Major events or transactions — such as a natural disaster, a cyberattack, a regulatory change or the loss of a large business contract — may happen after the reporting period ends but before financial statements are finalized. The decision of whether to report these so-called “subsequent events” is one of the gray areas in financial reporting. Here’s some guidance from the AICPA to help you decide.

Recognition

Financial statements reflect a company’s financial position at a particular date and the operating results and cash flows for a period ended on that date. However, because it takes time to complete financial statements, there may be a gap between the financial statement date and the date the financials are available to be issued. During this period, unforeseeable events may happen in the normal course of business.

Chapter 27 of the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities classifies subsequent events into two groups:

1. Recognized subsequent events. These provide further evidence of conditions that existed on the financial statement date. An example would be the bankruptcy of a major customer, highlighting the risk associated with its accounts receivable. There are usually signs of financial distress (such as late payments or staff turnover) months before a customer actually files for bankruptcy.

2. Nonrecognized subsequent events. These reflect conditions that arise after the financial statement date. An example would be a tornado or earthquake that severely damages the business. A business usually has little or no advanced notice that a natural disaster is going to happen.

Generally, the former must be recorded in the financial statements. The latter events aren’t required to be recorded, but the details may have to be disclosed in the footnotes.

Disclosure

To decide which events to disclose in the footnotes, consider whether omitting the information about them would mislead investors, lenders and other stakeholders. Disclosures should, at a minimum, describe the nature of the event and estimate the financial effect, if possible.

In some extreme cases, the effect of a subsequent event may be so pervasive that your company’s viability is questionable. This may cause your CPA to re-evaluate the going concern assumption that underlies your financial statements.

When in doubt

If you’re unsure how to handle a subsequent event, we can help eliminate the guesswork. Contact us for more information.

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Summer is just around the corner. If you’re fortunate enough to own a vacation home, you may wonder about the tax consequences of renting it out for part of the year.

The tax treatment depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Here’s the test: if you use it personally for more than the greater of 1) 14 days, or 2) 10% of the rental days, you’re using it “too much,” and you can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years. If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.

If you “pass” the personal use test (i.e., you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

As you can see, the rules are complex. Contact us if you have questions or would like to plan ahead to maximize deductions in your situation.

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Business transactions with related parties — such as friends, relatives, parent companies, subsidiaries and affiliated entities — may sometimes happen at above- or below-market rates. This can be misleading to people who rely on your company’s financial statements, because undisclosed related-party transactions may skew the company’s true financial results.

The hunt for related parties

Given the potential for double-dealing with related parties, auditors spend significant time hunting for undisclosed related-party transactions. Examples of documents and data sources that can help uncover these transactions are:

• A list of the company’s current related parties and associated transactions,
• Minutes from board of directors’ meetings, particularly when the board discusses significant business transactions,
• Disclosures from board members and senior executives regarding their ownership of other entities, participation on additional boards and previous employment history,
• Bank statements, especially transactions involving intercompany wires, automated clearing house (ACH) transfers, and check payments, and
• Press releases announcing significant business transactions with related parties.

Specifically, auditors look for contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s-length transactions between unrelated third parties.

For example, a spinoff business might lease office space from its parent company at below-market rates. A manufacturer might buy goods at artificially high prices from its subsidiary in a low-tax country to reduce its taxable income in the United States. Or an auto dealership might pay the owner’s daughter an above-market salary and various perks that aren’t available to unrelated employees.

Audit procedures

Audit procedures designed to target related-party transactions include:

• Testing how related-party transactions are identified and coded in the company’s enterprise resource planning (ERP) system,
• Interviewing accounting personnel responsible for reporting related-party transactions in the company’s financial statements, and
• Analyzing presentation of related-party transactions in financial statements.

Accurate, complete reporting of these transactions requires robust internal controls. A company’s vendor approval process should provide guidelines to help accounting personnel determine whether a supplier qualifies as a related party and mark it accordingly in the ERP system. Without the right mechanisms in place, a company may inadvertently omit a disclosure about a related-party transaction.

Let’s talk about it

With related-party transactions, communication is key. Always tell your auditors about known related-party transactions and ask for help disclosing and reporting these transactions in a transparent manner that complies with U.S. Generally Accepted Accounting Principles.

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Once a relatively obscure concept, “income in respect of a decedent” (IRD) may create a surprising tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there may be ways to minimize or even eliminate the IRD tax bite.

Basic rules

For the most part, property you inherit isn’t included in your income for tax purposes. Items that are IRD, however, do have to be included in your income, although you may also be entitled to an IRD deduction on account of them.

What’s IRD? It is income that the decedent (the person from whom you inherit the property) would have taken into income on his or her final income tax return except that death interceded. One common IRD item is the decedent’s last paycheck, received after death. It would have normally been included in the decedent’s income on the final income tax return. However, since the decedent’s tax year closed as of the date of death, it wasn’t included. As an item of IRD, it’s taxed as income to whomever does receive it (the estate or another individual). Not just the final paycheck, but any compensation-related benefits paid after death, such as accrued vacation pay or voluntary employer benefit payments, will be IRD to the recipient.

Other common IRD items include pension benefits and amounts in a decedent’s individual retirement accounts (IRAs) at death as well as a decedent’s share of partnership income up to the date of death. If you receive these IRD items, they’re included in your income.

The IRD deduction 

Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that’s caused by having the IRD items subject to the decedent’s estate tax as well as the recipient’s income tax.

To calculate the IRD deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows:

• First, you must take the “net value” of all IRD items included in the decedent’s estate. The net value is the total value of the IRD items in the estate, reduced by any deductions in respect of the decedent. These are items which are the converse of IRD: items the decedent would have deducted on the final income tax return, but for death’s intervening.
• Next you determine how much of the federal estate tax was due to this net IRD by calculating what the estate tax bill would have been without it. Your deduction is then the percentage of the tax that your portion of the IRD items represents.

In the following example, the top estate tax rate of 40% is used. Example: At Tom’s death, $50,000 of IRD items were included in his gross estate, $10,000 of which were paid to Alex. There were also $3,000 of deductions in respect of a decedent, for a net value of $47,000. Had the estate been $47,000 less, the estate tax bill would have been $18,800 less. Alex will include in income the $10,000 of IRD received. If Alex itemizes deductions, Alex may also deduct $3,760, which is 20% (10,000/50,000) of $18,800.

We can help

If you inherit property that could be considered IRD, consult with us for assistance in managing the tax consequences.

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That’s right! Columbus has announced that they will be allocating an additional $8 million to a grant program for small businesses. Grants from the Columbus-Franklin County Recovery Fund can range from $5,000 to $20,000 and are available for immediate access.

To be eligible for-profit small businesses must meet the following requirements:

• Be located in the City of Columbus or Franklin County
• Have 25 full-time employees or less
• Have documentation showing the pandemic caused at least a 25% loss in sales.
• Began operations prior to March 17, 2020
• Are currently open and operating
• Be owned by an owner that is at least 18 years or older

The intention of the grant is to help and prioritize businesses located in underserved communities that are minority-, women-, or veteran-owned. As Mayor Andrew J. Ginther said, “minority- and women-owned businesses were more likely to miss their chance or be passed over for Paycheck Protection Program loans from the federal government. By putting these entrepreneurs at the front line for local funding, we hope to support businesses disproportionately impacted by the pandemic.”

 

How are the grants allocated and how can they be used?

According to a City of Columbus press release: business owners can apply for one of three grants:

• $5,000 recovery grant: For self-employed, single entity, sole proprietors and sole owner LLCs
• $10,000 recovery grant: For small businesses with at least one full-time employee
• $20,000 job restoration grants: For businesses with at least one full-time employee that lost employees due to the COVID-19 pandemic. Business who are selected for this grant will start by receiving an initial $10,000. They then are eligible for the additional $10,000 for hiring an additional full-time employee within two months and maintaining their payroll for four months after receiving initial grant funding.

Grants provided by this fund can be used to relieve financial hardships caused by a loss of sales, hire new personnel, train staff, or even fill previously lost positions.

Small business owners who are interested in applying can use this link to learn more and prepare their applications. The next grant application begins on April 11^th, 2022 at 9:00 am, and ends on April 25^th, 2022. The application pool closes early if they meet their maximum capacity of 500 applicants prior to the closing date.