Manufacturer. Dust off the expansion plans. What s your company worth? Emerging markets may be key to growing your customer base

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1 Manufacturer Summer 2011 Dust off the expansion plans 3 tax incentives make now an attractive time to invest in your company What s your company worth? A business valuation can achieve many objectives Emerging markets may be key to growing your customer base New IRS measures on liens make dealing with back taxes easier East 17th Street, Suite 100 Tustin, CA (714) Fax: (714)

2 Dust off the expansion plans 3 tax incentives make now an attractive time to invest in your company During the recent economic downturn, you may have been forced to put off making investments in your manufacturing company. With the passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act late last year, it may be worth your while to revisit your expansion plans. The Tax Relief act includes incentives designed to jumpstart spending and free up cash for businesses. Let s take a closer look at three provisions that could benefit your company. 1. Bonus depreciation If you need new plant equipment or office furniture, buying it now can provide a sizable tax break. Typically you must spread deductions for your asset purchases over several years. But if you buy and begin using a qualified asset by the end of 2011, bonus depreciation will allow you to deduct 100% of the cost on your 2011 tax return. If you buy and begin using the asset in 2012, you can deduct 50% of the expense. (Both deadlines are one year later for certain long-lived and transportation property, such as materials used in building construction and vehicles, respectively.) Qualified assets include new equipment with a lifespan of 20 years or less, off-theshelf computer software and qualified leasehold improvement property, which generally is an improvement on a rental property that is at least three years old. Some corporations can choose to accelerate their alternative minimum tax (AMT) credits instead of taking the bonus depreciation for assets they acquire and begin using in 2011 or For certain longlived and transportation property, you can buy and begin using those assets through 2013 and accelerate AMT credits Section 179 expensing Under Sec. 179 expensing, you may be able to deduct the cost of qualified business assets, including machinery, equipment, vehicles and furniture, rather than depreciating them over a period of years. Qualified leasehold improvement property is also an eligible asset in 2011, but not in 2012 and beyond.

3 Annual limits apply to both the total dollar amount you can deduct and the total amount you can buy. For every dollar you spend beyond the purchase limit, your deduction is reduced by a dollar. Through the end of 2011, it may make more sense to take advantage of 100% bonus depreciation instead of Sec. 179 expensing, because bonus depreciation has no dollar limit. Traditionally, the limits were low, so only small businesses benefited from Sec. 179 expensing. The Small Business Jobs Act of 2010, however, ramped up those limits to $500,000 ($250,000 of which can be qualified leasehold expenses) and $2 million, respectively, for 2010 and 2011, so more businesses can now benefit. The Tax Relief act sets the limits for 2012 at $125,000 and $500,000 (both to be indexed for inflation), but the limits are scheduled to drop to only $25,000 and $200,000 in Through the end of 2011, it may make more sense to take advantage of 100% bonus depreciation instead of Sec. 179 expensing, because bonus depreciation has no dollar limit. In 2012, when bonus depreciation is 50%, you ll want to consider the total cost of your purchases when deciding which incentive to use. Also, keep in mind that only new property is eligible for bonus depreciation, whereas both new property and used property are eligible for Sec. 179 expensing. 3. Work Opportunity credit If you ve been waiting to boost your staffing, this could be the financial push you need: The Tax Relief act extends the Work Opportunity credit to qualifying hires made through Dec. 31. (The credit previously was set to expire after Aug. 31.) If you hire from certain disadvantaged groups, such as disabled veterans, food stamp recipients The research credit extended again Uncle Sam is once again helping to make it worth your time and money to engage in research and manufacturers should consider taking advantage while the getting is still good. The research credit (sometimes referred to as the research and development or research and experimentation credit) expired at the end of 2009, but the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended it through the end of Businesses can also carry back the credit to Congress is mulling making the research credit permanent, but as of this writing nothing is set in stone. You can use the research credit for virtually any research that benefits your business. Wages for researchers, the cost of research supplies and the cost of computer licensing for research purposes are all expenses that qualify for the credit. You can claim the credit in one of two ways: The traditional research credit is equal to 20% of qualified research expenses over a defined base amount related to your gross receipts and previous research spending, while the simplified credit is equal to 14% of any spending for that year that s over 50% of your qualified research expenses for the previous three years. and convicted felons, you can receive a tax credit for 40% of the first $6,000 you pay to each qualified new worker $12,000 if the worker is a veteran. Other tax incentives Other tax breaks you may be able to tap into include enhanced deductions for certain charitable donations and credits for manufacturing energy-efficient appliances. Your financial advisor can help you determine which tax incentives are most applicable for your company. n 3

4 What s your company worth? A business valuation can achieve many objectives There are myriad reasons to conduct a business valuation. The main reason is in preparation for selling your manufacturing or distribution business. But knowing the company s value can be helpful when doing succession and estate planning and for other business-related reasons. It s also important to become familiar with the four main valuation methods. Succession and estate planning When you re transferring ownership of the business by gifting shares, a valuation can help ensure the gifts hold up under IRS examination. A valuation can also help in the assessment of the adequacy of life insurance coverage and in planning an exit strategy for shareholder retirement. Business-related reasons There are more business-related reasons to conduct a valuation, including post-transaction accounting. After a merger or acquisition, a valuation may be required to comply with Financial Accounting Standards Board rules. A valuator can help a company determine purchase price allocations, evaluate asset impairment and untangle postdeal tax issues. If your business structure is changing for example, converting from a C to an S corporation a valuation may be necessary to establish a value basis for company stock. A valuation also may be needed when implementing an employee stock ownership plan (ESOP). ESOPs typically require establishing a value basis for company stock that can withstand scrutiny from the IRS and the Department of Labor. And if you re facing commercial litigation, a valuation can be useful in legal contexts, such as an owner s divorce, an economic damages claim, bankruptcy or a shareholder dispute. A valuator can help the parties settle their differences out of court or serve as an expert witness during trial. In addition, a valuation may be required for filing an estate tax return for an owner s estate and to satisfy any related tax liability. Establishing business value is also important when structuring a buy-sell agreement s terms for buying back owner shares. Examples of occasions where buy-sell agreements may apply include shareholder retirements or disputes, divorce proceedings and legal division of assets, and disability or death of a shareholder. Valuation methods For most publicly traded companies, assessing value is as easy as checking the closing stock price for the day. But for a privately held business, it s not so simple. Your financial statements can serve as a starting point, but they won t provide the full picture of your company s worth. There s no one-size-fits-all valuation method. That s why it s critical to retain a qualified business appraiser. 4

5 The valuation process involves valuing both tangible assets, such as inventories and equipment, and intangible assets, such as a company s management team and name or brand recognition. Applicability of methods may vary depending on the valuation s purpose. Using a combination of methods generally provides a more reliable valuation. Here are four commonly used methods: 1. Asset or cost approach. This approach restates the company s assets and liabilities including unrecorded intangible assets and contingent liabilities with fair market values replacing book values. It may be particularly useful to manufacturers, distributors and other businesses that maintain a lot of hard assets. The approach factors in items such as inventory, improvements made to a business s facility space, and receivables (adjusted for aging and bad debts). 2. Income approach. Using this approach, a valuator focuses on the anticipated benefits of investing in the business and determines the required rate of return based on the company s unique risk factors. A common method under this approach estimates a business s value by dividing its expected earnings by a capitalization rate. Atypical business scenarios, such as start-ups or companies with volatile short-term earnings expectations, may call for more complex discounted cash flow analyses. 3. Market approach. The market approach involves the use of pricing multiples, which are based on 1) stock prices of comparable public companies, or 2) asset or stock sales of comparable private companies compiled by various proprietary databases. When selecting comparable companies, valuators use a variety of criteria, including industry, size, transaction date and financial condition. 4. Industry rule of thumb. Industry pricing formulas often spread by word of mouth or published in trade publications serve as useful sanity checks for values determined from other methods. But rules of thumb possess numerous drawbacks and should never be used as a sole method of valuation. For example, variables may be poorly defined and formulas may be oversimplified, failing to consider, say, excess working capital, volatile historic earnings or expected changes in market conditions. Achieve your objectives To gain an accurate picture of your company s value, work with a professional valuator who has the financial expertise and knowledge of your industry. A comprehensive valuation can help achieve both personal and business objectives. n Emerging markets may be key to growing your customer base Did you realize that new customers might be living halfway around the world? Even though offshoring manufacturing facilities in developing countries is nothing new, manufacturers typically have exported finished products out of developing countries for sale elsewhere. But now many of these same countries have seen their own economies expand in recent years, creating a prime opportunity for manufacturers to expand their customer bases. Because of this development, it may be worth the time to consider expanding into emerging markets. 5

6 6 Where are the emerging markets? Key emerging markets include Brazil, Russia, India and China. These countries mounting spending power, focus on infrastructure improvements, and growth in industries such as mining and large-scale agriculture have spurred a need for all types of manufactured products. Manufacturers may find additional growth opportunities across the rest of Latin America, Eastern Europe, Southeast Asia, the Middle East and parts of Africa. How can you connect with customers? Options for capturing customers in emerging markets include: Exporting. If you export your goods, you can establish a sales office within the emerging market, fulfill orders by mail or work with an intermediary who finds customers for you. While this approach minimizes your financial risk, you may not learn your new market s needs or how to cater to them to increase sales as well as you would with a more direct overseas presence. Licensing production to another company. This can be a good strategy for businesses with scarce financial resources. But it also can cap your potential profits, because you ll collect only a royalty on sales. Forming a joint venture with or acquiring an established company in the emerging market. These can be good compromises for companies that are ready for a significant commitment but want established local expertise to guide them through the process. Startup costs can be hefty, but you can save on import taxes and international transportation costs. Launching a physical operation of your own directly in the emerging market. This demands the biggest financial investment unless you already have a manufacturing facility in the country but can have big advantages, too. Committing to a market by creating local jobs can help foster goodwill among your potential customers, and some countries may offer you tax incentives to open up shop. While traditionally low labor costs in developing countries may rise as these countries continue to mature, the skill level among job seekers in these markets is also growing. Are you prepared to make the move? Before you expand, you need to understand the market. Talk with other companies in the area, potential customers, dealers and distributors, bankers, consulates, and local government authorities to get a handle on the financial, cultural, legal and political landscape. Emerging markets, such as Brazil, Russia, India and China, have increasing spending power, focus on infrastructure improvements, and growth in industries such as mining and large-scale agriculture, thus spurring a need for all types of manufactured products. You ll also want to crunch the numbers on your various options, including transportation costs, wages for workers, construction and financing for a new site. The price, benefits and risks vary for each option, so conduct a careful analysis to find the best way to accomplish your goals.

7 In addition, going multinational means navigating some complicated tax issues, including transfer pricing between your U.S. and foreign operations, income and other local taxes in your new market, and your foreign operation s organizational structure. Developing strategies to minimize your taxes in the United States and abroad will go a long way toward your financial success. Patience required Be patient as you work to establish a foothold in your new market. While you may not see an immediate return on investment, positioning yourself to grow alongside a country on the upswing may result in additional profits down the road. n New IRS measures on liens make dealing with back taxes easier If you re worried about unpaid taxes, recent IRS measures may help you breathe easier. The IRS has relaxed its policies on liens, which are claims that the federal government puts on the assets of delinquent taxpayers. Manufacturers with liens against them risk having the government seize their property and may have trouble obtaining credit. Thus it s important to promptly take the steps necessary to have a lien withdrawn. The new rules make it easier for small businesses to set up payment plans for back taxes and, ultimately, have their liens withdrawn. While the IRS doesn t specify which manufacturers fall into the small business category, the U.S. Small Business Administration generally defines a small business as one with 500 or fewer employees. Small businesses with $25,000 or less in back taxes can now qualify for a payment plan previously, the tax threshold was $10,000. If you owe more than $25,000 in back taxes, you can pay down the amount to $25,000 and then qualify. Once you start making your payments, the IRS will withdraw the lien after a probationary period. You must pay off the balance within two years. If you have unpaid taxes but haven t yet been slapped with a lien, you also may be in luck: The IRS also announced that it is significantly raising the dollar threshold when liens are issued, though it hasn t specified what the new threshold is. Still, if you owe back taxes, it s in your best interests to pay up quickly to avoid problems. This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use MFGsu11 7

8 ABOUT HMWC: How do you judge the strength of a professional services firm? At HMWC CPAs & Business Advisors, we believe two measures are relevant: the success of our clients and the quality of our people the professionals who bring their knowledge, skills and experience to the engagement. For more than 40 years, HMWC CPAs & Business Advisors has specialized in serving the financial and tax needs of privately-held businesses and their owners throughout Southern California. The depth and breadth of our experience which includes such ancillary services as business consulting, business valuation, employee benefits and human resources services, estate planning and computer consulting make us a valuable member of our clients management team. At HMWC CPAs & Business Advisors, we are more than accountants, we are trusted business advisors. As a member of Integra International, we have both a national and international presence, which provides us with the resources to consult on a variety of multi-state and global tax and business issues. At the local level, the firm has a highly talented partner and manager group whose involvement on each account helps ensure that our client receives the necessary attention and personal service needed to effectively manage their business. At HMWC CPAs & Business Advisors, our mission is to provide our clients, regardless of size, with a level of service and quality that is unparalleled in the industry East 17th Street, Suite 100 Tustin, CA (714) Fax: (714)