Month: August 2020

The Importance of a Good Partnership Agreement (Segment I of II)

Credit: Nevin Beiler, Attorney

In this article I will tell you about two business partners, who I will call Jake and Henry. The specific facts of this story are fictional, but the issues that are illustrated are ones that many partnerships have faced.

Jake and Henry were brothers. Jake was twelve years older than Henry, and when Jake finished school he started helping his father with the family hardware store. When Henry finished school, he also starting working full-time at the store.

When Jake turned 25 his father let him buy 10% of the business at a discounted price, and when Henry turned 25 he had the same option. When their father’s health declined to a point that he no longer could work at the store he offered to let Jake and Henry buy him out completely, again at a discounted price. This resulted in them being 50/50 owners with equal management rights. Jake would have rather purchased a larger share of the business, but he decided not to raise a fuss.

Jake and Henry’s working relationship slowly deteriorated over time. They had very different personalities, and they struggled to see eye to eye on many issues. Jake had a more careful and frugal personality, while Henry was more aggressive and liked to spend money to try to grow the business. Because they were 50/50 owners, and they had no partnership agreement stating who was in charge, they frequently disagreed about how to handle things. Their level of communication kept decreasing until they were hardly talking at all.

Eventually, things came to a point where they could no longer ignore their differences. This was mainly due to their lack of communication, but also partly due to the fact that some of Jake’s sons were interested in buying a share of the hardware store. Several of them had been working for the store for a while, and Jake wanted to give them a chance to become owners like his dad did for him. But neither Jake nor Henry wanted to sell any of their ownership shares because doing so would mean that the other brother would have more ownership percentage, and therefore more control over the business.

The bad feelings were beginning to make for strained interactions at family gatherings, and sometimes also between the uncles and their nephews during the workday. Henry finally decided that he could not continue on in the business because he didn’t see any way his family and Jake’s family would be able to work well together.

Henry offered that Jake could buy out his share of the store. Henry said that he could start his own separate hardware store in a different location that would not compete significantly with the existing store. Jake didn’t mind the idea of buying out Henry, or that Henry wanted to start another store in another location. This agreement was a great start!

But when they started talking about the buyout price for the store, their ability to agree abruptly ended. Each brother had vastly different opinions about what was a fair buyout price, based on what they had each paid for their shares of the store and the amount of years they had each invested in working there. Jake thought that because he had worked there longer than Henry and helped their father build up the business in its early years, he should get a significantly discounted price. Henry thought that because he was willing to sell out and let Jake have the business, he should get at least close to full price. They were not trying to be unfair to each other, they just had different ideas of what was fair, and their lack of communication prevented them from fully understanding the perspective of the other.

To complicate matters further, the eight-acre parcel of land on which the store was located was located in a rapidly-developing commercial area and had risen in value dramatically. It would have perhaps made financial sense for the existing business to sell the property for a high price and move to another location, but Jake was reluctant to sell the original business location as it had been in the family for many years and it was located just a short walk from his home.

After several months of fruitless and sometime tense negotiations, they both realized that they were not going to be able to resolve their disagreement on their own. Fortunately, they both knew that it was wrong to take their dispute to court. Based on the advice of their church leaders, they were both willing to work with a trained Christian mediator to help resolve their dispute. But even with the mediator’s assistance, the road to reaching an agreement was not easy. It required many meetings and long discussions, but in the end they were able to reach a resolution.

To be continued…. 

Nevin Beiler is an attorney licensed to practice law in Pennsylvania (no other states). He practices primarily in the areas of wills & trusts, estate administration, and business law. Nevin and his wife Nancy are part of the conservative Anabaptist community, and Nevin served as the in-house accountant for Anabaptist Financial before becoming an attorney. Nevin’s office is in New Holland, PA, and he can be contacted by email at info@beilerlegalservices.com or by phone at 717-287-1688. More information can be found at www.beilerlegalservices.com.

Why Private Student Loan Borrowers Should Refinance Right Now

Preface: Sales of personal residences have specific tax attributes with provisions for exclusions for taxable gains when a residence sales price exceeds the property basis. Tracking basis on your residence before the sale, and tax planning appropriately can lead to a good crop on harvest.  

2020 Transaction Planning: Sale of Main Residence

When selling your main home, you may qualify to exclude from your taxable income all or part of any gain from the sale. Your main home is generally the one in which you live most of the time.

Ownership and Use Tests

To claim the Section 121 sale of home exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

• • • • Owned the home for at least two years (the ownership test)
      • Lived in the home as your main home for at least two years (the use test)

Gains and Losses

If you have a gain from the sale of your main home, i.e. your sales price exceed your basis in the property, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a married filing joint return). You cannot deduct a loss from the sale of a main home.

Reporting the Sale Transaction

If you receive an informational income-reporting document such as Form 1099-S, Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable with tax Section 121. Additionally, you must report the sale of the home if you can’t exclude all of your capital gain from income.

More Than One Home

If you have more than one home, you can exclude gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

Example One. You own and live in a house in town. You also own a vacation house in the mountains, which you use periodically during year. The house in town is your main home; the vacation house in the mountains is not.

Example Two. You own a house in specific municipal jurisdiction, but you live in another house that you rent in that jurisdiction. The rented house is your main home for tax purposes and a Section 121 exclusion.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.

Example. On February 1, 2014, Amy bought a house. She moved in on that date and lived in it until May 31, 2015, when she moved out of the house and put it up for rent. The house was rented from June 1, 2015, to March 31, 2017. Amy moved back into the house on April 1, 2017 and lived there until she sold it on January 31, 2019. During the 5-year period ending on the date of the sale (February 1, 2014 – January 31, 2019), Amy owned and lived in the house for more than 2 years.

Amy can exclude gain up to $250,000. However, she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house.

Sale Home on Installment Sale Method

If you sold your home under a contract that provides for all or part of the selling price to be paid in a later year, you made an installment sale. If you have an installment sale, you may report the sale under the installment method unless you elect out. Even if you use the installment method to defer some of the gain, the Section 121 exclusion of gain remains available on the main home.

If you have any questions related to the sale of your main home or vacation home, please call our office. We’re happy to discuss your options.

Preface: Some would say that deducting tax losses from one business activity to offset income from another activity would be a great tax strategy. Not so fast, say the tax courts!

Passive Activity Loss Rules

Credit: Benuel B. Glick, EA

Do you own a business (or shares in a business) with minimal or no participation? Perhaps you own, or are considering to purchase, real estate or some other asset to lease out. If so, you may want to familiarize yourself with passive activity loss rules for strategic business and tax planning.

What is Considered a Passive Activity?
In IRC section 469(c), passive activity is defined as any activity which involves the conduct of any trade or business, and in which the taxpayer does not materially participate. Section 469(c)(2) also says except as otherwise provided, the term “passive activity” includes any rental activity.

Why is This Part of the Tax Code?
Prior to 1986, a taxpayer could usually deduct losses in full from rental activities and businesses regardless of his or her participation. This gave rise to a significant number of tax shelters that allowed taxpayers to deduct non-economic losses against wages and investment income, thus the Tax Reform Act of 1986 added IRC 469 to the package. Section 469 limits the taxpayer’s ability to deduct losses from passive activities.

Passive or Non-Passive Activity?
A trade or business activity is not a passive activity if you “materially participated” in the activity during the tax year. According to IRS Publication 925, you materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. There are other requirements for rental properties.

• • • • You participated in the activity for more than 500 hours.

• • • • Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.

• • • • You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.

• • • • The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests….

• • • • You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.

• • • • The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.

Based on all the facts and circumstances you participated in the activity on a regular, continuous, and substantial basis during the year.

There are a few additional stipulations to the above list but in general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Do not treat the work you do in connection with an activity as participation in the activity if both the work isn’t work that’s customarily done by the owner of that type of activity and, one of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules.

Passive Activity Income and Loss
Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity. It is noteworthy that investment income, e.g. stocks, bonds, interest from financial institutions etc., is not classified as passive income.

Passive activity loss is the amount, if any, by which the aggregate losses from all passive activities for the taxable year, exceed the aggregate income from all passive activities for such year.

Active Participation for Real Estate
If you or your spouse actively participated in a passive rental real estate activity, provided you’re not a limited partner or less than 10% partner without regard to limited partners, there is a special provision that allows you to deduct up to $25,000 of loss against your non-passive activity income. This special allowance is an exception to the general rule disallowing the passive activity loss. Additionally, there is a phase-out rule based on your filing status and MAGI that limits or disallows this special allowance.

Not to be confused with material participation, the IRS says that you may be treated as actively participating if you make management decisions in a significant and genuine sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Activity Groupings
To add to the Section 469 complexities, it has a provision for “grouping” activities if they form an “appropriate economic unit.” This essentially says that if business A is appropriately connected to business B economically, you can elect to group these activities. This could potentially offset otherwise passive activity gains with non-passive losses. Unless the original election is obviously inappropriate, this election is permanent and should be considered carefully prior to making the election.

Conclusion
While Section 469 provides rules for passive activity losses, there are some strategies that can be employed by the prudent entrepreneur to efficiently maximize his or her business’s resources. One consideration might be grouping appropriate economic units. Yet another might be materially participating in the correct enterprise.

The Unknown Unknowns: Preparing for the Future of Business During a Covid-19 Pandemic 

Credit: Donald J. Sauder, CPA | CVA

Written in 1742, one overlooked masterpiece from the most underrated century of English verse, Thomas Gray’s poem “Ode on a Distant Prospect of Eton College” concludes “And happiness too swiftly flies. Thought would destroy their paradise. No more, where ignorance is bliss, ‘Tis folly to be wise.”

The business world has changed since 1742, and so has the North American continent. Yet those timeless words still resonate today as a masterpiece. With the Covid-19 pandemic rapidly shifting reflections on both the macroeconomic and microeconomic landscape of business, entrepreneurs are increasingly likely to be entering an era where the business unknown unknowns are more evident than ever before. While ignorance is bliss, ignorance also has risk.

In recent decades, with a firm reliance and trust in the management of the US economy and economic policymakers, entrepreneurs have had an unparalleled opportunity to develop enterprises. The sunny business climate of past years has provided the best of resilient opportunities for enterprising entrepreneurs.

Approaching the new planning horizons of the Covid-19 business climate realistically, when we consider the reality that now we have a new classification of enterprises – essential and non-essential businesses, it should raise awareness that these quick shifts in trends and the business climate are likely not simply temporary. Today, for some businesses classified as many non-essential companies, strategic planning is merely a viable survival plan.

Too many businesses with aggressive growth strategies often fail to appreciate that business growth requires capital and access to capital financing; ultimately, growth involves a corresponding amount of cash. Companies that have continued to aggressively gain market share with the simple assumption that funding will always be available whenever needed should cautiously consider shifts in regulated lending practices and credit policies amidst a Covid-19 pandemic. Bottom line: Don’t pursue business growth if your financing funds are not assured.

Easy financing access in prior years has been a plain and straightforward vehicle that can transport any entrepreneur farther than they planned to go on the highway of commerce. The assumption, all risks are financeable in some fashion, is a truism until it isn’t. Perhaps you’ve never considered the fact your bank could get in financial trouble?

History tells us that companies confront financial trouble more often from a lack of cash flow than a lack of net income. This is no more apparent than when inventory is sold, and payment collection on contracts or accounts receivable is deferred because your customers are under financial duress. Increasing risk is supply chain disruption with just-in-time inventory margins, and the supply chain unexpectedly tightens. Too often, business owners are overly optimistic or unrealistic about real underlying micro and macroeconomic trends, hazards, and tensions, leading to unnecessary risks.

It would seem to be a reasonable expectation for many individuals, that Covid-19 pandemic business risks will perhaps last beyond the 2020 business year. For this cause, having a plan and cash equivalent reserves to continue to comfortably cashflow term debt and fixed expenses among variables in cashflows, is most prudent.

Envisioning what these Covid-19 business changes will look like in say even six months, would be folly for us to prognosticate with any credit as an expert. Plainly, we don’t know what we don’t know, and we don’t know what the unknowns are. On the contrary, considering possible business climate change and pandemic scenarios is advised.

The foreknowledge of the right business decisions in 2020 will only be known after the fact, and many necessary business decisions will be made with less than complete and perfect information. The words “Welcome to business speculation” should bring a degree of realistic awareness to current Covid-19 pandemic risk(s). Business leadership today must be increasingly decisive, and not be influenced by fear and concern.

If you’re a business leader and you’re fearful today or have more risk than you can handle or have prepared for, you know what you need to do. Begin immediately downsizing your enterprise risks. If you need help with this task, retain a trusted advisor. You are now aware that you exceeded your comfort zone of feeling appropriately equipped to navigate an economic storm. If you lack the necessary confidence both for yourself and those who look to you for business leadership, the voyage is unadvisable with your charted course. Do you see the lighthouse keepers? (More importantly, can you discern like a certain Apostle when you should be in the harbor?)

Many business industries are solely dependent on credit market access. In real estate, most buy | sell transactions, and more substantial construction activity is associated with loan financing. The real estate’s current and future value is pillared on the assumption that someone else will be able to access credit to purchase the property when the owner desires to sell.

The domino effect of the credit market reliance is the chief concern we need to consider for business strategy developing Covid-19 business plans. Instability in financial markets, and therefore credit markets, are a trusted forerunner of microeconomic business crisis developments.

When interest rates are near zero, it signals a leading indicator of the future value of that money. When interest rates are negative, banks will also be less likely to lend if they don’t pass on the additional costs to those customers who borrow. Correspondingly, the price to access credit can increase. It is not unrealistic to suppose fees can be placed on lines of credit and other financing sources. What would it look like to have to pay your bank a 1% or 2% fee simply to keep your business line of credit from being closed (without any amount drawn on financing)?

Restructuring balance sheets should be of top priority for businesses that want to avoid a potential risk of insolvency when counting the costs of a possibly longer-term planning horizon than expectation from a Covid-19 business climate. This includes downsizing inventory to pay off debt(s) and increasing equity either with additional capital or strategic downsize planning of the balance sheet. Paying off debt is the objective. When financing insolvency, financing experts will tell you that the last dollar of financing is the most expensive and may be too costly in business recovery.

Planning horizons should include all possible scenarios your team can think of with regards to risk including such things as a business shutdown or an off-line team. Events could occur for any number of reasons. Additionally, suppose government resources become strained and for peaceful discussion purposes a possible insolvency of local municipalities. In those instances, judges could rule that the property owners will make up the deficit in revenues. From a microeconomic perspective, when a homeowner’s association faces revenue deficits, who pays? (The appraiser thought those condos were worth $1.0m apiece, and now listed at $75,000 because costs rose to $5,000 per month payable to the HOA?) Or say real estate taxes doubled for any number of reasons, what would that do to local household budgets and, therefore, your customer’s discretionary revenue?

We are in a season when there are no perfect business decisions, and knowing the right choice is impossible to discern when complete information is absent until after the fact.

A business chief risk officer is increasingly vital to enterprise successes in a Covid-19 pandemic. If your business omits a meeting to assess Covid-19 business risk(s) regularly, you’re unprepared for the unknown unknows ahead. You should quickly be more diligent before it is too late. At a minimum, you should meet to examine and discuss pressures among other industries, resolutions, precautions, and plans to resolve potential tensions if they should reach your trade or enterprise.

Develop a list of the ten best events that could happen to your business, both during and absent a Covid-19 pandemic. Also, develop a list of the ten worse events that could occur, i.e., shutdowns, cashflow interruptions, or supply chain breaks.

After you successfully outline these twenty events, and develop workable and implementable solutions, you’ll be further prepared and ready for the future Covid-19 pandemic business unknown unknowns that may be encountered ahead.

 

Preface: Eight bills linked together comprise the pending HEALS Act legislation as a counter proposal to the HEROES Act, as additional Covid-19 relief measures are negotiated in Congress.

The HEALS Act: A Boots on Sand Covid-19 Safeguard

Credit: Donald J. Sauder, CPA | CVA

Staring this week’s Senate discussions, Republican Senators unveiled the next steps to safeguard the US economy from the possible risks of sinking sands amidst the coronavirus impact with a new bill – the Health, Economic Assistance, Liability Protection and Schools Act (HEALS). The new coronavirus relief provisions outlined in this pending legislation could bring $1.0 Trillion of additional economic relief funding.

The bills package includes a buffet of economic legislation including $306.0 billion in emergency appropriation from the SAFE TO WORK act introduced from Senator John Cornyn (R-Texas), the Safely Back To Work and Back to School Act from Lamar Alexander (R-Tennessee), the American Workers, Families, and Employers Assistance Act from Chuck Grassley (R-Iowa), the Continuing Small Business Recovery and Paycheck Protection Program Act from Marco Rubio (R-Florida) and Susan Collins (R-Maine), the Time to Rescue United States Trusts Act from Mitt Romney (R-Utah) and Restoring Critical Supply Chains and Intellectual Property Act from Lindsey Graham (R – South Carolina).

Relief Funds

First and foremost, the HEALS Act includes a second round of taxpayer stimulus checks like the CARES Act. This would provide qualifying taxpayers with $1,200 of relief funds for whatever spending purposes they so choose, with phase-outs on funds above $99,000 for individuals and $198,000 for couples. The Treasury announced these stimulus checks could arrive as early as August to qualifying taxpayers.

Secondly, economic relief with extra unemployment benefits proposed at $200 per week, as an extension to the original CARES Act $600 per week additional UC benefit that expired July 31. The federal supplement would not exceed 70% of previous wages when combined with both state and federal assistance, to incentivize workers to look for gainful employment.

The SAFE TO WORK Act proposal is designed to offer employers more durable protection from lawsuits brought from workplace coronavirus compliance risks. The Act would provide a guard to employers from personal injury lawsuits from coronavirus workplace risks. It would also place a ceiling on any awards, as long as employers did not demonstrate willful misconduct.

Update on PPP Loans

The famous Paycheck Protection Program would be extended to December 31, 2020, for bolstering treasuries of the forty-plus percent of small businesses that are concerned with making payroll without the aid of a PPP subsidy. The second round on these financings on the forgivable PPP loans would be limited to business with 300 or fewer employees with special funding channeled to micro-businesses with ten or fewer employees to ensure small business loan equality. Also, legislation is pending on automatic loan forgiveness on PPP loans below $150,000. The forgiveness features of the PPP loans are in a continued state of fluctuation, and borrowers should be patient as the trends are continuing towards reducing fears of inability or hassle to obtain forgiveness on PPP loans below $2.0 Million.

Also, a Long-Term Recovery Sector Loan facility would provide guaranteed long-term low-interest loans for working capital to businesses that equal up to two times annual revenues, with a $10.0 million ceiling. Maturity dates on these loans would be up to twenty years, with 1% interest rates. Eligible businesses would include 500 fewer employees that have seen declines in revenues of 50% or more in the first or second quarter of 2020 compared to 2019.

School Funding

School funding features in the HEALS Act provide for $105.0 Billion to education, with $70.0 billion allocated to grade schools and $29.0 for colleges and universities. The emergency funding would offer scholarships to parents to send children to private schools and funding for private schools based on certain stipulations and student numbers.

The bill proposed from Tim Scott (R-South Carolina) would provide a tax deduction of 100% for business meals to give relief to support America’s restaurant workers.

Summary

While the HEALS Act is pending, the significance of the additional relief package, if approved, will bring a new wave of economic relief awaiting a tide to turn on the Covid-19 tribulations.

This article is general in nature, and it does not contain legal advice.  Contact your advisors to discuss your specific situation