The Los Angeles Business Journal has once again turned to two of the leading accountants in the region to get their assessments regarding the current state of business accounting, economic variables, and the various trends that they have been observing, and in some cases, driving.
Following is a series of questions we posed to these financial stewards of Los Angeles and the unique responses they provided – offering a glimpse into the state of business accounting in 2018 – from the perspectives of those in the trenches delivering financial advice and leadership to the businesses of our region today.
Thanks to these two leaders in the business accounting space for taking the time to provide thoughtful advice and responses to our questions.
How have the fiscal changes that have come with the current administration affected your clients thus far?
Yamada: It’s been a mixed bag, but one issue that’s touched all our clients is the new Tax Act. Our corporate clients welcome the reduction in the tax rate but are concerned about many of the other provisions that have been implemented. The changes in the Tax Act also reduced year-over-year comparability from both a financial reporting and cash flow standpoint. This puts many clients who don’t have a technical tax background in an uncomfortable position when they’re asked about these differences by stakeholders. As a firm, we’ve done a significant amount of coaching to equip clients to have a level of comfort in talking through the provisions that impact them.
Mazza: Many taxpayers and their advisors are frustrated by the uncertainties created by a number of new provisions of the Tax Cuts and Jobs Act of 2017. Some uncertainties are unavoidable – such as whether the new 20 percent pass-through deduction and other individual provisions will be made permanent, or whether the 21 percent corporate tax rate, theoretically ‘permanent,’ will be increased by a later Congress. Other issues arise from the novelty of many of the new provisions, the existence of apparent gaps or possible errors in the expedited drafting process, and questions as to whether those gaps can or will be filled by technical corrections legislation, regulations or other IRS guidance. Alternatively, taxpayers and their advisors will simply have to deal with the statutory language as is, and make their best determination as to what Congress intended in any particular case.
Specifically in terms of tax reform, what do your clients need to know about the road ahead?
Yamada: The road is paved with a fair amount of uncertainty, particularly because there will be additional guidance coming out of the IRS and Treasury in the coming months. Some of the new provisions included in the law are incredibly complicated—the GILTI, BEAT, FDII, and Sec. 199A provisions all come to mind. And there isn’t a one-size-fits-all solution. Modeling out the impact tax reform will have on effective tax rates and cash flows requires taking into account the nuances of each individual client.
Mazza: Tax reform will impact all businesses beginning in 2018. Here are a few important changes in the new law that will impact your clients. Under the new tax law, federal income tax rates on C corporations are reduced to 21% and a new 20% deduction on qualified business income for individuals, estates and trusts that own interest in pass-through entities. These changes could have an impact on entity choice and will affect the personal taxes of business owners. Enhanced bonus depreciation and Section 179 deduction rules are favorable changes to business owners. Bonus depreciation deduction has increased from 50% to 100% and Section 179 deduction increased from $500,000 to $1 million. These changes will allow companies to consider making larger capital improvements and an increase in tax deduction. Other not so favorable changes to the law are the limitations on net operating loss (NOLs) utilization, business interest deduction and disallowance of certain meals and entertainment expenses. These limitations can reverse a company’s anticipated tax loss to a taxable income situation. Consult with your tax advisors and understand how the tax reform affects your business.
How would you forecast the fiscal outlook for businesses in California over the coming few years?
Yamada: Given all the forces at play it’s likely to be a challenging time, and solid management will continue to be the key to success. California is known for being a powerhouse of economic growth, but continuing on that trajectory means businesses need to navigate the fiscal challenge of rising personnel, capital and compliance costs. If businesses have solid strategies in place to address these issues, they’ll be much more likely to thrive in the coming years.
What industries in particular are seeing the largest growth in Los Angeles?
Mazza: The consumer industry continues to evolve rapidly alongside changing consumer preferences. Despite new headwinds, investor interest in consumer products remains strong. Consumer preferences and buying behaviors continue to evolve. Few sectors are affected more than the restaurant space, which also faces work force constraints and intense competition. As tastes and preferences continue to change, the industry will likely create a deeper divide between successful and unsuccessful restaurant operators. Those who respond in a timely, effective way will have more opportunity to thrive while others may struggle to survive.
Yamada: The technology sector is particularly strong right now, evidenced by the levels of funding we are seeing in the industry. But along with growth comes significant challenges in scaling up, including attracting local talent, expanding facilities, and more. Fortunately, there are significant tax incentives, like the federal and state R&D tax credits, that can help cover some of the costs associated with growth.
What specific federal or state regulations are likely to cause the most significant problems for your clients’ businesses? Why?
Mazza: For our clients selling their products on the internet, their biggest challenge will relate to the outcome of the Supreme Court case Wayfair v. South Dakota to be decided by the end of June. The states have been redefining nexus standards for decades and the Supreme Court will need to affirm physical presence or make economic nexus the new standard due to our ever-changing economy. If the decision errs in favor of the states, economic nexus, based on the dollar volume of sales into a state, will determine whether a company will be required to register, collect and remit taxes in the state. On the other hand, if physical presence is affirmed, the states will become much more aggressive and impose more regulatory filing requirements where non-compliance will result in large penalties and fees. States like Washington have already factored these penalties into their budget as expected revenues.
Yamada: Some of the newer sales tax provisions states are implementing to circumvent the physical nexus standards can be worrisome. Requiring companies to provide increased reporting to customers is a huge compliance burden, and considering these regulations are often paired with significant non-compliance penalties, facing a compliance notice or a due diligence scenario can be particularly unpleasant. Some states like Pennsylvania and Washington are already making moves, and California-based businesses should stay on top of them to ensure they’re not affected.
Are there any new accounting pronouncements that will greatly affect future financial statements?
Mazza: The following are accounting pronouncements that will greatly affect future financial statements:
• ASC 606, Revenue from Contracts with Customers, will impact the way preparers will recognize, measure, present and disclose revenue in their financial statements. The standard will impact all industries.
• ASC 842, Leases, will impact the way lessees recognize almost all leases in their balance sheet (i.e., lessees will now be required to recognize a right-of-use asset and lease liability for both finance and operating leases). Lessors are also impacted by the standard, however, this is to a lesser extent than lessees. The standard will impact all industries.
• ASC 326, Financial Instruments – Credit Losses, will impact how companies account for credit losses for financial instruments, it also increases the disclosure requirements relating to credit losses. The standard is going to be more impactful to financial institutions.
What are some of the top concerns of CFOs in 2018 – and how do you help them?
Yamada: CFOs nationwide need to ensure they have a good handle on the Tax Act provisions that may impact them. Since the bill was passed quickly, and changes were being made up to the last minute, we worked very closely with our clients following the passage of the bill so they were able to visualize the impact, initially from a financial statement perspective. As we continue to move through the year we are getting a lot of questions about how to optimize tax strategies, so savings can be deployed elsewhere.
Mazza: This year is particularly challenging for CFOs and their teams as they look to implement the new revenue recognition and lease accounting standards and interpret how they will be affected by tax reform. Although all industries are impacted, there are varying levels of modification required in accounting methods and tax treatment from industry to industry. Each of these pronouncements requires changes to current systems and processes and potentially investment in additional software and hardware. At RSM, we help clients address these challenges by taking time to understand their current operation and business practices and then analyzing the specific impact the new accounting and tax requirements will have on their business. We then work with the client to develop a strategy for addressing required changes to their process. We can support CFOs where they lack internal resources, or assist from assessment all the way through implementation and evaluation of the solutions.
What advice do you give clients considering expansion into global markets?
Yamada: Have a defined plan in place for how the new location fits in the company’s overall strategy. Then determine what can feasibly be done to turn that plan into reality. We have seen many companies enter a foreign market without doing the requisite diligence, and it rarely works. Even when a foreign entity achieves early profitability, other ancillary issues always seem to arise—movement of cash back and forth to the United States, employment issues, etc.— if a comprehensive plan isn’t in place.
Mazza: Planning, benchmarking and consulting with trusted service providers to identify unseen pitfalls. For manufacturers, oftentimes expansion is triggered at the request of a key client, but the foreign market opportunity could be significant. With the current administration pushing hard to improve exports to China, and the Chinese government signaling sincere interest to do so by buying billions more in US products and services, China alone represents a huge opportunity. Market analysis, working with the US Commercial Services to help source prospective buyers, IP protection, tax planning, and developing a long term investment plan to weather initial challenges are all key. Especially with tax planning, companies that try to go it alone often wind up paying undue compliance penalties, higher tax rates, and limit cash mobility and repatriation more than necessary.
Do you think we will see continued consolidation in certain industries such as healthcare and financial institutions?
Mazza: We do expect continued consolidation in the financial institution industry nationally and in the western region. The cost of regulatory compliance and economies of scale are creating opportunities for mergers and acquisitions in the community banking sector of $500 million to $1 billion in total assets. Larger financial institutions in the $10 billion total asset range are seeking to increase market share, improve efficiency, strengthen organic growth and meet regulatory expectations on safe and sound growth.
What role can smart accounting play when it comes to helping a company grow its business these days?
Yamada: From a tax perspective, accountants can look for opportunities that improve cash flow even if a business is not yet profitable. Once a business gains profitability, smart accountants make sure that we apply every tool in our tool belt to achieve the best possible tax position. Being able to optimize tax strategy comes from both comprehensive knowledge of tax opportunities and an intimate knowledge of our clients and their businesses. Our priority is helping clients achieve the best possible tax position and find ways to use any savings to fund additional growth.
Mazza: Smart accounting requires the right attitude, discipline, personnel, and advisors, but when done right – it works. Companies that have a smart system of accounting obtain better financing to support growth, gain an edge on competition by using a more effective system, and have the ability to expand more efficiently through acquisition. As a Company implements a smarter system of accounting; one which provides accurate information in “real-time” 24/7, is adaptable from a reporting perspective to drill down into detail, and create reports from the same data base, it becomes a powerful tool to do business and allows management to make better decisions in order to grow the business.
What keeps your clients up at night in 2018?
Mazza: The housing market continues to be a complex issue for clients. Housing demand in the United States remains brisk even as issues with supply and affordability mount, particularly in the West. We continue to forecast solid sales and consumption throughout the economy this year. It is a misnomer to label the housing outlook as “weak.” While the overall macroeconomic outlook remains strong, the housing market is constrained by four fundamental issues: a lack of available lots, a shortage of available workers, high regulatory costs and federal tax law that is damping construction and sales activity in some areas of the economy.
What’s the biggest piece of advice you give your clients when it comes to planning for the future?
Yamada: Start with your business goals in mind, but be flexible about the strategies you take to get there. We maintain a constant open dialogue with our clients, allowing us to the help them pivot when unforeseen circumstances arise. Our goal is to work in lock step with our clients to help them achieve their goals and manifest their strategic vision.
Joseph Mazza leads RSM’s practice in Los Angeles. As leader of the Los Angeles region, Joe directs growth development and spearheads the Firm’s business initiatives. He is a past member of the Board of Directors of RSM and has over 25 years of diversified public and private accounting experience, serving both public and privately held middle-market companies. Joe has provided audit and management advisory services to clients in a wide range of industries, including consumer products, industrial manufacturing, e-commerce, technology, life sciences, medical device, media and communications.
Aaron Yamada has nearly 20 years of experience providing corporate tax planning and compliance services to publicly traded and privately held clients. He provides services to several large privately owned businesses and assists in several areas, including tax provision, tax strategy and tax return preparation matters. Aaron has significant experience in multi-state taxation. He also specializes in the preparation and review of his clients’ income tax provision under ASC 740 (FAS 109).