DGC Blog

Is Your Home Office Eligible for a Tax Deduction?

 

 

By Chris Hussey, CPA

More people than ever are working from home, but few understand the strict rules that govern the ability to claim a home office tax deduction.  

There are two scenarios that allow for a home office deduction: 1) the self-employed individual and 2) the telecommuting employee. 

For both scenarios, in order to qualify for the home office deduction you must use the office exclusively and on a regular basis for business. If you have a spare bedroom that you use as your office, but occasionally have a guest stay in the room, the room is not considered exclusively used as an office. The regular basis requirement means that you must use the office on a regular and recurring basis.  As a general guideline this means a minimum of a few hours a week, every week.  Occasional, "once-in-a-while" business use will not qualify. 

In addition to the exclusive and regular basis requirement there are three tests that have been established, and if you meet any one of them, you qualify for the home office: 

1. The principal place of business test.  To qualify you must use the home office as your primary place of carrying on the business activity. 
2. The second test can be satisfied if you use your home office to meet with patients, clients, or customers.  The patients, clients, or customers must be physically present in the home office to qualify.
3. The third test is the separate structures test.  If your home contains a separate structure that is used in the business you would qualify.

The rules for a telecommuting employee require that you meet one of the three tests above as well as one additional requirement.  In order to qualify for the home office deduction your home office must also be used for the "convenience of your employer." 

Again, there are three tests to determine if you meet the convenience of your employer requirement.  You must meet one of these three tests.  The first test is that the home office is maintained as a condition of employment.  Specifically, your employer requires you to maintain the home office and work there.  The second test is that your home office is necessary for the functioning of the employer's business.  Finally, the third test is that the home office is necessary to allow you to perform your employee duties properly.  

Next it is important to understand what you are entitled to deduct.  In addition to being able to deduct expenses that are directly associated with the office, such as supplies and furniture, you are also entitled to other items.  You can claim a deduction for a percentage of items that are not normally deductible, such as depreciation, home owner's insurance, and utilities.  The percentage you are allowed to deduct is equal to the square footage of the office divided by the square footage of the entire house.   In the case of a phone, fax or internet subscription, a dedicated line used exclusively for business would be 100% deductible. 

A lesser known benefit of the home office deduction is that the cost of computers and other equipment that would normally have to be allocated between personal and business use, will qualify 100% as business use.  This allows you a full deduction of the purchase price.  It is important the computer or other equipment be used exclusively for business and a separate piece of equipment be used for personal purposes.  Another benefit is that the costs of travelling from your home to other work locations are deductible transportation expenses instead of nondeductible commuting expenses. 

For a telecommuting employee, if you do qualify for home office deductions, they are treated as miscellaneous itemized deductions that are deductible only to the extent that they (together with all other miscellaneous itemized deductions) exceed 2% of your adjusted gross income. In addition, if you are subject to the Alternative Minimum Tax (AMT) there is no tax benefit for telecommuting expenses.  Whereas, for a self-employed individual, the home office deduction is included on their Schedule C and is not limited or subject to AMT. 

Employees who use space in their home to occasionally do work do not qualify for a home office deduction. 

When you sell a home (at a profit) that contains, or contained, a home office, the capital gain is calculated  separately on the home office portion due to the depreciation expense that has been claimed. In addition, the onetime exclusion of gain of $250,000/$500,000 on the sale of one's primary residence won't apply to the portion of your profit allocable to a home office. 

It is important you review your situation with your DGC service provider to ensure you understand the rules that apply to your situation to maximize any potential deductions.  Please contact your DGC services provider to discuss these rules further.

IRS Can Request Electronic Backup of Accounting Records

 

 

By Joseph Lanzi, CPA

A recent U.S. Court ruling will require greater vigilance when it comes to your electronic records. Specifically, the ruling upholds the right of the U.S. Internal Revenue Service to request an electronic backup of any company’s accounting records. This means if a business attempts to withhold electronic records, the IRS can either issue a summons demanding them or disallow all tax items it cannot substantiate without access to the records.

At DGC, we recommend that bookkeepers (and anyone else with access to company financial records) maintain those records as if an IRS auditor may be reviewing them someday. We are encourage our clients to adhere to best practices including:
•		Keep audit trails on
•		Use adjusting entries
•		Document everything
•		Archive or condense data for prior tax years

As advocates for our clients, we want to make sure you have the right procedures in place. With this latest ruling, it is more important than ever before that your bookkeepers be properly trained on the use of QuickBooks. Remember, we are available to provide training and consulting to make sure you are implementing best policies and practices. For more details, contact your DGC representative today.

Form 8938: What is FATCA and what is a Foreign Financial Asset

 

 

By Laura K. Barooshian, CPA, MST

Throughout the past year we have been writing to alert our clients and their advisors that new Foreign Account Tax Compliance Act (FATCA) rules and the related reporting requirements would be part of the 2011 income tax filing. Well, tax season is here and those new rules are now a reality. What does it all mean?

For financial institutions FATCA will generally be effective in 2013 but for individuals with "foreign financial assets" the rules apply to 2011. So what is a "foreign financial asset," to whom do these new reporting rules apply, and what are the filing thresholds?

A "foreign financial asset" is generally defined as:
•		any financial account maintained by a foreign financial institution,
•		stocks and securities issued by someone who is not a U.S. person and which are not held in a U.S. financial account,
•		any interest in a foreign entity (partnership, corporation or trust), or
•		any financial instrument or contract with an issuer or counterparty that is not a U.S. person.
Some examples of items which are considered to be a "foreign financial asset" include:
•		stock purchased directly on a foreign stock exchange,
•		stock issued by a foreign corporation and held directly by a U.S. person,
•		interest in a foreign mutual fund, foreign hedge fund, and foreign private equity fund,
•		a note, bond or other indebtedness issued by a foreign person,
•		an interest in a foreign trust or estate, and
•		an interest in a disregarded entity which holds any of the above.

Now let's take a look at who must report these assets on their 2011 income tax return. Generally, Form 8938 (Statement of Specified Foreign Financial Assets) will be required to be filed by a U.S. citizen, permanent resident (green card holder), or resident alien of the U.S. or a nonresident alien who makes an election to be treated as a resident alien for tax purposes.

The last item to consider in determining whether or not Form 8938 is required to be filed is the value of the foreign financial assets. The following guidelines apply to filing Form 8938:
•		Single individuals (and Married individuals filing a separate return) living in the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $50,000 on the last day of the year or $75,000 at any point during the tax year.
•		Married individuals, filing a joint income tax return, and living in the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $100,000 on the last day of the year or $150,000 at any point during the tax year.
•		Single individuals (and Married individuals filing a separate income tax return) living outside of the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $200,000 on the last day of the year or $300,000 at any point during the tax year.
•		Married individuals, filing a joint income tax return, and living outside of the U.S. must file Form 8938 if the total value of the foreign financial assets exceeds $400,000 on the last day of the year or $600,000 at any point during the tax year.

We suggest individuals and their advisors who believe they have "foreign financial assets" that will be required to be reported on Form 8938 for 2011 gather as much information as possible as to the ownership and value of those assets and contact their DGC team member to discuss how these new rules will apply to them.

We expect these rules to become more complex and invasive as the IRS fully implements FACTA. Recently, the U.S., France, Germany, Italy, Spain, and the United Kingdom announced they are "exploring a framework to share information on bank accounts across borders."

The international tax team at DGC is ready to assist with any questions you have in this area. Please contact Laura K. Barooshian at 781-937-5332 or Laurie J. Austin at 781-937-5329 with any questions.

Gift Tax Exemptions Increased in 2012

 

 

By Christopher Hussey, CPA

Beginning in 2011 Congress set the lifetime exemption for estate tax, gift tax, and generation skipping tax (GST) at $5 million per taxpayer. This means that a married couple can gift $10 million of assets without paying federal gift taxes or generation skipping taxes. The estate and gift tax exemption are indexed for inflation and increased to $5.12 million on January 1, 2012. The GST exemption remains at $5 million.

Taxpayers that maximized their exemptions in 2011 are now able to gift another $120,000 ($240,000 for a married couple) during 2012, again without paying any gift tax. Taxpayers that have not yet taken advantage of the increased exemptions are encouraged to do so. The exemptions for estate, gift, and GST are slated to revert to the old amounts of $1 million each as of January 1, 2013. Although there is much talk that the actual exemption to be enacted by Congress will be higher than that, no one can be sure what will transpire.

In addition to the lifetime exemption amounts, a taxpayer is allowed an annual exclusion of $13,000 per beneficiary. This means that a married couple could give their child $26,000, $13,000 each, without using any of their lifetime exemption.

Please contact a member of your DGC service team if you would like to discuss the gift opportunities available to you.

Positive Signs for Boston's Hospitality Industry

 

 

By Sandra Caffrey and Laura Gregoriadis, CPA

With personal income on the rise and corporate budgets allowing for more travel and entertainment, the hospitality industry is starting to reap the benefits. The Boston hotel industry experienced positive growth during 2011 and experts predict the upward trend will continue into 2012. Revenue per available room (RevPAR) increased by 8.3% during the first three quarters of 2011 compared to prior year. The increase in RevPAR is due primarily to higher occupancy. Although room rates have increased since the industry hit rock bottom, competition still remains strong and corporations are sensitive to pricing.

The outlook for the Boston hotel industry for 2012 is bright. Boston hotels and investors are estimating RevPAR growth for 2012 to be within the range of 5% - 10%. Some other positive signs cited by experts in the Boston area include:

• An estimated 38% increase in the number of events scheduled for the Boston convention centers in 2012 over prior year.
• For the first time ever, the United States is advertising in other countries to increase U.S. tourism. Whether it is a point of entry or the final destination, Boston will benefit from this marketing effort.
• Local tourism groups and industry leaders are working with politicians to reform the visa process and allow easier access for international travel into the U.S.

As the economy fights to recover, increased tourism will not only benefit the hospitality industry, the rewards will also trickle down to other sectors of the economy. The recovery in the Boston marketplace is ahead of the national average with the hotel industry helping to lead the way.

Tracking trends and key performance indicators is just one of the ways the professionals in the Real Estate group at DGC stay ahead of the curve and add value for clients.

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.