Month: December 2018

Preface: As sales and use taxes can create a complex web for tax compliance, harnessing the right tools to manage and reduce those tax risk is advisable. With this three series blog, you should now have an awareness of what the advisable steps are towards that tax compliance.

Village Property Maintenance Company, Inc.

Credit: Donald J. Sauder, CPA | CVA

Managing more than 15,000 rental units within the state, from the metropolitan center to vibrant college town, Village Property Maintenance Company, Inc. (VPMC) management worked every angle for another dollar or two. When new management joined the business, they voted that a new accounting firm would provide high level CPA services with more conservative tax risks.

In initial meetings, VPMC’s CPA discussed all the relevant tax and accounting facts from multi-state tax nexus to sales and use tax, and inquired on compliance with applicable state payroll taxes. During the conversation, it became evident that the 2,000 wash machines and dryers the company purchased each year, were subject to sales or use tax that had not been paid. The CPA assessed the cost of compliance between $100,000 to $140,000 per year.

Management made the decision to have a thorough project evaluation of all tax filing compliance for the business. During that the compliance evaluation, the company obtained a compliance report on all relevant tax laws including the sales and use tax filings. With the assurance of appropriate accounting and tax oversight in place, the business fortunately was never audited for the pending tax risks, and never assessed a potentially alarming audit settlement for noncompliance with appropriate tax leadership.

Sales tax evaluations

So what should your business do? A sales tax evaluation should begin with assessing a company’s customer revenues, and taxability of those customer’s purchases. This is most easily managed with appropriate software. Sellers of services and goods that are taxable can obtain and keep on file, exemption certificates from customers that exempt the sale from sales tax. If this document is not on hand, the sale is subject to the applicable sales tax rules. For good accounting department management, a company should request this form from all customers in every state, and even if not registered in the state, to protect from nexus risks. Penalties if assessed can exceed 10% with interest. Every accountant should advise and guide your business compliance with all sales and use tax laws.

The evaluation of use tax requires an assessment of the vendors and purchasing of a business. One of the largest risks companies can have beside taking no action on sales tax, is to gamble with use tax compliance. The first place to start evaluating this risk is with recent vendor payments and high-dollar expenses. Paying appropriate use taxes is the advised business policy.

Summary: As sales and use taxes can create a complex web for tax compliance, harnessing the right tools to manage and reduce those tax risk is advisable. It begins with a review processes for tax compliance, then characterizing the taxability features of each process from customer sales to vendor payments. Sometime technology assessments and implementation are necessary. Working with an accountant who will invest the time with you to ensure your business is compliant with sales and use tax laws is advised and necessary. This advised compliance evaluation is one more step towards perpetuating your businesses long-term successes and managing your business with integrity.

Preface: Segueing into Segment II…. When sales and use tax compliance issues are located from uncollected or under-accrued tax payments, sometimes with substantial penalties and interest too, it can result in a few businesses even needing to embark on emergency measures…… 

Appropriate Steps to Avoid the Web of Sales and Use Tax Risks (Segment II)

Credit: Donald J. Sauder, CPA | CVA

Farm Manufacturing, Inc.

Farm Manufacturing, Inc. had been operating for a number of years as a successful metal fabrication company of agricultural equipment. The three-person office staff had rotated in recent years, with better job offers and changes of pace.  The experienced office manager was established, and had been there for more than five years, and Ephraim had reason to trust his team and placed confidence in their knowledge of accounting to keep his business running successfully. When he saw an tax audit notice on his desk for sales and use tax from the State Department of Revenue, he never envisioned the sales tax audit problems looming.

After his office manager advised him to contact his accountant with regards to the seeming complexity of the sales tax audit notice, Ephraim mentioned on the phone call to his accountant that he didn’t handle any of those tasks, and was assigning his accountant responsibility to resolve. The accountant responded that he was aware from notes and discussions that Farm Manufacturing, Inc. prepared and filed all sales tax forms in-house, but that he’d be happy to help with tax audit.

After reviewing the information document requests Ephraim forwarded, the accountant contacted the office manager for copies of the prior sales tax filings. The office manager replied, after talking with the accounting department that they were unaware of any necessary filings having ever been prepared for audit period, and more importantly, none had been prepared or filed since they had been at the company to their knowledge. In fact, and furthermore, the registration for sales tax filings, had apparently never been approved at the State Department Revenue.

The accountant began an assessment of the taxable sales from the business with a review of the vendor transactions and revenue type, and calculated the unpaid tax may be around $15,000 to $25,000 per year.

After scheduling the initial audit meeting, that included three days on site filed work, reviewing GL detail, tax filings, customers list’s, invoices, and sale records, it was apparent that the auditor was aware the filings had been both unpaid and unfiled, and that there was substantial tax assessments likely. Since there was no record of what was taxable and what was non-taxable, the auditor prepared their own assessment of $140,000 unpaid sales taxes for the audit period, assuming the tax filings had been appropriately prepared.

The accountant deemed the sales tax to costs or liabilities to be substantially less than the auditor assessment, and requested additional time to work through the details and prepare proper sales tax filings. After a several weeks’ project, the accountant had the revised numbers and prepared sales tax filings, with supporting documents, and scheduled a follow-up with sales tax auditor.

At the meeting, the accountant met with the auditor, to discuss the settlement cost of the Farm Machinery Inc. unpaid audit sales tax liabilities. The sales tax filings indicated the total cost was $92,000 plus accountant fees. The auditor wanted time to review the documents. After, negotiations, they agreed on an $105,000 settlement with an agreement the sales tax compliance would be followed in the future with all tax filings prepared, and taxes submitted to the state, plus penalties and applicable interest.

In this instance, Ephraim assumed his business was running with all tax compliance features in place, and since the accountant was not assigned to file sales tax reports, was unaware of the non-compliance and omission of a standard tax filing feature. More concerning, the accountant made inaccurate assumptions about his clients, given that no sales tax liabilities were ever listed on the balance sheet. The $105,000 settlement reduced working capital to critically low levels. The business survived. Yet, it is not always that way for small business organizations who contact sales tax shoals.

Any business that has experienced a field audit for sales and use tax examinations knows a sales tax and use tax audit can be expensive and create substantial financial problems for a business. When compliance issues are located from uncollected or under-accrued, sales and use tax, sometimes with substantial penalties and interest, can result in a few businesses even needing to embark on emergency measures as outlined in the prior two examples.

Conclusion of Segment II of III

 

Preface: As sales and use taxes in business can create a complex web for tax compliance, harnessing the right tools to manage and reduce those tax risk is advisable.

Appropriate Steps to Avoid the Web of Sales and Use Tax Risks

Credit: Donald J. Sauder, CPA | CVA

The new sales tax laws of 2018 following the SCOTUS “Wayfair” ruling, substantially increases the amount of compliance work already required in the perplexing field of sales tax. Let’s begin our work on the appropriate steps to avoiding the web of sales and use tax risk with these questions:

1. Do you ship products across state border’s?
2. Do you perform services across state border’s?
3. Do sell online?
4. Do any employees travel across state lines?
5. Are you registered in all the states you have customer in?
6. Do you know the state and jurisdictional rules for your revenue sources?

Specifically, the 2018 “Wayfair” ruling “bright-lines” that substantial nexus occurs for sales tax reporting when a value of goods exceeds $100,000, or the number of transactions is more than 200.

While the latitude of this field is advised to be managed with expert accounting advise, great decisions can only be made with even more precise and accurate information.

Let’s consider first some fictional stories with a pertinent hypothesis to gain an increased understanding of what sales tax non-compliance can cost a business, and then talk about easy (but not necessarily inexpensive) steps to proactively ameliorate the web of audit risks with sales and use taxes. Before we begin, there are 7,500 approximate taxing jurisdictions in the US for state and local sale tax, so the proper management of the fields risk, can quickly become challenging, for any tax professional or entrepreneur for that matter.

Residential Services, LLC

Residential Services, LLC was heading into a successful second decade of business having blossomed with a capable team and diligent effort. With superior earnings, the company had devised a strategy of purchasing supplies and materials for projects from a sales tax free state that was nigh and convenient, given their jurisdictional location. The Company then sold the supplies to customers, and other friendly competitors with appropriate markups for the industry. With more than $1.5m of these tax- free supplies transacted per year, the company was earning a comfortable net profit of other income from the “tax strategy.”

The Company had just finished a signature prevailing wage project, when an audit letter arrived from the State Department of Revenue.

The business owner called his accountant and requested their assistance with the documentation assembly response. The accountant sensed a larger problem when the client began to outline the requested items, and called a meeting.

As the accountant asked questions, and understood more about his client’s activities and transactions he realized the scope of the audit and the risk associated. The client was earning nearly $100,000 in net profit from the devised “tax-strategy.” The accountant realized that if they showed the auditor that tax had not been paid on the supplies purchased, the risk was concerning, but there was no escape route from the audit.

At the first meeting with the auditor, the accountant began answering questions and providing requested documents. One question they ask was, “Why did you purchase out of state?” The answer, “Lower prices!” Searching the vendor records and purchase amounts, it was obvious the auditor knew what they were looking for, and requested copies of vendor invoices for the prior two years. Working together with the client, the accountant could only provide 10% of vendor invoices requested.

Given the substantial risks, the auditor realized that they had located a treasure trove of tax collections. Using general assessments, and estimates of material purchases, the auditor assessed a $570,000 audit settlement. The client and accountant realized they had a substantial and going-concern risk from lack of compliance with state sales tax rules.

The accountant told his client that appealing the assessment would likely lead to only more scrutiny and that the “tax strategy” was clear non-compliance with tax rules. After numerous conversations, the client agreed to cooperate and request a negotiated settlement.

The auditor was surprised. The accountant walked with the auditor through the obscure laws of sales tax compliance, and admitted the non-compliance factor, asking the auditor for an affordable settlement. The auditor didn’t agree, and the owner had to obtain a seven-year business loan to finance the payment. Good New? The “small business organization” has survived and is flourishing today, albeit somewhat indebted.

Segment I of III

Preface: “People will pay more to be entertained than educated.” Quote from: Johnny Carson

Implementing a Bonus Plan in Your Business (Segment IV)

Construction Example

Jaden was so pleased with his new bonus plan that he told his friend Brendan about it. Brendan runs a construction company.

Brendan loved the idea, but he realized he would need to adapt Jaden’s bonus plan to make it work for his company. Why? Some of Brendan’s profits came from work his men did as subcontractors for other businesses. In those situations, labor was pretty much his only direct cost. Therefore, it was a significant percentage of sales. Some of his other sales came from projects he did for homeowners, such as adding a sunroom. In those situations, his direct costs were labor and materials. Although labor was still a significant percentage of sales, it was decreased. Some of his sales came from general contracting jobs, where his direct costs were labor, subcontractors, and materials. On these jobs, sometimes labor was a relatively small percentage of sales.

Brendan realized that to create an effective bonus plan, he could not simply base it on a reduction in the direct labor percentage. If he did that, then employees would receive a bonus or be denied a bonus based mostly on what type of jobs the company was doing, and not based on their performance.

He and his accountant Jonas sat down and discussed the specifics of Brendan’s business. They realized that for every job the company did that included labor, Brendan calculated an estimated cost for labor. That cost was then marked up and put in the bid. After the job was finished, Brendan would see what the cost of labor was for that job.

They opened a spreadsheet and started calculating. Eventually, a formula appeared that would give the employees a bonus based on coming in below estimated cost for the labor portion of the job. If they performed well, the company would benefit, and the employees would benefit.

What if Brendan simply started estimating the cost lower so that he no longer would need to pay the employees a bonus because they could no longer perform under the estimated cost? Jonas encouraged Brendan to tweak and modify the bonus system as needed, but to always remember fairness. If he lowers the estimated cost, for example, then perhaps he should increase the bonus in another way. If the bonus does not benefit the employees, then it may fail to motivate.

Alignment

A variable pay plan can help align the goals of the employees with the owner’s vision. If your company could use a realignment, consider implementing a variable pay plan.

This article is general in nature, and it does not contain legal advice. Please contact your accountant to see what applies in your specific situation.

Jake Dietz is a CPA, Business Consultant, with Sauder & Stoltzfus, LLC, a certified public accounting firm, in Ephrata, PA, specializing in entrepreneurial business accounting and tax services, bookkeeping, business valuation, and peripheral CPA services. Jake can be contacted at 717-961-9811, or jdietz@saudercpa.com

 

Preface:  “Hard work most often leads to success, but it’s not every day, and it’s not every week. It will pay off at different times over the course of your career.”  Quote from Sallie Krawcheck

Implementing a Bonus Plan in Your Business (Segment III)

Credit: Jacob M. Dietz, CPA

Evaluation

Jonas suggests that Reuben and Justin implement the new bonus plan for the next quarter. They agree to sit down and review the bonus plan after at least the next two quarters and see how it is working. They should likely tweak the bonus plan to get it working properly.

Manufacturing Example

Suppose that after several quarters Reuben and Justin are delighted with their new variable pay bonus program. In fact, they are so delighted that they tell their neighbor Jaden, who is also a businessman. Jaden really values the idea of aligning his employees’ goals with his goals. Armed with a copy of the bonus plan that Reuben and Justin implemented, he excitedly goes back to his office to implement a bonus plan.

The excitement melts away as Jaden realizes that the bonus plan designed for car washing does not work well for Jaden’s manufacturing company. His employees punch the time clock in the morning and then get to work manufacturing wood structures in the shop. They punch out for lunch, and then they punch in again for the afternoon. There is no tracking of billable versus non-billable hours. The only way Jaden’s company gets paid is when they sell a wooden structure. It doesn’t matter if they made the wooden structure in 10 hours or 30 hours, or if they were efficient or inefficient. The customer pays them the same price.

Jaden calls his accountant Jonas, and together they discuss the nature of his business and what metrics (standards of measurement) might work. As part of the discussion, Jaden shares his goals for the variable pay program.

• He wants to align the goals of the employees with his goals
• He wants to increase profits
• He wants to share a portion of those increased profits with his employees
• He wants to fairly compensate the employees so that they continue to work for him and can provide for their families

As they brainstorm for ideas for a bonus plan, they come up with these ideas to base the bonus on:

• Total units manufactured
• Total square feet of units manufactured
• Reduction in gross labor percentage

Jaden and Jonas agree that in Jaden’s specific situation, the best method is to give the employees a bonus based on a reduction in the gross labor percentage.

How will they calculate the bonus? Fortunately, Jaden’s financial reports are accurately prepared every month and examined and adjusted as necessary. By looking at historical reporting, Jonas and Jaden can easily see that his average direct labor percentage is 28%. That means that for every $100,000 of sales, Jaden pays $28,000 to his employees, on average. They structure the bonus so that for every 1% decrease in direct labor percentage below 28% (excluding the bonus), the employees get a bonus equal to roughly 30% of it, as calculated on a spreadsheet.

How will the employees earn the bonus? It is earned by striving for efficiency and productivity. In the past the employees produced $100,000 of sales per month and were paid $28,000 per month. That calculates to a 28% direct labor percentage. If, by striving to improve with the new bonus plan, the employees manage to start producing $110,000 of sales per month while maintaining labor at $28,000, then the direct labor percentage would then drop to 25%. That calculation is 28,000/110,000. The difference between a 28% direct labor percentage and a 25% direct labor percentage, with $110,000 of sales, is about $2,800.

The variable pay bonus plan calls 30% of it (about $840) to go to the employees. 840/28,000 is a 3% bonus for employees that month. Ideally, the extra bonus for the employees will compensate and reward them, and the extra profitability from increased productivity will reward the owner.

Jaden and Jonas agree to monitor the bonus plan over the next quarters to see if it is working to improve the company by aligning goals, and what tweaks and modifications may help make it more effective and fair.

Segment III