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Read this if you use QuickBooks Online.

You should be running reports in QuickBooks Online on a weekly—if not daily—basis. Here’s what you need to know.

You can do a lot of your accounting work in QuickBooks Online by generating reports. You can maintain your customer and vendor profiles. Create and send transactions like invoices and sales receipts, and record payments. Enter and pay bills. Create time records and coordinate projects. Track your mileage and, if you have employees, process payroll.

These activities help you document your daily financial workflow. But if you’re not using QuickBooks Online’s reports, you can’t know how individual elements of your business like sales and purchases are doing. And you don’t know how all of those individual pieces fit together to create a comprehensive picture of how your business is performing. 

QuickBooks Online’s reports are plentiful. They’re customizable. They’re easy to create. And they’re critical to your understanding of your company’s financial state. They answer the small questions, like, How many widgets do I need to order?, and the larger, all-encompassing questions like, Will my business make a profit this year?

Getting the lay of the land

Let’s look at how reports are organized in QuickBooks Online. Click Reports in the toolbar. You’ll see they are divided into three areas that you can access by clicking the labeled tabs. Standard refers to the comprehensive list of reports that QuickBooks Online offers, displayed in related groups. Custom reports are reports that you’ve customized and saved so you can use the same format later. And Management reports are very flexible, specialized reports that can be used by company owners and managers.

A partial view of the list of QuickBooks Online’s Standard reports 

Standard reports

The Standard Reports area is where you’ll do most—if not all—of your reporting work. The list of available reports is divided into 10 categories. You’re most likely to spend most of your time in just a few of them, including:

• Favorites. You’ll be able to designate reports that you run often as Favorites and access them here, at the top of the list.
• Who owes you. These are your receivables reports. You’ll come here when you need to know, for example, who is behind on making payments to you, how much individual customers owe you, and what billable charges and time haven’t been billed.
• Sales and customers. What’s selling and what’s not? What have individual customers been buying? Which customers have accumulated billable time?
• What you owe. These are your payables reports. They tell you, for example, which bills you haven’t paid, the total amount of your unpaid bills (grouped by days past due), and your balances with individual vendors.
• Expenses and vendors. What have I purchased (grouped by vendor, product, or class)? What expenses have individual vendors incurred? Do I have any open purchase orders?

The Business Overview contains advanced financial reports that we can run and analyze for you. The same goes for the For my accountant reports. Sales tax, Employees, and Payroll will be important to you if they’re applicable for your company.

Working with individual reports

Each individual report in QuickBooks Online has three related task options.

To open any report, you just click its title. If you want more information before you do that, just hover your cursor over the label. Click the question mark to see a brief description of the report. If you want to make the report a Favorite, click the star so it turns green. And clicking the three vertical dots opens the Customize link. 

When you click the Customize link, a vertical panel slides out from the right, and the actual report is behind it, grayed out. Customization options vary from report to report. Some are quite complex, and others offer fewer options. The Sales by Customer Detail report, for example, provides a number of ways for you to modify the content of your report so it represents exactly the “slice” of data you want. So you can indicate your preferences in areas like:

• Report period
• Accounting method (cash or accrual)
• Rows/columns (you can select which columns should appear and in what order, and group them by Account, Customer, Day, etc.)
• Filter (choose the data group you want represented from several options, including Transaction Type, Product/Service, Payment Method, and Sales Rep)

Once you’ve run the report, you can click Save customization in the upper right corner and complete the fields in the window that opens. Your modification options will then be available when you click Custom reports, so you can run it again anytime with fresh data.

You can customize QuickBooks Online’s reports in a variety of ways.

We’ll go into more depth about report customization in a future article. For now, we encourage you to explore QuickBooks Online’s reports and their modification options so that you’re familiar with them and can put them to use anytime. Contact our Outsourced Accounting team if you have any questions about the site’s reports, or if you need help making your use of QuickBooks Online more effective and productive.

Read this if you are a financial institution.

As you know by now, ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), better known as the CECL standard, has already been implemented for some and will soon be implemented for all others (fiscal years beginning after December 15, 2022 to be exact). During your implementation process, the focus has likely been on your loan portfolio, and rightfully so, as CECL overhauls 40+ years of loan loss reserve practices. But, recall that the CECL standard applies to all financial instruments carried at amortized cost. So, it therefore includes held-to-maturity (HTM) debt securities. And, although not carried at amortized cost, the CECL standard also makes targeted enhancements to available-for-sale (AFS) debt securities. As if re-hauling your entire allowance methodology wasn’t enough! Before tearing out your hair because of another CECL-related change, let’s quickly review what is currently required for securities, and then focus on how this will change when you implement CECL.

Current US GAAP

Under current US generally accepted accounting principles (GAAP), direct write-downs on HTM and AFS debt securities are recorded when (1) a security’s fair value has declined below its amortized cost basis and (2) the impairment is deemed other-than-temporary. This assessment must be completed on an individual debt security basis. Providing a general allowance for unidentified impairment in a portfolio of securities is not appropriate. The previous amortized cost basis less the other-than-temporary impairment (OTTI) recognized in earnings becomes the new amortized cost basis and subsequent recoveries of OTTI may not be directly reversed into interest income. Rather, subsequent recoveries of credit losses must be accreted into interest income.

CECL: Held-to-maturity securities

Then comes along CECL  and changes everything. Once the CECL standard is implemented, expected losses on HTM debt securities will be recorded immediately through an allowance for credit loss (ACL) account, rather than as a direct write-down of the security’s cost basis. These securities should be evaluated for risk of loss over the life of the securities. Another key difference from current GAAP is that securities with similar risk characteristics will need to be assessed for credit losses collectively, or on a pool basis, not on an individual basis as currently prescribed. Also, contrary to current GAAP, since expected losses will be recorded through an ACL account, subsequent improvements in cash flow expectations will be immediately recognized through earnings via a reduction in the ACL account. CECL effectively eliminates the direct write-down method, with write-offs only occurring when the security, or a portion thereof, is deemed to be uncollectible. 

In practice, there may be some types of HTM debt securities that your institution believes have no risk of nonpayment and thus risk of loss is zero. An example may be a US Treasury debt security or possibly a debt security guaranteed by a government-sponsored enterprise, such as Ginnie Mae or Freddie Mac. In these instances, it is acceptable to conclude that no allowance on such securities is necessary. However, such determination should be documented and changes to the credit situation of these securities should be closely monitored.

Financial institutions that have already implemented CECL have appreciated its flexibility; however, just like anything else, there are challenges. One of the biggest questions that has risen is related to complexity, specifically from financial statement users in regards to the macroeconomic assumptions used in models. Another common challenge is comparability to competitors’ models and estimates. Each financial institution will likely have a different methodology when recording expected losses on HTM debt securities due to the judgment involved. These concerns are not unique to the ACL on HTM debt securities but are nonetheless concerns that will need to be addressed. A description of the methodology used to estimate the ACL, as well as a discussion of the factors that influenced management’s current estimate of expected losses must be disclosed in the financial statements. Therefore, management should ensure adequate information is provided to address financial statement users’ concerns.  

CECL: Available-for-sale securities

Upon CECL adoption, you are also expected to implement enhancements to existing practices related to AFS debt securities. Recall that AFS debt securities are recorded at fair value through accumulated other comprehensive income (AOCI). This will not change after adoption of the CECL standard. However, the concept of OTTI will no longer exist. Rather, if an AFS debt security’s fair value is lower than its amortized cost basis, any credit related loss will be recorded through an ACL account, rather than as a direct write-down to the security. This ACL account will be limited to the amount by which fair value is below the amortized cost basis of the security. Credit losses will be determined by comparing the present value of cash flows expected to be collected from the security with its amortized cost basis. Non-credit related changes in fair value will continue to be recorded through an investment contra account and other comprehensive income. So, on the balance sheet, AFS debt securities could have an ACL account and an unrealized gain/loss contra account. The financial institution will be responsible for determining if the decline in the value below amortized cost is the result of credit factors or other macroeconomic factors. In practice, the following flowchart may be helpful:

Although changes to debt securities may not be top of mind when working through CECL implementation, ensuring you reserve time to understand and assess the impact of these changes is important. Depending on the significance and composition of your institution’s debt security portfolio, these changes may have a significant impact on your financial institution’s financial statements from CECL adoption forward. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

Read this if you are at a state Medicaid agency. 

As the end of the Public Health Emergency becomes more likely, much attention has been paid to the looming coverage cliff as state Medicaid agencies re-determine eligibility for their programs. The impacts can be mitigated in part by planning and taking proactive steps.

In the unsettling initial days of the COVID-19 Public Health Emergency (PHE), the Centers for Medicare and Medicaid Service (CMS) temporarily increased federal matching funds for state Medicaid programs. In exchange, states would suspend redeterminations of enrollees’ eligibility for the duration of the PHE. 

For Medicaid, states were in effect prohibited from disenrolling an individual from Medicaid programs. The result, according to CMS data, is 14.8 million more people were enrolled in Medicaid as of late 2021 than before the pandemic, reaching a total of nearly 79 million Medicaid enrollees.  According to one estimate, the end of the PHE could bring a decline in the number of Medicaid enrollees by as many as 15 million. This number includes an estimated 8.7 million adults and 5.9 million children. 

Local and state government eligibility staff will need to review the submitted documents and determine if these members qualify for continued Medicaid coverage. The potential exists for members to lose coverage, due to factors such as having moved, not realizing their circumstances have otherwise changed, or being unable or unaware to return the required paperwork within appropriate timeframes.

State Medicaid agencies strive to maintain an equitable program while remaining trusted stewards of public funds. With a large base of beneficiaries, this change is expected to impact the community and the healthcare market, with broad implications for public health. Similarly, the federal requirement for continuous health coverage has also helped state Medicaid agencies by easing the strain on organizations during pandemic-related disruptions. 

For these reasons state Medicaid agencies may search for routes to limit the loss of coverage. This can be accomplished through finding policy levers to retain members, establishing routes to alternative forms of insurance, and mitigating the risk of coverage loss for members. 

Mitigating the likelihood of becoming uninsured

State Medicaid agencies can reduce the risk that members lose their coverage and become uninsured through a number of steps. 

• Designing comprehensive, multi-pronged, and targeted communication strategies. States can help Medicaid members understand the requirements and timelines required to maintain their coverage.
• Updating systems to automate and reduce administrative burden. Maximizing ex parte renewals through the use of existing data that is stored in integrated systems.
• Making key decisions early. States can minimize coverage loss by carefully planning the unwinding process and their approach to resuming Medicaid eligibility renewals.
• Coordinating with other forms of coverage. Confirm or design user-friendly pathways by which a member is transferred or referred to other alternatives like the Marketplace or CHIP.
• Leveraging their health plans. Particularly when it comes to coordinating outreach and updating member information. Managed care plans are also able to refer members who are losing coverage to other qualified health plans.

Policy levers for retaining members

States may consider reviewing emergency state plan amendments and appendix k amendments completed during the PHE to determine what flexibilities are possible to continue under existing authorities. At the same time, states should consider what other policy options may help retain coverage for existing members- for example:

• Adopt 12 months continuous eligibility. This can be done for children via a State Plan Amendment (SPA), for adults through an 1115 waiver, and for individuals enrolled in BHP (via BHP Blueprint revision) 
• Establish 12 months of postpartum coverage. This can be done through several paths, including SPAs 
• Review operational policy for efficiencies. For example, a State could consider modifying the frequency of periodic data matching 

Next steps

The US Department of Health and Human Service has previously indicated its intention to provide notification to states of the end of the PHE 60 days before its scheduled end. The PHE was renewed in April 2022, and as of this writing will last until mid-July, meaning enrollees could lose Medicaid coverage as soon as August 1. The enhanced FMAP and the Maintenance of Eligibility (MOE) requirements are in place until the end of the quarter in which the PHE ends. In the case of a July 2022 end date to the PHE, the enhanced FMAP would last through September 30, 2022. 

Regardless, Medicaid agencies will need to begin reviewing all enrollees’ eligibility, performing outreach, and designing system updates this summer. In terms of next steps, states should consider the following:

• Evaluate your program and identify initiatives to prioritize in the coming year. Ask your CMS contact about the latest applicable guidance. 
• Develop Advanced Planning Documents (APDs) to help fund technology needs for initiatives, along with training your SMA team and providers. 
• Implement a communications management approach to engage stakeholders, and inform affected Medicaid members.
• Marshal project management resources and develop a realistic and achievable roadmap to success.  
• Explore agency contracting vehicles, cooperative contracts, and other procurements tools. 

We’re here to help. If you have more questions or want to have an in-depth conversation about your specific situation, please contact the Medicaid consulting team.

Read this if you are at a financial institution.

While documentation of your CECL implementation and ongoing practices is essential to a successful outcome, it can sometimes feel like a very tall order when you are building a new methodology from the ground up. It may help to think of your CECL documentation as your methodology blueprint. While others will want to see it, you really need it to ensure that what you are building is well-designed, structurally sound, appropriately supported, and will hold up to subsequent “renovations” (model changes or tweaks). To help you focus on what’s essential, consider these documentation tips:

Getting started

Like any good architect, you need to understand the expectations for your design—what auditors and regulators want to see in your documentation. Two resources that can really help are the AICPA Practice Aid: Allowance for credit losses-audit considerations¹, and the Interagency Supervisory Guidance on Model Risk Management². One way to actively use these guides is to take note of the various section/subject headers and the key points, ideas, and questions highlighted within each, and turn that into your documentation checklist. You’ll also want to think strategically about where to keep the working document, who needs access to it, and how to maintain version control. It is also a good idea to decide up-front how you will reference, catalog, and store the materials (e.g., data files, test results, analyses, committee minutes, presentations, approvals, etc.) that helped you make and capture final decisions. You can download our CECL Documentation checklist now.   

What to watch out for

What’s new under CECL are areas requiring documentation (e.g., broader scope of “financial assets,” prepayments, forecasts, reversion, etc.). But watch out for elements that seem familiar—they may now have a new twist (e.g., segmentation, external data, Q factors, etc.). It’s a good idea to challenge any documentation from the past that you feel could be re-purposed or “rolled into” your CECL documentation. Be prepared also to spend time explaining or customizing vendor-provided documents (e.g., model design and development, data analysis memos, software procedures, etc.). 

While this material can give you a running start, they will not on their own satisfy auditor and regulator expectations. Ultimately, your documentation will need to reflect your own understanding and conclusions: how you considered, challenged, and got comfortable with the vendor’s work; what validations and testing you did over that work, and how you’ve translated this into policies and procedures appropriate for your institution’s operations, workflows, governance, and controls. For more information on making the vendor decision, and for suggestions of vendor selection criteria, read our previous article “CECL Readiness: Vendor or no vendor?” 

Point of view

It is human nature, especially whenever entering new territory, to want to know how others are approaching the task at hand. Related to CECL, networking, joining peer discussion groups, researching what and how those who have already adopted CECL are disclosing, are all great ways to see possibilities, learn, and gain perspective. When it comes to CECL documentation, however, the most important point of view to communicate is that of your institution’s management. Consider the difference in these two documentation approaches: (a) we looked at what others are doing, this is what most of them seem to be doing, so we are too; or (b) this is what we did and why we feel this decision is the best for our portfolio/risk profile; as part of our decision-making process, we did this type of benchmarking and discovered this. Example b is stronger documentation: your point of view is the primary focus, making it clear you reached your own conclusions. 

Other elements for CECL documentation

Documenting your CECL implementation, methodology, and model details is critical, but not the only documentation expected as you transition to CECL. It has been said that CECL is a much more enterprise-wide methodology, meaning that some of the model decisions or inputs may require you use data and assumptions traditionally controlled in other departments and for other purposes. One common example of this is prepayments. Up to this point, prepayment data may have been something between management and a vendor and used for management discussion and planning, but not necessarily validated, tested, or controlled for in the same way as your loss model calculations. Under CECL, this changes specifically because it is now an input into the loss estimate that lands in your financial statements. As a result, prepayments would be subject to, for example, “accuracy and completeness” considerations, among others (for more information on these expectations, refer to our earlier articles on data and segmentation). Prepayments is just one example, but does illustrate how CECL adoption will likely trigger updates to policies, procedures, governance, and controls across multiple areas of the organization.    

One final note: There are some new financial statement disclosures required with CECL adoption. Beyond those, there may be other CECL-related information either you want to share, or your audit/tax firm recommends be disclosed. Consulting with your auditor at least a quarter prior to adoption will help make sure you aren’t scrambling last minute to draft new language or tables.  

Struggling with CECL documentation or other elements of CECL? 

No matter what stage of CECL readiness you are in, we can help you navigate the requirements as efficiently and effectively as possible. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

¹You can find the AICPA Practice Aid here.
²The interagency guidance was released as OCC Bulletin 2011-12, FRB SR 11-7, and as FDIC FIL 22-2017
 

Read this if you use QuickBooks Online.

Are you taking on a worker who’s not an employee? QuickBooks Online includes tools for tracking and paying independent contractors.

The COVID-19 pandemic created millions of self-employed individuals and small businesses. Whether they chose to, or circumstances forced them to, these new entrepreneurs had to learn new ways to get paid and to prepare their income taxes.

If you’re thinking about taking on a contract worker, you, too, will have to educate yourself on the paperwork and processes required to comply with the IRS’ rules for his or her compensation. It’s much easier than hiring a full-time employee, but it still takes some knowledge of how QuickBooks Online handles these individuals.

You’ll also need to make certain that the person you’re hiring is indeed an independent contractor and not an employee. The IRS takes this distinction very seriously. If you’re at all unsure of your new hire’s employment status, we can help you sort it out.

Creating records for contractors

Once new contractors have accepted your offer, you’ll need to have then fill out an IRS Form W-9. You can download a copy here. Employees complete the more detailed Form W-4 so that the employer can withhold income taxes correctly, but you won’t have to withhold taxes for your contract workers. They will be responsible for calculating and paying quarterly estimated taxes and filing an IRS Form 1040 every year. 

You, though, will be responsible for sending them an IRS Form 1099-NEC (Non-Employee Compensation) every January if you paid them more than $600 during the previous year. You do not need to send a 1099-NEC to a corporation or to an LLC that is treated as a C Corp or an S Corp. 

You can complete the Vendor Information window for each independent contractor, checking the box in front of Track payments for 1099.

Using the information the contractors provide, you can create records for them in QuickBooks Online. If you don’t have a QuickBooks Payroll subscription, you can set them up as 1099 vendors. Click the Expenses tab in the toolbar and then on the Vendors tab. Click New vendor in the upper right to open the Vendor Information window. Complete the fields for the worker and be sure to check the box in front of Track payments for 1099, as shown in the partial image above.

The vendor records you create will appear in QuickBooks Online’s Vendors list (again, Expenses | Vendors). Click on one to open it. You can toggle between two tabs here. The first, Transaction List, will eventually display all your financial dealings with that contractor. Vendor Details opens the record you just created, which you can edit from this screen.

Paying contractors

When independent contractors send you invoices, you’ll return to this same screen. There are three ways you can pay them. Click the down arrow next to New Transaction in the upper right corner to see your options (or look down at the end of the row while you’re in list view). You can record the debt as a Bill if you want to pay it later (or if that’s the way you structure your recordkeeping). If you’re paying it right away, you can create an Expense or write a Check. 

You can choose an option from this vendor action menu to pay your independent contractors.

When you click one of these, QuickBooks Online opens a form with many of the contractors’ details already filled in. You’ll need to complete any additional fields at the top of the screen, and then either record the payment or debt under Category details or Item details, depending on how you do your bookkeeping. Either way, you’ll be able to enter the quantity and rate and/or amount and mark it billable (with a markup percentage, if you’d like) to a customer or project.

You’re probably going to want our help here, since there’s more than one way to pay independent contractors. If you subscribe to QuickBooks Payroll, you can use the service’s contractor features, which include the ability to invite your contractors to fill out their own records in QuickBooks Online. You may also want to add an account to your Chart of Accounts, and we’d want to offer guidance there. And you need to ensure that you’re classifying payments correctly, so they’ll appear in 1099 reports and 1099s themselves.

Creating records for independent contractors and paying these individuals seem like they should be simple operations. But anytime you’re dealing with payroll issues, you’re dealing with peoples’ livelihoods – and the IRS. We strongly encourage you to let us help you get this right. Contact the Outsourced Accounting team, and we’ll make sure you’re handling your worker payments with absolute accuracy.

Read this if you invest in research and development. 

Businesses that invest in research and development, particularly those in the technology industry, should be aware of a major change to the tax treatment of research and experimental (R&E) expenses. Under the 2017 Tax Cuts and Jobs Act (TCJA), R&E expenditures incurred or paid for tax years beginning after December 31, 2021, will no longer be immediately deductible for tax purposes. Instead, businesses are now required to capitalize and amortize R&E expenditures over a period of five years for research conducted within the U.S. or 15 years for research conducted in a foreign jurisdiction. The new mandatory capitalization rules also apply to software development costs, regardless of whether the software is developed for sale or license to customers or for internal use.

Tax implications of mandatory capitalization rules

Under the new mandatory capitalization rules, amortization of R&E expenditures begins from the midpoint of the taxable year in which the expenses are paid or incurred, resulting in a negative year one tax and cash flow impact when compared to the previous rules that allowed an immediate deduction.

For example, assume a calendar-year taxpayer incurs $50 million of US R&E expenditures in 2022. Prior to the TCJA amendment, the taxpayer would have immediately deducted all $50 million on its 2022 tax return. Under the new rules, however, the taxpayer will be entitled to deduct amortization expense of $5,000,000 in 2022, calculated by dividing $50 million by five years, and then applying the midpoint convention. The example’s $45 million decrease in year one deductions emphasizes the magnitude of the new rules for companies that invest heavily in technology and/or software development.

The new rules present additional considerations for businesses that invest in R&E, which are discussed below.

Cost/benefit of offshoring R&E activities

As noted above, R&E expenditures incurred for activities performed overseas are subject to an amortization period of 15 years, as opposed to a five-year amortization period for R&E activities carried out in the US. Given the prevalence of outsourcing R&E and software development activities to foreign jurisdictions, taxpayers that currently incur these costs outside the US are likely to experience an even more significant impact from the new rules than their counterparts that conduct R&E activities domestically. Businesses should carefully consider the tax impacts of the longer 15-year recovery period when weighing the cost savings from shifting R&E activities overseas. Further complexities may arise if the entity that is incurring the foreign R&E expenditures is a foreign corporation owned by a US taxpayer, as the new mandatory capitalization rules may also increase the US taxpayer’s Global Intangible Low-taxed Income (GILTI) inclusion.

Identifying and documenting R&E expenditures

Unless repealed or delayed by Congress (see below), the new mandatory amortization rules apply for tax years beginning after December 31, 2021. Taxpayers with R&E activities should begin assessing what actions are necessary to identify qualifying expenditures and to ensure compliance with the new rules. Some taxpayers may be able to leverage from existing financial reporting systems or tracking procedures to identify R&E; for instance, companies may already be identifying certain types of research costs for financial reporting under ASC 730 or calculating qualifying research expenditures for purposes of the research tax credit. Companies that are not currently identifying R&E costs for other purposes may have to undertake a more robust analysis, including performing interviews with operations and financial accounting personnel and developing reasonable allocation methodologies to the extent that a particular expense (e.g., rent) relates to both R&E and non-R&E activities.

Importantly, all taxpayers with R&E expenditures, regardless of industry or size, should gather and retain contemporaneous documentation necessary for the identification and calculation of costs amortized on their tax return. This documentation can play a critical role in sustaining a more favorable tax treatment upon examination by the IRS as well as demonstrating compliance with the tax law during a future M&A due diligence process.

Impact on financial reporting under ASC 740

Taxpayers also need to consider the impact of the mandatory capitalization rules on their tax provisions. In general, the addback of R&E expenditures in situations where the amounts are deducted currently for financial reporting purposes will create a new deferred tax asset. Although the book/tax disparity in the treatment of R&E expenditures is viewed as a temporary difference (the R&E amounts will eventually be deducted for tax purposes), the ancillary effects of the new rules could have other tax impacts, such as on the calculation of GILTI inclusions and Foreign-Derived Intangible Income (FDII) deductions, which ordinarily give rise to permanent differences that increase or decrease a company’s effective tax rate. The U.S. valuation allowance assessment for deferred tax assets could also be impacted due to an increase in taxable income. Further, changes to both GILTI and FDII amounts should be considered in valuation allowance assessments, as such amounts are factors in forecasts of future profitability.

The new mandatory capitalization rules for R&E expenditures and resulting increase in taxable income will likely impact the computation of quarterly estimated tax payments and extension payments owed for the 2022 tax year. Even taxpayers with net operating loss carryforwards should be aware of the tax implications of the new rules, as they may find themselves utilizing more net operating losses (NOLs) than expected in 2022 and future years, or ending up in a taxable position if the deferral of the R&E expenditures is material (or if NOLs are limited under Section 382 or the TCJA). In such instances, companies may find it prudent to examine other tax planning opportunities, such as performing an R&D tax credit study or assessing their eligibility for the FDII deduction, which may help lower their overall tax liability.

Will the new rules be delayed?

The version of the Build Back Better Act that was passed by the US House of Representatives in November 2021 would have delayed the effective date of the TCJA’s mandatory capitalization rules for R&E expenditures until tax years beginning after December 31, 2025. While this specific provision of the House bill enjoyed broad bipartisan support, the BBBA bill did not make it out of the Senate, and recent comments by some members of the Senate have indicated that the BBB bill is unlikely to become law in its latest form. Accordingly, the original effective date contained in the TCJA (i.e., taxable years beginning after December 31, 2021) for the mandatory capitalization of R&E expenditures remains in place.
 
The changes to the tax treatment of R&E expenditures can be complex. While taxpayers and tax practitioners alike remain hopeful that Congress will agree on a bill that allows for uninterrupted immediate deductibility of these expenditures, at least for now, companies must start considering the implications of the new rules as currently enacted. 

The automotive industry is experiencing a convergence of disruptions unlike any seen since 1910. Autonomous, connectivity, electrification, mobility, and subscription business models are reshaping the automotive industry and creating a frenzy of activity.

There are dozens of self-driving car companies, an untold number of connectivity applications, and over 500 mobility related technology and technology-enabled solutions offered by existing companies and start-ups. Additionally, there are subscription models with varying degrees of success, with some original equipment manufacturers (OEMs) terminating programs recently and others recommitting to them, and regarding electric vehicles (EV), there are 17 public EV OEMs and four private EV OEMs. As Harley-Davidson’s recent announcement to take its EV division, LiveWire, indicates there is ample fuel to fund new entrants into this space and capital to accelerate innovation. Where this lands is anyone’s guess but the factors at play do suggest significant uncertainty.

To highlight the disruption occurring within the automotive landscape, two great examples of disrupters entering the market are Tesla and Carvana. These two companies currently have market capitalization that far exceed the traditional dealerships and OEMs. Carvana has a market cap of $31B, exceeding the combined market capitalization of Carmax, AutoNation, and Asbury. Tesla has a market cap of $1T, exceeding the combined market capitalization of Toyota, Volkswagen, GM, and Ford.

An integral part of the industry, dealerships are also seeing significant changes, especially as it pertains to EV, which is the focus of our discussion in the rest of this article.

The market for electric vehicles

The market for EVs resulted from changes in three main areas including regulation, consumer behavior, and technology.

Regulation

Governments and cities have introduced regulations and incentives to accelerate the shift to sustainable mobility. Regulators worldwide are defining more stringent emissions targets. The European Union seeks to align climate, energy, land use, transport, and taxation policies to reduce net greenhouse gas emissions by at least 55% by 2030. The Biden administration introduced a 50% EV target for 2030.

Consumer behavior

Consumer mindsets have also shifted toward sustainable mobility, with more than 45% of consumers considering buying an EV. A recent survey by Cars.com revealed two-thirds of Americans are interested in buying an EV, despite barriers such as higher sticker prices than internal combustion engine (ICE) models and limited access to charging stations. In China, consumer interest is even stronger than in Europe and the US.

Technology

Both the convergence of technological innovations (e.g., autonomous) and battery development have created the path to an emissions free industry.

Are electric vehicles here to stay?

For many years, lack of product availability, unfavorable pricing, limited charging infrastructure and battery range, and consumer demand have held back the widespread adoption of EV. However, the tipping point in passenger EV adoption occurred in the second half of 2020, when EV sales and penetration accelerated in major markets despite the economic crisis caused by the COVID-19 pandemic. Europe spearheaded this development, where EV adoption reached 8% due to policy mandates such as stricter emissions targets for OEMs and generous subsidies for consumers.

On a global level, a recent McKinsey study projects EV adoption will reach 45% by 2030-2035 under current expected regulatory targets, with the major markets reaching these levels on varying timelines. New regulatory targets in the European Union and the United States now aim for an EV share of at least 50% by 2030, and several countries have announced accelerated timelines for ICE sales bans in 2030 or 2035. By 2035, the largest automotive markets will go nearly entirely electric.

• Europe may reach 60% – 75% EV sales by 2030, driven by regulatory targets on the low end and on reported consumer preference on the high end.
• In the US, in Q2 2021, EV sales reached 3.6% of total car sales. The aggressive electrification target for 2030 and US OEMs support of electrification have led to many declaring ICE bans by 2035.

China will also continue to see strong growth in electrification and remain the largest EV market by vehicle volume based on strong consumer demand, despite low EV subsidies and no official end date for ICE sales. Adoption modeling yields a Chinese EV share as much as 70% for new car sales in 2030.

Some OEMs have stated their intentions to stop investing in new ICE platforms and models and many more have already defined a specific date to end ICE vehicle production. There will be 100 EVs offered by over 25 OEMs in the US market by 2024. Many large traditional OEMs are targeting 50%-70% EV in all markets by 2030:

• General Motors announced it will sell only zero-emission vehicles and is aiming to produce only EVs by 2035, with 30 new plug-in models arriving by 2025, a $27 billion investment. GM generated excitement with the recent debut of the GMC Hummer all-electric pickup.
• Ford, which is investing $22 billion in EVs and announced 40% of its vehicles will be electrified by 2030, aims to achieve 100% of new vehicle sales in Europe to be EV. Ford similarly generated excitement with the recent debut of the F-150 Lightning all-electric pickup.
• New Mercedes platforms will be EV only by 2025 and all vehicles will be electric by 2030.

 
Headwinds to transition

While there is strong momentum toward EV transition and bets made by governments and OEMs will only accelerate it, there are significant headwinds which may slow the pace of the transition. Public institutions, businesses, and consumers will need to resolve several issues and overcome some challenges.

Chips

AlixPartners estimates the chip shortage has cost the industry $210B and 7.7 million units in 2021, doubling their forecast in May. And yet, according to Intel CEO, Pat Gelsinger, by 2030 chips will make up 20% of the components of premium cars — five times more than their proportion in 2019. Despite the major announcements of investments in new fab plants in the US and elsewhere, the long development time to bring these operations online begs the question whether this additional capacity will come in time to support the demand for EVs.

Battery prices

The high cost of vehicles based on batteries continues to hold back consumers. As lithium prices soar, reflecting escalating demand and limited sources of production, it’s unclear when battery costs will decline to establish EV vehicle price parity with ICE vehicles. That said, EV motor maintenance is limited to 100,000. While motors and engines last upwards of 20 years, the typical EV battery lasts 200,000 miles — not quite 20 years. Tesla, however, is rumored to be developing an EV battery that will last 1,000,000 miles, which would extend the life of an EV vehicle well beyond the 11.9 years of today’s average vehicle. So, over time, the total cost of ownership of an EV vehicle is likely to decline enough to overcome any consumer resistance due to price.

 Charging infrastructure

The lack of charging infrastructure and limited EV range due to battery life has greatly inhibited EV adoption. The Bipartisan Infrastructure Framework includes $15 billion to speed up adoption of EVs and accelerate the US EV market. The plan sets aside $7.5 billion to construct a nationwide EV charging network. However, according to a report issued in July 2021 by The International Council on Clean Transportation, the total charging units in homes, workplaces, and public stations to support the EV goals set by government and OEMs will require tremendous investments in charging stations, notably in home charging stations, and the electrical grid infrastructure to support demand. It is uncertain whether the required rate of growth in charging stations and grid capacity can be met to support EV goals.

New business models

Another issue on dealers’ minds is direct-to-consumer (D2C) sales, the business model that’s fueled Tesla’s marketing of more than 2,000,000 EVs sold to date. Tesla does operate about 160 company-owned showrooms, yet sales are transacted online. At last count, 33 states allowed D2C auto sales, with others’ legislatures debating bills that would bypass the so-called franchise system that has legally connected dealers and manufacturers for more than a century. National Automobile Dealers Association (NADA), state dealer groups and traditional automakers have advocated maintaining the franchise system, claiming that it levels the playing field.

Impact on after-market spending and margins

One genuine concern for dealerships is the fact that EVs don’t require oil changes, transmission repairs and other services owners of ICE vehicles routinely bear —services that account for 50% of dealerships’ gross profits. ICE vehicles have 2,000 moving parts while EVs have 20. Fewer moving parts require less maintenance and repair and lowers vehicle service contract (VSC) attachment rates. While owners will spend more on EV related parts (e.g., tires), BEV owners will likely spend 40% less on after-market parts and service compared to ICE owners by 2030. A 2019 report from AlixPartners estimates that dealers could see $1,300 less revenue in service and parts over the life of each EV they sell.

While this does not bode well for dealership profitability, the US now has a record 280 million cars, trucks, and SUVs registered with state motor vehicle departments. The average age of vehicles in the US has climbed to an all-time high of 11.9 years. One in four cars and trucks on the road are at least 16 years old. So, despite EV sales trending towards 50%-75% of total sales in the largest markets by 2030, the impact on dealership profitability will not be abrupt. With a significant install base of ICE vehicles with a remaining life that will extend well past 2030 and a continuing high volume of ICE vehicle sales over the next three years, dealerships do have some time to plan. 

Implications and key takeaways for dealers

One thing is clear: Dealerships are operating within an increasingly disrupted environment which has affected the bottom line and created some uncertainty for the future. Over the past several years (with the exception of the COVID-19 pandemic) dealerships have experienced margin compression on vehicle sales. With threats to their services business, margin compression could continue. Higher front-end margins, notably in finance and insurance (F&I), will come under further pressure as EV and battery prices decline.

The good news? Most EV OEMs require factory authorized dealership service departments for repair and maintenance. Further, even though 70% of aftermarket service of ICE vehicles are handled by independent shops, franchise dealers don’t want to cede EVs to them, especially as consumers familiarize themselves with battery charging and other peculiarities. “The EV owner might trust the dealers more to perform service than the aftermarket shops earlier in their ownership period,” according to Chris Sutton, Vice President of automotive retail for market research firm J.D. Power. So, the threat of DIY and independent service centers may be limited in the near term.

For reasons outlined in “The Dealership of Tomorrow 2.0” report, prepared in February 2020 by Glen Turner for NADA, the dealership model of store ownership should remain very dominant in the US through at least 2030, even with the disruption caused by EVs. The trend of the decline in store owners, however, will continue with rooftops per owner increasing from two stores per owner before the Great Recession to three stores per owner by the late 2020s. That’s a 50% increase in stores per owner.

Although the margin compression and scale of the investments to counter the disruptive forces dealerships face are significant and would typically suggest greater consolidation, Glen asserts that economies of scale are probably elusive beyond chains of 50-100 stores. So, there may very well be some leaders who emerge as winners in this transition.

The path forward

Many dealerships are embracing the EV transition. While there are fundamentals to guide dealerships over the coming years, there are many uncertainties and unanswered questions. To address these uncertainties and develop a plan to confidently face the future, dealerships should develop a business strategy, shift their operating model, and build a roadmap for change.

Regarding strategy, the key question centers on the degree of scale necessary to compete and grow profitably. Which portfolio of brands to invest in? How many stores to develop and in which markets? Whether to acquire other dealerships?

In redefining the operating model, dealerships must focus on how to create the best customer experience efficiently and effectively. How to enable this through the optimal digital and omnichannel strategy in collaboration with the OEMs? Should subscription services be offered for bundles of brand and vehicle portfolios and/or maintenance programs? Whether, when, and to what degree to invest in charging infrastructure to reduce electricity costs and/or to create new revenue streams by selling electricity back to the grid or by providing a service to customers? What role does solar play in this approach? How to fully utilize the federal, state, and local incentives? How to design the site plan to accommodate battery quarantines? What risks and costs are associated with onsite EV infrastructure? What insurance coverages are necessary and plans for litigation support may be appropriate? How to comply with OEM service department requirements and ensure the number of required and certified technicians are retained?

Once dealerships have answered these questions, the opportunities will need to be prioritized and organized into a roadmap to guide the transition through 2030 and beyond. For any investments required, a clear and tangible business case should be developed to properly filter out those initiatives which should and shouldn’t be pursued.

Written by Bob Gray. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

Read this if you are a Chief Financial Officer at a financial institution.

The Financial Accounting Standards Board (FASB) issued its second Accounting Standards Update (ASU) of 2022 on March 31, 2022. Seen as a fairly quiet year thus far on the accounting standards issuance front, both ASUs issued so far should catch the attention of financial institutions’ accounting and finance teams. For readers who may have missed it, on March 31, 2022, we wrote about the FASB’s first ASU of 2022: ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. Seen as enhancing the flexibility of hedge accounting, this ASU, among other things, expands on the “last-of-layer” hedging method by allowing multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments.

The most recently issued ASU, ASU No. 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, responds to feedback received during the FASB’s Post-Implementation Review process of ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Commonly known as the “CECL (current expected credit loss) standard,” financial institutions that have not yet adopted ASU No. 2016-13 should be well into their CECL implementation plan. ASU No 2016-13 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. 

The CECL standard is seen as a major disruptor event for financial institutions. I encourage you to check out my colleague Susan Weber’s CECL implementation series (the latest article can be found here) for best practices on a successful CECL implementation.

As soon as you see the acronym “CECL” in an article, especially one in regards to a new accounting standard, you may be already looking to “X” out of your web browser and save whatever horrors this ASU brings for another day. But, the changes that are forthcoming as a result of ASU No. 2022-02 are generally seen as being well received by accounting and finance teams (and likely credit teams as well). 

As its name implies, ASU No. 2022-02 addresses two separate issues: Troubled debt restructurings and vintage disclosures.

Troubled debt restructurings

The ASU eliminates the current troubled debt restructuring accounting guidance within Accounting Standards Codification (ASC) Subtopic 310-40 in its entirety. To help illustrate the impact of the proposed changes, let’s quickly review ASC Subtopic 310-40. ASC Subtopic 310-40, among other things, indicates a troubled debt restructuring should not be accounted for as a new loan because a troubled debt restructuring is part of a creditor’s ongoing effort to recover its investment in the original loan. A loan modification is considered a troubled debt restructuring if made to a borrower experiencing financial difficulty and if the modification grants a concession. Furthermore, all troubled debt restructurings are considered impaired loans. After adoption of the ASU, financial institutions will evaluate whether the modification represents a new loan or a continuation of an existing loan, in accordance with current ASC guidance (ASC 310-20-35-9 through 35-11). 

Current ASC guidance indicates a loan modification shall be treated as a new loan if the terms of the modification are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender. This condition would be met if the new loan’s effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. A modification is considered “more than minor” if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. However, even if the difference is less than 10 percent, the financial institution should evaluate whether the modification is more than minor based on the specific facts and circumstances surrounding the modification.

The ASU also modifies disclosure requirements. Rather than disclosing information on troubled debt restructurings, financial institutions will now be required to disclose information on loan modifications that were in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension (or a combination thereof) made to debtors experiencing financial difficulty. Among other things, ASC 310-10-10-50-42 through 50-44 requires financial institutions to disclose, by class of financing receivable, the types of modifications utilized and certain financial effects of the modification, depending on the type of modification. ASC 310-10-55-12A provides an example of the disclosures required by ASC 310-10-10-50-42 through 50-44. The new disclosures must be made regardless of whether a modification to a debtor experiencing financial difficulty results in a new loan. In part, this section of the ASU is seen as providing structure around some of the types of modification disclosures financial institutions were providing during the coronavirus pandemic. 

Financial institutions have long had internal controls surrounding the determination of troubled debt restructurings given the impact such restructurings can have on the allowance for loan losses and financial statement disclosures. Although internal controls surrounding loan modifications will still need to exist, they will likely need to evolve as a result of ASU No. 2022-02. Furthermore, the data gathered for preparation of financial statement disclosures will also change. However, the data needed to satisfy the new disclosure requirements should be readily available, with possibly minor manipulation required to obtain the information needed under the new disclosure requirements.

Vintage disclosures

The ASU amends ASC 326-20-50-6 to require public business entities to disclose current-period gross writeoffs by year of origination for financing receivables and net investment in leases within the scope of ASC Subtopic 326-20. ASC 326-20-55-79 provides an example of this disclosure.

ASU No. 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years—the same effective date for those who have not yet adopted ASU No. 2016-13. As always, if you have any questions as to how this ASU may impact your financial institution, please reach out to BerryDunn’s Financial Services team or submit a question via our Ask the Advisor feature.
 

Read this if you are a not-for-profit organization.

With springtime upon us, it may be difficult to start thinking about this upcoming fall, but that is exactly what many folks in the nonprofit sector are starting to do. The reason for this? It’s because 2022 brings with it the mid-term election cycle. While technically an off-year election, many congressional and gubernatorial races are being contested, in addition to a myriad of questions that will appear on ballots across the country. It is around this time of year we start to see many questions from clients in the nonprofit sector in the area of political campaign activities, lobbying (both direct and grassroots), and education/advocacy.

This article will discuss the three major types of activities nonprofit organizations may or may not undertake in this arena and will offer guidance to give organizations the vote of confidence they need to not run afoul of the potential pitfalls when it comes to undertaking these activities.

Political campaign activity

Political campaign activities include participating or intervening in any political campaign on behalf of (or in opposition to) any candidate for elective public office, be it at the federal, state, or local level. Examples of such activities include contributions to political campaigns as well as making public statements in favor of or in opposition to any candidate. The IRS explicitly prohibits section 501(c)(3) organizations from conducting political campaign activities, the consequence of doing so being loss of exempt status. However, other types of exempt organizations (such as 501(c)(4) organizations) are allowed to engage in such activities, so long as those activities are not the organization’s primary activity. Only Section 527 organizations may engage in political campaign activities as their primary purpose. 

Direct lobbying

Direct lobbing activities attempt to influence legislation by directly communicating with legislative members regarding specific legislation. Examples of direct lobbying include contacting members of Congress and asking them to vote for or against a specific piece of legislation.

Grassroots lobbying

Grassroots lobbying, on the other hand, attempts to influence legislation by affecting the opinions of the general public and include a call to action. Examples of grassroots lobbying include requesting members of the general public to contact their representatives to urge them to vote for or against specific legislation.  

A quick way to remember the difference:
Political = think “P” for People – advocating for or against a specific candidate 
Lobbying = think “L” for Legislation – advocating for or against a specific bill

Education/advocacy

Organizations may engage in activities designed to educate or advocate for a particular cause so long as it does not take a specific position. For example, telling members of Congress how grants helped constituents would be considered an educational activity. However, attempting to get a member of Congress to vote for or against specific piece of legislation that would affect grant funding would be considered lobbying. Another example would be educating or informing the general public about a specific piece of legislation. Organizations need to be mindful here as taking a specific position one way or the other would lend itself to the activity being deemed to be lobbying, and not merely education of the general public. There is no limit on how much education/advocacy activity a nonprofit organization may conduct.

Why does this matter?

As you can see, there is a very fine line between lobbying and education, so it is important to understand the differences so that an organization conducting educational activities does not inadvertently end up conducting lobbying activities.

Organizations exempt under Code Section 501(c)(3) can conduct only lobbying activities that are not substantial to its overall activities. A 501(c)(3) organization may risk losing its exempt status and may face excise taxes on the lobbying expenditures if it is deemed to be conducting excess lobbying, whereas section 501(c)(4), (c)(5), and (c)(6) organizations may engage in an unlimited amount of lobbying activity.

What is substantial?

Unfortunately, there is no bright line test for determining what is considered substantial versus insubstantial. As an industry standard, many practitioners have taken a position that insubstantial means five percent or less of total expenditures, but that position is not codified and could be challenged by the IRS. 

Section 501(c)(3) organizations that intend to conduct lobbying activities on a regular basis may want to consider making an election under Code Section 501(h). This election is only applicable to 501(c)(3) organizations and provides a defined amount of lobbying activity an organization may conduct without jeopardizing its exempt status or becoming subject to excise tax. The 501(h) election limit is based on total organization expenditures with a maximum allowance of $1 million for “large organizations” (defined as an organization with total expenditures over $17,000,000). 

While the 501(h) election provides some clarity as to how much lobbying activity can be conducted, it may be prohibitive for some organizations whose total expenditures greatly exceed the $17,000,000 threshold. Another item to be aware of is that the lobbying threshold applies to all members of an affiliated group combined, which means the entire group shares the maximum threshold allowed. 

Another option for those engaging in lobbying is to create a separate entity (such as a 501(c)(4) organization) which conducts all lobbying activities, insulating the 501(c)(3) organization from these activities. As previously mentioned, organizations exempt under Code Section 501(c)(4) can conduct an unlimited amount of lobbying activities but can only conduct limited political campaign activities.

What about political campaign activities?

Section 527 organizations, known as political action committees, are exempt organizations dedicated specifically to conducting political campaign activities. If a 501(c)(4), (c)(5), or (c)(6) organization makes a contribution to a 527 organization, it may be required to file a Form 1120-POL and be subject to tax at the corporate tax rate (currently a flat 21%) based on the lesser of the political campaign expenditures or the organization’s net investment income. State income taxes may also be applicable. Section 501(c)(3) organizations may not make contributions to 527 organizations. 

If your organization is considering participation in any of the above activities, we would recommend you reach out to your not-for-profit tax team for additional information. We’re here to help!