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Defined contribution plan distributions: Considerations and recommendations

07.21.21

Read this if you are a plan sponsor of employee benefit plans.

This article is the seventh in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. You can read the previous articles here.

The COVID-19 pandemic has challenged individuals and organizations to continue operating during a time where face-to-face interaction may not be plausible, and access to organizational resources may be restricted. However, life has not stopped, and participants in your employee benefit plan may continue to make important decisions based on their financial needs. 

To help you prepare for a potential IRS examination, we’ve listed some requirements for participants to receive Required Minimum Distributions (RMD), hardship distributions, and coronavirus-related distributions, recommendations of actions you can perform, and documentation to retain as added internal controls. 

Required Minimum Distributions

Recently, the IRS issued a memo regarding missing participants, beneficiaries, and RMDs for 403(b) plans. If an employee benefit plan is subject to the RMD rules of Code Section 401(a)(9), then distributions of a participant’s accrued benefits must commence April 1 of the calendar year following the later of 1) the participant attaining age 70½ or 2) the participant’s severance from employment. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, RMDs was temporarily waived for retirement plans for 2020. This change applied to defined contribution plans, such as 401(k), 403(b), 457(b) plans and IRAs. 

In addition, RMDs were waived for IRA owners who turned 70½ in 2019 and were required to take an RMD by April 1, 2020 and have not yet done so. Do note the waiver will not alter a participant’s required beginning date for purposes of applying the minimum distribution rules in future periods. Although you may be applying this waiver during 2020, it is important you prepare to make RMDs once the waiver period ends by verifying participants eligible to receive RMDs are not “missing.”

There are instances in which plans have been unable to make distributions to a terminated participant due to an inability to locate the participant. In this situation, the responsible plan fiduciary should take the following actions in applying the RMD rules:

  1. Search the plan and any related plan, sponsor and publicly available records and/or directories for alternative contact information;
  2. Use any of the following search methods to locate the participant: a commercial locator service, a credit reporting agency, or a proprietary internet search tool for locating individuals; and
  3. Attempt to initiate contact via certified mail sent to the participant’s last known mailing address, and/or through any other appropriate means for any known address(es) or contact information, including email addresses and telephone numbers.

If the plan is selected for audit by the IRS and the above actions have been taken and documented by the plan, the IRS instructs employee plan examiners not to challenge the plan for violation of the RMD rules. If the plan is unable to demonstrate that the above actions have been taken, the employee plan examiners may challenge the plan for violation of the RMD rules.

We typically recommend management review plan records to determine which participants have attained age 70½. Based on the guidelines outlined above, we recommend plans document the actions they have taken to contact these participants and/or their beneficiaries.

Hardship distribution rules

A common issue we identify during our employee benefit plan audits is that the rules for hardship distributions are not always followed by the plan sponsor. If the plan allows hardship withdrawals, they should only be provided if (1) the withdrawal is due to an immediate and heavy financial need, (2) the withdrawal must be necessary to satisfy the need (you have no other funds or ways to meet the need), and (3) the withdrawal must not exceed the amount needed. You may have noted we did not add the plan participant must have first obtained all distribution or nontaxable loans available under the plan to the list of requirements above. This is due to the recently enacted Bipartisan Budget Act of 2018 (the Act), which removed the requirement to obtain available plan loans prior to requesting a hardship. Thus, the removal of this requirement may increase the number of eligible participants to receive hardship withdrawals, if the three requirements noted are satisfied. The plan sponsor should maintain documentation the requirements for the hardship withdrawal have been met before issuing the hardship withdrawal.

The IRS considers the following as acceptable reasons for a hardship withdrawal:

  1. Un-reimbursed medical expenses for the employee, the employee’s spouse, dependents or beneficiary.
  2. Purchase of an employee's principal residence.
  3. Payment of college tuition and related educational costs such as room and board for the next 12 months for the employee, the employee’s spouse, dependents, beneficiary, or children who are no longer dependents.
  4. Payments necessary to prevent eviction of the employee from his/her home, or foreclosure on the mortgage of the principal residence.
  5. For funeral expenses for the employee, the employee’s spouse, children, dependents or beneficiary.
  6. Certain expenses for the repair of damage to the employee's principal residence.
  7. Expenses and losses incurred by the employee as a result of a disaster declared by the Federal Emergency Management Agency (FEMA), provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster.

Prior to the enactment of the Act, once a hardship withdrawal was taken, the plan participant would not be allowed to contribute to the plan for six months following the withdrawal. The Act repealed the six-month suspension of elective deferrals, thus plan participants are allowed to continue making contributions to the plan in the pay period following the hardship withdrawal. Prior to the Act we had seen instances where the plan participant was allowed to continue making contributions after the hardship withdrawal was taken. Now we would expect participants who received a hardship distribution to continue making elective deferrals following receipt of the distribution.

Coronavirus-related distributions

Under section 2202 of the CARES Act, qualified participants who are diagnosed with coronavirus, whose spouse or dependent is diagnosed with coronavirus, or who experience adverse financial consequences due to certain virus-related events including quarantine, furlough, or layoff, having hours reduced, or losing child care, are eligible to receive a coronavirus-related distribution. 

Distributions are considered coronavirus-related distributions if the participant or his/her spouse or dependent has experienced adverse effects noted above due to the coronavirus, the distributions do not exceed $100,000 in the aggregate, and the distributions were taken on or after January 1, 2020 and on or before December 30, 2020.  Such distributions are not subject to the 10% penalty tax under Internal Revenue Code (IRC) § 72(t), and participants have the option of including their distributions in income ratably over a three year period, or the entire amount, starting in the year the distribution was received. Such distributions are exempt from the IRC § 402(f) notice requirement, which explains rollover rules, as well as the effects of rolling a distribution to a qualifying IRA and the effects of not rolling it over. Also, participants can be exempt from owing federal taxes by repaying the coronavirus-related distribution. 

Participants receiving this distribution have a three-year window, starting on the distribution date, to contribute up to the full amount of the distribution to an eligible retirement plan as if the contribution were a timely rollover of an eligible rollover distribution. So, if a participant were to include the distribution amount ratably over the three-year period (2020 – 2022), and the full amount of the distribution was repaid to an eligible retirement plan in 2022, the participant may file amended federal income tax returns for 2020 and 2021 to claim a refund for taxes paid on the income included from the distributions, and the participant will not be required to include any amount in income in 2022. We recommend the plan sponsor maintain documentation supporting the participant was eligible to receive the coronavirus-related distribution. 

There is much uncertainty due to the current status of the COVID-19 pandemic, and this has forced many of our clients to review and alter their control environments to maintain effective operations. With this uncertainty comes changes to guidance and treatment of plan transactions. We have provided our current understanding of the guidance the IRS has provided for the treatment surrounding distributions, specifically RMDs, hardship distributions, and coronavirus-related distributions. If you and your team have any additional questions which may be specific to your organization or plan, an expert from our Employee Benefits Audit team will be gladly willing to assist you. 
 

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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

Read this if you are a small retailer in Massachusetts.

If you are a small retailer in Massachusetts, it’s likely you are already making efforts to prepare for the upcoming sales tax holiday that’s set to occur on August 14 and 15. Perhaps you have been advertising the savings to your customers, in an effort to generate more foot traffic, or putting additional signage on your door, next to your register, or on the cash wrap.  

All good steps to take, and another essential step is to educate your staff on the additional measures that need to be taken to ensure all generated sales are recorded properly.  

Larger retailers have the ability to program these types of events into their point-of-sale systems, including assigning dates and times of the promotion, types of products effected, and many more. This is nothing new for your local box store, for example. However, for the small retailer, this type of event requires much more manual intervention.  

Small retailer approaches, tips, and tricks

Turning sales tax on and off for your complete inventory is easy for most POS systems. But what if only some of the products you offer are eligible for the sales tax exemption? What is the best approach to take?

For the platform that offers inventory file uploads, a wise approach would be to export your current inventory list, adjust the sales tax as needed in Excel, and then import the new file back into the system. This will ensure the appropriate sales tax is captured for the holiday weekend. Don’t forget to do this once more, after the sales tax reprieve has ended.  

Overriding your products individually as a sale occurs may also be necessary for some POS systems. This option will require your sales associates to intervene on each individual transaction. There is great potential for increased human error, particularly in a fast-paced retail environment.  

Making a list and checking it twice

Another good idea to reduce your chance of errors is to meet with your employees at the start of each applicable shift and remind them of the sales tax holiday. Simple but effective, as is adding a simple note to your register. This can offer an additional layer of accountability.

Any sales tax collected in error during this holiday weekend will require payment to the Mass DOR, which will need to be reported on your sales tax return. If a customer discovers they paid unnecessary sales tax during the tax holiday weekend the retailer will be required to refund the customer for the tax collected. In turn, an amended sales tax return will need to be filed, for the month in question. 

When it comes time to reconcile your sales tax for the month of August, you can expect to see a bump in the exempt sales tax you will be required to report. Setting a reminder about the infrequent holiday event on your calendar can speed up your reconciliation process. Again, by writing a quick little note to remind you that you will see unusual activity could alleviate the need for any undue research.

If you have any questions about the upcoming tax holiday, please don’t hesitate to contact our Outsourced Accounting team. We’re here to help.
 

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Massachusetts annual sales tax holiday: Small retailer considerations

Read this if you are a timber harvester, hauler, or timberland owner.

The USDA recently announced its Pandemic Assistance for Timber Harvesters and Haulers (PATHH) initiative to provide financial assistance to timber harvesting and hauling businesses as a result of the pandemic. Businesses may be eligible for up to $125,000 in financial assistance through this initiative. 

Who qualifies for the assistance?

To qualify for assistance under PATHH, the business must have experienced a loss of at least 10% of gross revenue from January, 1, 2020 through December 1, 2020 as compared to the same period in 2019. Also, individuals or legal entities must be a timber harvesting or timber hauling businesses where 50% or more of its revenue is derived from one of the following:

  • Cutting timber
  • Transporting timber
  • Processing wood on-site on the forest land

What is the timeline for applying for the assistance?

Timber harvesting or timber hauling businesses can apply for financial assistance through the USDA from July 22, 2021 through October 15, 2021

Visit the USDA website for more information on the program, requirements, and how to apply.
If you have any questions about your specific situation, please contact our Natural Resources team. We’re here to help. 

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Temporary USDA assistance program for timber harvesters and haulers

Read this is you use QuickBooks Online.

Whether you sell products or services, you may need to create estimates in QuickBooks Online. Here’s how it’s done.

It would be nice if you could just instantly invoice every sale. But sometimes your customers need to know what a particular purchase will cost before they make the decision to buy. So you need to know how to create an estimate. If the sale goes through, you’ll of course want to send an invoice.

QuickBooks Online automates this entire process. It even helps you track the progress of your estimates by providing a special report. Here’s how it works.

Just like an invoice, almost

The process of creating an estimate in QuickBooks Online is almost identical to creating an invoice. You click the New button in the upper left and select Estimate


Creating an estimate in QuickBooks Online is like creating an invoice, with a few differences.

When the form opens, you’ll notice one difference right away. Directly below the Customer field, you’ll see the word Pending next to a small down arrow. Click it to see what your options are here. You’ll be able to update its status later. Select a Customer to get started. If this is a new customer, click + Add New and enter at least the name. If you want to build a more complete profile at this point, click Details and complete the fields in the window that opens. To send a carbon copy or blind copy of the estimate to someone else, click the Cc/Bcc link.

Next to the Estimate date, there’s a field for Expiration date. Enter that and continue on to add the products and/or services that will be included, just as you would on an invoice. If you’re generating an estimate for a new product or service, click + Add new in the drop-down list. A panel will slide out from the right that allows you to create one. 

You’ll see more options for your estimate at the bottom of the page. You can add a message in the message box (or leave the default message if there is one). You can also Customize it, Make recurring, or Print or Preview it. When you’re satisfied, Save it, and send it to the customer. 


You can preview your estimate to see what the customer will see before saving it.

Updating the status

Your estimate will not be considered a transaction until you accept it. To do this, click the Sales link in the toolbar, then All Sales. Find your estimate in the list by looking in the Type column. Click the down arow next to Create invoice to see your other options there. You’ll see that you can Print or Send it or save a Copy

Click Update status. In the window that opens, click the down arrow next to Pending. From the list that drops down, select Accepted. You can also mark it Closed or Rejected. If you choose any of the last three options, another window opens that allows you to enter the name of the individual who authorized the action and the date it was done.

Click Create invoice if your estimate was accepted. You’ll have three options here. You can invoice your customer for:
•    The estimate total.
•    A percentage of each line item.
•    A custom amount for each line.


When you locate your estimate on the Sales Transactions page, you’ll have several options for managing it.

After you’ve made your selection, click Create invoice to open the form with the amounts filled in based on your preference. Complete anything that’s unfinished but do not change any of the product or service line items. Save it, and your invoice is ready to go. You can always check the status of your estimates by running the Estimates by Customer report.

Creating and tracking estimates is as easy as working with invoices. You may run into difficulties, though, if you need to do anything beyond that point with estimates, such as modifying it and re-submitting them. We’re here to answer any questions you might have about this. It’s important that you get your estimates and their subsequent invoices exactly right, so you don’t lose money or sales. Contact our outsourced accounting team if you want to go over these concepts.

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How to create estimates in QuickBooks online

Read this if you are a solar investor, developer, or installer.

The IRS recently released Notice 2021-41 that extends the Continuity Safe Harbor requirements for the production tax credit for qualified facilities under I.R.C. Section 45 (the “PTC”) and the investment tax credit for energy property under I.R.C. Section 48 (the “ITC”). The extension is in recognition of the supply chain delays caused by COVID-19 that are impacting completion of renewable energy projects.

In May 2020, the IRS released Notice 2020-41 to address construction delays caused by the COVID-19 pandemic. The requirements for the PTC and the ITC include provisions establishing methods to determine the beginning of construction and include a continuity requirement—that the project show continuous construction or continuous efforts. Per Notice 2020-41, the continuity requirement is deemed satisfied if the taxpayer “places an energy property in service by the end of a calendar year that is no more than four calendar years after the calendar year during which construction of the energy property began” (Continuity Safe Harbor).

The IRS recognizes that the COVID-19 pandemic has caused extraordinary delays in development of renewable energy projects. As a result, many projects would no longer satisfy the existing four calendar year Continuity Safe Harbor. Notice 2021-41 extends the original Continuity Safe Harbor based on the year the property began construction under the Physical Work Test or the Five Percent Safe Harbor as follows:

  • Any property that began construction in calendar year 2016, 2017, 2018, or 2019 will satisfy the Continuity Safe Harbor if the taxpayer “places an energy property in service by the end of a calendar year that is no more than six calendar years after the calendar year during which construction of the energy property began.”
  • Any property that began construction in calendar year 2020 will satisfy the Continuity Safe Harbor if the taxpayer “places an energy property in service by the end of a calendar year that is no more than five calendar years after the calendar year during which construction of the energy property began.”

If you have questions about your specific situation, please don’t hesitate to contact the Renewable Energy team. We’re here to help.
 

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

There is no question that cryptocurrency has been gaining in popularity over the past few years. It may be hard to believe, but Bitcoin, the first and most commonly known form of cryptocurrency, has been around since the good old days of 2009! What was once only seen as a quasi-asset traded solely on the dark web by a handful of private yet savvy investors has recently begun to step out into the light. With this newly found mainstream popularity come many questions from the not-for-profit (NFP) sector about how their organizations should proceed when it comes to donations of cryptocurrency, and how they might benefit (or not) from doing so. 

This article will answer some of the questions we’ve received from clients in this area and attempt to shed some light on the tax reporting and compliance requirements around cryptocurrency donations for not-for-profit organizations, as well as other topics not-for-profit organizations should consider before dipping their toes into the crypto current.

So, what exactly is cryptocurrency? 

Cryptocurrency is a digital asset. It generally has no physical form (no actual coins or paper money). Further, it is not issued by a central bank and is largely unregulated. Its value is dependent upon many factors, the largest being supply and demand.

Can a not-for-profit organization accept cryptocurrency as a donation?

Yes! For tax purposes, cryptocurrency is considered noncash property, and is perfectly acceptable for not-for-profit organizations to accept.

With that said, NFPs absolutely need to review and update their gift acceptance policies as necessary as to whether or not they are willing to accept cryptocurrency. Having a clear and established policy position in place one way or the other can mitigate any confusion or misunderstanding between the organization and a potential donor.

The organization may also want to consider adding language to the policy regarding its intent to either hold the asset or sell it as soon as administratively possible. A savvy donor may request that the organization hold the cryptocurrency donation for a period of time after the donation is made, so organizations will want to have clear policies in place.

What about acknowledging the donor’s gift?

Standard donor acknowledgement rules still apply. Any donation of $250 or more requires a standard “thank you” acknowledgement to the donor. Remember, the IRS has deemed cryptocurrency to be noncash property, which means a description of the donated property (but not its value) should be mentioned in the donor acknowledgement.

Are there any other forms I need to be aware of?

Yes. Forms 8283 & 8282 apply to donations of cryptocurrency. Where the donation is noncash, the donor should be providing the organization with Form 8283, Noncash Charitable Contributions, for a claimed value of more than $500. Further, if the claimed value is more than $5,000, the Form 8283 should be accompanied by a qualified appraisal report. Form 8283 should be signed by the donor, the qualified appraiser (if applicable), as well as the recipient organization upon acceptance.

NOTE: Form 8283, Part V, Donee Acknowledgement, contains a yes/no question asking if the organization intends to use the property for an unrelated use. Where the property in question is cryptocurrency, the answer to this question is likely always to be ‘yes’.

Should the organization sell the underlying cryptocurrency within three years of acceptance, the organization must complete Form 8282, Donee Information Return, and file a copy with the IRS as well as providing a copy to the original donor. Other rules apply if the organization transfers the property to a successor donee.

NOTE: Organizations may want to consider referencing the Forms 8283 & 8282 in their aforementioned gift acceptance policy.

How is a cryptocurrency donation reported on the financial statements and Form 990?

If donated and held by the organization as of the end of the year, it will be reported as an intangible asset on the balance sheet, and contribution revenue on the statement of activities. 

Similar reporting would follow for 990 purposes—the donation would be reported as part of noncash contribution revenue with additional reporting on 990, Schedule B, Schedule of Contributors, and Schedule M, Noncash Contributions, as necessary.

Why should I accept cryptocurrency?

This is by far the hardest question to answer, for a variety of reasons. There is no question that cryptocurrency has its risks. Cryptocurrency is known to be highly volatile. Bitcoin, which originally was valued at eight cents per coin in 2010 soared to an all-time high of over $63,000 back in April of 2021—and then two months later sold for around $34,000 per coin. And who could forget the recent Dogecoin (I’m still not sure how to pronounce that) phenomenon? It too in recent months became a sensation only to see its value plummet by almost 30% in a single day after an appearance by Elon Musk on Saturday Night Live (it did subsequently rebound after a Musk tweet).

The fact is no one really knows where the value of cryptocurrency is headed, so should a not-for-profit organization decide to proceed, you should be aware it may not be worth what it was when originally accepted, which could be either good or bad depending on the day. Ultimately, any value is still good for a not-for-profit organization, but the risks with cryptocurrency and its volatility are very real.

Other things to know about crypto

As of right now, cryptocurrency has its own trading platforms. Robinhood, a platform in the news recently when it halted trading of Gamestop’s stock when speculative traders got the price to soar to all new highs, being the most well known. Large investment firms are well on their way to creating their own platforms as cryptocurrency gains in popularity, so we certainly recommend speaking with your current investment advisors to find the platform that best suits your needs.

Cryptocurrency is held in a digital wallet, which can only be accessed by a password, or private keys. Digital wallets can be stored locally on a computer, but there are also web-based wallets.

There have been horror stories about people losing or forgetting passwords, ultimately rendering the cryptocurrency worthless because it cannot be accessed. Cryptocurrency, due to its private nature, is very desirable by hackers who could also potentially access the wallet and steal its contents. And if stored locally, the currency could be lost forever if the computer containing the wallet were to become corrupted or compromised.

Organizations holding cryptocurrency will need to ensure proper internal controls are in place to make sure the funds are secure and cannot be easily accessed or potentially stolen. Working with your internal IT department is a good strategy here. The questions above are not intended to be all inclusive. Cryptocurrency is still finding its way in the world and we’ll continue to keep an eye on any developments and keep clients up to date as cryptocurrency continues to expand its reach and as further guidance is issued.

If you have any questions, please contact me or another member of our not-for-profit tax services team. We're here to help.

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Read this if you are a New Hampshire resident, or a business owner or manager with telecommuting employees (due to the COVID-19 pandemic).

In late January, the Supreme Court asked the Biden Administration for its views on a not-so-friendly neighborly dispute between the State of New Hampshire and the Commonwealth of Massachusetts. New Hampshire is famous amongst its neighboring states for its lack of sales tax and personal income tax. Because of the tax rules and other alluring features, thousands of employees commute daily from New Hampshire to Massachusetts. Overnight, like so many of us, those commuters were working at home and not crossing state boundaries.

As a result of the pandemic and stay-at-home orders, Massachusetts issued temporary and early guidance, directing employers to maintain the status quo. Keep withholding on your employees in the same manner that you were, even though they may not be physically coming into the state. New Hampshire was against this directive from day one and sought to sue Massachusetts over its COVID-19 telecommuting rules for employees who had previously been sitting in an office in the Bay State. The final nail in the coffin was an extension of the guidance in October. 

New Hampshire’s position
New Hampshire took particular issue because it does not impose an Individual Income Tax on wages and it believed that the temporary regulations issued by the Commonwealth overstepped or disregarded New Hampshire’s sovereignty—in violation of the both the Commerce and Due Process Clauses of the U.S. Constitution. Each clause has historically prohibited a state from taxing outside its borders and limits tax on non-residents. For Massachusetts employers to continue withholding on New Hampshire residents' wage earnings, New Hampshire argues, Massachusetts is imposing a tax within New Hampshire, contrary to the Constitution.

What makes the New Hampshire situation unique is that it does not impose an income tax on individuals, a “defining feature of its sovereignty”, the state argues. New Hampshire would say that its tax regime creates a competitive advantage in attracting new business and residents. Maine residents, subject to the same Massachusetts rules, would receive a corresponding tax credit on their Maine tax return, making them close to whole between the two states. Because there is no New Hampshire individual income tax, their residents are out of pocket for a tax that they wouldn’t be subject to, but for these regulations.

Massachusetts’ position
Massachusetts' intention behind the temporary regulations was to maintain pre-pandemic “status quo” to avoid uncertainty for employees and additional compliance burden on employers. This would ensure employers would not be responsible for determining when an employee was working, for example, at their Lake Winnipesaukee camp for a few weeks, or their relative’s home in Rhode Island. 

Additionally, states like New York and Connecticut have long had “convenience of the employer” laws on the books which imposed New York tax on telecommuting non-residents. Additionally, Massachusetts provided that a parallel treatment will be given to resident employees with income tax liabilities in other states who have adopted similar sourcing rules, i.e., a Massachusetts resident working for a Maine employer.

Other voices
The US Supreme Court requested a brief from the Biden administration. Additionally, many states wrote to the court on behalf of New Hampshire. To demonstrate the impact a decision against New Hampshire could have, New Jersey said that it expects to issue $1.2 Billion in tax credits to its residents because New York declined to loosen their strict telecommuting rules. In the final days before the Court recessed, it declined to hear the case brought by the State of New Hampshire against the Commonwealth of Massachusetts. Had the Court decided to move forward with the case, it stood to impact long-standing, pre-pandemic telecommuting rules by New York and others.

What now?
For Massachusetts employers specifically, you should review current withholdings and ensure compliance with the temporary regulations. The state of emergency has been lifted in Massachusetts, and the rules have an end date of September 19, 2021. Employers who haven’t been following the regulations will have a costly tax exposure to correct. 

Massachusetts’ temporary regulations were not unique as dozens of states issued temporary regulations asserting a “status quo” regime for those employees who would normally be commuting outside their home state. Unwinding from the pandemic is going to be a long road, and for all employers, it’s important that you review the rules in each state of operation and confirm that the proper withholding is made.

If you have questions about your specific situation, please contact the state and local tax consulting team. We’re here to help.

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New Hampshire v. Massachusetts: Sovereignty or status quo?

Read this if you are a business owner. 

Consider the value of the following two hypothetical companies. Roger owns Wag More, Bark Less (WMBL), a pet service company that employs 10 full-time dog walkers. Anita owns a very similar company, Happy Dog Walking Service (Happy Dog), which also happens to employ 10 full-time dog walkers. These companies are both almost identical, and last year, they generated the same amount of revenue and income. A key difference, however, is in the management styles of the owners. Roger is extremely disorganized and has difficulty with record retention, locating information, and tracking and analyzing data. He is relatively inexperienced as a manager. Anita, meanwhile, is very punctual and organized and has 15 years of management experience. She is very capable of monitoring dog-walking data to optimize routes, manage employee utilization, and track client satisfaction. Which company is more valuable? 

Despite being identical in terms of service offering and size, most people would identify Happy Dog as being more valuable. Alarm bells start to ring in a valuation analyst’s head when learning about the sloppy management style, lack of experience, and poor use of data at WMBL. The difference in value should be substantial. Despite generating the same amount of profit last year, Happy Dog could be worth twice as much as WMBL because these risk factors may jeopardize future profits.

In addition to the risk factors from the above example, there are many other drivers of business value.

Valuation formula

In its simplest form, the valuation of a business can be reduced to the following formula based on earnings before interest, taxes, depreciation, and amortization (EBITDA). Factors that affect value do so by affecting the valuation multiple. Companies such as WMBL would be worth a lower multiple of EBITDA, and a higher multiple would be justified for less risky companies such as Happy Dog. 

Estimating an EBITDA multiple

A generic multiple often thrown around is 5x EBITDA. EBITDA multiples from the DealStats database show a slightly lower average over time. From 2017 to 2019, the EBITDA multiples were around 5x, then declined in 2020 and 2021. The chart below shows trends in historical EBITDA multiples.1 

Median Selling Price/EBITDA with Trailing Three-Quarter Average


In reality, EBITDA multiples vary widely by industry. For example, in the DealStats database, the median EBITDA multiple for retail trade was 3.8x compared to 6.5x for manufacturing companies.2 The chart below presents EBITDA multiples by industry from the DealStats database.

Selling Price/EBITDA Interquartile Range by Industry Sector (Private Targets)


Even within a specific industry, multiples can vary dramatically. For example, from the chart above, the median wholesale trade multiple was slightly above 5.0x, but the 75th percentile multiple for this industry was approximately 10.0x. 

Factors affecting EBITDA multiples

Differences in valuation multiples from company to company reflect differences in risk profiles. High-risk companies command lower multiples than safe investments. The following chart illustrates how certain operational risk factors may affect the valuation multiple.

Other factors that affect valuation multiples include the following:

  • Access to capital
  • Supplier concentration 
  • Supplier pricing advantage 
  • Product or service diversification 
  • Life cycle of current products or services 
  • Geographical distribution 
  • Currency risk 
  • Internal controls 
  • Business owner reliance
  • Legal/litigation issues 
  • Years in operation
  • Location   
  • Demographics 
  • Availability of labor 
  • Employee stability 
  • Internal and external culture 
  • Economic factors 
  • Industry and government regulations 
  • Political factors 
  • Fixed asset age and condition 
  • Strength of intangible assets 
  • Distribution system 
  • IT systems 
  • Technology life cycle 

One model to assess risk and select an appropriate multiple is the exit and succession planning software prepared by MAUS Business Systems (“MAUS”). The MAUS Business Attractiveness model assists analysts in assessing and diagramming the risk profile of a company. This model was developed to assess business attractiveness to potential acquirers based on common risk factors. Analysts can use this software as part of their assessment of an appropriate valuation multiple. This model is also a helpful communication tool because it provides a visual representation of a company’s risk profile and highlights the areas in which a company can improve. 

Using this model, analysts assess a company’s risk profile regarding several key factors. MAUS then generates a report that includes a series of diagrams like the one below. Business attractiveness factors are positioned around the outside of a polygon. If a company performs well regarding a particular factor, a point is plotted towards the outside of the polygon. If the company performs poorly, a point is plotted towards the center of the shape. The points are then connected to visualize a company’s risk profile. 

Business Risk & Value Factors

         

The larger the colored shape is in the MAUS diagram, the higher the valuation multiple should be. However, these factors do not all affect the multiple equally. The valuation multiple may be highly responsive to some factors and less responsive to others. Additionally, each factor may not have a linear effect on the valuation multiple. For these reasons, formula-based estimates of valuation multiples are often inaccurate, although a great place to start for a ballpark indication of value. For matters of importance where accuracy is paramount, we strongly recommend consulting with a valuation professional. In addition to valuation expertise, an outside party provides an independent, unbiased assessment of value. 

Conclusion

The value of a business can be affected dramatically by its risk profile. Analysts value businesses based on a number of different factors that affect value. 

1,2 DealStats Value Index 2Q 2021, Business Valuation Resources, LLC (www.bvresources.com).

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Factors affecting the value of a company