Acuity Blog

A net operating loss on your 2017 tax return isn’t all bad news

3D Profit Loss Crossword

When a company’s deductible expenses exceed its income, generally a net operating loss (NOL) occurs. If when filing your 2017 income tax return you found that your business had an NOL, there is an upside: tax benefits. But beware — the Tax Cuts and Jobs Act (TCJA) makes some significant changes to the tax treatment of NOLs.

Pre-TCJA law

Under pre-TCJA law, when a business incurs an NOL, the loss can be carried back up to two years, and then any remaining amount can be carried forward up to 20 years. The carryback can generate an immediate tax refund, boosting cash flow.

The business can, however, elect instead to carry the entire loss forward. If cash flow is strong, this may be more beneficial, such as if the business’s income increases substantially, pushing it into a higher tax bracket — or if tax rates increase. In both scenarios, the carryforward can save more taxes than the carryback because deductions are more powerful when higher tax rates apply.

But the TCJA has established a flat 21% tax rate for C corporation taxpayers beginning with the 2018 tax year, and the rate has no expiration date. So C corporations don’t have to worry about being pushed into a higher tax bracket unless Congress changes the corporate rates again.

Also keep in mind that the rules are more complex for pass-through entities, such as partnerships, S corporations and limited liability companies (if they elected partnership tax treatment). Each owner’s allocable share of the entity’s loss is passed through to the owners and reported on their personal returns. The tax benefit depends on each owner’s particular tax situation.

The TCJA changes

The changes the TCJA made to the tax treatment of NOLs generally aren’t favorable to taxpayers:

  • For NOLs arising in tax years ending after December 31, 2017, a qualifying NOL can’t be carried back at all. This may be especially detrimental to start-up businesses, which tend to generate NOLs in their early years and can greatly benefit from the cash-flow boost of a carried-back NOL. (On the plus side, the TCJA allows NOLs to be carried forward indefinitely, as opposed to the previous 20-year limit.)
  • For NOLs arising in tax years beginning after December 31, 2017, an NOL carryforward generally can’t be used to shelter more than 80% of taxable income in the carryforward year. (Under prior law, generally up to 100% could be sheltered.)

The differences between the effective dates for these changes may have been a mistake, and a technical correction might be made by Congress. Also be aware that, in the case of pass-through entities, owners’ tax benefits from the entity’s net loss might be further limited under the TCJA’s new “excess business loss” rules.

Complicated rules get more complicated

NOLs can provide valuable tax benefits. The rules, however, have always been complicated, and the TCJA has complicated them further. Please contact us if you’d like more information on the NOL rules and how you can maximize the tax benefit of an NOL.

© 2018

 


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Internal control testing: What role does sampling play?

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Auditors must test the effectiveness of internal controls before signing off on your financial statements. But it’s impossible to analyze every transaction that’s posted to the general ledger, due to time and budget constraints. Instead, auditors select and analyze a representative sample of transactions to make assertions about the entire population. Here’s more on how sampling works — along with the pros and cons of using it during internal control testing.

Picking a sample

Auditors may use statistical techniques to develop a sample of transactions to test. For example, an auditor might select enough transactions to represent a specific percentage of 1) the total transactions in an account, or 2) the company’s total assets or revenue. Alternatively, a sample of transactions may be pulled randomly using statistical sampling software.

Auditors also can use nonstatistical sampling techniques based on a dollar threshold or professional judgment. These techniques tend to be more effective when the CPA has many years of audit experience to ensure that the sample chosen is representative of the population of transactions.

Unexpected outcomes

Before analyzing a sample, your auditor has expectations about the number of “exceptions” (such as errors and omissions) that will appear in the sample. If the actual exceptions exceed the auditor’s expectation, he or she may need to perform additional procedures. For instance, your auditor might expand the sample and conduct more testing to assess the degree of noncompliance.

Ultimately, your auditor might conclude that your internal controls are ineffective. If so, he or she will perform more work to estimate the magnitude of the control failure.

Pros vs. cons

Sampling helps keep audit costs down by streamlining the internal control testing process. It also reduces disruptions to business operations during audit fieldwork. When applied correctly, the results of sampling are theoretically as accurate as if the audit team had analyzed every transaction posted to the general ledger. But, in practice, sampling can sometimes cause problems during internal controls testing.

For example, sampling presumes that controls function consistently across the whole population of transactions. If an exception doesn’t appear in the sample — because the sample was too small or otherwise unrepresentative of the entire population — your audit team could reach the wrong conclusion about the effectiveness of your internal controls.

There’s also a risk that your audit team could rely too heavily on nonstatistical sampling. Relying more on judgment than statistical methods could result in errors, especially if an auditor lacks professional experience.

A collaborative process

You can help maximize the benefits of sampling by providing the audit team with document requests in a timely manner and following up on your auditor’s management points at the end of each year’s audit. It’s frustrating to both auditors and business owners when internal control weaknesses recur year after year. Our auditors have extensive experience testing internal controls, and we’d be happy to answer any questions you have on testing and sampling techniques.

© 2018

 


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Should you file Form SS-8 to ask the IRS to determine a worker’s status?

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Classifying workers as independent contractors — rather than employees — can save businesses money and provide other benefits. But the IRS is on the lookout for businesses that do this improperly to avoid taxes and employee benefit obligations.

To find out how the IRS will classify a particular worker, businesses can file optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” However, the IRS has a history of reflexively classifying workers as employees, and filing this form may alert the IRS that your business has classification issues — and even inadvertently trigger an employment tax audit.

Contractor vs. employee status

A business enjoys several advantages when it classifies a worker as an independent contractor rather than as an employee. For example, it isn’t required to pay payroll taxes, withhold taxes, pay benefits or comply with most wage and hour laws.

On the downside, if the IRS determines that you’ve improperly classified employees as independent contractors, you can be subject to significant back taxes, interest and penalties. That’s why filing IRS Form SS-8 for an up-front determination may sound appealing.

But because of the risks involved, instead of filing the form, it can be better to simply properly treat independent contractors so they meet the tax code rules. Among other things, this generally includes not controlling how the worker performs his or her duties, ensuring you’re not the worker’s only client, providing Form 1099 and, overall, not treating the worker like an employee.

Be prepared for workers filing the form

Workers seeking determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to health, retirement and other employee benefits and want to eliminate self-employment tax liabilities.

After a worker files Form SS-8, the IRS sends a letter to the business. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return it to the IRS, which will render a classification decision. But the Form SS-8 determination process doesn’t constitute an official IRS audit.

Passing IRS muster

If your business properly classifies workers as independent contractors, don’t panic if a worker files a Form SS-8. Contact us before replying to the IRS. With a proper response, you may be able to continue to classify the worker as a contractor. We also can assist you in setting up independent contractor relationships that can pass muster with the IRS.

© 2018

 


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Learn the warning signs of earnings “spin”

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Management wants to paint the rosiest possible picture of a company’s financial performance. But aggressive earnings management, or “spin,” can mislead investors and lenders. Here are some ways U.S. Generally Accepted Accounting Principles (GAAP) can be manipulated to obscure the truth.

Creative accounting vs. cooking the books

Earnings management usually starts out small, but it can become increasingly aggressive and eventually cross the line into fraud if it goes unchecked. An external audit may help detect the red flags of earnings management, including:

Premature revenue recognition. Some companies recognize revenue early to make the income statement temporarily appear more attractive. This ploy is common when a company is applying for bank financing or up for sale.

Miscellaneous “cookie jar” reserves. Management can create a hidden reserve of funds during good times. Then the reserves can be tapped into to nourish earnings in lean times.

“Big bath” restructuring changes. Some companies overstate the costs associated with restructuring. This enables them to clean up their balance sheets and create reserves for a rainy day.

Immediate acquisition write-offs. Acquired companies may classify a portion of the purchase price as “in process research and development,” which they immediately write off. This reduces the amortization of the purchase price to future earnings.

Overreliance on EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) and other non-GAAP metrics have become popular ways to evaluate a company’s performance. But they aren’t usually audited, and they may be calculated differently from company to company.

EBITDA is generally intended to resemble cash flow. But this metric can obscure problems for start-up companies with major debt. Although their EBITDAs give these start-ups appeal, their debt service may mean they won’t be profitable for many years.

Too good to be true?

Pay attention when reviewing financial statements and corporate press releases — the opportunity and pressure to spin earnings is everywhere. Contact us for more information on how to identify when a business may have engaged in “creative” accounting practices to improve their financial picture.

© 2018

 


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2018 Q2 tax calendar: Key deadlines for businesses and other employers

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Here are some of the key tax-related deadlines affecting businesses and other employers during the second quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

April 17

  • If a calendar-year C corporation, file a 2017 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004), and pay any tax due. If the return isn’t extended, this is also the last day to make 2017 contributions to pension and profit-sharing plans.
  • If a calendar-year C corporation, pay the first installment of 2018 estimated income taxes.

April 30

  • Report income tax withholding and FICA taxes for first quarter 2018 (Form 941), and pay any tax due. (See exception below under “May 10.”)

May 10

  • Report income tax withholding and FICA taxes for first quarter 2018 (Form 941), if you deposited on time and in full all of the associated taxes due.

June 15

  • If a calendar-year C corporation, pay the second installment of 2018 estimated income taxes.

© 2018

 


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