Tax Issues to Consider When Investing in Training and Recruiting
Adam Guldan, CPA, MST
A common challenge for manufacturers is the shortage of skilled workers. Training and recruiting are effective options to resolve this issue; however, they require significant time and monetary commitments. The goal is to meet the labor needs of your company in the most cost-effective manner, while keeping employees excited and enthusiastic about prospects of development and growth.
Deducting Training Costs
Before looking outside your organization for skilled applicants, consider existing employees. Trustworthy and dedicated employees who have been with the company are already familiar with certain processes and the overall culture of your company. This could be a great, cost-effective way to fill a position. In addition to any continuing education requirements, employees may want to advance their skill set or simply keep their skills current. Depending on the interest level from employees, employers might decide to offer classes or send employees to an off-site location for training.
These courses do not have to improve or maintain job-related skills. Instead, they can be used strictly for educational purposes, to help the worker meet minimum requirements or to even lead to a new job. A company that maintains these educational assistance plans allows employees to receive up to $5,250 in annual tax-free education benefits, while the business is entitled to the applicable deduction. These payments can be for qualified education expenses related to undergraduate or graduate level courses.
The qualified expenses eligible to be excluded from income under the educational assistance plan include tuition, books and supplies. The exclusion does not apply to meals, lodging or transportation. As an employee, it is important to remember that reimbursed expenses cannot be deducted or used to claim any educational tax credits. If you pay more than $5,250 in educational assistance benefits to an employee annually, he or she must generally pay tax on the excess amount, unless the expenses are considered a working condition fringe benefit.
A working condition fringe benefit is an employer-provided service or property tax that is free to an employee, provided that it would have been a deductible business expense if the employee paid out of their own pocket. Educational expenses provided by employers are able to be excluded from employees’ income if it meets this definition. To be deductible under this premise, the course must maintain or improve skills required in performing a present job. Educational costs cannot be deducted to meet the minimum requirements of a profession or to qualify the individual for a new job. The deduction covers tuition, books, supplies and travel expenses.
If it is not possible to fill a position with existing employees, it is time to look outside of your company. Internships can be an affordable method to evaluate talent and infuse your team with new ideas. Many manufacturers partner with local high schools, tech schools, community colleges and universities for these purposes. Keep in mind that it may still be required to offer a modest salary under state and federal labor laws.
A modest salary certainly helps attract applicants to your recruitment programs. However, many companies wonder whether they are legally required to pay interns for their services, or whether receiving on-the-job training or earning high school/college credit will suffice. Under the Fair Labor Standards Act (FLSA), companies are generally required to pay at least minimum wage to employees. The FLSA also applies to interns, unless they qualify for an exception.
The Department of Labor uses the following criteria to evaluate exceptions:
- The internship is similar to training that would be given in an educational environment;
- The internship experience benefits the intern;
- The intern does not displace regular employees;
- The intern works under close supervision of existing staff;
- The employer receives no immediate advantage from the activities of the intern;
- The intern is not necessarily entitled to a job at the conclusion of the internship; and
- The employer and the intern agree that the intern is not entitled to wages for the time spent in the internship.
The more of these points that apply, the stronger the case will be for exemption from the FLSA. Seek legal advice regarding state laws and other regulations that pertain to internships. The bottom line is that interns who are paid and assigned meaningful work can be eager, productive team members. They are also more likely to return to work for you as full-time employees.
Relocating New Hires
For hard-to-fill positions, you may need to expand the search beyond your company’s geographical reach, and you might have to offer financial incentives to lure applicants. In addition to paying signing bonuses and premium salaries, relocation packages can also help attract talent. Typically, employers provide an advance for moving expenses with an agreement that the new hire will return any excess funds within a reasonable time period. Reimbursed moving expenses made in accordance with the IRS rules for “accountable plans” are deductible as normal business expenses. The reimbursements are generally tax-free to the employee.
If a reimbursement arrangement does not meet the IRS requirements for accountable plans, the reimbursement will be treated as “non-accountable.” Payments made under non-accountable plans are taxable compensation to the employee that is subject to payroll and income taxes. However, the employee can offset the income on his or her personal tax return by deducting qualified job-related moving expenses.
Family Business: How to Survive a Divorce
Seamus Donoghue, CPA, MST
Many small manufacturing businesses are run by families. Unfortunately, when business and personal lives are so intertwined, disagreements can happen and family members may decide to part ways. There are a few valuation methods that apply when buying out a dissenting shareholder or dividing up a marital estate that includes a family-owned business.
Valuing a Private Business Interest
During shareholder divorces and buyouts, it is important to determine how much the business is worth. There are three ways to value a privately-held manufacturing business:
- Cost Approach
The cost (or asset-based) approach starts with the company’s balance sheet. Adjustments are then made to various balance sheet accounts, such as inventory or equipment, in order to reflect the fair market value. For example, raw materials inventory may be undervalued if your company uses the LIFO (last in, first out) method. Similarly, equipment may also be undervalued because manufacturers typically use accelerated tax depreciation methods. The cost approach may also overlook goodwill and other intangible assets. The value of intangible assets is better captured by the market and income approaches.
- Market Approach
This approach derives value from the sales of similar businesses. Here, the value of the company is derived from a pricing multiple, such as price-to-earnings or price-to-EBITDA (earnings before interest, taxes, depreciation and amortization expense).
- Income Approach
Under the income approach, a future earnings stream (typically cash flow) is discounted to its present value. Stable cash flow is then divided by a capitalization rate, which can be thought of as the mathematical inverse of a pricing multiple under the market approach.
Goodwill is the excess of a business’s value (under the income or market approach) over its net tangible book value (the cost approach). In a few states, the entire value of the business is part of the marital estate. Alternatively, some states exclude all goodwill from the marital estate.
About half the states distinguish goodwill as either personal or entity. The former cannot be separated from the business owner, whereas the latter is a function of the business’s location, employees, name recognition, contracts and customer lists. These states include entity goodwill in the marital estate, but exclude personal goodwill if maintenance awards are based on the owner’s future earnings.
Personal goodwill is most frequently associated with professional practices, such as medical practices or law firms. However, some courts recognize that manufacturers can also possess this type of goodwill. For example, business success that is tied to key relationships with the owner or if the owner has unique knowledge that cannot be transferred to others would be considered personal goodwill.
When evaluating personal goodwill in a dissenting shareholder context, it is important to consider whether personal goodwill could be transferred to a third party. If a shareholder would need to work closely with a hypothetical buyer to transition the business after a closed deal, a portion of personal goodwill might belong to the individual shareholder, rather than the business.
Adjusting the Financials
Family businesses are not always run like major companies that strive to maximize profits and shareholder value. Therefore, adjustments may be needed to reflect how unrelated parties would operate the business.
Common financial statement adjustments include:
- Owner and family compensation and perks (company vehicles and season tickets to sporting events, etc.);
- Non-market value rent paid to related parties;
- Inventory accounting anomalies; and
- Unrecorded liabilities (pending lawsuits and warranty claims).
When valuing a minority owner’s interest, courts in divorce and dissenting shareholder lawsuits generally consider whether a buyout price is fair. So, they may sometimes be reluctant to apply discounts for the lack of marketability and control if the discounts would provide a windfall to the controlling shareholder.
Finding Your Expert
These valuations are likely to face scrutiny in court. If your business needs to be valued for a shareholder divorce or buyout, contact a business valuation specialist. Choose someone who understands manufacturing industry trends, accounting practices and key value drivers.
For more information on business valuation, contact Seamus Donoghue at email@example.com, or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing & Distribution Group.