What are some year-end business tax-saving strategies I can try before the end of 2023?
Year-end is a good time to explore strategies to unlock potential tax-saving opportunities. This is especially true in 2023 when high interest rates and the upcoming expiration of certain tax benefits make some strategies particularly beneficial.
Learn what tax strategies businesses should consider before year-end 2023, including changing your accounting method, the timing of fixed asset purchases, and business succession planning.
Weigh accounting method changes considering high-interest rates
There are pros and cons to changing accounting methods, which can help your organization save money in some cases. When the cost of capital was low, there were fewer benefits, but now that interest rates have risen significantly, considering a new method may be worth revisiting.
Another consideration to factor in is the upcoming tax rate and deduction changes. The lower individual tax rates from the Tax Cuts and Jobs Act and the Section 199A deduction are scheduled to sunset on December 31, 2025. Barring congressional action, the top tax rates on pass-through income from a non-specified service business will increase from 29.6% to 39.6%. Depending on your cost of capital, a deduction against 39.6% income in 2026 may be more valuable than a deduction in 2023 against 29.6% income. Businesses with a relatively low cost of capital that anticipate future tax rate increases may prefer to take a wait-and-see approach.
Explore some of the following common accounting method changes worth considering before year-end:
Overall cash method of accounting
Tax reform expanded the availability of the cash method of accounting, yet some eligible businesses have remained on the accrual method. The cash method of accounting generally defers recognition of income relative to the accrual method because most taxpayers have more receivables than payables.
Advance payments for goods
Accrual-method taxpayers can either account for certain advance payments and include them in taxable income in the year received (the full-inclusion method) or include the payments in taxable income in the year of receipt to the extent included in revenue for financial statement purposes and include the remaining amount in income in the next tax year (the deferral method). The deferral method requires businesses to determine the portion of deferred revenue earned in the year after receipt, so the administrative burden should be considered.
Accrual-method taxpayers can generally deduct certain prepaid expenses, such as insurance, taxes, and warranty or maintenance service contracts if the term covered by the prepayment does not extend beyond the earlier of 12 months after the first date on which the taxpayer realizes the right or the end of the tax year following the year of payment.
Fixed asset methods
Taxpayers who own real estate may be able to accelerate deductions by performing a cost-segregation analysis to determine the appropriate tax life of various real estate assets or a repair analysis to identify costs that can be expensed rather than capitalized. Likewise, they may be able to accelerate deductions related to an energy-efficient building by performing a Section 179D analysis.
There are generally two acceptable inventory valuation methods: cost or lower-of-cost-or-market. The lower-of-cost-or-market inventory method takes more time but may reduce the value of the taxpayer’s inventory and thus accelerate deductions.
A business may be able to deduct obsolete or damaged inventory if it can no longer sell the inventory in a normal manner or at its normal price. The deduction for obsolete inventory is available only if the inventory is disposed of or the taxpayer establishes the reduction in its value by offering the inventory for sale to the public at a reduced price within 30 days after the inventory date. Taxpayers may want to evaluate their inventory for potential valuation-related adjustments.
The uniform capitalization rules are complex; however, opportunities exist for taxpayers to accelerate tax deductions by analyzing their capitalization methodologies. As just one example, many taxpayers have not fully explored the tax benefits of the new modified simplified production method uniform capitalization (UNICAP) calculation included as an option in final regulations issued in November 2018.
Retirement Plan Selection
Many businesses keep using the same retirement plan year after year, such as a SEP IRA or 401(k) plan. Your business may have outgrown its existing plan, or your tax objectives may have changed. Consider whether another retirement plan is a better option (e.g., 401(k), profit sharing, SIMPLE IRA, SEP IRA, ESOP, cash balance plan, non-qualified deferred compensation, personal traditional or Roth IRA).
Employee Retention Credit (ERC)
Have you filed for an Employee Retention Credit? Either way, now is a good time to revisit eligibility for benefit. As a refresher, the ERC is a lucrative tax credit offered to businesses that were negatively affected by COVID-19 restrictions.
For those who have filed, don’t forget ERC factors into your annual financial statement review. If you’ve filed but have yet to receive your credit, the IRS has warned payments may take more time and the agency has put a moratorium on processing new claims until 2024. If you haven’t yet filed for a credit, there may be eligibility paths you haven’t considered that are worth exploring.
Timing of fixed asset purchases
Bonus depreciation for equipment and other assets is set to drop to 60% in 2024 from its current 80%. If you use immediate expensing under Section 179 and not bonus depreciation, this isn’t a major concern, but it’s something to be aware of for the future.
For 2023, the Section 179 limit is $1.16 million with a phaseout beginning when purchases exceed $2.89 million. The additional bonus depreciation available in 2023 provides an extra incentive for taxpayers subject to a Section 179 limit to place assets in service before year-end. Anticipated tax rates in 2023 and future years should be considered as well.
Business and wealth succession planning
Year-end is a key time for future planning. For business owners, that may mean looking at what’s next for your business. There are significant tax consequences associated with selling or transitioning a business.
If you’re considering a business transition in the next few years, be aware that the lifetime gift tax exemption is scheduled to be cut in half starting in 2026 (from $12.92 million per person in 2023 to $6.46 million in 2026, adjusted for inflation). Gifts made prior to 2026 will be eligible for the higher exemption — even if the law subsequently changes — so there may be an incentive for taxpayers to make gifts before the rules change. Though tax rules are hard to predict — Congress has extended the enhanced exemption in the past and may do so again.
Considering the current high-interest rates, there are some wealth transfer strategies worth considering. Here’s an example:
- A qualified personal residence trust (QPRT) is a trust that holds the taxpayer’s principal residence.
- The taxpayer retains the right to use the residence for a fixed period, after which the residence transfers to the trust’s beneficiaries. The taxpayer can continue to live in the property after the trust ends but must pay a fair market value rent to the beneficiaries.
- The trust reduces the taxable amount of the gift in two ways: the value is discounted for the grantor’s retained interest and the value of the gift is frozen based on the value of the property at the time the QPRT is established.
- Higher interest rates increase the discount for the grantor’s retained interest, thereby reducing the amount of the taxable gift.
How We Can Help
These are just five of many tax strategies that could help your business situation. At CTC, we believe proactive, personalized planning is key to helping you navigate tax liabilities and identify new opportunities for savings. Contact us to explore whether these suggestions could help your business.
What are some year-end individual tax-saving strategies I can try before the end of 2023?
- Max out pre-tax retirement savings. The deadline to contribute to a 401(k) plan to get a 2023 taxable income reduction is December 31st. So, if your employer’s plan allows it, consider making a last-minute lump sum contribution. For 2023, you can contribute up to $22,500 to a 401(k), plus another $7,500 if you’re age 50 or older. Even better, you have until April 15, 2024, to contribute up to $6,500 into a traditional IRA. And if your income does not exceed phaseout limits, you can reduce your taxable income on your 2023 tax return.
- Convert to a Roth IRA. Consider converting some or all your traditional IRA, SEP IRA, or SIMPLE IRA into a Roth IRA. Although you pay income tax on the amount of the Roth conversion the year it is made, subsequent growth is tax-free in a Roth IRA, and withdrawals from the account are 100% tax-free after five years from the date of the conversion.
- Tax loss harvesting. If you own stock outside a tax-deferred retirement plan, you can sell your under-performing stocks by December 31st and use these losses to reduce any taxable capital gains. If your net capital losses exceed your gains, you can net up to $3,000 against other income such as wages. Losses over $3,000 can be used in future years.
- Selling appreciated assets. Consider selling appreciated assets in the tax year that helps you the most. While this strategy may be hard to accomplish this late in the year, it is still worthy of consideration. To do this, estimate your current year’s taxable income and compare it to next year’s projected income. Then sell the appreciated asset in the year that will yield the lowest tax. Remember to account for the 3.8% net investment income tax in your estimates.
- Review health spending accounts. If you participate in a Health Savings Account (HSA), try to maximize your annual contribution to reduce your taxable income. Remember, these funds allow you to pay for qualified health expenses with pre-tax dollars. More importantly, unlike Flexible Spending Accounts (FSA), you can carry over all unused funds into future years. If you do have an FSA, you can carry forward a maximum of $610 from 2023 into 2024 if your plan allows this. The deadline for contributing to your Health Savings Account (HSA) and still getting a deduction for the 2023 tax year is April 15, 2024. The maximum contribution for 2023 is $3,850 if single and $7,750 for married couples. If you’re age 55 or older, you can add $1,000 to your HSA contribution.
While the year is quickly coming to an end, there is still time to reduce your 2023 tax liability, but only if you act now.
What are the filing deadlines for common federal income tax returns for 2023? * / **
The deadline for individual tax returns (Forms 1040 and 1040SR) is April 15, 2024. You may request a six-month extension and extend the filing deadline to October 15, 2024. Extensions apply only to filing deadlines. Amounts owed to the IRS are due no later than April 15, 2024, despite the extension.
Trust and Estate income tax return (Form 1041) is due April 15, 2024. However, trusts and estates can request a five-and-a-half-month filing extension. The extended deadline is September 30, 2024.
S Corporation (Form 1120S) has an initial filing deadline of March 15, 2024. The corporation may file a request to extend the deadline to September 16, 2024. S Corporations with a fiscal year-end other than a calendar year must file by the 15th day of the third month following the end of the corporation’s fiscal year and are permitted to extend for another six months.
Partnership return (Form 1065) is due March 15, 2024. However, you may file a six-month extension request and extend the filing deadline to September 16, 2024.
The calendar year C Corporation (Form 1120) tax return is due April 15, 2024. The corporation may request a six-month extension and extend the filing deadline to October 15, 2024. As noted for the individual extensions, tax payments cannot be extended and must be paid no later than April 15, 2024.
C Corporations with a fiscal year-end other than a calendar year must file by the 15th day of the fourth month following the end of the corporation’s fiscal year. A six-month extension may be requested. ***
* See our tax calendar in the Client Area of this Web site for a more comprehensive list of 2023 income tax return deadlines.
** Some states and counties may be affected as a federally declared disaster and are permitted an extended deadline. Contact your Cooper, Travis & Company, PLC advisor for more details.
*** C Corporations with a fiscal tax year ending on June 30 and beginning before January 1, 2026, must file its tax return on or before September 15 and may extend seven months until April 15.
How long should I keep my tax records?
Generally, tax records related to federal income taxes should be kept for three years from the date you filed your tax return. The IRS requirements for record keeping are listed below:
1. Keep records for three years if situations (4), (5), and (6) below do not apply to you.
2. Keep records for three years from the date you filed your original return or two years from the date you paid the tax, whichever is later if you file a claim for credit or refund after you file your return.
3. Keep records for seven years if you file a claim for a loss from worthless securities or bad debt deduction.
4. Keep records for six years if you do not report income that you should report and it is more than 25% of the gross income shown on your return.
5. Keep records indefinitely if you do not file a return.
6. Keep records indefinitely if you file a fraudulent return.
7. Keep employment tax records for at least four years after the date that the tax becomes due or is paid, whichever is later.
If the records relate to property (land, building, equipment, etc.), then you generally should keep those records until the period of limitations expires for the year in which you dispose of the property. Additional limitation rules apply to property you receive in a nontaxable exchange.
Who qualifies as my dependent?
The IRS identifies two types of dependents, each subject to its own rules. The first is a qualifying child, and the second is a qualifying relative. See below for the general requirements and the rules for each type of dependent.
General requirements for both qualifying child and qualifying relative:
- TIN. Must include the dependent’s taxpayer identification number on the return of the taxpayer claiming the dependent. This is generally their social security number.
- Citizenship / Residency. The dependent must be a citizen or national of the U.S. or a resident of the U.S., Canada, or Mexico for part of the year.
- No Dependents. The dependent cannot claim any dependents on his return.
- Married Dependent. A married individual that files a joint return with their spouse cannot be claimed as a dependent. Certain exceptions apply.
The following additional rules apply to each type of dependent:
Are they related to you? The child must be your son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister (or descendant of such relatives). The relationship test also includes foster and adopted children if certain restrictions are met.
Do they meet the age requirement? Your child must be under age 19 at the end of the year or, if a full-time student, under age 24 at the end of the year. There is no age limit if your child is permanently and totally disabled.
Do they live with you? Your child must live with you for more than half the year, but several exceptions apply.
Do you financially support them? Your child may have a job, but that job cannot provide more than half of their support.
Joint Return? The child cannot file a joint return with their spouse except as a claim for a refund.
Are you the only person claiming them? This requirement commonly applies to children of divorced parents.
Do they live with you? The individual must have the same principal place of abode as you and be a member of your household all year or be on the list of “relatives who do not live with you” in Publication 501. About 30 types of relatives are on this list.
Do they make less than $4,700? The individual cannot have a gross income of more than $4,700 for tax year 2023 and be claimed by you as a dependent.
Do you financially support them? You must provide more than half of the individual’s total support for the year.
Are you the only person claiming them? This means you can’t claim the same person twice, once as a qualifying relative and again as a qualifying child. It also means you can’t claim a relative—say a cousin—if someone else, such as his parents, also claims him.
Should I itemize or take the standard deduction?
This is the fifth year under the Tax Cuts ad Jobs Act (“TCJA”) – which made extensive changes to the tax code at the beginning of 2018. Due to some of those changes, many individual taxpayers found it more advantageous (and easier) to take the standard deduction than itemizing their deductions for the first time ever.
For 2023, the standard deduction increases to $27,700 for married filing jointly, $20,800 for head of household, and $13,850 for single taxpayers and married individuals filing separately.
A taxpayer who files married filing jointly, married filing separately, or surviving spouse, who is age 65 or older, blind, or both at the end of the tax year may add $1,500 ($3,000 if both 65 or older and blind) to the basic standard deduction.
A taxpayer who files single, unmarried, or head of household and is age 65 or older, blind, or both at the end of the tax year may add $1,850 ($3,700 if both 65 or older and blind) to the standard deduction.
As a result, many taxpayers who previously reported itemized deductions can receive a higher deduction and save time gathering documents by taking the standard deduction.
In addition to increasing the standard deduction, the TCJA limited several itemized deductions. For example, under TCJA, a taxpayer can only deduct up to $10,000 for state and local taxes ($5,000 if married filing separately). Previously there were no limits.
The TCJA also reduced the amount of interest deductible on acquisition debt for a primary and secondary residence to interest paid on debt of up to $750,000 ($375,000 of debt for married filing separately taxpayers). Before TCJA, interest expense on debt of up to $1 million was deductible. The reduced limit only applies to acquisition debt for a primary or secondary residence incurred after December 15, 2017, and before January 1, 2026.
For some taxpayers, the decision to take the standard deduction is easy. But for those taxpayers whose itemized deductions may exceed the standard deduction, providing your tax preparer with all the information will be beneficial. The decision will be based on which deduction offers the greatest benefit for you.
How much can you contribute annually to an IRA? Are my contributions deductible?
The annual contribution limit for 2023 is $6,500, or $7,500 if you’re 50 or older. Your Roth IRA contributions may also be limited based on your filing status and income.
Traditional IRA contributions may be deductible on your tax return. If neither you nor your spouse is covered by a retirement plan at work, your deduction is allowed in full. ROTH IRA contributions are not deductible.
What are self-employment taxes?
Self-employment tax is a social security and medicare tax primarily for self-employed individuals. Self-employed individuals who earn over $400 during the year are subject to self-employment tax. For 2023, income up to $160,200 ($166,800 for 2024) is taxed at a rate of 15.3% (12.4% Social Security tax and 2.9% Medicare tax). For 2023, income over $160,200 ($166,800 for 2024) is taxed at the 2.9% Medicare tax rate. (A 0.9% additional Medicare tax may also apply. See the next question below.) One-half of your self-employment taxes are deductible from your adjusted gross income on your tax return.
Your self-employment tax payments contribute to your coverage under the social security system. Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and hospital insurance (Medicare) benefits.
Will I be subject to the Additional Medicare Tax (0.9%) in 2023?
You are liable for Additional Medicare Tax if your wages, compensation, or self-employment income (together with that of your spouse if filing a joint return) exceeds the threshold amount for your filing status. For those with a filing status of married filing jointly, the threshold amount is $250,000 (married filing separately is $125,000). The threshold is $200,000 for those filing as single, head-of-household, or qualifying widow(er) with a dependent child.
If total wages, compensation, or self-employment income paid to you (including your spouse’s income if filing a joint return) exceeds the applicable threshold amount, then you are subject to the Additional Medicare Tax on that excess. The Additional Medicare Tax rate is 0.9%.
What is the Net Investment Income Tax?
For individual taxpayers, the net investment income tax is 3.8% on the lesser of:
- Your net investment income, or
- The excess of your modified adjusted gross income over the following threshold amounts:
- $250,000 for married filing jointly or qualifying widow(er)
- $125,000 for married filing separately
- $200,000 for those filing as single or head of household
Generally, investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading financial instruments or commodities and businesses that are passive activities to the taxpayer.
What is the Qualified Business Income Deduction?
The Qualified Business Income Deduction (“QBID”; also known as Section 199A) was enacted with the Tax Cuts and Jobs Act of 2017 and created a deduction for qualified pass-through entities. The QBID was a congressional attempt to mirror the reduced tax rate of 21% afforded C-Corporation under the TCJA to pass-through entities.
The Qualified Business Income Deduction (QBID) is a 20% deduction for qualified business income. Certain income limitations apply and are discussed later.
The deduction is taken at the individual level and is available for taxpayers who have ownership in a pass-through entity such as a sole proprietorship, partnership, or S Corporation.
Partnerships and S Corporations will include the necessary information for the deduction on the taxpayer’s Schedule K-1. Your business must be a qualified trade or business to be eligible for the deduction.
Exceptions under the Act include specified service trades or businesses, which include any trade or business whose principal asset is the reputation or skill of one or more of its owners, such as accounting, law, investment management, financial services, athletics, trading, or dealing in certain assets. Under TCJA, these types of businesses do not qualify for the deduction if the taxpayer’s income exceeds the income limitations described below.
Are there income limitations for the Qualified Business Income Deduction?
As mentioned above, the QBID is a 20% deduction on qualified business income. The 20% deduction is taken on the lesser of the qualified business income or the taxpayer’s taxable income.
Income limitations on the QBID apply to taxpayers whose taxable income is above certain thresholds. For 2023, the threshold amounts are:
- $364,200 for married filing jointly;
- $182,100 for all other returns
If the taxpayer’s taxable income is above the threshold amounts, the QBID is subject to limitations. Limitations include a reduction in the amount available for the 20% deduction based on W2 wages paid and qualified assets owned.
The QBID is complicated. For further questions on the QBI deduction, please consult one of our tax professionals.
What is Section 179 and Bonus Depreciation?
Section 179 Deduction. The section 179 deduction is an election to recover all or part of the cost of certain qualifying property (new or used, as long as the previously used equipment is new to you). You can elect the section 179 deduction instead of recovering the cost by taking annual depreciation deductions.
In 2023, the maximum section 179 deduction for property placed into service was $1,160,000. However, businesses exceeding $2,890,000 of purchases in qualifying equipment are subject to the Section 179 deduction dollar-for-dollar phase-out. Accordingly, the election is completely eliminated if qualifying purchases exceed $4,050,000.
In 2024, the maximum section 179 deduction is $1,220,000. The dollar-for-dollar phase-out begins at $3,050,000, and the deduction is completely eliminated if total purchases exceed $4,050,000.
Bonus Depreciation. Bonus depreciation allows you to elect to expense up to 100% of the cost of certain vehicles and equipment purchased and placed into service in the 2021 tax year. TCJA increased bonus depreciation from 50% to 100% and eliminated the rule that the asset be new. Therefore, bonus depreciation can be taken on new or used purchases (as long as it is new to you and not purchased from a related party, along with other limitations) with a useful life of 20 years or less. The ability to expense 100% of asset purchases goes through December 31, 2022. After that, the deduction decreases to 80% for the 2023 tax year, 60% for 2024, 40% for 2025, and 20% thereafter.
Can I still deduct meals and entertainment expenses?
In prior years, businesses could deduct 50% of business meals and entertainment costs on their tax return. However, the TCJA changed this deduction, eliminating the deduction for entertainment expenses, such as tickets to a sporting event, concert, or golf game with a client or customer.
General Rule: The cost of business meals is still deductible at 50%. The cost of entertainment that includes food and drink must have an invoice showing the amount related to food and drink to take the 50% deduction for that portion of the cost. Meals and entertainment expenses provided to the general public as a way of advertising are deductible in full as advertising costs.
COVID Temporary Rules for 2022: The cost of food and beverages provided by a restaurant as a business meal is 100% deductible.
Are the credits received under the Employee Retention Tax Credit program taxable?
The short answer is yes. The credits are taxable for federal income tax purposes. Under section 2301(e) of the CARES Act, the qualifying payroll and health plan expenses are reduced by the amount of the credit obtained.
The non-taxability of the ERC funding stands in contrast to the Paycheck Protection Act grant funding received by many businesses. It took a congressional act, but PPP was finally clarified as nontaxable for federal income tax purposes.
Under the SECURE Act 2.0, signed into law on December 29, 2022, at what age am I now required to begin taking required minimum distributions?
Under the Act, the age when minimum distributions (RMD) are required increases to age 73 in 2023 and 75 in 2033. Previously, RMD had to begin at 72.
Additionally, the penalty for failing to take an RMD decreased from 50% to 25% of the RMD amount in 2023. The penalty can further be reduced to 10% for IRA account distributions if the RMDs are corrected promptly.
What are attest services?
Attest services can only be performed by a CPA that works within a CPA firm. The hallmark of an attest service is that the CPA must be independent to provide the service. Attest services include audits, examinations, reviews, agreed-upon-procedures, and in most states, compilation engagements.
What are assurance services?
For an assurance service, the CPA expresses an opinion or a conclusion on the subject matter so the user can make informed decisions. Assurance services include audits, examinations, and review engagements.
What is an audit?
An audit of a nonpublic company is performed in accordance with the AICPA Statements on Auditing Standards, also referred to as generally accepted auditing standards, aka GAAS. Those standards are applied to historical financial statements to obtain reasonable assurance that the financial statements are free from material misstatement. Reasonable assurance is a high level of assurance under GAAS. The nature, timing, and extent of procedures performed are based on the auditor’s judgment. Such procedures may include confirmations of balances and other information with outside sources, attorney representations regarding litigation and unasserted claims, an inspection of documents, inquiries with the Company’s personnel, recalculations, analytics, and written representations from the Company’s management documenting specific responses made to the auditor during the engagement. Reasonable assurance is the highest level of assurance that a CPA can provide. Under reasonable assurance, however, the auditor does not guarantee that the financial statements are 100% correct. Instead, the auditor opines that the financial statements present fairly, in all material respects, the Company’s financial position, operations, and cash flows. Audited financial statements give the end-users, such as banks, sureties, and parties involved in business acquisitions, high assurance that the financial statements used to make decisions are fairly presented.
What is an Examination?
Examinations are performed in accordance with the AICPA Statements on Standards for Attestation Engagements. An examination is an audit-level engagement applied to information other than historical financial statements. There is very little difference in approach between an audit and an examination; the most significant difference is the subject matter being examined. An examination, like an audit, is designed to provide a high level of assurance (i.e., reasonable assurance). An example of an examination engagement would include an examination of prospective financial information.
What is a Review Engagement?
In a review of financial statements, the CPA seeks to obtain limited assurance whether there are any material modifications that should be made to the financial statements for them to be presented in accordance with generally accepted accounting principles, i.e., GAAP or, in some engagements, other applicable financial reporting framework. A review engagement is substantially less in scope than an audit. A review consists primarily of two procedures borrowed from the audit toolbox: those being inquiries and analytical procedures. The CPA may occasionally apply other procedures when necessary to obtain limited assurance. Reviews of historical financial statements or other historical financial information are conducted in accordance with the AICPA Statements on Standards for Accounting and Review Services. However, reviews of certain interim financial information are conducted in accordance with the AICPA Statements on Auditing Standards. Review engagements of information other than historical financial statements, including pro forma financial information, are performed in accordance with AICPA Statements on Standards for Attestation Engagements.
What is an agreed-upon-procedures engagement?
Agreed-upon-procedure engagement is one of the three types of engagements performed in accordance with the AICPA Statements on Standards for Attestation Engagements. (The other two types described above are the examination engagement and certain review engagements.) An agreed-upon-procedures engagement is an attest service. Accordingly, the CPA must be independent. However, it is not an assurance engagement because the CPA does not express an opinion or conclusion on the subject matter. Instead, the client engages the CPA to issue a report of findings based on procedures agreed to between the CPA and the engaging party. The subject matter may be financial or nonfinancial information. An example of an agreed-upon-procedures scenario is when a CPA is engaged to recalculate employee bonuses based on the term of employment agreements.
What is a compilation engagement?
A compilation engagement is conducted in accordance with the AICPA Statements on Standards for Accounting and Review Services. In most states, a compilation engagement is a non-assurance attest engagement. Accordingly, only CPAs can perform a compilation engagement in those states. A CPA may be engaged to compile financial statements, prospective financial information, pro forma financial information, or other historical financial information. Unlike an audit or review, a compilation does not include performing any procedures to verify the accuracy or completeness of the information provided by management. Instead, the CPA applies accounting and financial reporting expertise to assist management in presenting financial statements without undertaking to obtain or provide any assurance that there are no material misstatements in the financial statements. As a result, a compilation may be more cost beneficial in some cases. However, it is rare for some end-users, such as a bonding company, to accept a compilation at year-end. However, sometimes smaller bonding programs can and do accept compiled financial statements.
What is a preparation engagement?
A preparation engagement is conducted in accordance with the AICPA Statements on Standards for Accounting and Review Services and is a nonattest service. Therefore, the CPA is not required to be independent. In a preparation service, the CPA uses their knowledge of the Company’s financial reporting framework (generally GAAP) and business knowledge to prepare financial statements or prospective financial information. The CPA is not required to verify the accuracy or completeness of the information provided by management. Therefore, the CPA does not provide any assurance regarding the financial statements or the financial information and, accordingly, does not express an opinion or conclusion. However, the CPA adds value in a preparation engagement by assisting management with significant judgments regarding amounts or disclosures to be reflected in the financial statements.
Are there other nonattest services?
Yes. CPAs can provide certain nonattest services for a company’s management and still maintain their independence to perform attest services, such as audit, examination, review, agreed-upon-procedures, and compilation engagements, as long as they comply with certain stringent ethical requirements. For example, at Cooper, Travis & Company, we often assist our clients with nonattest services, such as drafting their financial statements, preparing tax returns, depreciation schedules, job schedules, and assisting with year-end close.
What is the difference between an audit and a review engagement?
There are significant differences between an audit and a review regarding the amount of test work required and the cost of the engagement. An audit provides greater assurance to the end user than the limited assurance provided by a review engagement. Because of this, considerably more test work must be performed during an audit to achieve this higher level of assurance. Auditors will avail themselves of all the tools in the audit toolbox. This includes vouching, tracing, scanning, observation, inspection, confirmation, inquiry, recalculations, reperformance, testing of details, and analytical procedures.
Additionally, the standards require the auditor to perform a more robust risk assessment and gain a deeper understanding of the Company’s system of internal controls than is necessary for a review engagement. Because a review engagement is substantially less in scope than an audit and therefore provides less assurance to the end-user than an audit, it requires fewer procedures and less time to perform. Generally, a review engagement only borrows two tools from the audit toolbox: inquiries and analytical procedures. In some cases, other procedures are performed to obtain the limited assurance required in a review engagement.
How do I know if I should get an audit, review, or compilation of the financial statements?
The level of service is customarily driven by the end-users of the financial statements. Most private companies choose compiled or reviewed financial statements; however, creditors, investors, and bonding companies may require an audit. We will typically talk a contractor out of an audit and instead perform a review if their bonding company, bank, or licensing board does not require an audit. Sureties often require an audit rather than a review engagement when the aggregate bonding program exceeds $30 million. Certain regulatory agencies, such as the Tennessee Board of Contractors, also have requirements for the level of service (see below for the Tennessee Board for Licensing Contractors requirements).
How much will an audited or reviewed statement cost?
An audit requires substantially more procedures and documentation than a review engagement and is, therefore, more costly. Fees are set at our standard hourly rates for the professionals involved. Our initial audit or review engagement proposal will provide an estimated fee range based on the Company’s size and complexity.
What services do you offer?
We offer a variety of services as described above, with a concentration geared toward the construction/ real estate industry. Additionally, we are familiar with numerous state contractor licensing boards and contractor pre-qualification requirements and offer services in those areas. We provide related services to the owners of our business clients, such as personal financial statements. Furthermore, we perform ERISA audits with a focus directed to profit-sharing and 401(k) qualified plans.
Does the Tennessee Board for Licensing Contractors require that the financial statements submitted to the Board be audited, reviewed, or compiled?
The question of whether the financial statement submitted to the Tennessee Board for Contractors for licensing be audited, reviewed, or compiled depends primarily on two broad considerations: 1) Whether the request is for an original application for a license, a renewal, or a monetary limit increase request 2) the monetary limit of the license. Nevertheless, the financial statements presented to the Board must be less than 12 months old.
When you initially apply for a contractor’s license, a review is required for a monetary limit request of $3,000,000 or less. For limits over $3,000,000 to unlimited, an audit is required.
You must renew your Tennessee Contractor’s license every two years. If the existing monetary limit is $3,000,000 or less, you can submit a compiled financial statement with the renewal form. This compiled financial statement can be prepared by either a CPA or you can internally compile the statement using the Board formatted financial statement found on its website. If your existing monetary limit exceeds $3,000,000, you must submit a reviewed financial statement with your renewal form. A licensed CPA must perform the review.
If you request an increase of the monetary limit on your existing contractor’s license, you must submit with the limit increase request a reviewed financial statement for requests of $3,000,000 or less and an audited financial statement for any request over $3,000,000.
Reviewed financial statements MUST include the following:
- CPA signed report letter
- Balance sheet based on GAAP
- Notes to the financial statements
Audited financial statements MUST include the following:
- CPA signed opinion letter
- Balance sheet, income statement, and statement of cash flows based on GAAP
- Notes to the financial statements
What is an Attorney Letter, and Is it Necessary?
An attorney letter is a letter of inquiry from the Company’s management to the Company’s external legal counsel. The letter requests that the attorney reply directly to the auditor regarding litigation and unasserted claims. The letter is mailed (or emailed) by the auditor. The attorney generally bills the Company for responding to this letter. Under auditing standards, the auditor must obtain an attorney letter (assuming an attorney has been consulted) if there is evidence that the Company has actual or potential litigation, claims, or assessments that may give rise to a risk of material misstatement. Additionally, many auditors find it prudent to send an attorney letter to the Company’s general counsel even if there is no evidence of litigation.
What is a Management Representation Letter, and is it Necessary?
As odd as it may sound, the management representation letter is a letter on the Company’s letterhead, addressed to the auditor, that is written by the auditor on behalf of the Company’s management. Even though written by the auditor, the letter is styled as a letter from management to the auditor. Once the contents of the letter are agreed to and signed by management, it becomes just that, a letter from the Company’s management to the auditor that confirms important representations to the auditor. Those representations include management’s acknowledgment of their responsibilities regarding the preparation and fair presentation of the financial statements, the quality of the information provided to the auditors and the completeness of transactions, and many other representations critical to the fair presentation of the financial statements. The management representation letter provides the auditor with corroborating support for audit evidence obtained during audit fieldwork. Auditors are required under auditing standards to get this signed letter from management on every audit.
What is a “SAS 115” Letter?
The auditing standards require the auditor to obtain an understanding of the Company’s internal controls over financial reporting sufficient to enable the auditor to design appropriate audit procedures. This requirement is not for the purpose of expressing an opinion on the effectiveness of internal control but is a tool to assist the auditor in assessing the risk of a material misstatement in the financial statements. During the risk assessment process, the auditor may identify deficiencies in internal control that are of sufficient magnitude that they should be communicated to the Company’s management. That is done with a SAS 115 letter. (SAS 115 is the AICPA’s original standard that requires the auditor to communicate to management certain deficiencies in internal control identified during an audit.) Under the standard, two categories of internal control deficiencies merit reporting to management: 1) material weakness and 2) significant deficiencies. A material weakness is the most problematic. A material weakness means that the auditor identified a weakness in internal control whereby it is reasonably possible that a material misstatement of the financial statements will not be prevented or detected and corrected on a timely basis. A significant deficiency in the Company’s internal control is less severe than a material weakness yet important enough to merit the Company’s attention. This written communication aims to bring to management’s awareness the internal control weaknesses and the significance of those weaknesses so that management can remedy them.
How do I account for the Paycheck Protection Program Loan for financial statement purposes?
The CARES Act established the Paycheck Protection Program (“PPP”), signed into law on March 27, 2020. The intent of the PPP is to provide loans to qualifying businesses to pay up to 8 weeks (later extended to 24 weeks via the PPP Flexibility Act signed into law on June 5, 2020) of certain qualifying expenses. Those expenses include payroll costs, including benefits, mortgage interest, rent, and utilities. The SBA administers the Program. Under provisions of the Program, the loan and interest may be forgiven provided the business meets the eligibility criteria for forgiveness.
The AICPA, in Q & A Section 3200.18, suggests four ways to account for a potentially forgivable loan received under the SBA program. While there are four possible approaches, we recommend the following two:
- As Debt. The legal form of the funds is that of a debt. So, it is always permissible to account for the PPP loan under FASB ASC 470 – Debt. Though the stated interest rate may be below market, interest will not be imputed because government-guaranteed obligations are excluded from this requirement. Under further guidance in FASB ASC 405-20-40-1, the loan remains recorded as a liability until it is paid off or forgiven, either in whole or in part. If forgiven, the debt liability is reduced by the amount forgiven, and gain on extinguishment of debt would be recorded.
- As Deferred Income Liability. If the Company determines that it is probable it will meet the PPP’s eligibility criteria for loan forgiveness, it may conclude that the loan is, in substance, a government grant. Therefore, it may account for the PPP loan as a grant by analogy to the provisions of International Accounting Standard 20, Accounting for Government Grants and Disclosure of Government Assistance. Remember that the likelihood of forgiveness must meet the “probable” threshold under GAAP, which is a high threshold. Under the IAS 20 model, the PPP loan funds would initially be recorded as a deferred income liability. The deferred income liability would be reduced as income is recognized “on a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate.” The income would be presented in the income statement as either 1) a separate caption or under a general caption such as Other Income, or 2) as a reduction to the related expenses. If, in a subsequent accounting period, it is determined that all or a portion of the previously recognized income is repayable, it will be accounted for prospectively as a change in estimate.
For financial statement purposes, how do I account for the payroll tax credits received under the Employee Retention Tax Credit program?
The structure of the ERTC was to provide refundable payroll tax credits to entities as an incentive to retain employees during the pandemic. The entity obtained the credit by incurring qualifying payroll expenses and certain health insurance costs. The credit could be taken as an advance on IRS Form 7200 or credit on either a timely filed IRS Form 941 or amended IRS Form 941-X.
If the Company received a PPP loan the prior year, it should consider the accounting treatment for the PPP loan. If the Company treated the PPP loan as debt, then the Company now has a first-time election on how to account for the ERTC government funding. It can choose to treat the proceeds in one of the following three ways:
- As a grant under the IAS 20 model,
- As a grant under the not-for-profit model,
- As a contingency gain under FASB ASC 450-30.
However, if the Company received a PPP loan the prior year and made a policy election to treat the loan under one of the three methods described directly above, the ERTC must be accounted for the same way. In other words, since it made an election for the PPP loan, it must consistently use the same method to account for the ERTC government grant.
Please see our blog dated January 17, 2022, for a more in-depth discussion.
Why should I have a valuation of my closely-held business?
Several situations that may require a business valuation, including:
- Sale or purchase of a business
- Debt financing support
- Mergers and acquisitions
- Estate and gift taxes
- Buy-sell agreements
- Property settlements in divorce
- Stockholder or partner buyouts
- Goodwill impairment
- Litigation related to bankruptcy, contractual disputes, and a variety of other issues
Do CPAs perform business valuations?
Yes. CPAs perform business valuations under professional standards issued by the AICPA. CPAs are required to adhere to those stringent standards when performing business valuations. Additionally, CPAs can bring their broad perspective of business operations and understanding of financial statements and the underlying value drivers to the table in business valuations.
What types of business valuation are available?
The AICPA valuation standards permit two types of valuations:
- Valuation Engagement. The highest level of service is the valuation engagement. The valuation engagement requires more procedures than the second type described below and results in a conclusion of value (or a range of values). The valuation engagement permits the valuation analyst freedom to choose the valuation approaches and methods they consider appropriate in the circumstances to issue a conclusion of value.
- Calculation Engagement. A calculation engagement does not include all the procedures required for a valuation engagement. For a calculation engagement, the valuation analyst and the client agree on the approaches and methods and the extent of the valuation analyst’s procedures. Then, based on the limited procedures performed, the analyst will arrive at a calculated value (or range of calculated values). Often, an engagement that begins as a calculation engagement will be restructured to a valuation engagement if it appears advisable.
What type of valuation should I have?
It depends primarily on the subject matter of the valuation and the reason for the valuation. In most cases, the client’s needs are better served by a valuation engagement. However, we will work with you to assess the situation and scope our work to fit your needs and budget.
What are some of the procedures involved in a valuation?
A valuation requires considerable fact-finding related to the entity, industry, and the local, regional, and national economies, including:
- Personnel interviews and site visits
- Review of the entity’s history and entity records
- Analysis of the entity’s financial performance over several years
- Analysis and comparison to similar companies
- Forecast of future earnings
- Analysis of the economic environment in which the entity operates and other factors.
How long a period is a valuation report valid?
A valuation report is typically valid for a maximum of one year. After that, it may be necessary to update the report to reflect subsequent company performance and current economic/industry conditions. However, there could be some extreme subsequent events, such as a natural disaster or a plant fire, which, while not invalidating the valuation as of the valuation date, could make it less useful to the end-users.
Do you appraise real or tangible personal property?
No. Our valuation work is directed to ownership interests and intangible assets. However, if your engagement requires an appraisal of real or tangible property, we will work with independent property appraisal professionals to develop our conclusion of value or calculated value.
Do you comply with professional standards?
Yes. Our firm adheres to the professional standards of the American Institute of Certified Public Accountants (AICPA) and the Tennessee State Board of Accountancy. Our valuation services comply in all respects with the Statement of Standards for Valuation Services (SSVS) as promulgated by the AICPA.
What is forensic accounting?
Forensic accounting, also called investigative accounting, is a detailed examination and analysis of documents for use as evidence in a court of law. The term forensic accounting can include the following areas:
- Fraud detection, documentation, and presentation of the report.
- Calculation of economic damages.
- Tracing income and assets, usually to find hidden assets or income (customarily performed for divorce and bankruptcy cases).
- Reconstruction of financial statements that may have been destroyed or manipulated.
Who uses fraud and forensic services?
Forensic accountants are retained by law firms, corporations, banks, government agencies, insurance companies, and other organizations to analyze, interpret, summarize, and present complex financial and business-related issues in an understandable manner.
Why would my auditor not discover fraud and financial manipulation during the annual audit of my company’s financial statements?
The difference between the public expectation of the purposes and objectives of an audit and the CPA’s responsibilities under Generally Accepted Auditing Standards, aka GAAS, is referred to as the expectation gap. Audits of financial statements are not specifically designed to detect fraud but to express an opinion on the financial statements as a whole. However, should fraud be discovered during a financial statement audit, the CPA will notify the company’s management of the findings. The client engagement letter and audit opinion state that the object of the audit is to obtain reasonable assurance that the financial statements are free of material misstatement, not the detection of fraud.
What possible fraud red flags should a business owner be alert to?
In many cases, the business owner or management may have suspicions that fraud or accounting irregularities are happening. Some of the more frequent observations that lead to these hunches are:
- There is no clear separation of accounting duties.
- Employees with control or access to cash and accounting records do not take vacations or time off
- There are significant transactions with related parties, suppliers, or subcontractors who are unknown or unfamiliar.
- There is a distinct difference between an employee’s income and lifestyle.
- Significant and frequent adjustments are made to the accounting records using journal entries.
Our firm can provide a review of your company’s internal controls to make changes that would lessen the opportunities for fraud to occur.
What is the cost of a forensic accounting or economic damages analysis?
Our fees are typically based on hourly rates. The fees ultimately charged will depend on the case’s complexity, the timing of the required analysis, and the purpose of the engagement. In non-litigated engagements, we can offer fixed-fee arrangements under certain circumstances. Please contact us for specific information regarding our fee structure or to receive a proposal for a particular engagement.
Does a FAR (Federal Acquisition Regulation) audit include an opinion on my complete financial statements?
No. A FAR audit is designed to provide assurance that the indirect overhead is accurately computed. Therefore, the audit opinion scope is limited and restricted to users of the FAR audit.
Do I need a FAR audit for every state where I work?
Generally no. Usually, the company has a FAR audit performed for its home State Department of Transportation (DOT). The home State DOT then issues a “cognizant letter” that is generally accepted by other states.
What is a “cognizant approved indirect cost rate”?
The term refers to the indirect cost rate established by an audit performed in accordance with Generally Accepted Government Auditing Standards to test compliance with the FAR cost principles and accepted by a cognizant Federal or State agency such as the Federal Highway Administration or a State DOT.
What work does a State DOT perform to accept an audit conducted by a CPA to issue an approved cognizant letter?
The State DOT reviews the CPA’s workpapers using the Review Program for CPA audits of Consulting Engineers’ Indirect Cost Rates identified in Appendix A of the AAHSTO Uniform Audit & Accounting Guide.
How long is an audited indirect cost rate valid?
One-year. The one-year applicable accounting period means the annual accounting period for which financial statements are regularly prepared for the consulting engineering firm.
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