, absent congressional action, companies will generally have to capitalize the cost of asset purchases and recover those costs much more slowly — unless the asset purchases qualify for Sec. 179 expensing.

The TCJA also increased the Sec. 179 deduction. In 2024, companies may be able to claim first-year-in-service deductions of up to $1.22 million for eligible asset purchases (subject to various limitations). Before the TCJA, Sec. 179 deductions were limited to a mere $500,000. Fortunately, the higher limit isn’t scheduled to expire, and it will continue to be indexed for inflation annually.

Matters to consider

Because of the scheduled increase in individual tax rates and lower standard deductions, business owners that operate their companies as sole proprietorships, most forms of partnerships, and S corporations — and that don’t itemize deductions — may want to consider accelerating income to take advantage of the lower tax rates and higher standard deductions through 2025.

Beyond that, you may want to evaluate the tax accounting methods your business uses on a contract-by-contract basis, particularly in an industry such as construction. Several options are available to align tax payments with contract revenue — including the accrual method, which allows eligible contractors to recognize revenue as soon as they bill for work, regardless of payment status.

Also, to the extent possible, forecast whether you’ll need to make any big-ticket asset purchases in upcoming years — and, if so, which ones. You may want to buy equipment, vehicles and other qualifying items while bonus depreciation is still available and before it decreases any further.

Bear in mind that your company may be able to combine bonus depreciation with the Sec. 179 deduction in the same tax year.

© 2024 KraftCPAs PLLC

Are you an older taxpayer who owns a house that has appreciated greatly? At the same time, maybe you need extra income?

A solution could involve a reverse mortgage, and it could include a tax-saving bonus.

Reverse mortgage basics

With a reverse mortgage, the borrower doesn’t make payments to the lender to pay down the mortgage principal over time. Instead, the reverse happens. The lender makes payments to you and the mortgage principal gets bigger over time. Interest accrues on the reverse mortgage and is added to the loan balance. But you typically don’t have to repay anything until you permanently move out of the home or pass away.

You can receive reverse mortgage proceeds as a lump sum, in installments over time, or as line-of-credit withdrawals. So, with a reverse mortgage, you can stay in your home while converting some of the equity into much-needed cash. In contrast, if you sell your highly appreciated residence to raise cash, it could involve relocating and a big tax bill.

Most reverse mortgages are so-called home equity conversion mortgages, or HECMs, which are insured by the federal government. You must be at least 62 years old to be eligible. For 2024, the maximum HECM allowed is a little over $1.1 million. However, the maximum you can actually borrow depends on the value of your home, your age, and the amount of any existing mortgage debt against the property. Reverse mortgage interest rates can be fixed or variable depending on the deal. Interest rates can be higher than for regular home loans, but not by much.

Basis step-up and reverse mortgage to the rescue

An unwelcome side effect of owning a highly appreciated home is that selling your property could trigger a taxable gain well over the federal home sale gain exclusion tax break. The exclusion is up to $250,000 for unmarried individuals, or $500,000 for married couples filing jointly. The tax bill from a big gain can be painful, especially if you live in a state with a personal income tax. If you sell, you lose all the tax money.

Fortunately, taking out a reverse mortgage on your property instead of selling it can help you avoid this tax bill. Plus, you can raise needed cash and take advantage of the tax-saving basis “step-up” rule.

The basis step-up: The federal income tax basis of an appreciated capital gain asset owned by a person who dies, including a personal residence, is stepped up to fair market value (FMV) as of the date of the owner’s death.

If your home value stays about the same between your date of death and the date of sale by your heirs, there will be little or no taxable gain — because the sales proceeds will be fully offset (or nearly so) by the stepped-up basis.

The reverse mortgage: Holding on to a highly appreciated residence until death can save a ton of taxes thanks to the basis step-up rule. But if you need cash and a place to live, taking out a reverse mortgage may be the answer. The reason is payments to the lender don’t need to be made until you move out or pass away. At that time, the property can be sold and the reverse mortgage balance paid off from the sales proceeds. Any remaining proceeds can go to you or your estate. Meanwhile, you stay in your home.

Consider the options

If you need cash, it has to come from somewhere. If it comes from selling your highly appreciated home, the cost could be a big tax bill. Plus, you must move somewhere. In contrast, if you can raise the cash you need by taking out a reverse mortgage, the only costs are the fees and interest charges. If those are a fraction of the taxes that you could permanently avoid by staying in your home and benefitting from the basis step-up rule, a reverse mortgage may be a tax-smart solution.

© 2024 KraftCPAs PLLC

An advisory body for the Financial Accounting Standards Board (FASB) has chosen four key business accounting rules to scrutinize and determine whether relief measures or other changes are needed.

The Private Company Council (PCC) and its 12-member board, which advises the FASB on accounting issues faced by private companies, compiled a list of 16 topics that stood out after its annual survey of private company stakeholders earlier this year. In April, it agreed to research four of the most critical areas and determine whether action is needed by the FASB. PCC members also considered whether these issues have an identifiable scope and whether technically feasible solutions are achievable before the end of 2025.

PCC Chair Jere Shawver said the group will have its opinions ready to present to the FASB in 12-18 months.

The four topics being studies are:

1. Credit losses: Short-term trade receivables and contract assets

Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, requires an entity to estimate an allowance for credit losses (ACL) on financial assets based on current expected credit losses (CECL) at each reporting date. Under prior accounting rules, a credit loss wasn’t recognized until it was probable the loss had been incurred, regardless of whether an expectation of credit loss existed beforehand.

Under CECL methodology, the initial ACL is a measurement of total expected credit losses over the asset’s contractual life. The estimate is based on historical information, current conditions, and reasonable and supportable forecasts. The ACL is remeasured at each reporting period and is presented as a contra-asset account. The net amount reported on the balance sheet equals the amount expected to be collected.

The updated guidance was designed to be scalable for entities of all sizes. While banks and other financial institutions tend to hold more financial assets within the scope of CECL, nonfinancial entities with financial instruments, such as trade accounts receivables and contract assets, also must apply the CECL model.

Many private companies question whether the benefits of applying CECL to these assets justify the costs. For example, trade receivables are generally short term, and the amount collectible is rarely affected by macroeconomic conditions or the time value of money decay.

The PCC is considering a private company practical expedient or alternative to the application of CECL to short-term trade receivables and contract assets. One possible solution would be to allow the use of historical cost to estimate credit losses, without the evaluation of reasonable and supportable forecasts.

2. Debt modifications and extinguishments

During its September and December 2023 meetings, the PCC discussed the accounting and reporting requirements of Accounting Standards Codification (ASC) Subtopic 470-50, Debt — Modifications and Extinguishments. During those meetings, some PCC members said that applying the guidance in Subtopic 470-50 can be complex and costly when transactions involve multiple lenders. They also questioned whether the benefits of the different reporting outcomes justify the costs. This was identified as a particularly pressing concern as rising interest rates are causing many companies to renegotiate their debt terms.

Under the existing guidance, companies must assess whether a modification or extinguishment of debt has occurred when an entity either modifies the terms of an existing debt instrument or issues a new debt instrument and concurrently satisfies an existing debt instrument.

The assessment is based on a comparison of two factors:

• The present value of the cash flows from the terms of the new debt instrument
• The present value of the remaining cash flows from the original debt instrument on a lender-by-lender basis

If the difference is greater than 10%, the transaction is accounted for as an extinguishment of the original debt instrument. When debt is extinguished, the original debt is derecognized and a gain or loss equal to the difference between the carrying amount of the original debt and the fair value of the new debt is recognized. Any new fees paid to, or received from, lenders are expensed, and any new fees paid to third parties are capitalized and amortized as debt issuance costs.

If the difference in the present value of the cash flows is less than 10%, the transaction is accounted for as a modification of the original debt. When debt is modified, no gain or loss is recognized, and any new fees paid to, or received from, the existing lender are capitalized and amortized.

The PCC is considering a private company alternative to simplify the guidance. For example, some PCC members have suggested allowing private companies to bypass the required assessment and account for the transaction as a debt extinguishment. Additionally, some members have questioned whether it’s necessary to have different guidance for term debt and line-of-credit or revolving-debt arrangements when evaluating debt modifications and extinguishments.

3. Lease accounting

In 2016, the FASB issued updated guidance that requires companies to report on their balance sheets their leased assets (such as office space, vehicles, and equipment) and the rent they pay for them as liabilities. It also calls for detailed disclosures about the terms and assumptions used to estimate lease obligations, including information about variable lease payments, options to renew and terminate leases, and options to purchase leased assets. The rules took effect in 2019 for public companies and 2022 for private entities.

In some cases, deciding whether to report leases on the balance sheet requires complex judgment calls. Management must review data not just from rental agreements for real estate and equipment, but also from service arrangements and third-party outsourcing contracts. Plus, certain areas of guidance in ASC Topic 842, Leases, can be costly and complex to apply.

After evaluating PCC concerns, the FASB issued ASU No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities. The update allows private companies to elect to use the risk-free rate, as opposed to an incremental borrowing rate, at an underlying asset class level rather than having to elect it for their entire portfolio of leases.

The PCC is now considering whether additional practical expedients or alternatives for private companies should be considered. One area of particular concern is lease modifications.

4. Retainage and overbillings as contract assets and liabilities

Under ASC Topic 606, Revenue from Contracts with Customers, when either party has performed work on a long-term contract, the entity must present the contract on the balance sheet as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. Any unconditional rights to consideration are reported separately as a receivable.

Some private company stakeholders noted that Topic 606 changes the presentation of retainage in the construction industry and results in diversity in practice. Retainage is a construction industry concept, rather than a GAAP concept. It generally refers to a portion of consideration held back by the customer until project completion. For example, a company may invoice a customer 100% of the fee, but the customer holds back, say, 5% until a later date. In practice, companies could appropriately classify retainage as a receivable or a contract asset — or it could be allocated between the two, depending on the terms under which the right to consideration is conditional.

Before the adoption of Topic 606, companies presented conditional retainage separately from billings in excess of costs. Under Topic 606, conditional retainage is required to be netted with related contract liabilities on the balance sheet. Some stakeholders have suggested two possible alternatives for construction companies:

1. Grossing up the balance sheet, rather than netting the contract assets and contract liabilities
2. Providing additional disclosures about conditional retainage and billings in excess of costs

The PCC is considering whether these options could provide better transparency about retainage for companies in the construction industry.

PCC abandons study of share-based payment transactions

After two years of study, the PCC decided to remove the issue of stock compensation disclosures from its agenda. The PCC had discussed aspects of the guidance in Accounting Standards Codification Topic 718, Compensation — Stock Compensation, since 2014. It formed a working group in 2022 to discuss stock compensation disclosures for private companies in greater depth.

However, feedback from practitioners indicated that companies with share-based payment transactions are largely owned by private equity firms or are venture capital-backed start-ups. Because stock compensation disclosure issues aren’t broadly pervasive for private companies, PCC members agreed to focus on other topics identified by private companies.

© KraftCPAs PLLC 2024

Unless your business always collects payment for items and services on the spot (or accepts credit cards on your website), you need to know how to create effective invoices. QuickBooks Online makes this easy enough that you could be completing invoice forms and sending them out within about 15 minutes of logging in for the first time.

But would these sales forms really be the best you could do? No. To get them noticed and paid quickly, you need to take advantage of the tools QuickBooks Online provides to improve the effectiveness of your invoices. And you’ll need to use a little psychology to nudge your customers the right way.

Here are seven tips for doing just that.

1. Include everything

Think like a customer for a minute. Why do some invoices get your attention and others don’t?  Learn from the ones that do and incorporate those things into your own forms.

If you do nothing else to improve their quality, make sure that your invoices are thorough. Don’t leave anything out that could make your customers hesitate and change their perception of your business. People will think better of you if you don’t leave them hanging by neglecting to include everything they might want to know. So be sure to:

• Provide comprehensive contact information for your company and for your customer – and triple-check to make sure it’s correct. If the invoice goes to the wrong individual, it may not be paid.
• Do the same for your product and service descriptions, so they know you got the order right.
• Display the due date prominently.
• Fill in QuickBooks Online fields for sales reps, reference numbers, shipping addresses, etc. – anything at the top of the form that applies.
• Make sure adjustments like sales tax and discounts can’t be missed.

2. Sweat the details

This again goes to shaping your customers’ impression of your business. Spell everything correctly. Make sure the type and any graphics are sharp and clear, so your customers will have no trouble reading the forms. Use color if you can and make the invoice aesthetically pleasing without overdoing it and making it look like a birthday party invitation.

You probably don’t have many opportunities to communicate with your customers personally. Accurate, attractive invoices bolster your company’s overall image.

3. Use your company logo

A good-looking, professional logo speaks volumes about your company. If you don’t have one, or if you’re not happy with your current one, you can have one designed for you by freelancers at a reasonable price. Websites like Fiverr are often good options.

4. Offer an unexpected discount to regulars

You might consider surprising repeat or even new customers with a small discount. You might make up for the reduced sales totals in other ways, like repeat business. It certainly will foster goodwill.

5. Make customer messages meaningful

“Thank you for your business” is QuickBooks Online’s default Message on invoice. You can probably be a little more creative and personal with yours. If your sales volume isn’t overwhelming, write a new message on each invoice that references something about your customer or the products and/or services ordered. Here are some examples:

• Suggest similar items they might consider.
• Tell them you hope they’re pleased with their purchase.
• Pay special attention to repeat customers. Let them know you recognize them as such.
• Alert them to upcoming sales, discounts, new offerings, etc.
• And yes, thank them for their order.

6. Send invoices immediately

When you send invoices quickly after orders are placed, you signal to customers that you’re organized, professional, and conscientious.

7. Use QuickBooks Online’s sales form design tools

You have a great deal of control over how your invoices look. You can, for example:

• Choose from different templates.
• Select colors and fonts.
• Add, remove, and relabel standard fields.
• Add custom fields.
• Edit the emails that go out with invoices.

Click the gear icon in the upper right and select Account and settings, then click Sales. Click Customize look and feel. You can either Edit an existing style or create your own. You don’t have to be a design expert to modify your forms, but you may need our help making these changes.

Changes coming to QuickBooks Online

Intuit is introducing major new invoice and dashboard layouts and navigation tools. You may or may not see them yet because the company is releasing them slowly. You’ll see links when the changes are active for your account. They’re easy to learn, but you can go back to the old invoice layout if you don’t have time to make the adjustment immediately. Eventually, they’ll be in place for all users.

© 2024 KraftCPAs PLLC

It’s not uncommon to dream of turning a hobby into a regular business. Perhaps you enjoy boating and would like to open a charter fishing business. Or maybe you’d like to turn your sewing or photography skills into an income-producing business.

You probably won’t have any tax headaches if your new business is profitable over a certain period of time. But what if the new enterprise consistently generates losses and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby rather than a business. Then you’ll be unable to deduct losses.

By contrast, if the new enterprise isn’t affected by the hobby loss rules, all otherwise allowable expenses are deductible, generally on Schedule C, even if they exceed income from the enterprise.

Before 2018, deductible hobby expenses could be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

How to not be a hobby 

There are two ways to avoid the hobby loss rules:

1. Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses).
2. Run the venture in such a way as to show that you intend to turn it into a profit-maker rather than a mere hobby. The IRS regulations themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.

How can you prove you have a profit-making objective? You should operate the venture in a businesslike manner. The IRS and the courts will look at the following factors:

• How you run the activity
• Your expertise in the area (and your advisors’ expertise)
• The time and effort you expend in the enterprise
• Whether there’s an expectation that the assets used in the activity will rise in value
• Your success in carrying on other activities
• Your history of income or loss in the activity
• The amount of any occasional profits earned
• Your financial status
• Whether the activity involves elements of personal pleasure or recreation

Case illustrates the issues

In one recent court case, partners operated a farm that bought, sold, bred and raced Standardbred horses. It didn’t qualify as an activity engaged in for profit, according to a U.S. Appeals Court. The court noted that the partnership had a substantial loss history and paid for personal expenses. Also, the taxpayers kept inaccurate records, had no business plan, earned significant income from other sources, and derived personal pleasure from the activity. (Skolnick, CA 3, 3/8/23)

© 2024 KraftCPAs PLLC