The CPA Desk

A Thought Leader Production by PKFTexas

How Your Not-for-Profit’s Internal and Year-End Financial Statements Can Differ

Do you prepare internal financial statements for your board of directors on a monthly, quarterly or other periodic basis? Later, at year end, do your auditors always propose adjustments? What’s going on? Most likely, the differences are due to cash basis vs. accrual basis financial statements, as well as reasonable estimates proposed by your auditors during the year-end audit.

Simplicity of Cash
Under cash basis accounting, you recognize income when you receive payments and you recognize expenses when you pay them. The cash “ins” and “outs” are totaled by your accounting software to produce the internal financial statements and trial balance you use to prepare periodic statements. Cash basis financial statements are useful because they’re quick and easy to prepare and they can alert you to any immediate cash flow problems.

The simplicity of this accounting method comes at a price, however: Accounts receivable (income you’re owed but haven’t yet received, such as pledges) and accounts payable and accrued expenses (expenses you’ve incurred but haven’t yet paid) don’t exist.

Value of Accruals
With accrual accounting, accounts receivable, accounts payable and other accrued expenses are recognized, allowing your financial statements to be a truer picture of your organization at any point in time. If a donor pledges money to you this fiscal year, you recognize it when it is pledged rather than waiting until you receive the money.

Generally Accepted Accounting Principles (GAAP) require the use of accrual accounting and recognition of contributions as income when promised. Often, year-end audited financial statements are prepared on the GAAP basis.

Need for Estimates
Internal and year-end statements also may differ because your auditors proposed adjusting certain entries for reasonable estimates. This could include a reserve for accounts receivable that may be ultimately uncollectible.

Another common estimate is for litigation settlement. Your organization may be the party or counterparty to a lawsuit for which there is a reasonable estimate of the amount to be received or paid.

Minimizing Differences
Ultimately, you want to try to minimize the differences between internal and year-end audited financial statements, which can be helped by, for example, maximizing your accounting software’s capabilities and improving the accuracy of estimates.

What Are the Tax Consequences of Making Gifts to Loved Ones?

Many people choose to pass assets to the next generation during life, whether to reduce the size of their taxable estate, to help out family members or simply to see their loved ones enjoy the gifts. If you’re considering lifetime gifts, be aware that which assets you give can produce substantially different tax consequences.

Multiple Types of Taxes
Federal gift and estate taxes generally apply at a rate of 40% to transfers in excess of your available gift and estate tax exemption. Under the Tax Cuts and Jobs Act, the exemption has approximately doubled through 2025. For 2018, it’s $11.18 million (twice that for married couples with proper estate planning strategies in place).

Even if your estate isn’t large enough for gift and estate taxes to currently be a concern, there are income tax consequences to consider. Plus, the gift and estate tax exemption is scheduled to drop back to an inflation-adjusted $5 million in 2026.

Minimizing Estate Tax
If your estate is large enough that estate tax is a concern, consider gifting property with the greatest future appreciation potential. You’ll remove that future appreciation from your taxable estate.

If estate tax isn’t a concern, your family may be better off tax-wise if you hold on to the property and let it appreciate in your hands. At your death, the property’s value for income tax purposes will be “stepped up” to fair market value. This means that, if your heirs sell the property, they won’t have to pay any income tax on the appreciation that occurred during your life.

Even if estate tax is a concern, you should compare the potential estate tax savings from gifting the property now to the potential income tax savings for your heirs if you hold on to the property.

Minimizing Your Beneficiary’s Income Tax
You can save income tax for your heirs by gifting property that hasn’t appreciated significantly while you’ve owned it. The beneficiary can sell the property at a minimal income tax cost.

On the other hand, hold on to property that has already appreciated significantly so that your heirs can enjoy the step-up in basis at your death. If they sell the property shortly after your death, before it’s had time to appreciate much more, they’ll owe no or minimal income tax on the sale.

Minimizing Your Own Income Tax
Don’t gift property that’s declined in value. A better option is generally to sell the property so you can take the tax loss. You can then gift the sale proceeds.

Capital losses can offset capital gains, and up to $3,000 of losses can offset other types of income, such as from salary, bonuses or retirement plan distributions. Excess losses can be carried forward until death.

Choose Gifts Wisely
No matter your current net worth, it’s important to choose gifts wisely and understand each of their tax consequences.

What Tax Payers Need to Know About International Tax Reform

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with Frank Landreneau, one of our international tax directors. Frank, welcome back to the Playbook.

Frank: Well, thanks for having me back.

Jen: So, we’ve been covering international tax reform. What else do people need to know? What haven’t we covered yet?

Frank: I think other than the Toll Tax, which is getting more immediate attention because of the timing of it, there’s also other aspects of international tax reform that tax payers need to be aware of.

For example, that there’s disparate treatment between individuals and corporate tax payers when it comes to certain provisions, such as GILTI, and we’ve talked about FDII in previous segments – the Foreign Derived Intangible Income. And so, with respect to GILTI, for example, the top individual rate is 37%, and if there’s any amount to be included from a foreign corporation that’s taxed immediately as GILTI, that’s also taxed at 37%. However, for corporate tax payers any income inclusions from GILTI is taxed at 10.5%. That’s quite a rate differential between the two.

Jen: Wow, that’s huge. I know we’ve also talked about middle market entrepreneurs. Should they stop doing business as flow-through entities? We’ve talked about that in several different videos.

Frank: That’s a great question. In fact, that’s a big question that you see the international tax community or the tax community as a whole should ask, “Is this the death of limited liability companies?” And I think the answer is, I think, companies need to really start to think about where do they want their cash; do they want it back home? Do they want to keep it offshore? Where do they need it for their operational needs?

Once you determine that then you can kind of say then maybe we can do some things like some structuring options, like doing business as a C corporation for international operations, but not for your domestic operations. I think we talked a little bit about that in previous segments. That way you can minimize the GILTI tax and also take advantage of the special 13.125% of FDII. So, those are the kinds of things tax payers need to be aware of.

Jen: Okay. Now is there an advantage though to still being an LLC at all?

Frank: There is. For domestic business the tax law does provide for LLCs – taxes, partnerships – this 20% deduction, which kind of gets individual tax payers closer to a corporate tax rate – not entirely. And then, of course, passers still avoid double taxation once the funds are admitted to the ultimate owners. So, I wouldn’t give up on your LLC yet, just examine what operations are done under the LLC and what might need to be done in another way.

Jen: Sounds good. Well, we’ll get you back to talk a little bit more about that.

Frank: Thank you. Appreciate it.

Jen: Perfect. To learn more about other international topics, visit PKFTexas.com/internationaldesk. This has been another Thought Leader production brought to you by PKF Texas The Entrepreneur’s Playbook. Tune in next week for another chapter.

The Best-Suited Charity Vehicle for Family Philanthropy – What to Consider

The Houston Business Journal published an article on their website co-authored by PKF Texas Tax Practice Leader and Director, J. Del Walker, CPA, and Tax Manager, Annjeanette Yglesias, CPA. The article discusses the differences between a private foundation (PF) and the donor advised fund (DAF), which impact family philanthropy efforts.

So, what are the differences? Walker and Yglesias primarily define the two terms:

“A private foundation is an IRC Section 501(c)(3) organization that has one primary source of funds, typically either from an individual/ family but may also be a business. This discussion focuses on private non-operating foundations, otherwise known as grant-making foundations.

A donor advised fund (DAF) is a separately identified fund or account that is maintained and operated by an IRC Section 501(c)(3) organization (public charity). Once the donor contributes to the DAF, the managing organization legally controls the funds going forward. The donor only maintains advisory privileges with respect to amount and recipient of distributed funds.”

The co-authors then present various things to consider when deciding which is better suited for donors and philanthropic goals:

  • Formation,
  • Administrative considerations,
  • Tax implications to donors
  • and more.

For the full article, visit www.bizjournals.com/houston/news/2018/10/09/family-philanthropy-tips-on-private-foundation-vs.html

To learn more information, contact J. Del Walker (dwalker@pkftexas.com) or Annjeanette Yglesias (ayglesias@pkftexas.com).

Tips on Valuing Donated Property

Not-for-profits often struggle with valuing noncash and in-kind donations. Whether for record-keeping purposes or when helping donors understand proper valuation for their charitable tax deductions, the task isn’t easy. Although the amount that a donor can deduct generally is based on the donation’s fair market value (FMV), there’s no single formula for calculating it.

FMV Basics
FMV is often defined as the price that property would sell for on the open market. For example, if a donor contributes used clothes, the FMV would be the price that typical buyers pay for clothes of the same age, condition, style and use. If the property is subject to any type of restriction on use, the FMV must reflect it. So, if a donor stipulates that a painting must be displayed, not sold, that restriction affects its value.

According to the IRS, there are three particularly relevant FMV factors:

  1. Cost or selling price. This is the cost of the item to the donor or the actual selling price received by your organization. However, note that, because market conditions can change, the cost or price becomes less important the further in time the purchase or sale was from the contribution date.
  2. Comparable sales. The sales price of a property similar to the donated property can determine FMV. The weight that the IRS gives to a comparable sale depends on the:
    • Degree of similarity between the property sold and the donated property,
    • Time of the sale,
    • Circumstances of the sale (was it at arm’s length?), and
    • Market conditions.
  1. Replacement cost. FMV should consider the cost of buying or creating property similar to the donated item, but the replacement cost must have a reasonable relationship with the FMV.

Businesses that contribute inventory can generally deduct the smaller of its FMV on the day of the contribution or the inventory’s basis. The basis is any cost incurred for the inventory in an earlier year that the business would otherwise include in its opening inventory for the year of the contribution. If the cost of donated inventory isn’t included in the opening inventory, its basis is zero and the business can’t claim a deduction.

Important Reminder
Even if a donor can’t deduct a noncash or in-kind donation (for example, a piece of tangible property or property rights), you may need to record the donation on your financial statements. Recognize such donations at their fair value, or what it would cost if your organization were to buy the donation outright.

Tax-Free Fringe Benefits for Small Businesses and Their Employees

In today’s tightening job market, to attract and retain the best employees, small businesses need to offer not only competitive pay, but also appealing fringe benefits. Benefits that are tax-free are especially attractive to employees. Let’s take a quick look at some popular options.

Insurance
Businesses can provide their employees with various types of insurance on a tax-free basis. Here are some of the most common:

Health insurance. If you maintain a health care plan for employees, coverage under the plan isn’t taxable to them. Employee contributions are excluded from income if pretax coverage is elected under a cafeteria plan. Otherwise, such amounts are included in their wages, but may be deductible on a limited basis as an itemized deduction.

Disability insurance. Your premium payments aren’t included in employees’ income, nor are your contributions to a trust providing disability benefits. Employees’ premium payments (or other contributions to the plan) generally aren’t deductible by them or excludable from their income. However, they can make pretax contributions to a cafeteria plan for disability benefits, which are excludable from their income.

Long-term care insurance. Your premium payments aren’t taxable to employees. However, long-term care insurance can’t be provided through a cafeteria plan.

Life insurance. Your employees generally can exclude from gross income premiums you pay on up to $50,000 of qualified group term life insurance coverage. Premiums you pay for qualified coverage exceeding $50,000 are taxable to the extent they exceed the employee’s coverage contributions.

Other types of tax-advantaged benefits
Insurance isn’t the only type of tax-free benefit you can provide — but the tax treatment of certain benefits has changed under the Tax Cuts and Jobs Act:

Dependent care assistance. You can provide employees with tax-free dependent care assistance up to $5,000 for 2018 though a dependent care Flexible Spending Account (FSA), also known as a Dependent Care Assistance Program (DCAP).

Adoption assistance. For employees who’re adopting children, you can offer an employee adoption assistance program. Employees can exclude from their taxable income up to $13,810 of adoption benefits in 2018.

Educational assistance. You can help employees on a tax-free basis through educational assistance plans (up to $5,250 per year), job-related educational assistance and qualified scholarships.

Moving expense reimbursement. Before the TCJA, if you reimbursed employees for qualifying job-related moving expenses, the reimbursement could be excluded from the employee’s income. The TCJA suspends this break for 2018 through 2025. However, such reimbursements may still be deductible by your business.

Transportation benefits. Qualified employee transportation fringe benefits, such as parking allowances, mass transit passes and van pooling, are tax-free to recipient employees. However, the TCJA suspends through 2025 the business deduction for providing such benefits. It also suspends the tax-free benefit of up to $20 a month for bicycle commuting.

Varying Tax Treatment
As you can see, the tax treatment of fringe benefits varies.

What Entrepreneurs Need to Know About Toll Tax

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with Frank Landreneau, one of our international tax directors. Frank, welcome back to the Playbook.

Frank: Thanks, Jen. Great to be back.

Jen: So, last time we talked about the toll tax. Can you give us a little bit of an overview; are there some specifics in the regulations that middle market entrepreneurs need to know about?

Frank: For the most part it really goes over all the things that we knew earlier this year through all the notices that were issued by the IRS through the spring time and early summer. But one of the things that it really kind of confirmed that we weren’t quite sure about is that upon the repatriation of the toll tax amount…

So, first of all, the entrepreneurs is taxed on this repatriation amount, but it’s not necessarily distributed; it’s deemed distributed. And once the amounts are distributed, then passive owners of float-through entities would be taxed on the net investment income tax at 3.8% for the full inclusion amount, and it’s not subject to installments like the toll tax is.

So, that was something that was clarified and we weren’t quite sure about that may come up to be a surprise to some entrepreneurs.

Jen: Now, is this toll tax going to affect different industries, or is it kind of across the board if you’ve got a pass-through entity?

Frank: I think it’s affecting industries all across the board. I think the real issues become, “Where do you want your cash at the end of the day,” – and we’ll talk a little bit about that more in subsequent segments – but also, “Are you doing business in high tax jurisdictions?”

There are certain things that are available under the law such as a Section 962 election, which allows an individual to be taxed like a corporation, which can be favorable, however there’s a downside that upon repatriation you’re taxed a second time to the extent you were taxed the first time. It gets rather convoluted and complicated, so we would need to have someone sit in and have a consultation with us to learn more.

Jen: Definitely. Well, we’ll get you back to talk a little bit more about the toll tax and some other things for international entrepreneurs.

Frank: Thank you very much. Appreciate it.

Jen: Perfect, thanks. To learn more about other international topics, visit PKFTexas.com/internationaldesk. This has been another Thought Leader production brought to you by PKF Texas The Entrepreneur’s Playbook. Tune in next week for another chapter.

Why Your Not-For-Profit Needs to Embrace Accountability

To protect the organization, demonstrate openness and support the greater good, your not-for-profit needs to embrace accountability. Doing so will also help you fulfill your fiduciary responsibilities to donors, constituents and the public.

Fairness and Clarity
Accountability starts by complying with all applicable laws and rules. As you carry out your organization’s initiatives, do so fairly and in the best interests of your constituents and community. Your status as a not-your-profit means you’re obligated to use your resources to support your mission and benefit the community you serve. Evaluate programs accordingly, both in respect to the activities and their outcomes.

There can be no accountability without good governance, and that’s ultimately your board’s responsibility. Your board needs to understand the importance of its role and focus on the big picture — not the process-oriented details best handled at the staff or committee level.

For example, management will likely prepare internal financial statements and review performance against approved budgets on a quarterly basis. But it will present these statements to the board (or its audit or finance committee) for review and approval. Your board is also responsible for establishing and regularly assessing financial performance measurements.

Communicating with your Public
Communication is a big part of accountability. Your annual report, for example, is designed to summarize the year’s activities and detail your not-for-profit’s financial position. But the report’s list of board members, management staff and other key employees can be just as important. Stakeholders want to be able to assign responsibility for results to actual names.

Your not-for-profit’s Form 990 also provides the public with an overview of your organization’s programs, finances, governance, compliance and compensation methods. Notably, charity watchdog groups use 990 information to rate not-for-profits.

Big Impact
Whether your organization is accountable — and able to communicate its accountability — can affect everything from donations to grants, hiring to volunteering and good word-of-mouth.

How Can Charitable IRA Rollover be Beneficial in 2018?

The considerations involved in deciding whether to make a direct IRA rollover have changed in light of the Tax Cuts and Jobs Act (TCJA). If you’re age 70½ or older, you can make direct contributions — up to $100,000 annually — from your IRA to qualified charitable organizations without owing any income tax on the distributions. This break may be especially beneficial now, because of TCJA changes that affect who can benefit from the itemized deduction for charitable donations.

Counts Toward Your RMD
A charitable IRA rollover can be used to satisfy required minimum distributions (RMDs). You must begin to take annual RMDs from your traditional IRAs in the year you reach age 70½. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (Deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)

So if you don’t need the RMD for your living expenses, a charitable IRA rollover can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid to you.

Doesn’t Require Itemizing
You might be able to achieve a similar tax result from taking the RMD and then contributing that amount to charity. But it’s more complex because you must report the RMD as income and then take an itemized deduction for the donation.

And, with the TCJA’s near doubling of the standard deduction, fewer taxpayers will benefit from itemizing. Itemizing saves tax only when itemized deductions exceed the standard deduction. For 2018, the standard deduction is $12,000 for singles, $18,000 for heads of households, and $24,000 for married couples filing jointly.

Doesn’t Have Other Deduction Downsides
Even if you have enough other itemized deductions to exceed your standard deduction, taking your RMD and contributing that amount to charity has two more possible downsides.

First, the reported RMD income might increase your income to the point that you’re pushed into a higher tax bracket, certain additional taxes are triggered and/or the benefits of certain tax breaks are reduced or eliminated. It could even cause Social Security payments to become taxable or increase income-based Medicare premiums and prescription drug charges.

Second, if your donation would equal a large portion of your income for the year, your deduction might be reduced due to the percentage-of-income limit. You generally can’t deduct cash donations that exceed 60% of your adjusted gross income for the year. (The TCJA raised this limit from 50%, but if the cash donation is to a private non-operating foundation, the limit is only 30%.) You can carry forward the excess up to five years, but if you make large donations every year, that won’t help you.

A charitable IRA rollover avoids these potential negative tax consequences.

Manufacturers – Take the National Manufacturing Outlook Survey!

The Leading Edge Alliance (LEA Global) has officially launched its third annual National Manufacturing Outlook Survey! This year, LBMC is distributing the survey, along with PKF Texas, the Greater Houston Manufacturers Association, Economic Alliance Houston Port Region, BioHouston and many more partners.

The survey is conducted in association with leading accounting firms across the country, and the report is a benefit to clients as part of our efforts to help co-develop the client experience with us as trusted advisors.

Through October 30, 2018, the survey is available to manufacturers worldwide, with responses kept confidential. To access and complete the survey, click HERE.

The results from the survey aim to:

  • Provide insight to better serve manufactures
  • First-hand understand the goals and challenges in manufacturing
  • Provide regional results
  • Expand LEA member firm’s reputation and recognition

The final report is scheduled to be issued on Friday, December 14, 2018 with copies available to participants in January 2019.

For more information and to view reports from previous years, visit PKFTexas.com/Manufacturing.

Questions? Contact Karen Kehl-Rose at karen.kehl-rose@leaglobal.com.