Measure Twice, Cut Once - Maintain Quality in the Estimating Process

Work is hard to come by these days, with all the bidders on jobs and razor thin margins, building quality backlog is not an easy task.  In talking with contractors, I've heard that it requires increased bid activity/volume in this competitive environment to win the work needed to keep the business moving forward.  On the face of it there doesn't seem much to take issue with regarding that statement.  I'm generally in agreement with it as long as the quality and integrity of the estimating process is maintained.

If it takes 100 hours to properly estimate a certain job in the "normal" times, it should take 100 hours to estimate that same job in these more challenging times.  What I've heard from some contractors in recent months is that because they are increasing bid activity with the same or even fewer estimators, the per job bid time is sometimes significantly less.  Some bids that should have taken, say, the 100 hours referenced above are getting bid in as little as 30 or 40 hours.  In order to get the quantity of bids higher, the amount of time per bid has dropped decreasing attention to detailed specifications being called for.  Mistakes are being made.  Whether it is a full line item/trade missed, or parts of the scope of a trade, missing scope of work in your bid will certainly unintentionally improve your chances of winning the job.  The obvious problem becomes how to figure your way out of the hole and mitigate your losses or hopefully make nominal profit.

It is far more important, as with most things in life and business, to maintain quality over quantity.  There's an old saying in the construction business that every contractor is one or two bad jobs away from going out of business.  This is especially true when balance sheets/capital structures have been weakened these past few years by losses.  Be sure to maintain quality in your business processes to ensure mistakes you can ill afford to make are avoided...Measure Twice, Cut Once.

The Importance of Buy-Sell Agreements

As the business owner’s average age continues to increase given the demographics of our population, there are a number of issues that may not have been perceived as important a few years ago that gain increasing attention as time marches on.  The truth is that these issues (e.g. buy sell-agreements, business continuity plans, etc.) have always been important.  There are a number of ways one can exit his/her business.  Many of those exit plans are voluntary and planned while some are not.  These agreements are often times overlooked as there is no sense of immediate need/urgency, etc.  They also generally deal with less than pleasant scenarios that people prefer not to think about.  The reality is that if you want to take care of your spouse and children, you really need to think about how your business is going to produce a liquidity event, in a timely, efficient and fair (think valuation) manner so your family can be well taken care of.  It can also be helpful to you as a shareholder if for some reason you find yourself, or your partner, having to divest from the business for whatever reason.

In basic terms, buy-sell agreements deal with situations whereby a business owner leaves the business through death, incapacitation or some other unexpected set of circumstances.  These agreements are also important in that if your partner is the one who is unexpectedly unable to continue in the business, the buy-sell agreement is the vehicle which will preclude his/her spouse from becoming your business partner.  This last item alone can be very motivational for business owners to address this issue.  

Some of the key terms addressed via a buy-sell agreement include who may buy the business interest, the events that trigger the agreement and the price to be paid for the business interest.  All of these are very important elements and must be addressed thoroughly and with professionals who are expert in preparing such agreements.  There are a few major, critical considerations which also must be addressed when structuring buy-sell agreements; 1) valuation criteria and 2) properly funding the buy-sell agreement.

The valuing of a business, or a share in a business, is an undertaking that can produce varied results.  I’ve said many times over the years you can have one valuation expert arrive at different valuations for different purposes (there are a number of reasons a company may need to obtain a valuation) at the same point in time.  You can also have different valuation firms arrive at very different results all valuing the business for the same purpose at the same time.  The best way to mitigate the potential for an unexpected and/or unfair result is to hire valuation experts familiar with your industry and business.  One size does not fit all when it comes to valuation and the selection of the right valuation firm is critical.  Valuation is contingent on many factors including methodologies, styles and perspectives, who the valuation firm is hired by (buyer or seller), etc.  Within the context of a buy-sell agreement, valuation is further challenging in that the principals are not necessarily looking for a value today, rather the goal is to ascribe a value to a business, or share of a business, at some unknown point in the future. 

The best way to handle the valuation issue in a buy-sell agreement is to have a valuation performed in the first year and then get annual, less expensive updates to that valuation in subsequent years.  Using this process, the many variables associated with properly valuing a business can be addressed given the set of conditions present at that time.  It is impossible to build a formula that will successfully process all of the variables that can change in the future.  That being said, in addition to building in a valuation requirement, it makes sense to insert a formulaic approach into your buy-sell agreement if for some reason a valuation wasn’t performed at the scheduled time(s) as a backup safety valve.  A dynamic formula is better than none at all and can be critical in the absence of a valuation being performed.  Arriving at a fair value for the business is essential to ensuring you and your family’s interests are protected.

Another important consideration in structuring buy-sell agreements is the funding of the liquidation event.  Depending on the particular set of circumstances, there are a variety of ways to fund buy-sell agreements so that the business is not disrupted.  Also, insurance can be an effective tool serving as value preservation in the event that the loss of a key individual adversely affects the valuation of the business.  Generally speaking, there are a number of insurance products used to fund the buy-sell agreements so that the business has the liquidity it needs to pay out the proper value of the business to the appropriate parties.  

A buy-sell agreement that isn’t properly funded is similar in many ways to establishing a living trust without funding it (i.e. converting title of assets into the trust, etc.)  It ends up causing additional heartache and stress and the good intentions of putting such structures in place are nullified by the failure to complete the job and address all the issues up front.  If you do not have a buy-sell agreement in place, or if you are unsure if it’s properly funded, you should reach out to your trusted advisor team and address it immediately.  If your agreement hasn’t been reviewed in a number of years you should revisit it to ensure it will achieve your objectives so you and your family are protected in the event the agreement is triggered.

Changes to Mechanic's Lien and Stop Notice Laws

In September 2010, the Governor signed into law SB 189 which changes certain aspects of the lien law code.  The changes are generally effective July 1, 2012 (unless otherwise noted in the bill).  It is important to familiarize yourself with these changes.  Atkinson, Andelson, Loya, Ruud & Romo did a nice job summarizing the salient points in a two page summary below...

Captive Insurance Programs Under Scrutiny

Many of us have heard of captive insurance plans and have some level of familiarity with them.  In a nutshell, captive insurance plans involve a business forming its own insurance company as a risk management technique.  The basic premise which must be in place is that legitimate risks are being insured and the associated premiums are reasonably priced relative to those risks.  If bogus, aggressive risk pools are created and/or overpriced premiums are being charged, then the captive and all those associated with its formation may be at risk.  I have had conversations with a number of professionals in the business community over the past several months suggesting the IRS and other agencies will be significantly cracking down on abusive plans.

A business contact sent me this concise, one page article last week from the January issue of California Broker magazine.  




The author, Lance Wallach, puts forth some troubling news/information for those who have established a captive insurance plan which may be considered abusive as well as those who helped structure those plans (including the plan architects, insurance brokers, CPAs, etc.)  Mr. Wallach states in the article "...my office has been receiving over 50 calls per month from people that are being threatened with large IRS fines...Not all 412i, captive insurance and Section 79 plans are abusive, listed or reportable transactions, but almost all the Section 79 and captive insurance plans that I have recently seen are abusive...I have had phone calls from taxpayers that contributed less than $100,000 to a listed or reportable transaction and were fined over $500,000."    There is an IRS form, 6707A, which is used "to help detect, deter, and shut down abusive tax shelter activities...The IRS has fined hundreds of taxpayers who did file under 6707A.  They said that they did not fill out the forms properly, or did not file correctly."  Given Mr. Wallach's observations and experiences, if you (or a contractor you work with) are involved with a captive insurance program it may make sense to review the plan with professionals who are expert in this area to ensure you don't get penalized given the recent spotlight focused on captive insurance programs.

For more on this issue and to see Mr. Wallach's credentials, be sure to click on the link above to read the full article.  As always, reach out to your trusted advisors for guidance (or seek outside counsel if these advisors were instrumental in structuring your captive insurance program in order to get an outside opinion).

Workers' Comp Pure Premium Rate To Rise 30% in 2012

On November 4^th, the California Insurance Commissioner approved an increase, effective January 1, 2012, to the pure premium rates for workers’ compensation insurance resulting in an average increase of just over 30% in those rates (to $2.30 per $100 of payroll).  This is the first increase in the advisory pure premium rates since a 5% rate increase was approved by the Commissioner effective January 1, 2009.  In 2010 and 2011, the Commissioner kept the pure premium rates flat despite being presented with recommendations for increases in both years.  Keep in mind workers’ compensation rates are determined by the industry classification code your business falls within.  I was told by a reputable insurance broker contractors can expect to face increases anywhere from 10% to 40% on average.  If your loss history is relatively clean and your business is strong financially, you may see a lesser increase.  Regardless of the code your business falls within, you must begin planning now for these increased charges.  It is also important to note, as I discuss below, that the pure premium rate doesn't necessarily correlate precisely with the premium you pay.  There are a number of variables insurance companies use to affect the premium calculation.

This is very important news for contractors as this will increase the cost of doing business and therefore requires management to revisit the estimating process.  The work you are bidding on now will be bearing this significantly higher cost.  You do not want to be caught bidding work with 2011 rates only to see your backlog in 2012 experience profit fade relating to the higher actual costs of insurance you will be facing.

It is important to keep in mind that although pure premium rates are an input/base in determining workers’ comp rates, they do not account for a number of costs borne by an insurance company.  These costs include administrative/overhead costs and therefore the premium rates that a business pays are generally higher to cover those costs as well.  There may be ways to mitigate the impact of this increase based on your particular circumstances.  I would urge you to contact your insurance broker to discuss as he or she can help by being proactive.  It is also good to include other trusted advisors, such as your CPA and bond agent, in the discussion as well.

Although the increase effective January 1, 2012 will be significant, it bears noting that these rates are still approximately 50% lower than the rates effective July 2003 (when it was an average of $4.80 per $100 of payroll).  That is little solace during these tough times however knowledge is power… Knowing the rates are rising provides you the ability to keep ahead of the curve.

Year End Tax Planning Considerations

Our firm sends a letter to our clients at year end outlining some possible tax planning considerations.  I thought I'd publish it here as well.  If you have any questions, as always please contact me.  I hope you find a point or two in here useful!

Year-end tax planning is especially challenging this year because of uncertainty over whether Congress will enact sweeping tax reform that could have a major impact in 2012 and beyond. And even if there's no major tax legislation in the immediate future, Congress next year still will have to grapple with a host of thorny issues, such as whether to once again “patch” the alternative minimum tax (e.g., to avoid a drastic drop in post-2011 exemption amounts), and what to do about the post-2012 expiration of the Bush-era income tax cuts (including the current rate schedules, and low tax rates for long-term capital gains and qualified dividends), and the expiration of favorable estate and gift rules for estates of decedents dying, gifts made, or generation-skipping transfers made after Dec. 31, 2012.

Regardless of what Congress does late this year or early the next, there are solid tax savings to be realized by taking advantage of tax breaks that are on the books for 2011 but may be gone next year unless they are extended by Congress. These include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line deduction for qualified higher education expenses; and tax-free distributions by those age 70- 1/2 or older from IRAs for charitable purposes. For businesses, tax breaks that are available through the end of this year but won't be around next year unless Congress acts include: 100% bonus first-year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation (and within that dollar limit, $250,000 of expensing for qualified real property); and the research tax credit.

We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make.

Year-End Tax Planning Moves for Individuals

□ Increase the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year. Don't forget that you can no longer set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.

□ If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2011.

□ Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.

□ Postpone income until 2012 and accelerate deductions into 2011 to lower your 2011 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2011 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2011. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year.

□ If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2011.

□ If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as-is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the rollover or conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.

□ It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2012.

□ Consider using a credit card to prepay expenses that can generate deductions for this year.

□ If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2011 if doing so won't create an alternative minimum tax (AMT) problem.

□ Take an eligible rollover distribution from a qualified retirement plan before the end of 2011 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won't sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2011. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2011, but the withheld tax will be applied pro rata over the full 2011 tax year to reduce previous underpayments of estimated tax.

□ Estimate the effect of any year-end planning moves on the AMT for 2011, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should not be accelerated.

□ Accelerate big ticket purchases into 2011 in order to assure a deduction for sales taxes on the purchases if you will elect to claim a state and local general sales tax deduction instead of a state and local income tax deduction. Unless Congress acts, this election won't be available after 2011.

□ You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.

□ If you are a homeowner, make energy saving improvements to the residence, such as putting in extra insulation or installing energy saving windows, and energy efficient heaters or air conditioners. You may qualify for a tax credit if the assets are installed in your home before 2012.

□ Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Thus, consider prepaying eligible expenses if doing so will increase your deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.

□ You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.

□ You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.

□ Purchase qualified small business stock (QSBS) before the end of this year. There is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2012, and (2) held for more than five years. In addition, such sales won't cause AMT preference problems. To qualify for these breaks, the stock must be issued by a regular (C) corporation with total gross assets of $50 million or less, and a number of other technical requirements must be met. Our office can fill you in on the details.

□ If you are age 70- 1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before year-end, can achieve important tax savings.

□ Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70- 1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70- 1/2 in 2011, you can delay the first required distribution to 2012, but if you do, you will have to take a double distribution in 2012—the amount required for 2011 plus the amount required for 2012. Think twice before delaying 2011 distributions to 2012—bunching income into 2012 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2012 if you will be in a substantially lower bracket that year, for example, because you plan to retire late this year.

□ Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $13,000 in 2011 to each of an unlimited number of individuals but you can't carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

Year-End Tax-Planning Moves for Businesses & Business Owners

□ Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2011, the expensing limit is $500,000 and the investment ceiling limit is $2,000,000. And a limited amount of expensing may be claimed for qualified real property. However, unless Congress changes the rules, for tax years beginning in 2012, the dollar limit will drop to $139,000, the beginning-of-phaseout amount will drop to $560,000, and expensing won't be available for qualified real property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.

□ Businesses also should consider making expenditures that qualify for 100% bonus first-year depreciation if bought and placed in service this year. This 100% first-year writeoff generally won't be available next year unless Congress acts to extend it. Thus, enterprises planning to purchase new depreciable property this year or the next should try to accelerate their buying plans, if doing so makes sound business sense.

□ Nail down a work opportunity tax credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2011. Under current law, the WOTC won't be available for workers hired after this year.

□ Make qualified research expenses before the end of 2011 to claim a research credit, which won't be available for post-2011 expenditures unless Congress extends the credit.

□ If you are self-employed and haven't done so yet, set up a self-employed retirement plan.

□ Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2012, and disposing of a passive activity to allow you to deduct suspended losses.

□ If you own an interest in a partnership or S corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year.

Update on H.R. 674 (Repeal the 3% Withholding on US Government Contracts)

Earlier today the Senate unanimously passed (95 - 0) this bill to repeal the 3% withholding on US Government Contracts (see my post below providing more background).  The House did pass the bill on October 27th however since the Senate inserted an amendment to the bill (which included a provision for tax credits to employers hiring unemployed veterans) it now needs to go back to the House for approval of the bill as amended.  

After the House approves the amended bill it needs to go to the White House for signature.  Approval by the White House is expected and this repeal seems very likely to come to fruition at this point.