DGC Blog

Start Preparing Now If You Intend to Sell Your Business Later

 

 

By George D. Shaw, CPA

In some ways, selling a business is comparable to selling a home. By making improvements before you go to market, you’ll increase your odds of attracting future buyers and commanding a higher price. Business improvements take time, however, so don’t wait until just before you’re ready to sell to make them. In fact, it is best to start planning 2-3 years in advance. When you consider that every $1 million increase in EBITDA could result in a $6 million increase in the purchase price, it will be well worth the time and effort in the end.

First, it’s important to look at your business from the buyer’s perspective. Assess the qualities your company has and areas that need improvement. Understand what both financial buyers and strategic buyers are looking for, and do whatever you can to make your company more attractive.

Buyers and investors are interested in companies that offer:

• An attractive growth story that is well-articulated
• Long-term relationships with high-quality customers that provide attractive profit margins
• A defensible industry position that creates sustainable revenue and profitability
• Competitive advantages, such as lower costs, superior products, a well-known brand and a reputation for outstanding service
• Leading technology
• Above-average gross margins and EBITDA margins

Next, prepare a “to do” list that includes the following:

Develop a growth strategy.  Buyers are purchasing future performance, not past performance. That is why it’s important for sellers to have an achievable strategy for robust growth that they can articulate well.  Company management should fully support the strategy and progress should be benchmarked using ongoing customer surveys to track performance. Recognize, too, that competitors are not standing still and be certain to analyze their performance, too.

Study your market.  You should be able to describe to buyers or investors what your target markets are, what your position is in them and the potential for growth in each market. If you cannot provide this information, retain the services of someone who can.

Review your customer list.  The desire to lock-in customers with contracts should be weighed against margins, potential cost increases and service requirements. To demonstrate a defensible position, customer contracts are just a starting point. You also need to analyze your profit margins, which are especially important if the potential buyer is publicly held. Start by generating margin reports with a breakdown by both customer and product. Then, based on an analysis of the reports, either shed low-margin customers, or make changes to your operations or products that will enable your company to increase margins.

Strengthen your management team.  Financial buyers like companies with strong management teams.  The pre-sale period is a great time to add to bench strength and weed out underperformers.

Minimize risk.  Buyers dislike uncertainty. You can remove a great deal of risk and potentially increase the purchase price of your business by anticipating buyer concerns and addressing them. For example, an audited financial statement is typically a prerequisite for any sale; not having one ahead of time will only slow down the process. Start having audits 3 years before a potential transaction so that any GAAP adjustments are not reflected in the trailing twelve month EBITDA.

Review and plan your taxes.  Recognize that it’s the after-tax proceeds from the sale that are important.  Plan ahead and make certain you fully understand the tax implications of selling your business before you complete the sale. It may, for example, be advantageous to change the structure of your company and/or explore generational wealth planning opportunities. Also weigh the implications of a stock sale versus an asset sale.

Taking a strategic approach to selling your business gives you the upper hand. Advance planning will help maximize value and improve the likelihood of a successful transaction closing. If you plan on selling your business in the future, now is the time to discuss and implement a strategy with your DGC advisor.

A Gift from Congress: Gift Up to $10 Million Tax-Free

 

 

By  Stephen Colella, CPA and Sarah Wulf, CPA

For a limited time, married taxpayers can make lifetime gifts of assets worth up to $10 million without paying federal gift taxes or other transfer taxes.

The exemption for gift taxes, estate taxes, and generation skipping transfer (GST) taxes was fixed at $5 million per taxpayer when Congress extended the Bush-era tax cuts through 2012.  Married couples can now give away up to $10 million and single people can give away up to $5 million without incurring gift or GST taxes, as adjusted for prior taxable gifts, which is a pretty powerful planning opportunity.

While the estate tax currently offers the same exemption, one needs to pass away in order to take advantage of this $5 million exemption.  With the exemption for gift tax, estate tax, and the GST tax decreasing when the current Bush Tax Cuts extension expires, one may lose the opportunity to take advantage of the $5 million estate tax exemption, whereas the $5 million lifetime gifting and GST planning opportunity can be done now.

The gift and estate tax exemption amounts will revert to $1 million per taxpayer on Jan. 1, 2013, with the GST exemption amount reverting to an inflation adjusted $1 million per taxpayer, if Congress takes no action between now and December 31, 2012.  There are many practitioners who feel Congress will take action before then, and most predict that Congress is likely to decrease the exemption below $5 million.  As such, it would be best to act now.

Other reasons to act now include:

• The estate tax rate may be higher and the exemption may be lower when you die.
• You can benefit your heirs while you are still alive.
• Future appreciation of the gifted assets will take place outside of your estate.
• Most states do not tax gifts, but most states do tax estates.  In Massachusetts, an estate tax of up to 16% applies to estates exceeding $1 million in value.
• Some states, such as Florida, do not have an estate tax, but may decide to add one at some point.  Transferring assets now will ensure that they are not subject to a future state estate tax.

Taxpayers can also take advantage of annual exclusion gifts, which allows gifts valued at up to $13,000 a year per beneficiary without being subject to gift taxes and is a way of transferring wealth without incurring gift tax that can be done in addition to gifts that take advantage of the lifetime exemption.  There are also opportunities to make gifts that are not treated as gifts for gift tax purposes, such as making payments directly to qualified education institutions for tuition or to a provider of qualified medical expenses.

Congress also decreased the tax rate on gifts exceeding the exempt amount from 55% to 35%.  For some ultra-wealthy clients who have already taken advantage of the $5 million lifetime gift exemption, paying gift tax at a 35% rate on gifts that exceed the lifetime exemption may still be a valuable planning opportunity given that such rate may be higher at a later date.

For several reasons, trusts are commonly used when structuring lifetime gifts.  When a gift is made to a trust that is treated as a grantor trust to the donor for income tax purposes, the grantor, instead of the trust or beneficiary, is taxed on the income.  This can preserve more assets for the next generation since the trust retains the assets that would otherwise be needed to pay the income tax.  It is also not a gift to the trust for gift tax purpose when the grantor pays the income taxes. In effect, the payment of the income taxes on behalf of the trust is a tax free gift.

A married couple can retain limited access to the gifted assets without retaining the assets in their estate if the grantor’s spouse is a beneficiary of the trust, which will help ensure that they have enough assets to live on, as long as such spouse is alive.

Some Issues to Consider

When structuring a lifetime gift, one unknown that should be considered is whether Congress will include a “claw back” in future legislation.  A claw back would tax gifts made during the $5 million exemption period based on the exemption level that is in effect at the taxpayer’s death, which could be much lower ($1 million for example) if Congress reduces the $5 million exemption,.

The estate’s beneficiaries would bear the tax liability from both the lifetime gifts and their transfer at death, if there is a claw back.  Currently, when a taxpayer dies, lifetime gifts are included when calculating the estate tax exemption.  Estate taxes are owed on any amount that exceeds the unused portion of the exemption.

This issue is especially important to consider when the lifetime beneficiaries are different from the remainder beneficiaries.  Regardless, any appreciation in value between the date of the gift and the date of death remains outside the estate and is not subject to estate or gift taxes, even if there were a claw back.  Prudent practitioners are therefore structuring estate plans to take advantage of the huge increased gifting and GST opportunities before they expire in the event there is no claw back, which many believe will not happen, and to also include flexibility in the plan to minimize or eliminate any negative tax impact in the event a claw back does occur.  This type of planning gives taxpayers the ability to benefit greatly from this opportunity given that they will at least remove from the taxable estate what could be significant appreciation on such large amounts gifted, and reap more savings in the event there is no claw back.     

Another important consideration when shifting ownership of assets that are likely to appreciate is whether the taxpayer is expected to have a long or short lifespan after the transfer.  When a taxpayer passes an asset to a beneficiary during his or her lifetime, the recipient takes over the original person’s holding period and cost basis assuming such is lower than the fair market value of the assets at the time of the transfer.  That could mean a significant tax liability to the recipient upon realization of the gain.

Under current law, when a taxpayer passes an asset to a beneficiary upon death, the asset receives a step-up in basis to its fair market value at the date of death.  As such, it may be best for the taxpayer to continue to hold onto assets that have already appreciated significantly and to allow the recipient to receive the increased basis upon the taxpayer’s death, particularly if the taxpayer has a short life expectancy and does not expect significant appreciation between now and when he or she passes away.

Conclusion

It is  important to discuss the current gift, estate and GST planning opportunities available with your advisors to make sure that your overall estate planning goals will be met, and that you plan as flexibly as possible to avoid potential pitfalls, based on the huge potential tax savings and limited time offer.

Uncertainty Paralyzing Commercial Real Estate Market

 

 

By Donald A. Greenhalgh, CPA

The word “may” best defines the current commercial real estate market. As in, the U.S. Congress may close tax loopholes. It may increase income taxes including capital gains taxes. It may cut spending.  It may renew expiring tax provisions.

It may.  Or it may not.  And there’s the rub.

Unfortunately, the word “may” causes industry-wide paralysis.  When a developer plans a multi-million dollar investment in a real estate project, but does not know with any degree of certainty what the tax implications will be, nothing happens.

On top of tax uncertainty, there is plenty of economic uncertainty. The stock market is not reaching new highs, but the volatility index is. Growth is so slow, we may be entering a double-dip recession, and the federal debt looms as an ongoing challenge.

Any business that is moving or expanding into new space today is making a bold business decision, yet that risk may not pay off.  That risk is shared by builders of office or retail space, who will find it more difficult than ever not only to fill space, but to keep tenants long-term.

Uncertainty for Years?

In a business climate like this one, uncertainty over taxes becomes even more problematic.  And there’s a good chance that uncertainty will continue for years.

Currently, one party wants to raise taxes and the other wants to cut spending.  In reality, neither action will be enough to balance the budget, never mind reduce the federal debt.  Given the scale of American debt, the logical approach would be to cut spending and raise taxes before the United States becomes a much larger version of Greece.

However, both parties have shown little willingness to compromise, as making the other party look bad seems to trump doing what’s best for the country.  If neither party budges, automatic across-the-board spending cuts will take place on Dec. 1, 2011.  If that happens, expect each party to blame the other for failing to take action.

Inertia is likely to continue through the next budget cycle, as the fiscal year will end on Sept. 30, 2012, just before the next Presidential election.  No one is in a hurry to either cut spending or raise taxes, as either will create dissatisfaction with some voters.

After the election, of course, it will still take some time for Congress to decide on a course of action.  Even when action is taken, any changes to the tax code will likely be phased in over the course of years.  Eliminating tax deductions or credits immediately would likely crater the market.

While no one knows what action will be taken, a consensus may build for closing tax loopholes and eliminating some deductions. If that happens, the real estate industry is likely to be affected.  While some question the feasibility of continuing deductions for residential mortgages, eliminating that deduction would be politically unpopular, especially at a time when homeowners have lost much of the equity in their homes.

Conversely, Congress is unlikely to be as sympathetic to commercial property owners. At a time when Congress is looking everywhere for tax revenues, how, for example, will it view the deductions allowed for property financed with qualified non-recourse debt?  Currently, the tax code allows the property owner to receive a tax benefit that may be up to 10 times the capital investment. Will those deductions continue to be allowed? What impact will eliminating it have on the industry?

No one invests in a question mark, but for owners of real estate, one thing is even worse than uncertainty.  When Congress finally does take action, it may remove incentives to invest in real estate and make many real estate projects financially less attractive.

The real estate industry should carefully track Congressional action, while trade associations and lobbyists should be prepared to make a strong case for continuing favorable tax treatment.

About the Author

Donald A. Greenhalgh, CPA, is a Partner in the Real Estate Practice Group at DiCicco, Gulman & Co., a CPA and business consulting firm located in Woburn, MA. He can be reached at dgreenhalgh@dgccpa.com.

Reviewed Financial Statements vs. Audited

 

 

The true cost of reviewed financial reporting may surprise you!

By George D. Shaw, CPA

In recent years many business owners have opted for reviewed financial statements rather than getting audited financial statements. The main reason is the desire to spend less for financial reporting. But there are other factors that business owners should consider when making the decision on getting reviewed rather than audited financial statements. In fact, the true cost of reviewed financial reporting may surprise you!

Accurate financial reporting is critical for business stakeholders who typically include shareholders, employees, vendors, financial lenders and other investors. They use the financial statements to help chart the course for the business, determine the value of a business, and to make decisions regarding creditworthiness.

The level of annual financial reporting that a small or middle market business presents is typically dictated by its banking agreements and the users of its financial statements.  In order to save costs, many business owners will often turn to their bank asking for permission to submit “reviewed” as opposed to “audited” financial statements for their annual reporting. In a recent discussion with several bank lender,s I noted that reviewed financial statements are not as reliable as audited and most of the lenders agreed with this assessment. I then asked the obvious question..why allow customers to do it then?  Answer: The lending market is very competitive on business loans and when other banks allow reviews and we demand audits, it is like we are charging an extra 1/4 of a point on the loan. In today’s competitive marketplace, most banks are willing to take the risk to gain market share.

While that helps us better understand why so many small and middle market businesses present reviewed financial statements, what about the impact on a future exit strategy for that middle market business owner?

A recent survey indicated that over 50% of privately owned businesses will have a succession or liquidity event in the next 5 years. There are also numerous studies indicating an increasing percentage of businesses that are owned by persons 55 years or older. In the buyer’s market, private equity firms are aggressively pursuing acquisitions today and have a lot of cash on the sidelines. Strategic buyers who are challenged with the prospects of organic growth are looking to acquisitions as a major component of their growth strategy. For a future seller, this all means that you need to be prepared for a liquidity event regardless of whether you are currently pursuing a transaction. Audited financial statements are an important part of being prepared for your exit strategy and contribute to increased value and purchase price.

Let me explain the potential economic impact of reviewed vs. audited financial statement reporting:

When a buyer or investor is interested in the purchase of a business, there is a process of due diligence related to the quality of earnings of the seller. The process involves a verification and analysis of the historical and forecasted profitability that a preliminary purchase price is based upon. The extent of the due diligence procedures typically increases with more sophisticated buyers who are serious buyers that a middle market seller would like to attract. My experience in performing due diligence analysis for private equity and strategic buyers on over 200 middle market transactions reveals that sellers of businesses who present reviewed financial statements have significantly more negative adjustments to earnings as compared to companies with audited financial statements. Due diligence adjustments are common in the areas of revenue recognition, accounts receivable reserves, inventory costing and obsolescence, and unrecorded liabilities.
 
Due diligence adjustments average approximately 10% of EBITDA (Earnings Before Interest Taxes Depreciation & Amortization) when the preliminary purchase price calculation has been based upon reviewed financial statements.  If the business is generating $2m of EBITDA that is a decrease in EBITDA of $200k. When you apply an average transaction multiple of 6 times EBITDA, this results in a $1.2M reduction on the transaction price that could have been identified earlier or avoided altogether had audited financial statements been prepared.

For the business with $2m in EBITDA, the difference in cost between reviewed and audited financial statements is probably $40k annually depending upon the industry. That means an investment of $120k for audited statements (over three years) may have resulted in increased business value of $1.2m depending upon what the due diligence adjustments relate to. That is a good investment return!
 
Business owners also need to understand that after a Letter of Intent ("LOI") is signed, there is a shift in negotiating leverage to the buyer as due diligence begins. If the buyer's financial due diligence identifies negative adjustments to earnings, the transaction price will be decreased. Often times, those adjustments may relate to items that an audit would have uncovered and if properly reported in the years under review would not negatively impact the current years earnings. In order to keep potential audit adjustments out of the most recent EBITDA results, the business owner should present audited financial statements two to three years before a liquidity event. Plan ahead and don't wait for financial due diligence to flush out financial reporting issues.

There are also many other benefits to audited financial reporting including:

• Good financial discipline - the audit process focuses on best practices and compliance with current accounting standards when it comes to internal controls and financial reporting. As a result, your management and finance team will become aware of the best practices which need to be in place if they are not already implemented. These practices may allow them to improve upon the monthly interim financial reporting process which may help identify financial reporting issues earlier. Due diligence regarding the quality of earnings oftentimes includes a review of monthly trends in financial results. The best practices learned during an audit process will help ensure interim financial reporting is more timely and accurate.

• Fraud deterrent - while an audit is not designed to detect fraud, having auditors present (and making inquiries) at your offices provides a visual reminder that someone externally is examining the financial records. It increases the risk perception on being caught and this is important for middle market companies where the finance team may wear multiple hats.

• Comfort to stakeholders - as indicated earlier, bankers are more comfortable with audited financial reporting. Ask them yourself. If bankers have more confidence in your financial reporting and in how you manage the business, they are more willing to increase the bank loan size and leverage ratio if needed. This could be important if an attractive acquisition appears or you just need additional financing to support organic growth.

• Improve the business - a good audit should be able to provide you with ideas that help you improve the business. An audit allows the CPA to become more knowledgeable about your business and they will be in a better position to provide valuable advice during the lifecycle of your business. Ideas on improved internal controls, development of key financial metric reporting, succession planning, tax minimization, international expansion, operational improvement, employee incentive plans and M&A strategy are just some of the areas where a CPA can help you improve your business and increase its value.

• Accelerate transaction timelines - quality financial reporting and information will help avoid delays when pursuing a transaction. When transaction timelines are stretched longer due to poor financial information and surprises, there is an increased risk that the transaction will not close. You will also find that your costs for professional fees will increase when surprises and adjustments are uncovered. If the transaction ultimately fails it could prove to be very detrimental to the business. The longer a transaction timeline, the greater the risk that the deal will close. The cost of a failed transaction is significant to the business and improving surety of close is very important.

These are some compelling reasons for business owners to reassess presenting reviewed annual financial statement reporting. Based upon the economics, any business with EBITDA in excess of $1m should have audited financial statements. For many business owners, the time to act is now as you need to be prepared for all opportunities that may present themselves to you in this ever changing marketplace.

Contact George D. Shaw at gshaw@dgccpa.com or 781-937-5125 to learn more.

Window of Opportunity Will Soon Close for Taxpayers with Offshore Assets

 

 

The IRS is serious about collecting unpaid taxes on foreign bank accounts. The new Voluntary Disclosure Program may be the last chance for taxpayers with offshore assets and income to come clean. Failure to comply with the program will result in stiffer penalties.

Taxpayers only have until August 31, 2011, to disclose offshore bank accounts and pay back taxes, interest and penalties based on the past eight years. Penalties are up to 25 percent of the highest annual amount in the overseas account from 2003 through 2010.

DGC has significant experience and expertise when it comes to reporting international activity. We can work with taxpayers and their attorneys to comply with the Voluntary Disclosure Program in the following ways:

• Foreign Bank Account Reporting
• Reporting for U.S. shareholders/partners of foreign corporations and partnerships
• Passive Foreign Investment Company analysis and reporting
• Preparation of amended federal and state income tax returns
• Calculate penalties

Time is of the essence! The window will soon close on the opportunity to reduce penalties through the Voluntary Disclosure Program. Contact Laurie Austin at laustin@dgccpa.com or 781-937-5329 for more details.

How to Save Millions with Qualified Small Business Stock

 

 

by Laura Barooshian, CPA, MST and Joel Rothenberg, CPA

In the right situation and with proper planning, business owners and private investors may be able to exclude up to $10 million in capital gains when they sell “qualified small business stock”(QSBS).  Under normal circumstances, appreciated securities that have been held for over one year and sold at a gain are taxed at 15% for federal purposes.  Internal Revenue Code (IRC) Section 1202 allows an individual taxpayer to exclude capital gains on the sale of QSBS from tax if certain criteria are met.

This exclusion has been available since 1993, however, a portion of the gain had been subject to the Alternative Minimum Tax (AMT) regime. As a result, taxpayers who were subject to the AMT, realized minimal federal tax benefit.

A new “twist” on the existing QSBS law, which went into effect on September 27, 2010, creates an enhanced federal tax benefit. The new law applies to any "new stock" issued before January 1, 2012, subject to the restrictions outlined below. When the "new stock" is eventually sold,  up to $10 million of gain will be excludable for both regular tax and AMT purposes (50% for Massachusetts purposes).

In order for the stock to be considered QSBS, the company must:

• Be organized as a C corporation,
• Own total assets (from inception until the time of stock issuance) with an adjusted basis of $50 million or less,
• Operate in a qualifying industry (some businesses, such as service businesses, do not qualify), and
• Use at least 80% of the value of the corporation’s assets to conduct its qualified business.

(Please note, this list is not all inclusive and the requirements are very complex. Given the potential significant tax savings available, we recommend that you contact DGC before moving ahead with any investment.)

In addition, the shareholder must have held the stock for at least 5 years from the date of issuance through the date of sale.  For stock issued in 2011, that would translate to an eventual sale in 2016 or later, after the 5-year holding period has been met. 

Time is of the essence as the 100% gain exclusion is set to expire on January 1, 2012.

While QSBS issued prior to September 27, 2010 does not qualify for the newly enhanced federal tax benefit, it still qualifies for the 50% Massachusetts capital gain exclusion. So, it also makes sense to assess whether you may own QSBS that was acquired prior to such date.

QSBS investments made via partnerships or LLC may also qualify for the tax benefits described above making this particularly attractive for private equity and venture capital funds.

To determine if your business or a business you have invested in qualifies for the old or new exclusion, talk to your DGC advisor.

Bonus Depreciation Can Have Multiple Benefits

 

 

By Patrick J. Bevington, CPA, MST

Taxpayer friendly transactions are hard to come by, and even more sought after in a tough economy.  One that has recently been discussed and highlighted by tax professionals and their clients relates to a double dipping of sort with regard to bonus depreciation. The Internal Revenue Code and the Treasury Regulations allow a taxpayer to take bonus depreciation on a newly purchased asset, dispose of that asset in a tax-free exchange and take bonus depreciation on that newly acquired asset. This allows a taxpayer to potentially take advantage of taxpayer friendly provisions three separate times.

Bonus Depreciation – First Event

The first step occurs when a taxpayer acquires an asset for use in their trade or business. In order to claim bonus depreciation, the asset must fit certain criteria. It must be a Modified Accelerated Cost Recovery System (MACRS) asset with a recovery period of 20 years or less, have its original use begin with the taxpayer, and it must be timely purchased and placed in service by the taxpayer. 

For example, a manufacturing company purchases a piece of machine equipment with a five-year recovery period for $200,000 and places it in service in the current tax year. Because the machine qualifies, the manufacturing company may write off 50 or 100% of the cost in the year placed in service as opposed to over the five-year period.

Exchange of Asset

There are two types of asset exchange that may occur. One is a like-kind exchange. Let’s say the company decides it would prefer a different piece of equipment and they set up a tax-free exchange with another company for a different machine. (The assets must be of like kind.) The newly acquired asset generally takes the basis of the relinquished asset plus/minus any additional considerations paid/received and gain/loss recognized. 

The other type of exchange can occur in the form of an involuntarily conversion (i.e. theft, destruction, seizure, or other), in which the company recognizes no gain on this transaction, but must replace the property. We’ll assume the insurance company pays $200,000 to replace the property. Even having a basis of zero in the original equipment (100% was written off to bonus depreciation), the company will recognize no gain on the transaction if it acquires a new asset. Because bonus depreciation was taken on the machine originally, the manufacturing company is deferring a much larger gain than it would have if they did not take bonus depreciation.

Bonus Depreciation – Second Event

A second bonus depreciation event happens when the manufacturing company decides to purchase a new $300,000 piece of equipment in place of the old machine. The new basis in the new piece of equipment will be $100,000 (zero carryover basis plus 100,000 additional considerations paid in excess of the insurance proceeds).  As long as the newly acquired asset fits into the same rules described above for bonus depreciation, the company may expense the entire new asset as well. That means the additional $100,000 paid for the new machine may be written off in the year placed in service.

The tax-free exchange provisions treat the transaction as an exchange of the first machine with a carryover basis to the new one, while the depreciation provisions look at these transactions in two steps as if they sold the original machine and purchased a new one. The company benefits in the following ways:

• Claiming bonus depreciation on newly acquired assets
• Having a tax free disposition of potentially appreciated assets
• Being able to claim bonus depreciation on a second asset with a carryover basis

In the example described throughout, the manufacturing company would be deducting $200,000 in the year of acquisition as opposed to the life of the asset, not recognizing a gain of $200,000 on the insurance proceeds, and again expensing the $100,000 paid in the new year of acquisition. If these assets are both five-year assets, the depreciation deductions are being taken over two tax years as opposed to over ten. 

These transactions, broadly depicted, have great potential to taxpayers, but they should be very careful to structure their transactions correctly in order to satisfy all the complex variables. Contact a DGC representative if you think you may be able to capitalize on such a transaction.

FASB May Ease New Real Estate Lease Accounting Standards

 

 

As a regional CPA firm that specializes in Real Estate, we are vigilant when it comes to issues that could have a significant impact on our clients’ businesses. New lease accounting standards are currently top of mind. Here is our take on the situation, as well as some insight into how we are preparing to advise clients regardless of the outcome.

Will proposed international lease accounting standards suffer the same fate in the U.S. as the metric system? Both lessors and lessees certainly hope so and have let the U.S. Financial Accounting Standards Board (FASB) know it, sending the board more than 800 comment letters in response to proposed standards.

While proposed standards would create greater transparency, as well as consistency, for companies that lease internationally, the potential harm they would cause appears to outweigh the benefits, as the new standards could potentially transform market behavior.

Critics say the new standards would create a heavy regulatory burden, result in more buying and less leasing, make it more difficult than ever to obtain financing and create pressure for lessors to lease property for shorter periods.  In addition, lower demand would cause rental prices to drop.  With the commercial real estate industry still reeling from the financial crisis, it would have to endure one more major hardship.

The FASB has taken notice and appears to be easing up on the proposed new standards.  Initially, new lease accounting regulations were supposed to be issued by June 2011.  Now FASB is saying it will issue new standards in the second half of the year, although the proposed effective date of Jan. 1, 2015 remains the same.

Uncertain Compromise
If there is an easing of the new standards, it’s uncertain what will emerge as a compromise.  Currently, companies leasing space treat lease contracts as an operating expense.  Under the proposed new regulations, lessees would have to show the full value of lease contracts on their balance sheets as a liability.

One option would be to develop separate lease accounting standards for public and private companies.  As about 90 percent of commercial real estate is privately owned, that approach would be preferable to most lessors, assuming that private owners would be exempt from radical changes.

FASB is also beginning to take a hard look at the regulations from the lessor’s perspective.  Although FASB has been working with the International Accounting Standards Board (IASB) to standardize worldwide accounting standards since 2002, its work on lease accounting standards has until now focused almost exclusively on the lessee.

As FASB shifts its attention to the lessor, property owners hope FASB will recognize that transparency is not a major issue for the industry, since most commercial property is privately owned.

And while convergence of U.S. Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS) would help large lessees, such as international retailers, lessors would like FASB to recognize that it would create a severe hardship for smaller companies.

To conform with new standards, both tenants and lenders will be hard pressed to develop an in-depth understanding of everything in their financial statements, including the footnotes.  They will also have to understand the economics of the real estate they own, including the impact of changing interest rates.

Standardization could also impact the give-and-take negotiations that have been essential to the landlord-tenant relationship since the first lease was written.  In the world of commercial real estate, leases are like snowflakes – no two are alike.  Flexibility is needed to ensure that the needs of both landlord and tenant are taken into account.
 
Income-Tax Basis of Reporting
If the proposed changes are approved without a significant easing from what is being proposed, lessors do have another option.  The new standards will not apply to property owners who use the income tax basis of reporting, which allows property owners to prepare their financial statements in a manner similar to preparing their income tax returns.

Even if the new standards are never approved, the income tax basis of reporting has become an increasingly attractive option as reporting requirements under GAAP have become more complex.

In anticipation of the new standards, property owners are advised to negotiate with lenders for permission to use this approach.  Given that the new standards would also create a hardship for lenders, they are likely to be open to reporting on an income tax basis if it appears that the new standards are going to be approved.

For more information, contact the Author:
Donald A. Greenghalgh, CPA, is a Partner in the Real Estate Practice Group at DiCicco, Gulman & Co., a CPA and business consulting firm located in Woburn, MA. He can be reached at dgreenhalgh@dgccpa.com

Start Preparing Now For New Foreign Reporting Rules

 

 

Foreign investments are likely to pay out big returns this year and in years to come – not necessarily for investors, but definitely for the IRS.

The U.S. is taking a hard line against owners of foreign investments, who for years have been avoiding taxes by opening accounts in Switzerland, the Cayman Islands and other countries that promised secrecy for account holders.

Almost all taxpayers with foreign investments will be subject to the new Foreign Account Tax Compliance Act (FATCA), which increases the cost and complexity of reporting foreign assets, increases penalties for noncompliance and doubles the statute of limitations during which the IRS can audit taxpayers.

Accountants, likewise, will be affected, as those who fail to gather the required information will be held responsible and may be assumed to be complicit with tax-evading clients.

Accountants will need to be diligent, because some private investors may own foreign investments and not know it.  If, for example, a client has invested in a fund or funds with even a small amount invested offshore or given money to a venture investor with a fund that’s investing in a non-U.S holdings, problems could arise.

Some clients may also think they can continue to hide their foreign investments and avoid a hefty tax bill, but a Swiss bank account isn’t what it used to be.  In fact, neither is an account in Liechtenstein, Panama or the Virgin Islands, as the IRS is going worldwide in search of uncollected tax revenues.

In general FATCA takes effect in 2013 but the additional reporting requirements relating to foreign bank accounts will take effect in 2012.  Accountants should be discussing the 2012 changes with their clients this year when preparing the Foreign Bank Account Reports (FBARs) due in June.  Preparing for the changes now will ease the stress of implementation next year.

What’s Coming Next
Even taxpayers who have consistently paid taxes on foreign investments may feel like they are being penalized when they learn about FATCA reporting requirements.

Investors with international mutual funds and other investments purchased in the U.S. are not affected, but foreign residents who moved to the U.S. and other private investors with funds in offshore accounts will be affected.

FATCA requires all U.S. taxpayers with foreign assets that have an aggregate value exceeding $50,000 to report them on a special return.  It is not clear yet whether the threshold applies for asset value at the end of the tax year or anytime during the year.

The FATCA reporting requirements are in addition to, not in place of, filing a FBAR.  Unlike FBAR, they apply to foreign private equity funds, foreign hedge funds and real estate, foreign partnerships, corporations and trust funds.

Even without FATCA, noncompliance penalties were harsh.  The penalty for willful failure to file an FBAR, for example, is the greater of $100,000 or 50% of the total account balance of the foreign account per violation.  Willful violations may also be subject to criminal penalties.

While details are still being worked out, regulations will require taxpayers to list all financial institutions and the country where the institution is located, dates the accounts were opened and closed, plus contacts at each institution.  An explanation of all communications, including face-to-face meetings, will also be required, as well as the names, locations and dates of any communications.

In addition, taxpayers will be required to provide the name and address of the issuer of any securities, and information about the assets, such as the class or issue of securities, and the maximum value of the asset during the tax year.

FATCA also increases the statute of limitations for auditing returns with foreign assets from three years to six years.

It’s clear that the FATCA reporting requirements will be burdensome, but, considering the consequences of noncompliance, taxpayers should be grateful when their tax preparer starts asking lots of questions about their foreign assets.

For more information related to foreign bank account reporting rules,  contact Laura Barooshian, CPA, MST at lbarooshian@dgccpa.com

Boston Architectural Firms Show Signs of Recovery

 

 

To accurately assess the current state of the A&E industry in Boston, let’s start by putting things in perspective. During the recent recession, architecture firms in New England were hit harder than most. Over 90% of firms experienced layoffs and/or pay cuts and over half of the firms were operating at a loss. If we were talking about a patient in the hospital, physicians would have listed them in “critical” condition. It was touch-and-go for most.

Initial findings of our 2011 Architectural Study indicate that Boston-area architectural firms could finally be on the mend. The annual survey, which benchmarks financial performance, is based on input from over 30 prominent firms in the Greater Boston marketplace.

The good news is that, on average, firms saw 7.5% of their net fees drop to the bottom line compared to last year when the average firm realized a meager profit of 0.4% of net fees. The average utilization rate of architectural firms for 2010 increased to 61.5% after dropping to 58.9% in 2009, the lowest chargeability rate on record. 

Still, the industry has a long way to go before it returns to pre-recession levels. The numbers may show that firms are busier, but backlog levels remain a concern. Firms are continuing to run very lean and will likely continue to do so until the industry sees more consistent improvement.

The survey also shows that the direct labor billing multiple appears to be a healthy 3.23.  However, we caution that this may be artificially high when compared to historical trends because of the impact of severe pay cuts. It is important to note that average total hourly wage rates remain relatively flat in 2010 after seeing a 5% deflation in wages in 2009.

And in reality, the industry is still hindered by financing issues, high unemployment, poor cash flow and heavy competition for few projects. Project pricing continues to be a challenge, as some firms lowered their rates to bring in new work.

Right now, architecture and engineering firms can make the most of the recovery by carefully evaluating their business strategies and plans for growth. They should examine their business models and determine whether they need to be altered. They should ask themselves whether they are in the right markets and providing the right level of client service. Most importantly, however, firms need to evaluate whether they have the right people in the right places for the future growth of their firm. CLICK HERE for a re-cap of our A&E Summit.

To come full circle with our health analogy, we would say that Boston-area architectural firms have been upgraded to “serious but stable” condition. Recovery is taking place at a slower pace than the industry would like, but it appears that the worst is behind us.

The 2011 Archictectural Study will be available later this summer. CLICK HERE to place an order.