Acuity Advisors

Accelerate depreciation deductions with a cost segregation study

Business owners may be able to see substantial tax savings faster by conducting cost segregation studies. These studies identify property components and their costs, allowing you to maximize current depreciation deductions by using shorter lives and speeding up depreciation rates available for the qualifying parts of the property.

Depreciation rules

Buildings generally are depreciated over 27.5 years (residential rental) or 39 years (commercial) using the straight-line method. This recovery period applies to real property, which includes buildings as well as structural components such as walls, concrete floors, paint, windows, ceilings and HVAC systems.

You may be able to write off some parts of a property faster than 27.5 or 39 years by separating the parts that aren’t structural. In some cases, you can use a 5-, 7- or 15-year rate of depreciation. There are no hard-and-fast rules for distinguishing personal property eligible for accelerated depreciation from structural components that are depreciated as part of a building. Various factors come into play, including how the property is affixed to the building, whether it’s designed to remain in place permanently, and how difficult it would be to move or remove.

Examples of personal property that can qualify for a faster depreciation deduction include:

Decorative fixtures,
Cabinets, shelves,
Movable wall partitions, and
Carpeting.

You can also depreciate the allocated portion of certain capitalized indirect or overhead costs — such as architectural and engineering fees. And land improvements that you can isolate with a cost segregation study include parking lots, sidewalks, fences and landscaping.

Consider a cost segregation study when you buy, build or remodel — or when you’ve done so within the last few years. Be aware that the overall benefits may be limited in certain circumstances, such as when a business is subject to the alternative minimum tax or located in a state that doesn’t follow federal depreciation rules. Passive activity loss rules can also defer benefits.

A cost segregation study can be an excellent way for gaining faster write-offs on real estate and construction projects. Contact us to help determine whether you can benefit.

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Beware of accounts deceivable

More than half of financial statement frauds involve sales and accounts receivable, according to the Committee of Sponsoring Organizations of the Treadway Commission. (COSO is a joint initiative of five private sector organizations that develops frameworks and guidance on enterprise risk management, internal control and fraud deterrence.) But why do fraudsters tend to target accounts receivable?

For accrual-basis entities, accounts receivable is typically one of the most active accounts in the general ledger. It’s where companies report contract revenue and any other sales that are invoiced to the customer (rather than paid directly in cash). The sheer volume of transactions flowing through this account helps hide a variety of scams. Here are some examples.

Fictitious sales

Sometimes fraudsters book phony sales — and receivables — to make their company’s performance appear rosier than reality. Increased sales assure stakeholders that the company is growing and building market share. They also increase profits artificially, because bogus sales generate no costs. And, overstated receivables inflate the collateral base, allowing the company to secure additional financing.

Timing differences

Unscrupulous owners or employees might manipulate cutoffs to boost sales and receivables in the current accounting period. For example, a salesperson could prematurely report a large contract sale even though material uncertainties exist. A retail chain CFO could hold the accounting period open a few extra days to boost year-end sales. Or a contractor might use aggressive percentage-of-completion estimates to boost revenues.

Lapping

Some employees divert customer payments for their personal use. Then, the fraudster applies a subsequent payment from another customer to the customer whose funds were stolen. The second customer’s account is credited by a third customer’s payment, and so on. Delayed payments continue until the fraudster repays the money, makes an adjusting journal entry or gets caught.

Know the red flags

Accounts receivable fraud can be hard to unearth. Fortunately, experienced forensic accountants know to look for such anomalies as:

Dramatically increased accounts receivable compared to sales or total assets,
Revenues increasing without a proportionate increase in cost of sales or shipping costs,
Deteriorating collections, and
Significant write-offs and returns in subsequent periods.

If something seems awry with your accounts receivable, we can help verify your outstanding balances and find holes in your internal controls system to safeguard against future scams.

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Investigate the tax benefits of the research credit

If your company engages in research and development, you’re driven to innovate and bring new products and improvements to market. It’s that spirit of discovery that keeps businesses in the United States on the leading edge. Even better, you may qualify for a lucrative federal tax credit for some of your expenses related to R&D. Many states also offer research tax incentives.

Improved and permanent

The federal research tax credit is now permanent, thanks to the Protecting Americans from Tax Hikes (PATH) Act of 2015. This is good news because, for more than 30 years, the popular tax break periodically expired and was reinstated (usually for a year or two), which caused uncertainty for businesses.

Generally, the credit is equal to a portion of qualified research expenses incurred during the taxable year. The credit is complicated to calculate and not all research activities are eligible but the tax savings can be sizable.

The PATH Act added two new features that are especially favorable to small businesses.

Beginning in 2016, small businesses with $50 million or less in gross receipts may claim the credit against alternative minimum tax liability.
The credit can be used by certain even smaller businesses against the employer’s portion of Social Security tax. This provision also became effective in 2016.

Tax planning opportunity

Now that the credit is permanent, companies can count on it when they plan R&D projects. There could also be an opportunity to file an amended tax return and collect a refund if you incurred qualified expenses in previous years but didn’t claim them.

Be aware that the IRS announced recently that it “does see a significant amount of misuse of the research credit each year.” Good recordkeeping is important. To claim a credit, taxpayers must document their activities to establish the amount of qualified research expenses paid. Contact us to find out how to maximize the benefits allowed under the law.

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Substantial doubt: It’s a matter of opinion

Auditors reconsider the “going concern” assumption every time they audit your financial statements. When your company’s long-term viability is doubtful, it may cause the auditor to issue a qualified audit opinion. Depending on the level of uncertainty and the underlying reasons, a qualified opinion could raise a red flag that your company is under financial distress and might need to file for bankruptcy in the near future.

Going concern assumption

Financial statements are generally prepared under the assumption that the business will remain a going concern. That is, the entity is expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business.

Sometimes adverse conditions and events — such as negative operating cash flow or pending lawsuits — cast “substantial doubt” on the entity’s ability to continue as a going concern over the next year.

Levels of opinion

Audit opinions vary depending on available information, financial viability, errors discovered during audit procedures and other limiting factors. When an auditor issues an unqualified opinion, he or she is saying that the company’s financial condition, position and operations are fairly presented in the financial statements.

When uncertainties exist regarding the going concern assumption, the auditor will typically issue a qualified opinion. A qualified opinion may also be issued if your financial statements appear to contain a small deviation from U.S. Generally Accepted Accounting Principles (GAAP) — or if management limits the scope of audit procedures.

Much less desirable are adverse opinions. They indicate material exceptions to GAAP that affect the financial statements as a whole.

By far the most alarming opinion is a disclaimer, which occurs when the auditor gives up midaudit. Reasons for a disclaimer may include significant scope limitations and uncertainties within the subject company itself.

Management’s role

Guidance that shifts the responsibility for identifying going concern issues from external auditors to internal managers was issued by the Financial Accounting Standards Board in 2014. This change is intended to inform stakeholders about financial problems sooner.

If you identify a going concern issue, ask yourself, “Can we fix it?” Then, assemble a team of internal and external advisors to brainstorm remedies. If it’s not fixable, expect a downgraded audit opinion and prepare to address inquiries from your lenders and investors when your financial statements are issued.

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Corporate shareholder-employees: Find the right compensation balance

The IRS may object to the compensation of C corporation shareholder-employees. If it’s deemed too high — or not “reasonable” under the circumstances — the IRS could force you to make adjustments that increase taxes.

This can be particularly troublesome for C corporation owners and executives who are also shareholders, because they’ll then be hit with double taxation.

When double taxation comes into play

When a corporation distributes profits as salaries, the firm gets a deduction for the amount. The owner or executive pays personal income tax on the money, of course, but it’s only taxed once. But if the corporation pays the owner or executive dividends, the money is taxed twice — once at the corporate level and again at the personal level. Plus, the business can’t deduct dividend payments.

But compensation must be reasonable. If the IRS considers it too high, it can label part of the payments as “disguised dividends,” which are taxed twice. There could also be back taxes and penalties.

What’s considered reasonable?

There’s no simple formula for determining a reasonable salary. The IRS will look at the amounts that similar corporations pay their executives for comparable services. Some of the other factors it considers are the employee’s duties, experience, expertise and hours worked.

Not surprisingly, the issue of reasonable compensation frequently winds up in court. To protect yourself, spell out the reasons for compensation amounts in your corporate minutes. The minutes should be reviewed by a tax professional before being finalized. Cite any executive compensation or industry studies, as well as other reasons why the compensation is reasonable.

If your business is profitable, you should generally pay at least some dividends. By doing so, you avoid the impression that the corporation is trying to pay out all profits as compensation. We can help determine whether dividends should be paid and, if so, how much they should be.

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