Business

Article Dean Dorton

When planning for the future, business owners often are engaged in forecasting, reflecting on past performance, and setting goals. While budgets, financial statements, and tax returns may be part of this process, it is equally important to devote attention to your business’s organizational structure, corporate governance, and potential sale considerations. Often overlooked, these elements can significantly impact your business’s success and long-term viability.

It is important to begin this process early often years in advance if possible.

In this article, we emphasize the importance of revisiting your organizational structure, delve into the types of buy-sell agreements, and explore considerations for a potential sale of your business.

1. The Importance of Revisiting Organizational Structure

Your business’s organizational structure serves as the foundation for its operations, decision-making processes, and growth trajectory. Outdated structures can impede progress, hinder adaptability, and limit your ability to attract potential buyers. By reviewing and updating your organizational structure, you can:

  • Streamline operations: Assess whether your current structure aligns with your business goals and objectives. Clearly define decision-making authority and accountability within your organizational structure to limit exposure to a key-man discount.
  • Attract potential buyers: A clean corporate structure and buy-sell agreement can make future exits much simpler. Messy ownership structures can scare away potential buyers. If you believe selling to an outside party is a likely exit, planning this process earlier is paramount to ensure you maximize value.

2. Types of Buy-Sell Agreements

Buy-sell agreements are essential for privately-held businesses, especially during ownership transitions or potential sales. Good agreements safeguard the interests of owners and their families, ensuring a fair and orderly process. Poorly structured agreements can create headaches and strip value from your business. In his book, Buy-Sell Agreements for Closely Held and Family Business Owners, Chris Mercer identifies commonly used buy-sell agreements:

  1. Valuation agreements — The business value is determined by one or multiple valuation appraisers. The buy-sell agreement defines key aspects of the valuation process such as the standard of value, level of value, application of discounts for lack of marketability and control, etc.
  2. Fixed-price agreements — Owners agree on a fixed price for the business value. Price remains static over time which may or may not represent a fair and
    reasonable price depending on changes in the business, industry, and economic environment.
  3. Formula agreements — A formula agreed upon by the owners will determine the business value typically based on financial metrics (e.g. stated multiple of earnings or book equity value). Similar to a fixed-price agreement, the formula may or may not result in a fair and reasonable price over time due to the changes in facts and circumstances of the business.
  4. Shotgun agreements — A triggering event results in an owner tendering a price to buy or sell an ownership interest in the business. The owner receiving the offer has the option to buy at the offered price or sell at the same price. A “fair and reasonable price” is anticipated as each owner could be the buyer or seller. However, the financial circumstances and personal employment status of each owner and their family can influence the offering price and related decisions or implications.

Each type of buy-sell agreement has many nuances, advantages, and disadvantages. The “right” type of buy-sell agreement often depends upon the circumstances of the business, owners, and the owner family dynamics.

3. Considerations for a Potential Sale

In addition to reviewing your organizational structure and buy-sell agreements, it is crucial to consider the potential sale of your business. Factors to evaluate may include:

  • Business valuation: Assess the current value of your business, taking into account its assets, revenue, market position, and growth potential
  • Market analysis: Understand the market conditions, industry trends, and potential buyer profiles that may influence the sale process. Identify opportunities to position your business strategically to maximize its attractiveness to potential buyers.
  • Exit strategy planning: Develop a robust exit strategy that aligns with your personal and financial goals. Consider the timing, succession planning, and potential tax implications of the sale. Who is your target buyer? A family member, someone interested in your business’ legacy, or private equity?

Conclusion

Remember to allocate time and resources to review your business’s organizational structure, buy-sell agreements, and potential sale considerations.

Dean Dorton’s business advisory and valuation group has assisted many business owners with transitions and structuring their buy-sell agreements. Let us become part of your advisory team to review your business organizational and governance and help you ensure a smooth and rewarding journey as you navigate the future of your business.

Article Dean Dorton

Over two months ago, the Consolidated Appropriations Act, 2021 (Appropriations Act) brought welcome news to many Paycheck Protection Program (PPP) borrowers. Until then, PPP borrowers were prohibited from claiming the employee retention credit (ERC), a refundable payroll tax credit created by the CARES Act. The Appropriations Act changed the law to allow PPP borrowers who meet the ERC eligibility criteria to claim the ERC, with the caveat that the same wages cannot be used to calculate the ERC and also obtain PPP loan forgiveness. This change was retroactive to the CARES Act’s effective date, giving PPP borrowers who had not claimed the ERC in 2020 but qualified for the credit the opportunity to claim it for periods beginning March 13, 2020, and ending December 31, 2020.

Despite this favorable development, questions surfaced regarding the interaction between ERC and PPP wages. When the Appropriations Act became law in late December 2020, many borrowers had already applied for forgiveness of their PPP loan. To ensure full forgiveness, some borrowers reported gross wages on their forgiveness application in excess of their loan amount. It was unclear whether gross wages included on a forgiveness application, but unnecessary for full forgiveness, were eligible for the ERC. Also, while many borrowers paid or incurred eligible non-payroll costs during the covered period, they often excluded those costs from their application to streamline the lender and SBA review processes.

On March 1, 2021, these questions were finally answered by the IRS in Notice 2021-20. Per the notice, PPP borrowers may use wages reported on a loan forgiveness application in excess of the amount necessary to support full forgiveness as qualified wages for the ERC. However, borrowers cannot use wages in an amount equal to other eligible non-payroll expenses (such as mortgage interest, rent, or utilities) that they did not include on their submitted application.

To understand the IRS guidance, let’s consider two examples.

Example 1

Employer A received a PPP loan of $200,000 and paid $250,000 of wages that would qualify for the ERC in 2020. Employer A submitted a forgiveness application and reported the $250,000 of qualified wages as PPP forgivable wages. Employer A did not report any other eligible expenses on its application. Employer A’s entire loan was forgiven.

Employer A may not use $200,000 of the qualified wages necessary for forgiveness for ERC purposes. However, Employer A may use the $50,000 of qualified wages reported on the forgiveness application that were not necessary for full forgiveness.

Example 2

Employer B received a PPP loan of $200,000. Employer B paid $200,000 of qualified wages that would qualify for the ERC in 2020. Employer B also paid other eligible non-payroll expenses of $70,000. Employer B submitted a forgiveness application and reported the $200,000 of qualified wages to support the loan’s forgiveness. Employer B did not report the other eligible expenses of $70,000. Employer B’s entire loan was forgiven.

Employer B may not use the $200,000 of qualified wages for purposes of the ERC. Additionally, although Employer B could have reported $70,000 of eligible expenses other than wages, no portion of this amount may be used for loan forgiveness to free up qualified wages for the ERC.

The IRS notice states that PPP borrowers that are eligible businesses can claim the ERC for eligible quarters in 2020 by filing Form 941-X, but only for qualified wages not necessary and used for loan forgiveness.

The notice also formalizes and expands upon many Frequently Asked Questions (FAQs) about the ERC previously posted on the IRS’s website.  The formalization of the FAQs allows taxpayers to rely on the guidance for penalty protection.

The Appropriations Act extended the ERC into the first and second quarters of 2021. The IRS intends to issue separate guidance on the 2021 ERC.

For general information on the ERC, follow the link below:

Employee Retention Credit

Do you have questions about the new law? Contact your Dean Dorton advisor, or contact us at:

covid19solutions@deandorton.com

Article Dean Dorton

In the first two parts of this Tax Cuts and Jobs Act QBI deduction series, we discussed the computation of the deduction and the businesses and income that qualified for the deduction. In Part 3, we will discuss special rules applicable to specified service businesses and other provisions. (Please note that the discussion below is based on the statute and committee explanations and is subject to change with additional guidance.)

As noted in Part 2, the qualified business income deduction generally does not apply to the specified service businesses listed in the article. However, there is an exception for otherwise nonqualifying businesses if the owner’s taxable income is below a certain amount. The owner of a specified service business can claim the full deduction otherwise available for a qualified trade or business if the owner’s taxable income does not exceed $315,000 on a joint return and $157,500 on all other returns. If the owner’s taxable income is between $315,000 and $415,000 on a joint return, or between $157,500 and $207,500 on all other returns, then the owner can claim a reduced deduction. The deduction is equal to the deduction otherwise available for a qualified trade or business multiplied by the applicable percentage. If the owner’s taxable income exceeds the upper amount, no deduction is allowed.

As an example, assume that joint filers operate a specified service business and have taxable income of $375,000 for 2018, which is $60,000 over the threshold. Also assume that the deduction allowable for a qualified trade or business with the same business income, wages, and property is $50,000. Since this is a specified service business the otherwise allowable deduction is 40% (the applicable percentage) of this amount or $20,000 (100% – $60,000 / $100,000 = 40%). As one may note from the computation in Part 1 and this computation, between the threshold amounts and the threshold amounts plus $100,000 or $50,000, depending on the filing status, the wage and property limitations are phased in and the specified service business deduction is phased out. The final deductible amount, after combining all separate business deductions and 20% of REIT and publicly-traded partnership income, is then subject to the taxable income limitation.

As noted in Part 2, there is some uncertainty as to how broadly the definition of specified service trade or business will be implemented. Additionally, if a sole proprietorship or other pass-through entity conducts both a qualified trade or business and a specified service business, there is currently no guidance on how to determine the business income, wages, and property allocable to each. If a taxpayer has both types of businesses in separate entities but there are transactions among the entities, such as rent, interest, or management fees, will this require adjustments in determining business income subject to the deduction?

The qualified business income deduction does not reduce the amount of income subject to self-employment tax, nor would it appear to reduce the net income for purposes of calculating contributions to self-employed retirement plans, although no guidance in this area has been issued. The deduction reduces the taxpayer’s taxable income, not the taxpayer’s adjusted gross income, and the deduction is not included in itemized deductions. The deduction is not adjusted in arriving at alternative minimum taxable income.

One area of uncertainty is the interaction of this deduction with the passive activity limitations. The passive activity regulations permit a taxpayer to treat certain activities as separate activities or to group activities based on regulatory criteria. Since the qualified business income provisions do not reference the passive activity rules and do not permit the grouping of businesses, guidance will be needed to determine the relationship between these provisions, and planning for individuals with multiple activities and businesses may need to be reconsidered.

The qualified business deduction is also impacted by other provisions of the Tax Cuts and Jobs Act. The Act created a new limitation on the deductibility of business interest expense by individual taxpayers conducting business as sole proprietors, partners, or S corporation shareholders. Although the qualified business income deduction does not reduce the deduction for interest, the interest limitation will impact the amount of business income subject to the qualified business income deduction. We will discuss the interest limitation in an upcoming article.

Read All Tax Cuts and Jobs Act Articles

Article Dean Dorton

Rather than keeping track of the actual cost of operating a vehicle, employees and self-employed taxpayers can use a standard mileage rate to compute their deduction related to using a vehicle for business. But you might also be able to deduct miles driven for other purposes, including medical, moving and charitable purposes.

What are the deduction rates?

The rates vary depending on the purpose and the year:

Business: 54 cents (2016), 53.5 cents (2017)

Medical: 19 cents (2016), 17 cents (2017)

Moving: 19 cents (2016), 17 cents (2017)

Charitable: 14 cents (2016 and 2017)

The business standard mileage rate is considerably higher than the medical, moving and charitable rates because the business rate contains a depreciation component. No depreciation is allowed for the medical, moving or charitable use of a vehicle.

In addition to deductions based on the standard mileage rate, you may deduct related parking fees and tolls.

What other limits apply?

The rules surrounding the various mileage deductions are complex. Some are subject to floors and some require you to meet specific tests in order to qualify.

For example, miles driven for health-care-related purposes are deductible as part of the medical expense deduction. But medical expenses generally are deductible only to the extent they exceed 10% of your adjusted gross income. (For 2016, the deduction threshold is 7.5% for qualifying seniors.)

And while miles driven related to moving can be deductible, the move must be work-related. In addition, among other requirements, the distance from your old residence to the new job must be at least 50 miles more than the distance from your old residence to your old job.

Other considerations

There are also substantiation requirements, which include tracking miles driven. And, in some cases, you might be better off deducting actual expenses rather than using the mileage rates.

So contact us to help ensure you deduct all the mileage you’re entitled to on your 2016 tax return — but not more. You don’t want to risk back taxes and penalties later.

And if you drove potentially eligible miles in 2016 but can’t deduct them because you didn’t track them, start tracking your miles now so you can potentially take advantage of the deduction when you file your 2017 return next year.

Article Dean Dorton

The IRS is placing increased scrutiny on the use of tax exempt bonds by 501(c)(3) organizations. Since interest earned on the revenue bonds issued by state and local governmental organizations is exempt from federal income taxation, bonds are subject to compliance with federal tax law requirements.

One important requirement under the Internal Revenue Code is that not more than 5% (or 10% in the case of a governmental unit) of the net proceeds of the bonds, before issuance costs, may be used for private business use.

Private business use means the use of the bond financed facility, both actual or beneficial use, by a person other than a 501(c)(3) organization or a state or local government or by a 501(c)(3) in an activity that is an unrelated trade or business.

If the property is used both for a related purpose and an unrelated purpose, the property is still considered used in a private use, but the private business use may be allocated. If the organization fails the private use test, then the interest on the bonds can become taxable.

It is common for private business use to arise in connection with management and rental contracts at colleges and universities with management of cafeterias, concession stands, bookstores, retail facilities, parking garages, summer camps, other rental activities, or research contracts. If you have contracts with these types of activities, it is recommended that you review the contracts and make sure they meet an exclusion or the safe harbor requirements under the Code based on your facts and circumstances. The Code does provide for exceptions to private business use, such as use by the general public, incidental use, and short term use, but you must meet the requirements under each exception.

If you would like more information on private business use or help with review of your current or potential contracts, please contact your Dean Dorton advisor or Allison Carter at alcarter@deandorton.com.

Article Dean Dorton

In order to take advantage of two important depreciation tax breaks for business assets, you must place the assets in service by the end of the tax year. So you still have time to act for 2016.

Section 179 deduction

The Sec. 179 deduction is valuable because it allows businesses to deduct as depreciation up to 100% of the cost of qualifying assets in year 1 instead of depreciating the cost over a number of years. Sec. 179 can be used for fixed assets, such as equipment, software and leasehold improvements. Beginning in 2016, air conditioning and heating units were added to the list.

The maximum Sec. 179 deduction for 2016 is $500,000. The deduction begins to phase out dollar-for-dollar for 2016 when total asset acquisitions for the tax year exceed $200,000,000.

Real property improvements used to be ineligible. However, an exception that began in 2010 was made permanent for tax years beginning in 2016. Under the exception, you can claim a Sec. 179 deduction of up to $500,000 for certain qualified real property improvement costs.

Note: You can use Sec. 179 to buy an eligible heavy SUV for business use, but the rules are different from buying other assets. Heavy SUVs are subject to a $25,000 deduction limitation.

First-year bonus depreciation

For qualified new assets (including software) that your business places in service in 2016, you can claim 50% first-year bonus depreciation. (Used assets don’t qualify.) This break is available when buying computer systems, software, machinery, equipment, and office furniture.

Additionally, 50% bonus depreciation can be claimed for qualified improvement property, which means any eligible improvement to the interior of a nonresidential building if the improvement is made after the date the building was first placed in service. However, certain improvements aren’t eligible, such as enlarging a building and installing an elevator or escalator.

Contemplate what your business needs now

If you’ve been thinking about buying business assets, consider doing it before year end. This article explains only some of the rules involved with the Sec. 179 and bonus depreciation tax breaks. Contact us for ideas on how you can maximize your depreciation deductions.