Is Risk Where the Reward Is?

Preface: “Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did. So throw off the bowlines, sail away from the safe harbor, catch the trade winds in your sails. Explore. Dream. Discover.” — Mark Twain

Is Risk Where the Reward Is?

Credit: Donald J. Sauder, CPA | CVA

Most people, including entrepreneurs, do not understand risk in entirety. Risk (say financial or business) is often a vague term with different connotations for many individuals. If you flip a quarter ninety-nine times, and it is heads on each, what is the probability it will be heads or tails on the next coin flip? Secondly, what if anything is at risk?

Many would like to say the world is becoming less risky – say continuous improvements in healthcare, job safety, and financial regulation. When you hear “It’s different this time,” consider that often when (business) leadership makes great decisions most don’t realize it; and the realization of a good or bad decision are often only apparent after the fact (consider the real estate decision on May 24th 1626, when Peter Minuit purchased the island of Manhattan for the equivalent of $24 worth of beads and trinkets.)

Insurance and banking are industries built on risk management. The tenure of an average Fortune 500 executive is five years, so why would a prudent CEO take risks with a longer-term payback where they will not receive the credit? What is your timetable for the rewards and payoffs of your business decision(s)? Are you effectively able to make a decision with no payoff rewards for at least three to five years?

Risk management can be painful – both to talk about and to perform. What if you’re wrong? “People who don’t take risks generally make about two big mistakes a year. People who do take risks generally make about two big mistakes a year.” — Peter Drucker.

Yet events of risk are sometimes similar but always different, and common sense is an oxymoron. For instance, the risk of a tulip bulb mania such as the Dutch speculation in 1637 where one bulb at the height of the market frenzy was worth the price of an average personal Dutch residence. And so again, high returns usually are generated from high risks.

Risk is not the same as gambling. Do you intentionally avoid risk? If you avoid uncertainty in business, there should be few to no expectations of rewards. Successful business owners manage risk expertly and deliberately or otherwise. Risk aversion is not exemplified with a swashbuckling cowboy dice roller. Yet without the “range rollers” risk riding on their ATVs say, you couldn’t enjoy a beef barbecue picnic, where you manage the uncertainty in the weather from a few possible sprinkles on your guests.

Are the risks in business more or less than they were fifteen years ago? Risk involves change, industry disruption, and automation. What new changes are coming, such as tax laws, product innovations, or financial regulation? To keep up, businesses need to effectively adapt and be prepared to adjust with workable solutions.

In the early years of computers, it was said that no executive was fired for purchasing an IBM mainframe because they worked flawlessly every time – a characteristic of the excellence in IBM products. Yet some well-intentioned and educated executives were fired because they purchased computer mainframes where the implementation risks didn’t proceed according to plan (i.e., they were not IBM models) and hence the risk of the blame for a wrong decision was reality. Most individual decisions are made with the best of intentions in reason. Now, what can IBM’s Watson do?

Studying the past often provides little helpful indication of when wilderness can result in (business) disruptions in the future. Economic and financial changes, wars and civil strife have been in the equation of life since the early days of history, and today companies have data loss risks too. If your business generates high rates of return, do you understand the risks? That’s what you’re being compensated for in the marketplace.

“What you have to do, and the way you have to do it is incredibly simple. Whether you are willing to do it is another matter.” — Peter Drucker.

After the fact, when we look at the history of what’s happened, we often think we would have been smarter than “those people”, made better decisions too, and appreciated more successful outcomes from the “wildness.” Data analytics and news channels today balm our concerns that we are perhaps ignorant or misinformed about business wilderness trends, developing risks, unpredictable disruptions, and quickly are completely engrossed in and reliant on these leading-world outlets to often give an oracle sense of perception to our managing of risks and astute decisions.

Risk and uncertainty are not the same things. There is never a zero-risk decision, and every decision you make, whether in business or daily life has risks, although not always monetary. Sometimes that risk is forfeiture of the rewards from an alternative choice. Today a decision to wear the emblem of the Covid-19 era, or not to wear a mask, can result in approval or appreciation from some to opposition, arguments, or worse.

Weather forecasters are also great examples or false negative and false positives on decision risk. If there is an 80% chance of rain or even 90% of rain, we immediately assume that it is 100% probability. Or if there is a 15% chance of rain, we believe it’s a zero percent probability, and the outdoor activities of the day will be enjoyable. In most instances, naivety to appropriate risk mitigation lowers the learning opportunity to understand and manage risk effectively. If you’re a farmer or work outdoors you appreciate weather forecasters as an easy example of variables in decision risk(s); and as you gain responsibility and success in your organization it only becomes increasingly complex. The best risk managers should wisely consider and remember Ahithophel and the fact that their is more to risk management than brilliant synapses.

And so, in life and business, weighing the risk(s) in the right balance, is the grand challenge.


Feast and Famine

Feast and Famine

Credit: Jacob M. Dietz, CPA

2020 just passed the halfway point and it could be called a year of feast and famine financially. The economy showed signs of strength early in the year, but then Covid-19 hammered the economy.

Many years ago, things were going very well in Egypt. In fact, there were 7 years of plenty. Those years of plenty, however, gave way to 7 years of famine. Fortunately, a very wise man providentially stored up resources during the years of plenty, which allowed him to feed his family and others during that time. Today there are also options to help business owners provide for their families.

Churches and Charities

If you are struggling to make ends meet, consider checking with your local church and charities to see if there is assistance available.

More importantly, if you are blessed and do not need assistance, consider donating to your local church and charities to help those that are in need. Some businesses may thrive through the Covid-19 pandemic. Local charities or churches may be able to inform you of the needs that are nearby if you are unaware of who needs help. “Give, and it will be given to you. Good measure, pressed down, shaken together, running over, will be put into your lap. For with the measure you use it will be measured back to you.” Luke 6:38 ESV

Lancaster County Small Business Recovery & Sustainability Fund Phase 2

Lancaster employers with fewer than 100 employees may apply for this grant. Companies may apply for this grant even if they received other grants, such as PPP, EIDL, and PIDA. They may not apply, however, if they already received this grant under phase 1. The application process begins 7/20/2020.

Covid-19 Relief PA Statewide Small Business Assistance

The second window to apply is intended to open in August. Eligible businesses must have at least 51% of their revenues in PA and are limited to 25 or fewer full-time employee equivalents as of 2/15/2020.

This program prioritizes certain businesses, such as those owned that are historically disadvantaged and those businesses owned by with low or moderate incomes.

Paycheck Protection Program (PPP)

We have written earlier about this loan program with the option of having the loan forgiven. The deadline to apply for this loan has been extended until August 8, 2020.

Economic Injury Disaster Loan (EIDL)

The Small Business Administration (SBA) is accepting EIDL loans. Applicants can have up to 500 employees, and possibly more in some cases. These loans are not grants, and they do need repaid.

Pennsylvania’s Covid-19 Dairy Indemnity Program

This program provides financial aid to farmers who had to dump milk during the covid-19 crisis. Farmers should apply for this by September 30th.

And the List Could Go On

We could continue to go on and name possible help available. Some of the options available might be just right for you, and some may not be a good fit. These programs may also have additional qualifications in addition to the summary mentioned here. If your business is struggling, feel free to call our office to discuss what options may be right for you.

CARES ACT: Qualified Improvement Property + Student Loans

Preface: Enacted to bring relief for those economically affected from the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides roughly $2 trillion in economic relief to eligible businesses and individuals with legislation of historical magnitude. 

CARES ACT: Qualified Improvement Property Depreciation + Student Loans

In addition to numerous other provisions that provide cashflows to businesses, the CARES Act includes a modification to the recovery period for qualified improvement property.

Depreciation of Qualified Improvement Property

Under the CARES Act, a 15-year recovery period is retroactively assigned to qualified improvement property placed in service after December 31, 2017. Therefore, qualified improvement property may be depreciated over 15 years or, alternatively, qualifies for 100 percent bonus depreciation if all bonus requirements are met.

Qualified improvement property is broadly defined as an internal improvement to nonresidential real property but does not include improvements related to elevators and escalators, the internal structural framework, or an enlargement of the building. The improvement must be placed in service after the date the improved building is first placed in service. The improvement must be made by the taxpayer. Therefore, the 15-year recovery period and bonus depreciation does not apply to a taxpayer that purchases a building that includes qualified improvement property depreciated by the seller over 15 years.

Opportunity to Amend for Tax Refunds

As a result of the retroactive application of the reduced recovery period, if a taxpayer filed two or more returns using a 39-year recovery period for qualified improvement property placed in service after 2017 an incorrect accounting method was adopted and automatic consent to change to the correct method must be filed on Form 3115. Taxpayers who only filed one return using a 39-year recovery period (e.g., a calendar year taxpayer who has not filed a 2019 return) may file an amended return to correct the recovery period or may file Form 3115 with their current year return.

Generally, a taxpayer must elect out of bonus depreciation by the extended due date of the return for the tax year in which the property eligible for the bonus was placed in service. Some taxpayers may not want to claim 100 percent bonus depreciation on qualified improvement property that retroactively qualifies for the additional allowance. The IRS will presumably issue guidance allowing these taxpayers to make a late election out of bonus depreciation and to file an amended return or Form 3115, as applicable, based on a 15-year recovery period.

The reduced recovery period not only allows businesses to improve their cashflow by filing an amended return, but also encourages investment in further qualified property improvements to stimulate the economy.

Exclusion for Employer Payments of Student Loans

The CARES Act provides improved tax relief and tax incentives for individuals and businesses alike. Included in the numerous tax provisions is the exclusion of up to $5,250 from income for payments of an employee’s education loans.

Normally, employee benefits provided under an employer’s nondiscriminatory educational assistance plan are not includible in the employee’s gross income to the extent the benefits do not exceed $5,250 for the tax year.

Educational assistance means the employer’s payment of expenses incurred by or on behalf of an employee for education or the employer’s direct provision of education to an employee. Assistance includes, but is not limited to, tuition, fees, and similar payments, books, supplies and equipment. The employer’s plan must meet certain requirements to qualify.

Under the CARES Act, the definition of educational assistance has been expanded to include the payment of student loans. Payments made before January 1, 2021, by an employer to either an employee or a lender to be applied toward an employee’s student loans can be excluded from the employee’s income. The payments can be of principal or interest on any qualified education loan that is incurred by the employee for the employee’s education.

The $5,250 cap applies to both the new student loan repayment benefit as well as other educational assistance (e.g., tuition, fees, books) provided by the employee. Any excess of benefits is subject to income and employment taxes.

Double benefit denied. No deduction is allowed for student loan interest payments paid by the employer that are excluded from the employee’s gross income.

Please call our office with any questions on provisions of the CARES Act. We are here to answer your tax questions.

Safe Harbor Rule for Rental Real Estate Businesses with Section 199A

Preface: If all the safe harbor requirements are met, an interest in rental real estate will be treated as a single trade or business for purposes of the section 199A deduction.

Safe Harbor Rule for Rental Real Estate Businesses with Section 199A

The IRS has guidance on a safe harbor for certain rental real estate businesses to qualify as a trade or business for the qualified business income deduction under Code Sec. 199A.

Congress enacted Code Sec. 199A to provide a deduction to non-corporate taxpayers of up to 20 percent of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship. Individuals, estates and trusts can also deduct 20 percent of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.

Safe harbor requirements for a rental real estate business to be considered a qualified trade or business include maintaining separate books and records for income and expenses; participation in a minimum number of hours in rental services; and maintaining reports or logs for dates of service, description of services performed, and hours tracking.

Qualifying rental services under the safe harbor include:

  • advertising to rent or lease the real estate;
  • negotiating and executing leases;
  • verifying information contained in prospective tenant applications;
  • collection of rent;
  • daily operation, maintenance, and repair of the property;
  • management of the real estate;
  • purchase of materials;
  • supervision of employees and independent contractors;

The term rental services does not include financial or investment management activities (such as arranging financing), procuring property, studying and reviewing financial statements or reports on operations, planning, managing, or constructing long-term capital improvements, or hours spent traveling to and from the real estate.

It is essential to note that certain real estate types excluded under Code Sec. 199A are real estate used for personal residence by the taxpayer and triple net lease arrangements.

Please call our office to discuss these safe harbor requirements for rental real estate businesses. We can review your current business operations and organization to see if your rental real estate business qualifies for the Code Sec. 199A deduction.