Article by: Jeff Skolnick, CPA, M.S. Taxation

According to the IRS website opportunity zones were created to “spur economic development and job creation in distressed communities.” They are investments created where if certain rules are met, will provide preferential tax treatment for investors. These zones were created as part of the Tax Cuts and Jobs Act in December of 2017.

In order to qualify as an opportunity zone a locality must have been nominated by its state and certified by the Secretary of the US Treasury through the Internal Revenue Service.

How exactly do these opportunity zones work?

Individuals, partnerships, LLCs, S corporations and C corporations are all eligible to receive the benefits of investing in opportunity zones.

The first thing that occurs is one of the entities listed in the previous paragraph invests either a short-term or long-term capital gain within 180 days of recognizing that gain. The date of recognition would be measured from the date of sale for transactions such as real property (land, commercial buildings or residential real estate), trade date if you are selling stocks, bonds, etc. or the last day of the taxable year if your capital gain came to you by way of a K-1 from a pass-through entity (such as a partnership or S corporation). The election is made with your tax return.  For example, if you sold a commercial building in 2018 and realized a $500,000 gain and you reinvested it in an opportunity zone fund within 180 days you would elect on your 2018 income tax return to defer the gain.

Let’s stay with the $500,000 gain example.  You realized a $500,000 long-term capital gain upon the sale of property in 2018 and invested in a qualified opportunity zone fund within 180 days and properly made the election to defer the gain on your 2018 return.  Keep in mind this will also work with short-term gains and the capital gain may have arisen from the sale of stocks, bonds, etc. or come to you through a K-1 from a partnership or S corporation.  The problem with capital gains coming from K-1s is that they must be invested within 180 days of the year end and many times taxpayers are unaware that there are capital gains until months after the yearend, however, if an S corporation, LLC or partnership you invested in has large capital gains hopefully you will have an idea before year end and can plan accordingly.

Unlike Section 1031 exchanges (which I’ve covered before) only the capital gain portion of the proceeds must be invested in order to take advantage of the tax benefits. If you remember when you are dealing with a 1031 exchange (selling for example a piece of property and deferring the gain by purchasing another property) you must invest the entire proceeds of the property sold or you will pick up some gain (meaning you cannot defer the entire gain).

Again, we go back to the $500,000 gain realized. The gain is deferred until the earlier of the date you sell the opportunity zone fund or December 31, 2026.  Your gain on that date will be the lesser of your deferred gain or the fair market value of the qualified opportunity zone fund, less your basis in the fund.  Your basis in the fund is 10 percent of your deferred gain originally invested if you’ve held your investment for 5 years or 15 percent of your deferred gain if you’ve held it for 7 years.  Keep in mind in order to hold your investment for 7 years by December 31, 2026, the funds must be invested by December 31, 2019.

Let’s say you invested your funds March 1, 2019, which is within the 180 day requirement and hold the investment. On December 31, 2026 you must now recognize the capital gain We will further assume your investment is now worth $1,000,000. Originally you deferred $500,000. Your deemed sale will be $500,000 (the lesser of the gain you deferred or the fair market value of the fund of $1,000,000). If your investment in the fund had a fair market value of $400,000 on December 31, 2026, then $400,000 would be used as the sale price since it is lower than the original deferral of $500,000. However, remember since you held the investment for 7 years your basis in the $500,000 is 15% or $75,000. You will pay tax on $425,000 of capital gain income. You have saved income tax on $75,000 of capital gain and deferred paying tax on the $425,000 for 8 years. Keep in mind if the investment was held for more than 5 years but less than 7 years than you would exclude 10% ($50,000) instead of the $75,000, and therefore pay income tax on $450,000 of gain.

Now your basis in the opportunity fund is $500,000 ($75,000 for holding the property 7 years plus the $425,000 recognized in your tax return in 2026). If you were to sell your share of the opportunity zone fund the next day you would recognize a $500,000 gain (assuming the fair market value is still $1,000,000). This figure comes from the fair market value of your investment in the fund of $1,000,000 less your basis of $500,000 (which we previously calculated).  If, however, you hold on to your opportunity zone fund investment for at least 10 years then your basis in the fund becomes its fair market value.  Let’s say on May 15, 2029 your investment in the opportunity zone fund is $1,200,000 and you decide to sell it. Since you’ve held your investment in the opportunity zone fund for more than 10 years your basis becomes the fair market value of $1,200,000 (similar to a step-up in basis which occurs in Estate situations).  Now you have taken a $500,000 capital gain and eliminated tax on $75,000 (because you held the investment for 7 years before December 31, 2026) and $700,000 because you held the opportunity zone fund for more than 10 years. To summarize, you realized $1,200,000 of capital gains, eliminated tax on $775,000 of capital gains and deferred tax on $425,000 for 8 years.

Opportunity zone investments are very new and I absolutely could not urge any stronger that you discuss this type of investment with both tax professionals and individuals with a formidable reputation when dealing with the actual investment.

Article by: Jeff Skolnick, CPA, M.S. Taxation

There are a number of factors that can lead to cash flow issues in your business.  We’ve all heard the adage “Cash is King” but this can be especially true of your business and even more so in the early years.

I will now address some of the more common cash flow problems that your business may incur with some suggestions to help mitigate these circumstances.

Your company is brand new and you have just commenced operations.  First of all, Congratulations! It takes hard work and courage to open your own business and most people are not willing to do the work or lack the confidence to take this step. Here are a few things you must watch out for:

• If you’re in a brick and mortar business you may have to outlay significant cash in order to purchase equipment, inventory, rent retail space or hire employees. There are also the normal operating expenses such as telephone, utilities, advertising, etc.
• In order to fund the above items, you may need to obtain a loan. This is not always so easy for a startup company. There is no track record that you can show a bank and while you will be a guarantor on any loan if you have recently left your job, you may not be as good a risk as you were when you were working full time.
• Whether you are in a brick and mortar business, service business or some other entrepreneurial endeavor, it is almost impossible to generate income on day 1.  Let’s say you become a realtor and you sell a house on day 1 (ignore for a second how unlikely this is). If you are lucky enough to sell a house on day 1, you probably will not be paid for almost 2 months.  If you are a contractor (let’s say you install flooring) and again you land your first job on the day you open your doors.  Many times, as a contractor you will not be paid until the general contractor is paid by his/her customer and again you will have some type of a waiting period.
• Most businesses have periods that are a little slower than other periods. Some businesses have wide swings while others are much more consistent, but you must be ready for a slow month
• Businesses incur unexpected expenses all the time. Equipment can break or expenses may go up suddenly on a product or service essential to your business.

Now that I’ve depressed you with many things that can go wrong in your business, let’s discuss what you can do to help mitigate such situations.

• You can establish a line of credit. 
• You can dig into past savings if you’ve ben able to create a little nest egg before you start your business.
• You could borrow money from family and/or friends
• You may use credit cards, although this is generally my least favorite option simply because the interest rates tend to be very high.

It is essential that as soon as practical you are able to set aside enough cash to cover three to six months of expenses. If you are able to do this, you should be able to cover the shortfalls that are almost sure to come in your business.

Borrowing money can lead to other traps that can hurt your cash flow.  When you borrow money for your business you do not pay income tax on it. This makes sense because it is not income.  The borrowing will certainly help your cash position but when you begin to pay this money back it can hurt your cash position. Let me explain with an example. Your Company borrows $100,000 and let’s say that money is used for deductible business expenses which reduce your income and help your cash flow. So far this is all good, so why am I worried?  The issue comes when you pay back the loan. While the interest portion of your debt is a deductible expense the principal portion is not. Let’s say you borrowed the $100,000 in year one of your business and in year two your business generates a $40,000 profit for tax purposes but you use the $40,000 to pay off part of the principal of the debt. The problem occurs because your business has a $40,000 profit with no money available for taxes because it was used to pay off the principal balance of a loan which is not deductible.  Proper planning must be done in this scenario to pay down some debt but also leave enough cash available to be able to cover your tax liability.

There are also the obvious ways to help cash flow such as increasing revenue. This is not always as easy as it sounds because this may require advertising dollars which can actually reduce your cash before the benefits eventually start to kick in.

I often hear from business owners that they are not interested in hearing about or reading about taxes or bookkeeping however both ae essential in cash flows. First of all, a proper set of books will make it much easier to identify areas where your Company is spending money in excess of what is necessary.  Taxes are important because knowing the rules can help to reduce your tax bill which will in turn allow you to keep more cash in your pocket.  I am in no way trying to say that you need to become a CPA, however, I am saying if you are aware of the rules it will enable you to make more informed decisions throughout the year.  Tax savings techniques available to businesses after the year has closed are much more limited than those available during the year.

As a business owner you will always be in a position where you are looking to increase revenue, decrease expenses (including taxes) and put more cash in your pocket.  I cannot stress enough that it takes planning for all of these things to happen. My goal here is to make you aware that cash flow management is a vital part of managing your business and the better you become at this task, the easier and more stress free your life will become.

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Article by: Jeff Skolnick, CPA, M.S. Taxation

Whether incurred by individuals, estates, trusts or corporations, net operating losses (NOLs) have almost the same definition and treatment. In almost all cases these are caused by losses in a trade or business (including rental real estate). NOLs can be caused by other factors such as casualty and theft losses but these causes are not as common and I therefore will not be focusing on these. Business losses can be generated by your sole proprietorship (or single member LLC), rental real estate property, partnership (or multi member LLC) or S corporation.

Net operating losses occur when your business losses exceed your items of income. Unfortunately, this is not a straightforward calculation as certain deductions such as capital losses in excess of capital gains, the NOL deduction and the section 199A deduction for Qualified Business Income are not counted when figuring an NOL. Each of these types of deductions have their own rules on how they are calculated. The Qualified Business Income deduction is the 20% deduction applicable to individuals with business income from their sole proprietorship, partnership, S corporation, LLC or rental property. Additionally when calculating an NOL for an individual income tax return there are adjustments made for what are considered to be Nonbusiness income (Retirement benefits, social security benefits and certain investment income) and Nonbusiness deductions (Alimony paid, retirement plan deductions, certain health savings deductions, the standard deduction and most itemized deductions).

If you have a business or businesses that generate enough losses to reduce your income to a negative amount, then you have an NOL. 

The 2018 Tax Cuts & Jobs Act placed additional restrictions on how NOLs are applied to income tax returns.  

• On the individual side of things a net operating loss generated by all of the taxpayer(s) businesses may not exceed $250,000 ($500,000 for married taxpayers filing jointly).  The rule before this change was a net operating loss was allowed to offset taxable income. An example should help clarify. Let’s say a single taxpayer has wages of $500,000 and a business loss from his/her business of $350,000. Prior to 2018 the law allowed the full $350,000 loss to be used to offset $500,000 of income and therefore the taxpayer paid tax on $150,000 of income. The $150,000 would then be decreased by the adjustments to income such as retirement plans, self-employed health insurance and the standard or itemized deductions. In years after 2017 the $350,000 loss would be limited to $250,000 (again this would have been a $500,000 limit if the example was a for a married couple filing a joint return), therefore leaving the taxpayer gross income at $250,000 before adjustments and deductions.  The remaining $100,000 (difference between $350,000 total NOL and the $250,000 limit) is carried forward to subsequent years. This $250,000 (or $500,000) limit does not apply to C corporarations.
• An NOL can only offset 80% of taxable income in a future year. An example would be a taxpayer incurring a $100,000 loss in 2018. In 2019 the taxpayer has $100,000 of taxable income. Under the rules that existed prior to 2018 the NOL of $100,000 would offset the income of $100,000. Under the new law only 80% of the 2019 taxable income is eligible to be offset. The taxpayer will use $80,000 to reduce taxable income to $20,000 with the remaining $20,000 of the NOL that was not used being carried forward to 2020.
• Prior to the new law net operating losses were generally carried back 2 years and any unused NOLs were then carried forward for 20 years. The new law eliminates carrybacks and requires all losses to be carried forward. Carryback allowed taxpayers with NOLs to amend prior year returns, lower their income and receive refunds immediately vs. carrying them forward and offsetting future income. Taxpayers also had the option of foregoing the carryback to carry the loss forward if they felt they would be in a higher income tax bracket in the future. Carrybacks are still allowed for farming losses. On the bright side, the new law eliminates the loss of NOLs if not used within 20 years after they are incurred. The new law allows losses to be carried forward indefinitely.

I want to also point out that there are rules for when a taxpayer(s) have a change in marital status. I am not going to discuss the technicalities here, but please be aware that if your marital status has changed between the time an NOL was incurred and when it is applied, then there is another layer added to the calculation.

While the concept is simple, “if you have losses from a business or businesses, then you can use these losses to offset future income”, there are a number of regulations that can complicate matters.  If you have an NOL consult with a tax professional. Proper use of the NOL regulations can save valuable tax dollars but misapplication of these rules can cause aggravation, penalties and interest.

Article By: Jeff Skolnick, CPA, M.S. Taxation

The purpose of a buy-sell agreement is to facilitate a change in ownership upon the occurrence of certain events.  These events can either be voluntary, such as retirement or involuntary, such as death, disability, or the inability of a partner/shareholder/owner to meet his/her financial obligations.

Buy-sell agreements set a market for a Company. These agreements are generally used by privately held businesses which do not have a readily available market. In other words, selling shares in your business is not going to be quite as easy as selling shares of Microsoft or Facebook. It is not always practical to try to sell a privately held business and virtually impossible to sell a portion of a privately held business. How many people do you think will want to buy into a business where they become partners or shareholders with people they do not even know?

The buy-sell agreement either sets the price of the business or lays out the mechanism to determine such a value. Typically, these agreements will use one or more of a variety of methods to determine value. Value can be based on book value of the Company, some type of multiples of either revenue or earnings or through the use of a valuation expert. 

Details are needed in the agreement even when using a valuation expert. Both the departing and remaining owner(s) may hire their own valuation experts, or they may mutually agree on a third party. It is important to remember that valuation is not an exact science and different experts may come up with different values.  There must be a determination of how these potentially differing values will be utilized. Being able to determine the correct value of a Company is a major focus of a buy-sell agreement.

These agreements also allow the current owners to maintain control. In many situations, the remaining owner or owners would love to buy out a departed owner but may not have the wherewithal to do so. Additionally, there are very good reasons why a remaining owner wants to purchase the interest of a departed owner. Let’s take an example where two siblings are partners (Jack and Jill), and each is married. If one of the siblings passes away (Jack) and his interest passes to his spouse now Jill has become a partner with Jack’s spouse. They may or may not get along as well as the two siblings did, but what if Jack’s former spouse gets remarried? In this situation although Jill is not  partners with this new spouse, that spouse may be chirping in the ear of Jack’s former spouse which can cause many complications.

Once the terms of the buy-sell agreement are determined very often, the owners will purchase life insurance policies on each other. These policies help to provide funds if one owner passes away. The policy will pay the remaining owner or owners who can then use these funds to purchase the interest of the diseased owner from his/her family.

Let’s look at an example. If there are two partners, Nancy and Jim that each own 50% of a Company valued at $1,000,000, then how would life insurance be used to finance a buy-sell agreement? Each partner would have a $500,000 policy on the life of the other partner. Let’s move forward here and assume that Jim dies. Nancy will collect $500,000 from the insurance policy on Jim’s life which she would then use to purchase Jim’s interest from his beneficiaries.

In the case of an owner who has the left the Company but not passed away, payment methods aside from using life insurance proceeds are necessary. The agreement should spell out the terms if the buyout is to be financed. Terms would be similar to those determined in any financing situation, amount of down payment, amount of years for the payout, method to determine an applicable interest rate and consequences of not abiding by the payment terms.

It is also important to review buy-sell agreements on a regular basis. Owners want to make sure from time to time that the terms of the agreement still make sense. If you entered into a buy-sell agreement when your business first opened but haven’t looked at the agreement in 25 years things may have changed. Remember my earlier example? You don’t want a situation where each partner has taken out a $500,00 life insurance policy on the other partner but now the business is worth $5,000,000 and not $1,000,000. I encourage at least a quick review every few years to make sure everyone is happy with the way things will transpire if the agreement is invoked.

While not the sexiest of all business agreements, a well-crafted buy-sell agreement that is drafted with some effort and foresight will allow remaining owners to maintain their ownership and allow departed members or their families to be reasonably compensated when relinquishing their ownership. I believe that when drafting a buy-sell agreement that the assistance of professionals (attorneys and possibly accountants and valuation experts) is essential.