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Tax Impact of the 2014 Election Results

Last night we finally made our way through the 2014 mid-term elections. It was a very successful election for the Republican Party which will soon be in control of both houses of the US Congress.  Last night’s victory speeches and today’s interviews have taken a relatively positive tone.  Political pundit and former Republican US Representative Joe Scarborough recently said “most Republicans I talk to understand if all they do is obstruct in 2015, they will lose the big election, the big prize, in 2016.”

So, what does all this mean for tax policy?

First Things First:  In a previous posting we discussed the “Tax Extenders”.  To briefly summarize – the tax extenders are 55 temporary tax provisions that are generally extended every couple years.  These provisions expired at the end of 2013 leaving a lot of unknowns for many businesses and individuals. The Republican controlled House of Representatives had been favoring a targeted approach to the extenders with the intent to make certain provisions permanent.  Conversely the Democrat controlled Senate had sought a blanketed 2 year extension of all the expired tax provisions.  We’ve seen inaction on these extenders because of election year politics and not necessarily because of the provisions themselves.  The provisions have generally received support from both sides.  These extensions are overdue by a year and need immediate attention.  While some skepticism has set in about whether or not we’ll see an extension of the provisions for 2014, it is still my opinion that we will see a retroactive short-term package that will cover the majority of the provisions for 2014 and 2015.  The upcoming lame duck legislative session has only 14 days in it and the IRS has to finalize tax forms and calculations.  I think they’ll get it done.

Beyond 2014:  Unfortunately we’ve seen this song and dance before and by the time you read this we will be full-throttled into the 2016 presidential election.  However I believe there is a real possibility that comprehensive tax reform will be put back on the table.  The effective tax rate of this country’s economic engine, the middle class, is still too high and the corporate tax rate is not competitive with the rest of world.  Both Republicans and Democrats understand this and want to change it.  The White House will want some “loopholes” closed to increase the tax base but I also believe the White House will concede on lowering the tax rates.  There is real common ground in this area and with some compromise it can get done.  Furthermore if the Republicans can deal on immigration and/or infrastructure there should be even more momentum for tax reform.

We should know where we stand by Friday when the Congressional leadership meets with President Obama. If you see John Boehner and Mitch McConnell dejected and sounding off outside on the White House driveway, I’d say things didn’t go well and tax reform along with everything else is dead…….again.

Tax Implications of a Construction Allowance

One of the main elements of negotiating a leased space is the cost associated with the build out of the space. Tenants generally require some level of customization of the space for their business purpose.  The construction allowance seems to be a straightforward mechanism that allows a landlord to improve their property by simply reimbursing the new lessee with a pre-negotiated amount.  In exchange the lessee generally has significant control in matching the finishes to their needs while also limiting the size of their investment in their temporary home.

Under the most basic read of the Internal Revenue Code the payment from the landlord is taxable income to the lessee. This creates an obvious dilemma for the lessee.  Internal Revenue Code Section 110 was created to address this inequity.  The provision establishes the parameters of a tax-free construction allowance.

  • The lease is limited to 15 years or less.
  • The improvements are for nonresidential real property.
  • The improvements must be part of a retail space (includes services to the public).
  • The landlord owns the improvements.
  • The provision will not apply to Section 1245 property (tangible personal property).

If the construction allowance violates any of these provisions then the payment will likely be taxable income at least in some portion. There are some planning steps that can help solidify favorable treatment under this provision and it all starts with adding the correct language in the lease agreement and following proper procedures for payment.  From there proper documentation of the expenditures should be maintained and the tax return should have the proper disclosures.  If some portion of the construction allowance will still be used for personal property then the terms of the lease should be adjusted to ensure that the tax consequences match the intended results.

Considering Becoming a Franchisee? – A Critical Must

Franchising has become a common path in a variety of industries. It can be a tremendous growth engine for the originators of a concept and in turn provides a platform for someone to launch a business.  It is not uncommon for a life-long employee to become consumed with the desire to “be their own boss” and a franchise is often the answer to: “But, what?”

Franchisors spend significant time and dollars road testing and documenting their concept, formulas and processes. A qualified and experienced franchisor does an excellent job of eliminating many of the pain points so the process of launching a business is seemingly automated.

However, there is a critical “Must” for all prospective franchisees in considering a business. The most important thing a prospective franchisee MUST acknowledge is that they are participating in a sales process of the franchisor and its representatives.

Franchisors genuinely believe they have THE best concept and they need partners to help grow it. In exchange for the right to use their concept a franchisor is typically compensated by a large upfront fee and a royalty off the top line revenue (generally 5%-8%).  Their objective is to open as many “units” as possible.  The prospective franchisee’s objective is to launch a profitable business.  These are two very different objectives.

Let’s look at a restaurant franchise as an example. The restaurant business is built on strict margins.  It is becoming increasingly more difficult to keep food costs at or below 30%.  There are also increasing challenges in the labor market with the introduction of the Affordable Care Act and the vigorous debate on raising the minimum wage.  If we conservatively assume food and labor costs will consume 65% of the sales while occupancy and overhead will consume 20%, you’re left with 15% of sales.  Is this concept worth splitting the 15% operating profit with the franchisor?  Well, maybe……..but wait, you haven’t paid the bank yet which will come from your half and the franchisor’s half is guaranteed because it comes off the top – immediately.  Oh yeah, you also personally guaranteed the bank debt and the lease.  So you have a 50/50 partnership with all the risk exposure and operating challenges on your half.  Also if sales dip, the fixed costs will dip into your percentage points.  To be fair – if sales excel, additional percentage points will tip your way.  In the end the franchisor must have a strong value proposition.

I’ve seen both good and bad franchisors. I’ve also see good and bad franchisees.  It takes both.  However, the onus is on you – the franchisee – to thoroughly vet the concept and franchisor.  From there it is wise to have advisors outside of the franchisor to help you evaluate the projected numbers and the terms of the various legal agreements especially on real estate matters.  Frankly, you need an outside advisor that’s going to question the whole idea in the first place.  There are so many intangibles to discuss about business ownership that go beyond cost, risk or strength of concept.  It is far better to spend some consulting dollars on the front end than being locked into a lofty sales goal with an expensive lease in an industry you know very little about.  Maybe a vacation is all you really need.

Reviewing the August 2014 Jobs Data

There was a fair amount of concern over the August employment numbers released last week. The economy added 142K jobs which is a significant drop when compared to the rolling 12 month average of 212K.  Furthermore, June and July numbers were revised down by another 28K.

Here are a few additional details in the data release:

  • The long-term (27+ weeks) unemployed dropped by 192K down to 3M.
  • Professional and Business Services added 47K jobs.
  • Healthcare added 34K jobs.
  • Food Services and Drinking Places added 22K jobs.
  • Construction added 20K jobs.
  • Manufacturing was largely unchanged.
  • The Average Hourly and Weekly Earnings continued trending up.

While the headline doesn’t read well the details provide a more moderate report. It’s very good to see the reduction of the long-term unemployed and continued increases in average earnings.  It’s also good to see the construction sector continue to add jobs for eight straight months.  There is no question that we want to see more out of the manufacturing sector in the long-term.  However these monthly results are not alarming considering how well June and July performed compared to 2013.

Considering where we’ve been – we should continue to feel positive about the direction of the economy. Anecdotally business owners feel very differently compared to two years ago or even just one year ago.  Increased hiring is undoubtedly more widespread across industries and employers of various sizes.  We still have our limitations but there continues to be a growing sense of stability and confidence by both business owners and consumers.

Overdue Tax Breaks Expected at Year-End

With the Summer of 2014 closing out, it is finally time for us to start talking about what everyone has been waiting for all year long – Football.

Well, no, but equally exciting we can start talking about the Tax Extenders.   “Tax Extenders” is a package of temporary Federal tax breaks (over 50) that expire and extend every couple years.  These provisions expired at the end of 2013.

Since 2014 is a mid-term election year there has been little political courage to see the extension through to completion.  Both the US House of Representatives and the US Senate have taken up differing versions of the legislation.  The House version attempts to make some key provisions permanent and the Senate version, referred to as the EXPIRE Act, attempts to give all provisions a two year extension.  Both efforts were officially stalled several months ago in favor of waiting for the November election results.

Below are some key provisions that have widespread applicability that we should hope to see extended:

  • Qualified Restaurant Buildings, Retail Improvements and Leasehold Improvements – $4.8 Billion (10 Year Cost) – Restaurant operators have the ability to recover their real estate investment over a 15 year depreciable period rather than the default period of 39 years. Other similar provisions would also benefit a retailer’s improvements to real estate and a lessee making qualifying leasehold improvements.

 

  • Bonus Depreciation – $2.85 Billion (10 Year Cost) – Bonus depreciation allows for a 50% immediate write-off of qualifying property. When coupled with a cost segregation study this provision can be a major incentive for companies to not only purchase new equipment but perhaps expand their facilities.

 

  • Increased Limit to IRC Section 179 Expensing Election – The expensing election for qualifying equipment reverted back to its $25,000 limit on January 1, 2014. Increasing this limit has become part of the Tax Extenders. The extenders version raises the limit to $500,000.

 

  • Research & Experimentation Tax Credit (R&D Tax Credit) – $16 Billion (10 Year Cost) – This has wide-spread applicability to businesses that are willing to invest in the betterment of the science of their product. Qualifying start-ups may benefit from a payroll tax credit.

 

  • Work Opportunity Tax Credit (WOTC) – $3.16 Billion (10 Year Cost) – Employers are incentivized through this tax credit to hire qualifying individuals that are on living assistance, unemployed or disabled veterans or ex-felons.

 

  • Energy Efficient Commercial Building Deduction (179D) – $304 Million (10 Year Cost) – Real estate owners willing to invest in energy efficient systems (lighting, HVAC, etc.) that increase the efficiency by at least 50% can benefit from a deduction of up to $1.80 per square foot. This extended version of the law does increase the efficiency requirements from prior years.

 

  • New Market Tax Credit – $1.8 Billion (10 Year Cost) – This is a major tool in the development of targeted markets that incentivizes private investment through the award of tax credits. When these tax credits are administered through a non-profit development corporation that has a large scale (multi-year) strategic plan of development they can really make an impact on a city and its economy.

This is just a sample of the provisions covered in the Tax Extenders.  Most of these provisions have had support from both sides of the aisle.  So while these provisions become a politically charged topic in an election year, we’re nearly certain to see an extension in some form regardless of the election results.  In the past when we’ve seen expired provisions extended it has been applied retroactively to eliminate the gap.  We’ll be following these developments closely but the variables should be factored into your year-end plan currently.  You may need to add a few if/then statements to your formula….

Selecting Your Accountant

Selecting your accountant can feel like a big decision.  It is such an important relationship because one’s livelihood is such a personal matter.  It is hard to know who to trust.  As with anything, glitter and salesmanship can take over the courtship making it a challenge to really understand what will be the true experience.  However I believe there are certain indicators that can help you in assessing your options.

  • A Lot of Chatter and Little Listening – Larger firms tend to have a lot of pressure to “sell” new business.  This pressure often manifests itself in the accountant going on and on about themselves and why they are so wonderful or why everyone else is so horrible.  If your meetings with an accountant consist of them pontificating without end then you can rest assured you won’t get an astute adviser focusing on you and your experiences.  An adviser’s job is not only to help an advisee in making decisions but also to help them gain enlightenment and perspective for their situation.  It has to be about YOU, the client.
  • Know Who’s on First and What’s on Second – You have to know who will be on your team.  Firms that are growing very quickly are faced with major challenges in staffing enough of the right people and getting them trained/experienced.  If a firm is bragging about their growth then there is a reasonably good chance that they have instability with client service teams.  If you are a small client for that firm you’ll have minimal stability and it will show in the service. You also need to know who is the primary relationship person and then you must be comfortable with both the title and level of involvement of that person.  If you are a restaurant and your work is primarily tax-based but your relationship is with an audit manufacturing partner then you need to have a clear understanding of how that equates to your services.
  • Reasonable & Transparent Fees – Imagine going to the grocery store and shopping without price labels on the shelving.  You deserve to pay reasonable and transparent fees for your accounting and tax services too.  Most routine accounting and tax services can be quoted as a fixed fee or with a fixed fee range.  However you should be very wary of an abnormally low bid.  It is an age-old tactic to low bid the fixed fee work with the intention to bill extra for EVERYTHING else.  This is not to say that out of scope fees are never warranted but being billed for every little phone call is an old and tired way of doing business.  Sometimes we can’t always tell what the cost is until we “get in there”.  For some things we don’t have a choice but to utilize the hourly rate structure.   Communication cures all.  Open and regular communication about fees is a critical element of the relationship.  I recommend setting fee parameters which will allow your accountant to proceed as needed but also know when they should seek approval in advance.
  • How Good is the Promise? – I think you can tell a lot about someone simply based on whether or not they have a tendency to deliver on a commitment.  We all know things can and will happen.  Schedules and timelines must be adjusted.  However if there is an issue every time and everything is always adjusted then you are either a low priority or you don’t have the advocate that you need and deserve.  I was once described by a client as “a thorn in my side that I’ve come to rely on”.  I wouldn’t let my client’s permanently-busy schedule set us back on our commitments to each other.

Every situation is unique and there are pros and cons to each option in choosing an accountant. These four indicators will cut through some of the noise and allow you to focus on the merits. 

We’re Growing!

We saw some great economic news last week. First, it was reported that unemployment benefit applications dropped to the lowest level in six years and the US economy grew 3.6% from July through September compared with an expected rate of 2.8%. Friday provided some additional positive news when it was reported that the US economy added 203,000 jobs in November compared to 183,000 as projected. This took the official unemployment rate down to 7.0%.

I have seen some very promising results inside the trenches with my clients over the past six months. Within that context these macro-level statistics are very meaningful and frankly, very exciting. More economic activity means more opportunity for growth. However it is important for businesses to not only understand how to grow but to also understand what role growth plays within the business.

As a new small business owner growth is very important to me………to say the least. Growth is my survival. However if it is not approached and handled properly then growth can be devastating to a business. Growth doesn’t always equate with survival. In fact growth can be a killer. I’ve seen many businesses not understand both the good power and the bad power of growth. Frankly, I’ve seen too many accountants not understand the powers of growth. I can’t help but to laugh when someone says “I want to double in size”. Okay. Good. Why? What then? Many people can’t answer those two questions after making that declaration.

Amazon.com’s CEO, Jeff Bezos, was interviewed by CBS’s “60 Minutes”. He was asked to comment on the criticism that Amazon is putting small businesses out of business (book stores as an example). His answer was brilliant: “Amazon isn’t happening to book-selling, the future is happening to book-selling” and he also acknowledges that Amazon will be disrupted one day. Amazon’s growth is really about utilizing innovation to enhance the customer experience. That’s “Why”. Amazon has required the growth in revenue and goods to build more distribution centers which allowed them to reach a wider customer base more quickly. The consumer can now visit a single website for an unimaginable variety of goods and have those goods at the doorstep in two days. With their growth they have redefined the online shopping experience which used to be a long process. The return process is equally as easy. Amazon has a lot of loyal customers because of this strategy which gives it an insane stock value compared to its actual earnings (P/E Ratio of 1,391.59 vs Walmart’s 15.34). Amazon was once a small online retailer surrounded by a lot of online retailers. Growth is a powerful thing.

Growth has to have a higher purpose. Growing to be bigger is not smart business. Growing because you want people to know your name is not smart business. Growing because growth means more profit is just flat out wrong. There can be a lot of great reasons for growing but business leaders must understand how to grow. Growth can be good for the owners, employees, customers and communities. Growth can also kill quality, morale, profits and the business itself. As I consult with my clients I insist on gaining an understanding of why growth is important for their business. I insist on this because it usually takes more than just growth to achieve whatever is their real objective. Growth should never be viewed as the goal but merely a tool within a tool belt. In my experience the most successful businesses are ones that combine a commitment to high quality in everything it does as well as the well-being of their employees and communities. If you can handle growth without compromising that commitment it can be a very powerful thing for the business and all of its stakeholders.

Retirement – The NEW American Dream, apparently.

This morning MSNBC’s Morning Joe discussed a recent USA Today Wells Fargo Harris study of Adults 25-75 regarding retirement:

  • 37% will work until death or they’re too sick.
  • 48% are confident they won’t have enough to retire.
  • 34% will have to work until they are 80 years old.
  • 59% say their top daily concern is paying the bills.
  • 42% say it is impossible to save and pay the bills.

I agree with the panel: This is a crisis. The American Dream was a concept that said each successive generation has the opportunity to build at least a little bit better of a life than the previous generation. It wasn’t a competition or a guarantee but rather an opportunity that if you work hard and follow some basic principles you could build something better for yourself. The idea that the NEW American Dream is simply the ability to retire before death is alarming.

This is the major driver of the discord in Washington and why our government is so afraid to address meaningful reform to Social Security and Medicare. Many people want our government to keep taxes low and cut the spending but yet when it comes to Social Security and Medicare: HANDS-OFF! Why should there be cuts? These people paid into the programs their entire working life. It isn’t welfare. It’s an earned benefit. The solution is not simple because it seems to be a choice between Bad and Bad. If the political spins could stop for one minute and the choices are more appropriately defined as Something versus Nothing, I think we could find some compromise very quickly. The truth is these programs won’t alone fix the crisis highlighted in the study.

If you’re a small business owner: There is no question that the economy has and continues to slowly get better. However the economy is missing the “pops” that once occurred…………a double-digit month, quarter, season or even year. These little surges along the way fund things like raises, accelerated debt reduction and retirement contributions for small businesses. The epidemic underlying the economy is the fact that the middle class is not thriving and in fact is shrinking into the poorhouse. Compensation is contracting and costs are increasing. All of this pressure even in two-income households means the 401k plans and IRAs are not getting funded. Pension plans essentially do not exist anymore and, again, Social Security and Medicare are not the answer.

I’ve had retirement conversations with three clients just over the past two days. We clearly don’t give retirement enough thought until we hit about age 55. When you’re discussing retirement with someone in their late 50s who really hasn’t done nearly enough to retire, you can see the regret on their face. You can see how they would love to go back to the 25 year old and give them advice. Life takes over and time goes so very quickly.

There are four basic commitments that a working adult must make as soon as possible in their life:

  • Save at least 10% of your earnings into a qualified plan (401k, IRA, etc.) every year. No exceptions.
  • Pay your total credit card balance every month.
  • Stay with your original mortgage term. If you refinance 10 years in on a 30 year note, refinance for 20 years. If you buy a home later in life then limit the term to age 60 at the most.
  • If you choose to assist your children with college then fund what you can early in a 529 plan and never co-sign a loan. The rest has to be up to them to budget their choice in school. Your only OBLIGATION is to help your children understand the cost of their school, debt and the alternatives.

Any working adult that cannot commit to these four basic principles must adjust their lifestyle. Buy less house or even rent a home. Buy less car. Eliminate expensive vacations. Stop eating out 4 days a week (unless you are visiting one of my clients). Stop buying the latest and greatest tech gadget.

Our government has to do more to address economic growth, the shrinking middle class and the long-term health of our social programs. In the meantime we must take personal responsibility and commit to our own fiscal health. The individuals and businesses that do not get distracted and maintain strong fiscal principles will realize the NEW American Dream and even perhaps the OLD American Dream.

Ohio’s New Tax Laws – Good? Bad? or Just Okay?

In June Ohio passed a biennial budget bill which tinkered with the state’s tax laws. While the initial version of the law was very concerning for businesses and the Ohio economy, the final version is much more palatable. The following is a summary of the key provisions:

The Good:
• Small Business Investor Income Deduction – If there was a “Great” category this would be in it. This is a 50% deduction on an individual’s Ohio business income up to the first $250,000. This ultimately nets to over $6,000 of tax savings for owners maximizing the deduction. While this amount won’t turn around a company, it is a tremendous help to all the small businesses working hard in Ohio.

The Bad:
• Commercial Activity Tax Increase – Businesses grossing less than $1M in taxable receipts will not see an increase in their Ohio CAT. However businesses grossing between $1M and $2M will pay $650 more; $2M and $4M will pay $1,950 more; And greater than $4M will pay $2,450 more. We did not see an increase in the stated rate or an increase in the taxable base so while this isn’t horrible news it’s still a tax increase on businesses. Bad.

• Gambling Loss Deduction: Repealed – Federal law allows for a deduction of gambling losses as an itemized deduction up to the point of gambling winnings. Ohio’s taxable income starts with Federal Adjusted Gross Income which is before the itemized deductions. Since Ohio started profiting from the newly built casinos throughout the state it matched the Federal policy on allowing gambling losses to offset gambling winning. Unfortunately this new law never saw the light of day. It’s been repealed. While this will not be an issue for me as I never walk out until I’m thoroughly in the red (do as I say and not as I do), this is bad not only for the taxpayer but bad for the Ohio economy. This could be a meaningful edge for Ohioans to visit their Ohio casinos rather than the casinos in the neighboring states. Bad.

• Sales Tax Increase – In September the state sales tax rate will increase from 5.5% to 5.75%. This is separate from local sales tax which still applies. Bad.

The Okay:
• All Ohioans will benefit from a slight reduction in the individual income tax rates. The Ohio individual tax rates will be reduced by 10% over the next three years. This will take the highest marginal rate in Ohio down to 5.33% from 5.925%. This is still high compared to its neighbors: Michigan at 4.35%, Indiana at 3.4% and Pennsylvania at 3.07%. The rate is just slightly better than Kentucky’s highest rate of 6%. Furthermore Ohio is freezing the inflation adjustments on its tax brackets and it is taking away the $20 personal exemption credit for taxpayers making more than $30,000. While Ohio should do more on this front we can’t label a tax cut as bad. So it’s OK for now.

There are a few other provisions dealing with individual income tax, sales tax, excise tax and property tax. The version of the bill that passed is significantly better than what was initially proposed. Considering where this effort started Ohio businesses and residents are in a better spot. However there is more work for the state to do. Perhaps this is the first step.