Business Continuity Planning Can Help Ensure Peace of Mind

Businesses face more risks to their existence than perhaps ever before, and many never recover from the unexpected. Terrorism is a relatively new threat, but there are countless other potentially devastating ones.

As a business owner, what keeps you up at night? Probably any number of things - the threat of natural disaster, fire or explosion, sustained economic misfortune, catastrophic human error, supplier collapse, product failure, fraud, litigation, public relations fiasco, workplace violence, or sustained labor outage.

Are You Prepared?

Could your company survive one of these events? Are you at least prepared for the possibility they could occur?

A study by Gartner, a research and advisory firm, estimates that two out of five businesses that experience a major interruption will fail within five years. But studies also indicate that companies with robust, up-to-date continuity plans are more likely to survive a disastrous event.

Business continuity planning goes well beyond backing up computer data or planning for information technology outages. It is a broad-based process of comprehensively preparing for business interruptions and developing plans for business resumption and recovery. Ensuring physical safety, restoring service to customers, and protecting revenue flow are key goals.

According to the Federal Emergency Management Agency, business continuity planning at its most basic level involves:

• Assessing a company's vulnerability to disaster
• Identifying primary areas of risk
• Developing a continuity plan to protect all mission-critical functions
• Testing the plan
• Updating the plan regularly
  

Although no business owner wants to envision and plan for worst-case scenarios, doing so will give your company a fighting chance to survive if disaster strikes. It might also help contain your business insurance costs and will probably provide some peace of mind.

If your company has not yet developed a business continuity plan, what are you waiting for? The risk environment continues to worsen, and in today's fast-moving business world even a little down time can have a far-reaching negative effect.

Beyond the physical and financial damages, businesses caught off guard may suffer permanent damage to their reputation. Your business advisor can help you develop a business continuity plan or update one if yours has languished on a shelf. To decide if continuity planning is worth the time, effort, and potential expense involved, take this simple test: Ask yourself what you have to lose. If
the answer makes you flinch, now is a good time to act.

New Rules Boost Home Office Deduction

The home office deduction has suddenly become much more attractive, thanks to new regulations that clarify home sale taxation rules.

Under the new rules (Treasury Decision 9030), taxpayers who take the home office deduction no longer have to face the tax consequences of that deduction when they sell their house.

Previously, taxpayers had to divide the gain on the sale of their house between the business and nonbusiness portions and pay tax on the business portion of the gain. The new rules eliminate this requirement.

One key stipulation, however, is that the office must be within what the Internal Revenue Service calls "the dwelling unit." A detached structure used as an office would not qualify for the exclusion.

Avoiding Capital Gains Tax

Most taxpayers can now avoid the capital gains tax completely when they sell their house. The home sale rules allow homeowners to exclude from $250,000 (for single taxpayers or married filing separately) to $500,000 (for married taxpayers filing jointly).

Taxpayers still must pay tax on the gain from their house sale equal to the total depreciation taken after May 6, 1997, but any additional gain is nontaxable up to the maximum exclusion limits.

For instance, suppose a taxpayer bought a home in 1999 and sold it in 2003 for a $20,000 profit. The taxpayer took depreciation deductions of $3,000 during that period. Accordingly to the new rules, the taxpayer would only be taxed on $3,000 - the gain equal to the depreciation deductions taken.

Retroactive to "Open' Years

Another positive aspect of the new rules is that they're retroactive. Taxpayers who sold a home in 1999 and paid taxes on the gain allocated to their home office may be able to recover the tax paid.

Tax returns can be amended for open years - typically the three years prior to the current tax year. You would have until April 15, 2003, for instance, to file an amended return for 1999.

Taxpayers who declined the home office deduction in the past because of the potentially significant capital gains tax they would have faced when they sold their home may now want to reconsider. The only potential obstacle left is to ensure you're eligible for the deduction. The eligibility rules were liberalized in 1999, but very specific guidelines still must be met.

This is an excellent time to seek advice from your tax advisor about claiming the home office deduction if you have not been taking it. If you have claimed it in the past and have sold a home within the last few years, ask if you're a candidate to recover any gains tax paid.

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Old Buildings Yield Tax Credits for New Offices

If your company is in the market for a new office, you may want to consider the tax benefits of hanging your shingle outside an old building.

The rehabilitation tax credit officer financial incentives for rehabilitating old buildings for use as income producing properties. Rehabilitation is defined as renovation, restoration, and reconstruction. The Internal Revenue Service (IRS), National Park Service, and state historic preservation offices jointly administer the federal program.

Property owners receive either 10 percent or 20 percent of qualified rehabilitation expenditures as a tax credit. The percentage received depends on the historical status of the building in question.

Many states, already suffering severe budget shortfalls, have recently passed legislation to disallow the new federal depreciation allowance. Businesses in states that have elected to "decouple" from, or not to conform to, the liberalized depreciation rule may face cumbersome tax and bookkeeping issues as a result.

At press time, at least 28 states and the District of Columbia had decoupled in order to maintain prior depreciation rules and avoid lost revenue. These states had previously conformed automatically with federal depreciation laws, so taxpayers can't presume to know their state's position based on the past. At least 13 states have conformed to the new depreciation rule; others have not yet acted or have special circumstances.

For business owners this means that while they may reap depreciation savings at the federal level, they won't necessarily get the same favorable treatment at the state level. Furthermore, it may be necessary to keep multiple sets of books to track the cost basis and depreciation of assets for tax purposes. Business owners should consult their tax advisers to verify the action taken by their states, file amended returns if necessary, and learn more about the impact of decoupling on their individual tax situation.

Applying the Tax Credit

Unlike an income tax deduction, which lowers taxable income, a tax credit reduces the amount of tax owned. The tax credit is applied against renovation related costs, including professional services such as architectural or engineering fees.

For example, a building owner who incurred $500,000 in rehabilitation costs and qualifies for the 10 percent credit would receive an immediate $50,000 credit when the property is placed in service. The entire credit is usually claimed in the first year, providing an immediate savings benefit and dramatically reducing the amount left to be depreciated over time. The cost basis of the building is also reduced by the amount of the credit.

One caveat, however, is that the credit can only be applied against regular tax and may not be used to reduce alternative minimum tax (AMT). In the above example, for instance, a credit of $50,000 is generated but will only be allowed until the regular tax equals the AMT. If the regular tax is $100,000 before the credit and the AMT is $75,000, only $25,000 of the credit will be used, and the remaining credit will be carried forward until it can be used.

10 Percent or 20 Percent?

The 20 percent tax credit is available for certified historic structures, regardless of when they were built. All projects seeking the 20 percent credit must be reviewed and certified by the National Park Service.

The 10 percent credit applies to the rehabilitation of nonhistoric buildings built before 1936. Although there is no formal review process for these projects, certain general guidelines must be followed to receive the credit. For instance, at least 75% of the building's internal structural framework has to be retained.

To receive either credit, the rehabilitation has to be "substantial" - that is, rehabilitation costs must exceed the greater of $5,000 or the adjusted basis of the building. The property must also be depreciable, meaning it must be used in a trade or business.

Owners who claim the rehabilitation credit are required to keep the property for five years and not adversely alter it during that period; otherwise, they must return a portion of the tax credit.

Other Benefits

In addition to the rehabilitation tax credit, many states and cities offer tax credits and incentives for rehabilitating buildings that include subsidies, favorable loans, and property tax abatements. Your state's historic preservation office can provide information specific to your state.

Owners of certified historic structures may also want to consider donating a façade easement, which means that a building's façade will be maintained and protected to preserve its historical integrity. An owner who donates a façade easement can take a deduction equal to the fair market value of the easement.

Accordingly to the IRS, proper valuation of a façade easement generally ranges from 10 percent to 15 percent of a property's value.

Although the 20 percent credit for historic buildings can be combined with a façade easement, the donation has to be properly timed to avoid having to repay some portion of the tax credit.

In view of both the financial and aesthetic benefits that can be derived, you may find that an older structure is worth considering when searching for a new home for your business.

The Minute Book: Use It to Your Advantage

Becoming a corporation is a one-time event, but the process of remaining one involves observing ongoing legal formalities.

One such formality is maintaining a corporate minute book that reflects adherence to legal requirements, such as annual meetings of shareholders and directors. But in many closely held corporations, especially when directors are also shareholders actively employed in the business, meetings are informal and corporate minutes are inadequately detailed - if they're produced at all.

The corporate minute book, however, should enhance, not endanger, your corporation's ability to support tax positions and maintain its legal status. Internal Revenue Service auditors typically review corporate minutes as part of their examinations, and if yours consists of nothing more than short entries about the election of officers and directors, you could have trouble defending tax positions.

What to Document

To enhance your protection, record discussions and decisions about corporate legal, tax and business issues. A general rule is to document anything that requires approval by directors or shareholders. Specific issues to document include:

• The approval of compensation, loans and bonuses to officers, shareholders, or directors. Recording this information can help prevent attempts to reclassify certain transactions as taxable dividends.
• Explanations about compensation to shareholders or officers. In particular, it's important to justify salaries that could be challenged as unreasonable and detail aspects of compensation packages, such as the use of automobiles.
• The approval of retirement plan contributions.
• Explanations about the need to retain substantial funds within the business for future business needs. This can help defined the corporation against attempts to impose the accumulated earnings tax.
  

Seek Advice

You may want to ask your CPA to review your corporate minute book to see if it is maintained in a way that supports crucial tax positions. If your corporation has been lax in keeping the minute book, it would be wise to seek advice on the proper way to reconstruct minutes so that you'll have a paper trail of important decisions.