As you are already aware, both Silicon Valley Bank and Signature Bank have entered into receivership programs from the federal authorities. Last weekend was a long and daunting one. Companies banking with these institutions were nervous about their unsecured deposits, which were necessary to meet payroll and other basic business functions. The Federal Reserve stepped in, took over the operations of both banks and announced a new program called the Bank Term Funding Program (BTFP) to try and quell the flood of withdrawals from other regional banks. This program allows banks to pledge certain assets that have lost market value due to the dramatic increase in rates as a result of Federal Reserve tightening, which began this time last year.
How much the Fed will be able to cover is still unknown. Should we consider all bank deposits guaranteed, even above the official $250,000 threshold? Will they keep this program for all future bank failures?
Besides the two banks previously mentioned, along with Silvergate – which was shut down earlier last week – there are many other banks in the limelight. Many publicly traded regional banks’ stock prices were down 50% or more on Monday alone – and the market is saying that this is only the start.
The biggest concern is that things are moving extremely fast. Just last week Wednesday, Federal Reserve Chair Jerome Powell testified in front of Congress stating that they aren’t seeing any issues in the banking world from the rate-hiking campaign they have been on over the last year. Since then, three banks with hundreds of billions of dollars of assets had to be bailed out!
So, what does this mean for us now? We believe this is a prudent and opportune time to rethink where and how we hold cash deposits. There are the large, ‘too-big-to-fail’ banks that many consider as safe as some government programs. Then there are the local regional banks that each bring along some benefits. The larger institutions offer safety to your assets, while smaller banks can give you higher yields, certain services and respect that only Fortune 500 companies get at the larger banks. The issue is that typically, these two are mutually exclusive. It’s rare to have safety and liquidity, along with higher interest, at the same institution.
Our wealth management partners at Equinum would like you to consider a third option – U.S. Government treasury bonds held in a brokerage account. Not only does this offer both security and higher yields, but it also offers tax advantages in some cases as well. Government treasures are backed by the full faith and credit of the United States Government. This is an assurance that supersedes the ‘too-big-to-fail’ status of some banks, and is on par with FDIC insurance as it relates to security. On top of this, yields are currently in the 4.5% range for short term treasuries. Obviously, for core banking functions and payroll processing, you will still need to have banking relationships. But for larger balances not needed for day-to-day operations, it’s imperative to consider where these assets are being held.
Keep in mind that there’s a key difference between assets held in a bank account versus those in a brokerage account. When you deposit $1,000,000 in a bank account, the bank takes most of that cash and invests the money into other things – mostly in new loans or existing fixed income investments. Your money is effectively mixed together with all the other bank depositors and invested by the bank. The bank has certain requirements as to what percentage of deposits need to be liquid, but that number is really small – currently just 10%. There are other ratios and stress tests that banks must adhere to, but as we all see with last week’s failings, there are obviously still risks out there.
Contrast this with brokerage accounts: When you hold an asset in your brokerage account, it’s in your name. You own the shares of the companies you invest in and can vote your ownership the way you want. You own the bond and receive the interest payments. Each respective client’s assets are in a segregated account held at the custodian in the client’s name. Even if something were to happen to the custodian, client assets are protected and secure. Even creditors would have no claim on client assets.
Each family and company’s situation varies – there’s no silver bullet to cover all circumstances. This is just something to consider in the current unique situation.
Always feel free to reach out to us or to our partners at Equinum.
This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for, legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
If you reside in a high-tax state, you may want to consider using nongrantor trusts to soften the blow of the $10,000 federal limit on state and local tax (SALT) deductions. The limit can significantly reduce itemized deductions if your state income and property taxes are well over $10,000. A potential strategy for avoiding the limit is to transfer interests in real estate to several nongrantor trusts, each of which enjoys its own $10,000 SALT deduction.
Grantor vs. nongrantor trusts
The main difference between a grantor and nongrantor trust is that a grantor trust is treated as your alter ego for tax purposes, while a nongrantor trust is treated as a separate entity. Traditionally, grantor trusts have been the vehicle of choice for estate planning purposes because the trust’s income is passed through to you, as grantor, and reported on your tax return.
That’s an advantage, because it allows the trust assets to grow tax-free, leaving more for your heirs. By paying the tax, you essentially provide an additional, tax-free gift to your loved ones that’s not limited by your gift tax exemption or annual gift tax exclusion. In addition, because the trust is an extension of you for tax purposes, you have the flexibility to sell property to the trust without triggering taxable gain.
Now that fewer families are subject to gift taxes, grantor trusts enjoy less of an advantage over nongrantor trusts. This creates an opportunity to employ nongrantor trusts to boost income tax deductions.
Nongrantor trusts in action
A nongrantor trust is a discrete legal entity, which files its own tax returns and claims its own deductions. The idea behind the strategy is to divide real estate that’s subject to more than $10,000 in property taxes among several trusts, each of which has its own SALT deduction up to $10,000. Each trust must also generate sufficient income against which to offset the deduction.
Before you attempt this strategy, beware of the multiple trust rule of Internal Revenue Code Section 643(f). That section provides that, under regulations prescribed by the U.S. Treasury Department, multiple trusts may be treated as a single trust if they have “substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries” and a principal purpose of the arrangement is tax avoidance.
Bear in mind that to preserve the benefits of multiple trusts, it’s important to designate a different beneficiary for each trust.
Pass the SALT
If you’re losing valuable tax deductions because of the SALT limit, consider passing those deductions on to one or more nongrantor trusts. Consult with us before taking action, because these trusts must be structured carefully to ensure that they qualify as nongrantor trusts and don’t run afoul of the multiple trust rule.
The end of one year and the beginning of the next is a great opportunity for reflection and planning. You have 12 months to look back on and another 12 ahead to look forward to. Here are five ways to strengthen your business for the new year by doing a little of both:
1. Compare 2019 financial performance to budget. Did you meet the financial goals you set at the beginning of the year? If not, why? Analyze variances between budget and actual results. Then, evaluate what changes you could make to get closer to achieving your objectives in 2020. And if you did meet your goals, identify precisely what you did right and build on those strategies.
2. Create a multiyear capital budget. Look around your offices or facilities at your equipment, software and people. What investments will you need to make to grow your business? Such investments can be both tangible (new equipment and technology) and intangible (employees’ technical and soft skills).
Equipment, software, furniture, vehicles and other types of assets inevitably wear out or become obsolete. You’ll need to regularly maintain, update and replace them. Lay out a long-term plan for doing so; this way, you won’t be caught off guard by a big expense.
3. Assess the competition. Identify your biggest rivals over the past year. Discuss with your partners, managers and advisors what those competitors did to make your life so “interesting.” Also, honestly appraise the quality of what your business sells versus what competitors offer. Are you doing everything you can to meet — or, better yet, exceed — customer expectations? Devise some responsive competitive strategies for the next 12 months.
4. Review insurance coverage. It’s important to stay on top of your property, casualty and liability coverage. Property values or risks may change — or you may add new assets or retire old ones — requiring you to increase or decrease your level of coverage. A fire, natural disaster, accident or out-of-the-blue lawsuit that you’re not fully protected against could devastate your business. Look at the policies you have in place and determine whether you’re adequately protected.
5. Analyze market trends. Recognize the major events and trends in your industry over the past year. Consider areas such as economic drivers or detractors, technology, the regulatory environment and customer demographics. In what direction is your industry heading over the next five or ten years? Anticipating and quickly reacting to trends are the keys to a company’s long-term success.
These are just a few ideas for looking back and ahead to set a successful course forward. We can help you review the past year’s tax, accounting and financial strategies, and implement savvy moves toward a secure and profitable 2020 for your business.
Audited financial statements come with a special bonus: a “management letter” that recommends ways to improve your business. That’s free advice from financial pros who’ve seen hundreds of businesses at their best (and worst) and who know which strategies work (and which don’t). If you haven’t already implemented changes based on last year’s management letter, there’s no time like the present to improve your business operations.
Auditing standards require auditors to communicate in writing about “material weaknesses or significant deficiencies” that are discovered during audit fieldwork.
The AICPA defines material weakness as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.” Likewise, a significant deficiency is defined as “a deficiency, or a combination of deficiencies, in internal control that is … important enough to merit attention by those charged with governance.”
Auditors may unearth less-severe weaknesses and operating inefficiencies during the course of an audit. Reporting these items is optional, but they’re often included in the management letter.
Looking beyond internal controls
Auditors may observe a wide range of issues during audit fieldwork. An obvious example is internal control shortfalls. But other issues covered in a management letter may relate to:
- Cash management,
- Operating workflow,
- Control of production schedules,
- Defects and waste,
- Employee benefits,
- Website management,
- Technology improvements, and
- Energy consumption.
Management letters are usually organized by functional area: production, warehouse, sales and marketing, accounting, human resources, shipping/receiving and so forth. The write-up for each deficiency includes an observation (including a cause, if observed), financial and qualitative impacts, and a recommended course of action.
Striving for continuous improvement
Too often, management letters are filed away with the financial statements — and the same issues are reported in the management letter year after year. But proactive business owners and management recognize the valuable insight contained in these letters and take corrective action soon after they’re received. Contact us to help get the ball rolling before the start of next year’s audit.
Extending credit to business customers can be an effective way to build goodwill and nurture long-term buyers. But if you extend customer credit, it also brings sizable financial risk to your business, as cash flow could grind to a halt if these customers don’t make their payments. Even worse, they could declare bankruptcy and bow out of their obligations entirely.
For this reason, it’s critical to thoroughly research a customer’s creditworthiness before you offer any arrangement. Here are some ways to do so:
Follow up on references. When dealing with vendors and other businesses, trade references are key. As you’re likely aware, these are sources that can describe past payment experiences between a business and a vendor (or other credit user).
Contact the potential customer’s trade references to check the length of time the parties have been working together, the approximate size of the potential customer’s account and its payment record. Of course, a history of late payments is a red flag.
Check banking info. Similarly, you’ll want to follow up on the company’s bank references to determine the balances in its checking and savings accounts, as well as the amount available on its line of credit. Equally important, determine whether the business has violated any of its loan covenants. If so, the bank could withdraw its credit, making it difficult for the company to pay its bills.
Order a credit report. You may want to order a credit report on the business from one of the credit rating agencies, such as Dun & Bradstreet or Experian. Among other information, the reports describe the business’s payment history and tell whether it has filed for bankruptcy or had a lien or judgment against it.
Most credit reports can be had for a nominal amount these days. The more expensive reports, not surprisingly, contain more information. The higher price tag also may allow access to updated information on a company over an extended period.
Explore traditional and social media. After you’ve completed your financial analysis, find out what others are saying — especially if the potential customer could make up a significant portion of your sales. Search for articles in traditional media outlets such as newspapers, magazines and trade publications. Look for anything that may raise concerns, such as stories about lawsuits or plans to shut down a division.
You can also turn to social media and look at the business’s various accounts to see its public “face.” And you might read reviews of the business to see what customers are saying and how the company reacts to inevitable criticisms. Obviously, social media shouldn’t be used as a definitive source for information, but you might find some useful insights.
Although assessing a potential customer’s ability to pay its bills requires some work up front, making informed credit decisions is one key to running a successful company. Our firm can help you with this or other financially critical business practices.