Author: C.O.R.E. Beliefs

The New Bonus Depreciation Deduction

~ C.O.R.E. Beliefs ~ Leave a comment

Continuing on with my examination of the new tax act, I am going to examine the purported meat of the “jobs” portion of this act.  Beginning 9/27/17 (that’s right, assets purchased as of a very odd date at the 3nd of the third quarter) you can deduct 100% of the purchase price for certain qualifying assets.

But, this is one of those temporary tax deals.

Placed in Service before % Deductible
1/1/2023 100
1/1/2024 80
1/1/2025 60
1/1/2026 40
1/1/2027 20

It get better, I think.  the new code appears to also allow for the purchase of used property.  The code section they added says, ”

c) APPLICATION TO USED PROPERTY.—
(1) IN GENERAL.—Section 168(k)(2)(A)(ii) is amended to read
as follows:
‘‘(ii) the original use of which begins with the
taxpayer or the acquisition of which by the taxpayer
meets the requirements of clause (ii) of subparagraph
(E), and’’.
(2) ACQUISITION REQUIREMENTS.—Section 168(k)(2)(E)(ii) is
amended to read as follows:
‘‘(ii) ACQUISITION REQUIREMENTS.—An acquisition
of property meets the requirements of this clause if—
‘‘(I) such property was not used by the taxpayer
at any time prior to such acquisition, and
‘‘(II) the acquisition of such property meets
the requirements of paragraphs (2)(A), (2)(B),
(2)(C), and (3) of section 179(d).’’

To interpret legaleze, the “original use” means new property.  Under the old code, what you had to buy in order to qualify was new, under the premise that new stuff creates jobs.

The new tax law adds a new clause, “such property was not USED by the taxpayer at any time prior to such acquisition…”  Again, to interpret, whatever you buy will qualify as long as you didn’t already use it before buying it.  Think converting a leased car.  You were using it and then decide to “buy” the car.  This would not qualify as you already used it.  It doesn’t stop you, however, from buying someone else’s leased vehicle and then claiming the bonus depreciation.

Ok, I am with you, used equipment doesn’t generate jobs.  But it does allow a business the option now of spending 30-40% less by buying pre-owned and still getting the 100% write off.

What is interesting is the new tax law provides taxpayers the option to elect out of the bonus depreciation.  I will admit that under the old rules, where we had graduated corporate tax rates, I often suggested that C Corporations elect out because the item was taxed at less than 25% and we were pretty certain that the next years tax rate was going to be 35%.  But now, it is a flat 21% so there are no brackets to maximize.

The election is no doubt for Schedule C businesses and possibly pass-through entities since they are still subject to the graduated tax brackets.  I have to analyze a few scenarios to see if the election is worthwhile though.

And try to find the hidden gem that is no doubt lurking in one of the “by extension” paragraphs.  These call to the other code sections to ensure their references are updated and possibly one of these has another limit I haven’t caught yet.  Stranger things have happened.

Naturally, please don’t take this as tax planning advice and whatever you do, don’t rush out and buy stuff without talking with your tax professional.  If you like, I am happy to discuss your situation and help you decide if taking the 100% bonus depreciation is worthwhile if you are not currently working with a professional.  Feel free to contact me if you have any questions about this or any other aspect of the new tax law.

Have a great day.

 

SALT Limitation Issues

~ C.O.R.E. Beliefs ~ Leave a comment

I went into the ITS offices yesterday.  We had a meeting with a client and also it gave me a chance to catch up with the other John.  He attended a tax update workshop last week and we wanted the chance to compare notes.  One thing that caused us a good deal of chuckling is the state and locate tax (SALT) limitation and how it is going to be applied.

Lets say you live in a state that taxes income – say like Oregon.  You make $100,000 a year as an engineer.  You live in a modest home priced at $500,000.

  • Your Oregon income tax withheld is $10,000
  • Your Property tax is $6,500
  • Total SALT is $16,500, capped at $10,000

Oh, but wait.  Your actual Oregon income tax is $9,000 when you finally get to filing the return.

So, lets start with the easy question:

Which part of the $10,000 SALT deduction is the actual deduction?

Why does it matter?  Well, lets start with the fact that you reached the $10,000 limit with your income tax withheld.  If the rule states that you first apply the SALT to income tax and then property tax, your $1,000 overpayment would be taxable income in the next year.  Recovery of a deduction rules.

But if the property tax is deduction first, then you only used $3,500 of your income tax to reach the cap.  So, did you really have a $1,000 overpayment?  Do you still need to recapture that overpayment in the next year?  The state of Oregon is still going to issue the 1099.

Oh wait, how about we pro-rate?  $10,000/$16,500 is (hold on had to dig out the calculator) 60.1%.  So does this mean that you only report 60.1% of the refund as taxable income next year?

Yes, in case you are curious, it seems that the code rewrite is somewhat silent on this trivial matter.  Which means we have to await a ruling from our friends at the IRS.

The same IRS that is getting its budget slashed again for 2018.

Speaking of the IRS, I think the rush to prepay property taxes has been overblown.  There are several problems with all the handwringing but not least of which is, the IRS doesn’t know what your property tax bill is.  This is one of the few items of deductibility where a form is not sent to the IRS.

So, this is going to be an audit issue.  It will most likely start by some enterprising young IRS employee programming an algorithm to look for property tax deductions that are more than 50% higher than the amount deducted in the prior year.  Sounds simple enough.

Nope.  I remember doing some basic research on this wayyyy back in college and there is no such thing as a simple command for the IRS database.  Problem number 1.

Problem number 2.  Assuming they deal with #1 they will send out a ton of notices to people who bought their first home in 2016 and who only deducted a fraction of the property tax.  Knowing the IRS, it will not be a pleasant little letter asking for a reasonable explanation of the deduction and, please disregard if you feel you received this notice in error.  Nooo, it will be a CP2000 notice of deficiency.  Awesome.

Problem number 3.  All these people who got all these notices will send a response back to the IRS.  The IRS computer system cannot read and respond, only a human.  Did I mention that the IRS is getting their budget cut again?  Where are they going to get all these highly trained tax experts who can review a client document and respond effectively?

Look, don’t take this as advice.  Lord knows I don’t want anyone thinking that they can rely upon my little missive to get them out of tax trouble.  But the truth is, anyone who prepaid their taxes is probably safe.  Make sure you have a copy of the check and the payment receipt.  DON’T MAKE IT UP!  If you didn’t prepay it then don’t think you can claim the deduction but if you did, I don’t see the IRS going out of its way to deny the deduction.  It is, after all, a one time deal and frankly…

They need to put their very limited resources into writing the rules to help poor taxpayers figure out how the SALT limitation is going to actually work.  Oh, and rules for every other piece of code section that got put into this major rewrite. The SALT issue is not the worst unknown lurking in this, unfortunately.

Have a great day.  As always, if you would like to discuss this or any other issue feel free to contact me.  And if you are looking for some great tax advice and planning, let me know and let me see what me or my network of great accountants can do for you.

Dad, What do you do?

~ C.O.R.E. Beliefs ~ Leave a comment

Brendan and I have been going to the gym 2-3 times a week and lifting weights.  He is starting to learn how to control free weights and he is enjoying charting his progress.  The other day, while we were between sets, he asked me, “What do you do as an accountant?”

One of those exciting moments every parent of a pre-teen lives for!

So I explain to him that I am an auditor, which is not really an accountant but a scientist.  He seemed puzzled but I pressed on.

“Do you remember learning about the scientific process?” I asked, he replied yes and then started to explain that you first set a hypothesis, test the hypothesis, and then draw a conclusion from your test.

I told him that is what makes an auditor a scientist.  We follow the exact same pattern.

Whenever an auditor begins work, we start by creating a hypothesis.  We changed it around a bit to state we test assertions but in reality we create the hypothesis about management’s assertions.  Ok, that is a little wonkish so perhaps an example.

The books show that the company has $100,000 in a bank account.  Management has made several assertions:

  • That the $100K Exists
  • That the Company has a Right to the money
  • That the $100K is Complete and all transactions are recorded
  • That it is actually Valued at $100K
  • That it is actually Classified as a bank account
  • And that management Cutoff all transactions on the right date

Six assertions on one little bank account but any one of them being an incorrect assertion possibly means that the $100K isn’t really.  So, as an auditor/scientist, the first thing we do is form the hypothesis; and our hypothesis is always a negative.  For instance, some of the hypotheses for this bank account could be

  • There really isn’t a bank account with $100K in it (it doesn’t Exist)
  • The bank account is in the name of another business (There is no Right to it).
  • Management failed to get checks signed and mailed by year end (The transactions are not Complete)
  • The account is in Peso’s in a Mexican bank (the Value is not $100K dollars but 100K Pesos)
  • The account is an investment account (it is not Classified correctly)
  • Management recorded deposits that were actually received later (they didn’t get a good Cutoff)

We create these hypothesis and then test them.  For a bank account, we have a ready-made solution – the bank confirmation.  We send out a letter to the bank and ask them to say they agree, or confirm, managements assertions.  The bank writes back and says, “Yes, there is $100K in the bank, it is actually in US Dollars and it is a demand deposit business checking account in the Company’s name.

One confirmation and poof, four assertions are taken care of.  Our hypotheses were disproven and we can safely say that, as far as those assertions go, management was correct.  As a matter of fact, one of the best forms of evidence for an auditor is when a third party can provide evidence that a transaction exists.  We can confirm a lot and prefer it whenever possible as it can help us with more than one assertion – other tests typically only go after one assertion at a time – which means we can spend hours trying to prove the remaining assertions.

Oh yes, by the way, I lost him at the six assertions – he is only 13 after all.  And, to be honest, he is far more curious about the times we catch people making poor choices and how we deal with it.

I told him to read my blogs.  No, he prefers Star War’s books.  But someday he will.  In the meantime, I hope you begin to have an appreciation of what steps we take as auditors to ensure that management is recording transactions to your books accurately.

An audit is designed to prove that the financial statements being presented are fair and accurate.  Management makes those six assertions on every account and ever dollar reported.  So, the next time you are meeting with your auditor, ask him about management assertions and how they design their hypothesis.  If nothing else, it is a great way to find out if they pay attention to their checklists!

Have a great day.  If you are looking for a firm to perform a review or audit of your financial statements, we would love the opportunity to be of service to you.  Go to our website, look us over and then click the Get a Quote tab.  We are a little wonkish but love to get the job done right and on budget.

 

GAAP and Projections

~ C.O.R.E. Beliefs ~ Leave a comment

I have a new project which I started at the end of last week and which must be ready for discussion by Friday.  I need to pull together a projection for a start-up company, determine its capital requirements, figure out how it should be structured by debt and equity class and then make sure that, given a certain range of possibilities, what the ROI is going to be.

Did I mention this has to be done by Friday?

It is interesting and I have a great model I have developed over the years (in my humble opinion) that helps me focus on the big picture while also making sure I cover the necessary ingredients.  One area I have spent a lot of time updating is the revenue projection side.  First, I am trying to design a revenue model which takes certain assumptions, like lead generation rates through sales close rates and figure out how many sales will happen.  And then from there how many sales support people are needed.  And then…

Sorry, I was going to slide right in and describe why I like modeling this so much but really, today I am writing to discuss how Generally Accepted Accounting Principles (GAAP) are causing a serious headache for me in this projection.

Naturally, my first irritation is the requirement of recognizing stock awards as compensation expense, although I know intuitively that it is something the employees earn.  It is still a challenge because the only “cash” part of this is the amount paid in taxes to gross up the award.  Why am I worried about it?  Because I am thorough and don’t want anyone to say they were “Unaware” that earnings were going to be lower than projected because GAAP treats stock compensation differently than cash models.

The bigger concern is the new GAAP on revenue recognition.  You remember, the one I have blogged about here recognizing that this particular headache was coming.  Well, this projection is impacted by it because, naturally, it is a software company that licenses its program on an annual subscription and offers free, unlimited tech support.  Love it.  Revenue recognition side?  Not so much.

I spent about 6 hours last night after the game (nice to see the Saint’s work hard to try and lose but they managed to survive until next week – not much hope there) updating my assumptions page and working through the model to address control and amortization of revenue.  No, I am still not done but I am getting closer.  What I can tell you is, I don’t like the results.

On a cash basis, this particular start-up should get to positive operating cash flow in about 14 months; right now it takes about 52 months to get to profitability under GAAP.  I am also seeing about $8,000,000 in deferred revenues.  That is, by the way, cash collected from customers that the company cannot claim as revenue.  Yes, it is software and there is no right to refund but still, under the control principles in new GAAP, the revenue is unearned.

How I get there is to make certain assumptions about purchasing patterns and I am making a rather aggressive assumption that most purchases will happen in the first part of the year.  It is more intuition at this stage but my research indicates that this is the likely time when this sort of software is installed – something about New Year resolutions.  So, this is only a few months of overall deferred revenues but it is enough to throw off accounting ROI.

Don’t get me wrong, I think the most important information comes from cash flow.  How quickly cash is burned through, minimum cash levels, marketing expenditures are absolutely essential to figuring out minimum equity positions, acceptable leverage, target interest rates; all that delightful CFO stuff that can make or break a project.   But still, I think that potential investors have a right to know everything about the project they are taking under consideration and GAAP is one of those things – because at the end of the day, if the goal is to go public, then GAAP is the beast to tame.

Like I said, I try to be thorough.

I will keep you updated, probably at the end of the week when I meet with the ownership to review what I have and start changing assumptions and figure out what to add.  They want to start pitching by the end of the month so I have my work cut out for me – because I am doing this on top of everything else I do!

If you are looking for an accountant who might be able to help you get to that next level, either by acting as your controller or CFO (or combination) feel free to contact me and lets schedule a time to talk.  I enjoy being of service to growing entities and risk-takers.ready for discussion

Have a great day.