In some cases, homeowners decide to move to new residences, but keep their present homes and rent them out. If you’re thinking of doing this, you’re probably aware of the financial risks and rewards. However, you also should know that renting out your home carries potential tax benefits and pitfalls.

You’re generally treated as a regular real estate landlord once you begin renting your home. That means you must report rental income on your tax return, but also are entitled to offsetting landlord deductions for the money you spend on utilities, operating expenses, incidental repairs and maintenance (for example, fixing a leak in the roof). Additionally, you can claim depreciation deductions for the home. You can fully offset rental income with otherwise allowable landlord deductions.

Passive activity rules

However, under the passive activity loss (PAL) rules, you may not be able to currently claim the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won’t affect your converted property for a tax year in which your adjusted gross income doesn’t exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don’t exceed $25,000.

You should also be aware that potential tax pitfalls may arise from renting your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape tax on up to $250,000 ($500,000 for married couples filing jointly) of gain on the sale of your principal home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So renting your home out for an extended time could jeopardize a big tax break.

Even if you don’t rent out your home so long as to jeopardize your principal residence exclusion, the tax break you would have gotten on the sale (the $250,000/$500,000 exclusion) won’t apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997, or to any gain allocable to a period of nonqualified use (any period during which the property isn’t used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse) after December 31, 2008. A maximum tax rate of 25% will apply to this gain (attributable to depreciation deductions).

Selling at a loss

Some homeowners who bought at the height of a market may ultimately sell at a loss someday. In such situations, the loss is available for tax purposes only if the owner can establish that the home was in fact converted permanently into income-producing property. Here, a longer lease period helps an owner. However, if you’re in this situation, be aware that you may not wind up with much of a loss for tax purposes. That’s because basis (the cost for tax purposes) is equal to the lesser of actual cost or the property’s fair market value when it’s converted to rental property. So if a home was bought for $300,000, converted to a rental when it’s worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000.

The question of whether to turn a principal residence into rental property isn’t easy. Contact us to review your situation and help you make a decision.

© 2022

Spring has sprung — and summer isn’t far off. If your business typically hires minors for summer jobs, now’s a good time to brush up on child labor laws.

In News Release No. 22-546-DEN, the U.S. Department of Labor’s Wage and Hour Division (WHD) recently announced that it’s stepping up efforts to identify child labor violations in the Salt Lake City area. However, the news serves as a good reminder to companies nationwide about the many details of employing children.

Finer points of the FLSA

The Department of Labor is the sole federal agency that monitors child labor and enforces child labor laws. The most sweeping federal law that restricts the employment and abuse of child workers is the Fair Labor Standards Act (FLSA). The WHD handles enforcement of the FLSA’s child labor provisions.

The FLSA restricts the hours that children under 16 years of age can work and lists hazardous occupations too dangerous for young workers to perform. Examples include jobs involving the operation of power-driven woodworking machines, and work that involves exposure to radioactive substances and ionizing radiators.

The FLSA allows children 14 to 15 years old to work outside of school hours in various manufacturing, non-mining, non-hazardous jobs under certain conditions. Permissible work hours for 14- and 15-year-olds are:

• Three hours on a school day,
• 18 hours in a school week,
• Eight hours on a non-school day,
• 40 hours in a non-school week, and
• Between 7 a.m. and 7 p.m.*

*From June 1 through Labor Day, nighttime work hours are extended to 9 p.m.

Just one example

News Release No. 22-546-DEN reveals the results of three specific investigations. In them, the WHD found that employers had allowed minors to operate dangerous machinery. Also, minors were allowed to work beyond the time permitted, during school hours, more than three hours on a school night and more than 18 hours a workweek.

In one case, a restaurant allowed minors to operate or assist in operating a trash compactor and a manual fryer, which are prohibited tasks for 14- and 15-year-old workers. The employer also allowed minors to work:

• More than three hours on a school day,
• More than 18 hours in a school week,
• Past 7 p.m. from Labor Day through May 31,
• Past 9 p.m. from June 1 through Labor Day, and
• More than eight hours on a non-school day.

The WHD assessed the business $17,159 in civil money penalties.

Letter of the law

In the news release, WHD Director Kevin Hunt states, “Early employment opportunities are meant to be valuable and safe learning experiences for young people and should never put them at risk of harm. Employers who fail to keep minor-aged workers safe and follow child labor regulations may struggle to find the young people they need to operate their businesses.”

What’s more, as the case above demonstrates, companies can incur substantial financial penalties for failing to follow the letter of the law. Consult an employment attorney for further details on the FLSA. We can help you measure and manage your hiring and payroll costs.

© 2022

The federal government is helping to pick up the tab for certain business meals. Under a provision that’s part of one of the COVID-19 relief laws, the usual deduction for 50% of the cost of business meals is doubled to 100% for food and beverages provided by restaurants in 2022 (and 2021).

So, you can take a customer out for a business meal or order take-out for your team and temporarily write off the entire cost — including the tip, sales tax and any delivery charges.

Basic rules

Despite eliminating deductions for business entertainment expenses in the Tax Cuts and Jobs Act (TCJA), a business taxpayer could still deduct 50% of the cost of qualified business meals, including meals incurred while traveling away from home on business. (The TCJA generally eliminated the 50% deduction for business entertainment expenses incurred after 2017 on a permanent basis.)

To help struggling restaurants during the pandemic, the Consolidated Appropriations Act doubled the business meal deduction temporarily for 2021 and 2022. Unless Congress acts to extend this tax break, it will expire on December 31, 2022.

Currently, the deduction for business meals is allowed if the following requirements are met:

• The expense is an ordinary and necessary business expense paid or incurred during the tax year in carrying on any trade or business.
• The expense isn’t lavish or extravagant under the circumstances.
• The taxpayer (or an employee of the taxpayer) is present when the food or beverages are furnished.
• The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact.

In the event that food and beverages are provided during an entertainment activity, the food and beverages must be purchased separately from the entertainment. Alternatively, the cost can be stated separately from the cost of the entertainment on one or more bills.

So, if you treat a client to a meal and the expense is properly substantiated, you may qualify for a business meal deduction as long as there’s a business purpose to the meal or a reasonable expectation that a benefit to the business will result.

Provided by a restaurant

IRS Notice 2021-25 explains the main rules for qualifying for the 100% deduction for food and beverages provided by a restaurant. Under this guidance, the deduction is available if the restaurant prepares and sells food or beverages to retail customers for immediate consumption on or off the premises. As a result, it applies to both on-site dining and take-out and delivery meals.

However, a “restaurant” doesn’t include a business that mainly sells pre-packaged goods not intended for immediate consumption. So, food and beverage sales are excluded from businesses including:

• Grocery stores,
• Convenience stores,
• Beer, wine or liquor stores, and
• Vending machines or kiosks.

The restriction also applies to an eating facility located on the employer’s business premises that provides meals excluded from an employee’s taxable income. Business meals purchased from such facilities are limited to a 50% deduction. It doesn’t matter if a third party is operating the facility under a contract with the business.

Keep good records

It’s important to keep track of expenses to maximize tax benefits for business meal expenses.

You should record the:

• Date,
• Cost of each expense,
• Name and location of the establishment,
• Business purpose, and
• Business relationship of the person(s) fed.

In addition, ask establishments to divvy up the tab between any entertainment costs and food/ beverages. For additional information, contact your tax advisor.

© 2022

Your business needs financial statements so management can monitor performance, attract investment capital and borrow money from a bank or other lender. But not all financial statements are created equal. Audited statements are considered the “gold standard” in financial reporting. While public companies are required to issue audited statements, smaller, privately held organizations have options. CPAs provide three other types of financial statements, which, in order of descending level of diligence, are: reviews, compilations and preparations.

Here’s some insight into the newest and most basic financial reporting service available to private businesses — preparations — and how these engagements differ from compilations.

Preparations

Financial statement preparations are often created as part of bookkeeping or tax-related work. While some lenders may accept preparations in support of small lending arrangements, preparations are generally reserved for internal purposes to provide information on the business’s current financial condition and as a basis of comparison against future accounting periods.

Preparations provide no assurance regarding the accuracy and completeness of the financial statements. Assurance is critical if you plan to share the financial statements with third parties. Generally speaking, the greater the level of assurance, the more trust a reader will have in the accuracy and integrity of your company’s financial statements.

In addition, professional standards don’t require CPAs to be independent of a business when preparing its financial statements. In other words, it’s OK for an accountant to have a financial interest in a company that he or she prepares financial statements for.

To avoid misleading any third parties who might receive a copy of these statements, each page of a prepared financial statement must include a disclaimer or legend stating that no CPA provides any assurance on the financial statements. In addition, prepared financial statements must adequately refer to or describe the applicable financial reporting framework that’s used and disclose any known departures from that framework.

Compilations

Like preparations, compilations provide no assurance that the financial statements are accurate and complete. And independence isn’t required when issuing compiled financial statements. But there are subtle differences when moving from a preparation to a compilation.

A compilation involves the issuance of a formal report by a CPA who’s required to read the statements and evaluate whether they’re free from obvious material errors. The CPA’s report appears on the first page, before the financial statements. If the CPA isn’t independent of the business, he or she must disclose this fact in the report.

Notably, the use of a compilation of financial statements can extend beyond the business owner to third parties, including investors, business partners and lenders who may view the input of a CPA as beneficial.

Building for the future

Preparations may be a cost-effective way for small business owners to monitor performance. But they provide limited usefulness as a business grows and needs to interact with third parties. Eventually, prepared statements may need to be upgraded to a compilation, review or audit to give stakeholders greater assurance about the company’s financial results. Contact us to determine what’s right for your current situation.

© 2022

Forecasting key business metrics — such as sales demand, receivables, payables and working capital — can help you reduce excess inventory and other overhead, offer competitive prices, and keep your business on solid financial footing. Although historical financial statements are often the starting point for forecasts, you’ll need to do more than just multiply last year’s numbers by a projected growth rate, especially in today’s uncertain marketplace.

To help determine the right forecasting methods for your business, ask yourself these five questions.

1. How far into the future do you plan to forecast?

Forecasting is generally more accurate in the short term — the longer the time period, the more likely it is that customer demand or market trends will change. While quantitative methods, which rely on historical data, are typically the most accurate forecasting methods, they don’t work well for long-term predictions. If you’re planning to forecast over several years, try qualitative forecasting methods, which rely on expert opinions instead of company-specific data.

2. How steady is your demand?

Weather, sales promotions, safety concerns and other factors can cause sales to fluctuate. For example, if you sell ski supplies and apparel, chances are good your sales will dip in the summer.

If demand for your products varies, consider forecasting with a quantitative method, such as time-series decomposition, which examines historical data and allows you to adjust for market trends, seasonal trends and business cycles. You also may want to adopt forecasting software, which allows you to plug other variables into the equation, such as individual customers’ short-term buying plans.

3. How much data do you have?

Quantitative forecasting techniques require varying amounts of historical information. For instance, you’ll need about three years of data to use exponential smoothing, a simple yet fairly accurate method that compares historical averages with current demand.

If you want to forecast for something you don’t have data for, such as a new product, you might use qualitative forecasting. Alternatively, you could base your forecast on historical data for a similar product in your lineup.

4. Do you carry inventory?

If you stock standard inventory items for customers to purchase, rather than working on custom orders, forecasting is particularly critical for establishing accurate inventory levels and improving cash flow. For peak accuracy, take the average of multiple forecasting methods. To optimize inventory levels, consider forecasting demand by individual products as well as by geographic location.

5. How many products do you sell?

If you’re forecasting demand for a wide variety of products, consider a relatively simple technique, such as exponential smoothing. If you offer only one or two key products, it’s probably worth your time and effort to perform a more complex forecasting method for each one, such as a statistical regression model.

What’s right for your business?

Although these questions focus primarily on retailers, manufacturers and other businesses that sell products, service providers can ask similar questions to determine the optimal forecasting approach. Contact us to discuss the forecasting practices that make sense for your business.

© 2022

If your business doesn’t already have a retirement plan, now might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.

For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for 2022. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000). 

More options

Other small business retirement plan options include:

• 401(k) plans, which can even be set up for just one person (also called solo 401(k)s),
• Defined benefit pension plans, and
• SIMPLE-IRAs.

Depending on your circumstances, these other types of plans may allow bigger deductible contributions.

Deadlines to establish and contribute

Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.

Important: The SECURE Act provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.

For example, the deadline for the 2021 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 17, 2022, if you extend your 2021 tax return. The deadline for making the contribution for the 2021 tax year is also October 17, 2022. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1, 2021. So, it’s too late to set up a plan for last year.

While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning and start saving for retirement. We can provide more information on small business retirement plan alternatives. Be aware that, if your business has employees, you may have to make contributions for them, too.

© 2022

Management needs timely, accurate feedback to guide operating decisions, anticipate problems and take advantage of emerging opportunities. Unfortunately, comprehensive financial statements take a long time to generate. Reporting key performance indicators (KPIs) on a monthly or weekly basis is a simplified alternative to gauge performance in real time.

Popular financial metrics

KPIs measure an organization’s progress toward its objectives. However, with so many metrics to choose from, data overload can easily happen. That’s why your KPI report should be customized and streamlined to cover the metrics that are the most critical to your success.

KPIs differ from one company to the next based on the industry and the company’s objectives. Common examples include:

Operating cash flow. This helps management evaluate how much cash is available for immediate spending needs. Poor cash flow, not slow sales or lagging profits, is one of the leading causes of business bankruptcy.

Return on assets. This metric equals net income divided by total assets. It measures how effectively your company is managing its assets to generate earnings.

Inventory turnover. The number of times inventory is converted into sales is usually computed by dividing cost of goods sold by the average inventory balance. This tells you how efficiently you’re “selling through” inventory. Many companies waste valuable cash by allowing slow-moving inventory to sit idle on their shelves for too long.

KPIs can also be industry specific. To illustrate, auto dealers might compare new vehicle sales to used vehicle sales; contractors might focus on the bid-hit ratio; and hospitals might want to know the average wait time in the emergency room or the bed occupancy rate in the intensive care unit.

Beyond the numbers

Many companies also include nonfinancial metrics in the areas of customer service, sales, marketing and manufacturing. However, nonfinancial KPIs must be both specific and measurable.

For instance, just saying that your company wants to “provide better customer service” doesn’t produce a sound KPI. Instead, if your goal is to improve response time to customer complaints, a relevant KPI might be to provide an initial response to complaints within 24 hours, and to eventually resolve at least 80% of complaints to the customer’s satisfaction.

Benchmarking results

A basis of comparison is important when reviewing KPIs. Benchmarks will provide a standard against which you can compare to see how your KPIs stack up. You can benchmark your current KPIs against historical results or averages published in trade publications.

This will help you spot trends and identify potential problems, allowing you to deal with them before they worsen. For example, if your accounts receivable days are lengthening, it might indicate that your collections are lagging and a cash flow crunch is looming.

Unlocking the keys to success

During the pandemic and the ensuing economic turmoil, tracking relevant performance metrics is more important than ever. Threats and opportunities abound — and new ones seem to arise quickly. We can help you tailor your KPI report to meet your business needs, as well as find meaningful benchmarks based on current market conditions.

© 2021

Management needs timely, accurate feedback to guide operating decisions, anticipate problems and take advantage of emerging opportunities. Unfortunately, comprehensive financial statements take a long time to generate. Reporting key performance indicators (KPIs) on a monthly or weekly basis is a simplified alternative to gauge performance in real time.

Popular financial metrics

KPIs measure an organization’s progress toward its objectives. However, with so many metrics to choose from, data overload can easily happen. That’s why your KPI report should be customized and streamlined to cover the metrics that are the most critical to your success.

KPIs differ from one company to the next based on the industry and the company’s objectives. Common examples include:

Operating cash flow. This helps management evaluate how much cash is available for immediate spending needs. Poor cash flow, not slow sales or lagging profits, is one of the leading causes of business bankruptcy.

Return on assets. This metric equals net income divided by total assets. It measures how effectively your company is managing its assets to generate earnings.

Inventory turnover. The number of times inventory is converted into sales is usually computed by dividing cost of goods sold by the average inventory balance. This tells you how efficiently you’re “selling through” inventory. Many companies waste valuable cash by allowing slow-moving inventory to sit idle on their shelves for too long.

KPIs can also be industry specific. To illustrate, auto dealers might compare new vehicle sales to used vehicle sales; contractors might focus on the bid-hit ratio; and hospitals might want to know the average wait time in the emergency room or the bed occupancy rate in the intensive care unit.

Beyond the numbers

Many companies also include nonfinancial metrics in the areas of customer service, sales, marketing and manufacturing. However, nonfinancial KPIs must be both specific and measurable.

For instance, just saying that your company wants to “provide better customer service” doesn’t produce a sound KPI. Instead, if your goal is to improve response time to customer complaints, a relevant KPI might be to provide an initial response to complaints within 24 hours, and to eventually resolve at least 80% of complaints to the customer’s satisfaction.

Benchmarking results

A basis of comparison is important when reviewing KPIs. Benchmarks will provide a standard against which you can compare to see how your KPIs stack up. You can benchmark your current KPIs against historical results or averages published in trade publications.

This will help you spot trends and identify potential problems, allowing you to deal with them before they worsen. For example, if your accounts receivable days are lengthening, it might indicate that your collections are lagging and a cash flow crunch is looming.

Unlocking the keys to success

During the pandemic and the ensuing economic turmoil, tracking relevant performance metrics is more important than ever. Threats and opportunities abound — and new ones seem to arise quickly. We can help you tailor your KPI report to meet your business needs, as well as find meaningful benchmarks based on current market conditions.

© 2021

Now that 2022 is up and running, business owners can expect to face a few challenges and tough choices as the year rolls along. No matter how busy things get, don’t forget about an easily accessible and highly informative resource that’s probably just a few clicks away: your financial statements.

Assuming you follow U.S. Generally Accepted Accounting Principles (GAAP) or similar reporting standards, your financial statements will comprise three major components: an income statement, a balance sheet and a statement of cash flows. Each one contains different, but equally important, information about your company’s financial performance. Together, they can help you and your leadership team make optimal business decisions.

Revenue and expenses

The first component of your financial statements is the income statement. It shows revenue and expenses over a given accounting period. A commonly used term when discussing income statements is “net income.” This is the income remaining after you’ve paid all expenses, including taxes.

It’s also important to check out “gross profit.” This is the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of direct labor and materials, as well as any manufacturing overhead costs required to make a product.

The income statement also lists sales, general and administrative (SG&A) expenses. They reflect functions, such as marketing and payroll, that support a company’s production of products or services. Often, SG&A costs are relatively fixed, no matter how well your business is doing. Calculate the ratio of SG&A costs to revenue: If the percentage increases over time, business may be slowing down.

Assets, liabilities and net worth

The second component is the balance sheet. It tallies your assets, liabilities and net worth to create a snapshot of the company’s financial health on the financial statement date. Assets are customarily listed in order of liquidity. Current assets (such as accounts receivable) are expected to be converted into cash within a year. Long-term assets (such as plant and equipment) will be used to generate revenue beyond the next 12 months.

Similarly, liabilities are listed in order of maturity. Current liabilities (such as accounts payable) come due within a year. Long-term liabilities are payment obligations that extend beyond the current year.

True to its name, the balance sheet must balance — that is, assets must equal liabilities plus net worth. So, net worth is the extent to which assets exceed liabilities. It may signal financial distress if your net worth is negative.

Other red flags include current assets that grow faster than sales and a deteriorating ratio of current assets to current liabilities. These trends could indicate that management is managing working capital less efficiently than in previous periods.

Inflows and outflows of cash

The statement of cash flows shows all the cash flowing in and out of your business during the accounting period.

Cash inflows typically come from selling products or services, borrowing and selling stock. Outflows generally result from paying expenses, investing in capital equipment and repaying debt. The statement of cash flows is organized into three sections, cash flows from activities related to:

1. Operating,
2. Financing, and
3. Investing.

Ideally, a company will generate enough cash from operations to cover its expenses. If not, it might need to borrow money or sell stock to survive.

The good and the bad

Sometimes business owners get into the habit of thinking of their financial statements as a regularly occurring formality performed to satisfy outside parties such as investors and lenders. On the contrary, your financial statements contain a wealth of data that can allow you to calculate ratios and identify trends — both good and bad — affecting the business. For help generating accurate financial statements, as well as analyzing the information therein, please contact us.

© 2022