Financial literacy in today’s economic climate is more than just receiving reconciled accounts in periodic financial statements from your accounting firm. It is the ability to know where you are today, where you are going, and the plan to achieve it. To achieve your goals, you need to invest in a system, process and an advisor who can relay knowledge to you in a way that is easy to understand. This will allow you to change direction, set measurable goals and celebrate your successes.

Understanding the Relationships in Your Financial Statements

Business owners often get caught in the weeds and believe the way to solve a problem is by digging deeper into the soil. Have you ever paused to look at the key financial drivers that are causing the problem? Understanding the underlying problem and the impact it is having on your business is key. A skilled accounting firm has the ability to educate you on the meaning behind the numbers reported in your financial statements.

Accounting is based on a double entry system, meaning we must have a debit and credit that are in balance. You can also think of accounting as the study of financial relationships, meaning as we debit one account, we have a corresponding credit in another. To provide meaning we need to understand the relationships. Your financial statements are simply the summation of your transactions for a given period. By taking these financial statements and using ratios or non-financial data, you can begin to unravel the context behind these relationships – allowing you the opportunity to transform your business.

Here’s an Example

In the restaurant industry the key components of cost of goods sold includes food, beverage, paper goods and labor costs. The summation of these costs is also referred to as the prime costs. Often, your financial statements may report these costs on one line called cost of goods sold. By performing a simple ratio such as cost of goods sold divided by sales, we can determine how efficiently we are utilizing our resources to generate sales. By benchmarking this ratio month after month, we can begin to identify changes in the ratio that may need to be investigated. The benchmarking can be against your own data but should also be compared against industry data to better evaluate how you are performing.

To bring even more meaning to the relationships within cost of goods sold, you will need to investigate costs in more detail. One way to do this is to extract data on your costs individually such as having a food cost percentage to sales along with separate calculations on beverage, paper goods and labor. As these ratios fluctuate over time, you can determine the reason why and how it may affect your future selling prices. The outcome of this analysis may lead you to raise prices, change a supplier or review labor schedules.

You can also track non-financial data such as number of patrons served, number of hours open, and facility square footage. When comparing the non-financial data to sales we can get average sales per patron, per hour and per square foot. These averages can be compared over a period of time to gain an understanding of changes in your business or peak times for your business. This information in turn can be used to schedule your workers, order inventory or even adjust your restaurant hours.

The Role of Your Accountant

Your accountant can provide significant value by educating you on ratio and non-financial data to help you analyze your financial statements and guide you in discussing the efficiency of your business, forecasting operating results and providing the strategic direction for your business. We often refer to these tools as key performance indicators (KPIs). By tracking KPIs on a regular basis and keeping ongoing communication with your accountant, you can begin to understand the relationships in your financial statements. This understanding will provide you the ability to make decisions in your business that will allow you to track the realization of your strategic goals.

If you are not already having these discussions with your accountant, now is the time to tap into the value they can provide. As you begin the new year, we recommend identifying KPIs to track. Please contact Cray Kaiser today if you would like to discuss your financial reports.

The Tax Cuts and Jobs Act of 2017 – with its many changes impacting the 2018 tax year and beyond – brought the Qualified Business Income deduction (sometimes called the QBI deduction or 199A deduction). This new deduction can be up to 20% of the net income of a qualified business, meaning only 80% of your QBI is taxed on the federal level. But, if you are a real estate investor you are probably wondering if this deduction will apply to you. The answer is, of course, not so simple.

Defining a Qualified Trade or Business

The biggest limitation of the QBI deduction is that it only applies to a “qualified trade or business”.  There is not a lot of clarity within IRS regulations in determining what exactly is a trade or business in the real estate arena and there are many unique situations concerning real estate.

The IRS cites “key factual elements” that are relevant to whether an activity is a trade or business: (a) the type of property (commercial versus residential versus personal); (b) number of properties rented; (c) day to day involvement of the owner or agent; and (d) type of lease (triple-net versus traditional).  Therefore, due to the large number of actual combinations that exist in determining whether a rental activity rises to the level of a trade or business, the IRS says bright-line definitions are impractical.

Below are a few example situations that demonstrate when real estate investments would likely or likely not pass as a qualified trade or business.

1. If an investor owned a single property and it was leased under a triple-net lease with an unrelated party, it would likely NOT qualify as a trade or business. In a triple-net lease, the tenant pays the owner rent and the tenant is also responsible for the real estate taxes, repairs and maintenance of the property. The investor activity is generally limited to the collection of rent. Upon audit it would be difficult to prove these rental activities constitute a trade or business.
2. If in the above situation the triple-net lease was associated with a qualified trade or business with at least 50% common ownership, the rental property would not be excluded from the QBI deduction as this would be a trade or business under the new rules. If the income comes from multiple tenants, one being a related party and one being unrelated, only the portion attributable to the related party will be considered to be an active trade or business.
3. If a real estate investor was a retired individual who owned and rented five residential properties and regularly maintained the properties, collected rents, paid bills and found tenants, there likely would be a strong argument that this would constitute a trade or business. This individual should keep a log of their daily activities relating to the rental properties should they need to later prove their participation under audit.

We can help you determine if your rental activity facts and circumstances can give rise to a trade or business and thus allow you to be eligible for QBI. If you are not eligible, we can develop some operational strategies which can allow you to qualify for the deduction. Please contact us today at 630-953-4900.

Fraud. The dreaded word that none of us are comfortable addressing or discussing, especially when it comes to how it may impact you or your business. But it’s important not to avoid conversations about fraud. Why? Because several studies and statistics support that businesses may lose approximately 5% of their revenues every year due to fraud. And when fraud is concealed, it may continue for years before being discovered. Further, fraud remains a strong indicator as to the failure of a business. Although attempts are made to recover, many businesses cannot overcome the negative impacts both financially and reputationally and are ultimately forced to close their doors within a few years.

So, what can you do to prevent fraud?

First, it’s important to remember that no controls or systems are perfect. Due to limited resources and personnel, opportunity for fraud will always exist. Thus, as technology and the ways of doing business continue to evolve, so too must your control processes and procedures. Periodic and systematic evaluations and assessments of your controls should be designed to mitigate or detect misstatements or misappropriations in a timely manner. So, while a control may not prevent fraud, it will at least detect it quickly so that you can take appropriate action.

Here are a few suggestions we recommend when it comes to preventing fraud:

• Assess Your Business: It all starts with an honest self-assessment of your business. Where are you vulnerable to fraud? What internal controls do you currently have in place? By assessing the nature of your business and where you are most susceptible, you can begin to plan and design internal controls to mitigate those risks.

• Create the Internal Controls: A system of internal control remains the most important deterrent to fraud. Make sure to set clear roles and responsibilities for employees and segregate duties that overlap and create opportunity for fraudulent activity. For example, personnel responsible for paying vendors should not also be reconciling the bank account. Or, personnel responsible for ordering product should not also be signing or receiving the delivery.

• Document Policies and Procedures: Put your policies and procedures into written and approved documentation. Conflicts of interest, fraud reporting and whistleblower protection are a few examples of vital documents to create and share with your employees. Remember, no two businesses are alike and throughout your assessment processes there must be consideration of your specific risks and vulnerabilities. You should also consider the “cost/benefit” relationship of the controls developed. In other words, does the cost of your internal control appropriately match the risk of fraud? Consult your accounting team for help with this step.

• Be observant: Don’t assume that someone you have known for years isn’t capable of fraud. While you don’t want to create a judgmental environment, you also don’t want to let your guard down. Pay attention to your team and make note if someone’s behavior has drastically changed. Open communication among employees and regular check ins with management will help keep opportunity for fraud low.

If you have any questions or would like to know how Cray Kaiser can help you develop and implement internal controls, please contact us today.

Your business partner(s) should balance your strengths and support you through the good times and the bad. They should also be willing to communicate with you freely and often. And while you and your partner may agree about everything now, disagreements and unexpected events are inevitable. That’s why a written partnership agreement is so valuable. Do you and your partner(s) have one?

The Value of Your Partnership Agreement

The need for a partnership agreement can be summed up in two words: things change. It’s important to sit down now and hammer out potential scenarios and solutions in a written agreement. You never know what the future may hold for you, your partner(s) or your business. Your agreement will make sure that you have a plan ready no matter what may come your way.

What to Include

A partnership agreement should anticipate major business changes and spell out how to deal with them. The agreement should also indicate what initial capital contributions (or services) will be made when additional capital contributions will be required, and how profits and losses will be shared.

Questions to discuss include:

• What are the rights and obligations of the other partner if one partner passes away?
• Under what circumstances can a partner leave, retire or be expelled?
• What are the financial arrangements for departing partners?
• How long must an ex-partner wait before starting a competing business?

A partnership agreement can’t address every possible contingency, so consider an arbitration clause to handle disputes that you and your partner aren’t able to resolve on your own. Without such a clause, your only alternative could be costly litigation.

With a carefully designed partnership agreement, your business will run more smoothly and provide you and your partner(s) with peace of mind. Your attorney can assist you with the legal aspects of the agreement and you can contact Cray Kaiser with questions regarding your finance and tax-related aspects.

As your business grows, you may find yourself hiring employees out of state. While the growth associated with having an employee in another state is great, keeping up with the payroll compliance in each state can feel like trudging through murky waters. States have varying requirements related to withholding income tax and paying unemployment tax.  Additionally, states have increased their tax compliance efforts over the years making it even more necessary that employers be aware of their responsibilities. So, if you have an out-of-state employee, here’s what you need to consider:

Where does the employee work?

Generally, you are required to withhold income tax and pay unemployment tax in the state in which the employee physically works. Makes sense, right? But it’s not always so straightforward. If your employee travels into several states, you need to be familiar with each state’s requirements. Some states require withholding from the first day an employee works in the state while other states have thresholds (minimum numbers of days or minimum amount earned) that determine when withholding is required.

If your employee works in one state but lives in a neighboring state, he or she may have to file tax returns in both states. However, if the two states have entered into a reciprocal agreement, the employee would only need to file in the resident state.

What is a reciprocal agreement?

Some states have formed reciprocal agreements, which exempt employees from paying income tax on wages earned within the state if the employee lives in a bordering state. That means that wages are only taxed by the employee’s resident state. This simplifies compliance for the employee, who would otherwise be required to file income tax returns both in the resident state and the state in which the wages were earned.

What is a reciprocal exemption?

When an employee has a reciprocal exemption, the employer withholds income tax in the employee’s resident state but generally pays unemployment tax to the state in which the wages were earned. For example, consider an employee working in Illinois but living in Michigan. The employer would report the wages as Michigan wages on the payroll withholding reports, but the wages would be reported as Illinois wages for Illinois unemployment tax reports.

What else should I consider with employees in other states?

Payroll taxes are an obvious consideration when you have employees working in other states. You will also need to consider other workforce requirements of each state, including:

• Minimum wage, overtime, and equal pay requirements
• Employee rights posting requirements
• State disability requirements

Additionally, be sure your workers’ compensation policy includes all employees, even those working remotely. In the case of remote workers, be sure to inform your workers’ compensation company of the employees’ duties, work area and work hours.

Asking yourself these questions is the first step in being compliant with the states and also providing the best possible state withholding for your employees. Cray Kaiser is available to assist you when these issues come into play. Please contact us anytime at 630-953-4900.

Employee benefit plan (EBP) audits are much more than a simple audit of net assets and income contained in the benefit plan’s financial statements. They also serve as a safeguard to participants, plan management, and plan fiduciaries through compliance testing procedures. In addition to testing the plan’s operational compliance in accordance with DOL/IRS regulations and the plan document, auditors will also note areas for improvement in internal controls and other matters through written communications with management.

It is very important to operate the benefit plan in accordance with the DOL/IRS and plan document for many reasons, such as:

1. It prevents unnecessary fines and penalties, including personal fiduciary responsibility.
2. It protects the participants’ assets.
3. It prevents the plan from losing its tax-exempt status.

Cray Kaiser has extensive experience with EBP audits. Often, when we work with a new client on an EBP audit, it’s their very first benefit plan audit. We also see many cases where the client’s plan was previously audited by a firm without the training and expertise needed in the complex area of EBP audits. During the most recent audit season, we performed an EBP audit for a plan whose previous auditor had stopped performing EBP audits altogether. We discovered numerous operational deficiencies, which if left uncorrected could have jeopardized the plan’s tax-exempt status and potentially exposed the plan sponsor and fiduciaries to fines and penalties. We worked with plan management to identify corrections and processes to prevent the issues from occurring again. Internal control weaknesses were also brought to management’s attention.

Often, plan auditors are selected solely based on fees. While fees are an important consideration, there are other crucial factors to consider when selecting a plan auditor. EBP auditing is a specialized area with complexities not found in traditional audit engagements of company financial statements. For this reason, it is essential to select a firm that:

• has sufficient professional experience in auditing employee benefit plans.
• participates in regular training and updates in the EBP audit area.
• is independent and appropriately licensed.

At Cray Kaiser, we are committed to quality EBP audit engagements. Our highly experienced EBP audit team continually monitors developments and changes in the industry. Cray Kaiser is also a member of the American Institute of Certified Public Accountants’ Employee Benefit Plan Audit Quality Center, a select group that provides EBP audit resources and industry updates to member firms. Our experience and resources ensure that our EBP audit clients receive rigorous, precisely executed audits to support plan operations and help plan fiduciaries fulfill their responsibilities. If you would like more information on EBP audits, please contact us.

If you have the means, making extra payments on your mortgage before the end of its term seems like a no-brainer. After all, who wouldn’t want to reduce that substantial debt and be done with those monthly principal and interest payments? But paying off your mortgage early may not be the best choice for every household.

Before you start paying off your mortgage early, here are five questions to ask yourself.

1. Do you have high-interest credit card or loan debt?

Let’s say your credit card company is charging 15% on your outstanding balance. You can earn a guaranteed 15% by paying off that debt. It makes the most sense to pay off high-interest accounts before putting extra funds toward your low interest rate mortgage. This is especially important if you’re in a higher tax bracket, because home mortgage interest is tax deductible, whereas interest on consumer debt is not.

2. Have you established an emergency fund?

Life happens. If you haven’t set aside funds in an easy to access “rainy day” account, you could be forced to acquire additional debt if an emergency comes along. Your emergency account should cover at least a few months of living expenses. Before supplementing your mortgage payments, make sure that you’re financially protected in case of an emergency.

3. Are you contributing to a retirement plan at work?

Many companies will match a percentage of funds that you contribute to a 401(k) retirement account. For example, your employer might match 50% of the money you contribute, up to a maximum of 6% of your salary. Don’t pass up the opportunity to save for retirement. It’s easy and it earns a better return than dollars paid toward your mortgage principal.

4. Can you get a better return elsewhere?

Investing in stocks for a speedy windfall is tempting. But the stock market is notoriously unpredictable. Paying off your mortgage is very low risk, but if you can handle the uncertainty of stock based mutual funds or similar accounts, you could benefit with a much higher rate of return.

5. How’s your cash flow?

Starting your retirement without mortgage debt may be one of your financial goals. But it’s important to base your decisions on facts, not wishful thinking. Before you retire from full-time employment and paychecks are replaced by social security payments, pensions, and/or retirement account withdrawals, do the math. Your life on a fixed income could look very different from now, so make sure you have enough saved to maintain a comfortable lifestyle.

There are many implications to paying off your mortgage early, and they all depend on your unique circumstances. Contact us today to discuss which path is right for you.

If you own a business that operates out of your home, you may be able to deduct a wide variety of expenses. These deductions could include part of your rent or mortgage costs, insurance, utilities, repairs, maintenance and even cleaning costs. This can be a tricky area of the tax code, so make sure you have professional guidance.

Here are some of the top mistakes people make when taking home office deductions:

1. Not Taking the Deduction

The most common mistake for home office users is simply not taking the deduction! Taking the deduction seems too complicated for some, while others believe taking it increases your chances of being audited. The rules can be complex, but a home office structured correctly would allow for the home office deduction. There is even a simplified method that can be used to compute the deduction. Contact Cray Kaiser for any questions you may have.

2. The Space Isn’t Exclusive or Regular

The IRS mandates that the space you use must be exclusive and regular for your business. In a nutshell, here’s what that means:

Exclusively: If you use a spare bedroom as a business office, it can’t double as a guest room, a playroom for the kids or a place to store your hockey gear. Any kind of non-business use can invalidate the deduction.

Regularly: Your home office needs to be the primary place you conduct your regular business activities. That doesn’t mean that you must use it every day or that you can’t ever work outside the office. However, it should be the primary place for activities such as recordkeeping, billing, making appointments, ordering equipment or storing supplies.

3. Mixing Up Your Other Work

If you work for someone else in addition to running your own business, you need to be extra careful. IRS rules state that you can use a home office deduction as an employee only if you work remotely for your employer.

Unfortunately, this means if you run a side business out of your home, you can’t bring work home from your employer’s office and do it in your home office. Doing so would invalidate your use of the home office deduction.

4. The Recapture Problem

If you own your home and have been using your home office deduction, you could be in for a future tax surprise. If you sell your house, you will need to account for the depreciation of your home office. This rule, called the Depreciation Recapture Rule, often creates a tax liability for many unsuspecting home office users.

5. Not Getting Help

There are special rules that apply to your use of the home office deduction. If any of the below statements are true for you, contact us for support with navigating the deduction.

• You are an employee of someone else.
• You are running a daycare or assisted living facility out of your home.
• You have a business renting out your primary residence or a vacation home.

While there are benefits of utilizing the home office deduction, there are many details that are important not to overlook. If you have questions about your home office and the deductions available to you, please contact us today.