Owners of closely held corporations are often interested in easily withdrawing money from their businesses at the lowest possible tax cost. The simplest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” And it’s not deductible by the corporation.
Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five strategies to consider:
- Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make future cash contributions to the corporation, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.
- Compensation. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient(s). This same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In both cases, the compensation amount must be reasonable in terms of the services rendered or the value of the property provided. If it’s considered excessive, the excess will be a nondeductible corporate distribution.
- Loans. You can withdraw cash tax free from the corporation by borrowing money from it. However, to prevent having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or note. It should also be made on terms that are comparable to those in which an unrelated third party would lend money to you, including a provision for interest and principal. Also, consider what the corporation’s receipt of interest income will mean.
- Fringe benefits. You may want to obtain the equivalent of a cash withdrawal in fringe benefits, which aren’t taxable to you and are deductible by the corporation. Examples include life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other corporation employees. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.
- Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50%-owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50%-owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those in which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.
If you’re interested in discussing any of these ideas, contact us. We can help you get the most out of your corporation at the lowest tax cost.
© 2020 Covenant CPA
Does your business receive large amounts of cash or cash equivalents? You may be required to submit forms to the IRS to report these transactions.
Each person engaged in a trade or business who, in the course of operating, receives more than $10,000 in cash in one transaction, or in two or more related transactions, must file Form 8300. Any transactions conducted in a 24-hour period are considered related transactions. Transactions are also considered related even if they occur over a period of more than 24 hours if the recipient knows, or has reason to know, that each transaction is one of a series of connected transactions.
To complete a Form 8300, you will need personal information about the person making the cash payment, including a Social Security or taxpayer identification number.
You should keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.
Reasons for the reporting
Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”
What’s considered “cash”
For Form 8300 reporting, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders.
Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.
Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.
E-filing and batch filing
Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.
The IRS also reminds businesses that they can “batch file” their reports, which is especially helpful to those required to file many forms.
Setting up an account
To file Form 8300 electronically, a business must set up an account with FinCEN’s BSA E-Filing System. For more information, interested businesses can also call the BSA E-Filing Help Desk at 866-346-9478 (Monday through Friday from 8 am to 6 pm EST) or email them at BSAEFilingHelp@fincen.gov. Contact us with any questions or for assistance.
© 2020 Covenant CPA
Do you want to withdraw cash from your closely held corporation at a low tax cost? The easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” But it’s not deductible by the corporation.
Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five ideas:
1. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.
2. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient. The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.
3. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.
4. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.
5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.
If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.
© 2019 Covenant CPA
It should come as no surprise that cash is the most popular target of fraud perpetrators. After all, once stolen, cash itself is virtually untraceable. But that doesn’t mean forensic accounting professionals can’t unearth cash fraud schemes — and the crooks behind them.
According to the Association of Certified Fraud Examiners, there are three main categories of cash fraud (which includes checks because they’re easily converted to cash):
- Theft of cash on hand,
- Theft of cash receipts, and
- Fraudulent disbursements.
The last category comprises many of the most frequently executed schemes, such as overbilling and “ghost” vendor or employee schemes. For example, overbilling vendors usually submit inflated invoices by overstating the price per unit or the quantity delivered. A dishonest vendor also might submit a legitimate invoice multiple times. Overbilling may involve collusion with employees of the victim organization, who typically receive kickbacks for their assistance.
Employees also can conduct billing fraud on their own, submitting bogus invoices payable to a fictitious vendor and diverting the payments to themselves. Similarly, an employee might set up payroll disbursements to nonexistent ghost employees.
Cash can be difficult to trace once it’s in the hands of a thief. But forensic experts usually are able to trace the path that stolen cash took before the fraudster pocketed it. This includes who “touched” the cash and what prompted its flow out of the organization.
Inflated invoices, for example, often leave a trail of red flags. Experts look for invoices that bill for “extra” or “special” charges with no explanation. Other suspicious signs include round dollar amounts, or amounts just below the threshold that requires management’s signoff, and discrepancies between invoice amounts and purchase orders, contracts or inventory counts.
If forensic experts suspect that fictitious billing has occurred, they often investigate accounts with no tangible deliverables — such as those for consulting, commissions and advertising — and check vendor addresses against employee addresses. Invoices with consecutive numbers or payable to post office boxes receive extra scrutiny.
Returned checks can supply useful information, too. Fraud perpetrators are more likely to cash checks, whereas legitimate businesses typically deposit them and rarely endorse checks to third parties.
To trace ghost employee schemes, experts examine payroll lists, withholding forms, employment applications, personnel files and other documents. The information collected from these sources may provide vital links between actual and ghost employees that wouldn’t otherwise be apparent.
To catch a thief
Strong internal controls are instrumental in preventing cash-type schemes. But even the strongest controls sometimes fail to prevent a determined fraudster. If that happens, we can help your business ferret out the fraud and track down the perp. Call or email us today for help– 205-345-9898 or email@example.com.
Donating to charity is a key estate planning strategy for many people. It reduces the size of your taxable estate and it can help you leave a lasting legacy with organizations you care about.
The benefit of making such gifts during life rather than at death is that you may be eligible for an income tax deduction. Qualifying for a charitable deduction is, in some respects, a matter of form over substance. The IRS could disallow a deduction, even if it’s otherwise legitimate, if you fail to follow the substantiation requirements to the letter.
If you’ve made charitable donations in 2018, it’s wise to review the substantiation rules as you file your 2018 tax return. Here’s a quick summary of the rules:
Cash gifts under $250: Use a canceled check, receipt from the charity or “other reliable written record” showing the charity’s name and the date and amount of the gift.
Cash gifts of $250 or more: Obtain a contemporaneous written acknowledgment from the charity stating the amount of the gift, whether you received any goods or services in exchange for it and, if so, a good-faith estimate of their value. An acknowledgment is “contemporaneous” if you receive it before the earlier of your tax return due date (including extensions) or the date you actually file your return. Also, there’s no need to combine separate gifts of less than $250 to the same charity (monthly contributions, for example) to determine if you’ve hit the $250 threshold for the contemporaneous written acknowledgment requirement.
Noncash gifts under $250: Get a receipt showing the charity’s name, the date and location of the donation, and a description of the property.
Noncash gifts of $250 or more: Obtain a contemporaneous written acknowledgment from the charity that contains the information required for cash gifts plus a description of the property. File Form 8283 if total noncash gifts exceed $500.
Noncash gifts of more than $500: In addition to the above, keep records showing the date you acquired the property, how you acquired it and your adjusted basis in it.
Noncash gifts of more than $5,000 ($10,000 for closely held stock): In addition to the above, obtain a qualified appraisal and include an appraisal summary, signed by the appraiser and the charity, with your return. (No appraisal is required for publicly traded securities.)
Noncash gifts of more than $500,000 ($20,000 for art): In addition to the above, include a copy of the signed appraisal (not the summary) with your return.
Failure to follow the substantiation rules can mean the loss of valuable tax deductions. We can help determine if you’ve properly substantiated your 2018 charitable donations. Call us today at 205-345-9898.
© 2019 Covenant CPA
Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.
Previously, the cash method was unavailable to certain businesses, including:
- C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners — whose average annual gross receipts for the previous three tax years exceeded $5 million, and
- Businesses required to account for inventories, whose average annual gross receipts for the previous three tax years exceeded $1 million ($10 million for certain industries).
In addition, construction companies whose average annual gross receipts for the previous three tax years exceeded $10 million were required to use the percentage-of-completion method (PCM) to account for taxable income from long-term contracts (except for certain home construction contracts). Generally, the PCM method is less favorable, from a tax perspective, than the completed-contract method.
The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your business’s average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured, your industry or whether you have inventories. And construction firms under the threshold need not use PCM for jobs expected to be completed within two years.
You’re also eligible for streamlined inventory accounting rules. And you’re exempt from the complex uniform capitalization rules, which require certain expenses to be capitalized as inventory costs.
Should you switch?
If you’re eligible to switch to the cash method, you need to determine whether it’s the right method for you. Usually, if a business’s receivables exceed its payables, the cash method will allow more income to be deferred than will the accrual method. (Note, however, that the TCJA has a provision that limits the cash method’s advantages for businesses that prepare audited financial statements or file their financial statements with certain government entities.) It’s also important to consider the costs of switching, which may include maintaining two sets of books.
The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. Contact us to learn more at 205-345-9898.
© 2018 Covenant CPA
Many retail businesses implement careful controls over the use of their cash registers. For this reason, register-disbursement schemes are among the least costly types of cash frauds. Without such controls, however, businesses risk significant losses. Here’s how to make sure your company is doing everything it can to prevent this type of fraud.
Issuing fictitious refunds and falsely voiding sales are a couple of common ways employees steal money. Both methods involve paying out cash without a corresponding return of inventory and usually result in abnormally high inventory shrinkage levels.
But high shrinkage is just one way to spot cash register disbursement fraud. Other red flags include:
- Disparities between gross and net sales,
- Decreasing net sales (increasing sales returns and allowances),
- Decreasing cash sales relative to credit card sales,
- Forged or missing void or refund documents,
- Increasing void or refund transactions by individual employees, and
- Multiple refunds or voids just under the review limit.
Any of these warning signs may warrant investigation. A fraud expert can help you determine whether discrepancies have innocent explanations or indicate a more serious problem.
Your business can prevent cash register theft by taking preventive measures. These include having written ethics policies and providing employees with antifraud training. In many cases of register theft, several employees are aware that it’s happening. So be sure to provide a confidential hotline or other means for employees to report unethical behavior without fear of reprisal.
Your fraud detection and deterrence program should also include training internal auditors to regularly perform horizontal analysis of income statements. Horizontal analysis — which compares financial statement line items from one period to the next — can identify suspicious trends, such as an increasing number of cash refunds.
Taking these simple steps can prevent significant losses. But signs of extensive cash register theft usually indicate bigger issues. Contact us. We can help you nip theft in the bud by strengthening internal controls and, when necessary, assemble evidence for criminal prosecutions and civil lawsuits. Call us today at 205-345-9898.
© 2018 Covenant CPA
You’ve no doubt heard the old business cliché “cash is king.” And it’s true: A company in a strong cash position stands a much better chance of obtaining the financing it needs, attracting outside investors or simply executing its own strategic plans.
One way to ensure that there’s always a king in the castle, so to speak, is to maintain a cash reserve. Granted, setting aside a substantial amount of dollars isn’t the easiest thing to do — particularly for start-ups and smaller companies. But once your reserve is in place, life can get a lot easier.
Now you may wonder: What’s the optimal amount of cash to keep in reserve? The right answer is different for every business and may change over time, given fluctuations in the economy or degree of competitiveness in your industry.
If you’ve already obtained financing, your bank’s liquidity covenants can give you a good idea of how much of a cash reserve is reasonable and expected of your company. To take it a step further, you can calculate various liquidity metrics and compare them to industry benchmarks. These might include:
- Working capital = current assets − current liabilities,
- Current ratio = current assets / current liabilities, and
- Accounts payable turnover = cost of goods sold / accounts payable.
There may be other, more complex metrics that better apply to the nature and size of your business.
Believe it or not, many companies don’t suffer from a lack of cash reserves but rather a surplus. This often occurs because a business owner decides to start hoarding cash following a dip in the local or national economy.
What’s the problem? Substantial increases in liquidity — or metrics well above industry norms — can signal an inefficient deployment of capital.
To keep your cash reserve from getting too high, create financial forecasts for the next 12 to 18 months. For example, a monthly projected balance sheet might estimate seasonal ebbs and flows in the cash cycle. Or a projection of the worst-case scenario might be used to establish your optimal cash balance. Projections should consider future cash flows, capital expenditures, debt maturities and working capital requirements.
Formal financial forecasts provide a coherent method to building up cash reserves, which is infinitely better than relying on rough estimates or gut instinct. Be sure to compare actual performance to your projections regularly and adjust as necessary.
More isn’t always better
Just as individuals should set aside some money for a rainy day, so should businesses. But, when it comes to your company’s cash reserves, the notion that “more is better” isn’t necessarily correct. You’ve got to find the right balance. Contact us at 205-345-9898 to discuss your reserve and identify your ideal liquidity metrics.
© 2018 Covenant CPA