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Benchmarking Performance in Business Valuation

One way to gauge company-specific risk is to benchmark financial performance over time and against competitors. In turn, the risk assessment helps an expert estimate the subject company’s expected return. Here are critical benchmarks that business valuation experts monitor when valuing a private business.

Profitability

Profitability metrics evaluate how much money the subject company earns from each dollar in revenue. For-profit companies need to earn enough to cover fixed and variable costs, but some may accept a loss on certain products to gain market share or lure customers.

For example, a consumer product manufacturer might not make much money from selling a razor base — in fact, these may be given away for free or for a nominal amount. But the manufacturer makes up for the loss when it sells replacement blades and complementary products with a hefty margin.

Common profitability metrics include:
• Gross margin [(revenue – costs of sales) / revenue], and
• EBITDA margin (earnings before interest, taxes, depreciation and amortization / revenue).

Profit margin (net income / revenue) may be less relevant when benchmarking private firms, because it’s hard to compare companies with different tax structures. So, EBITDA may be used instead. This also eliminates from the analysis the effects of accelerated first-year depreciation deductions for private companies that have recently acquired major fixed assets — as well as the effects of differing interest rates between the subject company and its comparables.

Liquidity

The income statement tells only part of the story. Business valuation experts also spend significant time dissecting the balance sheet, starting with working capital metrics. To the extent that current assets exceed current liabilities, the subject company has extra cushion (or liquidity) to weather short-term cash shortfalls and adverse events.
Conversely, when a company’s current ratio (current assets / current liabilities) is less than 1, a line of credit might be needed in case of emergency. A business with above- or below-average liquidity may warrant an adjustment for excess or deficit working capital. It’s also important to evaluate the composition of working capital for bad debts, obsolete inventory and shrinkage.

Asset management

Business valuation experts also consider how much revenue is generated for each dollar invested in assets (revenue / total assets). This analysis can be broken down by different categories of assets and evaluated in terms of days (rather than the number of times an account turns over). For example, an expert might compute:

• Days in receivables [(average receivables / annual revenue) × 365 days], or
• Days in inventory [(average inventory / annual cost of sales) × 365 days].

Productivity metrics also can be industry specific. For example, a hospital might be evaluated based on revenue per bed or a hotel based on revenue per room. A labor-intensive manufacturer might be evaluated in terms of output per worker. Human capital isn’t reported on the balance sheet, but it can be a valuable asset.
Leverage

Debt can be an inexpensive alternative to equity financing that helps the business grow and lowers the cost of capital. Typically, the cost of debt is less than the cost of equity. That’s because debtholders are paid before equity investors in a liquidation. Plus, interest expense is generally tax deductible. (Dividends paid to equity investors aren’t tax deductible.) However, the cost of debt may become prohibitive as the debt-to-equity ratio increases.

For tax years that begin in 2018 or later, the Tax Cuts and Jobs Act generally imposes new limits on interest expense deductions for businesses with annual gross receipts over $25 million. Additional rules and restrictions apply, and there are some exceptions. For certain businesses above this threshold, the change could increase the cost of debt capital.

Borrowing money can be a cost-effective way to grow a business. But there are limits. At some point, the cost of debt capital becomes prohibitive, and creditors may be unwilling to lend additional funds.

It’s all relative

When benchmarking financial performance, what’s “normal” varies depending on the company’s size, industry and geographic location. Business valuation professionals understand these nuances and how they affect a company’s perceived risk and expected return. Contact a trained specialist for more information on how financial benchmarking is used to value a business.

Ohio Senate Celebrates Holbrook & Manter’s Centennial

The Ohio State Senate has formally congratulated Holbrook & Manter on our 100 years of innovation and economic development in the state.

Breaking Down Barriers, Building Up Businesses

This past century of success is a testament to our neverending dedication to our clients. Holbrook & Manter’s unique ability to uphold its foundational traditions while leading the way when it comes to accounting ingenuity has allowed us to thrive throughout Central Ohio – and we look forward to continuing to serve our clients on a personable level with a long-term vision.

Here’s to Another 100 Years of Tradition & Innovation!

 

QBI and the Rental Real Estate Safe Harbor

 

 

By: Linda Fargo, Tax Manager

Is rental income Qualified Business Income (QBI)? The answer is, it depends.

Section 199A was enacted on December 22,2017 as part of the Tax Cuts and Jobs Act providing a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income (QBI), subject to certain limitations and netting rules.

The first step in the calculation of the deduction is for the taxpayer or relevant pass through entity (RPE) to determine whether they are engaged in a trade or business and, if so, how many trades or businesses.

Section 199A(d) defines a qualified trade or business as any trade or business other than a specified service trade or business (SSTB) or the trade or business of performing as an employee. There are two requirements for an activity to be considered a trade or business under Section 162: a profit motive and considerable, regular and continuous activity.

This provision raised the question as to when/whether an investment in a real estate business constitutes a qualified business for the QBI deduction, versus “just” being an investment?

Proposed regulations issued in August 2018 made some things clear:

  • Triple-net leases decrease the chances of a rental property rising to the level of a trade or business.
  • Real estate investors should keep track of their time (and the time of others) spent working on the real estate business to support their regular and continuous activity.
  • Real estate investors owning several units have a greater chance of the activity rising to “trade or business”.

So, merely owning real estate that generates income does not qualify as a trade or business.

On January 18, 2019 Section 199A guidance was released including Notice 2019-07. Notice 2019-07 proposes a safe harbor procedure that would treat a “rental real estate enterprise” as a trade or business solely for purposes of Section 199A.

A safe harbor is just that – not a true bright line test. Facts and circumstances prevail in all cases.

An enterprise that fails to satisfy the requirements of this safe harbor may still be treated as a trade or business for purposes of Section 199A if the enterprise otherwise meets the definition of trade or business in § 1.199A-1(b)(14) on a facts and circumstances, case by case basis.

Under the rules, the rental or licensing of tangible or intangible property to a related trade or business is
treated as a trade or business if the rental or licensing activity and the other trade or business are commonly controlled under Regs. Sec. 1.199A-4(b)(1)(i).

A rental real estate enterprise is defined, for purposes of the safe harbor, as an interest in real property held to produce rents. A rental real estate enterprise may consist of multiple properties. The interest must be held directly or through disregarded entity. Taxpayers either must treat each property held to produce rents as a separate enterprise or must treat all similar properties held to produce rents as a single enterprise. Commercial and residential real estate cannot be combined in the same enterprise.

Safe harbor to qualify Rental Income for the new 20% Qualified Business Income Deduction –
1. Maintain separate books & records;
2. 250 hours or more of rental services performed; and
3. Maintains contemporaneous records including time report logs or similar documents regarding

  • Hours of all services performed
  • Description of all services performed
  • Dates on which such services were performed
  • Information on who performed the services.

The contemporary records requirement will not apply to taxable years beginning prior to January 1, 2019.

Rental services include:

  • Advertising to rent or lease real estate
  • Negotiating and executing leases
  • Verifying information contained in tenant applications
  • Collection of rent
  • Daily operation, maintenance, and repair of the property
  • Management of the real estate
  • Purchase of materials
  • Supervision of employees and independent contractors

Rental services may be performed by owners, employees, agents and/or independent contractors of the owners.

The term rental service does not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.

Real estate rented or leased under a triple net lease is also not eligible for this safe harbor.

A taxpayer must include a statement attached to the return on which it claims the section 199A deduction or passes through section 199A information that the requirements have been satisfied. The statement must be signed by the taxpayer, or an authorized representative of an eligible taxpayer or RPE, which states: “Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”
Taxpayers may rely on the safe harbor, which generally applies to tax years ending after 12/31/17, until the proposed Revenue Procedure is published in final form. Notice 2019-7.

This article does not constitute a full and complete discussion of everything that someone would need to know about Section 199A and real estate leasing. The Section 199A rules have a number of requirements that may need to be met. For example, high earner taxpayers who wish to take a 199A deduction attributable to rental income will need to satisfy a wage and/or Qualified Property test that may require that they pay a minimum amount of wages and/or have a minimum amount of depreciable property based upon the original cost of depreciable components.

Posted in News

Fewer taxpayers to qualify for home office deduction

Working from home has become commonplace for people in many jobs. But just because you have a home office space doesn’t mean you can deduct expenses associated with it. Beginning with the 2018 tax year, fewer taxpayers will qualify for the home office deduction. Here’s why.

Changes under the TCJA

For employees, home office expenses used to be a miscellaneous itemized deduction. Way back in 2017, this meant one could enjoy a tax benefit only if these expenses plus other miscellaneous itemized expenses (such as unreimbursed work-related travel, certain professional fees and investment expenses) exceeded 2% of adjusted gross income.

Starting in 2018 and continuing through 2025, however, employees can’t deduct any home office expenses. Why? The Tax Cuts and Jobs Act (TCJA) suspends miscellaneous itemized deductions subject to the 2% floor for this period.

Note: If you’re self-employed, you can still deduct eligible home office expenses against your self-employment income during the 2018 through 2025 period.

Other eligibility requirements

If you’re self-employed, generally your home office must be your principal place of business, though there are exceptions.

Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a guest bedroom or your children do their homework there, you can’t deduct the expenses associated with that space.

Deduction options

If eligible, you have two options for claiming the home office deduction. First, you can deduct a portion of your mortgage interest, property taxes, insurance, utilities and certain other expenses, as well as the depreciation allocable to the office space. This requires calculating, allocating and substantiating actual expenses.

A second approach is to take the “safe harbor” deduction. Here, only one simple calculation is necessary: $5 multiplied by the number of square feet of the office space. The safe harbor deduction is capped at $1,500 per year, based on a maximum of 300 square feet.

More rules and limits

Be aware that we’ve covered only a few of the rules and limits here. If you think you may qualify for the home office deduction on your 2018 return or would like to know if there’s anything additional you need to do to become eligible, contact Holbrook & Manter today. 

Using an Installment Sale to Transfer Assets

Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.

Giving away vs. selling

From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.

But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.

Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.

Advantages and disadvantages

An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.

One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.

Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.

Simple technique, big benefits

An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.

Bear in mind, however, that this simple technique isn’t right for everyone. Holbrook & Manter can review your situation and help you determine whether an installment sale is a wise move for you.

The Benefits of Being on a Board

 

 

By: William Bauder, CPA, CITP, CGMA- Manager of Assurance and Advisory Services

I was recently elected to the board of the Greater Powell Area Chamber of Commerce. I join the ranks of other H&M team members who currently do, or have in the past, sat on chamber boards. As a firm, we strongly believe in supporting the communities where our offices are located and those that our team members call home. I have been active with the Greater Powell Area Chamber of Commerce for some time now, and I am excited to take my commitment to them and their member businesses to the next level.

My recent election got me thinking about some of the reasons why any professional should consider volunteering for a chamber board, or a board of any non-profit organization for that matter. The reasons to be a board member are many and vary from person to person. For me, the following elements drive my board involvement: 

· Being a board member allows me to give back to the community. Again, our firm stands strong in our commitment to giving back and personally, it is very important to me as well.

· Becoming a board member allows me an opportunity to exercise my leadership skills. Keep this key component in mind when you consider joining a board. Having a seat at the table allows you to share your experiences and professional insight.

· Being on the board allows me to network on a frequent basis with other professionals. Networking isn’t just about sharing referrals and leads. It is about getting to know others both in my field and in other fields. Those relationships help to mold me as a person and as a professional.

·  My board commitment ensures that I am being kept up-to-date on happenings around the community. The more I know about what is taking place, the more I can be present and helpful as a board member.

·  The exercise of interacting with others from different professional and civic backgrounds is invaluable and rewarding. Being a board member allows you to stop, look around, and appreciate and learn from those you sit at the table with.

I look forward to my time as a board member and would encourage anyone else to be of service in the same capacity if it is appealing to them. Giving back and growing on a professional and personal level… it doesn’t get much better than that.

If you are looking to join a board, feel free to reach out and we can point you to various resources available or connect you with others in our network who are currently looking for great volunteers.

Tax Filing Season Set to Kick Off on January 28

While the U.S. Government is still shutdown, the Internal Revenue Service is taking the proper steps to make sure that tax filing season begins this month. The IRS has set January 28, 2019 as the official start date for the season.

This means the IRS will begin accepting tax returns on that date and up until the filing deadline, which is April 15, 2019. This eliminates the fear that there would be a delay in processing returns and issuing refunds due to the shutdown.

The IRS shares the most recent detailed information about this latest development at the link below. As always, reach out to Holbrook & Manter with any questions you may have.

https://www.irs.gov/newsroom/irs-confirms-tax-filing-season-to-begin-january-28

Government Shut Downs Causes the IRS to Press Pause

The recent government shut down has halted operations for a large portion of the Internal Revenue Service (IRS) and given that tax season is fast approaching, this is concerning to both tax preparers and taxpayers. Let’s talk about what we know currently….

Help is sparse at the IRS with only a handful of staff members working- most without pay.  With so few hands on deck and a government that is not fully operational, you guessed it- tax documents aren’t churning. Refunds aren’t being issued. The phone lines are not open.

As for us here at Holbrook & Manter…. like most accountants right now would likely tell you… we wish the circumstances were different heading into tax season. The passage of the Tax Cuts and Jobs Act (TCJA) already presented many changes for tax preparation, and the shutdown certainly complicates things a bit.  However, we are up for the challenge and our commitment to client service will keep us focused on navigating this situation.

The IRS usually announces the opening of tax season around this time each year. The announcement is our cue to begin filing returns electronically. The announcement is the official “let the games begin” for all taxpayers. Due to the shutdown, that announcement has yet to be made.

While we await word, it will be as close to business as usual here at Holbrook & Manter. The shutdown could cause some delays during tax season, but it won’t take the need to be timely out of play.  The TCJA presents major overhauls to the tax code and we won’t be taking our eye off the prize, which is keeping our clients compliant.  We will still be preparing returns for our clients during the shutdown.

Should the shutdown drag on far into the filing season, taxpayers need to be aware that refunds will be delayed because they won’t be processed and issued until operations resume. This is likely not the year you can be certain of a timeframe for your refund to arrive. Planning to spend your refund dollars at a specific time is not advisable this year.

We are still holding tax planning meetings with our valued clients, we are still accepting new tax clients, we are still armed with a talented team that is aware of tax reform…. they will make this unconventional tax season a seamless one for those we work with.

We are monitoring the situation with the shutdown closely and will keep you informed. If you have any questions at all, please reach out to us.

H&M Team Donates Holiday Toys to Nationwide Children’s Hospital

Our commitment to helping those receiving care at Nationwide Children’s Hospital continues on with a donation of toys just in time for the holidays. H&M team members have been collecting toys since just after Thanksgiving.

The boxes you see in the pictures below were filled with many fun items. Coloring books and card games… legos and hot wheels… puzzles and board games. We didn’t forget about the littlest patients, as light up toys, teethers and rattles rounded out our annual toy donation.

H&M’s Jennie Schott and Molly Pensyl hand delivered the toys on behalf of the entire H&M team. The hospital does an amazing job of making the donation process an easy one, complete with a designated donation drop off point and and friendly people to greet and thank you.

It was our pleasure to donate all of these fun items!  It is our hope that they brighten up the holiday season for the kiddos and families at Nationwide Children’s Hospital.

 

 

 

 

Things to know about TCJA and personal exemptions

The Tax Cuts and Jobs Act (TCJA) made many changes to tax breaks for individuals. Let’s look at some specific areas to review as you lay the groundwork for filing your 2018 return.

Personal exemptions

For 2018 through 2025, the TCJA suspends personal exemptions. This will substantially increase taxable income for large families. However, enhancements to the standard deduction and child credit, combined with lower tax rates, might mitigate this increase.

Standard deduction

Taxpayers can choose to itemize certain deductions on Schedule A or take the standard deduction based on their filing status instead. Itemizing deductions when the total will be larger than the standard deduction saves tax, but it makes filing more complicated.

The TCJA nearly doubles the standard deduction for 2018 to $12,000 for singles and separate filers, $18,000 for heads of households, and $24,000 for joint filers. (These amounts will be adjusted for inflation for 2019 through 2025.)

For some taxpayers, the increased standard deduction could compensate for the elimination of the exemptions, and perhaps even provide some additional tax savings. But for those with many dependents or who itemize deductions, these changes might result in a higher tax bill — depending in part on the extent to which they can benefit from enhancements to the child credit.

Child credit

Credits can be more powerful than exemptions and deductions because they reduce taxes dollar-for-dollar, rather than just reducing the amount of income subject to tax. For 2018 through 2025, the TCJA doubles the child credit to $2,000 per child under age 17.

The new law also makes the child credit available to more families than in the past. For 2018 through 2025, the credit doesn’t begin to phase out until adjusted gross income exceeds $400,000 for joint filers or $200,000 for all other filers, compared with the 2017 phaseout thresholds of $110,000 for joint filers, $75,000 for singles and heads of households, and $55,000 for marrieds filing separately. The TCJA also includes, for 2018 through 2025, a $500 tax credit for qualifying dependents other than qualifying children.

Assessing the impact

Many factors will influence the impact of the TCJA on your tax liability for 2018 and beyond. For help assessing the impact on your situation, contact us Holbrook & Manter.