Trends – Roth&Co

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Are you a partner in a business? You may have come across a situation that’s puzzling. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.

Why does this happen? It’s due to the way partnerships and partners are taxed. Unlike C corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his or her share of a partnership’s loss to offset other income.)

Pass through your share

While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.

An information return must be filed by a partnership. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.

Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his or her partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his or her share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.

Illustrative example

Two people each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his or her partnership interest from $50,000 to $10,000.

More rules and limits

The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters. Contact us if you’d like to discuss how a partner is taxed.

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Pay equity is both required by law and a sound business practice. However, providing equitable compensation to employees who perform the same or similar jobs, while accounting for differences in experience and tenure, isn’t easy. That’s why every company should at least consider undertaking a pay equity audit to assess its compensation philosophy and approach.

Legal background

The federal Equal Pay Act requires employers to provide men and women with equal pay for equal work in the same establishment. The jobs don’t need to be identical, but they should be “substantially equal.” Moreover, it’s not job titles, but job content — including skill, effort and responsibility — that determines whether jobs are substantially equal.

Many states have enacted their own equal pay laws, some of which are more stringent than the federal legislation. California, for example, requires employers to pay employees the same wage rates for “substantially similar work,” a larger umbrella than “same or similar jobs.”

Some other countries have also introduced laws around pay equity. The United Kingdom, for instance, requires some public companies to annually disclose the ratio of their chief executive officers’ pay to the lower, median and upper quartile of their employees’ pay.

In addition to helping to prevent legal woes, pay equity can offer bottom-line benefits. A company’s commitment to equitable pay can enhance its employer brand, boost employee morale and performance, and reduce the risk of negative publicity.

An involved process

The purpose of a pay equity audit is to:

Uncover disparities in compensation,
Identify the drivers behind them, and
Develop ways to address the inequities.

Although the process can be quite involved, it’s typically worth the effort.

First, assemble participants from multiple departments — including HR, legal, and finance or accounting — to collect data on employee compensation, job classifications and demographics. This cross section of participants also will help ensure buy-in across the business.

The next step is determining how to group employees. That is, which ones will be considered to have substantially similar roles and, thus, should fall within the same pay range?

Some number crunching will come into play. For smaller employee groups, an analysis of, for example, differences in median pay between groups of employees might be enough to identify any unwarranted disparities. With larger groups, you may have to conduct more rigorous statistical analyses. For example, regression analysis can help control for variables, such as employees’ experience levels, when examining disparities.

Critical component

Over the past year, many workers have made it abundantly clear that they’ll leave a job if any of several employment components isn’t to their liking. Compensation is certainly one of these. Our firm can help support your efforts to conduct a pay equity audit.

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Disclosure of contingent liabilities — such as those associated with pending litigation or government investigations — is a gray area in financial reporting. It’s important to keep investors and lenders informed of risks that may affect a company’s future performance. But companies also want to avoid alarming stakeholders with losses that are unlikely to occur or disclosing their litigation strategies.

Understanding the GAAP requirements

Under Accounting Standards Codification (ASC) Topic 450, Contingencies, a company is required to classify contingent losses under the following categories:

Remote. If a contingent loss is remote, the chances that a loss will occur are slight. No disclosure or accrual is usually required for remote contingencies.

Probable. If a contingent loss is probable, it’s likely to occur and the company must record an accrual on the balance sheet and a loss on the income statement if the amount (or a range of amounts) can be reasonably estimated. Otherwise, the company should disclose the nature of the contingency and explain why the amount can’t be estimated. In general, there should be enough disclosure about a probable contingency so the disclosure’s reader can understand its magnitude.

Reasonably possible. If a contingent loss is reasonably possible, it falls somewhere between remote and probable. Here, the company must disclose it but doesn’t need to record an accrual. The disclosure should include an estimate of the amount (or the range of amounts) of the contingent loss or an explanation of why it can’t be estimated.

Making judgment calls

Determining the appropriate classification for a contingent loss requires judgment. It’s important to consider all scenarios and document your analysis of the classification.

In today’s volatile marketplace, conditions can unexpectedly change. You should re-evaluate contingencies each reporting period to determine whether your previous classification remains appropriate. For example, a remote contingent loss may become probable during the reporting period — or you might have additional information about a reasonably possible or probable contingent loss to be able to report an accrual (or update a previous estimate).

Outside expertise

Ultimately, management decides how to classify contingent liabilities. But external auditors will assess the company’s existing classifications and accruals to determine whether they seem appropriate. They’ll also look out for new contingencies that aren’t yet recorded. During fieldwork, your auditors may ask for supporting documentation and recommend adjustments to estimates and disclosures, if necessary, based on current market conditions. Contact us for more information.

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As a business leader, you have likely run countless meetings. Your meetings might have ranged from a large group of people to a one-on-one. Meetings can be an invaluable way at producing better business decisions or gaining valuable input, but have you ever left a meeting and couldn’t remember anyone besides yourself sharing or contributing ideas?

Some leaders need to be trained to speak up, but many leaders have the opposite problem — they talk too much and monopolize meeting discussions. While it is certainly important to share your point of view in meetings, it is also important to not overshare and suffocate discussion. Monopolizing the conversation can lead to your team members becoming frustrated because they want to share their own ideas. At the same time, your ideas get ignored because stakeholders lose patience and tune you out because they are tired of you dominating meetings.

If you think you may be monopolizing the conversation in meetings, here are some helpful tactics for sharing the floor and helping get your message across.

Measure. After a meeting, take time to reflect on how much you contributed compared to others and try to estimate how much you spoke at the meeting. Did you speak for half the meeting or a quarter? Also, try to remember how often you interrupted or spoke over someone who was trying to contribute? If you have a pattern of talking over others, make a mental note before the meeting to prioritize listening over talking.

Create a Speaking Rule. For routine meetings, creating a rule for yourself can be an effective way at letting others have the floor. For example, wait until at least two other people have shared their input before sharing yours, or limiting yourself to only two minutes every time you speak up. While limiting your speaking time doesn’t have to last forever, trying to follow a speaking rule can help you build the habit of letting others share.

Compress your thoughts. If you have a habit of rambling when verbalizing your ideas, you could come across as scattered and ill-prepared. When speaking, make sure that what you’re saying is necessary and impactful. It is easier said than done but try limiting your thoughts to only a few sentences and make sure your message is cut down to the essential points. Extra words make for a more muddled message, which reduces the impact of your ideas.

Build in pauses. Are you giving your colleagues enough time to digest your comments and to then ask questions? If not, commit to giving deliberate and extended pauses. This straightforward tactic can be one of the most effective ways to encourage input from others. By slowing down and taking deliberate pauses, you’ll be able to regulate your impulse to overshare, while encouraging others to speak up.

Ask for help. Taking an honest and hard look at oneself can be very difficult and many leaders may not even realize that they are oversharing or interrupting others. Consider asking a trusted

colleague or friend to provide insights into how you’re meeting your goal of talking less and listening more. Makes sure to ask someone you trust and who will give you honest feedback, as opposed to someone who will just tell you what you want to hear.

As a business leader your point of view is important, but remember it is not the only point of view out there. By soliciting input from others, you can make better business decisions for you and your business. Try some or all of these tactics to make sure everyone’s input is being heard. We want to make sure you are developing into the best business leader you can be and we are here to help you in any way we can.

Partners May Have to Report More Income on Tax Returns Than They Receive in Cash

Undertaking a Pay Equity Audit at Your Business

Contingent Liabilities: To Report or Not to Report?

Are You Monopolizing Your Meetings?