Does Your CPA Really Know You? Ask Yourself 5 Questions

Date February 9, 2024
Article Authors

Each day I talk to business leaders about what they like best – and least – about their Certified Public Accountants (CPAs). The responses range from, “I won’t buy a mobile phone without checking with Mary,” to “Mark is okay, but he likes my rival football team and that’s unacceptable.”

Clearly, there are many factors that can solidify or dissolve a relationship with a trusted advisor such as your CPA. Some, while not preferred, are tolerable; others are absolute deal breakers. Still, the services of a CPA are crucial to the success of any company. That’s why you should ask yourself these five questions to determine if your CPA is meeting your needs, or it’s time to move on to someone else.

Does my CPA understand my business and industry?

As the business development manager of a “Top 50” accounting and wealth management firm, I hear the term “generalist” quite often. In the accounting world, the label applies to a professional with clients in multiple industries. Traditionally, a CPA’s role was to have a working knowledge of each of their clients’ industries. Today, top firms specialize in precise areas of focus to ensure they are experts in the tax laws that govern their clients’ industries. For example, if you own a construction company and the only construction company your CPA works with is your own, are you certain you are taking advantage of every potential tax benefit and functional process available to streamline and grow your operations?

Am I getting the value I deserve?

Value has different meanings for different people. Accounting value is leverageable by:

  • Knowing your CPA is always there when you have questions
  • Trusting your CPA is current with the ever-changing tax laws that govern business owners
  • Counting on your CPA to complete important tasks on time

Value is essentially whatever you perceive it to be. Knowing what is important to you and your business will help you identify problems when your expectations of value are not being met. Make sure you can define “value” when working with your CPA, who must be a trusted advisor to be effective.

Have I outgrown my CPA?

You likely have a good relationship with your CPA. He or she has been with you since the beginning, seen your kids grow up, been there through tough times and good. But does that alone ensure he or she is the best partner for your company today? Can he or she guide you through the complex scenarios your business faces? In many cases after a consultation with their CPA of so many years, a business owner realizes the CPA is not only overwhelmed by the company’s growth, but also ill-prepared to help the company capitalize on its success. This is a dangerous place for a business owner.

Am I receiving the level of service I have come to expect from my CPA?

Do you feel like every time you call, your CPA isn’t in, and it takes forever to get a return call? Are you only meeting with your CPA once a year to drop off your tax documents? Have you ever had to write an unexpectedly large check to the IRS without knowing in advance why you owed so much? Think about what services you believe are most valuable to you, then ask yourself, are you receiving the level of service that you expect from your current CPA?

Are accounting services the only services the firm offers?

In today’s world, accounting firms must take a holistic approach to providing added value and top-level financial services. Does Mike from XYZ Tax do your accounting, Mary from the bank your 401k, and Diane from ABC Investments a business succession plan? What if your business could work with one company in a single location for all that? When the left hand knows what the right hand is doing, you gain significant efficiencies. Can you afford to not have all of your trusted business advisors working together, sharing information, and strategizing about your best options?

Having a trusted advisor as your CPA is more than simply hiring someone who belongs to your club or likes the same sports teams you do. It’s about partnering with a reliable professional who is a specialist in your field of business and who will help guide you and your company to the next level of financial success and security.

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Role of a Nonprofit Board

Date November 23, 2020
Categories
Article Authors
Teal Strammer

Role of the Board, finance committee, and the audit committee

The Sarbanes-Oxley Act (“Act”) reshaped the landscape for board oversight of for-profit companies in the aftermath of the financial scandals that marred the early 2000’s. Though the Act does not directly affect not-for-profit organizations, the Act’s rules relating to board governance have impacted the roles of the board, the finance committee, and the audit committee of these organizations. These three bodies work together in tandem to provide oversight and guidance to their nonprofit organization.

Board of Directors

The board of directors has a fiduciary responsibility to the organization and is therefore obligated to act in the best interests of the organization. The board of directors is comprised of individuals who seek to further the organization’s mission in an oversight and advisory role. Although there is no limit on the number of individuals who can sit on an organization’s board of directors, an individual’s position on the board is limited, usually to a few years. A common practice is to have only a certain number of board members meeting their term limit in any given year so that the individuals who comprise the board do not change significantly on an annual basis. This governing body is distinctly different than the organization’s management, as the board focuses on the organization’s overarching mission, strategy, and long-term goals. In comparison, management carries out the goals set out and defined by the board of directors.

The Finance Committee

Depending on the size of the organization, the finance committee is sometimes combined with the audit committee. When operating separately from the audit committee, the responsibilities of the finance committee encompass all things relating to the financial health of the organization. First, the finance committee reviews the organization’s budgeted financial statements and seeks to understand the budget to actual variances throughout the year. Second, the finance committee counsels the board on any financial decisions for the organization. Examples include advising the board on the organization’s investment portfolio, recommending compensation for the organization’s management, and understanding the organization’s books so that they can ensure the financials are accurate and reflect the true activity of the organization for the year. Third, the finance committee is the committee that determines the policies and procedures that are reviewed by the audit committee. Examples of policies and procedures include their conflict of interest, document retention, whistle-blower, and other policies or procedures whose existence is reported for public disclosure on the annual Form 990. Additionally, this committee monitors the organization’s compliance with any laws and regulations and is responsible for reporting any deficiencies to the board at large.

The Audit Committee

The audit committee works with management to review all forms of the organization’s financial statements and annual tax filings in order to obtain an understanding of such documents. The audit committee disseminates the relevant information through the proper channels and to the appropriate people both at the organization and with the independent auditor. The audit committee directly engages an independent auditor and monitors the audit process. Upon completion of the audit, members of the audit team, usually the engagement principal and a lead member of the team, present a draft of the audited financial statements to the audit committee. It is the responsibility of the audit committee to review and understand the audited financial statements, and once they are satisfied with the draft audited financial statements, will recommend approval to the board. Another main role of this committee is to supervise the organization’s internal controls for financial statement reporting. The audit committee is also actively involved in assuring that management is compliant with the organization’s policies and procedures and takes an active role in reviewing those policies, examples of which include whistle-blower policies, anti-fraud policies, and other various policies that serve to guide the organization in the event of a discovery of errors or illegal acts. As a result, the audit committee is a key participant in any resulting investigations or legal proceedings brought against the organization.

The board, the finance committee, and the audit committee allow an organization to be more accountable and transparent and help the organization be successful when working towards its mission. Even though not all organizations are large enough to have all three bodies, all organizations should have a board of directors that acts in all capacities and that is separate from management. The board should have a top-level focus while the management implements the daily operations to achieve the overarching goal set by the board. For additional information or questions please contact your HBK advisor.

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Nonprofit Audits Made Easy, Or Easier

Date February 25, 2020

Whether this is your first nonprofit accounting audit, and you have no clue what to expect or you’ve been involved in the process for years, there are always ways to make it more efficient.

Rule #1 – Plan ahead.
When should you start planning for your annual audit? The answer is really, as soon as last year’s audit is done. So, you’re a bit behind already, right? Let’s get started. First, who should be involved?

Typically, the Board of Directors or the Audit Committee starts the process by hiring the independent auditor and executing an audit engagement letter. Other services, such as tax preparation may also be included in the audit engagement letter. The Board may choose to meet with the auditor before the audit fieldwork to establish a relationship, open the communication process, and set the tone for the relationship with the audit firm. Communicate all internal and external deadlines with the auditor. When is the audit draft to be presented, when is the final audit due? Will the audit be needed for grant or lending deadlines? If the auditor will also be preparing tax and compliance filings, know those deadlines and the expectations of meeting those or if extensions will be requested.

Once contracted, the accounting/finance director usually meets with the auditor and determines exactly what they expect and when and how information should be communicated. Typically, a “Document Request” list is provided well in advance of audit fieldwork. Most auditors now work with electronic documents and have a secure portal system to transfer audit information. If you are still a “paper only” shop, let the auditor know this as well. Ask who will be on the audit and tax teams for the engagement, so you know the new team members who may be asking for information.

The “auditee”, i.e. YOU, should determine who will most likely be involved in the audit process. No, it’s not just the accounting/finance staff. Besides the Board or its Audit Committee, the CEO, COO, program directors, development staff and all accounting/finance staff will most likely participate in the audit process. Each of these parties needs to know the timing of the audit and what is expected of them.

Certain professionals will also be contacted such as your banker, investment manager, attorney, payroll service, billing service and insurance agent. You may want to let them know your audit is beginning and identify the firm that may contact them regarding the audit.

Rule #2 – Be ready.
Try to provide all requested documents on the auditor’s timeline. It will allow the auditor to plan and document preliminary procedures for your engagement. Be honest, if you cannot make a deadline, communicate with the auditor. NEVER allow the fieldwork to begin if you are not completely ready but know that audit teams are scheduled months in advance, so rescheduling may be difficult.

If possible, make a private space available for the audit team to work. They will need workspace and WIFI access if available. Let them know the logistics of your organization. What are the working hours? Do they have to deal with security? Is parking available? How should the audit team reach other staff members they might need to question? How would you like to handle audit questions, email or come on in and chat?

Try to respond to inquiries and additional document requests as soon as possible. If you have any difficulties with any of the audit team members, discuss your issues with the team manager or partner, immediately. Once the fieldwork is done, obtain a list of “open items” needed to complete the engagement and reiterate expected timelines. Depending on the progress of the engagement, the auditor may be in the position to give you proposed adjustments for your books and records and a preliminary final accounting. Respond to the open items and last inquiries as soon as you can. The ability to meet deadlines is resting with you at this point. At this point, the Audit Committee may request a “check-in” with the auditor.

Management should be allowed to review audit adjustments, and findings and present additional information if needed. Management should also review a draft of all reports, tax returns and communications to be presented to the Audit Committee and Board. By this time, there should be no “surprises” for anyone involved in the process. Good communication is key throughout the audit.

Invite the auditor to make their presentations to the Committee or Board in person. This will allow the Committee and Board is further their relationship with the auditor and potentially ask private questions. Board members will appreciate the audit presentation, particularly if they are new to the board.

Once the audit and tax returns are approved and finalized, debrief with the auditor. Make sure your books and records agree to the final audit. Ask: What when right this year? What can we do better this year?

Rule #3 – Stay in touch.
Make the auditor a trusted advisor. They want to hear from you throughout the year, particularly if you are involved in anything with an audit or tax significance, such as:

  • Starting or closing a program or service
  • Obtaining a new grant or large new contract
  • Starting a new fundraising appeal
  • Entering into new debt, or long-term leases
  • Converting to new software
  • Changes in key personnel
  • Unusual transactions
  • Pending litigation
  • Fraud or theft

It’s always better to solicit advice on handling these items as soon as possible so the impact on the audit is managed properly.

Rule #4 – Celebrate completing the audit.
Close the year and treat yourself and your team members. You’ll need them again next year.

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Are You Thinking About Selling Your Business?

Date June 8, 2018
Article Authors

An Open Letter to Business Owners:

Are you thinking about selling your business? Regardless of your reasons or circumstance, my first question as a professional advisor looking to help you would be, “Why do you think you are ready to sell now?” Your answer to that one question will likely give me the information I need to provide a helpful response.

Here are a few answers I’ve heard over the years of working with clients getting ready to sell their businesses:

• I was approached by a competitor who offered me a lot of money.

• I was approached by a private equity group who said they buy businesses like mine.

• My industry is changing and I don’t think I want to spend the time and money to keep up.

• My spouse has decided it is time for us to retire and start doing some things we have put off for years.

• My spouse has become ill and I need to be around to help.

• My children have no interest in taking over the business.

• I thought I’d shut the doors and sell off the assets, but figured I would see if anyone would buy it first.

• I want to use the proceeds from the sale of this business to start another business I am more passionate about.

• I just think now is the right timing for us to get a great price.

• There’s so much more that can be done with this business to benefit our clients, employees and community, but we just don’t want to risk our capital to expand at this stage of our lives.

These are just some of the answers I’ve heard, and they all provide important information, the exact reason or reasons why someone believes they are ready to sell. The sale of a business is one of the most significant transactions I can be involved in as an adviser looking to help you navigate this challenging transaction.

So what critical information will I get from your answer? Your timeline is one very important piece. Are you already talking with a potential buyer, investment banker or business broker? Or perhaps at the beginning of a two-to-three year exit plan? Regardless of where you are in the process, one of the best things I can do for you is let you know that HBK Corporate Finance will provide a no-obligation analysis of your business and talk with you about how to prepare, market, present and sell your business in a manner that keeps you in the driver’s seat.

Most of the time business owners feel they have very few, if any, people they can talk to about selling a business. In nearly every case they do not want their competitors, their customers, their employees or their community – and in some cases, even family members – to know of their plans. On top of all the financial considerations, selling a business can be emotional. Having someone to talk to about what to expect and how to lay out and implement a thoughtful plan can provide you with much-needed peace of mind.

Feel free to call me at 239-482-5522 or reach out to me at kveres@hbkswealth.com

Investment advisory services are offered through HBK Sorce Advisory LLC, doing business as HBKS Wealth Advisors. NOT FDIC INSURED – NOT BANK GUARANTEED – MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPAL – NOT INSURED BY ANY STATE OR FEDERAL AGENCY

HBKS® Wealth Advisors, is an affiliate of HBK CPAs & Consultants, and does not provide investment banking services. If investment banking services are needed, they will be provided through a third-party registered broker dealer properly licensed to provide such services.

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Business Interest Deduction Limitation

Date May 31, 2018
Article Authors
HBK CPAs & Consultants

Overview

The Tax Cuts and Jobs Act (the Act) created a new Business Interest Deduction limitation, effective for tax years starting after December 31, 2017. This new provision limits the deduction for business interest for all businesses, though an exception to the limitation applies for businesses who meet the gross receipts test, discussed below.

What is the Business Interest Deduction?

Businesses are allowed to deduct any interest paid or accrued on debt that is properly allocable to a trade or business, and is not considered investment income. Historically, this interest deduction has not been subject to many limitations.

Scope: Then and Now

Internal Revenue Code (IRC) Section 163(j) is the code section that provides for a limitation on the deduction for business interest. Prior to the Act, this provision had a limited application and only applied to U.S. corporations or U.S. branches of foreign corporations to prevent businesses from stripping earnings and avoiding U.S. taxation. The Act changed this code section to apply to all taxpayers and all debt, even if the debt arises from a related-party transaction.

The Limitation

The deduction is limited to the sum of business interest income, 30 percent of adjusted taxable income (ATI), and floor plan financing interest. ATI is generally taxable income, computed without regard to:

  • activity that is not allocable to the trade or business;
  • business interest expense or business interest income;
  • depreciation, amortization, or depletion (for tax years beginning before January 1, 2022);
  • net operating losses under Section 172; or
  • the new 20% qualified business income deduction under Section 199A.

Floor plan financing interest is generally defined as interest paid or accrued on debt used to finance the acquisition of motor vehicles held for sale or lease, and which is secured by the inventory acquired.

If the limitation applies, the disallowed business interest will carry forward to the succeeding taxable year.

Gross Receipts Test Exemption – Small Businesses

There is an exemption from the limitation for small businesses with average annual gross receipts for the three taxable years ending prior to the taxable year at hand that is less than $25,000,000. However, taxpayers in controlled groups and partnerships may be required to aggregate gross receipts, so this should be considered when calculating whether or not the limitation should apply.

Carve Outs

Farming, real estate businesses, dealerships and certain public utility businesses successfully lobbied to avoid the application of this limitation. For dealerships, floor plan financing is fully deductible without limitation. However, these dealerships are excluded from 100% bonus depreciation on any of their assets.

Farming and real estate businesses may elect out of the new 30% limitation, but they will be required to use the Alternative Depreciation System (“ADS”) to depreciate their depreciable assets. Businesses using ADS are not eligible for 100% bonus depreciation. If the election is made, it is irrevocable, and ADS treatment will apply to all depreciable assets that are already owned or will be purchased in the future.

Real Property Business – Election Comparison

   Application of Interest Limitation Election Out of Interest Limitation
Asset Category Depreciable Life (years) Eligible for Bonus Depreciable Life Eligible for Bonus
Nonresidential Real Property 39 NO 40 NO
Residential Rental Property 27.5 NO 30 NO
Qualified Improvement
Property – under current law
39 50%
168(k)(2)(A)(iv)
40 NO
Qualified Improvement
Property – if corrected
15 YES 20 NO

So, How does it Work?

Let’s use a hypothetical company, ABC Corporation, and assume it exceeds the small business exemption. ABC Corporation is in the business of residential rental property and, for illustration purposes, will not elect out of the business interest limitation. For the taxable year, ABC Corporation has the following income statement:

Application of Interest Limitation
Gross receipts 100,000,000
Interest income 1,000,000
Cost of goods sold 0
Interest expense -50,000,000
Amortization -500,000
Depreciation -25,000,000
Taxable income before interest limitation 25,500,000
 
Adjusted Taxable Income
Taxable income before interest limitation 25,500,000
Add back: net interest expense 49,000,000
Add back: Amortization 500,000
Add back: Depreciation 25,000,000
Adjusted taxable income 100,000,000
 
Business Interest Deduction Limitation
Adjusted taxable income 100,000,000
Multiply by 30% x 30%
Business interest deduction limitation 30,000,000
 
Taxable Income AFTER Interest Limitation
Gross receipts 100,000,000
Interest income 1,000,000
Cost of goods sold 0
Interest expense -30,000,000
Amortization -500,000
Depreciation -25,000,000
Taxable income before interest limitation 45,500,000

ABC Corporation can only deduct $30,000,000 of its $49,000,000 of net interest expense. The remaining $19,000,000 of disallowed interest expense will carry forward until used in a future year. The $19,000,000 disallowance is calculated as follows:

Disallowed Deduction Carried Forward
Net Interest Expense -49,000,000
Business Interest Deduction Limitation 30,000,000
Disallowed Deduction -19,000,000

$50,000,000 interest expense – $1,000,000 interest income = $49,000,000 net interest expense

$49,000,000 net interest expense – $30,000,000 interest expense limitation = $19,000,000 disallowance

ABC Corporation will have taxable income of $45,500,000 if they do not elect out, but will have taxable income of $25,500,000 if they do elect out. Therefore, the election out is most beneficial in the current year where there is high business interest expense. However, electing out will likely decrease the depreciation deduction for the current year and future years, thus slightly increasing taxable income. The decision of whether or not an election out should be made should therefore take into account the impact on current and future depreciation.

Effect of Depreciation, Amortization, and Depletion on ATI and the Deduction

The larger the ATI, the larger the deduction. Starting in 2022, ATI will be reduced by depreciation, amortization, and depletion. Therefore, the deduction will likely decrease for many businesses at that point. Looking at our example above, if depreciation and amortization were included in the calculation of ATI, ABC corporation would have $52,150,000 of taxable income. The following shows this calculation:

ABC Corporation YR 2022 Interest Limitation & Taxable Income
ATI $74,500,000.00
2022 Limitation $22,350,000.00
Taxable Income $52,150,000.00

ATI would be $74,500,000 because depreciation and amortization amount are not added back. ATI of $74,500,000 is then multiplied by 30%, which results in a limitation for business interest in the amount of $22,350,000. Taxable income ($74,500,000) is then reduced by the limitation amount ($22,350,000) to equal $52,150,000 of taxable income.

Conclusion

The new business interest expense limitation can be complicated, depending on the type of business and the business’s average gross receipts. For businesses that qualify to elect out of the limitation, it is important to compare the effects of the deduction limitation and the depreciation adjustments on overall taxable income for the current and future years. For businesses that will be subject to the limitation, planning should focus on the method of providing future financing since the limitation may restrict cash flow.

Please consult your tax advisor or a member of the HBK Tax Advisory Group to determine whether or not this limitation applies to your business.

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IRS Plans More Audits of Wealthy Taxpayers

Date March 15, 2017
Categories
Article Authors

Over the last five years, the number of IRS examinations of individual income tax returns has declined across all income levels. This is due in large part to the IRS having suffered from budget cuts. The chart below shows the percentage of tax returns audited from 2011 to 2015.

Income Level
Year All Individuals Under $200,000 Above $200,000 Above 1,000,000
2015 0.84% 0.76% 2.61% 9.55%
2014 0.86% 0.78% 2.71% 7.50%
2013 0.96% 0.68% 3.26% 10.85%
2012 1.03% 0.94% 3.70% 12.14%
2011 1.11% 1.02% 3.93% 12.48%

Most IRS examinations of tax returns are correspondence audits rather than face-to-face audits. The IRS matches income amounts, which includes information reported by payers of income, to the amounts reported on personal income tax returns and sends notices with proposed adjustments to the tax bill if the amounts do not match up. Information reported to the IRS by payers of income includes wages, interest, dividends, stock sales, and real estate sales proceeds, among other sources of income. It’s important to point out that the IRS is not always correct, so those who receive a notice from the IRS on a proposed tax increase should never automatically agree.

In addition to examinations that result from income matching, the IRS has a secret scoring system it uses to identify tax returns to audit, called the Discriminant Inventory Function (DIF) system. The higher the DIF score, the more likely a tax return will be audited. DIF scoring rates certain items in a tax return higher, such as home office deductions and hobby losses. The IRS also measures average deductions for each income level and uses that information in their DIF scoring. Data gathered from related party tax returns that were subject to examination is also used to determine if a tax return should be audited.

The IRS is planning to increase its auditing efforts, especially for higher income taxpayers. IRS has not tipped its hand on what they will specifically be looking for, but we expect the list to at the very least include the following:

  • Large charitable deductions. There are specific documentation requirements for deducting charitable contributions, especially for noncash donations.
  • Claiming losses on business ventures. Investors must pass several tests in order to be allowed to deduct a loss from a business venture. Some activities may not rise to the level of a business, such as raising horses, racing cars and farming, which may be characterized as hobby losses.
  • Energy credits. There have been several tax incentives allowed for alternate energy sources, which have specific requirements.
  • Offshore assets and banking. There are significant penalties for failing to report offshore financial assets. This has been a focus of the IRS for several years now.
  • Micro-Captive insurance companies. The tax law allows taxpayers to form their own insurance companies to manage their risks. The IRS has identified specific profiles of abusive captives and now requires additional information reporting for these companies.
  • Related party transactions. Transactions between related family members, owners and their companies are subject to certain limitations and reasonableness.

I always harken back to the quotes of the famous Tax Court Judge Learned Hand (yes that is his real name). He said:

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.”

The tax law allows many advantageous tax planning strategies. The IRS should not undo or challenge a tax strategy simply because it results in a lower tax liability. At the same time, we have a responsibility to comply with the tax laws and maintain the required documentation to support our tax filings. We can help you be prepared to manage and plan to take full advantage of tax planning opportunities the law allows. We will also have your back should the IRS comes calling. After all, it is your money.

This is an HBK Tax Advisory Group publication.

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Colorado Sales Tax Statute Has Far-Reaching Implications for Retailers Everywhere

Date December 13, 2016

States continue to struggle to pay for their institutions and programs. They are looking for ways to generate more revenue. And they are getting increasingly aggressive in their efforts.

Recently Ohio decided that a business didn’t have to have an in-state location to owe a “commercial activity tax” if it sold its products to customers in the Buckeye State. Now Colorado wants to collect sales tax on purchases its citizens make from out-of-state businesses. The Centennial State has passed and enacted a law that requires all companies making sales to consumers and businesses in Colorado to report the sales and related taxes to both the customers and Colorado. Amazon and other online retailers challenged the law, but on Monday December 12, 2016 the U.S. Supreme Court declined to hear the case, in effect, allowing the statute to stand.

That customers buying goods from businesses in other states owe sales taxes to those states is not new. But most customers making purchases online ignore the rule. Colorado’s statute is indicative of how states are now expending significant effort to collect these taxes. At least three other states – Louisiana, Oklahoma and Vermont – have passed similar laws that could take effect in the wake of Colorado’s action.

A 1992 Supreme Court decision states that a business must have a physical presence – the term is broadly defined – in a state to be required to collect and remit sales taxes. Colorado’s law does not contradict the Court; it doesn’t require the business to collect the tax, only to report the sale and related tax.

Most retailers are aware that customers buying goods from out of state owe sales taxes on those purchases to those states. Many retailers have received surprise audits from other states, some resulting in six-figure sales tax assessments on cross-border transactions. In requiring retailers to notify customers to pay sales tax and to report purchases to the state, Colorado might have found an easier way to track and eventually collect those taxes.

The Supreme Court’s refusal to hear Amazon’s challenge could have far-reaching implications for retailers serving out-of-state customers. Other states are certain to follow, interpreting the Court’s decision as an endorsement of the law and enacting similar statutes in effort to collect additional tax revenue. While it is likely that other challenges to such statutes will be launched on the basis that compliance by out-of-state retailers is an excessive burden to their businesses, retailers must comply with Colorado’s statute.

Further, retailers need to be prepared for what could be an onslaught of such state statutes. We advise dealers to put in place a system to (1) track purchases from out-of-state customers, (2) notify these customers of the sales tax amounts and their obligation to remit the taxes to their home states, and (3) report out-of-state sales to the designated state tax agencies.

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ObamaCare Being Funded Through a Tax on Dealers…Maybe

Date November 18, 2016
Categories

With the enactment of the Patient Protection and Affordable Care Act of 2010 (PPACA), also known as ObamaCare or the Affordable Care Act, many dealers may have been erroneously snared by a new tax.

This new tax, the Net Investment Income Tax, imposes a flat 3.8% tax on net investment income (NII) and was intended to impact higher income individuals as well as certain trusts and estates with income from passive investments (e.g., interest, dividends, capital gains, etc.). For more information, click the appropriate link below:

Automobile Dealerships

Equipment Dealerships

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Significant Changes to the Used Car Rule Made on November 11, 2016

Date November 14, 2016
Categories

The FTC has amended the Used Car Rule which deals with the use of Buyers Guides.  These changes are significant and dealers should take care to comply or risk significant fines.  The Used Car Rule, as revised, still requires the dealer to display a Buyers Guide in the window of all used vehicles; however, significant changes which are effective January 27, 2017 have been made to the language/disclosures that are required to be made on the Buyers Guide.

The new rules modify the description of an “As-Is” sale and add boxes to the front of the Buyers Guide for the dealer to check to indicate the status of any manufacturer or third-party warranty and the availability of a service contract.

Additionally, catalytic converters and air bags have been added to the list of potential major defects.  Further, statements are to be included in the Buyers Guide that inform the customer to obtain a vehicle history report, that direct the customer to check for open recalls and that advise the customer to ask for a Spanish-language version of the Buyers Guide (This statement is included in Spanish on the English-language version of the guide.)

Dealers are allowed to use their unused stock of Buyers Guides (for up to one-year from the effective date) but should use Buyers Guides that comply with the new rules once that supply is depleted.

Dealers can get more information from the FTC’s “Dealer’s Guide to the Used Car Rule,” which is available at www.ftc.gov/tips-advice/business-center/guidance/dealers-guide-used-car-rule.  Further, “Fillable” versions of the Buyers Guide in English and Spanish are also available at FTC.gov.

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Dealership Benefits from Use of Related Finance Companies

Date October 27, 2016
Categories

Many dealers are finding that the buy-here, pay-here (BHPH) business is extremely lucrative.  Along with running a profitable BHPH operation dealers should be aware of some significant tax planning opportunities with regards to establishing a related finance company to carry the paper. In order to ensure that you can utilize these opportunities, we would like to highlight here some of the potential pitfalls.

OVERVIEW

The use of related finance companies (RFC) is a common practice in the retail automotive industry.  Such companies serve many valid business purposes and were utilized before any tax advantage scheme was offered.  However, some RFC’s are being utilized by used and new car dealers to reduce or defer the reporting of income.  This section of this article is to be used as an overview of RFC’s.  In it will be found reasons for establishing RFC’s, and issues faced in an IRS examination of an RFC issue.

There are three issues that exist in dealing with RFC’s.  The first involves the economic reasons for the arrangement, the second involves the validity (form) of the RFC itself, and the third and most critical issue involves the economic substance of the discounting transactions.

ECONOMIC REASONS

There are several reasons for creating and using an RFC.  The following are some of the major reasons that an RFC is created.  Each of these reasons can provide a significant and valid business and economic reason for creating a separate entity to finance the dealer’s receivables, even if no third party receivables are acquired.  There are others that are equally valid and legitimate reasons for using an RFC.

  1. Providing credit to enable the purchaser to buy a car.

Many, if not most, of the purchasers that utilize the services of an RFC do so because of an inability to get credit elsewhere.  In this way, the RFC serves a useful purpose in providing credit to individuals with little, no, or bad credit.  A properly operating RFC also focuses the collection function outside of the dealership itself, which relieves the sales personnel from a task that is time consuming since payment schedules are on a weekly or monthly basis.

  1. Improving the collection of accounts receivable.

An RFC can significantly enhance the collection of accounts receivable by requiring the borrower/buyer to remit payments to a third party, even though the third party is related to the dealer.  It has been the industry’s experience that when payment is made directly to the dealer, a bad experience with the car often leads to a default on the note for the car.  This, in turn, creates a collection problem, and possibly a publicity problem for the dealership.  On the other hand, if an RFC is involved, experience shows that the customer is less likely to default on the payment.  Given the general credit worthiness of the customers, this is a significant advantage.  Some dealers, through effective management and controls, have RFC discount rates lower than what they can obtain from third parties and still make a profit on their RFC financing operations.

  1. Avoiding licensing and other regulatory requirements on the dealer entity.

Many states have licensing requirements for finance companies.  Establishing an RFC permits the dealer to isolate liability for violation of any requirements in a separate entity, without jeopardizing the status of the dealership.  In addition, some states have capital requirements for finance companies that may interfere with the normal operations of a dealership.

  1. Preventing adverse publicity on repossessions and other collection actions from affecting the dealership.

Repossession and collection problems are a daily fact of life for buy here/pay here dealers.  Creation of an RFC permits a new entity to undertake these actions, thereby insulating the dealer from any adverse publicity.  Even in states where disclosure of the relationship is required, the resulting publicity is usually less adverse when an RFC is used.

  1. Insulating the dealership from the financial risk of default on the notes.

The industry often deals with a customer base that generally has poor or non-existent credit.  The default rate on buy here/pay here notes is substantially higher than on general bank loans.  This economic fact is recognized both by the interest rates charged by the dealer or finance company and the reserves that independent finance companies generally maintain.  A separate RFC removes the financial risk from the dealership entity.

  1. Diversification of ownership.

Since the financing of used cars is not inherently a part of a dealership, an RFC permits the dealer to provide ownership in that specific business to both family and non-family members without diluting ownership in the dealership.  This allows the dealer to separate the two businesses and reward certain employees or other individuals with an ownership interest in a segment of the business.

A final advantage is that an RFC can be expanded, depending upon the dealer’s desire, to finance unrelated receivables as well as those of a particular dealership.  It should be pointed out that although this is possible, it rarely happens.

VALIDITY OR FORM OF RFC

The second issue that should be considered, the form issue, is how a valid RFC is structured and operated.  Since the purpose of the RFC is to isolate liability or segregate transactions in a separate entity, the RFC should meet several criteria to be treated as a separate, valid business.  These criteria are:

  1. The RFC should be a separate, legal entity.
  2. The RFC should meet all licensing requirements of the jurisdictions in which it operates.
  3. A major factor is that the RFC should be adequately capitalized in order to pay for the contracts.
  4.   The RFC should have its own employees and compensate them directly.  However, the fact that the RFC and the dealership or other related entities may elect to use a common paymaster does not indicate, in any way, that the RFC does not have its own employees.
  5. The RFC should obtain and maintain all appropriate local business and similar licenses.
  6. The RFC should have a separate telephone number.
  7. The RFC should have a separate business address, which may be a post office box.  Even if a separate business address is maintained, it is common for the RFC to have an office at the dealership.
  8. The RFC should maintain a separate set of books and records.
  9. The RFC should comply with all title, lien, and recordation rules in the jurisdictions in which it operates.
  10. The RFC should notify customers of the purchase of their notes.
  11. The RFC and the dealership should have a purchase contract for the receivables that both complies with the appropriate state law and provides evidence of how the FMV of the receivables was determined.
  12. The RFC should pay the dealer for the receivables at the time of purchase.  The RFC can generate the cash to make the payment from any combination of capitalization of the RFC, bank or third party borrowings, or borrowings from related entities or shareholders. Borrowings from related entities or shareholders could diminish the validity of this factor.
  13. The RFC should be operated in a business-like manner.

Clearly, to the extent that these attributes are absent, a serious question as to the substance of the RFC exists.

ECONOMIC SUBSTANCE

The third and most important issue that should be addressed is the sale of discounted receivables at fair market value (FMV).  Sales of receivables must have economic substance to qualify for tax purposes; valid business reasons alone will not suffice.

The FMV of a receivable or group of receivables will depend on a number of factors, the facts and circumstances of each receivable determining the importance of each factor.  Purchasing receivables is not an exact science, and many subjective factors enter into the determination of value.  The industry’s position is that a deep discount is warranted in nearly all transfers of receivables.  The factors that directly influence the amount of discount include:

  1. Absence of or poor credit history.
  2. History of payments on the note.
  3. Amount of time left on the note.
  4. The age of the vehicle.

Reviews of some third-party finance company documents indicate that these companies can offer to acquire the receivables from dealers at up to a 50 percent up-front discount.  These discounts apply whether or not the finance company buys in bulk or “cherry picks” the best accounts.

A dealer can use an RFC to discount its receivables and have it accepted for tax purposes.  To summarize the above discussion, the following three factors need to be addressed:

  1. The discounting transactions must have economic substance.  All of the relevant facts and circumstances must be considered.  Remember that the primary reasons for selling receivables are to obtain cash (improve cash flow) or to shift risk.  If both of these are missing, it is a good indication that the sales transaction lacks economic substance.
  2. The form of the transactions and the form of the RFC must be perfected.
  3. The receivables must be sold for fair market value.  The seller and purchaser must base the discount on some reasonable factors, not on an arbitrary determination of the discount rate.

The benefits to a related finance company are tremendous; but, as you can see, many potential pitfalls abound.  Accordingly, you will want to consult with an advisor who is fully aware of the BHPH business and how to properly structure and utilize RFC’s. That’s why HBK is here, to answer your questions on this and related tax matters.

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