January 30, 2015

Grouping Activities Can Prove to Be a Solid Tax Saving Technique

As you begin to gather documents for your CPA in late January and early February, it’s likely one of the first things you’ll do is assemble the accounting and tax information associated with your real estate and/or investment partnerships.  This is a great time to review your calendars and time logs and quantify the time spent working on these businesses during the previous year.

Often times, a taxpayer’s time spent on these types of activities is miniscule and the related income is considered to be passive as defined by IRS guidelines.  As you know, income earned from passive activities is subject to the additional 3.8% Net Investment Income Tax (NIIT).  However, if you combine all of the time spent on your various investment activities throughout the year, it’s possible that you can make an election to group activities and mitigate your exposure to the NIIT.

The IRS allows the grouping of activities using any reasonable method. There are five key factors provided to help taxpayers determine if activities can be grouped for income tax purposes.  These factors, in no particular order, include:

  • Similarities and differences between types of trade or business
  • Extent of common control
  • Extent of common ownership
  • Geography
  • Interdependency of activities

Grouping activities, a common technique for real estate professionals, can prove to be a solid tax saving technique in all industries.  Generally speaking, grouping elections are irrevocable, but taxpayers who have previously grouped activities have the opportunity to re-group activities in 2014 or the first year they are subject to the NIIT.  This can serve as a great opportunity for taxpayers to adjust previous groupings if they are no longer beneficial.

Because the grouping elections are generally irrevocable, a decision to group activities shouldn’t be made in a vacuum; there could be long term negative implications associated with an ill-advised election.  Be sure to consider the big picture and make sure you’re not making a grouping election to save 3.8% NIIT now at the expense of 39.6% deductions in the future.

Contact your Anders advisor to discuss how a grouping election can reduce your tax liability.

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January 28, 2015

The Fraud Triangle: Three Conditions That Increase the Risk of Fraud

The key to deterring fraud is to understand how and why people commit fraud. Knowing the “how” helps managers and business owners create policies and design internal controls to reduce the occurrence of fraud. The “why” is much more complicated, but just (if not more) important. There are three conditions that, when present in varying degrees, increase the risk of fraud: (1) the pressure to commit fraud, (2) the opportunity to commit fraud, and (3) the rationalization of committing the fraud.

 

Fraud Triangle - St Louis CPA Firm.

 

 

The pressure, or incentive, to commit fraud is the reason why a person commits fraud. There are several reasons a person would feel the need to commit fraud: feelings of resentment toward a manager or the company as a whole, personal financial problems (e.g., mounting medical bills, gambling debts, spouse laid off from their job), employee’s compensation tied to financial performance, and greed among others. The reason the employee commits the fraud can change over time.  For example, several of the fraud investigations we have worked on started off as embezzling funds to take care of a personal financial problem and then changed to greed once the financial hardship had been solved. Companies can help alleviate some of this pressure by providing programs where employees can seek anonymous help in their time of need. These programs can range from providing resources for a person battling addiction, to setting achievable, realistic goals for compensation purposes based on input from the employee.

The opportunity to commit fraud is the circumstances that allow fraud to occur and is the only condition over which the company has complete control.  For example, an employee who is in a position that gives him or her the ability to add vendors and write checks realizes he or she has the opportunity to write checks to a ghost vendor. Opportunities to commit fraud are more commonly present in organizations that have poor internal controls because it makes it easier for the employee to commit fraud and provide a low-risk environment for getting caught. However, companies with ample internal controls are still susceptible to fraud if controls can be overridden by management. If the internal control system is designed in a way that the risk of getting caught is too high, the employee will likely not exploit the perceived opportunity for his or her personal gain. Without opportunity, fraud generally cannot occur.

Rationalization of committing fraud is the most difficult condition to observe because it takes place in the mind of the perpetrator. Rationalization has to do with justifying the fraud. Since many fraudsters view themselves as honest, ordinary people and not as criminals, they have to come up with some reasoning to make the act of committing fraud more acceptable to them. Some common rationalization statements are “I’ll just take this money now and pay it back later,” “No one will notice,” or “I deserve this after all these years with this company.” Some fraudsters rationalize his or her behavior by reframing their definition of wrongdoing to exclude his or her actions.

All three conditions (i.e., pressure, opportunity and rationalization) must be present in varying degrees in order for fraud to occur. A financially strapped employee is not going to commit fraud if the opportunity is not available, or if the risk of getting caught is too high. Similarly, a person who perceives an opportunity to misrepresent financial statements and has the incentive to commit the fraud is unlikely to do so if he or she cannot rationalize the fraud. However, the more pressure a person feels to commit fraud, the easier he or she can justify it. Being aware of these three conditions can help managers and business owners minimize the risk of fraud in their organizations.

If you have any questions on preventing fraud in your organization, please contact an Anders advisor.

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January 21, 2015

Proactive Measures Can Reduce Some Risks of Owning a Small Business

The food safety scandal that touched McDonalds in China is an event that all business owners and operators fear on a daily basis. In order to satisfy its customers and shareholders, McDonald’s took quick steps to ensure that its food in China is prepared safely. Despite these efforts to ease customer concerns, McDonalds stated that their business in China, Japan and other markets experienced a significant negative impact to results.

McDonalds estimates that this food safety issue affected about 10 percent of the Company’s world-wide revenue. Some estimates show that McDonalds’ year-to-year sales for July in the affected markets were down by over 15 percent. There is little doubt it also affected other markets.

This McDonalds event illustrates that even large established companies are susceptible to disruptions in revenue and earnings from outside risks. Empirical data suggests that the companies get inherently riskier as they slide down the size spectrum. Even without this data, it is logical to assume that smaller companies face a steeper curve while looking up at the larger companies. Smaller companies are often more dependent on a small groups of customers, more dependent on key employees and often rely on smaller groups of suppliers, just to name a few.

While companies can’t expect to eliminate all risk they can try to reduce some risks by recognizing what they are and taking some necessary steps. Some of these steps could involve expanding their customer base through targeted marketing, expanding product offerings, implementing management training programs and working with suppliers to ensure the smooth and safe delivery of products and services.

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January 14, 2015

Discounting Future Lost Profits Damages

In calculating lost profit damages, one of the final steps is to discount the future lost profits damages to present value by utilizing a discount rate. The discount rate selected by the expert can significantly impact the present value calculation, and thus the amount of damages awarded to the plaintiff. What discount rate should be used by the expert? Like most things in litigation, the answer is “It depends”.

Courts have provided little guidance with regard to the selection of an appropriate discount rate. Courts tend to look at the discount rate as a question of fact rather than a matter of law. Thus, it is important for the financial expert to objectively review his or her lost profits damages calculation in order to be certain the calculation is supported by the facts and circumstances of the case.

Financial experts typically select a discount rate that matches the risk (or uncertainty) embedded in the projected future lost profits. If the projections are conservative and the risk associated with achieving the projections is low, the financial expert will usually apply a low-risk discount rate. However, if the projections are not conservative and the risk associated with achieving the projections is high, the financial expert will apply a high-risk discount rate.

When selecting a discount rate, there are a number of different benchmarks from which a financial expert can choose. Some examples of potential discount rates include:

  • A risk-free rate, such as a U.S. Treasury rate
  • The company’s cost of debt
  • The company’s weighted average cost of capital
  • The company’s cost of equity

Again, the key in selecting the appropriate discount rate is to match the discount rate to the risk embedded in the projections, all of which should take into consideration the facts and circumstances of the case.

Here is an example to illustrate the impact that a discount rate has on the calculation of lost profits damages. Assume that ABC Company has projected lost profits of $200,000 per year for the next five years, or $1,000,000 before discounting to present value. Three experts have been asked to prepare a present value calculation.

  • Expert 1 uses a risk-free rate of 3%.
  • Expert 2 uses the company’s weighted average cost of capital of 12%.
  • Expert 3 uses the company’s cost of equity of 22%.

Here is a comparison of each expert’s present value calculation (using a mid-year discounting convention):

Discount Rate Present Value
Expert 1 3% $929,579
Expert 2 12% $762,987
Expert 3 22% $632,599

If you would like more information on the calculation of lost profits damages, please contact the Forensic & Valuation Service group at Anders.

 

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January 12, 2015

Friends of Kids with Cancer Selected as 2015 Charity of Choice

friends-of-kids-logoPartners and staff have selected Friends of Kids with Cancer as the firm’s 2015 Charity of Choice. Now in its 10th year, the Charity of Choice program combines fundraising activities and volunteer efforts to support one local charity each year. Charities are submitted by members of the firm, and all members of the firm, from interns to partners, have the opportunity to vote for their choice at the firm’s meeting each January. In 2014, Anders raised more than $22,000 for Basket of Hope.

Friends of Kids with Cancer, was nominated by Kyle Coady, CPA, an audit supervisor and organization volunteer, whose family has benefited from the not-for-profit’s work. The charity was founded in 1992, with the goal of providing kids going through cancer treatment with diversions. Friends of Kids with Cancer is unique because the entire family benefits from their services, and all money raised through events, grants and donations stays in the St. Louis Community. It focuses on the importance of kids and their families getting through the day, and aims to fill in the gaps from treatment to make each child whole again.

While events such as dress down days, penny wars and volunteer days are held throughout the year, the first major Anders fundraising event will be the annual “Hoops for Hope” NCAA basketball pool, which draws participation from clients, colleagues, referral sources and friends of the firm from all over the U.S.

In addition to Friends of Kids with Cancer, other beneficiaries of the Anders Charity of Choice program have included Basket of Hope, Young Friends of Habitat for Humanity, Nurses for Newborns, Girls on the Run, St. Louis Crisis Nursery, Lafayette Industries, KidSmart, Re-Building Together and Kids Under Twenty-One (KUTO). Anders has raised over $200,000 in the past ten years.

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January 6, 2015

Method for Calculating Home Office Deductions Just Got Easier

The IRS has created a simplified method for calculating a tax deduction for taxpayers with home offices. This method gives the taxpayer a deduction of $5 per square foot used for the home office, capping the deduction at $1,500. Also, the deduction cannot exceed the profit from the business that is conducted in the home office. The home office must be exclusively used for business on a regular basis to qualify for this deduction.

In the past, there was only one way to receive the deduction for a home office. This method can still be used. To calculate the deduction, home expenses are multiplied by the square footage of the home office used exclusively for business in proportion to the homes entire square footage. Home expenses include utilities, depreciation, upkeep of the home, etc.

This simplified method saves both time and money for the taxpayer. Taxpayers no longer have to keep track of all home expenses during the year or pay additional fees to accountants for calculating the deduction.

A taxpayer can decide to elect the safe harbor each year or not as long as the election is made on an original return filed on time.

Although the simplified method is easier, the regular method is still allowed, and may be more advantageous for certain taxpayers. Contact your tax preparer to determine which method would benefit you the most.

As always, please contact your Anders tax professional with any additional questions

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