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Breaking down sales and use tax compliance for SaaS companies

06.28.22

Read this if you have offices in more than one state or are a SaaS company.

For many software-as-a-service (SaaS) providers, sales tax compliance remains a challenge. Approximately 20 states currently subject SaaS to tax, and taxability varies from state to state, which impacts many SaaS companies that scale rapidly and unknowingly expand their nexus footprint into these states.

In South Dakota v. Wayfair, Inc., the Supreme Court held that states may assert nexus on an out-of-state business that exceeds a reasonable economic threshold, whether or not the business has physical presence in the state. The 2018 ruling is particularly impactful to SaaS companies because:

  • Cloud-based offerings are delivered electronically without the need for in-state presence.
  • Following the decision, all states have enacted some form of legislation that adopts an economic nexus threshold (typically, this threshold is $100,000 in sales or 200 transactions).
  • With Wayfair standards now in place for over three years, historical noncompliance is becoming more material, and states are expected to increase enforcement.

The issue of sales tax compliance has become more pressing now for two key reasons:

First, liabilities and exposures are cumulative, and material exposures may continue to mount for companies that are noncompliant. This is especially relevant for companies that have failed to adhere to the Wayfair nexus standards. In addition, the increasing presence of remote employees will expand the nexus footprints of many technology companies that offer flexible work arrangements.

Second, while tech M&A activity is expected to slow for the remainder of 2022, some SaaS firms may still be looking to sell or raise capital. Sales tax exposure will remain a priority consideration during the due diligence process for any strategic deals taking place. Due to the short lifecycle of most technology companies, tax due diligence is key in preparing for an exit or capital raise.

The impact of evolving tax policy

An increasing number of states are amending the statutory definition of taxable services to include SaaS or are categorizing SaaS as taxable “tangible personal property.” For example, Maryland recently enacted legislation that imposes sales tax on certain digital products, including SaaS.

Adding to the complexity, states often construe certain technology-based services as taxable SaaS. For example, state administrative guidance and case law may interpret online advertising and data analytics services as taxable SaaS if software is the predominant component of the offering. Also, as noted above, the state-by-state treatment varies widely. For instance, New York aggressively subjects cloud-based offerings to sales tax, whereas California does not subject SaaS or electronically downloaded offerings to sales tax.

Remote work

The recent adoption of remote-work models further complicates the determination of nexus and sales tax obligations, as companies hire employees in states where they have not previously had a physical presence. The vast majority (84%) of all technology businesses surveyed in BDO’s 2022 Technology CFO Outlook Survey expect to see some impact on their total tax liability as a result of onboarding out-of-state remote workers.

The presence of in-state employees is a nexus-creating activity irrespective of whether the company’s sales exceed economic nexus thresholds. Therefore, if a SaaS company has employees working in a different state than its headquarters, it is critical to track employee start dates by state and consider the potential sales tax obligations.

Understanding your risk exposure

In an exit scenario, CFOs don’t want surprises, and buyers don’t want to absorb liabilities. SaaS companies must carefully analyze their sales and use tax posture in the deal context to understand risks and proactively address any shortcomings. Failure to adopt appropriate tax compliance procedures at the onset of nexus-creating activities can lead to a material exposure.

Given the complex nature of SaaS sales tax, technology companies must address compliance in a step-by-step phased approach:

  • Nexus study
    An initial nexus study consists of an examination of a company’s state specific activities in determining whether it has a filing obligation in various states. This includes an analysis of both physical presence (e.g., property, payroll, in-state services, etc.) and state-by-state economic nexus standards.
  • Taxability analysis
    Once the company’s nexus profile is established, a comprehensive taxability analysis is required to determine whether the states identified in the nexus study subject SaaS and other ancillary services to sales tax. Depending on the nature of the company’s offerings, this may involve in-depth research on a state-by-state basis. For instance, if the company is providing a technology-based service that is potentially classified as a nontaxable service rather than SaaS, research in the material states is required to develop a supportable position. In addition, the taxability process will include an assessment of potential mitigating factors, such as tax-exempt customers, sale-for-resale exemptions and use tax remittance, on a customer-by-customer basis.
  • Potential exposure quantification/remediation
    If the company has nexus in states that subject its offerings to tax, the exposure should be quantified to determine the magnitude of exposure in those states. This will help to determine whether to proactively remediate the exposure through participation in state voluntary disclosure programs. Voluntary disclosure participation allows a company that is historically noncompliant to pay the applicable back taxes in exchange for a limited lookback period (typically three to four years) with the waiver of penalties. 
  • Sales tax compliance automation
    Once the company has addressed its potential exposure in the applicable states, it will have a subsequent filing obligation. Depending on the complexity, an automated sales-tax solution is often recommended to assist with the nexus, taxability and filing compliance going forward. An automated solution often increases efficiencies, saves time and helps mitigate tax compliance risk. 

Developing a plan to address sales tax prior to undergoing a diligence process is key to better understanding and controlling the compliance process. Failure to do so may lead to material escrow or purchase price allocation to remediate a sales tax issue that could have otherwise been prevented. 

Way forward

Understanding state and local taxes (SALT) can make a big difference for technology companies, especially SaaS businesses. Non-compliance with tax standards could lead to financial risks and even affect customer relationships.

There is ample M&A opportunity to consider in 2022, with valuations leveling off and cash reserves ready to be spent. Nearly two-thirds of tech firms (65%) plan to buy, sell, or partner this year, according to BDO data. Tech companies should prepare for deal making by being proactive about sales and tax compliance. Not doing so can block deals in the pipeline, as buyers and investors are keenly aware of tax compliance obligations.

Consulting a third party on SALT compliance, especially regarding economic nexus standards and taxability, may help SaaS firms receive the full value of their companies, mitigate exposure and liability, and empower company leaders to feel prepared when it comes time to sell.

If you have questions about your specific situation, please contact our Consulting and Compliance team. We're here to help.

Written by Angela Acosta, Thomas Leonardo, and Matthew Dyment. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

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Read this if you are interested in learning about ESG. 

Although tax credits as subsidies have been a cornerstone catalyst for advancing many environmental, social, and governance (ESG) policies and technologies over the last several years, tax is often forgotten or minimized in the process of creating and implementing corporate ESG and value creation strategies. Ignoring the symbiotic relationship between tax and ESG is a losing strategy, given increased awareness of the importance of tax transparency among shareholders and other stakeholders as a mechanism for holding companies accountable to their stated ESG commitments. A rise in media and rating agency reports on the topic indicate tax will continue to be under scrutiny in the future and may increasingly have significant corporate reputational impacts as well.

As leaders of an organization’s tax function, including as vice presidents of tax, tax directors, or CFOs among others, you are the stewards charged with ensuring tax strategy and operations appropriately intersect with the corporate ESG vision and meaningfully advance ESG commitments. However, the 2022 BDO Tax Outlook Survey found that while an overwhelming majority of senior tax executives expressed an understanding of the value of ESG, three quarters of those responsible for tax were not currently involved in the organization’s ESG strategy. The findings indicate that tax leaders will need to insert the tax function into the ESG planning and execution process and take ownership of tax’s role in ESG. Insights from the survey outline how tax fits into ESG, the core principles of an ESG-focused tax strategy and key considerations for transparent reporting.

How does tax overlap with ESG?

Because there is some misunderstanding about how tax relates to environmental, social, and governance issues, there is a high probability that tax may not be incorporated in responsible business strategy and planning. While not reflected in the ESG acronym, there is an element of tax that is central to each of these principles. For example, environmental behavioral taxes and incentives, such as carbon taxes on greenhouse gas emissions and tax incentives for green energy adoption, are crucial to driving behavior change toward more sustainable practices in the near term while many impacts of climate change are still experienced in indirect ways. In terms of the social element, taxes are a key mechanism for companies to contribute to the societies in which they operate and to build trust among members of the public as a responsible corporate actor. Finally, proper tax governance can ensure that there is appropriate oversight over an organization’s tax strategy and decisions, ensuring they align with overarching business objectives and stakeholder communications around tax reporting.

Using the tax ESG cipher to unlock a successful ESG-driven tax strategy

Aligning the tax function with an overarching ESG strategy across the business is a heavy lift. To build and implement a responsible tax program will take time and requires careful consideration of an organization’s overall approach to tax, tax governance and total tax contribution. Each company will have a unique tax strategy based on its business and stakeholder considerations and may be at varying points along its responsible tax journey. Whether you are just beginning or at the stage of reassessing your approach based on changing market conditions, updates to your ESG strategy, or regulations, the cypher below can be used to guide these critical considerations and help ensure tax is meaningfully incorporated in ESG strategy. The process should be iterative over time and when implemented successfully, will drive improved decision-making on risk mitigation, strengthen risk awareness and increase transparency and accountability.

Core principle one: Approach to tax

The first step to meaningfully incorporating tax in ESG strategy is understanding and articulating the purpose and values that guide the tax function. This process includes defining the organization’s approach to regulatory compliance and the interaction with tax authorities. Writing a tax policy and strategy is an important way to articulate the company’s tax priorities and educate all team members across the organization about the function’s principles. The statement may include commitments to communicate transparently with regulators and disclose more information than required by law in some cases, for example.

As the organization evolves due to changes in the industry, overall ESG commitments and sustainability strategies, the tax strategy statement should be updated accordingly. Regulatory changes will also necessitate continuous assessment and consideration of whether the strategy meets the current understandings of transparency, risk mitigation and accountability based on new information. Through this set of guiding principles, the tax function can help improve decision-making and reporting actions to align with changes in the broader corporate ESG strategy, purpose, and values. 

Core principle two: Tax governance and risk management

Establishing a robust governance, control, and risk management framework provides comfort and assurance that the reported approach to tax and tax strategy is well embedded in an organization’s substantiable business strategy and that there are mechanisms in place to effectively monitor its compliance obligations.

However, it’s important to remember that tax governance and risk management have broad considerations that go beyond the traditional frameworks governing internal controls over financial reporting (ICFR). A common pitfall for many is a narrow focus on governance strategies. Generally, ICFR focuses on accurate and complete reporting in financial statements. While this is an important area of governance, it does not account for or represent the many objectives included in a tax ESG control framework, which is typically broader as it focuses on how and why decisions regarding tax approaches and positions are made.

The objective of this core principle is to demonstrate to stakeholders how the organization’s tax governance, control and risk management function are in alignment with the values and principles outlined in the Approach to Tax statement. This can include establishing a risk advisory council, guidelines for including tax in ESG reporting deliverables and any corresponding regulatory requirements, and communications to relevant stakeholders on executive oversight activities related to the tax strategy.  

However, many organizations have not taken the time to document and define their risk mitigation and executive oversight strategy. Often this is left merely to control procedures that are mechanical and regulatory in nature. Instead, a tax governance and risk management strategy should aim to establish a framework focused on strengthening risk awareness and transparently communicating governance activities to both internal and external audiences when appropriate.

Core principle three: Total tax contribution

While quantifying and providing necessary qualitative context around an organization’s total tax contribution is not an easy task, today, stakeholders from employees and customers to investors and regulators expect transparency around tax strategies, tax-related risks, total tax contribution and country-by-country activities. Recently, tax has received increased scrutiny from these stakeholders because it is a core component of many ESG metrics used to evaluate a business’s tax behaviors and ensure there is accountability across its tax practices. The result is that how a company shares tax information with stakeholders and what it includes in reports has a significant impact on reputation and perceptions of corporate ESG statements.

However, the increased demand for tax transparency is not without its challenges. Nearly two-thirds of respondents in the 2022 BDO Tax Outlook Survey (62%) said data collection and analysis (the quantitative component of ESG-focused tax) is the greatest challenge of tax transparency reporting efforts, pointing to an underlying issue of tax data governance and fragmented systems. Often this is an area where tax leaders require outside assistance to establish automated processes that can collect tax data on a periodic basis for regular analysis. The importance of ESG and attention around the topic will only continue to increase over the next several years, so it is critical to begin thinking about adequate data collection and analytic capabilities for tax leaders looking to incorporate tax in ESG practices and strategy. For those just beginning the process, our advice is to partner with in-house IT functions or external consultants for assistance and support.

Collecting relevant tax data on a regular basis is a critical early step because it affords tax leaders the opportunity to determine which information will be disclosed to various stakeholders and which information can help shape and support broader ESG narratives being developed by corporate leadership. While determining data collection processes, it is also important to consider and seek counsel on communication and information delivery strategies that will best reach and address the concerns of priority stakeholder groups.   

Although this task can be a heavy lift, it may also result in significant business advantages. A key benefit is that the data and information gathered will help tax leaders further define and evolve ESG-driven tax strategies through tax monetization structures and company core value items, among others. Ultimately, organizations that better understand their total tax contribution across various taxing jurisdictions and country-by-country activities are best equipped to make data-driven tax strategy decisions that are aligned with broader ESG and sustainability objectives, while also avoiding value creation hinderances. 

Key reporting considerations

Once the quantitative data have been collected, the next step is to consider how you report the information. Communicating the numbers themselves is not enough. Communicating the narrative behind the numbers – the qualitative component of reporting – is extremely important. The narrative should always aim to communicate the company’s approach to tax, values guiding decision-making and the impact of the tax strategy to key stakeholders in a straightforward and transparent manner. However, qualitative reporting can vary by organization depending on several factors, from choice of standards to company philosophy.

The 2022 BDO Tax Outlook Survey also found that challenges and variance in tax transparency reporting are driven by a lack of universal reporting standards and clarity around which ESG frameworks to follow. In the meantime, the best reporting framework for any company is one that drives a deep understanding of the organization’s ESG philosophy and vision, which may require more investment in terms of time and effort. When determining a reporting approach, it is important to consider the goal of the report or disclosure and which data best demonstrate ESG progress and strategy. Because the ESG-related tax reporting is not a mandated process and is currently a voluntary disclosure in the U.S., it can often be helpful to review tax reports related to ESG from other companies already making these disclosures as a baseline.

Keep in mind that one of the main reasons businesses are electing to publish comprehensive ESG and Sustainability Tax Reports and Global Tax Footprints is to articulate their broader total tax contribution to ensure that the tax narrative speaks to the needs and demands of their stakeholders. Each report must be unique and relevant to the company in terms of content and method of disclosure.

Currently, there is a relatively small number of companies electing to make such disclosures, based on the findings of the 2022 BDO Tax Outlook Survey outlined below. Of the 150 senior tax executives polled, less than a quarter (23%) are implementing both qualitative and quantitative disclosures:

Tax transparency reporting disclosures

Today, tax is an essential component of the ESG metrics that determine how stakeholders perceive an organization. Despite this fact, the movement to incorporate tax in ESG planning and strategies is still in its infancy. This means leaders of tax functions still have time to begin the process of implementing ESG-driven tax strategies and operations to ensure the function evolves with the importance of ESG. While there is no simple one-size-fits-all solution, given the nuances and complications of the tax function for each organization, the general framework in the Tax ESG Cipher can help guide tax leaders at any point on the journey. The cipher outlines key considerations to ensure an organization’s ESG vision is well-structured and appropriately includes tax strategies. While the process requires long-term effort and dedication, it generates high returns in terms of accountability, transparency, and reputational and sustainable value.

As ESG takes center stage in a rapidly changing business landscape, how is your organization advancing toward true sustainability?

Written by Daniel Fuller and Jonathon Geisen. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com  

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Navigating the intersection of tax and ESG

Read this if you file taxes with the IRS for yourself or other individuals.

To protect yourself from identity thieves filing fraudulent tax returns in your name, the IRS recommends using Identity Protection PINs. Available to anyone who can verify their identity online, by phone, or in person, these PINs provide extra security against tax fraud related to stolen social security numbers of Tax ID numbers.

According to the Security Summit—a group of experts from the IRS, state tax agencies, and the US tax industry—the IP PIN is the number one security tool currently available to taxpayers from the IRS.

The simplest way to obtain a PIN is on the IRS website’s Get an IP PIN page. There, you can create an account or log in to your existing IRS account and verify your identity by uploading an identity document such as a driver’s license, state ID, or passport. Then, you must take a “selfie” with your phone or your computer’s webcam as the final step in the verification process.

Important things to know about the IRS IP PIN:

  • You must set up the IP PIN yourself; your tax professional cannot set one up on your behalf.
  • Once set up, you should only share the PIN with your trusted tax prep provider.
  • The IP PIN is valid for one calendar year; you must obtain a new IP PIN each year.
  • The IRS will never call, email or text a request for the IP PIN.
  • The 6-digit IP PIN should be entered onto your electronic tax return when prompted by the software product or onto a paper return next to the signature line.

If you cannot verify your identity online, you have options:

  • Taxpayers with an income of $72,000 or less who are unable to verify their identity online can obtain an IP PIN for the next filing season by filing Form 15227. The IRS will validate the taxpayer’s identity through a phone call.
  • Those with an income more than $72,000, or any taxpayer who cannot verify their identity online or by phone, can make an appointment at a Taxpayer Assistance Center and bring a photo ID and an additional identity document to validate their identity. They’ll then receive the IP PIN by US mail within three weeks.
  • For more information about IRS Identity Protection PINs and to get your IP PIN online, visit the IRS website.

If you have questions about your specific situation, please contact our Tax Consulting and Compliance team. We’re here to help.

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The IRS Identity Protection PIN: What is it and why do you need one?

Read this if you are a business owner or responsible for your company’s accounts.

US businesses have been hit by the perfect storm. As the pandemic continues to disrupt supply chains and plague much of the global economy, the war in Europe further complicates the landscape, disrupting major supplies of energy and other commodities. In the US, price inflation has accelerated the Federal Reserve’s plans to raise interest rates and commence quantitative tightening, making debt more expensive. The stock market has declined sharply, and the prospect of a recession is on the rise. Further, US consumer demand may be cooling despite a strong labor market and low unemployment.

As a result of these and other pressures, many businesses are rethinking their supply chains and countries of operation as they also search for opportunities to free up or preserve cash in the face of uncertain headwinds.

Income tax accounting methods

Adopting or changing income tax accounting methods can provide taxpayers opportunities for timing the recognition of items of taxable income and expense, which determines when cash is needed to pay tax liabilities.

In general, accounting methods either result in the acceleration or deferral of an item or items of taxable income or deductible expense, but they don’t alter the total amount of income or expense that is recognized during the lifetime of a business. As interest rates rise and debt becomes more expensive, many businesses want to preserve their cash. One way to do this is to defer their tax liabilities through their choice of accounting methods.

Some of the more common accounting methods to consider center around the following:

  • Advance payments. Taxpayers may be able to defer recognizing advance payments as taxable income for one year instead of paying the tax when the payments are received.
  • Prepaid and accrued expenses. Some prepaid expenses can be deducted when paid instead of being capitalized. Some accrued expenses can be deducted in the year of accrual as long as they are paid within a certain period of time after year end.
  • Costs incurred to acquire or build certain tangible property. Qualifying costs may be deducted in full in the current year instead of being capitalized and amortized over an extended period. Absent an extension, under current law, the 100% deduction is scheduled to decrease by 20% per year beginning in 2023.  
  • Inventory capitalization. Taxpayers can optimize uniform capitalization methods for direct and indirect costs of inventory, including using or changing to various simplified and non-simplified methods and making certain elections to reduce administrative burden.
  • Inventory valuation. Taxpayers can optimize inventory valuation methods. For example, adopting to (or making changes within) the last-in, first-out (LIFO) method of valuing inventory generally will result in higher cost of goods sold deductions when costs are increasing.
  • Structured lease arrangements. Options exist to maximize tax cash flow related to certain lease arrangements, for example, for taxpayers evaluating a sale vs. lease transaction or structuring a lease arrangement with deferred or advance rents.

Improving cash flow: Revisiting your tax accounting methods

Optimizing tax accounting methods can be a great option for businesses that need cash to make investments in property, people, and technology as they address supply chain disruptions, tight labor markets, and evolving business and consumer landscapes. Moreover, many of the investments that businesses make are ripe for accounting methods opportunities—such as full expensing of capital expenditures in new plant and property to reposition supply chains closer to operations or determining the treatment of investments in new technology enhancements.

For prepared businesses looking to weather the storm, revisiting their tax accounting methods could free up cash for a period of years, which would be useful in the event of a recession that might diminish sales and squeeze profit margins before businesses are able to right-size costs.

While an individual accounting method may or may not materially impact the cash flow of a company, the impact can be magnified as more favorable accounting methods are adopted. Taxpayers should consider engaging in accounting methods planning as part of any acquisition due diligence as well as part of their regular cash flow planning activities.  

Impact of deploying an accounting method

The estimated impact of an accounting method is typically measured by multiplying the deferred or accelerated amount of income or expense by the marginal tax rate of the business or its investors.
For example, assume a business is subject to a marginal tax rate of 30%, considering all of the jurisdictions in which it operates. If the business qualifies and elects to defer the recognition of $10 million of advance payments, this will result in the deferral of $3 million of tax. Although that $3 million may become payable in the following taxable year, if another $10 million of advance payments are received in the following year the business would again be able to defer $3 million of tax.

Continuing this pattern of deferral from one year to the next would not only preserve cash but, due to the time value of money, potentially generate savings in the form of forgone interest expense on debt that the business either didn’t need to borrow or was able to pay down with the freed-up cash. This opportunity becomes increasingly more valuable with rising interest rates, as the ability to pay significant portions of the eventual liability from the accumulation of forgone interest expense can materialize over a relatively short period of time, i.e. the time value of money increases as interest rates rise.

Accounting method changes

Generally, taxpayers wanting to change a tax accounting method must file a Form 3115 Application for Change in Accounting Method with the IRS under one of two procedures:

  • The “automatic” change procedure, which requires the taxpayer to file the Form 3115 with the IRS as well as attach the form to the federal tax return for the year of change; or
  • The “nonautomatic” change procedure, which requires advance IRS consent. The Form 3115 for nonautomatic changes must be filed during the year of change.

In addition, certain planning opportunities may be implemented without a Form 3115 by analyzing the underlying facts.

Next steps for businesses

Taxpayers should keep in mind that tax accounting method changes falling under the automatic change procedure can still be made for the 2021 tax year with the 2021 federal return and can be filed currently for the 2022 tax year.

Nonautomatic procedure change requests for the 2022 tax year are recommended to be filed with the IRS as early as possible before year end to give the IRS sufficient time to review and approve the request by the time the federal income tax return is to be filed.

Engaging in discussions now is the key to successful planning for the current taxable year and beyond. Whether a Form 3115 application is necessary or whether the underlying facts can be addressed to unlock the accounting methods opportunity, the options are best addressed in advance to ensure that a quality and holistic roadmap is designed. Analyzing the opportunity to deploy accounting methods for cash savings begins with a discussion and review of a business’s existing accounting methods.

Please contact our Tax Consulting and Compliance team if you have questions or concerns about your specific situation. We’re here to help.

Article
When interest rates rise, optimizing tax accounting methods can drive cash savings

Read this if you use QuickBooks Online.

QuickBooks Online provides numerous ways for you to know which customers owe you money – and who is late.

There are so many financial details to keep track of when you’re running a small business. You have to make sure your products and services are in good shape and ready to sell. You have to stay current with your bills. Orders need to be processed as quickly as possible, as do estimates and invoices. And you may have numerous questions from customers and vendors that must be addressed.

Your number one priority, however, is ensuring that your customers are paying you. Whether you accept credit cards or bank transfers or issue sales receipts for cash and checks, you need to always know where you stand with incoming payments. “Are my receivables current?” should be a question you’re asking yourself or your staff frequently.

QuickBooks Online offers numerous ways to know whether you’re being paid for your products and/or services and who might be falling behind. That information is critical to your understanding of how your receivables are stacking up against your payables. You should be able to gauge whether you’re making a profit, staying even, or losing money. Here’s a look at the tools you can use.

Learning when you launch

QuickBooks Online provides a good overview of your current cash flow as soon as you log into the site and see your two-pronged Dashboard. The first thing you see when you click the Business overview tab is a cash flow forecast that goes up to 24 months. Other content includes a profit and loss graph and charts showing expenses, income (including open and overdue invoice totals), and sales. Your account balances are there, too.

This is helpful data, but it’s broad. To get far more detailed information, hover your mouse over Sales in the toolbar and select All Sales. The horizontal bar across the top displays dollar and transaction totals for estimates, unbilled activity, overdue (invoices), open invoices, and (invoices) paid last 30 days. When you click one of the bars, the list changes to show only that particular set of transactions.

 Partial view of the toolbar at the top of the Sales Transactions page

The table of transactions is interactive. That is, there’s an Action column at the end of each row. Click the down arrow next to any of the activity listed there, and you’ll see a menu of options. Depending on the status of each, these options include commands like Receive payment, Send reminder, Print packing slip, Send, and Void

Running reports

The Sales Transactions page provides more of your receivables nuts and bolts than the b screen does. But to get the most in-depth, customizable, comprehensive view of who owes you, you’ll need to run reports. Click Reports in the toolbar and scroll down to Who owes you

There are three columns here. You’ll land on Standard, which is a complete list of all of the pre-formatted reports that QuickBooks Online offers. Click Custom reports to see the reports you’ve customized and saved. Management reports opens a list of three reports that can be viewed by a variety of date ranges: Company Overview, Sales Performance, and Expenses Performance. You can view, edit, and send these, as well as export them as PDF and Microsoft Word files.

There are five reports listed under Who owes you that you should be creating on a regular basis. How regularly? That depends on the size of your business. The greater your sales volume, the more frequently you should run them.

When you select A/R Aging Summary, you’ll see at a glance which customers have current balances and those that are 1-30, 31-60, 61-90, and 91+ days past due. A few customization options appear at the top, like Report period, Aging method, and Days per aging period. To really zero in on the precise data set you want, click Customize. The panel that slides out from the right contains option in several areas: General, Rows/Columns, Aging, Filter (by customer), and Header/Footer.

QuickBooks Online helps you target the data set that you want.

There are four other reports that can help you track your receivables:

  • Open Invoices displays a list of invoices that still contain a balance.
  • Unbilled Time tells you about any billable time that hasn’t been invoiced.
  • Unbilled Charges lists billable charges that haven’t been invoice.
  • Customer Balance Summary simply provides all open balances for you customers.

These are all very simple reports that you shouldn’t have any trouble customizing and running. They can give you a complete picture of where your receivables stand. But there are other reports that will require our help. These are standard financial reports that should be created monthly or quarterly, including Statement of Cash Flows, Profit and Loss, and Balance Sheet. You’ll need these critical financial statements if, for example, you’re applying for a loan or trying to attract investors.

Please contact the Outsourced Accounting team if you want us to run and analyze these so you can get a detailed, comprehensive view of your financial health.

Article
Keeping up with receivables: Know who owes you

Read this if you are at a financial institution with employees working remotely.

Working remotely is not a new concept. Over the past 20 years, technology enhancements have increased the ability for employees to connect remotely and perform many job functions without ever leaving their homes. When the COVID-19 pandemic began in early 2020, working remotely became a necessity for essential businesses like financial institutions to provide safe environments for both employees and customers and remain open.

One of the benefits of an increase in working from home during the pandemic is that it provided financial institutions and other businesses an opportunity to learn how to perform essential job functions and manage teams from a distance. In addition, many organizations experienced indirect benefits, including a more flexible work environment, higher job satisfaction, increased productivity, and improved employee retention. Now that employees are being asked to return to the office, many financial institutions are considering if a permanent work-from-home arrangement is possible. 

What you need to know

For starters, financial institutions need to know where their employees are providing services. Is it across state lines or across the country? What if you have two or more employees who want to work out of state—and they are all different states? What are the tax implications? Are there legal concerns?

Nexus

Nexus is the connection that taxpayers have with a state that permits the state to assess various types of taxes, including income tax. Nexus rules vary from state to state, but generally a business with nexus in a state is required to register with the Secretary of State/Department of Revenue, file tax returns, and pay various taxes to the state. 

Employees working in a "different state" (a state which income tax returns are not already being filed) may create nexus to that state for tax purposes. Even if your financial institution has only one employee working in a state and otherwise has no other connection to the state, there may be tax implications. Some states have established nexus waivers because of the pandemic, providing relief to some businesses and employees who have temporary work-from-home arrangements. These waivers, however, will soon expire or have expired already. 

The following details should be considered before offering out-of-state remote employee work arrangements.

State income tax filing requirements

  • If your financial institution has an employee working remotely from a different state, the financial institution has created physical presence nexus in that state. Once nexus has been established, the financial institution may be subject to state and local income taxes, gross receipts taxes, unique taxes specific to financial institution, or franchise taxes. When it comes to taxing a financial institution, not all states assess tax in the same manner. 
  • After nexus has been established, your financial institution will also need to understand how the state apportions wages in determining income tax liability to the state. One example is a factor approach: Total payroll paid to employees working in the state divided by total payroll paid to all employees. In a simplified example, the fraction would be multiplied by taxable income resulting in amount of taxable income in that state. One employee in a state is not likely to create a significant income tax liability to the state, however, many states have minimum tax liabilities and other fees—some more significant than others—which should also be considered along with additional administrative costs. 

State tax withholding

  • Employees will need to pay personal state income tax based on their primary state of residence as well as the state in which they work. If your financial institution's remote employee is performing most of their work from home in a different state than the financial institution, and travels to the financial institution for occasional meetings or in-person days, this could result in the employee having a personal state income tax liability in both states. It may be necessary for your financial institution to track the employee’s location and properly withhold state income taxes from the employee’s pay based on the state that the employee is providing services. 
  • Failure to properly withhold state income taxes could create a liability for both the employee and the employer including penalties and interest. Proper policies should be in place regarding the responsibility of tracking where employees are performing their work may mitigate these concerns. You should encourage your employees to work with their individual tax advisors on state tax issues as each employee's tax filing position is unique (we generally advise against providing tax advice to your employees). 

Unemployment taxes and workers’ compensation

  • Unemployment is typically paid to the state in which an employee has their permanent place of work. Your financial institution should review the state’s unemployment rules to determine if the financial institution is required to collect and remit unemployment tax to a state that it has employees. If your employee is working in a different state on a temporary basis or due to the pandemic, we believe there is no need for unemployment to change from the state where the financial institution is located.
  • Workers’ compensation is also typically paid to the state in which the employee is permanently assigned. If the out-of-state work arrangement is temporary, we do not feel you need to change your workers’ compensation. However, if the out-of-state arrangement from home becomes permanent, you may need to change your policy. Some states require employers to have a minimum number of employees in the state before requiring a workers’ compensation policy in that state. We recommend working with BerryDunn’s employee benefits experts on state rules and discussing with your insurance carrier.

Personal property and other taxes

  • Employees working from home are often provided furniture and equipment for their remote office set up. Financial institutions should consider whether they want to provide these items without retaining ownership to the property, as owning property in another state could result in the financial institution needing to file and remit personal property taxes to the state. It also would be considered a best practice to develop a policy that provides consistency among all remote employees, regardless of their location. 
  • Sales and use tax implications and other special or unique state and local taxes should be researched and understood prior to entering any state to determine the impact on existing products and services which may be offered to out of state customers who reside or relocate out of state. We will provide more information about the state tax issues related to providing services in a future installment of this state tax series. 

Other considerations

  • We recommend you discuss with your financial institution's attorney regarding the need to file a business license or update the financial institution's charter as these are legal matters. Here are some topics to consider as you have these discussions:
    • Your financial institution may be required to register with the state department of revenue/taxation
    • Registering as a foreign corporation is often necessary to access the legal system
    • Your financial institution may want to consider whether other regulatory licenses may be needed, such as insurance broker or license for trust services
  • Health insurance and other employee benefit plans should be reviewed to ensure that a remote employee eligible to receive benefits still qualifies and receives the same level of coverage that is available to in-state employees. 

In summary, even one employee working out of state could create additional compliance costs and exposure to a state’s laws and regulations. You may be wondering how risky it is to have only one employee located in a state, and how likely is it that the state would make the connection to your out-of-state financial institution.

While  the risk may seem low, states are always looking to generate additional tax revenue, and many have the ability to cross check internal systems. Withholding and remitting state income taxes on behalf of an employee is likely going to require your financial institution to register with a state's income tax withholding agency. The state will then be aware of your financial institution’s connection to its state as the financial institution’s EIN will be in the system for payroll purposes. While the exposure may still be low, the state may start looking for an income tax filing and at least payment of minimum tax. Failure to file in a state means that the statute of limitations for the financial institution’s exposure to that state will not start.

The risks shouldn’t necessarily prevent your financial institution from allowing employees to work from home, and as many financial institutions want to offer more flexible work arrangements given what has been learned in recent years, it is possible to minimize tax risk and remain compliant with proper planning and awareness. 

For more information

To discuss your specific tax situation and state compliance risks, please contact the BerryDunn Financial Services team. We’re here to help.

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State tax issues impacting your financial institution part one: Remote employees

Read this if you are looking to buy or sell a construction company.

This article was previously published in Construction Accounting and Taxation, January/February 2022 ©2022 Thomson Reuters/Tax & Accounting.

The other day, my wife was telling me about her dad’s friend who used to be a daredevil backcountry skier. He loved cliff drops and had a reckless approach, once quipping, “I’ll find a landing spot on the way down.” 

Our valuation team includes several expert skiers and snowboarders, but we have little in common with this approach. When we ski, we carefully assess the risks before taking action. Because we spent all day assessing risk, we’re far more likely to take a scouting run and develop a couple of alternatives. Even in our wildest days, we would never go off cliffs without first investigating the landing.  

The same approach should be used when acquiring a business. Acquiring a business can be a big financial risk, possibly the biggest financial risk of one’s life. It might even feel like skiing off a cliff. We frequently work with clients that are acquiring businesses, and we recommend a strategy of investigation and analysis, carefully vetting potential acquisitions, before taking action. 

Recent M&A activity

The pandemic caused a drop-off in merger and acquisition (M&A) activity as many companies were focused on the challenges immediately at hand. As shown in the accompanying chart, the sale of construction companies reported in the DealStats database1 dropped by approximately 53% in 2020. 

As the business environment settles down to the “new normal,” M&A activity will likely begin to pick up again. An opportunity created by the pandemic is the opportunity to acquire struggling companies at a discount. Some companies are unable (or unwilling) to adapt to the new business environment and its many challenges. This fact pattern may represent an opportunity for stabilized companies to expand through acquisition. 

There are numerous other reasons to acquire a business. One common reason historically is to expand into a new service area. For example, one of our clients wanted to expand into concrete services, so they acquired a concrete contractor rather than developing those skills in-house. Another residential builder decided to eliminate a bottleneck in the building process by acquiring a roofing contractor. 

Particularly in the current tight labor market, we have observed numerous “acquihires” where the primary motivation for a deal is to secure a key person or team of employees – particularly for in-demand specialty subcontractors. 

Companies also use acquisitions as an opportunity to establish a new geographical footprint. This strategy is especially useful when ties to the community are important in the business development process. The motivation for an acquisition might also be access to a particular client or access to a new niche. 

Growing through acquisition can enable companies to achieve economies of scale and synergistic benefits through elimination of redundancies. Acquiring a competitor may also yield a secondary benefit by eliminating a source of competition. 

All of these opportunities may paint an overoptimistic picture of the benefits of mergers and acquisitions. According to Harvard Business Review, approximately 70% to 90% of acquisitions fail to realize their targeted outcomes.2  There are a myriad of factors that can cause acquisitions to go awry. Keep the following tips in mind that we have learned from our experience working with companies that completed a successful acquisition. 

Tip #1: Avoid being rushed

Acquiring a business is a big decision that will change the trajectory of the acquirer. If one is rushed into a decision, it is easier to miss key pieces of information. If there is not enough time to learn about the business model and make a careful decision, pass on the acquisition. There will always be future opportunities.

Tip #2: Perform rigorous financial due diligence

Two primary factors drive business value: income and risk. Financial due diligence is the process of verifying income and assessing risk. We recommend having a financial due diligence checklist as an organized method to analyze a company that one is acquiring. By following this checklist, one can learn about a company’s income, assets, liabilities, contracts, benefits, and potential problems (customer concentration, claims and litigation issues, management bench strength, etc.). To perform adequate due diligence, request thorough documentation and dig deep. 

We once helped an individual out who was considering acquiring a business that had very limited financial information available. The seller painted a glowing picture of profitability but lacked the financial data to back the claims. With a significant investment on the line, the potential acquirer judiciously passed on this opportunity. He felt that it wasn’t prudent to rely on the word of a stranger in the absence of data. In order to make a good buying decision, require sellers to bring data to the table. Be skeptical. In one of our former careers in engineering, there was a common mantra – in God we trust, everyone else brings data. If it sounds too good to be true, it probably is.

As part of the financial due diligence, review financial statements for at least the last five years. Audited financial statements are preferred. Additionally, request monthly contract schedules showing completed contracts and work-in-progress (WIP). Monthly contract schedules can provide information about the timing of projects, margins over time, information about change orders, billing practices, and the cadence of work for a particular company.

Success in the construction industry hinges on cash management. Construction firms need to bid contracts and manage operations such that they collect payment as soon as possible in order to avoid a liquidity crisis. A positive indicator is the presence of contract liabilities, which represent billings from customers in excess of revenue recognized to date. This “good liability” indicates that project managers are attentive and understand the business aspect of their roles and/or that company has well written contacts allowing them to bill advantageously. In combination with strong cash flows from operations and good working capital metrics, a contract liability in excess of any contract asset is a good indicator of a strong cash management position. 

On the other hand, the alternative is a contract asset. Contract assets, which are often characterized as “bad assets,” represent revenue recognized in excess of amounts billed. In other words, the company does not have an unconditional right to payment. This could be due to poor contract writing, inattention to scope-creep, difficulty negotiating change orders with clients, or just bad billing practices. Contract assets may also be generated in a manner that does not raise concern. For example, a company might work primarily with government entities and therefore be restricted in their ability to pre-bill. In any case, if contract assets are consistent and substantial, one should inquire into what is giving rise to this asset. 

In the event that contract assets are generated through poor business practices, an acquirer may be able to implement their own billing practices to improve the target’s position, but existing poorly written contracts could pose a large liability and claim on cash flow post-merger. 

Tip #3: Analyze key relationships

A valuable component of intangible value is customer relationships. The most valuable customer base is one that is diversified and stable, ideally with contracts in place. Before acquiring a company, assess the risk associated with its customer base by analyzing concentration and the tenure of relationships with key customers. In some cases, customer reviews may also be available through Google and other platforms. 

Relationships with surety and bonding companies as well as subcontractors should also be topics in due diligence. 

Tip #4: Learn about the employees

Many businesses rightly state, “Our employees are our most valuable asset.” What if this valuable asset becomes disgruntled and walks away after a transaction? We recommend probing employee turnover and satisfaction, as well as analyzing employment contracts. External resources may also be available, or discussions with key customers and subcontractors can be revealing. 

Oftentimes, post-merger integration is unsuccessful due to differences in the cultures between the acquirer and the target. During the due diligence process, learn about the target’s culture and consider how it will likely integrate with your company’s existing culture. 

Tip #5: Assess key person dependence

Many companies cannot operate without the current owner in the driver’s seat. Many key processes, business development in particular, run through this individual. Develop an understanding of what would happen to the business without this person’s involvement. The individual in question (the “key person”) might not be the owner, but a key employee that is essential to business operations. Key person dependence represents a threat to the company in the event of the employee’s departure from the company or incapacitation. 

Some questions we often ask to identify and assess key person dependence include the following: 

  • Who is responsible for business development?
  • How important are individual relationships to the development of new work?
  • Do people become customers because of the reputation of the company or the reputation of an individual?
  • Has management began training up the next level of management beneath them?
  • Do any employees have any specialized knowledge or skills that no other employees have that would be difficult to replace?
  • What would happen to the company if a key employee won the lottery and never came into work again?

Tip #6: Have the seller stick around

Business owners are steeped in the knowledge of their business. This know-how may take time to transfer. Signing the seller to an employment agreement and/or earn-out as part of the transaction can provide the acquirer critical time to absorb the seller’s expertise. 

Tip #7: Don’t assume the good times will last forever

Many construction companies have reported strong profitability despite the pandemic. These profits may simply reflect recent economic trends rather than strong business models. If, or when, the economy takes another drop, many businesses will follow suit. Will the business being purchased survive in a difficult economic climate? To answer this question, consider the following strategies.

First, study how they performed in the last economic recession, keeping in mind the rule of thumb that construction industry downturns generally lag two years behind the rest of the economy and last twice as long. Second, compare a company’s growth and profitability to its industry to reveal whether it is a star or simply rising with the tide. In the words of Warren Buffett, “It’s only when the tide goes out that you learn who’s been swimming naked.” Third, study the business model to link their business drivers to economic factors. 

Tip #8: Consider tax and legal consequences

Many people focus their time and energy negotiating the transaction price and disregard the transaction structure. The amount of taxes paid may increase or decrease dramatically based on the transaction structure. However, tax consequences are often given less attention because they are frustrating and complicated. By spending a little extra time on the transaction structure, acquirers can optimize their after-tax sale proceeds. 

Different deal structures may also sever existing liability or create nightmares in the future. Be sure to discuss these with your legal counsel and weigh the potential risks and returns of structure.

Tip #9: Get different perspectives

Discuss the opportunity with trusted friends, families, and mentors. Bringing in different perspectives can cast light on elements that would otherwise have gone unnoticed.  

Bring in professional perspectives as well for tax, legal, and financial items. Contact a professional regarding the purchase price. Businesses are tricky to value. Two people can have disparate opinions about what it is worth. A business valuation can ground the expectations on price and provide a framework to keep “deal emotions” in check. A business valuation could save a considerable amount of money and time. 

We offer this word of caution: avoid blindly relying on the perspectives of others. Bring them in as counsel, but make sure to have a firm understanding of the offered terms and the business model yourself. Think critically about the decision to buy or walk away as the choice is yours to make. 

Conclusion

In both skiing and acquiring a business, we recommend taking calculated risks. Acquiring a business is a big decision and should be taken seriously. There are many benefits to M&A activity, including expanding services offerings, geographical footprint, employee base, and ultimately profitability. In order to ensure the full benefits of a successful acquisition, keep in mind the advice in this discussion when considering acquiring a company. 

1DealStats is a subscription-based database of business transactions available online at www.bvresources.com/.   
2“The Big Idea: The New M&A Playbook” by Clayton M. Christensen, Richard Alton, Curtis Rising, and Andrew Waldeck. Harvard Business Review, March 2011. Accessed online at https://hbr.org/2011/03/the-big-idea-the-new-ma-playbook

Article
Tips for acquiring a construction company

Read this if you are an employer that provides educational assistance to employees.

Under Section 127 of the Internal Revenue Code (IRC), employers are allowed to provide tax-free payments of up to $5,250 per year to eligible employees for qualified educational expenses. To be considered qualified, payments must be made in accordance with an employer’s written educational assistance plan. 

The Coronavirus Aid, Relief and Economic Security (CARES) Act amended Section 127 to include student loan repayment assistance as a qualified educational expense. The expansion of Section 127 allows employers to make payments for student loans without the employee incurring taxable income and the payment is a deductible expense for the employer, resulting in tax advantages to both parties.  

Originally, the CARES Act was a temporary measure allowing tax-free principal or interest payments made between March 27, 2020 and December 31, 2020.  Due to the difficulties in adopting a formal education assistance plan, many employers were unable to take advantage of the temporary incentive. As a result, the Consolidated Appropriations Act, signed into law on December 27th, 2020 extended the provision for five years through December 31, 2025.  

Employer requirements

For payments to qualify as tax-free under Section 127, you (the employer) must meet the following requirements: 

  • The employer must have a written educational assistance plan
  • The plan must not offer other taxable benefits or remuneration that can be chosen instead of educational assistance (cash or noncash)
  • The plan must not discriminate in favor of highly compensated employees
  • An employee may not receive more than $5,250 from all employers combined
  • Eligible employees must be reasonably notified of the plan

Eligible employees include current and laid-off employees, retired employees, and disabled employees. Spouses or dependents of employees are not eligible. Payments of principal or interest can be made directly to employees as reimbursement for amounts already paid (support for student loan payments should be provided by the employee) or payments can be made directly to the lender. Other educational expenses that qualify under Section 127 include:

  • Tuition for graduate or undergraduate level programs, which do not have to be job-related
  • Books, supplies, and necessary equipment, not including meals, lodging, transportation, or supplies that employees may keep after the course is completed

The five-year extension of this student loan repayment assistance can provide tax savings to both employers (employer portion of FICA) and employees (federal and state withholding, and FICA). Additionally, offering a qualified educational assistance program may help strengthen an employers’ recruitment and retention efforts. 

If you have more questions, or have a specific question about your situation, please call us. We’re here to help.

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CARES Act expansion of IRC Section 127: Tax savings on student loan repayment assistance