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Nearly all organizations rely on vendors to provide certain goods and services to facili-tate their business operations. Whether for repairs or maintenance service, a purchase of offi ce supplies, a consulting engagement, or a large capital contract, the need for vendors is universal—but it also carries an inherent risk of fraud. Th e same pressures, opportuni-ties, and rationalizations that lead dishonest employees to steal from a company can be catalysts for vendors to engage in fraudulent behavior. Are you familiar with the ways that suppliers and contractors can defraud their customers? Do you know the warning signs of vendor fraud? Take this quiz and fi nd out.

1. XYZ Corp.’s management suspects that a vendor, Green Inc., is intentionally billing the company for the same product order multiple times. Which of the following tests would be most helpful in uncovering such a scheme?

a. Comparing XYZ Corp.’s vendor master list to its employee master list for matching information.

b. Selecting a sample of invoices from Green Inc. and recalculating the totals for each line item.

c. Sorting invoices from Green Inc. by amounts, purchase dates, and delivery dates.

d. Reviewing all purchases from Green Inc. that fall just under internal authorization thresholds.

2. Which of the following would be the most likely indicator that contractors have collud-ed to rig the bidding process on a contract?

a. Th e winning bid for the contract price is unusually low.

b. Th e losing bidders become subcontractors on the project.

c. A high bid is followed by amendments that reduce the total payments to the contractor.

d. Many more bidders responded to the re-quest for proposals than expected.

What’s Your Fraud IQ?By Andi McNeal, CPA

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Although tax planning is a 12-month ac-tivity, year-end is traditionally the time to review tax strategies from the past and to revise them for the fu ture. At year-end 2014, and looking ahead to 2015, individu-als and businesses need to be ready for late tax legislation, prepare for a rash of new re-quirements and respon sibilities under the Patient Protection and Aff ordable Care Act (PPACA); and in corporate traditional as well as innovative strategies into their year-end planning.

PLANNING NOTE. At the time this Brief-ing was prepared, legislation to extend many popular but temporary tax extenders is be-ing considered by the lame-duck Congress. Late legislation could cause a delayed start to the 2015 fi ling season (and possibly delay refunds to in dividuals) because the IRS will need ad ditional time to reprogram its return pro cessing systems.

POST-ELECTION PLANNINGOn November 4, Americans learned the composition of the House and Senate in the 114th Congress that will convene in January 2015. Republicans increased their majority in the House and captured a ma-jority in the Senate. Th e changes could open the door for action on comprehensive tax reform in 2015 or 2016. Alternatively, lawmakers and the President may agree on smaller scale reforms.

Tax Extenders. Th e impact of the mid term elections on immediate year-end tax planning for 2014 principally revolves around a so-called “tax extenders” pack-age of expired individual and business tax breaks that await retroactive reinstatement to the start of 2014. It is not yet decided whether fi nal passage will happen in mid November or early December ...or, if ne-gotiations break down, in January when the new Congress meets.

IMPACT. Hill sources have recently in-dicated that the diff erences remaining in House and Senate extenders bills are “easily resolvable.” Making the research tax credit permanent in return for a two-year exten-sion of the other extenders has been part of the latest buzz around how fi nal negotiations will proceed. Although hav ing an extenders package eventually pass Congress is “almost a sure thing,” any sin gle extender remains subject to being jetti soned in last-minute negotiations, making year-end tax planning decisions subject to revision until fi nal Con-gressional action.

Year-End Strategies: Creating Pathways forTax Savings by Individuals and BusinessesCCH Tax Briefi ng

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We have tremendously underestimated how diffi cult it is to run a business ethically. We have assumed that it is much easier than it is. As a result, our business leaders are typi-cally poorly prepared to do the hard work required so that their companies continu-ally act in an ethical manner. Th e results are predictable: regular scandals, some with tremendous impact on our economy; leg-islatures scrambling to write laws that will prevent future wrongdoing; and increasing public cynicism about business motives. Th e cost of this is unsustainable; we must do bet-ter.

Th e Root of the ProblemWe act as if little specifi c training is neces-sary to lead an ethical business. We assume that whatever morality we have developed as we have grown will be adequate to tackle the ethical problems that arise in business. Th is is a very bad assumption. Th e ethical envi-ronment of business is fundamentally diff er-ent from most other environments. We must recognize this reality if we are really going to improve business ethics.

As we were growing up, it is likely that we learned some version of the Golden Rule: Treat others the way you would like to be treated. Part of learning to do this is to put ourselves in another person’s shoes: “How would you feel if that was done to you?” A great deal of our ethical training is about learning to see other people in their total-ity and complexity as we learn empathy and come to acknowledge everyone’s basic rights as human beings.

Immanuel Kant, a great philosopher, once talked about the diff erence between treating people as a “means” or as an “end.” He was focusing on the diff erence between seeing people only as a vehicle through which we reach a desired goal (someone as a means to our ends) and treating people as “ends in themselves,” recognizing their individual complexity as human beings. Kant saw this

diff erence as critical to living ethically, and it led him to formulate one of his core ethical commands: “Act so that you treat human-ity, whether in your own person or in that of another, always as an end and never as a means only.”

Th at’s a pretty good rule for our personal lives, but in business we cannot avoid treat-ing people as a means to our end goal of building a successful business. It’s the nature of business. We hire people to do specifi c things. We work with others because they have something our business needs. We give these people specifi c labels to describe the limited relationships we have with them: employees, contractors, customers, etc. We may get to know some of them more fully, but our primary relationship is limited in scope. As soon as that person cannot meet our company’s need, we usually fi nd some-one else who can.

How bad are business ethics?

41% of employees surveyed reported seeing ethical misconduct of some kind.

60% of the misconduct they saw involved someone with managerial authority.

Nearly 25% of those observed misdeeds involved senior manag-

ers.

Workers said 26% of the misconduct was ongoing.

Source: 2013 National Business Ethics Survey of the U.S. Workforce, conducted

by the Ethics Resource Center

Addressing the Real Drivers of UnethicalBusiness PracticesBy Frank Sadowski, Gallagher, Flynn & Company

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Th e purchase price allocation (PPA) process is oft en treated as an aft erthought in merg-ers and acquisitions (M&A). Th inking about PPA can help guide a deal to a more pre-dictable conclusion. In the most rewarding deals, a prompt PPA process helps acquirers analyze, from a fi nancial reporting point of view, the primary drivers or intangible val-ues associated with the transactions.

Accounting Standards Codifi cation (ASC) Topic 805 establishes the accounting stan-dards for determining and reporting the assets and liabilities acquired in a business combination for fi nancial reporting pur-poses. ASC 805 requires that “as of the ac-quisition date, the acquirer shall recognize, separately from goodwill, the identifi able intangible assets acquired, the liabilities as-sumed, and any non-controlling interest in the acquiree.” Th e acquirer is required to measure the identifi able assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at their acquisition-date fair values.

“Fair value” is defi ned in ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measure-ment date. Under ASC 805, the fair value of the business interest or assets acquired is determined, and the fair value of the consid-eration paid in the acquisition is allocated to the identifi able tangible and intangible assets acquired at the reporting unit level.

“Getting an early start on PPAs can add value. Incorporating the PPA process into M&A diligence can serve as a ‘sanity check’, forcing a rigorous exploration of what be-sides tangible assets is being purchased.”

Th e purchase price allocation (PPA) process is oft en treated as an aft erthought in mergers and acquisitions (M&A). Th e PPA can help guide a deal to a more predictable conclu-sion. In the most rewarding deals, a prompt PPA process helps acquirers analyze, from a fi nancial reporting point of view, the pri-mary drivers or intangible values associated with the transactions. A well-considered and well-executed PPA process can also prevent the so-called “Day-Two” earnings surprises due to unanticipated dilutive (or accretive) eff ects from larger- (or smaller-) than-an-ticipated accretion, depreciation, and amor-tization expenses of the acquired assets and liabilities.

Th e PPA process oft en is not a priority until aft er a deal has closed. Th e principle driver is the acquisition or the deal. However, for companies that integrate it into their M&A procedures early in the deal and have the help of valuation experts, the PPA process tends to run more smoothly. Early valuation involvement also is likely to produce more consistency between due diligence expecta-tions and post-closing realities.

Managing the process well can help an ac-quiring company understand the fi nancial accounting aspects of the assets and liabili-ties it is acquiring. Good process manage-ment also provides the opportunity for early exposure of the buyer and its auditor to the acquisition’s eff ect on the buyer’s fi nancial statements aft er the deal.

Determining how to express an acquisi-tion’s value in accounting terms might seem academic to deal makers who have studied a purchase inside and out and view the target as an integrated whole. It could be tempting, therefore, to treat the PPA process as an ex-ercise in post-deal rationalization.

Analyze Early and Avoid Earnings SurprisesGautam Anumukonda, CPA, CA (Ind), CVA, MFP, RFS,is a practicing Certifi ed Public Accountant

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How’s your ability to withstand short-term losses? Th is is the question at the core of any discussion of risk tolerance. Some people are able to ride through turbulence in the fi nan-cial markets with a shrug while others suff er headaches. Many investment profession-als recommend that their clients adopt an investment policy statement (IPS) to do so, and to address matters such as long-range goals and desired returns.

What life factors can shape your risk toler-ance? Two come quickly to mind. Th e fi rst factor is your age. Th e second is your time horizon.

As you age, you have fewer years to recoup market losses. So gradually reducing the amount of risk in your portfolio over time has merit. Many fi nancial professionals ad-vocate this, and Wall Street fi rms have even created investments around this premise, commonly featured in employer-sponsored retirement plans.

Your timeline to retirement can also infl u-ence your risk tolerance. If you are sure that you will start tapping into your retirement savings in 2021, your appetite for risk may pale compared to someone whose retire-ment may start at some vague point in the 2030s. Broadly speaking, your time horizon for any fi nancial goal aff ects your risk toler-ance in investing toward it.

Understanding Your Risk ToleranceDo you recognize the major factors that may aff ect it?

Provided by Jim Donohue

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Financial Considerations for 2015Is it time to make a few alterations for the near future?Provided by Jim Donohue

2015 is less than three months away. Fall is the time when investors look for ways to lower their taxes and make some fi nancial changes. Th is is an ideal time to schedule a meeting with a fi nancial, tax or estate plan-ning professional.

How do economists see next year unfolding? Morningstar sees 2.0-2.5% GDP for the U.S. for 2015, with housing, export growth, wage growth, very low interest rates and continu-ing vitality of energy-dependent industries as key support factors. It sees the jobless rate in a 5.4-5.7% range and annualized infl ation running between 1.8-2.0%. Fitch is far more optimistic, envisioning U.S. GDP at 3.1% for 2015 compared to 1.3% for the eurozone and Japan. (Fitch projects China’s economy slow-ing to 6.8% growth next year as India’s GDP improves dramatically to 6.5%.)

Th e Wall Street Journal’s Economic Fore-casting Survey projects America’s GDP at 2.8% for both 2015 and 2016 and sees slight-ly higher infl ation for 2015 than Morning-star (with the CPI rising at an annualized 2.0-2.2%). Th e Journal has the jobless rate at 5.9% by the end of this year and at 5.5% by December 2015.

Th e WSJ numbers roughly correspond to the Federal Reserve’s outlook: the Fed sees 2.6-3.0% growth and 5.4-5.6% unemployment next year. A National Association for Busi-ness Economics (NABE) poll projects 2015 GDP of 2.9% with the jobless rate at 5.6% by next December.

3. Alexandra is a procurement agent at a government agency with authority to inde-pendently approve transactions of $5,000 or less that are not subject to competitive bidding. A project with a projected price of $20,000 has just been approved. Alexan-dra wants to make sure a company owned by her friend is awarded the entire project, as she knows her friend will provide her a kickback for directing the business her way. She manipulates the project procurement documents to divide the contract into fi ve separate contracts worth $4,000 each. She then awards all fi ve of the smaller contracts to her friend’s company. Which of the fol-lowing schemes did Alexandra commit?

a. Bid tailoring.b. Need recognition.c. Bid rotation.d. Bid splitting.

4. Th ree construction contractors that typi-cally take contract work for the city collude to divide the city’s business among them. Contractor A takes contracts for work in the southern part of the city, Contractor B takes the central contracts, and Contractor C takes those in the north. Which of the fol-lowing best describes their scheme?

a. Bid suppression.b. Bid splitting.c. Market division.d. Complementary bidding.

5. Oak Inc. hires Gray Contracting to con-struct a storage building on Oak’s prop-erty. Th e storage building collapses four months aft er completion, and an investiga-tor is assigned to determine the cause. Th e investigator fi nds several problems in the construction project documents, including missing compliance certifi cates, failed in-spection reports, and employee complaints about the quality of the contractor’s materi-als. Given these facts, which of the follow-ing fraud schemes seems most likely to have been perpetrated?

a. Nonconforming goods or services.b. False invoicing via shell companies.c. Unnecessary purchases.d. Change-order abuse.

b. Calculating the ratio of the largest pur-chase to the next-largest purchase by ven-dor.

c. Comparing total write-off and purchase quantities of inventory items by stock num-ber.

d. Analyzing text descriptions for payments made to vendors for keywords such as “con-sulting fee” or “special commission.”

ANSWERS

1. (c) A common, unsophisticated form of vendor fraud involves submitting invoices to a customer more than once for payment. Oft en, the vendor simply issues an invoice with a new invoice number but leaves many other identi-fi ers—such as delivery date and specifi c line items—the same. Th e duplicate invoice might be submitted days, weeks, or months aft er the origi-nal to defl ect suspicion. A simple sorting of in-voices by the invoice amounts is an eff ective fi rst step in identifying possible duplicates. However, to help conceal the scheme, some vendors will change more than the invoice number when they submit duplicates. Th ey might remove or alter line items, tax or freight amounts, or dis-counts, which would aff ect the invoice total. Consequently, these invoices would not show up on a duplicates test by invoice amount, but sort-ing the invoices by delivery or purchase dates can help uncover such schemes.

2. (b) In bid-rigging schemes, competitors in the same market collude to defeat competition or to infl ate the prices of goods and services artifi cial-ly. Some of these schemes involve an agreement that the winning bidder will award subcontracts to losing bidders. Th is allows losing bidders to profi t from the contract in return for their part in the scheme. Other red fl ags of schemes in-volving collusion among contractors include:

• Th e same contractors bid on each project or product.

• Th e winning bid for a contract is unusually high.

• All contractors submit consistently high bids.

• Qualifi ed contractors do not submit bids.

• Fewer competitors than normal submit bids on a project or product.

6. Elm Soft ware Co. has three contracts with a large multinational company. Each contract involves developing a soft ware program for a particular department based on a single proprietary soft ware framework that Elm must create. Elm’s ordinary charge for developing this type of soft ware frame-work is $100,000. Knowing that each of the three contracts is being managed separately by the respective departments, Elm charges the full $100,000 to each department for the framework, in addition to the department-specifi c charges for the resulting soft ware programs, resulting in an extra $200,000 of income for the projects. Which of the following best describes this type of fraud scheme?

a. Need recognition.b. Commingling of contracts.c. Change-order abuse.d. Multiple reimbursements.

7. While reviewing vendor contracts for his employing company, Gregory fi nds a contract with an original price that appears unusually low for the type and amount of work to be performed. He also notes that the project’s requirements documentation lacks the detail he would have expected for the type of project under contract. Looking through the rest of the project documenta-tion, he fi nds numerous change orders that the contractor submitted to “clarify proj-ect requirements,” the result of which is a 200% increase in the project cost. Based on Gregory’s fi ndings, which of the following schemes is most likely occurring?

a. Change-order abuse.b. Duplicate invoices.c. Fictitious bidding.d. Price fi xing.

8. Acme Co.’s hotline received a call claim-ing that Acme’s purchasing manager has been ordering excessive amounts of certain inventory items to receive kickbacks from a vendor. Which of the following tests would be LEAST helpful in verifying the legitima-cy of the tip received?

a. Identifying inventory items for which the quantity purchased is disproportionately high compared with the quantity sold.

What’s Your Fraud IQ? continuedAudit & Accounting • Winter 2014

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• Th ere is a pattern in which the last party to bid repeatedly wins the contract.

• Th ere is evidence that several bids were pre-pared by the same party (e.g., they contain the same mathematical or spelling errors, or are prepared using the same typeface or template).

• Bidders or their employees maintain un-usually close relationships (e.g., competi-tors regularly socialize, hold meetings, or visit each other’s offi ces).

3. (d) Fraud schemes in which an employee con-spires with a vendor to defraud the company can be particularly damaging and especially dif-fi cult to prevent. Bid splitting occurs when an employee breaks a large contract into smaller portions that fall below the bidding threshold to avoid competitive practices. By splitting a contract into several separate contracts, the em-ployee has more opportunities to infl uence the award. Once the contract is split, the employee can award some or all of the component parts to a contractor with whom he or she is conspiring. Identifying unjustifi ed split purchases or a series of purchases that fall under the competitive bid-ding or upper-level review limits can help un-cover a bid-splitting scheme.

4. (c) Market division schemes occur when competitors collude to divide a procuring or-ganization’s contracts into certain areas, such as geographic regions or classes of customers, and refrain from competing—either by not bidding or by submitting overly infl ated bids—in one another’s designated areas. In some market divi-sion schemes, the contractors also submit bids from shell companies to give the appearance of competition and conceal the collusion. Th ese bids from fi ctitious suppliers serve to validate an overpriced quote from the winning contractor. Th e result of these schemes is that the customer loses the benefi t of true competition and pays a higher price than would be obtained through fair bidding under normal economic forces.

5. (a) Schemes involving nonconforming goods or services occur when a vendor or contrac-tor delivers goods or services that do not meet contract specifi cations. Th e vendor does not in-form the purchasing company of the defi ciency and bills the company as if the goods or services were in line with the contract. Unfortunately, these schemes are diffi cult to detect without close inspections or tests by independent subject matter experts because materials substituted or omitted from products are not readily identifi -able. However, several red fl ags are present in

anomaly that merits further investigation. Ad-ditionally, inventory items repeatedly purchased and written off might indicate that a purchasingagent is intentionally overpurchasing the item. Running tests to identify such red fl ags can help determine whether a purchasing kickback scheme might be occurring. However, while ex-amining payment text descriptions for keywords such as “consulting fee” or “special commis-sion” could be helpful in identifying kickback schemes in which a company employee is paying kickbacks, this test would be much less eff ective in identifying schemes in which a company em-ployee is receiving kickbacks.

SCORING

If you answered seven or eight questions cor-rectly, congratulations. Your understanding of the risks of vendor fraud will help you protect your clients or employer from potentially fraud-ulent conduct. Keep up the good work.

If you answered fi ve or six questions correctly, you’re on the right track. Continue to build on your knowledge of the ways dishonest suppliers and contractors defraud other organizations.

If you answered fewer than fi ve questions cor-rectly, you might want to brush up on your anti-fraud knowledge.

Enhancing your understanding of vendor fraud and its red fl ags will help ensure that you have what it takes to keep these schemes from going unnoticed.

Andi McNeal (amcneal@acfe.com) is director of research for the Association of Certifi ed Fraud Examiners.

this situation. When a recently completed proj-ect collapses, inspection failures are noted, certi-fi cations are missing, and tips about poor work quality have been received, investigators should suspect nonconforming goods or services.

6. (b) Commingling of contracts occurs when a contractor bills for the same personnel, fees, or expenses under multiple contracts, resulting in overcharging for goods or services. To protect against this type of scheme, the employee re-sponsible for approving contracts should review contracts prior to their award to ensure that the work to be performed under each contract is not duplicated in other contracts. In addition, the procuring entity should identify any contractors holding more than one contract to determine whether they run concurrently and cover simi-lar items. For any such contracts identifi ed, the contracting employee should closely monitor all billings on these contracts for any potential du-plicate payments.

7. (a) Change orders oft en receive less scrutiny than original bids, making them an eff ective means to fraudulently increase a contract price or to generate funds for kickbacks. In most change-order abuses, a corrupt contractor sub-mits a low bid to win the contract, then uses subsequent change orders to increase the proj-ect price. As a result, the procuring entity loses the advantages of the competitive bidding pro-cess and pays more for the project than initially agreed upon. Such schemes frequently involve collusion between the contractor and personnel from the procuring entity. For example, a dis-honest contractor might collude with contract-ing personnel to underbid competitors and ma-nipulate the change-order process to improperly extend or expand contracts or to avoid rebid-ding; in exchange, the contractor typically pays the procuring employee a kickback from the in-fl ated project profi ts.

8. (d) One type of kickback scheme occurs when a vendor makes an undisclosed payment to a purchasing company employee to obtain extra business from the company. If the sought-aft er business involves the purchase of excess inven-tory, red fl ags of the scheme will exist within the company’s inventory system and purchasing re-cords. For example, inventory items purchased in greater quantities or at greater frequencies than the amount supported by sales can be a warning sign that something is amiss in the purchasing process. Likewise, a vendor that re-ceives a disproportionate number of purchases or disproportionately large purchases compared with other vendors—particularly when there is no obvious advantage to this trend—is another

What’s Your Fraud IQ? continued

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Tax Reform. Comprehensive tax reform has not moved beyond the discussion stage in 2014. In the days aft er the November 4 elections, GOP leaders said that tax reform would be a priority in the new Congress but gave no specifi cs. President Obama said that tax reform could be an area where he and the GOP could cooperate. Th e Presi-dent noted his earlier proposal to pay for a reduc tion in the corporate tax rate by eliminating some unspecifi ed business tax preferences.

IMPACT. Broad tax reform, even if put on a fast-track for passage in 2015 likely will have an eff ective date of 2016 (or even later with phased-in provisions). An exception, however, may be carved out for sooner ac-tion on corporate inversions.

Health Care. Several provisions of the PPPCA could be modifi ed or repealed in the 114th Congress. Th ose being consid-ered for action in the near future include rolling back the 2.3 percent medical device excise tax and the 30-hour rule for treat-ment as a full-time employee for purposes of the employer shared responsibility re-quirement. Th e latter change would espe-cially impact current planning by employ-ers on avoiding liability under the employer mandate.

IRS. Th e IRS operated in FY 2014 at the same rate of funding as FY 2013 and at roughly $850 million below FY 2010 lev els. Th e lame-duck Congress is expected to ap-prove an omnibus spending bill to fund the IRS through the end of FY 2015. Th e GOP-controlled 114th Congress will prepare the IRS budget for FY 2016.

TRADITIONAL YEAR-END STRATEGIESYear-end 2014 presents unique challeng-es. At the same time, traditional year-end

for qualifi ed capital gains and dividends is also unchanged from 2013:20 percent.

STRATEGY. Year-end planning should look to avoiding spikes in income, whether capital gains or other income, which for higher-income taxpayers may push capital gains into either the 39.6 per cent bracket for short-term gains or the 20 percent capital gains bracket for long term gains. Spreading the recognition of certain income between 2014 and 2015 may accomplish this goal.

Net Investment Income (NII) Tax

Since 2013, taxpayers with qualifying in come are liable for the 3.8 percent net investment income (NII) tax. Th e threshold amounts for the NII tax are:

• $250,000 in the case of joint returns or a surviving spouse,• $125,000 in the case of a married tax payer fi ling a separate return, and• $200,000 in any other case.

STRATEGY. All net investment in come should be monitored for exposure to the NII tax. Net investment income is more than simply capital gains and dividends. It also includes income from a business in which the taxpayer is a passive participant. Rental income may also be considered NII unless earned by a real estate professional.

STRATEGY. Taxpayers with potential NII liability should consider keeping income below the $250,000/$125,000/$200,000 thresholds if possible by spreading income out over a number of years or off setting the income with both above-the-line and item-ized deductions.

planning techniques nevertheless remain important both to maximize benefi ts in connection with what’s new and to do so within the usual ebb and fl ow of the tax-payer’s personal economy. Th e following traditional income and deduction accelera-tion techniques and their reciprocal defer-ral strategies should be considered:

Income Deferral/Acceleration:

• Enter into/ Sell installment contracts• Defer/ Receive bonuses before January• Hold/ Sell appreciated assets• Accelerate income to use available carry-forward losses• Hold/ Redeem U.S. Savings Bonds• Accumulate/ Declare special dividend• Postpone/ Complete Roth conversions• Delay/ Accelerate debt forgiveness income• Minimize/Maximize retirement distribu-tions• Delay/ Accelerate billable services• Structure/ Avoid mandatory like-kind ex-change treatment

Deductions and CreditsAcceleration/Deferral

• Bunch itemized deductions into 2014 and take standard deduction in 2015/ re-verse steps• Pay bills in 2014/ postpone payments un-til 2015• Pay last state estimated tax installment in 2014/ delay payment until 2015• Accelerate economic performance/post-pone performance• Watch AGI limitations on deductions/credits• Watch net investment interest restrictions• Match passive activity income and losses

YEAR-END INDIVIDUAL PLANNINGFor individuals, the income tax rates for2014 are unchanged from 2013: 10, 15, 25, 28, 33, 35 and 39.6 percent. Th e top tax rate

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Additional Medicare Tax

Th e Additional Medicare Tax increases the employee share of Medicare tax by an addi-tional 0.9 percent of covered wages in excess of certain threshold amounts. Th e tax also increases Medicare tax on self-employment income by an additional 0.9 percent of self -employment income in excess of the thresh-old amounts. Th e threshold amounts are: $200,000 for single individuals (and heads of household); $250,000 for married cou-ples fi ling a joint return; and $125,000 for married individuals fi ling separate returns.

STRATEGY. Th is is now the second year in which aff ected taxpayers will fi le re turns refl ecting Additional Medicare Tax. Tax-payers who only now realize that they have had insuffi cient income tax withholding may request that their employer(s) take out an additional amount of income tax with-holding, which would be applied against taxes shown on the taxpayer’s individual income tax return, including any Ad-ditional Medicare Tax liability. Taxpayers may also consider making estimated tax payments.

Alternative Minimum Tax

Th e alternative minimum tax (AMT) is now permanently“patched.” Th e patch pro-vides for increased exemption amounts and allows taxpayers to take all of the non-refundable personal credits against regular and AMT liability.

STRATEGY. Even with the permanent patch, taxpayers should continue to review their AMT liability versus regular tax liabil-ity. For some taxpayers, AMT liability and regular tax liability may be roughly equal from year to year. Other taxpayers may fi nd that they have had signifi cant fl uctua-

Aff ordable Care Act

Eff ective January 1, 2014, the PPACA re-quires individuals, unless exempt, to carry minimum essential health insur ance cov-erage for each month or make an individual shared responsibility payment. Individuals liable for a shared responsi bility payment during 2014 will make their payment when they fi le their 2014 returns. Individuals who obtain health insurance coverage through the PPACA Marketplace may be eligible for the Code Sec. 36B premium assistance tax credit to help off set the cost of coverage. 2014 was the fi rst year that the Code Sec. 36B credit was available.

PLANNING NOTE. Taxpayers who elect to receive advance payments of the Code Sec. 36B credit must reconcile on their re-turns the amount forwarded to insurers with the credit they may claim.

Year-End Retirement Strategies

Generally, all types of qualifi ed plans (as well as traditional individual retirement ac counts) must satisfy a required minimum distribution (RMD) in which distribution of an employee’s or IRA owner’s interest in the plan or IRA must begin by the “required beginning date.”

PLANNING NOTE. Two year-end dead-lines should be kept in mind: (1) Th e RMD for any given year is based on the retire-ment account balance on Decem ber 31 of the calendar year immediately before the year of distribution; and (2) Th e RMD for any year generally must take place by De-cember 31 of that year. Th e interplay of these two deadlines will reach increasing importance as baby boomers begin to re-tire, and to do so with fewer pensions and a greater number of retirement account bal-ances to manage.

tions in income or AMT-targeted tax ben-efi ts from year to year and could explore the benefi t from being able to shift some AMT-triggering items from an AMT year to a non-AMT year.

Pease Limitation/PEP

Th e Pease limitation reduces the total amount of a higher-income taxpayer’s oth-erwise allow able itemized deductions by three percent of the amount by which the taxpayer’s adjusted gross income exceeds an applicable threshold. However, the amount of itemized deductions is not reduced by more than 80 percent. Tax payers who fi nd themselves within threshold adjusted gross income amounts that make them subject to the Pease Limitation will also need to plan for the revived personal exemp tion phaseout (PEP).

Individual Tax Extenders

Under current law - the individual extend-ers (as well as the business extenders dis-cussed below) - are unavailable for 2014 and subsequent years, unless extended by Congress. For individuals, they include the state and local sales tax deduction, special mortgage debt forgiveness provisions, tran-sit benefi ts parity, higher education tuition deduction, IRA distributions to charities, and teachers’ classroom expense deduction.

PLANNING NOTE. While some “extend-ers” legislation is eventually expected, the extent of what will be covered remains uncertain at press time. Some temporary individual incentives are available for 2014 and 2015 because they carry diff erent ex-piration dates. Th ey include the American Opportunity Tax Credit (AOTC) and the Lode Sec. 25D residen tial energy effi cient credit.

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In Bobrow, TC Memo. 2014-21, the Tax Court held that a taxpayer could make only one nontaxable rollover contribution within each one-year period regardless of how many IRAs the taxpayer maintained. Th e one-year limitation under Code Sec.408(d)(3)(B) is not specifi c to any single IRA maintained by an individual but in-stead applies to all IRAs maintained by a taxpayer, the court found.

PLANNING NOTE. Th e Bobrow decision aff ects only IRA to IRA rollovers managed by the account holders, and does not limit trustee-to-trustee transfers. For planning purposes, the pre-Bobrow rule will contin-ue to apply to IRA distributions occurring before january 1, 2015.

Estate and Gift Taxes

Th e maximum federal unifi ed estate and gift tax rate is 40 percent with an infl ation-adjust ed $5 million exclusion for gift s made and estates of decedents dying aft er December 31, 2012. Th e gift tax exclusion allows tax payers to give up to an infl ation-adjusted $14,000 to any individual, gift -tax free and without counting the amount of the gift toward the lifetime $5 million ex-clusion, adjusted for infl ation.

PLANNING NOTE. Th e applicable ex-lusion amount, as adjusted for infl a tion, is $5,340,000 for gift s made and estates of decedents dying in 2014 and rises to $5,430,000 in 2015.

PLANNING NOTE. Th ere is no limit on the number of individual donees to whom gift s may be made under the $14,000 exclu-sion. Spouses may “split” their gift s to each donee, eff ectively raising the per donee annual maximum exclusion to $28,000. Spouses may give an unlimited amount of gift s to one another without any gift tax im-posed.

Small Business Stock

A full 100-percent gain exclusion applies to qualifi ed small business stock that is ac-quired aft er September 27, 2010, and before January 1, 2014, and held for more than fi ve years. Under current law, the percentage that is excluded is 50-percent (60-percent for empowerment zone stock) for qualify-ing stock acquired aft er Decem ber 31, 2013.

STRATEGY. Even with the reduced ex-clusion, the provision is a worthwhile strat-egy. Taxpayers should consider making investments before year-end 2014 so that the required fi ve-year holding period be-gins to run. Also to keep in mind is that be-ing even a single day short of the fi ve-year period- mea sured from the acquisition date - eliminates any benefi t, with no proration allowed. Certain exchanges of similar stock before the fi ve year period, how ever, are permitted.

Code Sec. 199 Deduction

Th e Code Sec. 199 deduction allows taxpay-ers to deduct an amount equal to the lesser of a phased-in percentage of taxable income (adjusted gross income for individuals) or qualifi ed production activities income. Th e deduction is calculated as a percentage (generally nine percent under current law, subject to some exceptions) of qualifi ed pro duction activities income.

PLANNING NOTE. Th e Code Sec. 199 deduction is oft en viewed as being under utilized. Taxpayers should not let the com-plexity of the calculations deter po tential savings under the deduction.

YEAR-END BUSINESS PLANNINGBusinesses seeking to maximize tax benefi ts through 2014 year-end tax planning may want to consider three general strategies: (1) Use of traditional timing techniques for income and deductions; (2) Special con-sideration of signifi cant tax incentives that expired at the end of 2013 but may be ex-tended through 2014; and (3) Reaction to certain recent tax developments from IRS and the courts that may present either new opportunities or pitfalls.

Bonus Depreciation

For tax years aft er 2013, bonus deprecia-tion has offi cially expired (except for cer-tain non-commercial aircraft and longer production period property which may be eligible for 50 percent bonus depreciation through 2014).

STRATEGY. Although the possibility of retroactive reinstatement of the bonus-depreciation election should be factored into a year-end strategy, a fi nal decision on making it is not required until a return is fi led. Further, bonus depreciation is not mandatory. Certain taxpayers should con-sider electing out of bonus deprecia tion to spread depreciation deductions more even-ly over future years.

Research Tax Credit

Th e research tax credit also offi cially ex-pired aft er 2013, but it may be retroactively re vived by Congress. Th e research credit may be claimed for increases in business-related qualifi ed research expenditures and for in creases in payments to universities and other qualifi ed organizations for basic research. Th e credit applies to the excess of qualifi ed research expenditures for the tax year over the average annual qualifi ed re-search expendi tures measured over the four preceding years.

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Business Extenders

Business incentives that have offi cially ex-pired aft er 2013, unless revived by Con-gress, include, in addition to bonus de-preciation and the enhanced Code Sec.179 expensing, the Work Opportunity Tax Credit (WOTC), Indian employment credit, special expensing rules for fi lm and television productions, and many other temporary provisions.

Aff ordable Care Act

Eff ective January 1, 2015, the PPACAs em-ployer shared responsibility requirements (“employer mandate”) take eff ect for appli-cable large employers. However, there is a carve-out for mid-size employers for 2015. Some relaxed standards for larger employ-ers also are available in 2015.

PLANNING NOTE. Employers with few-er than 50 full-time employees (in cluding full-time equivalent employees)

are completely exempt from the em-ployer mandate for any year. Employ ers with at least 50 but fewer than 100 full-time employees (including full-time equivalent employees) are exempt from the employer mandate until 2016; and employers with 100 or more full-time employees (including full-time equiva lent employees) are subject to the em ployer mandate starting in 2015, with certain relaxed standards.

Repair Regulations

Final regulations for treating costs related to tangible property (the so-called “repair regulations”) may open signifi cant tax plan-ning opportunities. For acquisitions of tan-gible property, a de minimis safe harbor al-lows taxpayers to deduct certain items. Th e safe harbor applies to items that cost $5,000 or less (per item or invoice) and that are de-ducted on the company’s applicable fi nan-cial statement (AFS) in accordance with a written accounting procedure.

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LIFE CYCLE CHANGES IMPORTANT TO YEAR-END STRATEGIES

In addition to changes in the tax law, year-end tax strategies should also considerpersonal circumstances that changed during 2014 as well as what may change in2015. Th ese Life Cycle events include:

• Change in fi ling status: marriage, divorce, death or head of household changes• Birth of a child• Child no longer young enough for child credit• Child who has outgrown the “kiddie” tax• Casualty losses• Changes in medical expenses• Moving/relocation• College and other tuition expenses• Employment changes• Retirement• Personal Bankruptcy• Large inheritance• Business successes or failures

STRATEGY. Under the $5,000 de mini mis safe harbor in the fi nal regulations, taxpay-ers must have a written policy in place at the beginning of the year that spec ifi es a dollar amount for following book treatment. Th e de minimis safe harbor is an annual elec-tion and not an accounting method, so it can be made and changed every year. Cal-endar-year taxpayers need to have a written policy in place by year end 2014 to qualify for 2015. Th e annual election is made by fi l-ing a statement with the taxpayer’s income tax return.

PLANNING NOTE. Th e de minimis limit is $500 per item or invoice for com-panies without an AFS. A written policy, while not required here, is nevertheless rec-ommended.

Th is is not bad per se, but ethical problems develop when we treat people only as a means to our goals (end). Th is can happen all too easily in a business. In fact, the chal-lenges facing businesses today push compa-nies in this direction. Unless we conscious-ly build corporate cultures, organization structures, and policies that help us see peo-ple in their totality, any business will tend to increasingly treat people as just a means to its goals. When this happens, we all know how it feels. We feel used and manipulated. At this point, individuals and businesses are in a very dangerous ethical place.

Forces Th at Make the Problem WorseAt diff erent times, we all need people to do something for us so that we can accomplish a goal. Th at’s not a problem. Problems de-velop when one person is always a means to someone else’s goal. Th en, when you add common and powerful feelings like greed, fear, and envy, using someone to accom-plish a goal can easily turn into exploita-tion. When any of these feelings take hold, any focus on another individual as a person gets lost. Th at’s why they are so dangerous. And in business, there are always plenty of things that can trigger these feelings.

Leaders Are the Most VulnerableIn a business setting, who is most likely to get into situations where the view of em-ployees is most one-dimensional and these powerful emotions get triggered? Th e busi-ness leader. And the higher your position, the greater the moral risk you face. Becom-ing controlled by these emotions becomes more and more an occupational hazard as authority and responsibility increase.

Preventing unethical behavior is like man-aging a chronic illness. Th e potential for “getting sick” is always there, but you can stay well by carefully and continually doing the right things.

What Is To Be Done?To eff ectively address these challenges, companies need strategies, not platitudes, ongoing eff ort, not one-time pronounce-

ments. Companies need to recognize the continual nature of the challenge, respond to it on many diff erent levels, and actively develop people’s ability to act ethically in new situations. Th is work needs to include the following:

• At the level of corporate structure and culture, companies need to fi rst ask the question: What is our business purpose beyond making money for the owners? To put that question another way, what are the values and ideals that are expected to guide, and sometimes limit, how our company does business? Th en the question to be an-swered is: How consistent with these values are policies and practices related to core is-sues such as compensation and safety?

• At the level of corporate leadership development, we need to encourage leaders to develop a regular mindfulness practice and other actions to help them keep their moral balance.

• We need hard discussions to sort out where healthy motivation ends and greed begins, where reasonable concern ends and fear begins, and where healthy de-sire ends and envy begins.

• Th ere also needs to be situational-ized ethics training that will help people in each part of the company understand how the company’s values are expected to be implemented in their daily work.

We need to be thinking about human beings as much as we think about human resources or human capital.

For More InformationFrank Sadowski is a Partner at Gallagher, Flynn & Company in South Burlington, VT. He specializes in executive recruiting, compensation, and developing programs to improve the ability of companies to act ethically. You can fi nd more information at www.gfc.com and contact him at fsadows-ki@gfc.com. For more about his approach, see http://youtu.be/vqTIoI98yvo.

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However, the PPA can aff ect companies’ earnings. Th e acquired fi xed assets are ad-justed to fair value and depreciated at diff er-ent rates depending on the estimated useful lives of the fi xed assets. With respect to in-tangible assets, distinctions must be made among the separately identifi ed intangible assets. Liabilities need to be adjusted to current market expectations for assuming those liabilities.

Separately identifi ed intangible assets, such as patents, copyrights, and licenses, are amortized at diff erent rates, depending on each asset’s estimated useful life, including an indefi nite life if appropriate, and other circumstances specifi c to the asset. Good-will, on the other hand, is not amortized by public business entities for book purposes but is tested annually for impairment in-stead. (Th ere is an alternative to amortize goodwill available to non-public business entities.) Th erefore, if these separately iden-tifi ed intangible assets are not identifi ed and valued appropriately, the amortization expenses might be overstated or understat-ed. Th is, in turn, can aff ect future earnings, which is an important fi nancial indicator to investors—especially for public compa-nies—for which stock prices are oft en as-sessed by short-term performance indica-tors such as earnings per share.

A proper PPA process benefi ts from a regi-mented structure. Th e foundational fi rst steps are determining the rationale behind the acquisition and studying the consider-ation transferred, including the buyer’s an-ticipated internal rate of return. Th ese steps help an acquirer and its auditor understand, from an accounting perspective, the assets being purchased and liabilities being as-sumed.

Aft er the fair value of the tangible assets is identifi ed, the next step is to identify the in-tangible assets. To do that, it helps to under-stand the transaction’s main driver, which in most cases will serve as the primary income-generating asset. Other intangible assets also need to be identifi ed and valued separately. An assessment of how these in-tangible assets create value and how long these assets are expected to generate value provides the basis for value.

Th ere are clear benefi ts to taking a proac-tive, rigorous approach to the PPA process. Armed with the right expertise and a vig-orous method, an acquiring company can manage the M&A process to include the PPA considerations sooner and avoid any post-deal earnings or other surprises.

Given the varying lives and consumption patterns of tangible and intangible assets, a methodical approach is vital. Depending on the nature of the intangible assets, diff er-ent valuation methods are applied to value those assets.

Because of the inherent complexity of the process, companies new to M&A oft en have an understandable desire to delay a PPA until aft er a deal has been established. However, the process’s importance has led acquirers to incorporate PPAs more fre-quently into earlier-stage diligence eff orts. A benefi t of moving up the work is that it facilitates earlier interaction with the au-ditors and valuation appraisers, thereby inducing buyer, appraiser, and audit teams to be on the same level of understanding and minimizing unnecessary post-deal ac-counting surprises.

Getting an early start on PPAs can add value. Incorporating the PPA process into M&A diligence can serve as a “sanity check,” forc-ing a rigorous exploration of what besides tangible assets is being purchased.

A well-run PPA process that produces a sig-nifi cant allocation to goodwill might also indicate that an acquirer’s internal rate of return is below that of the market partici-pants, which could signify an overpayment. Th erefore the PPA process can help acquir-ers to re-evaluate the assumptions used in determining the consideration transferred. However, if the acquirer expects important synergies that other market participants don’t, then a high level of goodwill might be appropriate.

A prompt PPA process can provide an op-portunity for a closer look at a deal. Oft en based on rules of thumb, valuations that investment bankers and other consultants give during the diligence process frequently lack the specifi city that a PPA requires. In instances where valuations might be con-tested, a PPA can inject authority and clear metrics into the process. In a negotiation environment, the view of an independent party not involved in the deal can be invalu-able.

Analyze Early and Avoid Earnings Surprises continued

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What market factors can shape your risk tolerance? Four stand out. Th e most obvi-ous one is market risk. One common mea-sure of market risk is standard deviation, which tracks the variance of an invest-ment’s return from its mean return during a stated period. Adding and subtracting the standard deviation to a mean return shows the range of returns that may be anticipated 67% of the time. If an investment has a high standard deviation, it means that its returns have varied from the mean to a greater ex-tent than one with a low standard deviation. (You could argue that history means noth-ing with regard to an investment’s future performance, and that argument is legiti-mate – but lacking clairvoyance, we study history.) Across 1926-2012, the S&P 500 had a standard deviation of 19.1%.

Beta weighs volatility versus the S&P 500, NASDAQ or other broad benchmark. Th e benchmark is given a value of 1, and an in-vestment with a beta above 1 would show greater volatility than the benchmark. A 1.1 beta indicates an investment that in theory should move 10% more than the bench-mark does. Th e problem with beta is that some investments have low correlation to the benchmark used.

In ten years, you will actually need $134.39 rather than $130 to buy what you bought a decade back because of compound infl a-tion. Its eff ect is just like compound interest.

Look at retirees with conservative portfo-lios featuring a plethora of fi xed-income investments. In a world where stocks are returning 10% a year or better, their returns have been a fraction of that. In addition to the opportunity cost they are currently pay-ing, they risk struggling economically if the pace of infl ation quickly accelerates.

What kinds of risks do you feel comfort-able assuming? Th is is the big-picture ques-tion, the question for today and tomorrow. A discussion with a fi nancial professional may help you confi dently determine your answer.

“Securities off ered through Securities America Inc. Member FINRA/SIPC. James L. Donohue, Reg-istered Representative, Gallagher Flynn fi nancial Advisors, LLC and is affi liates are not affi liated with Securities America, Inc. Financial advisory services provided through Gallagher, Flynn Fi-nancial Advisors, LLC. Securities America and its Representatives do not provide tax advice. Tax services provided through Gallagher, Flynn & Company, LLP.” “Written by Securities America for distribution by James L. Donohue”.

Th e impact of market risk can be magnifi ed when a portfolio lacks diversifi cation. Hav-ing more eggs in more baskets promotes more insulation against market shocks.

Liquidity risk can emerge signifi cantly, es-pecially as you age. Sometimes retirees will invest in certain fi nancial vehicles and real-ize later (with frustration) that those dollars are “locked up;” they can’t get at that money, the investment is illiquid. If they want their money back, they’ll have to pay a penalty. Taking that kind of risk may be more than they can handle.

Marketability risk is the cousin of liquid-ity risk. It isn’t a measure of liquidity, but of tradability. If you can sell an investment quickly, its marketability risk is lower. If you can’t, its marketability risk is higher. Some people can’t tolerate investments that they can’t get in and out of.

Finally, you have infl ation risk. Th is is the risk of your purchasing power lessening over time. When you invest in such a way that you can’t keep up with infl ation, you lose ground economically. Suppose yearly infl ation increases to 3% soon. Th at means that a year from now, you will need $103 to buy what you bought for $100 a year earlier.

Understanding Your Risk Tolerance continuedInvestment Advisory Services (IAS) • Winter 2014

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What might happen with interest rates? In the Journal’s consensus forecast, the federal funds rate will hit 0.47% by June 2015 and 1.17% by December 2015. NABE’s forecast merely projects it at 0.845% as next year concludes. Th at contrasts with Fed offi cials, who see it in the range of 1.25-1.50% at the end of 2015.

Speaking of interest rates, here is the WSJ consensus projection for the 10-year Trea-sury yield: 3.24% by next June, then 3.58% by the end of 2015. Th e latest WSJ survey also sees U.S. home prices rising 3.3% for 2015 and NYMEX crude at $93.67 a barrel by the end of next year.

Can you put a little more into your IRA or workplace retirement plan? You may put up to $5,500 into a traditional or Roth IRA for 2014 and up to $6,500 if you are 50 or older

54, which lets taxpayers make “split” IRA rollovers of employer-sponsored retirement plan assets under more favorable tax con-ditions. If you have a workplace retirement account with a mix of pre-tax and aft er-tax dollars in it, you can now roll the pre-tax funds into a traditional IRA and the aft er-tax funds into a Roth IRA and have it all count as one distribution rather than two. Also, the IRS is dropping the pro rata tax treatment of such rollover amounts. (Under the old rules, if you were in a qualifi ed re-tirement plan and rolled $80,000 in pre-tax dollars into a traditional IRA and $20,000 in aft er-tax dollars into a Roth IRA, 80% of the dollars going into the Roth would be taxed under the pro-rated formula.) Th e tax liability that previously went with such “split” distributions has been eliminated.

this year, assuming your income levels al-low you to do so. (Or you can spread that maximum contribution across more than one IRA.) Traditional IRA contributions are tax-deductible to varying degrees. Th e con-tribution limit for participants in 401(k), 403(b) and most 457 plans is $17,500 for 2014, with a $5,500 catch-up contribution allowed for those 50 and older. (Th e IRS usually sets next year’s contribution levels for these plans in late October.)

Should you go Roth in 2015? If you have a long time horizon to let your IRA grow, have the funds to pay the tax on the con-version, and want your heirs to inherit tax-free distributions from your IRA, it may be worth it.

Are you thinking about an IRA rollover? You should know about IRS Notice 2014-

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Th e new rules on this take eff ect January 1, but IRS guidance indicates that taxpay-ers may apply the rules to rollovers made as early as September 18, 2014.

Can you harvest portfolio losses before 2015? Th rough tax loss harvesting – dump-ing the losers in your portfolio – you can claim losses equaling any capital gains rec-ognized in a tax year, and you can claim up to $3,000 in additional losses beyond that, which can off set dividend, interest and wage income. If your losses exceed that lim-it, they can be carried over into future years. It is a good idea to do this before December, as that will give you the necessary 30 days to repurchase any shares should you wish.

Should you wait on a major fi nancial move until 2015? Is there a chance that your 2014 taxable income could jump as a conse-quence of exercising a stock option, receiv-ing a bonus at work, or accepting a lump sum payout? Are you thinking about buy-ing new trucks or cars for your company, or a buying a building? Th e same caution ap-plies to capital investments. Look at tax effi ciency in your portfolio. You may want to put income-producing in-vestments inside an IRA, for example, and direct investments with lesser tax implica-tions into brokerage accounts. Finally, do you need to change your with-holding status? If major change has come to your personal or fi nancial life, it might be time. If you have married or divorced, if a family member has passed away, if you are self-employed now or have landed a much higher-salaried job, or if you either pay a lot of tax or get unusually large IRS or state refunds, review your current withholding with your tax preparer.

“Securities off ered through Securities America Inc. Member FINRA/SIPC. James L. Donohue, Reg-istered Representative, Gallagher Flynn fi nancial Advisors, LLC and is affi liates are not affi liated with Securities America, Inc. Financial advisory services provided through Gallagher, Flynn Fi-nancial Advisors, LLC. Securities America and its Representatives do not provide tax advice. Tax services provided through Gallagher, Flynn & Company, LLP.” “Written by Securities America for distribution by James L. Donohue”.

Financial Considerations for 2015 continued

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