How To: Trim the Inventory Fat

Inventory-costs_LI-532x266 How To: Trim the Inventory Fat
Photo: Samuel Zeller

Inventory is expensive. Here are some ways to trim the fat from your inventory without compromising revenue and customer service.

Objective Inventory Counts

Effective inventory management starts with a physical inventory count. Accuracy is essential to know your cost of goods sold — and to identifying and remedying discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

  • Gross margin ([revenue – cost of sales] / revenue),
  • Net profit margin (net income/revenue), and
  • Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms. It’s a function of raw materials, labor, and overhead costs.

The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing anti-theft devices or opting for less expensive insurance coverage.

Product Mix

To cut your days-in-inventory ratio, compute product-by-product margins. Stock more products with high margins and high demand — and less of everything else. Whenever possible, return excessive supplies of slow-moving materials or products to your suppliers.

Product mix should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Reality Check

Often management is so focused on sales, HR issues and product innovation that they lose control over inventory.

Contact us for a reality check.

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623908689 How To: Trim the Inventory Fat

Year-End Bonuses Shouldn’t Break the Bank

qtq80-GQ7bIA-1024x683 Year-End Bonuses Shouldn’t Break the Bank

Rewarding employees at the end of the year can brighten up their holidays and set the stage for your company to enjoy a good start to 2019. Some forethought and careful communications can avoid problems.

A key first step is to check your company’s financial condition. Year-end bonuses can boost morale, but you shouldn’t pay out more than your company can afford. On the other hand, if your business is doing well, some holiday generosity might help it do even better.

Spread the Word

Once you have a budget for bonuses in mind, tell your employees what to expect. Let them know as soon as possible so they can plan accordingly.

Long-time employees probably will expect the type and size of bonus they have received in the past. If that’s not going to be the case, explain the reason for the shortfall. Consider replacing any lack of cash with extra time off, if that’s practical.

Among possible methods of calculating bonuses, giving a flat amount to all full-time workers might be the simplest approach. Another tactic is to give everyone a percentage of their salary; the percentage might escalate for people with management responsibility or special tasks. Performance-based bonuses, which can be sizable, may motivate key employees and could help to retain valued workers.

Tax Treatment 

Cash bonuses are compensation for employees, so employment taxes apply. For income tax withholding, employers have some options about how to handle supplemental pay such as bonuses. Our office can help you choose the right method and properly comply with all the rules. If you use an outside payroll provider, that company should be notified in advance of your plans.

At many companies, cash bonuses might be a few hundred dollars per employee. Some firms, though, pay much larger bonuses as part of some workers’ compensation package. For ample bonuses, it may be advantageous to deduct them for 2018, but defer payment as late as March 15, 2019.

To qualify for this deduct-now-pay-later opportunity, your company must be on the accrual, rather than the cash, basis of accounting. You must spell out the recipients and the amounts involved, perhaps in corporate minutes, by year-end 2018. S corporation shareholders and over-50% C corporation shareholders don’t qualify for this tax benefit.

Reach Out For Assistance

At some companies, a pool of money for bonuses can be deducted at year-end without an employee-by-employee allocation, yet payments can be delayed until mid-March. Several rules apply, such as maintaining the amount declared at year-end. We can guide you through the complexities. Give us a call today.

Additional Resources

Throwing SALT Into The Property-Tax Wound

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The Tax Cuts and Jobs Act (TCJA) of 2017 sharply raised the standard deduction and placed limits on itemized deductions. In particular, no more than $10,000 can be deducted in state and local tax (SALT) payments on a single or joint tax return.

As a result, most people will take the standard deduction now and get no tax benefit from their property tax payments. Even those who itemize may get little or no tax benefit from their property tax payments if they also have ample outlays for state and possibly local income tax. The bottom line is that property tax payments will be fully or mainly out-of-pocket expenses for most homeowners — and for many home buyers — with reduced federal tax savings as an offset.

When the TCJA was passed, some observers predicted that this effective cost increase would significantly bring down home prices.

Example: John and Mary Smithe pay $20,000 a year in property tax. They had been in a 28% tax bracket, giving them a $5,600 (28% of $20,000) federal tax saving, resulting in a net cost of $14,400. If this couple sells their home, the buyer could owe the full $20,000 a year in property tax. This might reduce the home’s appeal to buyers, who would offer lower bids than would have been offered in the past.

Broadly, such price declines have not happened. The U.S. House Price Index Report from the Federal House Finance Agency shows a 6.5% growth in prices from the second quarter of 2017 to the second quarter of 2018. Nevertheless, residential housing markets are very local, and it is likely that the new tax rules are affecting numerous transactions, especially in areas where property taxes are steep.

For Sellers

If you are planning to sell a primary residence or second home, be aware that buyers probably will raise questions about the ongoing property tax they will incur. You should know the amount you’re paying now and the amounts you have paid in the past. If the growth rate has been modest, or if your home is taxed less than those in your neighborhood, tell your real estate agent. Then, your agent can use this fact as a selling point.

All homeowners, particularly those who plan a sale, should investigate the possibility of reducing their property tax bill. You should find out the procedure for obtaining a lower assessment in your community and see if you might qualify. Any reduction in annual tax obligation may be worth the effort, from increased cash flow today and a potentially higher selling price tomorrow.

For Buyers

If you are planning to buy a house, know your tax situation. Will you be taking the standard deduction? Will your itemized SALT deductions be capped? You’ll know whether you’ll get any tax savings from deducting property tax, so you will know what to expect in after-tax costs from a home purchase. If those costs, which are likely to rise in the future, might strain your budget, you can drop your bid price or look for another place with lower property taxes.

The IRS 15% Solution

Taxpayers in high tax states may hope that state “workarounds” will effectively preserve SALT tax benefits and their housing prices. One tactic has been to create state-run charities to which taxpayers can contribute in return for a credit against state income tax. These contributions would get federal tax deductions, which generally have much higher caps, instead of deductions for state and local tax payments, with lower caps.

In response, the IRS issued proposed regulations on this subject on August 23, 2018. Here, the IRS said that a taxpayer’s charitable deduction will be reduced if the anticipated state tax credit exceeds 15% of the contribution. The message from the IRS is that the new SALT deduction rules will be enforced.

Explaining the Proposed Regulations

  • For example, suppose Ann Clark contributes $20,000 to a state-sponsored health or education charity.
  • Ann expects to receive a $14,000 state income tax credit (70% of $20,000).
  • Ann’s state tax credit is greater than 15% of her contribution.
  • These IRS proposed regulations say that Ann’s charitable deduction will be reduced by $14,000, regardless of when she claims the tax credit.

Questions About Tax Deductions?

Give us a call. We specialize in personal and business taxes for companies, large and small.

Additional Resources

Year-End Retirement Planning

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A major feature of the TCJA is the reduction of income tax rates owed by individuals. For example, married couples filing jointly for 2018 may have taxable income up to $77,400 and remain in the 12% bracket, up to $165,000 and stay in the 22% bracket, and up to $315,000 and stay in the 24% bracket. For single filers, the taxable income numbers are exactly 50% of those in the last sentence. Keep in mind that the numbers are for taxable income after all deductions have been taken.

In terms of retirement planning at year-end, one result is that low tax rates make tax deferral less attractive. Boosting your 401(k) contributions now may have less of a payoff than in previous years.

On the other hand, withdrawing from tax-deferred retirement accounts has become less difficult. That includes converting pre-tax dollars from a traditional, SEP, or SIMPLE IRA to a Roth IRA for potential tax-free distributions after five years, if you are at least age 59½.

No Looking Back

Roth IRA conversions have a catch, though. You no longer can reverse (recharacterize) a Roth IRA conversion back to a pre-tax IRA.

Example 1: Suppose Stephanie Jackson converts a $100,000 traditional IRA to a Roth IRA in November 2018. No matter what happens to that Roth IRA’s value in the interim, Stephanie will report $100,000 of taxable income on her 2018 tax return.

Therefore, the end of a calendar year can be the best time for a Roth IRA conversion. By then, you may have a good idea of your taxable income for the year, so you can make a tax-efficient partial conversion.

Example 2: Stephanie and her husband Tom calculate that they will have about $110,000 in taxable income on their joint return for 2018. Thus, one or both Jacksons could convert up to $55,000 and stay in the 22% tax bracket. Instead, they choose to have Stephanie convert $40,000 in late 2018. That will add $8,800 to their 2018 federal income tax bill (22% of $40,000), an amount they can comfortably pay from their cash reserves.

Planning Ahead

An alternate approach is to set aside an amount to convert from a traditional to a Roth IRA each year.

Example 3: Chet and Doris Carson report from $200,000 to $250,000 of taxable income each year, placing them squarely in the 24% tax bracket. Between them, they have $600,000 in traditional IRAs. The Carsons plan to convert $60,000 to a Roth IRA every year, generating a $14,400 annual federal income tax obligation. After 10 years, their traditional IRAs will be mostly or fully depleted, so the Carsons will owe little in the way of RMDs after age 70½. Roth IRA owners never have RMDs.

Roth IRA distributions are completely tax-free once the age 59½ and the five-year hurdles are cleared. Any Roth IRA conversion in 2018, no matter how late in the year, has a start date of January 1, 2018, so the five-year requirement after a year-end conversion will be met in just over four years.

Double Trouble

Tax-deferred retirement accounts generally have RMDs after age 70½. Therefore, taxpayers in this age group should be sure to meet their annual requirement by year-end. Any shortfall can trigger a 50% penalty.

In addition, each spouse must withdraw the RMD from his or her own account to avoid the penalty.

Example 4: Robert and Jan King each have a $20,000 RMD for 2018. Suppose Robert withdraws $40,000 from his IRA in 2018, but Jan does not take anything from her IRA.

In this situation, the IRS has collected the amount owed by the Kings. That makes no difference. Jan will still face a $10,000 penalty: 50% of her $20,000 RMD shortfall.

Do you have questions?

With all the tax changes happening this year, it might make sense to contact us for help.

Year-End Business Tax Planning

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Under the TCJA, equipment expensing permitted by Section 179 of the tax code was expanded. In 2018, your business can take a first-year deduction of up to $1 million worth of equipment purchases. You might buy, say, $400,000 worth of equipment and deduct $400,000 from your company’s profits this year. Without the Section 179 tax break, that $400,000 tax deduction would be spread over multiple years.

New and used equipment that is bought or leased can qualify for first-year expensing. The equipment must be placed in service by December 31 to earn a 2018 deduction. For this purpose, the date you pay for the equipment doesn’t matter.

Section 179 is meant to benefit smaller companies, not giant corporations. Therefore, this tax break phases out, dollar for dollar, at $2.5 million of outlays in 2018.

Example 1: ABC Corp. buys $2.8 million of equipment in 2018. That’s $300,000 over the $2.5 million limit for expensing this year. Consequently, ABC’s Section 179 deduction is reduced by $300,000, from the $1 million ceiling, to $700,000. After taking a $700,000 deduction under Section 179, the remaining $2.1 million of ABC’s equipment purchases must be depreciated under other tax code rules.

Bonus Depreciation

The TCJA also expanded the use of “bonus” depreciation: first-year deductions for equipment expenditures that don’t qualify for Section 179 expensing. Prior law allowed for 50% bonus depreciation, but that has been increased to 100% deductions in the year of acquisition.

Certain equipment is excluded from bonus depreciation, but most of the items you use in your business probably will qualify. Indeed, bonus depreciation now applies to some used equipment, as well, whereas only new equipment qualified in the past. Again, exceptions apply, but 100% tax deductions probably will be available for items that have not been used by your company in the past and have not been acquired from a related party.

Acting by year-end may lock in substantial depreciation deductions for this year. You even may be able to use bonus depreciation deductions that exceed business income to reduce your personal income tax bill for 2018.

Sport-Utility Vehicles

For more than a decade, large passenger autos defined as sport-utility vehicles have faced a $25,000 cap in regard to Section 179 expensing.

Example 2: Jerry Miller bought an SUV for $60,000 in 2017 and used it 100% for business. Jerry was entitled to a $25,000 deduction under Section 179. The remaining $35,000 qualified for 50% bonus depreciation, so Jerry’s 2017 deduction was $42,500. The other $17,500 had to be depreciated over a longer time.

The new law appears to improve the tax treatment of SUVs.

Example 3: Suppose Jerry Miller’s partner, Nancy Owens, buys a $70,000 SUV in 2018 and uses it solely for business. She’ll still face a $25,000 limit on Section 179 expensing, but the other $45,000 can qualify for 100% bonus depreciation in 2018, generating a full $70,000 deduction for this year.

Certain conditions will affect the amount of the deduction, including the extent of business use. For any vehicle that you use fully or partially for business, keep a careful log to support any tax benefits you claim.

Changing Times

For business owners, this first year-end tax planning opportunity under the TCJA of 2017 may be a time to reconsider how the company is structured. Broadly, your choice is between operating as a regular C corporation or as a flow-through entity, such as an S corporation or a limited liability company.

The new tax law lowered the corporate income tax, which has been set at a relatively attractive flat 21% rate. However, C corporations still impose two levels of tax: the corporate income tax plus personal tax paid by company owners. Dividends are not tax deductible, so business owners effectively pay double tax on dividends received.

Flow-through entities may qualify for a newly enacted 20% deduction on qualified business income (QBI).

Example 4: Carol Lawson owns 100% of CL Inc., which is an S corporation engaged in manufacturing. In 2018, she expects her company to pass through about $100,000 of income to her. Thanks to a 20% ($20,000) QBI deduction, only $80,000 of that $100,000 will count as income on Carol’s personal tax return.

The QBI deduction tilts the scale towards choosing a pass-through entity. However, a successful small company might pass through large amounts of money to owners, and there are rules that limit the amount of QBI for certain high-income taxpayers. Also note that even a 20% QBI deduction for someone in the top 37% personal income tax bracket would effectively leave that income taxed at 29.6% (80% of 37%), higher than the corporate income tax rate.

Don’t go it alone. Give us a call.

Our staff can review your specific situation and help you compare the tax treatment you’d face with different business entities. In some cases, a small business that distributes most or all of its income to shareholders as dividends may do well to avoid the double taxation that C corporations generate. Reach out to us to help you with your business year-end taxes.