How to Trim the Fat From Your Inventory

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Inventory is expensive, and therefore, it needs to be as lean as possible. Here are some smart ways to cut back inventory without compromising revenue and customer service.

Objective inventory counts

Effective inventory management starts with a physical inventory count. Accuracy is essential to know your cost of goods sold — and to identify and remedy discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

Inventory ratios

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

  • Gross margin [(revenue – cost of sales) / revenue],
  • Net profit margin (net income / revenue), and
  • Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms; it’s a function of raw materials, labor, and overhead costs.

The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing anti-theft devices or opting for less expensive insurance coverage.

Product mix

To cut your days-in-inventory ratio, compute product-by-product margins. Stock more products with high margins and high demand — and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

Product mix can be a delicate balance, however. It should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Reorder point

Another important metric that’s not available from benchmarking studies is the reorder point. That’s the quantity level that triggers a new order. Reorder point is a function of your volume and the purchase order lead time. If your suppliers have access to your inventory system, they can automatically ship additional stock once inventory levels reach the reorder point.

Take inventory of your inventory

Often management is so focused on sales, HR issues and product innovation that they lose control over inventory. Contact us for a reality check. We can provide industry benchmarks and calculate ratios to help minimize the guesswork in managing your inventory.

© 2018

Supervisors Promoted From Within Call for Special Care

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When a supervisory position opens up, your immediate reaction as an employer may be to post a job opening to the general public. But don’t underestimate the value, efficiency and cost savings of an internal hire from your non-manager ranks.

Although promoting from within isn’t always feasible, when it is, you’ll likely be boosting that employee’s loyalty, eliminating (or greatly shortening) the onboarding process, and saving dollars on hiring costs. But, if you take this step, be prepared. These new supervisors typically need special care to avoid rocky transitions.

Cover the basics

Don’t make the mistake of promoting an employee to supervisor and then immediately moving on to other priorities. Most newly minted supervisors, no matter how strongly they performed in previous positions, will need some training and mentoring to grow into their new roles.

What specifically might they need? First, reflect upon your own experience for some ideas. If you had a smooth transition to a supervisory role, what made that possible? If it was a bumpy road, what would have made it smoother? Basic subjects that should be part of a supervisor boot camp include:

• Employee goal-setting

• Performance assessment

• Performance management

• Conflict resolution
Also, leadership training will be needed to supplement the nuts-and-bolts topics.

Assign a mentor

In devising a training program, you can’t anticipate every stumbling block a new supervisor will face. So, it’s important to give that person a mentor who, ideally, has made the same transition.

Putting some structure around the mentoring program at first — such as a scheduled weekly check-in session — can give rise to important discussions that might not otherwise take place. These check-ins don’t need to go on forever; three to six months may be all it takes.

Prepare for the worst

Unless the new supervisor will be moving to another department, prepare him or her for the challenges associated with becoming the boss of former co-workers. Just to name a few:

• Resentment from employees who believe they should have gotten the promotion instead of the person you chose,• Efforts by former co-workers to exploit friendship with their new boss by asking for or expecting special treatment, and• Difficulties the new supervisor may have in delivering honest but critical performance appraisals to former co-workers.
It will be tempting for new supervisors to downplay their authority over former co-workers. But they need to understand going in that there’s no getting around the fundamental change in the relationship. That change will probably require a cutback in purely social interaction with their former co-workers.

Give it a shot

The good news is that, if you have chosen wisely, a new supervisor will be able to surmount these hurdles. And the potential benefits can be striking. Our firm can provide more information and other budget-smart hiring ideas.

© 2018

How to Reduce the Tax Risk of Using Independent Contractors

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Classifying a worker as an independent contractor frees a business from payroll tax liability and allows it to forgo providing overtime pay, unemployment compensation and other employee benefits. It also frees the business from responsibility for withholding income taxes and the worker’s share of payroll taxes.

For these reasons, the federal government views misclassifying a bona fide employee as an independent contractor unfavorably. If the IRS reclassifies a worker as an employee, your business could be hit with back taxes, interest and penalties.

Key factors

When assessing worker classification, the IRS typically looks at the:

Level of behavioral control. This means the extent to which the company instructs a worker on when and where to do the work, what tools or equipment to use, whom to hire, where to purchase supplies and so on. Also, control typically involves providing training and evaluating the worker’s performance. The more control the company exercises, the more likely the worker is an employee.

Level of financial control. Independent contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers. Employees are more likely to be paid by the hour or week or some other time period; independent contractors are more likely to receive a flat fee.

Relationship of the parties. Independent contractors are often engaged for a discrete project, while employees are typically hired permanently (or at least for an indefinite period). Also, workers who serve a key business function are more likely to be classified as employees.

The IRS examines a variety of factors within each category. You need to consider all of the facts and circumstances surrounding each worker relationship.

Protective measures

Once you’ve completed your review, there are several strategies you can use to minimize your exposure. When in doubt, reclassify questionable independent contractors as employees. This may increase your tax and benefit costs, but it will eliminate reclassification risk.

From there, modify your relationships with independent contractors to better ensure compliance. For example, you might exercise less behavioral control by reducing your level of supervision or allowing workers to set their own hours or work from home.

Also, consider using an employee-leasing company. Workers leased from these firms are employees of the leasing company, which is responsible for taxes, benefits and other employer obligations.

Handle with care

Keep in mind that taxes, interest and penalties aren’t the only possible negative consequences of a worker being reclassified as an employee. In addition, your business could be liable for employee benefits that should have been provided but weren’t. Fortunately, careful handling of contractors can help ensure that independent contractor status will pass IRS scrutiny. Contact us if you have questions about worker classification.

© 2018

Keep it SIMPLE: A Tax-Advantaged Retirement Plan Solution for Small Businesses

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If your small business doesn’t offer its employees a retirement plan, you may want to consider a SIMPLE IRA. Offering a retirement plan can provide your business with valuable tax deductions and help you attract and retain employees. For a variety of reasons, a SIMPLE IRA can be a particularly appealing option for small businesses. The deadline for setting one up for this year is October 1, 2018.

The basics

SIMPLE stands for “savings incentive match plan for employees.” As the name implies, these plans are simple to set up and administer. Unlike 401(k) plans, SIMPLE IRAs don’t require annual filings or discrimination testing.

SIMPLE IRAs are available to businesses with 100 or fewer employees. Employers must contribute and employees have the option to contribute. The contributions are pretax, and accounts can grow tax-deferred like a traditional IRA or 401(k) plan, with distributions taxed when taken in retirement.

As the employer, you can choose from two contribution options:

1. Make a “nonelective” contribution equal to 2% of compensation for all eligible employees. You must make the contribution regardless of whether the employee contributes. This applies to compensation up to the annual limit of $275,000 for 2018 (annually adjusted for inflation).

2. Match employee contributions up to 3% of compensation. Here, you contribute only if the employee contributes. This isn’t subject to the annual compensation limit.

Employees are immediately 100% vested in all SIMPLE IRA contributions.

Employee contribution limits

Any employee who has compensation of at least $5,000 in any prior two years, and is reasonably expected to earn $5,000 in the current year, can elect to have a percentage of compensation put into a SIMPLE IRA.

SIMPLE IRAs offer greater income deferral opportunities than ordinary IRAs, but lower limits than 401(k)s. An employee may contribute up to $12,500 to a SIMPLE IRA in 2018. Employees age 50 or older can also make a catch-up contribution of up to $3,000. This compares to $5,500 and $1,000, respectively, for ordinary IRAs, and to $18,500 and $6,000 for 401(k)s. (Some or all of these limits may increase for 2019 under annual cost-of-living adjustments.)

You’ve got options

A SIMPLE IRA might be a good choice for your small business, but it isn’t the only option. The more-complex 401(k) plan we’ve already mentioned is one alternative. Some others are a Simplified Employee Pension (SEP) and a defined-benefit pension plan. These two plans don’t allow employee contributions and have other pluses and minuses. Contact us to learn more about a SIMPLE IRA or to hear about other retirement plan alternatives for your business.

© 2018

Assessing the S Corp

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The S corporation business structure offers many advantages, including limited liability for owners and no double taxation (at least at the federal level). But not all businesses are eligible – and, with the new 21% flat income tax rate that now applies to C corporations, S corps may not be quite as attractive as they once were.

Tax comparison

The primary reason for electing S status is the combination of the limited liability of a corporation and the ability to pass corporate income, losses, deductions and credits through to shareholders. In other words, S corps generally avoid double taxation of corporate income — once at the corporate level and again when distributed to the shareholder. Instead, S corp tax items pass through to the shareholders’ personal returns and the shareholders pay tax at their individual income tax rates.

But now that the C corp rate is only 21% and the top rate on qualified dividends remains at 20%, while the top individual rate is 37%, double taxation might be less of a concern. On the other hand, S corp owners may be able to take advantage of the new qualified business income (QBI) deduction, which can be equal to as much as 20% of QBI.

You have to run the numbers with your tax advisor, factoring in state taxes, too, to determine which structure will be the most tax efficient for you and your business.

S Eligibility Requirements

If S corp status makes tax sense for your business, you need to make sure you qualify – and stay qualified. To be eligible to elect to be an S corp or to convert to S status, your business must:

  • Be a domestic corporation and have only one class of stock,
  • Have no more than 100 shareholders, and
  • Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can’t include partnerships, corporations and nonresident alien shareholders.

In addition, certain businesses are ineligible, such as insurance companies.

Reasonable compensation

Another important consideration when electing S status is shareholder compensation. The IRS is on the lookout for S corps that pay shareholder-employees an unreasonably low salary to avoid paying Social Security and Medicare taxes and then make distributions that aren’t subject to payroll taxes.

Compensation paid to a shareholder should be reasonable considering what a nonowner would be paid for a comparable position. If a shareholder’s compensation doesn’t reflect the fair market value of the services he or she provides, the IRS may reclassify a portion of distributions as unpaid wages. The company will then owe payroll taxes, interest and penalties on the reclassified wages.

Pros and cons

S corp status isn’t the best option for every business. To ensure that you’ve considered all the pros and cons, contact us. Assessing the tax differences can be tricky — especially with the tax law changes going into effect this year.

© 2018

Choosing the Right Accounting Method for Tax Purposes

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The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.

Cash vs. accrual

Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.

In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:

1. Expressly prohibited from using the cash method, or
2. Expressly required to use the accrual method.

Cash method advantages

The cash method offers several advantages, including:

Simplicity. It’s easier and cheaper to implement and maintain.

Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.

Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.

Accrual method advantages

In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.

The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).

If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.

Making a change

Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.

If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.

© 2018

Six Ways to Run a Better Meeting

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There are few more self-destructive acts for an employer than to waste its employees’ time. You not only squander productivity but also hurt morale. Among the most common culprits of wasted time are bad meetings. A sloppily managed one can leave employees grumbling and frustrated for hours, even days, afterward. Here are six ways to run a better meeting:

1. Start on time. Beginning promptly shows you respect people’s time and encourages punctuality as an aspect of your organizational culture. Train and encourage meeting leaders to adhere to firm start times. Managers should address chronic latecomers verbally first (but after the meeting), and in writing later if necessary.

2. Lead with something positive. Poorly run meetings can quickly devolve into unproductive gripe sessions. Set the tone for a more constructive discussion of your agenda items by leading off with some good news highlighting an organizational or individual accomplishment.

3. Clear the air. After a positive start, if there’s an “elephant in the room,” confront it. Examples include a sudden staff change, bad sales report or unflattering story in the media. Say whatever needs to be said to acknowledge it and, if appropriate, discuss it. Then move on to a more constructive topic.

4. Deploy multiple voices. Depending on the agenda and meeting length, it’s usually a good idea to ask more than one team member to address a topic and lead a discussion. This will give the meeting more of a dynamic feel — lessening the likelihood that attendees will tune out a single voice. It also eases the burden on one person to run the whole show.

5. Follow a “no rehash” rule. Every topic should be thoroughly discussed. But backtracking to previous agenda items can turn meetings into a chaotic, confusing and laborious mess. Establish and enforce a clearly stated policy that, once the meeting has moved forward, previous discussions cannot be restarted.

6. Conclude optimistically with actionable tasks. Just as you started positively, also try to end the meeting on an upbeat, motivational note. Not every agenda item will require follow-up action, but many will. Identify those that do call for action and assign clear tasks to the appropriate attendees. Otherwise, dismiss everyone with a renewed sense of urgency to work on the items discussed. Contact us for more ideas on how to better accomplish your strategic objectives.

© 2018

What’s excluded from the balance sheet?

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Financial statements help investors and lenders monitor a company’s performance. However, financial statements may not provide a full picture of financial health. What’s undisclosed could be just as significant as the disclosures. Here’s how a CPA can help stakeholders identify unrecorded items either through external auditing procedures or by conducting agreed upon procedures (AUPs) that target specific accounts.

Start with assets

Revealing undisclosed liabilities and risks begins with assets. For each asset, it’s important to evaluate what could cause the account to diminish. For example, accounts receivable may include bad debts, or inventory may include damaged goods. In addition, some fixed assets may be broken or in desperate need of repairs and maintenance. These items may signal financial distress and affect financial ratios just as much as unreported liabilities do.

Some of these problems may be uncovered by touring the company’s facilities or reviewing asset schedules for slow-moving items. Benchmarking can also help. For example, if receivables are growing much faster than sales, it could be a sign of aging, uncollectible accounts.

Evaluate liabilities

Next, external accountants can assess liabilities to determine whether the amount reported for each item seems accurate and complete. For example, a company may forget to accrue liabilities for salary or vacation time.

Alternatively, management might underreport payables by holding checks for weeks (or months) to make the company appear healthier than it really is. This ploy preserves the checking account while giving the impression that supplier invoices are being paid. It also mismatches revenues and expenses, understates liabilities and artificially enhances profits. Delayed payments can hurt the company’s reputation and cause suppliers to restrict their credit terms.

Identify unrecorded items

Finally, CPAs can investigate what isn’t showing on the balance sheet. Examples include warranties, pending lawsuits, IRS investigations and an underfunded pension. Such risks appear on the balance sheet only when they’re “reasonably estimable” and “more than likely” to be incurred.

These are subjective standards. In-house accounting personnel may claim that liabilities are too unpredictable or remote to warrant disclosure. Footnotes, when available, may shed additional light on the nature and extent of these contingent liabilities.

Need help?

An external audit is your best line of defense against hidden risks and potential liabilities. Or, if funds are limited, an AUP engagement can target specific high-risk accounts or transactions. Contact our experienced CPAs to gain a clearer picture of your company’s financial well-being.

© 2018

Family Limited Partnerships & Succession Planning

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One of the biggest concerns for family business owners is succession planning — transferring ownership and control of the company to the next generation. Often, the best time tax-wise to start transferring ownership is long before the owner is ready to give up control of the business.
A family limited partnership (FLP) can help owners enjoy the tax benefits of gradually transferring ownership yet allow them to retain control of the business.

How it works

To establish an FLP, you transfer your ownership interests to a partnership in exchange for both general and limited partnership interests. You then transfer limited partnership interests to your children.

You retain the general partnership interest, which may be as little as 1% of the assets. But as general partner, you can still run day-to-day operations and make business decisions.

Tax benefits

As you transfer the FLP interests, their value is removed from your taxable estate. What’s more, the future business income and asset appreciation associated with those interests move to the next generation.

Because your children hold limited partnership interests, they have no control over the FLP, and thus no control over the business. They also can’t sell their interests without your consent or force the FLP’s liquidation.

The lack of control and lack of an outside market for the FLP interests generally mean the interests can be valued at a discount — so greater portions of the business can be transferred before triggering gift tax. For example, if the discount is 25%, in 2018 you could gift an FLP interest equal to as much as $20,000 tax-free because the discounted value wouldn’t exceed the $15,000 annual gift tax exclusion.

To transfer interests in excess of the annual exclusion, you can apply your lifetime gift tax exemption. And 2018 may be a particularly good year to do so, because the Tax Cuts and Jobs Act raised it to a record-high $11.18 million. The exemption is scheduled to be indexed for inflation through 2025 and then drop back down to an inflation-adjusted $5 million in 2026. While Congress could extend the higher exemption, using as much of it as possible now may be tax-smart.

There also may be income tax benefits. The FLP’s income will flow through to the partners for income tax purposes. Your children may be in a lower tax bracket, potentially reducing the amount of income tax paid overall by the family.

FLP risks

Perhaps the biggest downside is that the IRS scrutinizes FLPs. If it determines that discounts were excessive or that your FLP had no valid business purpose beyond minimizing taxes, it could assess additional taxes, interest and penalties.

The IRS pays close attention to how FLPs are administered. Lack of attention to partnership formalities, for example, can indicate that an FLP was set up solely as a tax-reduction strategy.

Right for you?

An FLP can be an effective succession and estate planning tool, but it isn’t risk free. Please contact us for help determining whether an FLP is right for you.

© 2018

Do you qualify for the home-office deduction?

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Under the Tax Cuts and Jobs Act, employees can no longer claim the home office deduction. If, however, you run a business from your home or are otherwise self-employed and use part of your home for business purposes, the home office deduction may still be available to you.

Home-related expenses

Homeowners know that they can claim itemized deductions for property tax and mortgage interest on their principal residences, subject to certain limits. Most other home-related expenses, such as utilities, insurance and repairs, aren’t deductible.

But if you use part of your home for business purposes, you may be entitled to deduct a portion of these expenses, as well as depreciation. Or you might be able to claim the simplified home office deduction of $5 per square foot, up to 300 square feet ($1,500).

Regular and exclusive use

You might qualify for the home office deduction if part of your home is used as your principal place of business “regularly and exclusively,” defined as follows:

1. Regular use. You use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use.

2. Exclusive use. You use the specific area of your home only for business. It’s not necessary for the space to be physically partitioned off. But, you don’t meet the requirements if the area is used both for business and personal purposes, such as a home office that also serves as a guest bedroom.

Regular and exclusive business use of the space aren’t, however, the only criteria.

Principal place of business

Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don’t have another fixed location where you conduct substantial administrative or management activities.

Examples of activities that are administrative or managerial in nature include:

  • Billing customers, clients or patients,
  • Keeping books and records,
  • Ordering supplies,
  • Setting up appointments, and
  • Forwarding orders or writing reports.

Meetings or storage

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if you physically meet with patients, clients or customers on your premises. The use of your home must be substantial and integral to the business conducted.

Alternatively, you may be able to claim the home office deduction if you have a storage area in your home — or in a separate free-standing structure (such as a studio, workshop, garage or barn) — that’s used exclusively and regularly for your business.

Valuable tax-savings

The home office deduction can provide a valuable tax-saving opportunity for business owners and other self-employed taxpayers who work from home. If you’re not sure whether you qualify or if you have other questions, please contact us.

© 2018