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Qualified Opportunity Zones: What to Know Before You Invest

By

John T. AmmannBy John Ammann, CPA

Since early 2018, much has been said about the opportunity zone provisions that were enacted as part of the Tax Cuts and Jobs Act (TCJA). Designed to spur economic growth in select low-income communities across the U.S., the provisions designate more than 8,700 such communities as qualified opportunity zones (QOZs). Taxpayers who invest in businesses or property within QOZs may be eligible for federal tax incentives.

The IRS guidance surrounding QOZs was initially quite vague. To alleviate confusion, the IRS issued proposed regulations in October 2018. Although the regulations clarified certain aspects of the provisions, much remains unclear. Nevertheless, this is certain: When leveraged correctly, QOZs have the potential to provide investors with significant tax benefits.

If you’re considering a QOZ investment, here are a few things you should know first.

Are you eligible?

According to the TCJA, any taxpayer who realizes eligible gain for federal tax purposes may elect to defer the gain—as long as the taxpayer meets certain requirements. A taxpayer could be an individual, C corporation, partnership, S corporation, trust, or estate.

What are the requirements?

To invest in a QOZ, a taxpayer must realize eligible gain, reinvest the gain within 180 days into a qualified opportunity fund (QOF), and then defer the gain for the year of sale. Before taking advantage of the associated tax benefits, a taxpayer must satisfy several requirements, including a specific process, critical definitions, deadlines, and quantitative tests. Also, at least 90% of the assets held by the QOF must be within the QOZ.

What are the tax benefits?

Taxpayers who invest in a QOZ and meet the necessary requirements may take advantage of the following tax benefits:

  1. Temporary deferral of capital gains reinvested in a QOF
  2. Partial exclusion of previously deferred gains from gross income when the QOF is held for at least five years
  3. Permanent exclusions of post-acquisition gains from the sale of an investment in a QOF held longer than 10 years

Is it a good investment?

Just because a business or property is in a QOZ does not make it a good investment, despite its tax benefits. Think of the potential for tax benefits as icing on the cake—they shouldn’t make the deal.

When should you take action?

The opportunity zone provisions won’t be around forever. In fact, a portion of the potential tax benefits will expire as early as 2020, and QOZs will disappear at the end of 2028. In order to take full advantage of the tax benefits, it’s important to act quickly. To qualify for the full exclusion of gains, investors will need to complete a deal by the end of 2019. But if you don’t make this deadline, don’t worry—you can still defer a portion of your gains up to 2026 and qualify for the permanent gain exclusion.

Look before you leap.

Although the benefits associated with QOZ investments may sound enticing, it’s important to fully understand the IRS requirements, potential tax benefits, and, of course, the viability of the investment itself before you move forward. If you have questions about the tax implications associated with QOZs, the JAK team  can help. We can also guide you through setting up the appropriate entity for investing in a QOF and provide an overall analysis of the investment. Contact us today  to learn more about how the opportunity zone provisions could benefit you.

Capital Lease or Operating Lease? 4 Questions to Ask

By

Stephanie LoilandBy Stephanie Loiland, CPA

Many companies choose to lease assets for a period of time instead of buying them outright. If you’re in this situation, it’s important to know whether you’re dealing with a capital lease or an operating lease. That’s because the type of lease will affect how you record it—and the payments you make to it—in your books.

A few additional differences between capital and operating leases to consider: Capital leases affect your balance sheet, which means they can also impact your covenants and ratio calculations. Also, capital leases allow the leased asset to be capitalized. If an asset is capitalized, it could possibly qualify for an accelerated depreciation option such as bonus depreciation or Section 179, providing you with a larger deduction in the year you sign the lease. Operating leases, on the other hand, require less administrative time to account for them and do not affect the balance sheet.

Not sure if a lease is capital or operating? Here are four questions that can help you determine its classification. If you answer “yes” to any of the questions, the lease is a capital lease. If you answer “no,” it’s an operating lease.

#1 – Is there a transfer of ownership?

If the lease states that your company retains ownership of the leased asset at the end of the lease, it’s a capital lease. In this case, the lease acts as a loan for you to purchase the leased asset.

#2 – Is there a bargain purchase option?

Many leases contain an option to buy out the leased asset at the end of the lease. If this option is less than the expected fair market value of the asset at the end of the lease, it represents a bargain purchase option. Leases that include a bargain purchase option are capital leases. The most common example of this type of lease is a $1 ending purchase option.

#3 – Does the lease period equal or exceed 75 percent of the asset’s useful life?

If the lease in question does not contain #1 and #2 above, the length of the lease is compared to the economic life of the leased asset. If the lease period is equal to or exceeds 75 percent of the leased asset’s useful life, it’s a capital lease. Your company’s capitalization policy should provide guidance on the length of life used for the type of asset being leased.

Minimum Lease Payment

#4 – Does the present value of the minimum lease payments exceed 90 percent of the asset’s fair market value?

If the lease does not contain any of the above features, the present value of the minimum lease payments should be compared to the fair market value of the leased asset. The present value of the lease payments can be calculated by inputting the total amount of lease payments to be paid over the life of the lease into a present value calculator. The fair market value of the leased asset is equal to its cash price. If the calculated present value of the lease payments is equal to or exceeds 90 percent of the asset’s fair market value, the lease is a capital lease.

What to know about recording the lease and lease payments

Operating leases are simple to record. The payments are recorded each month as an expense in a lease expense account; no asset or liability is recognized on the balance sheet.

Capital leases, however, require the value of the leased asset to be capitalized and recorded as a fixed asset on the balance sheet. This fixed asset is depreciated over time like any other fixed asset purchase. The related lease obligation is also recorded as a liability on the balance sheet and payments are applied to the obligation with a portion segregated for interest expense.

Lease classifications will change in the coming year—stay tuned!

A new lease standard effective for years beginning after December 15, 2019, will change the classification of leases. As this effective date approaches, the small business CPA firm of JAK, will provide more information on what you can expect. In the meantime, if you have questions about lease classifications or the new standard mentioned here, please don’t hesitate to call.

5 Signs It’s Time to Break Up With Your Bank

By

Kyla Hansen

By Kyla Hansen, CPA 

Your bank should be an asset, never a hindrance. If yours is holding you back, don’t feel trapped—consider shopping around. Here are five signs it could be time to say goodbye.

  1. Your loan covenants are too restrictive.

When a business fails its covenant, nine out of 10 times the bank will waive it with little difficulty, but this can create some level of difficulty on your end. Covenants are very common and necessary in many situations; however, if a bank isn’t familiar with a client’s situation, it may inadvertently set covenants higher than they need to be.  If you’re having to repeatedly request waiver letters, it may be time for a switch.

  1. Your banker is consistently MIA.

Good communication is critical to any relationship, and especially to the one between you and your bank. At a minimum, your banker should contact you quarterly to see how your year is going. Of course, communication is a two-way street, but if your banker rarely checks in or doesn’t return your calls, ask yourself: Could I get better service elsewhere?

  1. You don’t have a relationship manager.

On a similar note, dealing with different banker every time you interact with your bank is not ideal. Working with a banker who is comfortable and familiar with your business can prevent headaches, especially if your business is unique or seasonal.

  1. You’ve outgrown it.

Federal lending restrictions and limitations are generally based on a bank’s size. If your needs have exceeded your bank’s lending capabilities, it’s possible you could benefit from a larger establishment. Keep in mind that some banks will augment their lending power by offering an SBA loan. This approach gets part of the loan off of the bank’s coverage, but it can create additional fees and expenses for you. In some situations, however, an SBA loan will be the best fit for your business needs. If your bank suggests an SBA loan, make sure it’s the best option for you.

  1. They are behind the times.

Your bank should be able to support you with resources such as remote deposit, company credit cards and even fraud protection features such as Positive Pay. Having access to these not only creates efficiencies but also provides additional controls. If your bank is lacking in this area, you may be better served elsewhere.

Do your research before breaking up.

Moving your business to another bank should never be done on a whim. Think about the pros and cons. For instance, Bank ABC might have a higher lending capacity, but will moving expose you to pre-payment penalties at Bank XYZ?

Also, if you’re not happy with your bank, say so. Many business owners don’t realize it, but loan covenants are not set in stone—they can be negotiated. The banking industry is highly competitive, and many banks are willing to work with you, whether by offering a lower rate or additional services, to keep your business.

Confer with your accountant.

 Should you stay or should you go? Talk to your accountant before you make the call. He or she can help you identify pros and cons of switching and compare rates of other establishments. At JAK, we’ve helped several clients determine whether or not to end a banking relationship by running numbers and sharing our perspective.

When it comes to business banking, it’s important to know your options. And to make sure they are truly working for you. If you do need to make a change, know that we have strong relationships with many bankers, and can easily recommend a banker who we feel is a good match for you.

Are You Doing Enough to Prevent Fraud?

By

By Joy McAdoo, CPA

 “It could never happen to us.” When it comes to fraud, these are all too often the famous last words of small business owners. But fraud can happen to or within any organization. And any instance of fraud has the potential to be devastating. Thankfully, there are some fairly straightforward and inexpensive steps you can take to prevent it. 

Here are seven basic fraud prevention measures (i.e., controls) every business owner should follow.

  1. Segregate duties as much as possible.

Segregating duties involves making sure one person doesn’t have sole authority over any one process, which can be difficult when your employees wear several hats. But ignoring this control could be a recipe for disaster. For instance, someone who has the authority to prepare and authorize transactions should not be in charge of reconciling those transactions. Likewise, the person who signs a check should not be the same person who prepares it. Being aware of areas where duties may not be as segregated as they should be—or identifying new opportunities for segregation—is a critical step in keeping fraud at bay.

  1. Pay attention to cash processing activities.

Cash processing is often where the biggest risk for fraud lies in small businesses. But you can mitigate it by monitoring these activities. Best practices include regularly reviewing online banking activity, and having physical bank statements mailed directly to you, the business owner, rather than to an employee at your business. In addition, avoid writing checks out to ‘cash’ and consider requiring dual signatures on checks or wire transfers over a certain dollar value.

  1. Be smart about email fraud schemes.

Email fraud schemes are becoming more and more rampant, and criminals are growing bolder and bolder. While email-filtering software is designed to catch fraudulent emails, many fall through the cracks. For these reasons, it pays to be vigilant. Always be suspicious about any email you receive asking for banking information or money, and take appropriate measures to verify the authenticity of the sender. It’s also important to keep your computer security and firewall updated, and to only download files from known and reputable sources.

  1. Take advantage of Positive Pay.

Most banks offer a tool called Positive Pay that matches checks written by a business against those the business has previously authorized. It can detect fraudulent checks and prevent them from being paid. If you’re not taking advantage of this service, talk to your banker and set it up as soon as you can. It’s an easy way to guard against fraud—before it touches your bottom line.

  1. Implement sound hiring and training practices.

Preventing fraud starts with hiring honest people. Always insist on a background check, and be sure to call references of potential hires. Once your carefully screened employees are on the job, make sure they are trained in fraud prevention to allow them to serve as the eyes and ears of your company.

  1. Send a strong message: Fraud will not be tolerated.

 The fear of getting caught can be a significant deterrent—don’t be afraid to let your employees know they’re being watched. And if fraud happens, deal with it appropriately. Everyone should be aware of the consequences.

  1. Resist the temptation to put fraud prevention on the back burner.

Implementing basic fraud prevention measures as soon as possible is an investment in the long-term viability of your business. If you have questions about any of these controls and how they might work for you, don’t hesitate to give us a call.

5 Critical Questions To Ask Before Selling Your Business

By

By Jason J. Loven, CPA, CCIFP®

 If you’re planning to hand over the reins to your business, there’s a lot to think about. And it can be hard to know where to start. A good first step is to visualize how you would like it all to happen. Then, ask yourself the following five questions to gauge the feasibility of your vision. 

  1. How much is your company really worth?

This can be a tough question, especially if you’ve put a lot of sweat equity into your business. But having a realistic idea of your company’s value is critical to sorting out other aspects of the sale. This could require a simple cash flow analysis or a full-blown valuation, depending on the size and complexity of your operations.

  1. Will this amount work for me?

Once you have an accurate idea of what your sale price could be, you have to determine if this amount will meet your needs. If not, will you delay the sale or reconfigure your retirement plans? Remember, you’ll need to think about net cash after taxes—the sale price isn’t necessarily what will end up in your account.

  1. Have you identified potential buyers?

Having a sale price in mind also lets you narrow down the field of potential buyers. Some business owners have a child, relative or key employee who is ready to take over. Others look outside of the business to find a buyer. If you identify with the former, will this potential buyer be able to purchase your business for the amount you need to get? If not, are you OK with selling to an external buyer?

  1. Will you accept seller financing?

A seller-financing package can make it easier for a buyer to purchase your business. If you’re open to this, you must think about the level of risk you’re willing to accept. How large of a down payment do you need? How quickly do you need to be paid off, and at what interest rate? In many cases, business owners will do seller financing for an heir or employee, but not for an external buyer. There are tax consequences to consider, too. For instance, a gain over time could be more tax advantageous than getting the full amount up front.

  1. What’s your timing?

In a perfect world, you would be answering these questions two to three years before you plan to sell. Determining your company’s worth, figuring out your retirement needs, identifying potential buyers and structuring a deal requires serious thought. What’s more, planning ahead can give you more control over the sale price, as there are things you can do to up the pre-sale value of your business. It’s also important to think about the timing of your exit. Will you completely walk away after the sale, or will you stick around for a while? Will health insurance or other benefits be a factor?

Taking time to plan and evaluate your options should be non-negotiable. Regardless of when you begin the process of selling your business, there are advisers and consultants available to walk you through it. Your CPA can help you understand the options and tax implications associated with the transition. With the right sale strategy, you could have a better chance of walking away with your goals met.

If you’re ready to start discussing these issues contact JAK today to schedule a consultation!

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John A. Knutson & Co., PLLP

John A. Knutson & Co., PLLP, (JAK) is a Twin Cities-based accounting firm serving clients throughout Minnesota and beyond. A Team Committed to Quality Beyond Expectations