Cleveland Business Advisors

Advisor Insights

For the past several months, our Real Estate and Construction Group has been authoring a monthly column in Builders Exchange Magazine that offers advice to real estate and construction professionals.

So far this year, the following topics have been covered:

• The Benefits of Subprime Bonding  
• Selecting and Implementing Financial Software  
• The Value of a Niche Marketing Plan 
• Lessons Learned From the Construction Industry  
• Cancellation of Debt Income 
• Preventing Financial Fraud 
   

• Health insurers and group health plan sponsors are now prohibited from imposing pre-existing condition limitations on individuals who have not yet attained age 19 and from denying coverage to such individuals based on the existence of a preexisting condition. All such limitations and coverage denials, regardless of age, begin in 2014.
• Health insurers and group health plan sponsors are prohibited from imposing lifetime dollar limits on essential health benefits, and are required to sharply increase annual dollar limits on essential health benefits. Such annual limits will be eliminated starting in 2014.
• Coverage rescissions (except in the case of fraud or intentional misrepresentation) are prohibited.
• Plan-covered and insured individuals are given greater control over choosing a primary care physician and greater access to emergency services and related care.

To read more about these new rules, see this Executive alert from Baker Hostetler.

Go Directly From a 401(k) to a Roth  

Do you want to transfer your 401(k) plan assets to a Roth IRA? Under a recent tax law change, you can make the move in one fell swoop. Previously, it took two separate steps. In addition, another tax law provision taking effect this year may encourage this direct approach.

Click here to read more.

Should You Give to a Donor-advised Fund?

Wealthy entrepreneurs with charitable intentions may choose to set up a private foundation. But a more convenient alternative is gaining in popularity: the donor-advised fund.

This technique may be especially appropriate if you need to devote more time to business activities in the current economic environment. The fund does most of the hard work for you and requires less personal attention than a private foundation. In some cases, you might even convert an existing private foundation into a donor-advised fund.

Click here to read more.

New Law Revamps Student Loan Program

The new Health Care and Education Reconciliation Act of 2010—recently signed in conjunction with the monumental new health care law—includes dramatic reforms in the federal student loan program. This new legislation could affect families of all stripes for years to come.

Click here for a brief summary of four points you should know about.

Aurum Capital Markets Summary 

Please click here for a summary from Aurum Wealth Management Group on the performance of the major market indices through the end of May as well as a recap of the significant events influencing the markets.

Click here to view Part 1 of our series and learn more about the stock option landscape or Part 2 to learn more about the accounting and tax ramifications of issuing stock options.

What To Do?

As discussed above, there are significant risks that a company brings upon itself if it decides to issue stock options without properly valuing the options and the equity of the company. Rather than issuing stock options, if a company wants to offer an employee the opportunity to obtain an ownership interest, the most efficient and “clean” method may be to allow the employee to purchase shares from the company or from existing owners. There is no valuation requirement in this case (unless a party wants to hire an expert to ensure that they the transaction price is fair and reasonable) which also eliminates the out-of-pocket cost for the employer. In fact, a business actually recognizes a cash inflow when an employee purchases shares directly from the company. 

I am a valuation expert and I directly benefit from work associated with the valuation of stock options, so why am I telling you to consider alternative routes of compensation? Too often, the companies that issue stock options without having them professionally valued are the same companies that will fight against having their options valued at all due to the cost associated with the valuation. I simply want to spread awareness that there are other avenues of compensating employees and giving them opportunities for equity ownership that may be more cost efficient for companies that are under the illusion that issuing stock options does not require a cash outlay.

If you take anything away from this article, remember that issuing stock options is not a “cashless” expense. Consider that there are other alternatives for compensating employees other than using stock options. Remember that there are transaction costs associated with issuing stock options, specifically, hiring a valuation expert, that will create real out-of-pocket cost for any company. Unless you are ready to comply with the valuation requirements associated with issuing stock options, you may be better off simply not using them and compensating employees in another manner. Finally, just like selling a home, if you are going to issue stock options make sure that you bring in an expert to ensure that the value of the company and options are determined and documented appropriately – and be prepared to pay the “commission” for these services.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

Accounting and Tax Ramifications of Issuing Stock Options

 Click here to view Part 1 of our series and learn more about the stock option landscape.

To give you more perspective, first let us review the accounting treatment for the issuance of stock options (rest easy - this will not be too painful). When stock options are issued, an expense must be recorded based on the value of the option. A stock option’s value is derived from a variety of factors, two of which are the value of the stock as of the date of the option grant and the exercise price of the option (the price at which the option holder can purchase a share of stock). Determining the value of a company’s stock is not difficult when it is publicly traded, but privately-held companies do not have readily available market prices, which necessitates the services of a valuation expert. Unless the option is properly valued, a company cannot correctly record the associated compensation expense. If a company is unable to correctly record the results of its operations, it may find obtaining a clean audit opinion to be a difficult, if not impossible, task.

Now that I have warned you about the headaches that you may encounter on the “accounting” side of issuing stock options, let me further alarm you with the tax ramifications. If a company sets the stock option exercise price lower than the fair market value of its stock on the grant date, the stock option could be deemed to be deferred compensation according to Internal Revenue Code 409A. Under 409A, such deferred compensation would be immediately taxable to the employees receiving the grant and subject to regular income tax rates plus 1%. Perhaps even more distressing, a 20% penalty plus interest would also be triggered. In addition, employers would be responsible for withholding income taxes for employees on these types of option grants, which if not done, could result in additional tax penalties. The immediate taxability, penalty and withholding requirements do not apply when the stock option exercise price is equal to or greater than the fair market value of the company’s stock on the grant date. It is impossible to compare the exercise price of a stock option to the fair market value of a company’s stock unless a valuation of the company’s stock has been performed. In addition, when a valuation has been performed to establish the fair market value of a company’s stock, the burden of proof shifts to the IRS to disprove the appraised value. Therefore, unless there is documentation to support the fair market value of a company’s stock near the option grant date, there could be significant tax issues in addition to the accounting issues alluded to earlier.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 3: What to Do?

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.
 

When selling your home, it is common to use an agent to list, promote and show the property. In exchange, you pay a portion of the sales price as a commission to the agent. The benefits of using an agent include: 1) the listing of your home in a database so that homebuyers can access information about it; 2) the agent acting as your middleman during the negotiation process; and 3) the incentive it gives the agent to sell your home quickly (so that her or she can earn their commission). 

Some people choose to sell their home by owner and forego using an agent. These are typically the homes that have “For Sale” signs in their yards for many months, sometimes even years (you know the ones), before they are actually sold. These people often believe that the benefit of not having to pay an agent commission on the sale of their home is worth the prolonged period it will likely take to sell the property. 

What does the choice of hiring a real estate agent or selling your home by owner have in common with private companies issuing stock options? The strange answer is: Much more than many of us realize. 

The Stock Option Landscape

More and more private companies are issuing stock options as part of their key employees’ compensation plans. This may be driven by the ideas that: 1) stock options don’t “cost” anything to the company; 2) stock options will positively influence employees’ performance; or 3) since public companies issue stock options, it must be a good idea and private companies should follow suit. Regardless of the motivation, what most private company owners and executives do not realize is that accounting for stock options, for both tax and financial reporting purposes, may actually have an out-of pocket cost that is greater than the value of the options themselves.

In order to value stock options issued by private companies, there are two major steps that must be undertaken:

1. Determining the value of the company’s equity (which is a key input to valuing a stock option)

2. Determining the value of the stock option

There are not many privately-held companies with the in-house resources or expertise necessary to perform either of the requirements above, both of which are essential in accounting for the issuance of stock options. This often puts accountants in the awkward position of trying to explain to business owners the “unseen” costs and accounting ramifications associated with issuing stock options.

Back to our analogy, hiring a valuation expert to determine the value of stock options is much like hiring a real estate agent to sell your home. A valuation expert is able to perform both of the tasks identified above that are necessary to value the stock options issued by a private company, much like a real estate agent takes care of the necessary steps to sell your home. This work is not free, however, and depending on the complexity of the company and the options issued, the cost to value a private company’s stock options can range in cost from thousands to tens of thousands of dollars. When private companies issue stock options, they often do not consider the “commission” that they will have to pay to a valuation expert to ensure that the options are properly valued. Unlike real estate agent commissions, however, which are based on the sale price of the home, valuation fees are relatively fixed. 

Just like selling a home “by owner,” some companies will issue stock options and try to determine the value themselves (or even worse, not value them at all). By not using a real estate agent, homeowners often find themselves making no headway in the sale of their home. Similarly, by not hiring a valuation expert to value the stock options that they have issued, private companies create the risk that their auditors will not sign off on their financial statements. Maybe even more importantly for business owners and employees, unsubstantiated option values leave both companies and their employees in danger of stiff tax consequences.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 2: The Accounting and Tax Ramification of Issuing Stock Options

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

Advisor Insights

Skoda Minotti is conducting our 3rd annual survey of the Northeast Ohio real estate and construction industries. Every participant who completes the questionnaire will receive a free copy of the survey results and analysis and have a chance to win a $50 gift card to Dick's Sporting Goods.

The goal of the survey is to provide professionals in the real estate and construction industries in Northeast Ohio with the invaluable insight into their industries.

As an added bonus, one out of every 20 survey participants will be randomly selected to receive a $50 gift card to Dick's Sporting Goods. Note that only the first 100 survey participants will be eligible for the gift cards, so act quickly.

Click here to complete the real estate or the construction survey.

Please feel free to contact Bob Goricki at bgoricki@skodaminotti.com or 440-449-6800 with any questions related to the survey.

Lower Your Worker's Comp Premiums with the BWC's new Drug-Free Safety Program

The new Ohio BWC Drug-Free Safety Program (DFSP) will be available for all Ohio employers, including previous participants, beginning July 1, 2010. The DFSP is easier to understand and implement, and provides a long-term discount for an unlimited number of years of participation.

There are two levels in the DFSP; eligible employers may elect to join either level of the program:

BASIC LEVEL: Participating non-group-rated employers receive a 4-percent discount by meeting all program requirements. These include completion of a safety review, accident reporting, accident analysis training for supervisors, employee education, supervisor skill-building training, alcohol and drug testing, and a written DFSP policy.

ADVANCED LEVEL: Participating non-group-rated employers receive a 7-percent discount by meeting all of the Basic Level requirements, as well as conducting 15-percent random drug testing annually, and completing a safety action plan. Advanced level participants must also provide a second chance after employee’s first positive test with BWC to specify exceptions.

For more information on how you can sign up for this program, please contact me at rgingerich@skodaminotti.com  or 440-449-6800.

How to Raise Cash for a Business

It "takes money to make money," but some of the conventional sources of cash have dried up for small-business owners. But that does not mean you should give up. If you lack the necessary funds to start a business or you need more money to expand your current operation, there are still several possible ways to raise the cash.

Click here to read more. 

Sweep Away "Nanny Tax" Concern

If you employ a household worker, such as someone to watch young children, you may be liable for the so-called "nanny tax." However, you can sidestep any dire tax consequences if you pay close attention to the rules.

Click here to read more.

Protecting Your Business from Embezzlement

It seems that every other day the newspapers feature a story where a longtime employee has embezzled money from his or her employer. You may sadly shake your head and blithely continue to go about your business. After all, this cannot happen to you ... can it?

Click here to read more.

Aurum Capital Markets Summary

Please click here for a summary from Aurum Wealth Management Group on the performance of the major market indices through the end of March as well as a recap of the significant events influencing the markets.

Not-For-Profit Seminar - June 8th

Skoda Minotti is pleased to announce that we will once again be hosting a not-for-profit seminar featuring nationally recognized not-for-profit expert Dick Larkin of BDO Seidman.

Dick will be presenting a not-for-profit industry update that will contain valuable insights for anyone involved in the not-for-profit industry. In addition to Dick's presentation, two Skoda Minotti professionals will also be presenting on Form 990 as well as an information technology primer for not-for-profit entities.

Seminar Details

• Location: Hilton Garden Inn, 700 Beta Drive, Cleveland, OH
• Date: June 8th
• Time: 8:00 - 11:30am
• Cost: $25
• Registration: Click here - http://www.eventbrite.com/event/674362035 

If you have any questions on the seminar, please contact Bob Goricki at bgoricki@skodaminotti.com or 440-449-6800 with any questions.
 

Advisor Insights

This month, our monthly Advisor Insights column in Smart Business Cleveland Magazine takes a look at lessons learned from the restaurant industry.

The restaurant industry is still feeling the sting of the recession, and the general consensus is that consumers are very pessimistic about 2010.Therefore, restaurants have had to adapt to survive as their longtime patrons trim their dining-out budgets.

What can other industries learn from the restaurant industries struggles? Click here to read the full article, "Lessons Learned from the Restaurant Industry."

HIRE Act Provides Employers with Tax Incentives to Hire Unemployed Workers

The Hiring Incentives to Restore Employment, or HIRE, Act, was recently signed by President Obama after being approved by the Senate by a 68-29 bipartisan vote on Wednesday, March 17th. It is the first of a series of bills that the administration and Congress plan to introduce to reduce the unemployment rate.

Some key points are listed in our blog post here.
 
FRx Discontinued; Paves Way for Microsoft's New Business Intelligence Program

Microsoft currently offers three Corporate Performance Management (CPM) programs: FRx, Forecaster and Enterprise Reporting, which aid businesses in the areas of financial reporting, planning/budgeting/forecasting, and consolidation. Starting in May 2010, the capabilities of these CPM programs will gradually be combined into one program, Microsoft Dynamics Management Reporter, as part of an integration process that will take place over the next four years.

Click here to read more.

Skoda Minotti College Planning Seminars

In the coming months, we will be hosting free college planning seminars (great for current high school freshman, sophomores or juniors) on a monthly basis. We invite you to join us at one of the events listed below. All events will be hosted at our offices. Click the link to register. 

• April 27
• May 25
• June 29
• July 27 

• Analyze your ability to qualify for college funding and to what extent by computing your expected family contribution.
• Develop "college aid planning" concepts that may lower your out-of-pocket costs by increasing your eligibility for funding.
• Assume responsibility for the completion of the complicated FAFSA form annually. And at no additional cost, complete such other forms as may be required by individual colleges.

Click here for more information on Skoda Minotti College Planning Services.

Working at a Downsized Company

OK. You did it!  After listening to the advice of your experts and looking at the balance in the checkbook, you downsized 25% of your personnel and cut management salaries by 10%. It wasn’t easy and, in fact, it was a terrible experience. You order a complete review of job descriptions and issue a hiring freeze. But how do you keep the employees operating at optimum efficiency with only 75% of the workforce?

Click here to read more.

Combining a Business Trip with a Vacation

With the warmer weather approaching, you may be looking to spend some time at the beach, on the golf course or just relaxing by the pool. If you can add a few days of vacation onto a business trip, so much the better. Besides saving money, you may qualify for some generous tax breaks.

Click here to read more.

New Case Allows Deduction for Business Education

No matter how old you are, you can still learn to do your job better. For example, you might take a refresher course to stay on top of the latest developments in your field. Or you may enroll in a curriculum that will start you toward a new career.

Click here to read more.

Six Estate-planning Steps for This Year

The scheduled one-year repeal of the federal estate tax in 2010, plus the related changes in the federal estate- and gift-tax system, have certainly clouded estate-planning matters this year. It is expected that Congress will eventually take some legislative action, but that does not mean you should stand by idly. It is important to have your estate plan reviewed to ensure it still meets your objectives and that it is positioned to accommodate future developments.

Here are six steps you may take to shore up your estate plan under the current conditions.

Aurum Capital Markets Summary

Please click here for a summary from Aurum Wealth Management Group on the performance of the major market indices through the end of February as well as a recap of the significant events influencing the markets.

Skoda Minotti Blood Drive

We are pleased to announce that we will once again be supporting the American Red Cross by hosting a blood drive for our employees on April 26th at our Mayfield Village office.

Last year, our employees donated 69 pints of blood through these blood drives and we are aiming to top that number in 2010.

If you have any questions about any of these articles, post a comment below or contact us at 440-449-6800.  Or, if you would like to subscribe to this free, monthly e-newsletter, please send an email to information@skodaminotti.com.

With the crash of the real estate market some are looking to capitalize and purchase larger homes for a bargain price. In doing so, they face the problem of selling their current residence to make the move up. With the lack of buyer interest and with some people not willing to take such a large loss people are holding out for the market to rebound. This creates the problem of carrying two mortgages, which the monthly payments on two mortgages can create cash flow problems for many taxpayers in this situation. 

To help with this burden, a taxpayer may decide to rent out their prior residence to help bring in cash and cover the monthly costs on that property. If the tax payer decides to go this route there are a number of rules/guidelines that one has to be aware of. 

Rental vs. Vacation Property

The first of these rules (which would only apply to the first year of renting) is determining if the property being rented qualifies as a “rental property” or a “vacation property.” The general rule is if the home was personally used for more than the greater of 14 days or 10% of the days the dwelling is rented for the year it is classified as a vacation home and subject to the rules under code section 280A. The main difference between a rental and vacation property is the expenses that can be deducted. If it is classified as a vacation property the only rental expenses that are deductible is the portion of the year that the property was rented. If it is deemed to be a rental property all expenses are considered business related and possibly deductible. For the sake of this conversation we are assuming that this rule is met and the home qualifies as a rental property.

Depreciable Basis of a Property

After determining the home is a rental property the first step is determining the depreciable basis of the property. When a personal home is converted to business use, the total basis is calculated by taking the lower of the adjusted basis or the fair market value of the property on the date of conversion. If the property was a personal residence and no depreciation was taken for business use of home you should go back to the purchase documents of the home to determine original cost which would also be the adjusted basis. Once the total basis is calculated the land portion is broken out and the remaining portion is considered the depreciable basis. Once the depreciable basis is calculated it must be depreciated using the method and recovery period set by the IRS at the time of conversion (at this time the method to be used is straight line and recovery period is 27.5 years for residential property).

Along with depreciation expense the taxpayer must start keeping records of the income earned and expenses incurred in renting the home. The list of expenses that are deductible for rental properties is longer than that for a personal residence. Many of the costs of renting a home (mortgage interest, real estate taxes, insurance, advertising, repairs and maintenance, supplies, etc.) are deductible.

First Time Home Buyer Credit

If the home was purchased within 2008 or 2009 and the first time home buyer credit was taken on the purchase there may be additional tax consequences to consider. If the home for which the first time home buyer credit is taken is converted to a rental property within 36 months of purchase a portion of the credit will be required to be repaid. This portion will depend on how long the home was used as a personal residence. 

Selling the Property

Finally, after a taxpayer converts their former personal residence to rental property and gets to the point that they want to sell it there are more rules to be aware of. First the gain or loss must be calculated, and to do this the basis of the property must again be calculated. The basis can differ depending on if the property is being sold at a gain or a loss. If the property is sold at a gain, the basis of the property is the original cost basis to the taxpayer, plus any amounts paid for capital improvements (capitalized and not previously deducted), less any depreciation taken. If the property is sold at a loss, the basis is the lower of the original cost basis or the fair market value at the date of conversion, plus any capital improvements, less any depreciation taken. Rental property, when sold, is treated as a capital gain/loss but just because it was rented for a short period of time does not completely preclude the taxpayer from taking advantage of the gain exclusion rules for a personal residence. If the property is rented for less than 3 years before being sold, the taxpayer may still be eligible to take a portion of the personal home gain exclusion. This gain exclusion cannot be used against gain from recapture of depreciation though.

Summary

With the current state of the real estate market, renting a prior personal residence may be beneficial for a taxpayer to help wait out the recession and see some of the buyer interest and value come back. If one decides to go this route these are the rules/guidelines that should be considered at each stage of the process.

Contact our CPAs, business and financial advisors in Cleveland or Akron at 440-449-6800 or www.skodaminotti.com.

Many of us probably remember Harvey Dent, aka “Two-Face,” from our childhoods as one of Batman’s arch enemies. He looked like a normal guy from one perspective, but from the other side, he was a bizarre-looking villain. While normalizing adjustments in business valuation may not be quite as exciting as watching Batman battle Two-Face, they bear a similarity to this comic book character.

The results of many companies as reported in financial statements or tax returns do not always reflect economic reality. Therefore, normalizing adjustments are required when business valuations are performed to present a company’s income statements and balance sheets at their true economic levels, without distortion from accounting rules or the owners’ operational preferences. A company’s value can look completely different after normalizing adjustments have been made – it is almost like spinning Two-Face around to look at one side as opposed to the other. 

For example, an owner may be taking a very large salary in an effort to reduce taxable income and income taxes, effectively eliminating any net income. When employing an earnings-based approach in valuing such a company, a normalizing adjustment would likely be necessary to adjust owner’s compensation downward to an appropriate fair market value, effectively raising net income and the resultant value of the company. 

It is important to note that normalizing adjustments can both increase, or decrease, net income. Another common normalizing adjustment occurs when a related party rents property to the company being valued at a monthly cost lower than the property’s fair market rental value. In this case, the valuation expert would increase the company’s rent expense to fair market value, effectively reducing net income and lowering the company’s value. 

While valuation experts are trained to identify normalizing adjustments through trend analysis and management inquiry, business owners and advisors can make the valuation process run more smoothly by bringing potential adjustments to the attention of their valuation expert. It is ultimately up to the valuation expert’s judgment as to what normalizing adjustments are appropriate for a given company, but when a business owner is prepared to answer questions regarding potential adjustments, it can lead to a more efficient valuation engagement.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

While the likely adoption International Financial Reporting Standards (IFRS) is a hot topic for accountants, many privately-held small and medium-sized business owners may not be aware of the potential changes on the horizon for financial reporting. The general consensus is that in the coming years, the U.S. will move to adopt IFRS in place of Generally Accepted Accounting Principles (GAAP) as the governing standards for financial reporting, although no official date for conversion has been set yet. 

As discussed in the September 2009 issues of the Journal of Accountancy, IFRS for Small and Medium-Sized Entities (SME’s) was released in July 2009 after five years of development. SMEs are defined as businesses that publish general-purpose financial statements for external users and do not have public accountability. IFRS for SMEs is much more condensed than the full version of IFRS and does not address many of the areas that do not apply for privately-held companies, such as segment reporting or earnings per share.

What does this new standard mean for small to medium-sized business owners and operators? 

Some of the most significant differences between IFRS for SME’s and U.S. GAAP are:

-          Simplified disclosures for pensions, leases, financial instruments, and other areas.

-          Prohibition of the last-in, first-out (LIFO) method of inventory valuation.

-          Amortization of goodwill and indefinite-lived intangibles over a period of ten years or less.

-          Simplification of the temporary difference approach to income tax accounting.

-          Greater use of historical cost in accounting for financial assets and liabilities.

While the actual transition from U.S. GAAP to IFRS has yet to occur, privately-held small and medium-sized business owners should know that the next set of financial reporting standards that they may have to follow have been tailored to fit their needs and the needs of the users of their financial statements.

Looking for Cleveland or Akron CPAs, business or financial advisors? Contact Skoda Minotti at 440-449-6800.

What did Picasso’s paintings look like when he was only halfway finished? How did Michelangelo’s “David” look like after the first few chisels? How livable is a house after the frame has been erected, but no interior work has been done?

A valid answer to all of the preceding questions is, “Something different than the final product.” However, for financial experts who provide opinions on economic damages and other litigated matters involving calculated figures, current rules sometimes allow for previous non-submitted, and non-final, drafts of an expert’s report to be considered discoverable evidence. 

The review of draft iterations of an expert report is often considered to be a waste of time (and dollars) as such drafts often do not correctly capture all of the relevant information that was synthesized in the final submitted report. Oftentimes, the tactic of reviewing an expert’s draft reports is an attempt by an opposing attorney to discredit the expert or make the expert’s conduct appear improper in some way. Therefore, some attorneys will request that non-final draft iterations of reports be admitted as evidence and scrutinized, distracting the court from the analysis offered in the financial expert’s final, submitted opinion. 

This is akin to asking Phil Collins to stop all work on a song that he is still feeling his way through, releasing that song, and then asking him to defend its quality to the public and his fans. Not only is this unfair to Phil, but it is unfair to the music-listening public, who expect a polished, quality product that Phil would be willing to stand by. 

In a recent article by Thomas Hilton, MS, CPA/ABV/CFF, ASA, CVA in Financial Valuation and Litigation Expert, a highly-regarded publication in the business valuation and litigation support field, Mr. Hilton discussed that relief for this problem may be on the way. The Committee on Rules of Practice of the Judicial Conference of the United States (Committee) recently proposed amendments to the Federal Rules of Civil Procedure that would shield draft expert reports from discovery. If the proposal makes its way through the necessary channels without any holdups, this relief could come as soon as December 1, 2010. 

As part of the community of financial experts, we hope that relief from the proposals highlighted above (which have been backed by the AICPA) comes swiftly. Primarily, we believe that these proposals will force courts to focus on the merits of an expert’s submitted opinions rather than the potentially unfinished and in-process analysis that is present in draft reports.

Need assistance with a litigation matter? Contact our Litigation Advisory Services Group at 440-449-6800.

Topics: Litigation Advisory Services, Cleveland Business Advisors, Akron Business Advisors, Akron Business Consultants

We, as consumers, love discounts. There are few things more satisfying for a savvy shopper than finding a deal on an item that he or she has been longing for. When it comes to valuing a business, some believe that “discount” is a dirty word and that it implies that the seller is not receiving fair market value for his ownership interest and that the buyer is getting a deal. This is not the case, however, as valuation discounts merely adjust the value of an ownership interest indicated by certain valuation methods for specific characteristics that need to be addressed before arriving at fair market value. 

The most common discounts seen in valuation reports are for lack of control and lack of marketability. 

Lack of Control Discounts

Lack of control discounts are appropriate for ownership interests in which the owner cannot unilaterally direct the company’s operation. A lack of control discount is applied because a non-controlling owner cannot appoint management, set levels of management compensation, declare dividends or distributions, compel a liquidation of his or her ownership interest, set company policies, or purchase or sell assets, just to name a few things. These factors make a non-controlling interest less valuable than a controlling interest.

Marketability Discounts

Marketability discounts are also often appropriate in the valuation of privately-held businesses.  There are certain marketability differences between an interest in a privately-held business and an interest in the stock of a publicly-traded company. An owner of publicly-traded securities can know at all times the market value of his or her holding based on the quoted price per share. He or she can sell that holding on virtually a moment’s notice and receive cash, net of brokerage fees, within several working days.

This is not the case with ownership interests in privately-held companies, however. Liquidating or selling a position in a privately-held company is a more costly, uncertain, and time-consuming process than selling the stock of a publicly-traded company. An investment in which the owner can achieve liquidity in a timely fashion is worth more than an investment in which the owner cannot liquidate the investment quickly. Therefore, an ownership interest in a privately-held company with the exact same characteristics as a publicly-traded company would sell at a discount compared to the publicly-traded company.

What Does It All Mean?

Valuation discounts are not a simple matter, but they are an essential part of determining the fair market value of ownership interests in privately-held companies. The subjectivity in determining valuation discounts is often a source of contention in valuations for divorce, shareholder disputes, and estate and gift tax filings. Therefore, it is essential that your business valuation analyst have a well-reasoned and thorough discount analysis in order to stand up to challenge or scrutiny. 

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Topics: Cleveland Business Valuation, Akron Business Valuation, Certified Valuation Analyst

A business valuation is a just a business valuation – isn’t it? This would be akin to saying that a steak is just a steak when, in fact, there are ribeyes, strips, sirloins, and filets (just to name a few). Likewise, business valuations come in two distinct “flavors” – conclusions of value and calculations of value.

As of January 1, 2008, valuation analysts who hold either the Certified Valuation Analyst (CVA) credential supported by the National Association of Certified Valuation Analysts or the Accredited in Business Valuation (ABV) credential supported by the American Institute of Certified Public Accountants have been required to follow new standards that clearly delineate between two types of valuation engagements. Similar to the differing levels of service traditionally offered by accounting firms in performing audits, reviews, or compilations, business valuation engagements are now separated into two defined service categories:

Conclusion of Value

-          All three valuation methods (asset-based, income-based, and market-based) are required to be considered

-          Detailed development and reporting requirements must be adhered to by the valuation analyst, making the engagement more time consuming than a calculation of value

-          This is the required type of report for estate and gift tax filings; Also typically required for instances in which the valuation analyst will need to defend his or her findings and report (i.e. in litigation)

-          The valuation analyst opines on the value of the business or business ownership interest

Calculation of Value

-          The valuation methods to be used in determining value are discussed and agreed upon beforehand between the client and the valuation analyst

-          Reduced development and reporting requirements compared to conclusion of value engagement

-          Ideal for planning purposes (e.g. strategic planning, transaction (purchase or sale) planning, or litigation or divorce proceedings in the settlement stage)

-          Valuation analyst does not opine of the value of the business or business interest, rather, the valuation analyst applies the valuation methodologies agreed upon with the client

-          Generally not defensible in litigation settings because the valuation analyst is not offering an opinion of value, rather, the analyst “calculates” a value based on methods agreed upon with the client

-          Typically costs less than a conclusion of value

-          Has been found to be useful in divorce situations in which a spouse will obtain a calculation of value to aid in the settlement process; If a settlement is not reached, the engagement can then escalate to a conclusion of value so that the valuation analyst can opine on a value and defend it in court, if needed

As you can tell from the discussion above, all “valuation” work is not created equal. For business owners, as well as their attorneys and other advisors, it is important to be aware of the varying levels of valuation service offered so that the appropriate type of report is obtained. You should discuss the purpose of the valuation with the valuation expert in detail as the engagement is forming so that the level of service can be tailored to your specific needs. 

The last thing that you want to do when having a valuation performed is pay too much to obtain a conclusion of value that will only be used for planning purposes or pay too little to obtain calculation of value that will not hold up in litigation or under IRS scrutiny.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Topics: Cleveland Business Valuation, Akron Business Valuation

This week is our final update in our series on the changing rules and regulations and their impact on employee benefit plan audits.

This week’s topic:

2009 Cost of Living Adjustments for Qualified Retirement Plans

The Internal Revenue Service announced cost-of-living adjustments applicable to dollar limitations for pension plans and other items for tax year 2009.

Click here for more of this article.

Looking for assistance with your benefit plan audit? Contact the CPA’s business and financial advisors at Skoda Minotti at 440-449-6800.

One unique service we offer to clients is the ability to compare our client to their industry benchmarks.  Our external benchmarking tools are tailored to our clients and their specific industries.  We can generate benchmarks based on revenue size, geographic region, North American Industry Classification System (NAICS) codes, and also both public and private companies.  The service compares a number of financial metrics, and provides explanations and guidance as to variances your company has versus the industry.

These tools provide us, as business advisors, an ability to consult with our clients year-round and also allow us to prepare both short-term budgets, and long-term projections and forecasts.

This service maintains client data anonymously and confidentially, and has been approved by our business partner, BDO Siedman.

Are you looking for industry benchmarks?  Contact Paul Etzler at 440-449-6800.

Topics: Akron Business Advisors, Akron Business Consultants, Cleveland Business Advisors

If you had the choice of investing in two companies, both of which will earn $100 per year, but one company must pay $40 in taxes while the other pays nothing, which would you choose? The answer is easy - the company that does not have to pay taxes. But what if I told you that you would have to pay $40 in taxes personally on the earnings of the company that did not have to pay any taxes? 

The answer is not as clear cut once we introduce this nuance to the story because it would appear as if both companies are equally valuable. This simple illustration highlights one of the most controversial issues in both the business valuation community and the Tax Courts in recent years - whether it is appropriate to “tax-affect” the earnings of pass-through entities such as S-corporations, limited liability corporations, and partnerships, when determining their value. 

One school of thought on the subject is that because pass-through entities do not pay tax at the entity level, tax-affecting the earnings of such businesses (deducting an estimated amount of income tax from the entity’s earnings based on pre-tax income) is inappropriate. As a result, the value of a pass-through entity will be much higher than if income taxes had been deducted in determining its value. This approach gained popularity as five memorandum decisions issued by the Federal Tax Court from 1999-2006 denied a deduction for income taxes in determining the value of various S-corporations for gift and estate tax purposes. 

On the other hand, a more recent decision from the Delaware Chancery Court allowed a deduction for income taxes in the valuation of a pass-through entity. The Court’s reasoning was based on the theory that although income taxes are avoided at the business level for pass-through entities, the owners are ultimately responsible to pay income taxes on their share of the entity’s earnings that “pass-through” to them. Valuation analysts who subscribe to this theory argue that although income taxes are not paid at the entity level, there are still income taxes that must be paid on the earnings of pass-through entities – they are just paid at the shareholder/member level. When this theory is applied in the valuation of a pass-through entity, the resultant value is often times significantly lower than if the business’s earnings had not been tax-affected.

What does this mean for the owners and members of S-corporations, limited liability corporations, and partnerships? It means that when you are having your business valued, especially for estate or gift tax purposes, it is imperative that you gain an understanding of how the business valuation analyst intends to handle the controversial issue of tax-affecting pass-through entity earnings. Not only can the treatment of income taxes for pass-through entities have a significant impact on the concluded value of your business, it can also play a role in the likelihood of that value being challenged by the IRS. Therefore, it is crucial that your valuation analyst have a thorough understanding of the many complexities of this controversial issue, as well as a strategy for addressing them, or you could end up with a value that may not only be incorrect and unsupportable, but also result in the under-calculation (or over-calculation!) of your liability for estate tax, gift tax, or divorce purposes.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Topics: Cleveland Business Valuation, Akron Business Valuation

The Magis Advisory Group of John Carroll University is offering a seminar providing continuing legal education credits for attorneys, continuing education credits for certified financial planners, and continuing professional education credits for certified public accountants in estate planning, advanced planning for the family owned business and business and asset valuation.

Our own Robert A Ranallo, CPA/ABV, JD, CVA, CFF, will be presenting the "Business and Asset Valuation" session on Friday, June 19th, 2009.

Click here for more seminar imformation or to signup for the seminar.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Topics: Cleveland Business Valuation, Akron Business Valuation

There have been a series of recent economic, tax, and business valuation developments that give incentive for business owners to accelerate their consideration of the issue of succession planning. As most business owners are already aware, there can be significant adverse tax implications of shifting wealth to the next generation if the proper succession plan is not in place. However, the current environment offers a great opportunity for individuals to minimize the tax liability associated with this effort. 

First, as we are all well aware, the current economic environment is creating significantly depressed values in business investments. Just take a look at your 401(k) balance if you need evidence. The same is true for closely held businesses, which are experiencing weakened revenue and profitability levels. Therefore, as part of the wealth shifting process, business owners have the opportunity to transfer the ownership of a business interest that may be worth significantly less now than it was just one year ago. A diluted value of the business interest also results in a diminished tax liability, which, of course, is great news for the business owner.

Second, there are estate tax rules, either already in place or currently under consideration, that impact the succession planning effort. For example, the estate and generation-skipping exemption amount was recently increased to $3.5 million for 2009. While we would not expect this exemption to return to earlier levels ($2 million) anytime soon, this is certainly an incentive to further consider the acceleration of the implementation of a succession plan. 

In addition, there has been much talk in Congress about restricting or elimination the use of valuation discounts in estate and gift tax valuations. Valuation discounts have long been a controversial subject within the tax courts and the valuation community. Very recently, HR 436 (“Certain Estate Tax Relief Act of 2009”) was introduced. This proposal contemplates curtailing the use of “lack of marketability” discount on certain business interests. While the details of the circumstances under which this discount might be allowed or disallowed in the future cannot be predicted at this time, what is clear is this: if the lack of marketability discount is eliminated, it can have a significant adverse impact on a taxpayer’s estate or gift tax liability. The AICPA recently commented that this sort of estate tax reform will have an adverse impact on small businesses. 

In addition to the fact that it is just a smart business and personal decision to work with your advisors to design and implement a succession plan, all of the reasons outlined above give incentive to those on the fence about shifting wealth via business ownership interests. This concept does not exist in a vacuum, however.  Tax liability is not the only factor that must be considered when setting up and implementing a succession plan. Other factors, such as family relationships, health of the business, and competitive landscape must be contemplated before undertaking any effort to transfer ownership in a business.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

“Corporate Vigilance in Desperate Times” was the title of a presentation I made to a group of corporate controllers on behalf of the Ohio Society of Certified Public Accountants.

It’s hard not to pick up a newspaper these days and see dismal economic results. The next article discusses employee layoffs. “Happy Days Are Here Again” will not be heard on your car radio on the way home. And once home, chances are that you don’t want to look at your stock portfolio or 401k statement that came in the mail. 

Many employees are scared. Financial pressures are fierce. A spouse may have been laid off thus crippling the family cash flow. Retirement, carefully planned for years, may now have to be delayed since the market has halved your nest egg. With foreclosures at record numbers not seen since the Great Depression, many must evaluate whether they can provide a house for one’s family?

In troubling times such as this severe economic downturn, the opportunity is ripe for fraudsters to shake cash from unsuspecting companies. Companies must be more vigilant than ever to protect their financial resources.

Unfortunately, we have become aware of some companies cutting jobs within accounting departments and as a result potentially compromising their internal controls – controls vital to not only good financial reporting, but safeguards in general to the overall corporate assets.

Is there a correlation between a downturn in the economy and an increase in fraudulent acts such as embezzlement? Sure there is. In larger corporations there is intense pressure to “make the numbers” thus resulting in tempting financial statement crimes.

Eliminating staff in an accounting department will usually reduce the effectiveness of established internal controls.   Less effective internal controls is an invitation for embezzlement. And don’t think that the thieving opportunist doesn’t recognize the void suddenly created.