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Minimum Wage Rate in Maryland Changes January 1, 2015

 

Maryland flagGovernor O'Malley has signed a bill that will raise the minimum wage rate from $7.25 per hour to:

(1) $8.00 per hour on Jan. 1, 2015;

(2) $8.25 per hour on July 1, 2015;

(3) $8.75 per hour on July 1, 2016;

(4) $9.25 per hour on July 1, 2017; and

(5) $10.10 per hour on July 1, 2018.

The legislation also freezes the minimum cash wage for tipped employees at $3.63 per hour.

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Restatement Time for Your Retirement Plan

 

retirement plansEmployers who sponsor a retirement plan must “restate,” or rewrite, their plan to include recent law changes, including the Pension Protection Act. This restatement, referred to as the “PPA Restatement,” can be done as early as this summer. PPA restatements must be completed no later than April 30, 2016.

This might be a good time to consider some enhancements to your retirement plan, such as:

  • Adding a Safe Harbor matching or nonelective contribution to do away with the pesky test that can otherwise limit 401(k) deferrals for highly-compensated employees

  • Allowing Roth 401(k) deferrals

  • Allowing in-plan Roth rollovers to convert accounts to future tax-free income

  • Adding or removing participant loans

  • Adding or removing hardship distributions

We can help you decide if any of these changes would make sense for your retirement plan. We will be reaching out to our clients who utilize our Third Party Administration services; otherwise, give our office a call to discuss how we may be able to enhance your current retirement plan. Contact the Retirement Plan Services Group at 717-263-3910 to speak with a team member.

Terry EisenhauerTerry Eisenhauer, CPA has chosen to focus his professional development to the design, implementation and third party administration of retirement plans. As a Member of the Firm, Terry provides overall leadership and guidance to the Retirement Plan Services Group, which actively provides plan consulting and third party administration to over 300 clients.

teisenhauer@sek.com

New Financial Statement Options for Smaller Privately Held Entities

 

A natural consequence of the well-publicized financial scandals of the last decade has been a proliferation of highly complex and costly accounting standards designed to prevent the next accounting scandal. Unfortunately, many of these new standards added much complexity to smaller entity financial statements without providing any significant additional useful information.

However, relief is finally on its way! Several new options have become available in the past half year that promise to balance the need for complete and transparent financial statements for the users of smaller entity financial statements like banks and bonding companies.

First, what is a smaller entity? Generally, a business that is closely held and owner managed without significant outside investors would qualify. An eligible entity generally does not have foreign operations and does not operate in a highly regulated industry or have any intention of going public.

Accounting standards in the US are established by the Financial Accounting Standards Board (FASB). The FASB has worked closely with international standard setters as large multi-national businesses created the need for consistency of standards. Therefore the same standards used by the largest businesses in the world also applied to small closely held entities. However, the FASB recently created the FASB Private Company Council (PCC) that is responsible for reviewing new and existing standards for opportunities to simplify standards applicable to­ smaller entities. The PCC has already identified several areas where smaller entities can be granted relief from following the same rules that apply to the largest multi-national corporations.

Another option for smaller entity financial statements came from a grass roots effort of CPA practitioners (including SEK) and the American Institute of CPAs. This effort resulted in a FRF for SMEsTask Force that created the Financial Reporting Framework for Small and Medium Entities, commonly known as FRF for SMEs™. This framework represents an alternative accounting and financial reporting system different from the FASB standards. FRF for SMEs is a comprehensive accounting framework that is based on historic cost. The framework takes a basic approach to financial statement presentation related to many of the more complex areas of FASB standards, eliminating the need for fair value measurements, consolidation of variable interest entities, hedge accounting and many more. The result is financial statements that are easier to prepare and easier to understand.

Michael P. Manspeaker, CPA, CGMA is a Member of the Firm. Mike is the firm-wide Director of Michael P. Manspeaker jpg[1]Accounting and Auditing Quality Control. His experience includes working with manufacturing, retirement plan, construction, fi nancial institutions, nonprofi t, and local government clients. In addition, Mike provides clients with business planning and has significant experience in mergers and acquisitions and publicly traded companies.

The Better Way

 

house for Better WayAs we know, Hi Bracket has been a student in the Tax School of Hard Knocks for a long time. He has learned that tax planning has to be done up front so when he heard about the new Net Investment Income Tax on passive income (interest, dividends, capital gains, rents, etc.) of 3.8% for high income people, he was determined to keep the rental income from many of his business rental properties from being subject to this tax. He found out that if there was a certain relationship between the owner and tenant of the property that the income would not be classified as “passive” and therefore would escape the tax. He figured out what to do. He rearranged the ownership of several of the properties that were rented to companies in which he was an owner to meet the test. Alas, he had saved the additional tax and felt very proud.

 

Guess what? Now the profit on those properties was not available to offset losses on other rentals so those losses were not currently deductible. Great, he had saved the 3.8% tax only to lose deductions in the 35%+ bracket. Guess it didn’t work out too well!

 

The Better Way would be to carefully consider the ramifications of tax law changes, not just react to the obvious implications. To his defense, many people do just that and the true understanding comes later, often at a price. We can assist in such understands and utilize computer modeling to study the true impact on our clients. Please give us a call if you have planning concerns.

 

Photo Credit: G & A Sattler via photopin cc

New IRS Amnesty Program

 

describe the imageAre you a business owner with a retirement plan for only one employee, probably yourself?  Do you know that you need to file an annual form 5500-EZ with the IRS, unless you meet both of the following exceptions?

  • The form is not required for SIMPLE IRA, SEP, or SARSEP plans

  • The form is not required for plans with less than $250,000 at the end of the plan year

Form 5500-EZ is due the last day of the seventh month after the end of the plan year. The due date is extendable for an additional two and one-half months.

You must also file a form 5500-EZ within seven months after closing a retirement plan, even if the assets never exceeded $250,000.

The penalty for failing to timely file form 5500-EZ is $25 per day, with a maximum of $15,000 per return.

If you didn’t know about the filing requirements, you are not alone. Apparently the IRS thinks there are many others who aren’t meeting the filing requirements, because they recently announced a pilot program to allow delinquent or non-filers to file without any late-filing penalties.

No penalty is assessed if the delinquent return and appendix is filed between June 2, 2014 and June 2, 2015.

If you want to discuss if this applies to you, please contact our Retirement Plan Services Group at 717-263-3910.

Will the Real Buy-sell Please Stand Up?

 

divorce 02Divorce courts don’t always accept these agreements

Buy-sell agreements come into play in many situations. They facilitate ownership changes during shareholder disputes and when a partner exits the business. But oversimplified or outdated agreements sometimes come back to haunt divorcing shareholders.

Three-factor test

Buy-sell agreements provide evidence of value. But they may not necessarily bind the parties in a divorce — especially if both spouses didn’t sign the agreement. In evaluating whether to accept a formula set forth in a buy-sell, courts often look to a test that originated with the 1994 In re Marriage of Nichols decision. The test looks at three factors:

  1. Proximity of the agreement date to the separation date to ensure that the agreement was not entered into in contemplation of marital dissolution,
  2. Existence of an independent motive for entering into the buy-sell agreement, such as a desire to protect all partners against the effect of a partnership dissolution, and
  3. Whether the value resulting from the agreement’s purchase price formula is similar to the value produced by other approaches.

The last part demonstrates that there are no shortcuts when valuing a business. For divorce purposes, you cannot simply expect to value a private business interest using a valuation formula (or fixed price) set forth in the company’s buy-sell agreement. The buyout formula should be reconciled against appraised values derived under the cost, market and income approaches.

If the values derived using these methods vary substantially from the value derived from the buy-sell formula, the appraiser should identify reasons for the discrepancy in his or her valuation report. (See the sidebar “Is my buy-sell agreement still relevant?”)

describe the imageNo hard and fast rules

Divorce courts give buy-sell agreements varying degrees of consideration. At one end of the spectrum, some courts accept buy-sell agreements as objective indicators of value.

For example, in In re Marriage of Baker, an Iowa appellate court ruled that the $1,000 value
indicated by the buyout provisions of the owners’ agreement was within the“permissible range of evidence” for the husband’s interest in a general surgery clinic. His wife estimated the value of the interest at roughly $84,000, using other valuation methods.

On the opposite end of the spectrum, a Missouri appellate court rejected a formula set forth in a buy-sell agreement in Wood v. Wood, because it applied an inappropriate standard of value. The case was remanded to a trial court for a proper determination of business value on the divorce date.

State case law sometimes provides contradictory guidance about how to handle buy-sell agreements. For example, in Mandell v. Mandell, a Texas appellate court upheld an unsigned
buy-sell agreement when valuing the husband’s interest in a medical practice. But in Hasselbach v. Hasselbach, another Texas appellate court rejected the use of a buy-sell agreement to value the husband’s interest in a privately held company.

Goodwill is another factor that confounds the use of buy-sell formulas to value businesses in divorce cases. A recent Oklahoma appellate court case, In re Marriage of Kingery, points out that some buy-sell formulas include a “practice acquisition” or goodwill component. If so, a buy-sell may overstate the value of an owner-spouse’s business interest to the extent that state law excludes all or part of company goodwill from the marital estate.

Lessons to be learned

Buy-sell agreements can provide worthwhile valuation evidence. Shareholders and their attorneys should always consider buyout formulas in divorce cases — but reconcile them against values obtained using the cost, market and income approaches. A valuation professional can help parties understand discrepancies and defend appraisals in divorce court.

Sidebar: Is my buy-sell agreement still relevant?

Suppose you’re a business owner who bought 10,000 shares of a startup venture for $1/share based on the company’s buy-sell agreement 20 years ago. Since the date of your buy-in, sales have tripled, the number of employees has doubled and $3 million in new equipment has been added. You and the other three owners have been so busy growing the business that you forgot to update the buy-sell agreement.

When your spouse files for divorce two decades later, can you rely on this buy-sell agreement to value the business? The answer depends on relevant legal precedent. But most family court judges would consider this buy-sell agreement invalid for several reasons.

First, even if the buy-sell agreement has never been violated by any other buy-in or buyout transactions, the company has grown substantially, so the fixed price of $1/share is probably outdated. Twenty years is a long time for a contract or a fixed price to remain valid. Divorce courts also may disregard buy-sell agreements if they involve related parties or aren’t legally enforceable under state law.

On the other hand, the buy-sell may have some validity to the extent that your spouse signed the agreement — and if it has been used for recent arm’s-length shareholder buy-ins or buyouts. The agreement also may be valid if the results of the buy-sell formula are comparable to appraised values derived under the cost, market and income approaches.

View our Business Valuation Services page for more information.

Jacob KaufmanJacob Kaufman, CPA, CVA is a Member of the firm of Smith Elliott Kearns & Company, LLC. Jake joined SEK&Co in 1989. He is the lead member of the Business Valuation Team and serves as a consultant to the Accounting Services and Tax Departments in the firm's Chambersburg office. Jake's valuation experience was learned through years of study and practical experience. In addition to valuation theory and implementation, Jake possesses the relative tax, finance, and accounting experience necessary to perform a thorough quality valuation.

Hold on to Key Employees During a Merger/Acquisition Deal

 

staff retentionRyan’s software company was being courted by a large corporation with financial resources that would enable him to expand his offerings and reach new markets. The transaction was progressing according to plan — until the two companies announced their impending merger. That’s when Ryan’s Chief Technology Officer and several of his key developers resigned. A few weeks later, the deal fell apart.  

This scenario is more common than you might think. If a handful of key players are critical to your company’s value, you need to provide them with incentives to stay while you close a merger and acquisition (M&A) deal, as well as through the integration process.

Emotional stakes

As soon as initial negotiations with a buyer begin, identify your most valuable employees — for example, executives who will be responsible for integrating the company, top salespeople,
product developers, and managers responsible for a significant percentage of revenues. Such employees typically represent less than 10% of a business’s workforce.

Almost nothing can damage the morale of a valuable employee faster than learning about a merger through the grapevine. Therefore, keep your key staff members in the loop, informing them of your plans as soon as possible and even involving them in the M&A process. You might, for example, add them to your deal team and assign them to preintegration tasks that enable them to work with employees from the buyer’s company. All of this gives key people an emotional stake in the deal.

Financial incentivesmonetary incentive

Along with the need to feel like they have a role in your company’s future, key employees are likely to respond to various financial incentives. Stock options in the newly-merged company are one of the most common. Typically, they’re offered to executives and top managers and can be an excellent way to motivate their performance during integration and beyond.

Or you might offer a stay bonus, which rewards employees who agree to stay for a specified period, such as two years. It can be paid in a lump sum (usually a percentage of their
current salary). As an alternative to stay bonuses, some companies offer key employees a deferred bonus, with interest, due to be paid at some specified time in the future or when they reach certain department or company milestones. Employees may even respond positively to the offer of extra vacation time, an improved health care package or supplemental insurance policies such as disability or long-term care.

Some of these incentives have the potential to become costly over the long term, so consider offering task-specific rewards. You might, for example, promise a completion bonus for projects essential to your M&A deal, such as successfully conducting layoffs of redundant staff or integrating your IT network with your buyer’s. You also could offer “management-by-objectives” bonuses, which reward employees for completing tasks that might otherwise be neglected during the course of a merger.

Attractive supplements

There’s a limit, of course, to the financial incentives you can offer employees to stay on board. To supplement financial incentive plans or engage employees who aren’t necessarily motivated to stay by the offer of more money, work with your buyer to come up with some nonfinancial perks that you can selectively offer to holdout employees.

Often, these are relatively easy to provide, such as the guarantee of a new job title or responsibility for particular client accounts. Some employees may be more likely to remain loyal if they can take essential employees such as a trusted executive assistant or IT technician with them to the new company. Others may be motivated by the offer of more-flexible work hours or the ability to telecommute from home.

business people 10Cost is relative

Business owner Ryan learned the hard way that you can’t afford to take key employees for granted. Providing incentives can be costly, but they tend to cost less than the loss of essential staff when you’re trying to close an M&A deal. 

 

View our Business Valuation Services Page

Jacob KaufmanJacob Kaufman, CPA, CVA is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Jake joined SEK&Co in 1989. He is the lead member of the Business Valuation Team and serves as a consultant to the Accounting Services and Tax Departments in the firm's Chambersburg office. Jake's valuation experience was learned through years of study and practical experience. In addition to valuation theory and implementation, Jake possesses the relative tax, finance, and accounting experience necessary to perform a thorough quality valuation.

Is an ESOP Right for Your Community Bank?

 

What do you know about ESOPs?

Unless bankers have participated in a qualified retirement plan that invests in employer stock early in one’s career, many know little about employee stock ownership plans (ESOPs). Here’s some information about ESOPs to add to your knowledge base.

ESOPs invest in the bank’s stock

regional banksAn ESOP is a qualified retirement plan that invests in the bank’s own stock. The bank can contribute stock to the plan or it can contribute cash used to acquire bank stock, which is allocated to employees’ accounts. In a leveraged ESOP, the plan acquires a large block of shares from the bank or its shareholders by borrowing money from another bank, usually at favorable rates.

As with other qualified plans, your bank’s contributions to the ESOP are tax deductible (generally up to 25% of eligible participants’ compensation). In addition, ESOPs must comply with specific rules and regulations, including strict nondiscrimination requirements. Closely held banks must have their stock valued by a qualified, independent appraiser when it establishes the ESOP and annually thereafter.

When ESOP participants retire, die, become disabled or terminate their employment, their benefits are distributed as stock or cash. Closely held banks are required to give employees a “put option” — that is, the right to sell the stock back to the bank at its current fair market value. Some banks limit stock ownership in the corporation so that participants must sell their stock to the bank or the plan at distribution. These options can generate significant “repurchase liabilities” that your bank should plan for and monitor.

Equity attracts employees

Equity is a powerful incentive you can use to attract, retain and motivate employees. Sharing ownership with employees through an ESOP also ties them to your community bank and aligns their interests with your objectives and strategies. As your bank grows and its stock value increases, employees share in the success.ESOP

Another advantage of an ESOP is that your bank can spread the wealth in a tax-advantaged manner. Earnings and appreciation on stock held by an ESOP are tax-exempt, so employees’ accounts grow on a tax-deferred basis. Participants recognize taxable income only when they withdraw their benefits from the plan. Distributions are taxed the same as 401(k) plans and other qualified plans, including a penalty for withdrawals before age 59½, with certain exceptions. Additionally, like a 401(k), distributions from the ESOP must begin in the year the employee reaches age 70½.

The bank and owners also benefit

An ESOP provides several benefits  for your community bank and its owners. For example, the bank’s ESOP contributions are tax deductible (up to applicable contribution limits) and, under certain circumstances, it can deduct dividends paid on ESOP shares.

Also, a leveraged ESOP can be a highly tax-efficient vehicle for raising capital. Ordinarily, only interest is deductible on a business loan. But your bank can make tax-deductible contributions to a leveraged ESOP to cover both interest and principal payments.

For closely held banks, an important benefit of an ESOP is that it creates a market for the existing owners’ stock without necessitating a sale to “outsiders.” By selling a portion of the business to an ESOP, the owners can generate income or diversify their portfolios while retaining control of the bank.

And if the ESOP owns at least 30% of a C corporation bank’s stock immediately after the sale, the owners can defer their capital gains indefinitely by reinvesting the proceeds in qualified replacement property (QRP) within one year. QRP includes most stocks and bonds issued by publicly traded domestic operating companies.

Pros and cons for S and C corporations

ESOPs offer some remarkable opportunities for banks organized as S corporations. Notably, as pass-through entities, S corporations pay no entity-level taxes. Instead, shareholders report their share of the corporation’s profits, losses and other tax attributes on their personal income tax returns. Being tax-exempt, an ESOP wouldn’t pay tax on the S corporation’s profits.

One significant disadvantage for S corporations (over their C corporation counterparts) is that owners can’t defer the gain on the sale of their stock to an S corporation ESOP.  Additionally, the contribution limit to an S corporation ESOP is 25% of compensation for both principal and interest. There are a plethora of other considerations for both S and C corporations, which will require the advice of your bank’s financial and tax advisors.

 

View other Regional Bank blog posts 

  

View our Financial Institutions Services Page

 

Scott N. Drake, CPAScott Drake, CPA, is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Scott joined SEK&Co in 1975. He is the lead member of the Financial Institution Services Group Team which has extensive experience providing services such as external audits, SOX 404 exams, outsourced internal auditing, loan reviews, IT exams, ACH & BSA exams, SEC compliance and reporting, and taxplanning and compliance.   

 

Flashback Fridays: Opening New Waynesboro Office - 2/4/87

 

From left to Right:  Peggy B. Corley, Linda M. Bennett, Terry T. Eisenhauer, Charles L. Strausbaugh, Ronald S. Kearns, Paul R. Luka, Merle S. Elliott.

Waynesboro office1 resized 600

Hidden Assets and Liabilities Affect Business Valuation

 

To determine what a business is truly worth, appraisers must consider many aspects of its operations — from management, to products, to the health of its industry. They also need to look beyond the balance sheet, seeking any hidden assets or liabilities that may affect value and bringing them to light.

Whether in divorce matters or other kinds of litigation, appraisers often need to search for business valuationunusual, nonrecurring events in a company’s financial statements.  Such searches can provide a clearer picture of the company’s normal operations and help ensure the numbers better reflect reality.

Unearth hidden assets

An appraiser starts with the line that reports total net worth on a company’s balance sheet.  That’s the upfront part of the equation. From there, the appraiser hunts for unrecorded liabilities or contra assets, such as those with a negative credit balance. Here are several areas to examine:

Uncollectible receivables. Customer and factory receivables — those related to warranties and incentives — make up a significant portion of many companies’ total receivables. Holding items on the books that are overaged, and that the business is unlikely to collect, misrepresents its overall financial picture.

Management should review accounts receivable regularly to determine which accounts they probably won’t collect, and then adjust the allowance accordingly. The result after the adjustments is the net realizable value of the receivables.

Inventories. Of course, inventories make up an important part of many companies’ net worth. The prevalent use of the last-in, first-out (LIFO) method for valuing inventories could result in undervaluation if proper adjustments aren’t made. Thus, it’s usually proper to adjust inventory in accordance with the first-in, first-out (FIFO) method.

buy sell agreementFixed assets. For book purposes, companies may record depreciation on fixed assets (such as furniture, fixtures, tools and equipment) in several ways. Net book value, for instance, will usually differ drastically from the actual fair market value. This difference would alter the business’s net worth. The appraiser compares the net book value of a company’s fixed assets with their fair market value.

Fine-tune the value

After a valuator makes a preliminary estimate of a company’s value, he or she considers additional fine-tuning. Before finalizing the conclusion, the valuator assesses exactly what the preliminary value estimate includes. If anything is missing, the valuator makes a last-minute alteration.

Common last-minute alterations include changes to:

  • Excess/deficit working capital (compared with the company’s operational needs),
  • Contingent or unrecorded assets and liabilities,
  • Nonoperating assets, and
  • Real estate (if most industry participants rent their facilities).

When making last-minute adjustments, a valuator also adjusts the earnings for any income or expenses these assets or liabilities generate, including any tax benefits or consequences.  At this point the valuator can provide a more definitive business valuation.

Dig up the truth

Digging up hidden assets and liabilities will likely lead to a fairer presentation of a business’s succession planning true value. To make the appropriate adjustments, an appraiser needs to perform detailed analysis and have a good overview of the company’s current and future operations.

 

Sidebar: Detecting fraud

In marital dissolution cases, valuators may have to watch out (and adjust) for spouses trying to dissipate their businesses’ values. For instance, the moneyed spouse may attempt to hide business assets, delay revenue recognition or overstate expenses.

A lower bottom line benefits a moneyed spouse in two ways. First, to the extent that a company’s value is based on its earnings, reduced income lowers value.  Therefore, low profits increase a moneyed spouse’s share of the marital estate’s remaining assets. Some moneyed spouses will even hide physical assets or use fraudulent accounting tactics to lower profits reported before their divorce.

Of course, the nonmoneyed spouse has less experience and knowledge of the business, and such a charge may be baseless. But to determine whether the claim is justified or is completely without merit, valuation — and forensic accounting — expertise is essential.

 

View Other Valuation and Succession Planning Blog Posts

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Jacob KaufmanJacob Kaufman, CPA, CVA is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Jake joined SEK&Co in 1989. He is the lead member of the Business Valuation Team and serves as a consultant to the Accounting Services and Tax Departments in the firm's Chambersburg office. Jake's valuation experience was learned through years of study and practical experience. In addition to valuation theory and implementation, Jake possesses the relative tax, finance, and accounting experience necessary to perform a thorough quality valuation.

 

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