Issues for Consideration in Year-End Tax Planning
History of the Bad Debt Conformity Election for Banks
The conformity election for banks was added to the Treasury Regulations in September 1991 under Treas. Reg. Section 1.166-2(d)(3). The election was added as a result of the banking industry’s request for conformity in the accounting for bad debts for financial statement/regulatory purposes and tax purposes. The Regulation was added by the IRS in an attempt to reduce the amount of disagreements stemming from the timing of bad debt deductions for loan losses.
Pros of the Conformity Election
The conformity election allows for banks to have a safe harbor when deducting worthless loans. If the conformity election has been properly elected, any loan loss deductions recognized for financial statement or regulatory purposes is also a taxable deduction, in the same year. Without the conformity election, the deductibility of the loss could be deferred to future tax years.
The conformity election could also allow conformity in the financial statement/regulatory treatment of non-accrual loan interest. Meaning, typically, when a loan is moved to non-accrual status, the taxpayer is no longer required to continue to recognize the interest income related to the loan for tax purposes or regulatory purposes.
Cons of the Conformity Election
One of the disadvantages related to the application of the conformity election relates to limited flexibility for planning in the bad debt area. In the cases of a taxpayer with an NOL carry forward or a taxpayer subject to Section 382 built-in loss regulations, taxpayers may choose to not deduct the loan loss on their tax return until the loan is wholly worthless. However, if the conformity election has been applied, any partially worthless loan loss must be deducted in the year the loss is deducted for financial statement or regulatory purposes.
How to Adopt the Conformity Election
In order for a financial institution to elect the conformity election, the taxpayer must obtain an express determination letter from its primary regulator. The express determination letter is obtained in correlation with the most recent regulatory exam and states that the bank is maintaining and properly applying the loan loss classification standards consistent with regulatory standards in agreement with the regulator. After the express determination letter is obtained, the taxpayer must then complete and file the Form 3115 to properly change their method of accounting to agree with the conformity election Regulation.
Future of the Conformity Election
Since 1991 when the conformity election was added to the Treasury Regulations, bank regulators have adopted changes to the loan loss regulations. As a result, in 2013, the Internal Revenue Service issued Notice 2013-35 regarding the conclusive presumption of worthlessness of debts. The purpose of the Notice was to request public comments on Treasury Regulations 1.166-2(d)(1) and (3). In particular, the IRS requested comments regarding whether changes have occurred in banking regulatory standards and processes since the adoption of the Regulations, if the Regulation remained consistent with principles of Section 166, and whether the Regulation application applied to other types of entities. The comment period related to this Notice was closed in October 2013; however, as of now, there are no changes to the conformity election as a result to the Notice or the comments.
If you would like more information, please contact our firm.
Luke C. Martin, CPA
Member of the Firm
Smith, Elliott Kearns & Company, LLC
804 Wayne Avenue, Chambersburg, PA 17201
Phone: 717-263-3910, ext. 2150
Nicole E. Wilson, CPA
Smith, Elliott Kearns & Company, LLC
804 Wayne Avenue, Chambersburg, PA 17201
Phone: 717-263-3910, ext. 2155
Stock-based compensation has been used for many years to attract employees. But the practice reached a peak in the early 1990s as legislation, accounting practices and a proliferation of fledgling technology firms converged to cement the granting of stock options as a mainstream compensation strategy.
In 2006, the accounting rules changed, requiring companies to value options at the time of the grant instead of at the time they are exercised. Since there is no longer a significant earnings benefit to using stock options, many companies now use restricted stock as a common form of compensation.
Today, business valuations often include the valuation of stock-based compensation in various forms, including stock options, restricted stock and phantom stock.
How It’s Done
One of the keys to a business valuation is understanding the company’s big picture. Stock-based compensation — in any form — must be carefully considered because, as a claim on equity, it can significantly affect the value of a company.
According to valuation guru and NYU Professor Aswath Damodaran, the best way to deal with stock-based compensation in a discounted cash flow valuation is to “recognize its two-layered impact on value per share.”
Damodaran suggests that if the company is going to continue to compensate employees with options or restricted stock, forecasted earnings and cash flows for the company will be lower than for a company that doesn’t compensate employees in that way. Damodaran notes, “The lower cash flows will reduce the value of the business and equity today.”
Damodaran also describes what he calls the “deadweight effect” of options on the value of a company that has granted employees stock options in the past, and the options are still “live.” He explains that these options represent a claim “that must be netted out of equity to arrive at the value of the common stock. The latter should then be divided by the actual number of shares outstanding to get the value per share.” (Damodaran notes that restricted shares can simply be included in the outstanding shares.)
He continues, “While it may seem like you are double counting options … you are not.” He explains, “In fact, if a company stops using equity-based compensation after years of option grants, the first effect (on earnings/cash flows) will stop, but the second effect (the ‘deadweight’ effect of outstanding options) will continue until all of the options either expire or are exercised.”
The reality of valuing stock-based compensation is not always straightforward. Particularly in smaller companies, recordkeeping may be limited and some of the details, restrictions and agreements about shares and vesting may be lost. Because of their flexible nature, phantom stock grants are often incompletely documented or ambiguously worded, and disagreements over the intent of the granted stock are not uncommon.
If a business valuation includes stock-based compensation, be sure your valuation analyst is experienced and familiar with the valuation techniques required to account for the options and shares in question. As Damodaran cautions, “There are no free lunches, and if a company chooses to pay $5 million to an employee, that will affect the value … no matter what form that payment is in — cash, restricted stock, options or goods.”
If you would like more information about the valuation of stock-based compensation, please contact our firm.
Source: Aswath Damodaran, “Musings on Markets: Stock-based Employee Compensation: Value and Pricing Effects,” February 2014.
Jacob H. Kaufman, CPA, CVA, Member of the Firm
Smith Elliott Kearns & Company, LLC
804 Wayne Avenue, Chambersburg, PA 17201
Phone: 717-263-3910, ext. 2134
Now that Hi Bracket has retired, his tax return is pretty simple. Recently he got an offer to sell some land he owned, which had been handed down through the family for many years and had a large gain associated with it. He knew it would be a capital gain which was generally taxed at 15% (pretty good rate) so he decided to take the money and run. He went ahead and paid the federal and state estimated tax on the gain. But when his tax return was prepared, the tax he owed was way more than the 15% on his $500,000 gain! Now what went wrong?
Lots of “bad” things can happen when income shoots way up, all of which cost money. He learned that his rental loss deduction on the property was no longer allowed. He got no personal exemptions, he didn’t get all of itemized deductions, part of the capital gain was taxed at 20%, not 15% and he owed an extra 3.8% on the gain for what is commonly called the Obamacare tax. To make things worse, the Alternative Minimum Tax (AMT) kicked in so he got no federal benefit from paying his state income tax. And to add insult to injury, his Medicare premiums will triple for the following year!
The Better Way would be (you guessed it) to have the calculations done up front. The timing of when a sale takes place can affect the timing of estimated payments which can allow the federal benefit to be deferred to a year when AMT isn’t applicable. Also, to spread the gain into more than one year could keep income lower, saving the higher tax rates and even help the Medicare premiums. Heck, rental losses might be deductible, exemptions available and even things like child credit and education costs might not be wiped out!
If you are considering an unusual transaction, please check with us up front to save as much as possible.
The Department of Labor (DOL) and Internal Revenue Service (IRS) allow retirement plan participant disclosures and notices to be delivered electronically. This may be an effective way of reducing the time and expense involved in providing all of the required communications to the participants in your retirement plan. Some of the items that may be sent electronically rather than in paper format include the following:
- Participant Statements
- Safe Harbor Notice
- Participant Fee Disclosures under 404(a)(5)
- Qualified Default Investment Alternative (QDIA) notices
- Summary Plan Description (SPD)
- Summary of Material Modifications (SMM)
- Summary Annual Report (SAR)
Electronic Disclosure Rules
Complying with the following rules will ensure that the use of electronic communication meets DOL and IRS standards:
At the time that the participant receives the electronic notification, they must also be notified of what they are receiving and why it is important. This may be done in the body of an email that is sent to the participant.
Every participant should also be told that they have the right to request a paper copy of the disclosure if they would like.
The electronic delivery system should be designed in such a way as to ensure that the participant’s personal information is handled in a confidential manner and that the electronic communications are actually received. This may be accomplished through periodic surveys to confirm receipt or by sending the disclosure email with return receipt enabled.
Selecting Which Notices to Send Electronically and to Whom
Deciding to send disclosures and notices electronically is not an all or nothing proposition. You can choose to send a particular disclosure electronically and continue to disseminate other disclosures in the traditional paper format. In addition, you may elect to send disclosures electronically to some participants (e.g. current employees) while sending those same disclosures in paper format to other participants (e.g. former employees who retain a balance in the plan).
Whether or not you need to obtain the participant’s consent to electronic communication depends upon whether or not they have a computer at work that they have access to at any location where they are expected to perform their duties as employees. If they do, then consent is not required. Merely having access to a computer at the workplace is not sufficient; the computer must be at their designated workstation(s) and the use of the computer must be an integral part of their job. For any participants who do not meet this standard, such as former employees or current employees who do not use a computer at work, consent is required before you are able to electronically provide disclosures and notices.
Getting the Plan Participant’s OK
If consent is required, then you will need to have a system in place to collect and track the participants’ responses so that you are able to prove that a participant consented to electronic delivery. To obtain participant consent to electronic delivery, you may either send an email or a letter to the participant that includes the following:
- A list of the notices / disclosures to which the consent applies
- A notification to the participant that they may withdraw their consent at any time for no cost and instructions on how to do so
- Information on how to update their contact information for electronic delivery or physical delivery
- A notification to the participant that they may receive a paper copy of any notice / disclosure at any time and the cost of the paper copy (if applicable)
- Information on any hardware/software requirements for accessing and retaining the documents
The rules for obtaining consent and maintaining records of that consent make it difficult for plan sponsors to comply. Therefore, many sponsors who provide disclosures electronically to current employees who use computers as an integral part of their job continue to provide disclosures to everyone else in the traditional paper format by either handing them out or via first class mail.
Nathan T. Gage, QKA, MBA works in the firm's Retirement Plan Services Group. He joined the firm in 2014, bringing with him over 11 years of experience in retirement plan services and business analysis. His responsibilities include the design, implementation and third party administration of retirement plans. Nate holds the ASPPA designation as a Qualified 401(k) Administrator (QKA), which is offered to retirement plan professionals who work primarily with 401(k) plans.
Implementation should be completed no later than October 31, 2014
Federal regulators have issued final guidance on income tax allocation agreements involving holding companies and insured depository institutions to reduce confusion regarding ownership of tax refunds.
In 1998, the interagency policy statement said that a holding company that receives a tax refund from a taxing authority obtains these funds as an agent for its subsidiary insured depository institutions and other affiliates. The new guidance instructs the insured depository institutions and their holding companies to review their tax allocation agreements to ensure:
1. Agreements expressly acknowledge that the holding company receives any tax refunds as agent.
2. All bank organizations insert specific language in their tax allocation agreements to clarify refund ownership.
3. Clarity on how certain requirements of sections 23A and 23B of the Federal Reserve Act apply to tax allocation agreements between depository institutions and their affiliates.
We are here to help with implementation. For questions about how the new guidance affects your institution, contact Luke C. Martin, CPA, Member of the Firm, or Nicole E. Wilson, CPA, Supervisor at 717-263-3910.
Click here to download the complete addendum.
Luke C. Martin, CPA Nicole E. Wilson, CPA
Governor 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.
Employers 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 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.
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 Task 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 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.
As 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
Are 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.