Happy Labor Day!
No great achievement is possible without persistent work.
Have a safe and happy Labor Day from the staff at DPC!
Happy Labor Day!
Davidson Pargman
Financial statements at a glance
Financial statements tell investors information about an organization’s financial performance, helping to ensure corporate transparency and accountability. But they can also be used internally to help management make strategic decisions, improve upon past results and add value. There are three parts to comprehensive financial reporting under U.S. Generally Accepted Accounting Principles (GAAP) — each with a unique message.
Income statements
Many people focus on earnings, which are reported on the income statement (also known as the profit and loss statement). This statement provides an overview of revenue, expenses and earnings over a given period.
A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product. Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.
Though it may be tempting to just review revenue and profit trends, thorough due diligence looks beyond the income statement. Growth and profitability aren’t the only metrics that matter. For example, high-growth companies that report healthy top and bottom lines may not have enough cash on hand to pay their bills.
Balance sheets
The balance sheet (also known as the statement of financial position) provides a snapshot of the company’s financial health. It tallies assets, liabilities and equity.
Under GAAP, assets are reported at the lower of cost or market value. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.
Intangible assets (such as patents, customer lists and goodwill) can provide significant value to a business. But internally developed intangibles aren’t reported on the balance sheet. Intangible assets are only reported when they’ve been acquired externally.
Owners’ equity (or net worth) is the extent to which the book value of assets exceeds liabilities. If liabilities exceed assets, net worth will be negative. However, book value may not necessarily reflect market value. Some companies may provide the details of owners’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.
Statements of cash flows
The cash flow statement shows all the cash flowing in and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.
Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. Watch your statement of cash flows closely. To remain in business, companies must continually generate cash to pay creditors, vendors and employees.
Beyond compliance
Financial reporting is more than an exercise in compliance with accounting rules. Financial statements can be a valuable management tool. However, to get a holistic assessment of your organization’s performance, it’s important to look beyond profits. Contact us for help preparing these statements and benchmarking your organization’s performance over time and against competitors.
© 2023
TopLine Content Marketing Team
Divorcing business owners should pay attention to the tax consequences
If you’re getting a divorce, you know the process is generally filled with stress. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.
Transferring property tax-free
In general, you can divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).
For example, let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding period for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
- A year after the date the marriage ends, or
- Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.
Additional future tax issues
Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note: The person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.
In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.
Avoid surprises by planning ahead
Like many major life events, divorce can have significant tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Contact us. We can help you minimize the adverse tax consequences of settling your divorce.
© 2023
TopLine Content Marketing Team
Selling your home for a big profit? Here are the tax rules
Many homeowners across the country have seen their home values increase in recent years. According to the National Association of Realtors, the median price of existing homes sold in July of 2023 rose 1.9% over July of 2022 after a couple years of much higher increases. The median home price was $467,500 in the Northeast, $304,600 in the Midwest, $366,200 in the South and $610,500 in the West.
Be aware of the tax implications if you’re selling your home or you sold one in 2023. You may owe capital gains tax and net investment income tax (NIIT).
You can exclude a large chunk
If you’re selling your principal residence, and meet certain requirements, you can exclude from tax up to $250,000 ($500,000 for joint filers) of gain.
To qualify for the exclusion, you must meet these tests:
- You must have owned the property for at least two years during the five-year period ending on the sale date.
- You must have used the property as a principal residence for at least two years during the five-year period. (Periods of ownership and use don’t need to overlap.)
In addition, you can’t use the exclusion more than once every two years.
The gain above the exclusion amount
What if you have more than $250,000/$500,000 of profit? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.
If you’re selling a second home (such as a vacation home), it isn’t eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss, which you can’t do on a principal residence.
The NIIT may be due for some taxpayers
How does the 3.8% NIIT apply to home sales? If you sell your main home, and you qualify to exclude up to $250,000/$500,000 of gain, the excluded gain isn’t subject to the NIIT.
However, gain that exceeds the exclusion limit is subject to the tax if your adjusted gross income is over a certain amount. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.
The NIIT applies only if your modified adjusted gross income (MAGI) exceeds: $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; and $200,000 for unmarried taxpayers and heads of household.
Two other tax considerations
- Keep track of your basis. To support an accurate tax basis, be sure to maintain complete records, including information about your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed for business use.
- You can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if a portion of your home is rented out or used exclusively for business, the loss attributable to that part may be deductible.
As you can see, depending on your home sale profit and your income, some or all of the gain may be tax-free. But for higher-income people with pricey homes, there may be a tax bill. We can help you plan ahead to minimize taxes and answer any questions you have about home sales.
© 2023
TopLine Content Marketing Team
7 simple truths about payroll for employers
Employers tend to prioritize things such as maintaining or boosting productivity, accomplishing strategic objectives, and fulfilling their missions. All too often, managing payroll is taken for granted and not given much oversight once the checks start rolling out.
But this can lead to problems as big as a federal investigation or as small (relatively speaking) as employees grumbling around the watercooler. Here are seven simple truths about payroll to keep in mind:
1. A formal policy keeps everyone on the same page. Every organization should establish and document a formal policy outlining its payroll philosophy, rules and procedures. Doing so creates a single resource for payroll administrators to follow and employees to reference. It also sets forth guidelines for accomplishing payroll tasks efficiently and accurately. Your attorney should review the policy when it’s created and whenever it’s updated.
2. Workers need to be properly classified. Generally, workers classified as employees must be categorized as either hourly or salaried. Under the Fair Labor Standards Act (FLSA), hourly employees must receive overtime pay for any hours worked past 40 per week. (Some exceptions may apply.) Salaried employees are usually exempt from FLSA’s overtime rules. If you engage independent contractors, they need to be clearly treated as such — not managed the same way as employees. Should any questions arise regarding how to classify a worker, contact your employment attorney.
3. Compliance is critical. As you’re no doubt aware, payroll compliance means abiding by federal, state and local laws. At the federal level, there’s the aforementioned FLSA, as well as laws such as the Federal Insurance Contributions Act, Federal Unemployment Tax Act and Equal Pay Act. Agencies such as the IRS and U.S. Department of Labor typically conduct payroll compliance investigations. Be sure your staff and payroll services provider (if you have one) keeps up with the latest regulations and guidance.
4. For most employers, simpler is better. Naturally, the complexity of any organization’s payroll depends on its size and the nature of its operations. To the extent possible, however, try to keep your payroll processes “lean and mean.” You may want to use a centralized portal or a cloud-based “software as a service” application to help facilitate an efficient, affordable approach to payroll management. But it’s imperative to find the optimal solution for your distinctive needs.
5. Employee training is worth the investment. If you’re keeping payroll in-house, ensure every staff member involved receives the appropriate amount and nature of training. This should include ongoing training as procedures or technology change. Even if you outsource payroll, some employees may need training to functionally interact with the provider and maintain your end of the deal.
6. Outsourcing is often a viable option. Turning over major payroll functions to an outside provider is a strategy every employer should keep in mind. Under the right circumstances, outsourcing can increase efficiency, ease compliance, and save time and money. That said, you should perform a cost vs. benefits analysis before investing in a third-party payroll services provider.
7. Ultimately, it’s a people thing. Payroll isn’t about only dollars and cents; mistakes or inefficiencies in this area can be an absolute morale killer. Few employees will stick with an employer that regularly shorts or delays their checks. And even if mishaps are rare, staff members will remember if errors aren’t quickly corrected. Contact us if you’re interested in outsourcing. We can also help you review and improve the cost-effectiveness of your payroll processes.
© 2023
TopLine Content Marketing Team
New report identifies high-risk areas in financial reporting
In July 2023, the Public Company Accounting Oversight Board (PCAOB) published a report that highlights common areas of audit deficiencies for public companies. Private companies face similar challenges when reporting their financial results. Internal accounting personnel and external auditors can use the PCAOB’s report to identify high-risk areas in financial reporting that may warrant additional attention.
2022 findings
The PCAOB recently inspected portions of financial statement audits for public companies. The findings were published in a new PCAOB Spotlight report, Staff Update and Preview of 2022 Inspection Observations.
Many of the deficiencies found in 2022 are in inherently complex areas that have greater risks of material misstatement. The top seven financial statement deficiency areas were:
- Revenue and related accounts,
- Inventory,
- Information technology,
- Business combinations,
- Long-lived assets,
- Goodwill and intangible assets, and
- Allowances for loan and lease losses.
Auditors may find this information useful as they plan and perform their audits. Likewise, managers and in-house accounting personnel may benefit from a review of these findings to help improve financial reporting, minimize audit adjustments and use as a reference point when engaging with external auditors.
Spotlight on cryptocurrency transactions
The PCAOB report also highlights an emerging area of concern: cryptocurrency transactions. Examples of these transactions include:
- Earning a fee, or “reward,” for mining crypto,
- Purchasing or selling goods or services in exchange for crypto assets,
- Exchanging one crypto asset for another,
- Purchasing or selling crypto assets in exchange for U.S. dollars, and
- Investing in crypto assets.
The PCAOB notes that companies with material digital asset holdings and/or that engage in significant activity related to digital assets present unique audit risks. This was evidenced by the recent, high-profile collapse of crypto asset trading platform FTX. The risks associated with crypto assets may be elevated due to high levels of volatility, lack of transparency regarding the parties engaging in the transactions and the purpose of such transactions, market manipulation, fraud, theft, and significant legal uncertainties. The PCAOB recommends using specialists and technology-based tools to help audit these transactions in certain situations.
Bottom line
Regardless of whether they’re public or private, companies should take proactive measures to ensure their financial reporting is accurate and transparent. These measures may include providing accounting personnel with additional training and assistance, increasing management review and staff supervision, and beefing up internal audit procedures in relevant high-risk areas.
Also, expect external auditors to focus on these high-risk areas. As audit season approaches, prepare to provide additional documentation to back up your accounting estimates, reporting procedures and account balances for high-risk items.
© 2023
TopLine Content Marketing Team
