Manufacturing and Distribution Group Newsletter – Summer 2018
Brandon W. Vahl

Vendor Fraud: Know the Warning Signs


When fraud strikes, the culprit might be sitting in your purchasing department. This department is particularly vulnerable to fraud because of the volume of transactions it processes and the varying pricing and billing policies that vendors use.

Phony vendors

A common type of purchasing scheme involves fictitious vendors. Here, an employee in the purchasing department might set up a bogus supplier in the accounting system and then deposit payments to the supplier into his or her personal checking account.

Warnings of fictitious vendors include invoices that are photocopied, sequentially numbered and from companies that have post-office box addresses or addresses that match an employee’s home address. Also, be wary of invoices with amounts that consistently fall just below sums that require approval for payment and invoices for round dollar amounts.

Bogus invoices with real vendors

Some purchasing scams require collusion between an employee in the purchasing department and someone at the vendor’s office. For example, a vendor might submit falsified invoices, and then an employee in the purchasing department will deposit refunds into his or her personal account or split duplicate payments with his or her accomplice at the supply company.


If you perform contract work, you also might be susceptible to kickbacks. That is, the person who approves the contracts could be receiving kickbacks from vendors. Red flags include fewer bids than expected or required, widely divergent bids on the same projects and unexplained deadline changes.

Kickbacks also might occur if it seems like you are paying higher prices for lower-quality products. Cash payments to employees can be difficult to detect because those payments are not reflected in the company’s books. They probably are, however, reflected in higher pricing from the vendor. Even fraudulent vendors must cover their costs.

Companies should look for consistent shortages, informal communication (such as mobile phone calls or personal emails) between purchasing staff and suppliers and poor recordkeeping.

Prevention is key

You can prevent vendor fraud by targeting one of the legs of the fraud triangle: motive, opportunity and rationalization. Many preventive measures strengthen internal controls and develop policies and procedures to prevent theft, thereby reducing the opportunity to commit fraud.

For example, no employee should be authorized to handle most or all of your purchasing procedures. For example, the person who orders supplies and materials should not check shipments or approve invoices. Consider separating these functions or rotating who is responsible for them on a quarterly basis.

Also, consider performing background checks on new vendors. Such checks can provide information on the vendors’ affiliations, ownership, litigation, regulatory or legal violations or suspensions and financial standing. This can help you weed out vendors with dubious histories.

Companies also should state in writing how they expect employees and vendors to conduct business. This code of ethics should be reviewed and updated annually, and employees and vendors should be required to sign it every year, even if nothing changes. Annual reminders will reinforce the idea that the company considers ethical, professional business practices a priority.

Anonymous hotlines — one for employees and a separate one for vendors — can be an effective way to detect purchasing frauds, especially those involving collusion. Giving vendors a separate hotline makes them more comfortable sharing concerns and allows them to ask questions about the business’s ethics practices.

To catch a thief

If you notice the warning signs of vendor fraud, contact an accountant immediately. He or she can help unearth the cause of any anomalies, quantify your losses, build a defensible case (if you decide to prosecute the thief) and fortify your defenses against future scams.

For more information, contact Brandon Vahl at [email protected], or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

Learning the Basics of the QBI deduction for pass-through entities


The Tax Cuts and Jobs Act (TCJA) decreases the federal income tax rate for C corporations to a flat 21%, starting in 2018. However, manufacturers that are structured as sole proprietorships and pass-through entities (partnerships and S-corporations) are not eligible for this reduced tax rate. Instead, they may be eligible for a qualified business income (QBI) deduction for 2018 through 2025 – not made permanent with the new legislation. The goal of this deduction is to help mitigate some of the disparity between the tax rates applied for C corporations and pass-through entities.

Some manufacturers that are set up as sole proprietorships and pass-through entities are considering the advantages of potentially operating as a C corporation given the changes in legislation. Even though the corporate rate has been reduced, this should not be the ultimate decision driver. The answer depends greatly on the facts and circumstances of your tax situation. This decision should be carefully analyzed as there is a multitude of factors to consider.

Why are pass-through entities popular in manufacturing?

Many small and midsize manufacturers operate  as sole proprietorships or one of the following types of pass-through entities:

  • Partnerships;
  • Limited liability companies (LLCs) that are treated as sole proprietorships or partnerships for tax purposes; and
  • S corporations.

These structures allow a business to avoid double taxation. Income from C corporations is taxed when it is earned and again when a C corporation pays dividends. Income from sole proprietorships and pass-through entities is reported on an owner’s individual tax return and taxed just once at the owner level. The new law lowered the highest individual rate from 39.6% to 37%, as well as raising the tax bracket thresholds.

How are rates changing under the TCJA?

C corporations are still subject to double taxation under the new tax law. But, the TCJA substantially lowers the income tax rate and eliminates the alternative minimum tax (AMT) for C corporations, starting in 2018.

Individual income tax rate cuts are less significant and only temporary (from 2018 through 2025) under the new tax law. In addition, individual AMT still exists under the TCJA, although the exemption amount and phaseout thresholds have been temporarily increased. It is anticipated fewer individuals will subject to AMT during this period given the changes enacted.

The new law also creates a new QBI deduction for sole proprietorships and pass-through entities. The rules for this special deduction are complex. The IRS just recently released proposed regulations on this topic, which are extensive and include a specific set of anti-abuse rules.

What’s QBI?

The QBI deduction will be available to noncorporate owners of qualified businesses such as manufacturing. The deduction generally equals 20% of QBI; however there are various restrictions. The deduction will be taken on the owner’s tax return. For an individual, the QBI deduction can be taken regardless whether the taxpayer itemizes.

QBI is defined as the noncorporate owner’s share of taxable income, gain, deductions and loss from a qualified business. QBI does not include investment-related items, reasonable owners’ compensation and guaranteed payments from a pass-through business to its owners.

The QBI deduction and applicable limitations are determined at the owner level. Each owner must track his or her share of qualified items of income, gain, deductions and loss from the qualified business, as well as his or her share of W-2 wages paid by the entity.

What are the restrictions?

There are no additional limitations on the QBI deduction unless an unmarried owner’s taxable income exceeds $157,500 or $315,000 for a married joint filer. Above those income levels, the following restrictions are phased in over a $50,000 taxable income range ($207,500) for unmarried filers or over a $100,000 taxable income range for married joint filers ($415,000):

Service Business Limitation
This targets professional services providers, such as doctors, athletes and investment advisors. It does not generally affect manufacturers, unless a principal asset of the business is the reputation or skill of one or more of its employees.

W-2 Wage Limitation
This limits the QBI deduction to the greater of the noncorporate owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year; or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.

Qualified property means depreciable tangible property (including real estate) owned by a qualified business as of the tax year end and used by the business at any point during the tax year for the production of QBI.

Taxable Income Limitation
QBI deduction cannot exceed 20% of taxable income calculated before the deduction and without counting  capital gains and certain other income.

Need help?

These are just the basics. The rules for calculating the QBI deduction are complex. Contact your trusted ORBA advisor to discuss how the QBI deduction impacts your business.

For more information, contact Adam Guldan at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

Forward Thinking