The Los Angeles Business Journal has once again turned to some 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 2017 – from the perspectives of those in the trenches delivering financial advice and leadership to the businesses of our region today.
Is the new administration having an effect on your clients’ tax planning?
WHITE: The uncertainty about the new administration’s ability to get a significant tax package into law is putting the brakes on a fair amount of my clients’ tax planning. However, many of my clients do believe that we will see some corporate and individual tax rate reduction in the future, so they are implementing planning ideas to accelerate deductions as they may be worth more today than they would be in a rate-reduced future. The same goes for delaying the recognition of income as it may cost less tax dollars in the future.
ARMSTRONG: The proposed tax law changes coming from the new administration are causing pause and uncertainty within our client base. Unlike other proposed tax law changes that have occurred since the Tax Reform Act of 1986, the current administration’s simplified, one-page-proposal contains material changes to core elements of the US tax system. This means that any tax planning companies perform between now and when the proposed changes may occur will most likely result in some level of resolution in tax law that could ultimately produce substantially different tax results.
GREY: The new administration has created significant uncertainty concerning income tax rates and whether there will be estate taxes. Our clients want to know the rates, as this impacts their decision process. Some of our clients have held off selling assets due to their inability to adequately plan. Taxes should not control decisions. We advise our clients to make economic decisions and then SRG will minimize the taxes through effective tax planning. Most tax experts do not expect that the administration will be able to eliminate estate taxes. We do know the IRS issued proposed regulations to eliminate discounts for minority interest for family related entities, which could drastically increase the taxes on estates. We do not anticipate that California will decrease State taxes. Therefore, we advise our clients to continue developing techniques to reduce their Federal and State income taxes and refine their estate plans to substantially reduce their taxes.
How do the fiscal changes that have come with the new administration compare to the initial launches of previous administrations?
ARMSTRONG: After Reagan, every administration has looked to modify existing statutes, making slight changes here or there. The Trump administration’s proposed plan is truly a change in tax policy—seeking to change how the tax base itself is taxed.
How would you forecast the fiscal outlook for businesses in California over the coming few years?
ARMSTRONG: California continues to lead the country in having the highest tax rates. This can cause difficulties for companies looking to expand their operations here. The regulatory environment and tax structures of California’s neighboring states are generally easier to navigate and are much more attractive to businesses. However, California is still a major magnet for commerce—regardless of its tax complexities—and continues to attract trendsetters. The state’s combination of location, weather, size, access to resources, and its growing and diverse workforce offers benefits that are generally so great that businesses will still seek expansion here and continue to thrive.
What industries in particular are seeing the largest growth in the Los Angeles area?
WHITE: We are seeing a significant increase in the technology industry in the greater Los Angeles area. An additional benefit of this is that we are also seeing increases in industries that wouldn’t generally be related to technology. This includes real estate to house both the working and living spaces of the individuals in this industry. We are also seeing an increase in the secondary marketplace for apparel, furniture, electronics and motor vehicles as technology is giving an opportunity for a seller and buyer to come together much more efficiently.
ARMSTRONG: Los Angeles continues to be the West Coast hub of the fashion industry. Lifestyle brands and apparel companies in general do very well here given the abundance of industry knowledge, entrepreneurial spirit, and innovation. We’ve also seen an explosive growth in technology sectors such as hardware and software. The state’s continued focus on healthy living and overall wellness has also translated into new, growing segments in the food and beverage industry.
What are some of the top concerns of CFOs in 2017 — and how do you help them?
GREY: CFOs are concerned with many issues; however one of their primary issues is having sufficient debt or equity to fund their business expansion. We have unique and specific strategies that separate the financial statements from the income tax returns, thus enabling our clients to pay less tax while not impacting the financial statements. Commercial lenders make decisions based on the Company’s compiled, reviewed or audited financial statement. Therefore, our clients are able to increase their cash flow through paying less in income taxes and are still able to maximize their credit facilities. We actively assist our clients in the preparation of detailed financial projections to plan for their needs. We have developed strategic relationships with conventional and non-conventional financing sources that can provide the debt or equity as needed to expand their businesses.
What specific federal or state regulations are likely to cause the most significant problems for your clients’ businesses? Why?
ARMSTRONG: On the federal side, the introduction of a border adjustment tax will cause a major structural hurdle for Southern California companies that have expanded through manufacturing in Mexico. If the proposal passes as it’s currently envisioned, the effect will be a major market shift towards domestically sourced goods—since these goods will gain a competitive pricing advantage. On the state side, the fight for local and state tax revenue causes companies the most consternation. Although many municipalities and the state view tax rates as being relatively low, the aggregation of these taxes across a single tax base is monumental. This causes companies to spend a significant amount of time and energy managing their tax footprint so state and local taxes don’t erode their profitability.
Are there any new accounting pronouncements that will greatly affect future financial statements?
WHITE: The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 in May 2014 which established a comprehensive revenue recognition standard for virtually all industries, including those that previously followed industry-specific guidance such as real estate, construction, and software industries. The FASB later issued ASU 2016-20, which clarified certain narrow aspects of the standard including scope, contract cost accounting, disclosures, illustrative examples and other matters, but it did not change the core principles of the standard. These changes to revenue recognition are effective for public companies for the first annual reporting period beginning after December 15, 2017, with private companies having an effective date one year later.
ARMSTRONG: The new revenue recognition guidelines will affect every entity differently. Adopting the new guidelines is a significant undertaking, as the process will involve more than just your finance team. The Financial Accounting Standards Board’s (FASB’s) new Accounting Standards Codification (ASC) Topic 606 fundamentally changes how companies across nearly every industry will recognize revenue. A company should recognize revenue when it transfers goods or services to a customer. In certain types of arrangements, it may take some analysis to determine whether an entity has entered into a contract with a customer or not. Longstanding industry-specific guidelines will be eliminated—including some that have been a part of the generally accepted accounting principles (GAAP) for decades. Since the tax revenue recognition rules are not changing— with maybe one exception—it will mean that companies have a whole new set of book to tax differences.
In terms of tax reform, what do your clients need to know about the road ahead?
WHITE: When the White House announced President Donald Trump’s outline for individual and business tax reform in April, there were no detailed descriptions of the proposed provisions. Therefore, we need to see what Congress comes up with. The administration’s proposal is just one of many steps in the process of possible future tax reform legislation. In the near future, we can expect the House and Senate to each consider their own tax reform packages, which may lead to a tax reform package that the House, Senate and President must all agree to.
How do your clients handle the challenge of increasing their credit facilities while minimizing tax payments?
GREY: Clients preparing financial statements for financial institutions need to find a strategic balance between reducing federal and state taxes, and reporting strong earnings to the financial institutions that provide credit facilities. We have strategies that emancipate the clients’ financial statements from their tax reporting. How do we do this? Financial institutions require accrual-based financial statements, while tax law differs significantly from Generally Accepted Accounting Principles (GAAP). This difference can yield lower taxable income without impacting the accrual-based EBITDA of the company. We evaluate each company to identify areas where the financial statement and tax reporting can be separated by applying different year-ends and methods of accounting. At SRG, we use the GAAP and tax rules to our clients’ advantage, while maintaining integrity in all aspects of our reporting. This is another example of our creative, value-added approach to solving our clients’ problems.
What advice do you give clients considering expansion into global markets?
ARMSTRONG: Global expansion is a tale of two paths that compete with each other. The first path is sales-driven expansion, which occurs when expansion is caused by a growing customer base. The customer base expansion is driven by the sales force, which has its eye on growing the top line. This type of sales-driven growth means international locations are often established without infrastructure planning or consideration given to the local country’s laws and restrictions. The other path deals with addressing administrative risk and the complexity of managing a major expansion. Similar to what we’re experiencing in California, foreign taxing authorities are also looking to capture tax revenues from expanding companies. Far too often we’ve seen companies aggressively expand into foreign markets, only to find that the administrative complexity of compliance along with the added costs of direct and indirect taxes wasn’t properly considered.
What are some of the biggest mistakes companies make when it comes to managing their finances?
GREY: The biggest mistake companies make is that they try to reduce their tax obligation in the same entity that they are using to borrow from the bank. Tax minimization and financial statement optimization are mutually exclusive. The SRG Advantage is the emancipation of the financial statements from the tax returns, yielding our clients optimal results. Lower income taxes are paid and the financial statements are fairly stated; this enables the company to obtain the maximum amount of available financing. Companies need to better plan for their financing needs, and more effectively project their covenant performance. This planning helps to confirm and maintain compliance and the conditions required to increase their credit facilities. The Company can increase their line if they have complete and accurate monthly financials, projections and an annual review of audit. Companies also need to communicate more frequently with their lenders regarding both positive and negative situations.
What role can smart accounting play when it comes to helping a company grow its business these days?
GREY: The CPA firm needs to identify growth opportunities and help clients implement proactive strategies to optimize their market share. Short term, mid-term and long-term planning contributes to achieving these goals. Once a comprehensive business plan is developed, our firm will introduce lending institutions, private equity firms or private sources to achieve the goals. The accounting firm is an active partner with its clients in reaching their goals. Continual monitoring of results is a critical contribution of the accounting firm. The business plan and forecast should be monitored and revised regularly to properly plan for the company’s success. We have developed financial reporting tools that will enable the owners, key managers, and our firm of performance indices. We continually review variances and advise on corrective action if necessary.
What keeps your clients up at night in 2017?
WHITE: Cybersecurity is one of the top risk items that my clients are working to mitigate. While it is very difficult and expensive to be fully secure, they are taking several steps to diminish the risk. One step is changing technology user behavior through training programs and implementing cyber hygiene leading practices. Another step is going through the process of identifying system vulnerabilities and applying relevant system patches in a timely manner. Finally, having threat monitoring and analytic tools to detect an attack is important as the sooner an incident is identified, the sooner that mitigation strategies can be put into effect.
GREY: Uncertainty! Business leaders find great discomfort in uncertainty. Uncertainty in income and estate taxes, uncertainty with the global economy, uncertainty in the credit markets, uncertainty in how new regulations will affect business, uncertainty about what competitors are doing and uncertainty how new technology will affect their businesses. Uncertainty leads to short term focus. Companies are shying away from long term planning. Businesses have become more complex due to the rapid growth of information. Many companies suffer from information overload. SRG provides systems to enable management to convert the information into valuable knowledge for better short-term and long-term decisions. Strategic thinking and problem solving with alleviate stress and uncertainty.
What are some of the things that tech savvy accountants can do for their clients now that they couldn’t before?
ARMSTRONG: The accounting industry is marked by disruptive changes in how our services are rendered. It wasn’t all that long ago that your CPA had ledger sheets that would be the basis for tracking and itemization in big data analysis. With time, software has provided the sophistication to automate ledger sheets. Now we’re seeing innovation in not only how data is viewed, but also in how accountants analyze big data. The growing use of data visualization programs allows real-time transaction analysis, and when combined with artificial intelligence it’s allowing for a faster and more accurate analysis. This technology is poised to turn our industry upside down in how we perceive information.
WHITE: Sarbanes-Oxley combined with the complexity of ASC 740 has placed a high level of scrutiny on corporate income tax provisions and therefore, has led to an increase in the level of precision and documentation required. In response to this, we work closely with our clients to help develop an effective integrated strategy for analyzing, reviewing, managing, and upgrading their tax provision process including technology tools that are utilized in that process. This can include the development of stronger controls, more effective processes and procedures, strengthening integration of different tax processes, improving data flow, and managing risk while also creating efficiencies.
What specialties have you or your firm developed and how do you use them to benefit your existing clients?
GREY: Our services have evolved to meet the changing landscape of business operations today. We are strategic business consultants, and act at a level of a CFO and, in some cases, as the CEO. As Trusted Advisors we are active in our client’s business operations. Many of our partners and professional staff have been controllers, CFOs, or CEOs. This level of seasoned experience gives our firm a unique ability to meet our clients’ needs far beyond that of firms that are just CPAs focused on tax. We also are actively involved in Merger and Acquisition activities from the buy and sell side, selecting the appropriate investment banker, and assisting with long-term planning for tax minimization and succession planning. We have developed effective strategies to eliminate or substantially reduce estate taxes and regular taxes from the sale. Asset protection is another benefit that flows from an effective structure. Our firm has become global to meet the needs of our clients who cover the world.
ARMSTRONG: We’ve found that the market differentiators in the accounting industry focus around two key components: expertise in state and local tax as well as international tax and competitive pricing. The majority of accounting firms can handle a single location, a single state, and businesses that are only based in the United States. But as companies look to expand—even within a single state or to bring in a foreign investor—the field of qualified firms greatly diminishes. The firms that can support these two differentiators are generally priced at an incredibly high premium due to the infrastructure to support their services. We’ve found that if we focus on providing a practical, streamlined approach, we can bring these same services to market at more reasonable rates.
WHITE: We have built a breadth of technical resources across the nation that work alongside our local professionals to serve our clients in tax planning, compliance, financial reporting and internal tax department matters. This national group of professionals, known as Specialized Tax Services, includes teams focusing on fixed asset advisory services, global employer services, international tax, research and development tax credits, state and local tax, transfer pricing, tax process transformation, account and interest recovery services, mergers and acquisition due diligence and accounting for income taxes (ASC 740).
What’s the biggest piece of advice you give your clients when it comes to planning for the future?
GREY: Clients need to adapt to continually changing circumstances. We meet frequently with our clients to review their goals and ensure that we are providing the maximum value possible. We recommend that our clients plan their exit strategy well in advance. Exits can be costly; we have ways of reducing costs substantially. Our income tax and estate tax methods achieve the transfer while offering our clients maximum control. Many clients want to maximize their entity value and then exit through a sale. We can assist with the sale. We recommend that exit-strategy planning be done at least a year before marketing the Company for sale. Having a well-seasoned plan can ensure substantially less taxes through various strategies such as basis step-ups, deferred payment of taxes, utilization of the lower capital gains taxes, reductions of the amounts includable in the taxable estate tax and potentially eliminate taxes to California.
WHITE: We have told many clients that they shouldn’t let the “tax tail wag their business dog.” While we don’t think that anyone should ignore the tax consequences or benefits of a particular transaction, expansion or business strategy, clients need to look beyond taxes to see if this is the right thing to do for the future of the overall business. We also tell many clients to not look at taxes from a single-year perspective, rather look at them over a longer period of time to see if their business strategies have a different degree of tax impact over time.
ARMSTRONG: Always focus on your strategic goals as you’re growing a profitable and successful business. Like any complex endeavor, it’s easy to get lost in the details. We try to help businesses find the right balance between managing those details and working toward their strategic goals. It’s our role to understand their business objectives and then apply our expertise in developing the most tax-efficient planning for their operations. Tax services are designed to mitigate a company’s operational risk—it’s not a platform to build a business strategy on.
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