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Not the summer of love: IRS universal availability examinations

By:

An experienced Staff Accountant, David is a member of our Financial Services Group and Employee Benefits groups. He provides audit and accounting services to a wide range of clients, including financial institutions, broker-dealers and employee benefit plans. As a Certified Fraud Examiner, he supports BerryDunn's forensic accounting engagements, assisting with the investigation, detection, and prevention of suspected fraudulent activity.

David Stone, CPA, MBA, CFE
06.11.19

The IRS announced plans to conduct examinations of the universal availability requirements for 403(b) plans (Plans) this summer. Noncompliance with these requirements results in operational errors for Plans―ultimately requiring correction. Plan sponsors should review their Plans for proper inclusion and exclusion of employees. Such review can help you avoid costly penalties if the IRS does conduct an examination and uncovers an issue with the Plan’s implementation of universal availability.

Universal availability requires that, if you permit one employee to make elective deferrals into a 403(b) plan, then all other employees must receive the same opportunity. There are a few exceptions to this rule. Plan sponsors may exclude employees who meet one of the following exceptions:

  • Employees who will contribute $200 annually or less
  • Employees eligible to participate in a § 401(k), 457(b), or other 403(b) plan of the same employer
  • Employees who normally work less than 20 hours per week (the equivalent of less than 1,000 hours in a year)
  • Students performing services described in Internal Revenue Code § 3121(b)(10)

Of these exceptions, errors in applying the universal availability requirements are typically found with the less than 20 hours per week exception. Even if an employee works less than 20 hours per week (essentially a part-time employee), if this employee works 1,000 hours or more, you must allow this employee to make elective deferrals into the Plan. Further, you can’t revoke this permission in subsequent years―once the employee meets the 1,000 hour requirement, they are no longer included in the less than 20 hours per week employee class.

We recommend Plan sponsors review their Plan documents to ensure they are appropriately applying elected eligibility provisions. Further, we recommend Plan sponsors annually review an employee census to ensure those exceptions (listed above) remain appropriate for any employees excluded from the Plan. For instance, if you note that an employee worked 1,000 hours during the year, who was being excluded as part of the “less than 20 hours per week” category, you should ensure you notify this employee of their eligibility to participate in the Plan. In addition, you should retain documentation regarding the employee’s deferral election or election to opt out of the Plan. Such practices will help ensure, if your Plan is selected for IRS examination, it passes with no issues.

For more information: https://www.irs.gov/retirement-plans/403b-plan-fix-it-guide-you-didnt-give-all-employees-of-the-organization-the-opportunity-to-make-a-salary-deferral
 

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Editor’s note: Read this if you are a Chief Executive Officer, Chief Financial Officer, Chief Risk Officer, Chief Information Officer, or Controller.

Last month, the Office of the Comptroller of the Currency (OCC) issued its Semiannual Risk Perspective for Fall 2019. The report addresses key issues facing banks and focuses on those that pose threats to their safety and soundness. According to the report:

  • Bank financial performance is strong due to a favorable credit environment and the longest economic expansion in U.S. history.
  • Capital levels have reached historical highs.
  • Return on equity was above its 2006 pre-crisis level for the first time at 12.7%.
  • Net income grew 8.22% from the same period a year ago; however, net interest income grew only 4%, as loan growth is below historical averages and an increasing number of banks are facing a flat or declining net interest margin.
  • There is continued weakness in residential and commercial real estate loan growth.
  • Delinquent and nonperforming loans remain below their long-term averages.


Banks can thrive even with economic uncertainty

While these trends indicate that 2019 was by and large an excellent year, banks cannot afford to be complacent, as 2019 also saw increasing risks to the industry. For instance, in 2019 there was much discussion of the future cessation of the London InterBank Offer Rate (LIBOR). The OCC has indicated it will increase its regulatory oversight regarding the anticipated cessation, to ensure banks assess their exposure to LIBOR and are appropriately planning their transition from the widely used benchmark rate. The Financial Accounting Standards Board (FASB) is also working on a project to address accounting issues that could arise from the transition from LIBOR.

And, although 2019 continued the longest economic expansion in US history, economic uncertainty exists due to, in part, the US-China trade conflict and ongoing Brexit discussions. This economic uncertainty has caused volatility in the interest rate environment. Aside from the yield curve inverting in 2019, banks also saw the Federal Funds target rate increase 25 basis points prior to decreasing 50 basis points. Given the typically asset-sensitive nature of banks’ balance sheets, the current interest rate environment will also put pressure on net interest margins. The current volatility of interest rates has caused the OCC to conclude interest rate risk is currently at heightened levels. 

Net interest income continues to be the most significant driver of net revenues for community banks, comprising nearly 80% of net revenues. With a difficult interest rate environment and lackluster loan growth in residential and commercial real estate, banks may face a difficult path ahead. Banks should tread cautiously, especially if this uncertainty persists. Asset-liability management will need be a significant focus (more than usual) as banks try to position themselves to not only maintain profitability through this uncertainty, but also come out stronger than before. Specifically, if lower rates persist, asset growth will need be a priority over deposit growth to maintain profitability at lower net interest margins. If loan growth continues to wane, this will prove to be difficult.

Innovations to compete with new lending sources

Adding to the list of threats to performance is the increasing amount of alternative financial resources available to borrowers. Banks have traditionally been the only source of credit for borrowers. However, technology has rapidly changed that landscape. Person-to-person (P2P) lending (also known as crowd lending, or social lending), allows people to borrow funds directly from another person, cutting out traditional lending sources (banks). Additionally, blockchain technology, if the hype is accurate, has the potential to eliminate the need of a financial intermediary altogether. 

Banks are adapting to this competition and to customers looking for more convenience and alternative services by offering new, unique services that differentiate themselves from others and provide added value to the customer. Banks have delivered through remote deposit, ATMs, and interactive teller machines (ITMs). Banks will need to continue to adopt innovative services to remain competitive. 

For instance, banks could offer video conferencing services, in which customers could have a live conversation with a bank representative through their smartphone. This convenience would allow a customer to conduct a transaction, such as apply for a loan, from the convenience of their home, while still maintaining human interaction throughout the transaction. Such a service would help banks compete with digital channels offered by non-banks, such as Quicken Loans, which is now the largest mortgage originator in the United States.

Strategies to protect against technological risks

These services all require the use of existing and new technologies, which have caused banks to hold more personally identifiable information (PII) digitally across an increasing number of digital platforms. As noted by the OCC, this digital exposure has created persistent cybersecurity risks for banks. Adopting a robust cybersecurity framework is no longer an option. 

Banks should bring cybersecurity to the forefront of their strategic planning. Any strategic plan must consider cybersecurity implications, as a single disaster can be detrimental to a bank’s reputation. And, given this rapidly changing environment, the cybersecurity conversation must be ongoing through relevant bank committees and the board of directors.

Furthermore, these technological solutions require partnerships with businesses that banks would not traditionally partner with. Financial technology (fintech) companies don’t just pose as a competitor to traditional banks. Many fintech companies are offering their technological solutions to traditional banks. However, outsourcing technological solutions to fintech companies and other businesses does not relieve a bank from performing its own due diligence and ensuring those companies meet the bank’s standards. 

Banks should evaluate potential vendors to ensure they comply with the bank’s vendor management policy. Since environments are constantly changing, this evaluation should be ongoing. Many vendors now provide System and Organization Controls (SOC) reports which detail the control environment at the vendor and involve independent third-party testing of those controls that exist at the vendor. SOC reports can provide a useful starting point for evaluating a vendor’s ongoing compliance with the bank’s vendor management policy. However, it is not a substitute for ongoing communication with a vendor.

There is no doubt 2019 was a successful year for banks. But past performance is not a guarantee of future success. Banks face many challenges, risks, and uncertainties, of which only a few have been outlined above. The current landscape may be challenging but it is also filled with opportunity. Banks should consider expanding their services, adopting new technologies, and partnering with other companies to leverage their strengths. Doing so should help position themselves for an exciting decade ahead.

If you have specific concerns about challenges facing your institution, please contact the team

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Banking and finance: 2020 challenges and what to do to overcome them

LIBOR is leaving—is your financial institution ready to make the most of it?

In July 2017, the UK’s Financial Conduct Authority announced the phasing out of the London Interbank Offered Rate, commonly known as LIBOR, by the end of 20211. With less than two years to go, US federal regulators are urging financial institutions to start assessing their LIBOR exposure and planning their transition. Here we offer some general impacts of the phasing out, some specific actions your institution can take to prepare, and, finally, background on how we got here (see Background at right).

How will the phase-out impact financial institutions?

The Federal Reserve estimates roughly $200 trillion in LIBOR-indexed notional value transactions in the cash and derivatives market2. LIBOR is used to help price a variety of financial services products,  including $3.4 trillion in business loans and $1.3 trillion in consumer loans, as well as derivatives, swaps, and other credit instruments. Even excluding loans and financial instruments set to mature before 2021—estimated by the FDIC at 82% of the above $200 trillion—LIBOR exposure is still significant3.

A financial institution’s ability to lend money is largely dependent on the relative stability of its capital position, or lack thereof. For institutions with a significant amount of LIBOR-indexed assets and liabilities, that means less certainty in expected future cash flows and a less stable capital position, which could prompt institutions to deny loans they might otherwise have approved. A change in expected cash flows could also have several indirect consequences. Criticized assets, assessed for impairment based on their expected future cash flows, could require a specific reserve due to lower present value of expected future cash flows.

The importance of fallback language in loan agreements

Fallback language in loan agreements plays a pivotal role in financial institutions’ ability to manage their LIBOR-related financial results. Most loan agreements include language that provides guidance for determining an alternate reference rate to “fall back” on in the event the loan’s original reference rate is discontinued. However, if this language is non-existent, contains fallbacks that are no longer adequate, or lacks certain key provisions, it can create unexpected issues when it comes time for financial institutions to reprice their LIBOR loans. Here are some examples:

  • Non-existent or inadequate fallbacks
    According to the Alternative Reference Rates Committee, a group of private-market participants convened by the Federal Reserve to help ensure a successful LIBOR transition, "Most contracts referencing LIBOR do not appear to have envisioned a permanent or indefinite cessation of LIBOR and have fallbacks that would not be economically appropriate"4.

    For instance, industry regulators have warned that without updated fallback language, the discontinuation of LIBOR could prompt some variable-rate loans to become fixed-rate2, causing unanticipated changes in interest rate risk for financial institutions. In a declining rate environment, this may prove beneficial as loans at variable rates become fixed. But in a rising rate environment, the resulting shrink in net interest margins would have a direct and adverse impact on the bottom line.

  • No spread adjustment
    Once LIBOR is discontinued, LIBOR-indexed loans will need to be repriced at a new reference rate, which could be well above or below LIBOR. If loan agreements don’t provide for an adjustment of the spread between LIBOR and the new rate, that could prompt unexpected changes in the financial position of both borrowers and lenders3. Take, for instance, a loan made at the Secured Overnight Financing Rate (SOFR), generally considered the likely replacement for USD LIBOR. Since SOFR tends to be lower than three-month LIBOR, a loan agreement using it that does not allow for a spread adjustment would generate lower loan payments for the borrower, which means less interest income for the lender.

    Not allowing for a spread adjustment on reference rates lower than LIBOR could also cause a change in expected prepayments—say, for instance, if borrowers with fixed-rate loans decide to refinance at adjustable rates—which would impact post-CECL allowance calculations like the weighted-average remaining maturity (WARM) method, which uses estimated prepayments as an input.

What can your financial institution do to prepare?

The Federal Reserve and the SEC have urged financial institutions to immediately evaluate their LIBOR exposure and expedite their transition. Though the FDIC has expressed no intent to examine financial institutions for the status of LIBOR planning or critique loans based on use of LIBOR3, Federal Reserve supervisory teams have been including LIBOR transitions in their regular monitoring of large financial institutions5. The SEC has also encouraged companies to provide investors with robust disclosures regarding their LIBOR transition, which may include a notional value of LIBOR exposure2.

Financial institutions should start by analyzing their LIBOR exposure beyond 2021. If you don’t expect significant exposure, further analysis may be unnecessary. However, if you do expect significant future LIBOR exposure, your institution should conduct stress testing using LIBOR as an isolated variable by running hypothetical transition scenarios and assessing the potential financial impact.

Closely examine and assess fallback language in loan agreements. For existing loan agreements, you may need to make amendments, which could require consent from counterparties2. For new loan agreements maturing beyond 2021, lenders should consider selecting an alternate reference rate. New contract language for financial instruments and residential mortgages is currently being drafted by the International Securities Dealers Association and the Federal Housing Finance Authority, respectively3—both of which may prove helpful in updating loan agreements.

Lenders should also consider their underwriting policies. Loan underwriters will need to adjust the spread on new loans to accurately reflect the price of risk, because volatility and market tendencies of alternate loan reference rates may not mirror LIBOR’s. What’s more, SOFR lacks abundant historical data for use in analyzing volatility and market tendencies, making accurate loan pricing more difficult.

Conclusion: Start assessing your LIBOR risk soon

The cessation of LIBOR brings challenges and opportunities that will require in-depth analysis and making difficult decisions. Financial institutions and consumers should heed the advice of regulators and start assessing their LIBOR risk now. Those that do will not only be better prepared―but also better positioned―to capitalize on the opportunities it presents.

Need help assessing your LIBOR risk and preparing to transition? Contact BerryDunn’s financial services specialists.

1 https://www.washingtonpost.com/business/2017/07/27/acdd411c-72bc-11e7-8c17-533c52b2f014_story.html?utm_term=.856137e72385
2 Thomson Reuters Checkpoint Newsstand April 10, 2019
3 https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin18/si-winter-2018.pdf
4 https://bankingjournal.aba.com/2019/04/libor-transition-panel-recommends-fallback-language-for-key-instruments/
5 https://www.reuters.com/article/us-usa-fed-libor/fed-urges-u-s-financial-industry-to-accelerate-libor-transition-idUSKCN1RM25T

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When one loan rate closes, another opens

In auditing, the concept of professional skepticism is ubiquitous. Just as a Jedi in Star Wars is constantly trying to hone his understanding of the “force”, an auditor is constantly crafting his or her ability to apply professional skepticism. It is professional skepticism that provides the foundation for decision-making when conducting an attestation engagement.

A brief definition

The professional standards define professional skepticism as “an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence.” Given this definition, one quickly realizes that professional skepticism can’t be easily measured. Nor is it something that is cultivated overnight. It is a skill developed over time and a skill that auditors should constantly build and refine.

Recently, the extent to which professional skepticism is being employed has gained a lot of criticism. Specifically, regulatory bodies argue that auditors are not skeptical enough in carrying out their duties. However, as noted in the white paper titled Scepticism: The Practitioners’ Take, published by the Institute of Chartered Accountants in England and Wales, simply asking for more skepticism is not a practical solution to this issue, nor is it necessarily always desirable. There is an inevitable tug of war between professional skepticism and audit efficiency. The more skeptical the auditor, typically, the more time it takes to complete the audit.

Why does it matter? Audit quality.

First and foremost, how your auditor applies professional skepticism to your audit directly impacts the quality of their service. Applying an appropriate level of professional skepticism enhances the likelihood the auditor will understand your industry, lines of business, business processes, and any nuances that make your company different from others, as it naturally causes the auditor to ask questions that may otherwise go unasked.

These questions not only help the auditor appropriately apply professional standards, but also help the auditor gain a deeper understanding of your business. This will enable the auditor to provide insights and value-added services an auditor who doesn’t apply the right degree of skepticism may never identify.

Therefore, as the white paper notes, audit committees, management, and investors should be asking “How hard do our auditors get pushed on fees, and what effect does that have on the quality of the audit?” If your auditor is overly concerned with completing the audit within a fixed time budget, professional skepticism and, ultimately, the quality of the audit, may suffer.

Applying skepticism internally

By its definition, professional skepticism is a concept that specifically applies to auditors, and is not on point when it comes to other audit stakeholders. This is because the definition implies that the individual applying professional skepticism is independent from the information he or she is analyzing. Other audit stakeholders, such as members of management or the board of directors, are naturally advocates for the organizations they manage and direct and therefore can’t be considered independent, whereas an auditor is required to remain independent.

However, rather than audit stakeholders applying professional skepticism as such, these other stakeholders should apply an impartial and diligent mindset to their work and the information they review. This allows the audit stakeholder to remain an advocate for his or her organization, while applying critical skills similar to those applied in the exercise of professional skepticism. This nuanced distinction is necessary to maintain the limited scope to which the definition of professional skepticism applies: the auditor.

Specific to the financial statement reporting function, these stakeholders should be assessing the financial statements and ask questions that can help prevent or detect flaws in the financial reporting process. For example, when considering significant estimates, management should ask: are we considering all relevant information? Are our estimates unbiased? Are there alternative accounting treatments we haven’t considered? Can we justify our selected accounting treatment? Essentially, management should start by asking itself: what questions would we expect our auditor to ask us?

It is also important to be critical of your own work, and never become complacent. This may be the most difficult type of skepticism to apply, as most of us do not like to have our work criticized. However, critically reviewing one’s own work, essentially as an informal first level of review, will allow you to take a step back and consider it from a different vantage point, which may in turn help detect errors otherwise left unnoticed. Essentially, you should both consider evidence that supports the initial conclusion and evidence that may be contradictory to that conclusion.

The discussion in auditing circles about professional skepticism and how to appropriately apply it continues. It is a challenging notion that’s difficult to adequately articulate. Although it receives a lot of attention in the audit profession, it is a concept that, slightly altered, can be of value to other audit stakeholders. Doing so will help you create a stronger relationship with your auditor and, ultimately, improve the quality of the financial reporting process—and resulting outcome.

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Professional skepticism and why it matters to audit stakeholders

Read this if your company would like to request an advance payment of the tax credits.

In response to the paid sick and family medical leave credit provisions enacted by the Families First Coronavirus Response Act (FFCRA) and the employee retention credit enacted by the CARES Act, the IRS has issued Form 7200 to request an advance payment of the tax credits.

Who may file Form 7200?

Employers that file Form(s) 941, 943, 944, or CT-1 may file Form 7200 to request an advance payment of the tax credit for qualified sick and family leave wages and the employee retention credit.

Eligible employers who pay qualified sick and family leave wages or qualified wages eligible for the employee retention credit should retain the amounts qualified for either credit rather than depositing these amounts with the IRS.

With respect to the sick and family leave payments, the credit includes amounts paid for qualified sick and family leave wages, related health plan expenses, and the employer’s share of the Medicare taxes on the qualified wages.

With respect to the employee retention credit, the credit equals 50% of the qualified wages, including certain health plan expense allocable to the wages, and may not exceed $5,000 per qualifying employee. Of note:

  • Employment taxes available for the credits include withheld federal income tax, the employee's share of Social Security and Medicare taxes, and the employer's share of Social Security and Medicare taxes with respect to all employees.
  • If there aren’t sufficient employment taxes to cover the cost of qualified sick and family leave wages (plus the qualified health expenses and the employer share of Medicare tax on the qualified leave wages) and the employee retention credit, employers can file Form 7200 to request an advance payment from the IRS.
  • The IRS instructs employers not to reduce their deposits and request advance credit payments for the same expected credit. Rather, an employer will need to reconcile any advance credit payments and reduced deposits on its applicable employment tax return.

Examples

If an employer is entitled to a credit of $5,000 for qualified sick leave, certain related health plan expenses, and the employer’s share of Medicare tax on the leave wages and is otherwise required to deposit $8,000 in employment taxes, the employer could reduce its federal employment tax deposits by $5,000. The employer would only be required to deposit the remaining $3,000 on its next regular deposit date.

If an employer is entitled to an employee retention credit of $10,000 and was required to deposit $8,000 in employment taxes, the employer could retain the entire $8,000 of taxes as a portion of the refundable tax credit it is entitled to and file a request for an advance payment for the remaining $2,000 using Form 7200.

When to file

Form 7200 can be filed at any time before the end of the month following the quarter in which qualified wages were paid, and may be filed several times during each quarter, if needed. The form cannot be filed after an employer has filed its last employment tax return for 2020.

Please note that Form 7200 cannot be corrected. Any error made on Form 7200 will be corrected when the employer files its employment tax form.

How to file

Fax Form 7200, which you can access here, to 855-248-0552. Form 7200 instructions.

If you need more information, or have any questions, please contact a BerryDunn tax professional. We’re here to help.

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IRS releases Form 7200: Advance payment of employer credits due to COVID-19

Read this if your company is seeking assistance under the PPP. This information is current as of March 31, 2020.

The Treasury Department is encouraging people to apply ASAP because there is a funding cap.

The Treasury Department issued guidance on March 31, 2020, that alters some of the assumptions around PPP:

  1. At least 75% of the forgiven amount should be used for payroll (changed due to anticipated high demand for program)
  2. Repayment of non-forgiven amounts are now repaid over 2 years at 0.5% interest (not 10 years and 4% as in the CARES Act)

Although the “covered period” is February 15, 2020 to June 30, 2020, forgiveness of the loan is based on expenses (primarily payroll) during the eight-week period after the loan is received.

Important to note:

  1. Questions around 500 employees

    We don’t know for certain how the 500 employees are counted. Other SBA programs use average headcount over the prior 12-month periods. Some companies are proceeding on that assumption. We are awaiting additional guidance from the SBA for confirmation.

    Certain industries have an expanded headcount. The list can be found on SBA websites and BerryDunn has a lookup tool to help.

    If you don’t know, please reach out to us. We’re here to help.
  2. The CARES Act states that loans taken from January 31, 2020, until “covered loans are made available may be refinanced as part of a covered loan.”
  3. People may want to tap into available credit now. If they are granted a covered loan (PPP loan), they can refinance. Given anticipated demand, it may take time to get the PPP loan processed.
  4. Participation in PPP (Section 1102 and 1106 of the CARES Act) precludes participation in the Employee Retention Credit (Section 2301) Payment of Employer Payroll Taxes (Section 2302)

While we think it will generally be more favorable to participate in PPP (Section 1102 and 1106) than ERC (Section 2301), it would be wise to run some numbers and validate the assumption.

Economic Injury Disaster Loans (EIDL)

EIDLs are available through the SBA and were expanded under section 1110 of the CARES Act. Eligible are businesses with 500 or fewer employees, including ESOPs, cooperatives, and others. Up to $2 million per loan. Up to 30 years to repay. Comes with an emergency advance (available within 3 days) of $10,000 that does not have to be repaid – even if your loan application is turned down. This $10,000 does not impact participation in other programs/sections of the CARES Act. Some portion of the EIDL may reduce your loan forgiveness under PPP, but receiving an EIDL does not preclude you from participating in the PPP.

From Treasury.gov: Small business PPP 

The Paycheck Protection Program provides small businesses with funds to pay up to 8 weeks of payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and utilities.

Fully forgiven

Funds are provided in the form of loans that will be fully forgiven when used for payroll costs, interest on mortgages, rent, and utilities (due to likely high subscription, at least 75% of the forgiven amount must have been used for payroll). Loan payments will also be deferred for six months. No collateral or personal guarantees are required. Neither the government nor lenders will charge small businesses any fees.

Must keep employees on the payroll—or rehire quickly

Forgiveness is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Forgiveness will be reduced if full-time headcount declines, or if salaries and wages decrease.

All small businesses eligible

Small businesses with 500 or fewer employees—including nonprofits, veterans organizations, tribal concerns, self-employed individuals, sole proprietorships, and independent contractors— are eligible. Businesses with more than 500 employees are eligible in certain industries.

When to apply

Starting April 3, 2020, small businesses and sole proprietorships can apply. Starting April 10, 2020, independent contractors and self-employed individuals can apply.

How to apply

You can apply through any existing SBA 7(a) lender or any federally insured depository institution, federally insured credit union, or Farm Credit System institution that is participating. Other regulated lenders will be available to make these loans once they are approved and enrolled in the program. You should consult with your local lender as to whether it is participating. All loans will have the same terms regardless of lender or borrower. Find a list of participating lenders and additional information and full terms at sba.gov.

The Paycheck Protection Program is implemented by the Small Business Administration with support from the Department of the Treasury. Lenders should also visit sba.gov or coronavirus.gov for more information.

BerryDunn COVID-19 resources

We’re here to help. If you have questions about the PPP, contact a BerryDunn professional.

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Funding for the Paycheck Protection Program (PPP) starts Friday, April 3

Focus: Disaster Loan Program and Paycheck Protection Program (PPP)

Background

The Coronavirus Aid, Relief and Economic Security (CARES) Act will provide $562 million to cover administrative expenses and program subsidy for the US Small Business Administration (SBA) Economic Injury Disaster Loans and small business programs. 

Additionally, the CARES Act specifically provides the authorization for $349 billion for the SBA 7(a) program through December 31, 2020. 

SBA disaster loan program (updated for CARES Act) highlights


General
The US Small Business Administration is offering designated states and territories low-interest federal disaster loans for working capital to small businesses suffering substantial economic injury as a result of the coronavirus and COVID-19.

Eligibility 
Industry may be subject to different standards, but the general rule of thumb is that the SBA defines most small businesses as having less than 500 people, both calculated on a standalone basis and together with its affiliates (see PPP below for more information). A company’s average annual sales may also be used for the small business designation. 

Historically, businesses that are not eligible for this program included casinos, charitable organizations, religious organizations, agricultural enterprises and real estate developers that are primarily involved in subdividing real property into lots and developing it for resale for themselves (other real estate entities may apply, such as landlords). 

However, the CARES Act expanded eligibility to include (i) any individual operating as a sole proprietor or independent contractor; (ii) private non-profits and (iii) Tribal businesses, cooperatives and ESOPs with fewer than 500 employees during January 31, 2020 to December 31, 2020.

If the entity has bad credit or has defaulted on a prior SBA loan, the entity is not eligible. The CARES Act removed the credit elsewhere requirement (i.e., previously if the business had credit available through another source, such as a line of credit, it was ineligible). 

Basic terms

  • Loan amount
    The lesser of $2 million or an amount determined that that borrower can repay (i.e., underwriting requirement).
  • Maximum term
    Up to 30 years and all payments on these loans will be deferred for 12 months from disbursement date. Interest will accrue.
  • Interest rate
    3.75% for for-profit business and 2.75% for a non-profit entity.
  • Collateral
    Loans for under $25,000 do not require collateral.  Any person with an interest in the company worth 20% or more must be a guarantor; however the CARES Act eliminates the guaranty requirement on advances and loans under $200,000. 
  • Use of proceeds
    Loan proceeds may be used to pay fixed debts (including short-term notes and balloon payments that are due within the next 12 months), payroll, accounts payable, and other bills the borrower would have to pay that but for the disaster would have been paid, such as mortgage payments. Landlords and other passive entities are eligible. Agriculture-related entities are eligible, but farmers are not. Borrowers must maintain proof of how the loan proceeds were used for three years from the date of disbursement. Borrowers cannot use the proceeds to expand their business, buy assets, make repairs to real estate or refinance long-term debt. 
  • Forgiveness
    No forgiveness provision.

Applying
Loan applications are available here

Length of time for funding
Upon submittal of a completed application, it can take 18-21 days to be approved and another four to five business days for funding. However, the SBA has never dealt with this much volume so expect delays.  

If funding is needed immediately, contact any SBA partnering non-profit lender and request an SBA microloan up to $50,000 or contact a commercial lending partner to see if they offer SBA express loans up to $1,000,000 (CARES Act increases this from $350,000 to $1,000,000) and/or SBA 7(a) loans up to $5 million. The 7(a) loans are typically processed within 30 days, while microloans and express loans are processed even more quickly. 

The CARES Act has also established an emergency grant to allow eligible entities who have applied for a disaster loan because of COVID-19 to request an advance of up to $10,000 on that loan. The SBA is to distribute the advance within three days. 

This advance does not need to be repaid, even if the applicant is denied a Disaster Loan. ($10,000,000,000 is appropriated for this program and funds will be distributed on a first come, first served basis). An applicant must self-certify that it is an eligible entity prior to receiving such an advance. Advances may be used for providing sick leave to employees, maintaining payroll, meeting increased costs to obtain materials, rent or mortgage payments, and payment of business obligations that cannot be paid due to loss of revenues. Applicants must apply directly with the SBA for this program.

Other considerations
Each company should review any current loan obligations and confirm that it does not include a provision forbidding that applicant from acquiring additional debt. If the document does, the applicant will want to discuss a waiver of that provision with its current lender. The lender should be amenable to this waiver and the applicant will want the waiver verified in writing. The lender should be amenable because the SBA disaster loan can be used to satisfy monthly debt obligations and any collateral taken by the SBA would be subordinate, if the same collateral secures the lender’s loan.

Under the CARES Act, Congress has also directed the SBA to use funds to make principal and interest payments, along with associated fees that may be owed on an existing SBA 7(a), 504 or micro-loan program covered loan, for a period of six months from the next payment due date. Any loan that may currently be on deferment will receive the six months of covered payments once the deferral period has ended. This provision will also cover loans that are made up to six months after the enactment of the CARES Act. If the loan maturity date conflicts with benefiting from this amendment, the lender can extend the maturity date of the loan. 

Newly enacted Paycheck Protection Program (PPP)


General
This new program will be offered with a 100% SBA guaranty through December 31, 2020, to lenders, after which the guaranty percentage will return to 75% for loans above $150,000 and 85% for loans below that amount. 

Eligibility 
A business, including a qualifying nonprofit organization, that was in operation on February 15, 2020, and either had employees for whom it paid salaries and payroll taxes or paid independent contractors, is eligible for PPP loans if it (a) meets the applicable North American Industry Classification System (NAICS) Code-based size standard or other applicable 7(a) loan size standard, both alone and together with its affiliates; or (b) has an employee headcount that is lower than the greater of (i) 500 employees or (ii) the employee size standard, if any, under the applicable NAICS Code. 

Businesses that fall within NAICS Code 72, which applies to accommodations and food services, are also eligible if they employ no more than 500 people per physical location. Sole proprietorships, independent contractors, and self-employed individuals are also eligible. It is unclear as of what date the size test will be applied, but historically, SBA size tests have been applied on the date of application for financing. More information on the NAICS-Code-based size standards can be found here

Borrowers are required to provide a good faith certification that the loan is necessary due to economic conditions brought about because of COVID-19 and that the borrower will use the funds to retain workers, maintain payroll and pay utilities, lease and/or mortgage payments.

The credit elsewhere test is waived under this program. 

Lenders shall base their underwriting on whether a business was operational on February 15, 2020, and had employees for whom it was responsible for or paid for services from an independent contractor. The legislation has directed lenders not to base their determinations on repayment ability at the present time because of the effects of COVID-19.

Applicants for SBA loan programs, including PPP loans, typically must include their affiliates when applying size tests to determine eligibility. That means that employees of other businesses under common control would count toward the maximum number of permitted employees. A business that is controlled by a private equity sponsor would likely be deemed an affiliate of the other businesses controlled by that sponsor and could thus be ineligible for PPP loans. However, the CARES Act waives the affiliation requirement for the following applicants:  

  1. Businesses within NAICS Code 72 with no more than 500 employees
  2. Franchises with codes assigned by the SBA, as reflected on the SBA franchise registry
  3. Businesses that receive financial assistance from one or more small business investment companies (SBIC) 

Basic terms

  • Loan amount
    Lesser of $10 million or 2.5 times the applicant’s average monthly payroll costs of the business over the year prior to the making of the loan (practically, this may become the year prior to the loan application), excluding the prorated portion of any annual compensation above $100,000 for any person. Note that under the CARES Act, “payroll costs” include vacation, parental, family, medical, and sick leave; allowances for dismissal or separation; payments for group health care benefits, including insurance premiums; and retirement benefits. Calculations vary slightly for seasonal businesses and businesses that were not in operation between February 15 and June 30, 2019. To the extent that a SBA Disaster Loan was used for a purpose other than those permitted for PPP Loans, the Disaster Loans may be refinanced with proceeds of PPP loans, in which case the maximum available PPP loan amount is increased by the amount of the Disaster Loans being refinanced. 
  • Maximum term
    Payments will be deferred for a minimum of 6 months and a maximum of 12. SBA is directed to issue guidance on the terms of this deferral. Any portion of the PPP loan that is not forgiven (see below) on or before December 31, 2020, shall automatically be a term loan for a maximum of 10 years. For PPP loans, the SBA has waived prepayment penalties.
  • Fees
    SBA will waive the guaranty fee and annual fee applicable to other 7(a) loans. 
  • Interest rate
    Maximum rate of 4%.
  • Collateral
    The standard requirements of collateral and a personal guaranty are waived under this program. Accordingly, there will be no recourse to owners or borrowers for nonpayment, except to the extent proceeds are used for an unauthorized purpose.
  • Use of proceeds
    This loan can be used for: (i) payroll support, excluding the prorated portion of any compensation above $100,000 per year for any person; (ii) group healthcare benefits costs and insurance premiums; (iii) mortgage interest (but not prepayments or principal payments) and rent payments incurred in the ordinary course of business, and (iv) utility payments. 
  • Forgiveness
    A borrower will be eligible for loan forgiveness related to a PPP loan in an amount equal to 8 weeks of payroll costs, and the interest on mortgage payments (not principal) made in the ordinary course of business, rent payments, or utility payments so long as all payments were obligations of the borrower prior to February 15, 2020. Payroll costs are limited to compensation for a single employee to be no more than $100,000 in wages and the amount of forgiveness cannot exceed the principal loan amount. 

    The amount of loan forgiveness will be reduced proportionally by any reduction in the borrower’s workforce, based on the full-time equivalent employees versus the period from either February 15, 2019, through June 30, 2019, or January 1, 2020, through February 29, 2020, as selected by the borrower, or a reduction of more than 25% of any employee’s compensation, measured against the most recent full quarter. If a borrower has already had to lay off employees due to COVID-19, employers are encouraged to rehire them by not being penalized for having a reduced payroll at the beginning of the covered period, which means the initial 8 week period after the loan’s origination date. 

    Accordingly, reductions in the number of employees or compensation occurring between February 15, 2020, and 30 days after enactment of the CARES Act will generally be ignored to the extent reversed by June 30, 2020. Any additional wages that may be paid to tipped workers are also covered in the calculation of payroll forgiveness. Borrowers must keep accurate records and document their payments because lenders will need to verify the payments to allow for loan forgiveness. Borrowers will not have to include any forgiven indebtedness as taxable income. 

Applying
A company needs to apply on or before June 30, 2020, with a lender who is currently approved as a 7(a) lender or who is approved by the SBA and the Treasury Department to become a PPP lender. PPP lenders have delegated authority to make and approve PPP loan, with no additional SBA approval required. 

There are certain portions of the CARES Act that require SBA to provide further guidance so there may be some slight changes to the rules and procedures as best practices present themselves. 

We recommend contacting existing 7(a) lenders as soon as possible to learn what you will need to provide for underwriting and approving a PPP loan. 

We are here to help
Please contact a BerryDunn professional if you have any questions, or would like to discuss your specific situation.

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Impact of CARES Act on SBA loans

Read this if you are an employer that may have to close, or has closed, due to COVID-19.

Here is a brief recap of definitions and explanations of employee retention credits found in the CARES Act. If you have questions about your specific situation, please don’t hesitate to contact us. We’re here to help.

Eligible employer

The term ‘‘eligible employer’’ means any employer: 

(i) that was carrying on a trade or business during calendar year 2020, and 
(ii) with respect to any calendar quarter, for which...
a.     the operation of the trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to the coronavirus disease 2019 (COVID–19), or 
b. such calendar quarter where there is a significant decline in gross receipts...
i. beginning with the first calendar quarter in 2020, for which gross receipts for the calendar quarter are less than 50 percent of gross receipts for the same calendar quarter in the prior year, and 
ii. ending with the calendar quarter for which gross receipts of such employer are greater than 80 percent of gross receipts for the same calendar quarter in the prior year.


For tax-exempt organizations described in section 501(c) of the Internal Revenue Code and exempt from tax under section 501(a) of such Code, clauses (i) and (ii)(a) shall apply to all operations of such organization.

Generally, all organizations treated as a single employer under the controlled group or affiliated service group rules will be treated as one employer for purposes of this section.

If an eligible employer participates in the Paycheck Protection Program, such an employer is not eligible for the employee retention credits.

Amount of credit

There shall be allowed, as a credit against applicable employment taxes for each calendar quarter, an amount equal to 50 percent of the qualified wages with respect to each employee of such employer for such calendar quarter.

The amount of qualified wages with respect to any employee which may be taken into account by the eligible employer for all calendar quarters shall not exceed $10,000 (i.e., the maximum credit is $5,000 per employee).

If the credit exceeds the applicable employment taxes on the wages paid for such calendar quarter, such excess shall be treated as an overpayment that shall be refunded.

Qualified wages

The term ‘‘qualified wages’’ means:

(i) in the case of an eligible employer for which the average number of full-time employees (as defined by the Affordable Care Act Employer Mandate Provisions) employed by such eligible employer during 2019 was greater than 100:
a. wages paid by such eligible employer with respect to which an employee is not providing services due to the suspension of the business or a drop in gross receipts circumstances, or 
(ii) in the case of an eligible employer for which the average number of full-time employees (as defined by the Affordable Care Act Employer Mandate Provisions) employed by such eligible employer during 2019 was not greater than 100:
a. all wages paid by an eligible employer when shut down and each quarter where there was a sharp decline in year-over-year receipts.


Wages do not include amounts paid under the expanded sick/family leave provisions of the FFCRA.

Qualified wages paid or incurred by an eligible employer with respect to an employee who is not providing services may not exceed the amount such employee would have been paid for working an equivalent duration during the 30 days immediately preceding leave.

The term ‘‘qualified wages’’ shall include so much of the eligible employer’s qualified health plan expenses as are properly allocable to such wages.


CARES Act: Payroll tax payment delay

An extension of time to remit payroll taxes for the period beginning March 27, 2020 and ending before January 1, 2021 over a two-year period is allowed, with half due by December 31, 2021, and the remainder due by December 31, 2022.

If an eligible employer participates in the payroll tax delay programs, such an employer is not eligible for the employee retention credits.
 

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CARES Act―Employee retention credits for employers subject to closure due to COVID-19

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security (CARES) Act, which provides relief to taxpayers affected by the novel coronavirus and COVID-19. The CARES Act is the third round of federal government aid related to COVID-19. We have summarized the top provisions in the new legislation below, with more detailed alerts on individual provisions to follow. Click here for a link to the full text of the bill.

Compensation, benefits, and payroll relief
The law temporarily increases the amount of and expands eligibility for unemployment benefits, and it provides relief for workers who are self-employed. Additionally, several provisions assist certain employers who keep employees on payroll even though the employees are not able or needed to work. 

The cornerstone of the payroll protection aid is a streamlined application process for SBA loans that can be forgiven if an eligible employer maintains its workforce at certain levels. 

Additionally, certain employers affected by the pandemic who retain their employees will receive a credit against payroll taxes for 50% of eligible employee wages paid or incurred from March 13 to December 31, 2020. This employee retention credit would be provided for as much as $10,000 of qualifying wages, including health benefits. Eligible employers may defer remitting employer payroll tax payments that remain due for 2020 (after the credits are deducted), with half being due by December 31, 2021, and the balance due by December 31, 2022. 

Employers with fewer than 500 employees are also allowed to give terminated employees access to the mandated paid federal sick and child care leave benefits for which the employer is 100% reimbursed by the government through payroll tax credits, if the employer rehires the qualifying employees.

Any benefit that is driven off the definition of “employee” raises the issue of partner versus employee. The profits interest member that is receiving a W-2 may not be eligible for inclusion in the various benefit computations.

Eligible individuals can withdraw vested amounts up to $100,000 during 2020 without a 10% early distribution penalty, and income inclusion can be spread over three years. Repayment of distributions during the next three years will be treated as tax-free rollovers of the distribution. The bill also makes it easier to borrow money from 401(k) accounts, raising the limit to $100,000 from $50,000 for the first 180 days after enactment, and the payment dates for any loans due the rest of 2020 would be extended for a year.

Individuals do not have to take their 2020 required minimum distributions from their retirement funds. This avoids lost earnings power on the taxes due on distributions and maximizes the potential gain as the market recovers.

Two long-awaited provisions allow employers to assist employees with college loan debt through tax free payments up to $5,250 and restores over-the-counter medical supplies as permissible expenses that can be reimbursed through health care flexible spending accounts and health care savings accounts.

Deferral of net business losses for three years
Section 461(l) limits non-corporate taxpayers in their use of net business losses to offset other sources of income. As enacted in 2017, this limitation was effective for taxable years beginning after 2017 and before 2026, and applied after the basis, at-risk, and passive activity loss limitations. The amount of deductible net business losses is limited to $500,000 for married taxpayers filing a joint return and $250,000 for all other taxpayers. These amounts are indexed for inflation after 2018 (to $518,000 and $259,000, respectively, in 2020). Excess business losses are carried forward to the next succeeding taxable year and treated as a net operating loss in that year.

The CARES Act defers the effective date of Section 461(l) for three years, but also makes important technical corrections that will become effective when the limitation on excess business losses once again becomes applicable. Accordingly, net business losses from 2018, 2019, or 2020 may offset other sources of income, provided they are not otherwise limited by other provisions that remain in the Code. Beginning in 2021, the application of this limitation is clarified with respect to the treatment of wages and related deductions from employment, coordination with deductions under Section 172 (for net operating losses) or Section 199A (relating to qualified business income), and the treatment of business capital gains and losses.

Section 163(j) amended for taxable years beginning in 2019 and 2020
The CARES Act amends Section 163(j) solely for taxable years beginning in 2019 and 2020. With the exception of partnerships, and solely for taxable years beginning in 2019 and 2020, taxpayers may deduct business interest expense up to 50% of their adjusted taxable income (ATI), an increase from 30% of ATI under the TCJA, unless an election is made to use the lower limitation for any taxable year. Additionally, for any taxable year beginning in 2020, the taxpayer may elect to use its 2019 ATI for purposes of computing its 2020 Section 163(j) limitation. 

This will benefit taxpayers who may be facing reduced 2020 earnings as a result of the business implications of COVID-19. As such, taxpayers should be mindful of elections on their 2019 return that could impact their 2019 and 2020 business interest expense deduction. With respect to partnerships, the increased Section 163(j) limit from 30% to 50% of ATI only applies to taxable years beginning in 2020. However, in the case of any excess business interest expense allocated from a partnership for any taxable year beginning in 2019, 50% of such excess business interest expense is treated as not subject to the Section 163(j) limitation and is fully deductible by the partner in 2020. The remaining 50% of such excess business interest expense shall be subject to the limitations in the same manner as any other excess business interest expense so allocated. Each partner has the ability, under regulations to be prescribed by Treasury, to elect to have this special rule not applied. No rules are provided for application of this rule in the context of tiered partnership structures.

Net operating losses carryback allowed for taxable years beginning in 2018 and before 2021
The CARES Act provides for an elective five-year carryback of net operating losses (NOLs) generated in taxable years beginning after December 31, 2017, and before January 1, 2021. Taxpayers may elect to relinquish the entire five-year carryback period with respect to a particular year’s NOL, with the election being irrevocable once made. In addition, the 80% limitation on NOL deductions arising in taxable years beginning after December 31, 2017, has temporarily been pushed to taxable years beginning after December 31, 2020. 

Several ambiguities in the application of Section 172 arising as a result of drafting errors in the Tax Cuts and Jobs Act have also been corrected. As certain benefits (i.e., charitable contributions, Section 250 “GILTI” deductions, etc.) may be impacted by an adjustment to taxable income, and therefore reduce the effective value of any NOL deduction, taxpayers will have to determine whether to elect to forego the carryback. Moreover, the bill provides for two special rules for NOL carrybacks to years in which the taxpayer included income from its foreign subsidiaries under Section 965. Please consider the impact of this interaction with your international tax advisors. 

However, given the potential offset to income taxed under a 35% federal rate, and the uncertainty regarding the long-term impact of the COVID-19 crisis on future earnings, it seems likely that most companies will take advantage of the revisions. This is a technical point, but while the highest average federal rate was 35% before 2018, the highest marginal tax rate was 38.333% for taxable amounts between $15 million and $18.33 million. This was put in place as part of our progressive tax system to eliminate earlier benefits of the 34% tax rate. Companies may wish to revisit their tax accounting methodologies to defer income and accelerate deductions in order to maximize their current year losses to increase their NOL carrybacks to earlier years.

Alternative minimum tax credit refunds
The CARES Act allows the refundable alternative minimum tax credit to be completely refunded for taxable years beginning after December 31, 2018, or by election, taxable years beginning after December 31, 2017. Under the Tax Cuts and Jobs Act, the credit was refundable over a series of years with the remainder recoverable in 2021.

Technical correction to qualified improvement property
The CARES Act contains a technical correction to a drafting error in the Tax Cuts and Jobs Act that required qualified improvement property (QIP) to be depreciated over 39 years, rendering such property ineligible for bonus depreciation. With the technical correction applying retroactively to 2018, QIP is now 15-year property and eligible for 100% bonus depreciation. This will provide immediate current cash flow benefits and relief to taxpayers, especially those in the retail, restaurant, and hospitality industries. Taxpayers that placed QIP into service in 2019 can claim 100% bonus depreciation prospectively on their 2019 return and should consider whether they can file Form 4464 to quickly recover overpayments of 2019 estimated taxes. Taxpayers that placed QIP in service in 2018 and that filed their 2018 federal income tax return treating the assets as bonus-ineligible 39-year property should consider amending that return to treat such assets as bonus-eligible. For C corporations, in particular, claiming the bonus depreciation on an amended return can potentially generate NOLs that can be carried back five years under the new NOL provisions of the CARES Act to taxable years before 2018 when the tax rates were 35%, even though the carryback losses were generated in years when the tax rate was 21%. With the taxable income limit under Section 172(a) being removed, an NOL can fully offset income to generate the maximum cash refund for taxpayers that need immediate cash. Alternatively, in lieu of amending the 2018 return, taxpayers may file an automatic Form 3115, Application for Change in Accounting Method, with the 2019 return to take advantage of the new favorable treatment and claim the missed depreciation as a favorable Section 481(a) adjustment.

Effects of the CARES Act at the state and local levels
As with the Tax Cuts and Jobs Act, the tax implications of the CARES Act at the state level first depends on whether a state is a “rolling” Internal Revenue Code (IRC) conformity state or follows “fixed-date” conformity. For example, with respect to the modifications to Section 163(j), rolling states will automatically conform, unless they specifically decouple (but separate state ATI calculations will still be necessary). However, fixed-date conformity states will have to update their conformity dates to conform to the Section 163(j) modifications. 

A number of states have already updated during their current legislative sessions (e.g., Idaho, Indiana, Maine, Virginia, and West Virginia). Nonetheless, even if a state has updated, the effective date of the update may not apply to changes to the IRC enacted after January 1, 2020 (e.g., Arizona). 

A number of other states have either expressly decoupled from Section 163(j) or conform to an earlier version and will not follow the CARES Act changes (e.g., California, Connecticut, Georgia, Missouri, South Carolina, Tennessee (starting in 2020), Wisconsin). Similar considerations will apply to the NOL modifications for states that adopted the 80% limitation, and most states do not allow carrybacks. Likewise, in fixed-dated conformity states that do not update, the Section 461(l) limitation will still apply resulting in a separate state NOL for those states. 

These conformity questions add another layer of complexity to applying the tax provisions of the CARES Act at the state level. Further, once the COVID-19 crisis is past, rolling IRC conformity states must be monitored, as these states could decouple from these CARES Act provisions for purposes of state revenue.

2020 recovery refund checks for individuals
The CARES Act provides eligible individuals with a refund check equal to $1,200 ($2,400 for joint filers) plus $500 per qualifying child. The refund begins to phase out if the individual’s adjusted gross income (AGI) exceeds $75,000 ($150,000 for joint filers and $112,500 for head of household filers). The credit is completely phased out for individuals with no qualifying children if their AGI exceeds $99,000 ($198,000 for joint filers and $136,500 for head of household filers).

Eligible individuals do not include nonresident aliens, individuals who may be claimed as a dependent on another person’s return, estates, or trusts. Eligible individuals and qualifying children must all have a valid social security number. For married taxpayers who filed jointly with their most recent tax filings (2018 or 2019) but will file separately in 2020, each spouse will be deemed to have received one half of the credit.

A qualifying child (i) is a child, stepchild, eligible foster child, brother, sister, stepbrother, or stepsister, or a descendent of any of them, (ii) under age 17, (iii) who has not provided more than half of their own support, (iv) who has lived with the taxpayer for more than half of the year, and (v) who has not filed a joint return (other than only for a claim for refund) with the individual’s spouse for the taxable year beginning in the calendar year in which the taxable year of the taxpayer begins.

The refund is determined based on the taxpayer’s 2020 income tax return but is advanced to taxpayers based on their 2018 or 2019 tax return, as appropriate. If an eligible individual’s 2020 income is higher than the 2018 or 2019 income used to determine the rebate payment, the eligible individual will not be required to pay back any excess rebate. However, if the eligible individual’s 2020 income is lower than the 2018 or 2019 income used to determine the rebate payment such that the individual should have received a larger rebate, the eligible individual will be able to claim an additional credit generally equal to the difference of what was refunded and any additional eligible amount when they file their 2020 income tax return.

Individuals who have not filed a tax return in 2018 or 2019 may still receive an automatic advance based on their social security benefit statements (Form SSA-1099) or social security equivalent benefit statement (Form RRB-1099). Other individuals may be required to file a return to receive any benefits.

The CARES Act provides that the IRS will make automatic payments to individuals who have previously filed their income tax returns electronically, using direct deposit banking information provided on a return any time after January 1, 2018.

Charitable contributions

  • Above-the-line deductions: Under the CARES Act, an eligible individual may take a qualified charitable contribution deduction of up to $300 against their AGI in 2020. An eligible individual is any individual taxpayer who does not elect to itemize his or her deductions. A qualified charitable contribution is a charitable contribution (i) made in cash, (ii) for which a charitable contribution deduction is otherwise allowed, and (iii) that is made to certain publicly supported charities.

    This above-the-line charitable deduction may not be used to make contributions to a non-operating private foundation or to a donor advised fund.
  • Modification of limitations on cash contributions: Currently, individuals who make cash contributions to publicly supported charities are permitted a charitable contribution deduction of up to 60% of their AGI. Any such contributions in excess of the 60% AGI limitation may be carried forward as a charitable contribution in each of the five succeeding years.

    The CARES Act temporarily suspends the AGI limitation for qualifying cash contributions, instead permitting individual taxpayers to take a charitable contribution deduction for qualifying cash contributions made in 2020 to the extent such contributions do not exceed the excess of the individual’s contribution base over the amount of all other charitable contributions allowed as a deduction for the contribution year. Any excess is carried forward as a charitable contribution in each of the succeeding five years. Taxpayers wishing to take advantage of this provision must make an affirmative election on their 2020 income tax return.

    This provision is useful to taxpayers who elect to itemize their deductions in 2020 and make cash contributions to certain public charities. As with the aforementioned above-the-line deduction, contributions to non-operating private foundations or donor advised funds are not eligible.

    For corporations, the CARES Act temporarily increases the limitation on the deductibility of cash charitable contributions during 2020 from 10% to 25% of the taxpayer’s taxable income. The CARES Act also increases the limitation on deductions for contributions of food inventory from 15% to 25%.

We are here to help
Please contact a BerryDunn professional if you have any questions, or would like to discuss your specific situation.

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The CARES Act: Implications for businesses

Read this if you are a business owner, in management, or in HR at a company with less than 500 employees.

We have received many questions regarding the FFCRA and its provisions and how it affects different employers and their employees. Here are some of the questions our clients have asked the most. Please contact us if you have questions regarding your specific situation. We’re here to help.  

Besides compensation, what other costs paid by an employer are eligible for the credit (i.e., employer paid health insurance, employer payroll taxes)?
Employers can deduct the cost of providing continuing health care coverage, and the employer’s share of Medicare taxes related to the leave wages. Any compensation paid under the FFCRA is not subject to the employer’s portion of the Social Security tax.

How do you determine the total number of employees? 
In calculating the total number of employees, all full-time or part-time employees working within the US, including all US territories or possessions, are counted, including all employees on leave and temp employees who are jointly employed with another company as determined under the Fair Labor Standards Act (FLSA). 

How does a business know if it employs less than 500 employees and is subject to the FFCRA?
Generally, a private sector employer is subject to the Family and Medical Leave Act of 1993 (FMLA) if it employs 50 or more employees for each working day during each of 20 or more calendar workweeks in the current or preceding calendar year. The FAQs issued by the Department of Labor (DOL) indicate an employer has fewer than 500 employees if, at the time an employee’s leave is to be taken, there are fewer than 500 full-time and part-time employees within the United States, which includes any state of the United States, the District of Columbia, or any territory or possession of the United States. 

In making this determination, an employer should include employees on leave; temporary employees who are jointly employed by you and another employer (regardless of whether the jointly-employed employees are maintained on only your or another employer’s payroll); and day laborers supplied by a temporary agency (regardless of whether you are the temporary agency or the client firm if there is a continuing employment relationship). Workers who are independent contractors under the FLSA, rather than employees, are not considered employees for purposes of the 500-employee threshold.

Where a corporation has an ownership interest in another corporation, the two corporations are separate employers unless they are joint employers under the FLSA with respect to certain employees. In general, two or more entities are separate employers unless they meet the integrated employer test under the FMLA.

Please check with your advisors if you believe the integrated employer test may apply to your businesses.

Which employees are entitled to the $511 payment under sick leave?
For an employee who is unable to work because of the coronavirus quarantine or self-quarantine or has COVID-19 symptoms and is seeking a medical diagnosis, the employee may receive sick leave wages equal to the employee’s regular rate of pay, up to $511 per day and $5,111 in the aggregate, for a total of 10 days. Note that only employers who employ less than 500 employer are required to provide sick leave payments. Such employees may also receive a refundable tax credit for sick leave paid to employees.

Which employees are entitled to the $200 payment under sick leave?
For an employee who is caring for someone with COVID-19, or is caring for a child because the child’s school or child care facility is closed, or the child care provider is unavailable due to the coronavirus, the employee may receive sick leave wages equal to two-thirds of the employee’s regular rate of pay, up to $200 per day and $2,000 in the aggregate, for up to 10 days. Note that only employers who employ less than 500 employer are required to provide sick leave payments. Such employees may also receive a refundable tax credit for sick leave paid to employees.

Which employees are entitled to the $200 payment under the family leave portion of FFCRA?
For an employee who is unable to work because of a need to care for a child whose school or child care facility is closed or whose child care provider is unavailable due to the coronavirus, the employee may receive family leave wages equal to two-thirds of the employee’s regular rate of pay, capped at $200 per day or $10,000 in the aggregate. Up to 10 weeks of qualifying leave can be counted towards the child care leave credit. Note that only employers who employ less than 500 employer are required to provide sick leave payments. Such employees may also receive a refundable tax credit for sick leave paid to employees.

What is “regular rate of pay” for purposes of the FFCRA?
For purposes of the FFCRA, the regular rate of pay used to calculate paid leave is the average of the employee’s regular rate over a period of up to six months prior to the date on which leave is taken. If an employee has not worked for the current employer for six months, the regular rate used to calculate paid leave is the average regular rate of pay for each week the employee has worked for the current employer.

If an employee is paid with commissions, tips, or piece rates, these amounts will be incorporated into the above calculation to the same extent they are included in the calculation of the regular rate under the FLSA.

You can also compute this amount for each employee by adding all compensation that is part of the regular rate over the above period and divide that sum by all hours actually worked in the same period.

What is the effective date of the sick leave/family leave provisions?
Employers must comply with the FFCRA from April 1, 2020, until it expires on December 31, 2020. Paid leave prior to April1, 2020 will not count. The IRS recently issued guidance indicating the tax credits for qualified sick leave wages and qualified family leave wages required to be paid by the FFRCA will apply to wages paid for the period beginning on April 1, 2020, and ending on December 31, 2020.

Who is considered a “health care provider”?
For the purposes of employees who may be exempted from paid sick leave or expanded family and medical leave by their employer under the FFCRA, a health care provider is anyone employed at any doctor’s office, hospital, health care center, clinic, post-secondary educational institution offering health care instruction, medical school, local health department or agency, nursing facility, retirement facility, nursing home, home health care provider, any facility that performs laboratory or medical testing, pharmacy, or any similar institution, employer, or entity. This includes any permanent or temporary institution, facility, location, or site where medical services are provided that are similar to such institutions. 

This definition includes any individual employed by an entity that contracts with any of the above institutions, employers, or entities institutions to provide services or to maintain the operation of the facility. This also includes anyone employed by any entity that provides medical services, produces medical products, or is otherwise involved in the making of COVID-19 related medical equipment, tests, drugs, vaccines, diagnostic vehicles, or treatments. This also includes any individual that the highest official of a state or territory, including the District of Columbia, determines is a health care provider necessary for that state’s or territory’s or the District of Columbia’s response to COVID-19.

To minimize the spread of the virus associated with COVID-19, the DOL encourages employers to be judicious when using this definition to exempt health care providers from the provisions of the FFCRA.

For more information
If you have more questions, or have a specific question about your particular situation, please call us. We’re here to help. 

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Families First Coronavirus Response Act (FFCRA): FAQs for businesses

On March 18, 2020, the SBA issued relaxed criteria for Economic Injury Disaster Loans (EIDLs).

The two immediate impacts:

  • States are now only required to certify that a minimum of five small businesses within the state/territory have suffered significant economic injury, as opposed to proof of five small businesses within each reporting county/parish.
  • Prior regulation only made disaster assistance loans available to small businesses within counties declared disaster areas by a governor. Relaxed standards state the EIDLs will be available statewide following an economic injury declaration. This applies to current and future disaster declarations related to COVID-19.

Some SBA loan specifics:

  • EIDL amounts range from $25,000 to $2,000,000, at interest rates of 3.75% for small businesses and 2.75% for not-for-profits.
  • Companies can use the loans to pay bills that can’t be paid due to the disaster’s impact, including but not limited to fixed debts, payroll, and accounts payable.
  • Loan terms are determined on a case-by-case basis, based on the borrower’s ability to repay. SBA is offering repayment terms up to a maximum of 30 years.
  • EIDLs are one facet of an expanded and coordinated federal government response.

Small businesses in need of economic assistance may apply for an EIDL here. We will update as more information becomes available.

If you have questions about SBA loans, please contact your BerryDunn tax consultant
 

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Small Business Administration (SBA) eases criteria for disaster loans

Over the last few weeks, CMS and the President have enacted legislation and released guidance to assist the senior living industry in coping with the impact of COVID-19. We recognize the elderly residents of our country are the most vulnerable population and your days are filled caring for your population’s needs and health. Our senior living professionals have written this article to highlight new regulations impacting the industry and offer practical tips for guarding your facility's financial health through the COVID-19 outbreak.

Amidst rapid hourly changes in contending with the coronavirus and its far-reaching impacts, the way you run your facility has changed. Along with this change comes an increase in expenditures. To ensure that your facility is getting much needed financial relief and being properly reimbursed for the full impact of COVID-19, we recommend tracking your expenditures related to the coronavirus. Expenditures related to COVID-19 go beyond the cost of additional Personal Protective Equipment (PPE), they will likely include additional direct care staffing, along with housekeeping, dietary and laundry staffing, and supplies needed to maintain the heightened level of hygiene required to combat the spread of COVID-19 in your facility.

CMS issues waiver of 3-Day Stay and Spell of Illness
On March 14, Centers for Medicare and Medicaid Services (CMS) issued two waivers to aid skilled nursing facilities in addressing the national COVID-19 outbreak. CMS is waiving both the 3-Day Stay and Spell of Illness requirements. Read the COVID-19 Emergency Declaration.

Key provisions to consider with regard to 3-midnight qualifying stay requirement:

  • The exception applies to traditional Medicare coverage only (Medicare Advantage plans may or may not follow this exception);
  • It is in effect as of March 1, 2020, and will only be in effect while public health emergency is declared;
  • Applies only to beneficiaries affected by the emergency or who experience dislocations;
  • Providers have to document medical necessity and clinical reasons for not meeting 3-midnight requirement, understanding that the intent of this provision is to free up hospital beds and reduce potential risk of exposure to the patient;
  • Providers are to use condition code “DR” on the claims. 

Read additional AHCA clarifications and guidance regarding the waivers of 3-Day Stay and Spell of Illness requirements.

MDS completion and submission waivers
CMS is waiving 42 CFR 483.20 to provide relief to SNFs on the timeframe requirements for Minimum Data Set (MDS) assessments and transmissions. CMS has yet to issue technical guidance on how to implement.

On March 22, 2020, CMS announced temporary administrative burden relief related to Quality Reporting which includes certain SNF-specific changes:

  • Quality Reporting Program (QRP) April/May deadline for 10/1/19 - 12/31/19 data submission is optional for those facilities that have not yet submitted data;
  • Facilities do not need to submit 1/1/20 - 6/30/20 data for purposes of compliance with QRP;
  • CMS will not use any data for the first 2 quarters of 2020, 1/1/20 - 6/30/20, in its calculations;
  • Claims for 1/1/20 - 6/30/20 will be excluded from calculation of all-cause readmission measures that result in value-based purchasing adjustments.

Read the full CMS press release.

Families First Coronavirus Response Act (FFCRA)
On March 18, 2020, the President signed into law, H.R. 6201, the Families First Coronavirus Response Act. The legislation eliminates patient cost-sharing for COVID-19 testing and related services, establishes an emergency paid leave program, and expands unemployment and nutrition assistance. Moreover, the bill provides a temporary 6.2% increase in Federal Medical Assistance Percentages (FMAP) for each calendar quarter occurring during an emergency period.

FMAP is the federal portion of funds for state Medicaid programs. With this temporary increase states can use the increased federal funds for any portion of the state Medicaid program. Due to significant increases in unemployment from business closures, the increase may be used to provide Medicaid coverage for the newly unemployed and uninsured. This would result in less funding for provider rate increases to cover COVID-19 related costs. However, on March 21, 2020, the federal government also announced that it is considering a special enrollment period for Affordable Care Act Health Insurance Exchange coverage. A special enrollment period would offer lower cost coverage to individuals with reduced incomes and could influence how the FMAP increase will be used, possibly resulting in more being allocated to covering provider rates. As of today, it is still unclear how states will use the increased funds.

A table released by AHCA on March 14, 2020, provides estimates of the increase in Federal Medicaid funding from FMAP assuming the increase is in effect January through December 2020. 

There are two provisions of the FFCRA that deal with paid leave provisions for employees. BerryDunn's employee benefits consultants provide insight and clarity on the paid leave provisions for employees.

Prioritization of survey activities
CMS released guidance prioritizing and suspending most federal and state survey agency (SSA) surveys, and delaying revisit surveys, for the next three weeks beginning on March 20, 2020, for all nursing homes. Standard surveys and non-Immediate Jeopardy (IJ) related onsite surveys will be suspended for three weeks. Complaints and facility-reported incidents that are considered at the IJ level will be conducted during this time. Facilities are encouraged to use the CDC developed COVID-19 Focused Survey for Nursing Homes. Get additional CMS guidance

Coronavirus Aid, Relief, and Economic Security (CARES) Act
On March 25, 2020, the US Senate unanimously approved the $2 trillion CARES Act (The “Act”). It is anticipated that the House of Representatives will vote on the Act today, March 27, 2020. The White House has signaled that it will sign the measure as approved by the Senate. 

Major provisions of the proposed legislation include:

  • The Medicare 2% sequester will be temporarily suspended starting in late May 2020. 
  • $150 million for modifications of existing hospital, nursing home, and “domiciliary facilities” undertaken as part of COVID-19 response.
  • $65 million for housing for the elderly and people with disabilities for rental assistance, service coordinators and support services for the more than 114,000 affordable households for the elderly, and more than 30,000 affordable households for low-income people with disabilities.
  • $2.8 million to provide staff treating veterans living at Armed Forces Retirement Homes with the personal protective equipment they need. The funding provides this and other necessary equipment and staffing support to help minimize the spread of the coronavirus among residents.
  • $955 million for the Administration for Community Living to support nutrition programs, home- and community-based services, support for family caregivers, and expand oversight and protections for seniors and individuals with disabilities.
  • $200 million for the Centers for Medicare & Medicaid Services to assist nursing homes with infection control and support states’ efforts to prevent the spread of the coronavirus in nursing homes.

Practical tips for monitoring and maintaining your organization’s financial health 
As we navigate these next few months, facilities will face challenges to maintain the health and safety of their residents and staff as well as the financial health of the organization. Some things you should be doing now:

  • Calculate your working capital and cash position weekly or bi-weekly.
  • Perform cash flow projections for the next few months. Be sure the timing of your cash receipts will cover payroll and supplies expenditures each week. 
  • Contact your lenders to obtain or increase available working capital lines of credit.
  • Ascertain if you can release any investment balances if needed.


We are here to help
Please contact the BerryDunn senior living team if you have any questions, or would like to discuss your specific situation.

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Senior living organizations and COVID-19

The President signed The Families First Coronavirus Response Act (hereinafter the “Act”) into law on March 18th and the provisions are effective April 2nd. You can read the congressional summary here. There are two provisions of the Act that deal with paid leave provisions for employees. Here are some highlights for employers.

The provisions of the Act are only required for employers with fewer than 500 employees. Employers with over 499 employees are not required to provide the sick/family leave contained in the Act, but could voluntarily elect to follow the new rules. The expectation is that employers with over 499 employees are providing some level of sick/family leave benefits already. In any case, employers with over 499 employees are not eligible for the tax credits. 

Employers with fewer than 500 employees are required to provide employees with up to 80 hours of paid sick leave over a two-week period if the employee:

  • Self-isolates because of a diagnosis with COVID-19, or to comply with a recommendation or order to quarantine;
  • Obtains a medical diagnosis or care if the employee is experiencing COVID-19 symptoms;
  • Needs to care for a family member who is self-isolating due to a COVID-19 diagnosis or quarantining due to COVID-19 symptoms; or
  • Is caring for a child whose school has closed, or childcare provider is unavailable, due to COVID-19.

These rules apply to all employees regardless of the length of time they have worked for the employer. The 80-hours would be pro-rated for those employees who do not normally work a 40-hour week. 

Employees who take leave because they themselves are sick (i.e., the first two bullets above) can receive up to $511 per day, with an aggregate limit of $5,110. If, on the other hand, an employee takes leave to care for a child or other family member (i.e., the last two bullets above), the employee will be paid two-thirds (2/3) of their regular weekly wages up to a maximum of $200 per day, with an aggregate limit of $2,000.

Days when an individual receives pay from their employer (regular wages, sick pay, or other paid time off) or unemployment compensation do not count as leave days for the purposes of this benefit.

Family and Medical Leave Act

Employees who have been employed for at least 30-days also have the right to take up to 12 weeks of job-protected leave under the Family and Medical Leave Act (FMLA). The Act requires that 10 of these 12 weeks (i.e., after the sick leave discussed above is taken) be paid at a rate of no less than two-thirds of the employee’s usual rate of pay. Any leave taken under this portion of the ACT will be limited to $200 per day with an aggregate limit of $10,000.

Exemptions

The Secretary of Labor has the authority to issue regulations exempting: (1) certain healthcare providers and emergency responders from taking leave under the Act; and (2) small businesses with fewer than 50 employees from the requirements of the Act if it would jeopardize the viability of the business.

Expiration

The provisions of the Act are set to expire on December 31, 2020, and unused time will not carry over from one year to the next.

Tax credits 

The Act provides for refundable tax credits to help an employer cover the costs associated with providing paid emergency sick leave or paid FMLA. The tax credits work as follows:

  • A refundable tax credit for employers equal to 100 percent of qualified family leave wages paid under the Act.
  • A refundable tax credit for employers equal to 100 percent of qualified paid sick leave wages paid under the Act. 
  • The tax credits are taken on Form 941 – Employer’s Quarterly Federal Income Tax Return filed for the calendar quarter when the leave is taken and reduce the employer’s portion of the Social Security taxes due. If the credit exceeds the employer’s total liability for Social Security taxes for all employees for any calendar quarter, the excess credit is refundable to the employer.

For more information

We are here to help. Please contact our benefit plan consultants if you have any questions or would like to discuss your specific situation. 

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Highlights of the recently passed paid sick and family leave act: What you need to know

Editor’s note: read this if you work for, or are affiliated with, a charitable organization that receives donations. Even the most mature nonprofit organizations may miss one of these filings once in a while. Some items (e.g., the donor acknowledgement letter) may feel commonplace, but a refresher—especially at a particularly busy time of the year as it pertains to giving—can fend off fines.

As the holiday season is now in full swing, the season of giving is also upon us. Perhaps not surprisingly, the month of December is by far the most charitable month of the year, accounting for almost one-third of all charitable gifts made annually. And with all that giving comes the requirement of charitable organizations to provide donor acknowledgements, a formal “thank you” of the gift being received. Different gifts require differing levels of acknowledgement, and in some cases an additional IRS form (or two) may need to be filed. Doing some work now may save you time (and a fine or two) later. 

While children are currently busy making lists for Santa Claus, in the spirit of giving we present to you our list of donor acknowledgement requirements―and best practices―to help you gain control of this issue for the holiday season and beyond.

Donor acknowledgement letters

Charitable (i.e., 501(c)(3)) organizations are required to provide a donor acknowledgement letter to each donor contributing $250 or more to the organization, whether it be cash or non-cash items (i.e., publicly traded securities, real estate, artwork, vehicles, etc.) received. The letter should include the following: 

  1. Name of the organization
  2. Amount of cash contribution
  3. Description of non-cash items (but not the value) 
  4. Statement that no goods and services were provided (assuming this is the case)
  5. Description and good faith estimate of the value of goods and services provided by the organization in return for the contribution, if any
  6. Statement that goods or services provided by the organization in return for the contribution consisted entirely of intangible religious benefit, if any

It is not necessary to include either the donor’s social security number or tax identification number on the written acknowledgment and as a best practice should not be included in the letter.

In addition to including the elements above, the written acknowledgement is also required to be contemporaneous, that is, sent out in a timely fashion. According to the IRS, a donor must receive the acknowledgment by the earlier of:

  • The date on which the donor actually files his or her individual federal income tax return for the year of the contribution
  • The due date (including extensions) of the return in order to be considered contemporaneous

Quid pro quo disclosure statements

When a donor makes a payment greater than $75 to a charitable organization partly as a contribution and partly as a payment for goods and services, a disclosure statement is required to notify the donor of the value of the goods and services received in order for the donor to determine the charitable contribution component of their payment.

An example of this would be if the organization sold tickets to its annual fundraising dinner event. Assume the ticket costs $100 and at the event the ticketholder receives a dinner valued at $40. In this example, the donor’s tax deduction may not exceed $60. Because the donor’s payment (quid pro quo contribution) exceeds $75, the charitable organization must furnish a disclosure statement to the donor, even though the deductible amount doesn’t exceed $75.

It’s important to note that there are some exclusions to these requirements if the value received is considered to be de minimis (known as the Token Exception), but the value received needs to be relatively small (ex: receiving a coffee mug with a picture of the organization’s logo on it). Please consult your tax advisor for more details.

If the organization does not issue disclosure statements, the IRS can issue penalties of $10 per contribution, not to exceed $5,000 per fundraising event or mailing. An organization may be able to avoid the penalty if reasonable cause can be demonstrated.

Receiving or selling donated noncash property? Forms 8283 & 8282 may be required.

If a charitable organization receives noncash donations, it may be asked to sign Form 8283. This form is required to be filed by the donor and included with their personal income tax return. If a donor contributes noncash property (excluding publicly traded securities) valued at over $5,000, the organization will need to sign Form 8283, Section B, Part IV acknowledging receipt of the noncash item(s) received.

By signing Form 8283, the donee organization is not only acknowledging receipt, but is also affirming that if the property being received is sold, exchanged, or otherwise disposed of within three years of the original donation date, the organization will be required to file Form 8282. A copy of this form is filed with the IRS and must also be provided to the original donor. Form 8282 is not required for sales of donated publicly traded securities. The penalty for failure to file Form 8282 when required is generally $50 per form.

Cars, boats, and yes, even airplanes? That would be Form 1098-C.

An airplane? Yes, even an airplane can be donated, and the donee organization must file a separate Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, with the IRS for each contribution of a qualified vehicle that has a claimed value of more than $500. Contemporaneous written acknowledgement requirements apply here too, and Form 1098-C can act as acknowledgement for this purpose. An acknowledgment is considered contemporaneous if it is furnished to the donor no later than 30 days after the date of the contribution if you plan to use the item for a mission-related purpose, or 30 days after the date of the sale of the item to an unrelated third party.

Penalties for failure to provide contemporaneous written acknowledgement for qualified vehicles can be pretty stiff, generally calculated as a percentage of the sale price if sold, or a percentage of the claimed value if not sold. Should you have any questions or receive a request regarding any of the forms noted above, please consult your tax advisor.

As you can see, the rules around donor acknowledgements can seem a lot like Grandma’s fruitcake―complex and perhaps a bit on the nutty side. When issuing donor acknowledgements this holiday season and beyond, be sure to review the list above and check it twice. Doing so may end up keeping you off of the IRS’s naughty list!

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Donor acknowledgements: We have to file what?

Editor’s note: read this if you are a Maine business owner or officer.

New state law aligns with federal rules for partnership audits

On June 18, 2019, the State of Maine enacted Legislative Document 1819, House Paper 1296, An Act to Harmonize State Income Tax Law and the Centralized Partnership Audit Rules of the Federal Internal Revenue Code of 1986

Just like it says, LD 1819 harmonizes Maine with updated federal rules for partnership audits by shifting state tax liability from individual partners to the partnership itself. It also establishes new rules for who can—and can’t—represent a partnership in audit proceedings, and what that representative’s powers are.

Classic tunes—The Tax Equity and Fiscal Responsibility Act of 1982

Until recently, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) set federal standards for IRS audits of partnerships and those entities treated as partnerships for income tax purposes (LLCs, etc.). Those rules changed, however, following passage of the Bipartisan Budget Act of 2015 (BBA) and the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). Changes made by the BBA and PATH Act included:

  • Replacing the Tax Matters Partner (TMP) with a Partnership Representative (PR);
  • Generally establishing the partnership, and not individual partners, as liable for any imputed underpayment resulting from an audit, meaning current partners can be held responsible for the tax liabilities of past partners; and
  • Imputing tax on the net audit adjustments at the highest individual or corporate tax rates.

Unlike TEFRA, the BBA and PATH Act granted Partnership Representatives sole authority to act on behalf of a partnership for a given tax year. Individual partners, who previously held limited notification and participation rights, were now bound by their PR’s actions.

Fresh beats—new tax liability laws under LD 1819

LD 1819 echoes key provisions of the BBA and PATH Act by shifting state tax liability from individual partners to the partnership itself and replacing the Tax Matters Partner with a Partnership Representative.

Eligibility requirements for PRs are also less than those for TMPs. PRs need only demonstrate “substantial presence in the US” and don’t need to be a partner in the partnership, e.g., a CFO or other person involved in the business. Additionally, partnerships may have different PRs at the federal and state level, provided they establish reasonable qualifications and procedures for designating someone other than the partnership’s federal-level PR to be its state-level PR.

LD 1819 applies to Maine partnerships for tax years beginning on or after January 1, 2018. Any additional tax, penalties, and/or interest arising from audit are due no later than 180 days after the IRS’ final determination date, though some partnerships may be eligible for a 60-day extension. In addition, LD 1819 requires Maine partnerships to file a completed federal adjustments report.

Partnerships should review their partnership agreements in light of these changes to ensure the goals of the partnership and the individual partners are reflected in the case of an audit. 

Remix―Significant changes coming to the Maine Capital Investment Credit 

Passage of LD 1671 on July 2, 2019 will usher in a significant change to the Maine Capital Investment Credit, a popular credit which allows businesses to claim a tax credit for qualifying depreciable assets placed in service in Maine on which federal bonus depreciation is claimed on the taxpayer's federal income tax return. 

Effective for tax years beginning on or after January 1, 2020, the credit is reduced to a rate of 1.2%. This is a significant reduction in the current credit percentages, which are 9% and 7% for corporate and all other taxpayers, respectively. The change intends to provide fairness to companies conducting business in-state over out-of-state counterparts. Taxpayers continue to have the option to waive the credit and claim depreciation recapture in a future year for the portion of accelerated federal bonus depreciation disallowed by Maine in the year the asset is placed in service. 

As a result of this meaningful reduction in the credit, taxpayers who have historically claimed the credit will want to discuss with their tax advisors whether it makes sense to continue claiming the credit for 2020 and beyond.
 

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Maine tax law changes: Music to the ears, or not so much?

Proposed House bill brings state income tax standards to the digital age

On June 3, 2019, the US House of Representatives introduced H.R. 3063, also known as the Business Activity Tax Simplification Act of 2019, which seeks to modernize tax laws for the sale of personal property, and clarify physical presence standards for state income tax nexus as it applies to services and intangible goods. But before we can catch up on today, we need to go back in time—great Scott!

Fly your DeLorean back 60 years (you’ve got one, right?) and you’ll arrive at the signing of Public Law 86-272: the Interstate Income Act of 1959. Established in response to the Supreme Court’s ruling on Northwestern States Portland Cement Co. v. Minnesota, P.L. 86-272 allows a business to enter a state, or send representatives, for the purposes of soliciting orders for the sale of tangible personal property without being subject to a net income tax.

But now, in 2019, personal property is increasingly intangible—eBooks, computer software, electronic data and research, digital music, movies, and games, and the list goes on. To catch up, H.R. 3063 seeks to expand on 86-272’s protection and adds “all other forms of property, services, and other transactions” to that exemption. It also redefines business activities of independent contractors to include transactions for all forms of property, as well as events and gathering of information.

Under the proposed bill, taxpayers meet the standards for physical presence in a taxing jurisdiction, if they:

  1.  Are an individual physically located in or have employees located in a given state; 
  2. Use the services of an agent to establish or maintain a market in a given state, provided such agent does not perform the same services in the same state for any other person or taxpayer during the taxable year; or
  3. Lease or own tangible personal property or real property in a given state.

The proposed bill excludes a taxpayer from the above criteria who have presence in a state for less than 15 days, or whose presence is established in order to conduct “limited or transient business activity.”

In addition, H.R. 3063 also expands the definition of “net income tax” to include “other business activity taxes”. This would provide protection from tax in states such as Texas, Ohio and others that impose an alternate method of taxing the profits of businesses.

H.R. 3063, a measure that would only apply to state income and business activity tax, is in direct contrast to the recent overturn of Quill Corp. v. North Dakota, a sales and use tax standard. Quill required a physical presence but was overturned by the decision in South Dakota v. Wayfair, Inc. Since the Wayfair decision, dozens of states have passed legislation to impose their sales tax regime on out of state taxpayers without a physical presence in the state.

If enacted, the changes made via H.R. 3063 would apply to taxable periods beginning on or after January 1, 2020. For more information: https://www.congress.gov/bill/116th-congress/house-bill/3063/text?q=%7B%22search%22%3A%5B%22hr3063%22%5D%7D&r=1&s=2
 

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Back to the future: Business activity taxes!

This blog is the first in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with ERISA requirements.

On Labor Day, 1974, President Gerald Ford signed the Employee Retirement Income Security Act, commonly known as ERISA, into law. Prior to ERISA, employee pensions had scant protections under the law, a problem made clear when the Studebaker automobile company closed its South Bend, Indiana production plant in 1963. Upon the plant’s closing, some 4,000 employees—whose average age was 52 and average length of service with the company was 23 years—received approximately 15 cents for each dollar of benefit they were owed. Nearly 3,000 additional employees, all of whom had less than 10 years of service with the company, received nothing.

A decade later, ERISA established statutory requirements to preserve and protect the rights of employees to their pensions upon retirement. Among other things, ERISA defines what a plan fiduciary is and sets standards for their conduct.

Who is—and who isn’t—a plan fiduciary?
ERISA defines a fiduciary as a person who:

  1. Exercises discretionary authority or control over the management of an employee benefit plan or the disposition of its assets,
  2. Gives investment advice about plan funds or property for a fee or compensation or has the authority to do so,
  3. Has discretionary authority or responsibility in plan administration, or
  4. Is designated by a named fiduciary to carry out fiduciary responsibility. (ERISA requires the naming of one or more fiduciaries to be responsible for managing the plan's administration, usually a plan administrator or administrative committee, though the plan administrator may engage others to perform some administrative duties).

If you’re still unsure about exactly who is and isn’t a plan fiduciary, don’t worry, you’re not alone. Disagreements over whether or not a person acting in a certain capacity and in a specific situation is a fiduciary have sometimes required legal proceedings to resolve them. Here are some real-world examples.

Employers who maintain employee benefit plans are typically considered fiduciaries by virtue of being named fiduciaries or by acting as a functional fiduciary. Accordingly, employer decisions on how to execute the intent of the plan are subject to ERISA’s fiduciary standards.

Similarly, based on case law, lawyers and consultants who effectually manage an employee benefit plan are also generally considered fiduciaries.

A person or company that performs purely administrative duties within the framework, rules, and procedures established by others is not a fiduciary. Examples of such duties include collecting contributions, maintaining participants' service and employment records, calculating benefits, processing claims, and preparing government reports and employee communications.

What are a fiduciary’s responsibilities?
ERISA requires fiduciaries to discharge their duties solely in the interest of plan participants and beneficiaries, and for the exclusive purpose of providing benefits for them and defraying reasonable plan administrative expenses. Specifically, fiduciaries must perform their duties as follows:

  1. With the care, skill, prudence, and diligence of a prudent person under the circumstances;
  2. In accordance with plan documents and instruments, insofar as they are consistent with the provisions of ERISA; and
  3. By diversifying plan investments so as to minimize risk of loss under the circumstances, unless it is clearly prudent not to do so.

A fiduciary is personally liable to the plan for losses resulting from a breach of their fiduciary responsibility, and must restore to the plan any profits realized on misuse of plan assets. Not only is a fiduciary liable for their own breaches, but also if they have knowledge of another fiduciary's breach and either conceals it or does not make reasonable efforts to remedy it.

ERISA provides for a mandatory civil penalty against a fiduciary who breaches a fiduciary responsibility under ERISA or commits a violation, or against any other person who knowingly participates in such breach or violation. That penalty is equal to 20 percent of the "applicable recovery amount" paid pursuant to any settlement agreement with ERISA or ordered by a court to be paid in a judicial proceeding instituted by ERISA.

ERISA also permits a civil action to be brought by a participant, beneficiary, or other fiduciary against a fiduciary for a breach of duty. ERISA allows participants to bring suit to recover losses from fiduciary breaches that impair the value of the plan assets held in their individual accounts, even if the financial solvency of the entire plan is not threatened by the alleged fiduciary breach. Courts may require other appropriate relief, including removal of the fiduciary.

Over the coming months, we’ll share a series of blogs for employee benefit plan fiduciaries, covering everything from common terminology to best practices for plan documentation, suggestions for navigating fiduciary risks, and more.

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What's in a name? A lot, if you manage a benefit plan.

Executive compensation is often a contentious issue in business valuations, as business valuations are often valued by reference to the income they produce. If the business being valued pays its employees an above-market rate, its income will be depressed. Accordingly, if no compensation adjustments are made, the value of the business will also be diminished.

When valuing controlling ownership interests, valuation analysts often restate above- or below-market executive compensation to a market level to reflect what a hypothetical buyer would pay the executives. In the valuation of companies with ESOPs, the issue of executive compensation gets more complicated. The following hypothetical example illustrates why.

Glamorous Grocery is a company that is 100% owned by an ESOP. A valuation analyst is retained to estimate the fair market value of each ESOP share. Glamorous Grocery generates very little income, in part because several executives are overcompensated. The valuation analyst normalizes executive compensation to a market level, thereby increasing Glamorous Grocery income, the fair market value of Glamorous Grocery, and the ESOP share value.

Glamorous Grocery’s trustee then uses this valuation to establish the market price of ESOP shares for the following year. When employees retire, Glamorous Grocery buys employees out at the established share price. The problem? As mentioned before, Glamorous Grocery generates very little income and as a result has difficulty obtaining the liquidity to buy out employees.

This simple example illustrates the concerns about normalizing executive compensation in ESOP valuations. If you reduce executive compensation for valuation purposes, the share price increases, putting a heavier burden on the company when you redeem shares. The company, which already has reduced income from paying above-market executive compensation, may struggle to redeem shares at the established price.

A second issue is whether control-level adjustments are appropriate in ESOP valuations. A company might be 100% ESOP-owned, but an owner of an ESOP share may not actually be able to reduce executive compensation.

Interested in learning more? Please leave a comment below, or contact me. For additional discussion of the shareholder/executive compensation federal tax statutes and historical judicial precedents and sources of executive compensation data, please click here.

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Executive compensation: Making or breaking an Employee Stock Ownership Plan (ESOP)

Reading through the 133-page exposure draft for the Proposed Statement on Auditing Standards (SAS) Forming an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA, issued back in April 2017, and then comparing it to the final 100+ page standard approved in September 2018, may not sound like a fun way to spend a Sunday morning sipping a coffee (or three), but I disagree.

Lucky for you, I have captured the highlights here. And it really is exciting. Our feedback was incorporated into the final standard both through written comments on the exposure draft and a voice via our firm’s Director of Quality Assurance, who holds a seat on the Auditing Standards Board.

"Limited scope" audits will no longer exist

The debate over the “limited scope” audit has been going on for years. The new standard is designed to help auditors clearly understand their responsibilities in performing an audit, and provide plan sponsors, plan participants, the Department of Labor (DOL), and other interested parties with more information about what auditors do in situations when audits are limited in scope by the plan’s management, which is permitted by DOL reporting and disclosure rules.

Once effective, Audit Committee and Board of Director meetings in which plan financial statements are presented will include more clarity into what an employee benefit plan audit entails, based on revisions to the auditor’s report. I know I would frequently kick off meetings covering the auditor’s report opinion by explaining what a “limited scope” audit was. As a “limited scope” audit will no longer exist, the revised auditor’s report language clearly articulates what the auditor is, and is not, opining on.

When is the new standard effective?

The effective date is “to be determined” as it will be aligned with the new overall auditor’s reporting standard once that is finalized, and the standard does not permit early adoption. So there is still time to educate and prepare all parties involved.

Probably the biggest conversation piece around the water cooler for the new standard is the lingo. The “limited scope” audit language will be going away and now the auditor’s report and all related language will refer to an “ERISA section 103(a)(3)(C)” audit. I know, it’s a mouthful?try and say that one three times fast!

The auditor's report will look much different

The auditor’s report under an ERISA section 103(a)(3)(C) audit will look significantly different from the old “limited scope” auditor’s report, once the standard is effective. There are several illustrative examples of reports included in the standard to refer to. One thing you will immediately notice?the auditor’s report is getting longer and not shorter. Some highlights:

The Opinion section will include two bullets that explicitly state, in basic summarized terms: (1) the certified information agrees to the financial statements, and (2)  the auditor’s opinion on everything else, which the auditor has audited.

Other Matter—Supplemental Schedules Required by ERISA section will include two bullets that explicitly state, in basic summarized terms, (1) the certified information agrees to the financial statements and (2) the auditor’s opinion on everything else, which the auditor has audited in relation to the financial statements. Sound similar to the Opinion section? Well, that’s because it is!).

Other key takeaways

  • Auditors will be required to make inquiries of management to gain assurance they performed procedures to determine the certifying institution is qualified for the ERISA section 103(a)(3)(C) audit, as it is management’s responsibility to make that determination.
  • Fair value disclosures included within the plan’s financial statements are also included under the certification umbrella and subject to the same audit procedures. As an auditor, if anything comes to our attention that does not meet expectations, we would further assess as necessary.
  • The auditor is required to obtain and read a draft Form 5500 prior to issuance of the auditor’s report.

The final standard also removed some highly debated provisions included in the draft proposal as follows:

  • There is no report on findings required, but the auditor is required to follow AU-C 250, AU-C 260 and AU-C 265. Should anything arise that warrants communication to those charged with governance, those findings must be communicated in writing. Be sure to grab another coffee and refresh yourself on AU-C 250, AU-C 260 and AU-C 265!
  • The new required procedures section for an audit was scrapped and replaced with an Appendix A for recommended audit procedures based on risk assessments. There are some great tools there to look at.
  • The required emphasis-of-matter section paragraph section of the auditor’s report was also scrapped.

Questions about the new employee benefit audit standard or employee benefit plan audits

At BerryDunn, we perform over 200 employee benefit plan audits each year. If you have any questions, we would love to help. And we’ll keep the acronyms to a minimum. Please reach out with any questions.

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Auditing standards board approves new employee benefit plan auditing standard: What you need to know

Are you spending enough time on your paid time off plan?
Many questions arise regarding paid time off (PTO) plans and the constructive receipt of income, which can cause payroll complications for employers and phantom income inclusion for employees. In order to avoid being subject to penalties for not withholding income and payroll taxes and having employees be subject to tax on cash they have not received, certain steps need be followed if an employer wants to properly allow employees to cash-out PTO.

What the IRS is looking for.
The Internal Revenue Service (IRS) has issued a number of Private Letter Rulings (PLRs) that examine earned time cash-out programs. While such rulings don’t serve as precedent, it appears the IRS has come up with the following factors that it deems important in order to avoid constructive receipt in a PTO cash-out situation:

  1. Employees must make a written election before the end of December in the year prior to the year they will be earning and receiving the accrued earned time to be cashed-out.  This is an election to receive a cash payout of the earned time to be accrued in the following year.
  2. The election must be irrevocable.
  3. The payout can only happen once the employee has actually earned and accrued the earned time in the following year. Payouts are generally once or twice per year, but may happen more frequently.

The IRS appears to generally require that the earned time being paid out be substantially less than the accrued earned time owed to the employee. This is to ensure that the earned time program remains a bona fide sick or vacation pay plan and not a plan of deferred compensation. This particular requirement can get tricky and may be different in each employer’s case.

Why does it matter?
The danger of failing to follow IRS guidelines regarding earned time cash-outs is that the IRS could claim that the employees offered a choice to cash-out are in constructive receipt of their accrued earned time balances regardless of their choice. This would result in immediate taxation of all accrued amounts to the employees, even if they hadn’t received the cash. The employer would also be subject to penalties for not properly withholding federal and state taxes.

It is important to review your PTO plan to be sure there are no issues regarding constructive receipt and to make sure your payroll systems are correctly reporting income.

The IRS issued proposed regulations under Code Section 457 in June of 2016 regarding, in part, non-qualified deferred compensation plans of not-for-profit (NFP) organizations. Those regulations contain guidance regarding the cash-out of sick and vacation time and the possibility that certain cash-out provisions may create a plan of deferred compensation and not a bona fide sick leave or vacation leave plan. As noted above, such a determination would be disastrous as all amounts accrued would become immediately taxable. NFP organizations and their advisors should keep a close eye on the proposed Section 457 regulations to see how they develop in final form. Once the regulations are finalized, NFP organizations may need to make changes to their cash-out provisions.

Please note that the above information is general in nature and is not meant to provide guidance on any particular case. If you have any questions about your PTO plan, please contact Bill Enck.

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Paid time off plans: IRS guidelines and why they matter