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Electric vehicles: Convergence of the industry

04.12.22

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

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

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

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

The market for electric vehicles

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

Regulation

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

Consumer behavior

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

Technology

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

Are electric vehicles here to stay?

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

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

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

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

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


 
Headwinds to transition

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

Chips

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

Battery prices

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

 Charging infrastructure

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

New business models

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

Impact on after-market spending and margins

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

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

Implications and key takeaways for dealers

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

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

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

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

The path forward

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

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

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

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

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

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The US Department of the Treasury and the Internal Revenue Service on November 29 announced the release of guidance providing taxpayers information on how to satisfy the prevailing wage and apprenticeship requirements to qualify for enhanced tax benefits under the Inflation Reduction Act’s clean energy provisions. 

The publication of Notice 2022-61 and further guidance in the Federal Register—published on November 30, 2022—begins the 60-day period for these key labor provisions to take effect. In other words, these requirements will apply to qualifying facilities, projects, property, or equipment for which construction begins on or after January 30, 2023. So, in order to receive increased incentives, taxpayers must meet the prevailing wage and apprenticeship requirements for facilities where construction begins on or after January 30, 2023.

Prevailing wage and apprenticeship requirements

The Inflation Reduction Act, which President Biden signed into law on August 16, 2022, introduced a new credit structure whereby many clean energy tax incentives are subject to a base rate and a “bonus multiplier” of 5X. To qualify for the bonus rate, projects must satisfy certain wage and apprenticeship requirements implemented to ensure both the payment of prevailing wages and that a certain percentage of total labor hours are performed by qualified apprentices. 

Projects under 1MW or that begin construction within sixty days of the date when the Treasury publishes guidance regarding the wage and apprenticeship requirements are automatically eligible for the bonus credit.

The newly released guidance addresses the Inflation Reduction Act's two labor requirements—providing prevailing wages and employing a certain amount of registered apprentices—that taxpayers must meet for clean energy developments to qualify for the bonus rate. Both the prevailing wage and apprenticeship requirements apply to the following tax incentives:

  • Advanced energy project credit
  • Alternative fuel refueling property credit
  • Credit for carbon oxide sequestration
  • Clean fuel production credit
  • Credit for production of clean hydrogen
  • Energy-efficient commercial buildings deduction
  • Renewable energy production tax credit
  • Renewable energy property investment tax credit

The prevailing wages requirements also apply to the following tax incentives:

  • New zero-efficient home credit
  • Zero-emissions nuclear power production credit

New guidance

The new guidance describes the process for identifying the applicable wage determination for a specific geographic area and job classification on the Department of Labor’s sam.gov website. If no prevailing wage determination is posted for a specific geographic area and/or job classification, the notice provides that taxpayers should contact the DOL’s Wage and Hour Division, which would then provide the taxpayer with the labor classifications and wage rates to use.

For purposes of the apprenticeship requirements, the guidance provides specific information regarding the apprenticeship labor hour, ratio, and participation requirements. The guidance also describes the good faith effort exception, whereby a taxpayer will be deemed to have satisfied the apprenticeship requirements with respect to a facility if the taxpayer has requested qualified apprentices from a registered apprenticeship program and the request has been denied or the program fails to respond the request within five business days.

The guidance also specifies the recordkeeping requirements taxpayers must comply with to substantiate that they paid workers a prevailing wage and satisfied the apprenticeship requirements.

Beginning of construction guidance

As mentioned above, taxpayers must meet the prevailing wage and apprenticeship requirements with respect to a facility to receive the increased credit or deduction amounts if construction of the facility begins on or after the date sixty days after the Treasury publishes guidance. Notice 2022-61 confirms the use of long-standing methods for establishing the date of beginning of construction:

  • The physical work test (starting physical work of a significant nature)
  • The 5% safe harbor (incurring 5% or more of the total cost of the facility)

For purposes of both tests, taxpayers must demonstrate either continuous construction or continuous efforts—the continuity requirement—for beginning of construction to be satisfied.

Article
Treasury issues prevailing wage and apprenticeship requirements guidance

Read this if you are a Maine business or pay taxes in Maine.

Maine Revenue Services has created the new Maine Tax Portal, which makes paying, filing, and managing your state taxes faster, more efficient, convenient, and accessible. The portal replaces a number of outdated services and can be used for a number of tax filings, including:

  • Corporate income tax
  • Estate tax
  • Healthcare provider tax
  • Insurance premium tax
  • Withholding
  • Sales and use tax
  • Service provider tax
  • Pass-through entity withholding
  • BETR

The Maine Tax Portal is being rolled out in four phases, with two of the four phases already completed. Most tax filings for both businesses and individuals are now available. A complete listing can be found on maine.gov. Instructional videos and FAQs can also be found on this site.

In an effort to educate businesses and individuals on the use of the new portal, Maine Revenue Services has been hosting various training sessions. The upcoming schedule can be found on maine.gov

Article
New Maine Tax Portal: What you need to know

Read this if you are a financial institution with income tax credit investments.

Financial institutions and other businesses that participate in tax credit investments designed to incentivize projects that produce social, economic, or environmental benefits could benefit from proposed rules that simplify the accounting treatment of such investments and result in a clearer picture of how these investments impact their bottom lines.

FASB proposal

On August 22, 2022, the Financial Accounting Standards Board (FASB), issued a proposal that would broaden the application of the accounting method currently available to account for investments in low-income housing tax credit (LIHTC) programs to other equity investments used to generate income tax credits. The proposal, titled “Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method”, would expand the eligibility of the proportional amortization method of accounting beyond LIHTC programs to other tax credit structures that meet certain eligibility criteria.  

FASB introduced the option to apply the proportional amortization method to account for investments made primarily for the purpose of receiving income tax credits and other income tax benefits in ASU 2014-01. However, the guidance limited the proportional amortization method to investments in LIHTC structures.

The proportional amortization method is a simplified approach for accounting for LIHTC investments in which the initial cost of the investment is amortized in proportion to the income tax credits and other benefits received (allocable share of depreciation deductions). The cost basis amortization and income tax credits received are presented net on the investor’s income statement as a component of income tax expense (benefit). Under existing guidance, investments in non-LIHTC projects are accounted for using either the equity method or cost method, depending on certain factors. 

The proposal aims to address the concerns that the equity and cost methods do not offer a fair representation of the economic characteristics for investments for which returns are primarily related to federal income tax credits. Supporters of the proposal argue that the accounting method applied should not be determined by the legislative program under which the tax credits are authorized, but instead by the economic intent under which the investment was made. The hope is the FASB proposal will create a heightened sense of uniformity in accounting for investments in income tax credit structures. 

Additional provisions

Other provisions within the proposal would require a reporting entity to “make an accounting policy election to apply the proportional amortization method on a tax-credit-program-by-tax-credit-program basis” and disclose the nature of its tax equity investments and the impact on its financial position and results of operations. 

The significance of this proposal is amplified by the uptick in tax credit programs in recent years, including the New Markets Tax Credit (NMTC), Historic Rehabilitation Tax Credit (HTC), and Renewable Energy Tax Credit (RETC). While the FASB has yet to declare an effective date for the implementation of the proposal, comment letters from stakeholders were due October 6, 2022. 

For more information

To discuss the impact this new accounting pronouncement may have on your financial institution, please contact the BerryDunn Financial Services team. We’re here to help.

Article
FASB proposes changes to accounting for income tax credits

The Pennsylvania Commonwealth Court (one of Pennsylvania’s appellate-level courts) has unanimously ruled that the Pennsylvania Department of Revenue (the Department) could not assert nexus against out-of-state online businesses that sell merchandise through Amazon’s Fulfillment by Amazon (FBA) program. (Online Merchants Guild v. Hassell, Commonwealth Court of Pennsylvania, No. 179 M.D. 2021, September 9, 2022).

Case details 

The Online Merchants Guild case is one of the first state court decisions since the US Supreme Court’s Wayfair decision to apply Due Process Clause nexus to internet sellers. The main issue before the court was whether non-Pennsylvania merchants that sell through Amazon’s FBA program are subject to the sales tax and personal income tax (PIT) provisions of the state’s tax code because Amazon stored their merchandise inventory in warehouses located in Pennsylvania. Fulfillment by Amazon is a service that allows businesses to outsource order fulfillment to Amazon. Businesses send products to Amazon fulfillment centers and when a customer makes a purchase, Amazon picks, packs, and ships the order. Ever since the US Supreme Court’s Quill decision, the Due Process Clause’s “minimum contacts” nexus has only required an out-of-state business to have purposefully availed itself of a state’s market, including purely economic connections with the state. 

Ultimately, the court held that the Department failed to provide sufficient evidence that non-Pennsylvania businesses selling merchandise through the FBA program have sufficient contacts with the state. The court reasoned the connections to the state were shown to be limited to the storage of merchandise by Amazon in one of Amazon’s Pennsylvania warehouses. As such, FBA sellers do not have sufficient contacts with the state such that the Department can mandate they collect and remit sales tax or pay PIT.

While analyzing the specific facts of this case, the court indicated that an FBA seller has no control over its merchandise once Amazon receives the inventory. Applying the Due Process Clause and the so-called stream-of-commerce theory, the court stated that it is “hard pressed to envision how, in these circumstances, an FBA merchant has placed its merchandise in the stream of commerce with the expectation that it would not be purchased by a customer located in [Pennsylvania], or has availed itself of [Pennsylvania’s] protections, opportunities, and services.”

The court also addressed the Department’s authority of its nexus-auditing policy of issuing Business Activity Questionnaires (BAQs) to the FBA sellers. The 2021 BAQ indicates that a business may be subject to tax due to the storage of merchandise in one of Amazon’s Pennsylvania warehouses. The Department argued that the BAQ was merely a “demand for information.” The court disagreed with the Department. The BAQ indicates that “[f]ailure to provide the information requested will result in additional enforcement actions,” language that clearly suggests the existence of pending enforcement actions according to the court. The court was critical of the Department’s arguments, stating that the Department’s statutory investigative powers apply to the records of taxpayers, not individuals or entities the Department suspects may be taxpayers. The court went on to say that the Department does not have “unfettered authority to seek business information from any person or entity it desires for the purpose of determining its status as a taxpayer.”

Insights

  • The Department did not appeal to Pennsylvania’s Supreme Court “as of right” within 30 days. As such, the Commonwealth Court’s precedential opinion will likely be the final word in the nexus saga for Amazon FBA sellers in Pennsylvania, especially due to the fact that Amazon now collects sales tax on Pennsylvania sales. From the Department’s perspective, the outcome of this case is limited to a narrow situation—Amazon FBA sellers. If there is another fact pattern where a business is aware of its inventory in the state, it is possible nexus may be asserted by the state.
  • The tax period at issue in Online Merchants Guild preceded the enactment of Pennsylvania’s marketplace facilitator nexus statute. Although most states’ marketplace facilitator nexus laws have existed for several years, it is possible that other states will continue to attempt to collect sales tax from marketplace sellers for periods before the enactment of those laws.
  • The outcome of this case is limited to sales tax and PIT. It did not address Pennsylvania’s corporate net income tax (CNIT). Pennsylvania’s CNIT imposition statute includes an “owning property in the state” provision. Would the decision under the same fact pattern, but for CNIT purposes, have been different? Without a legislative amendment, businesses should analyze their specific facts and circumstances, apply Pennsylvania’s CNIT rules, and address whether they have nexus in the state for CNIT purposes.
  • This case was originally prompted by a trade association (Online Merchants Guild) in response to a Business Activities Questionnaire (BAQ) request it received as part of the Department of Revenue’s voluntary disclosure program for retailers with inventory in Pennsylvania in 2021. As a result of the decision, we expect the Department to update their administrative guidance on this topic.

Written by Ilya Lipin, Melissa Myers and Zach Lutz. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

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Pennsylvania: Remote sales via Amazon FBA did not create sales tax and personal income tax nexus.

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

With autumn now in full swing the NFP tax team finds itself in the calm before the storm with the 990 filing deadline on August 15 firmly in the rearview mirror and the November 15 deadline looming—much like winter. This brief lull between deadlines allows for a period of reflection. I myself have been reflecting on some of the issues I’ve seen over the past filing season on Form 990s, which I felt compelled to share. Here is my top five list of observations of this year's Form 990 filings.

Schedule B reporting

By now, most are familiar with Schedule B of Form 990. One of the lone holdouts from the pre-2008 “old” Form 990 (back when we only had Schedules A & B, now Schedules A all the way to R), Schedule B generally requires organizations to list out any donor who contributed $5,000 or more to the organization during the year.

While the disclosure appears straightforward, one of the variables that did change back in 2008 was that Schedule B is now required to be reported on the same accounting method as the organization’s books and records, and not exclusively on a cash basis, as was the requirement under the old rules.

Often-times we find that certain sections of the 990 information request are divvied up and completed by different organizational departments, with Schedule B often being tasked to the folks in the organization’s development/fundraising department. Because of this, we sometimes receive back information that is not reported correctly.

Unfortunately, the only way we know if there’s any issue is if total contribution income on the financial statements is less than is what is being reported to us on the Schedule B worksheet. Almost always, we find there’s a donor (or two) making payments on an amount previously pledged and the amount of cash received in the current year is being disclosed on Schedule B, which is incorrect. 

(Note: the example above implies the organization is on the accrual method of accounting, therefore the amount pledged was recorded as revenue when pledged. Subsequent payments on said pledge would not be recorded as revenue, causing the disconnect between contribution income for financial statement purposes and what is reported as contributions on Schedule B).

The rule of thumb is that organizations should follow what was recorded as contribution revenue during the year on the books (whether on a cash or accrual method of accounting) and then compile your list of donors from there. We could debate all day the somewhat intrusiveness of the Schedule B disclosure requirements, so we only want to disclose those that must be shown.


Conflicts of interest

It’s considered a best practice for all NFPs to check for any conflicts of interest (specifically with members of governance and management) at least annually. While most organizations do this diligently and far more often than once a year, I want to point out that the 990 has an entire schedule devoted to reporting of “interested persons”—that being Schedule L. Interested persons go beyond just corporate officers and members of the board; they also can be family members as well as business entities that are more than 35% owned or controlled by any of the above. Your organization may want to review your procedures as to how you identify potential conflicts to make sure you are also capturing these sorts of relationships.

Reporting thresholds for Schedule L disclosure can vary. If, for example, a board member’s child works for the organization and is paid more than $10,000, they are required to be disclosed and the board member is not considered to be independent by the IRS. Transactions with a business entity owned or controlled by an interested person has reporting thresholds of $10,000 for a single transaction, or $100,000 over the course of the year.

We offer a detailed conflict of interest survey that addresses these questions and more. If interested to learn more about this, please speak to your engagement principal.

Compensation to unrelated organizations

It seems more and more each year we hear some variation of the following: “X sits on our board and works here at the organization, but we don’t pay him/her directly—we pay their company.”

It’s important to know the IRS closed up this reporting loophole long ago and requires organizations to report the amounts paid to an unrelated organization for services they render as if you paid the individual directly. A narrative is also required on Schedule J explaining the arrangement. We find in most cases the organization may not be aware of what exactly X receives for compensation, which is perfectly fine. The narrative on Schedule J can explain this and that what’s being reported as compensation to X is the amount paid to the unrelated organization, and not necessarily what X’s compensation is. In any event, it is not appropriate to say that X receives nothing.

Fundraising events

COVID-19 certainly put a damper on most, if not all fundraising events over the past few years, but we’ve started to see some of events come back on the calendar recently, which is a great sign! Just a friendly reminder that if the price of admission to the event is $75 or more, it is necessary to note what items of value a participant is receiving in exchange for the amount of money they pay to attend so they can determine what amount, if any, of their entrance fee is tax deductible.

For example: An organization hosts a golf tournament and charges $100 per person to play. In exchange, the person gets use of a golf cart, a round of golf, and some food/drink on hole 19. The fair market value of everything per person totals $85. In this case, only $15 is tax deductible as a charitable contribution ($100 paid minus $85 value received) and the $85 of value received must be relayed to the attendee.

Should you have any questions as you begin to plan your next round of events, please do not hesitate to reach out to us.

Alternative Investments and Unrelated Business Income (UBI)

What top five list would be complete without at least a mention of UBI? During the pandemic, we saw many clients get more creative in terms of generating revenue sources, particularly in terms of alternative investments that typically come in the form of a partnership interest and can carry with them significant tax consequences, which are not always brought to the forefront at the time the investment is made. More than a few clients have been more than surprised (and less than impressed) to receive a Schedule K-1 at the end of year which not only contains UBI, but UBI that is spread over six different states, some, or all of which may require you to file tax returns. If the alternative investment happens to be domiciled overseas, that can bring with it its own set of obligations. You can read more about this here

It is vital for all organizations to be engaged in open and frequent communication with their investment managers and advisors (both within and outside the organization) to help ensure a full understanding of what sorts of obligations may stem from an investment. Organizations are strongly encouraged to review and share all relevant investment documentation and subsequent information (i.e., prospectus and any other offering materials) with its finance/accounting department, as well as its tax advisors prior to making the investment.

Just some things for you to think about as the next 990 filing deadline will be here before you know it. I hope you all enjoy the cooler temperatures and colorful foliage, and you all find some time to do whatever it is that brings you joy and peace. As for me, I think it’s time to get a hobby! 

If you have any questions about your specific situation, please feel free to contact our not-for-profit tax team.

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990 filing: Considerations for not-for-profit organizations

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its second quarter 2022 Quarterly Banking Profile. The report provides financial information based on call reports filed by 4,771 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In second quarter 2022, this section included the financial information of 4,333 FDIC-insured community banks. BerryDunn’s key takeaways from the report are as follows:

Community banks see quarterly growth in net income despite year-over-year decline.

Community bank quarterly net income increased to $7.6 billion in second quarter 2022, despite being down $523.0 million from one year ago. Higher noninterest expense, lower noninterest income, and higher provision expense offset growth in net interest income. Nearly three-quarters of community banks reported higher net income than one quarter ago. More than two-thirds of community banks reported an increase in net interest income from the year-ago quarter.


Loan and lease balances continue to show widespread growth in second quarter 2022.

Community banks saw a $82.3 billion increase in loan and lease balances from first quarter 2022. All major loan categories except commercial & industrial (C&I) and agricultural production grew year over year, and 69.9% of community banks reported annual loan growth. Total loan and lease balances increased $125.4 billion, or 7.7%, from one year ago. Excluding Paycheck Protection Program loans, annual total loan growth would have been 14.0% and annual C&I growth would have been 21.9%.

Community bank net interest margin (NIM) increased to 3.33% due to strong interest income growth.

Community bank NIM increased eight basis points from the year-ago quarter and 22 basis points from first quarter 2022. Net interest income growth exceeded the pace of average earning asset growth. The average yield on earning assets rose 25 basis points while the average cost of funding earning assets rose three basis points from the previous quarter. The quarterly increase in NIM was the largest reported since second quarter 1985. However, NIM remains below the pre-pandemic average of 3.63%. 

Slightly more than half of community banks reported quarter-over-quarter reductions in noncurrent loan balances.

The allowance for credit losses (ACL) as a percentage of total loans and leases decreased six basis points from the year-ago quarter to 1.25%. The coverage ratio for community banks is 46.4 percentage points above the coverage ratio for noncommunity banks. The coverage ratio increased 54.1 percentage points from the year-ago quarter to 245.4%, a record high since Quarterly Banking Profile data collection began in first quarter 1984.

It has been a time of momentous change for the banking industry; this has been the case since the pandemic but continues to hold true. The Federal Open Market Committee (FOMC) had already risen the target federal funds rate by 225 basis points in 2022 at the time of writing this summary, with further increases throughout the remainder of 2022 anticipated. Although rising rates have been the largest contributor to strengthening net interest margins, the impact these rate increases will have on the long-term economy is still to be seen.

Inflation also continues to run rampant, with rate increases thus far seeming to be ineffective in slowing inflation. The continued inflation has many wondering if rate increases are not the answer and that there may be other, inalterable forces at play. If this is the case, the FOMC’s target rate increases could have the effect of worsening an economic slowdown. Furthermore, although loan growth remained relatively strong in quarter two, deposit growth waned. Community banks saw only a 0.4% increase in deposits from a quarter ago. This has put some institutions in a liquidity crunch, having to rely more heavily on wholesale funding to fund loan growth. However, making funding decisions has proven to be difficult, given the economic uncertainty and potential target rate increases.

Community banks will have to continue to remain vigilant and remain a resource to their customers. Banks’ customers are facing many of the same challenges that banks are facing—interest rate uncertainty, rising costs, staffing shortages, etc. Therefore, as we’ve previously mentioned, it continues to be important for banks to maintain open dialogue with customers. As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions. You can also visit our Ask the Advisor page to submit your questions.

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FDIC Issues its Second Quarter 2022 Quarterly Banking Profile

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

With the 990 filing deadline of August 15 firmly in the rearview mirror, and with our NFP tax team getting to take some well-deserved late summer paid time off, I have a small window of time for some reflection on the filing season. Some of us choose to wind down with a good book, maybe mull over what to do with the last remaining weeks of summer before the inevitability of Labor Day, or perhaps you’re deliberating what to get the kiddos as the new school year approaches (mine is still a wee pup so still rather light in that department). I myself have been reflecting on some of the issues I’ve seen on our last round of Form 990s, the vast majority of which are hospital clients with September 30 year ends, which I felt compelled to share. Here is my top five list of observations of this year's Form 990 filings.

  1. 501(r) & hospital websites
    By now, most are familiar with the nuts and bolts of 501(r), but something to be mindful of is the interplay between 501(r) and requirements of what needs to be posted on your hospital’s website. Community health needs assessments and implementation strategies (both the most recent set and two subsequent sets) should be posted online at all times.

    Financial assistance policies (FAP), applications, and plain language summaries need to be online too. Those web addresses are provided on Schedule H for the IRS and general public alike.

    Further, items such as Amounts Generally Billed (AGB) calculations, and the list of providers not covered under your hospital’s FAP should be updated and reviewed at least annually. The IRS, despite their skeleton crew and shoestring budget, can and do vigilantly check and scour hospital websites and send out correspondence for any observed irregularities.
  2. Conflicts of interest
    It’s considered a best practice for all NFPs to check for any conflicts of interest (specifically with members of governance and management) at least annually. While most organizations do this diligently and far more often than once a year, I want to point out that the 990 has an entire schedule devoted to reporting of “interested persons”—that being Schedule L. Interested persons go beyond just corporate officers and members of the board; they also can be family members as well as business entities that are more than 35% owned or controlled by any of the above. Your hospital may want to review your procedures as to how you identify potential conflicts to make sure you are also capturing these sorts of relationships.

    Reporting thresholds for Schedule L disclosure can vary. If, for example, a board member’s child works for the hospital and is paid more than $10,000, they are required to be disclosed and the board member is not considered to be independent by the IRS. Transactions with a business entity owned or controlled by an interested person has reporting thresholds of $10,000 for a single transaction, or $100,000 over the course of the year.

    We offer a detailed conflict of interest survey that addresses these questions and more. If interested to learn more about this, please speak to your engagement principal.
  3. Compensation to unrelated organizations
    It seems more and more each year we hear some variation of the following: “Dr. X sits on our board and works here at the hospital, but we don’t pay him/her directly—we pay their company.”

    It’s important to know the IRS closed up this reporting loophole long ago and requires the hospital to report the amounts paid to an unrelated organization for services they render as if you paid the individual directly. A narrative is also required on Schedule J explaining the arrangement. We find in most cases the hospital may not be aware of what exactly Dr. X receives for compensation, which is perfectly fine. The narrative on Schedule J can explain this and that what’s being reported as compensation to Dr. X is the amount paid to the unrelated organization, and not necessarily what Dr. X’s compensation is. In any event, it is not appropriate to say that Dr. X receives nothing.
  4. Fundraising events
    COVID-19 certainly put a damper on most, if not all fundraising events over the past few years, but we’ve started to see some of events come back on the calendar recently, which is a great sign! Just a friendly reminder that if the price of admission to the event is $75 or more, it is necessary to note what items of value a participant is receiving in exchange for the amount of money they pay to attend so they can determine what amount, if any, of their entrance fee is tax deductible.

    For example: A hospital hosts a golf tournament and charges $100 per person to play. In exchange, the person gets use of a golf cart, a round of golf, and some food/drink on hole 19. The fair market value of everything per person totals $85. In this case, only $15 is tax deductible as a charitable contribution ($100 paid minus $85 value received) and the $85 of value received must be relayed to the attendee.

    Should you have any questions as you begin to plan your next round of events, please do not hesitate to reach out to us.
  5. Alternative Investments and Unrelated Business Income (UBI)
    What top five list would be complete without at least a mention of UBI? During the pandemic, we saw many clients get more creative in terms of generating revenue sources, particularly in terms of alternative investments that typically come in the form of a partnership interest and can carry with them significant tax consequences which are not always brought to the forefront at the time the investment is made. More than a few clients have been more than surprised (and less than impressed) to receive a Schedule K-1 at the end of year which not only contains UBI, but UBI that is spread over six different states, some or all of which may require you to file tax returns. If the alternative investment happens to be domiciled overseas, that can bring with it its own set of obligations. You can read more about this here

    It is vital for all organizations to be engaged in open and frequent communication with their investment managers and advisors (both within and outside the organization) to help ensure a full understanding of what sorts of obligations may stem from an investment. Organizations are strongly encouraged to review and share all relevant investment documentation and subsequent information (i.e., prospectus and any other offering materials) with its finance/accounting department, as well as its tax advisors prior to making the investment.

Just some things for you to think about as the next 990 filing deadline will be here before you know it, like the fall colors that will be joining us soon. I hope you all enjoy the last few gasps of what’s been a tremendous summer and you all find some time to do whatever it is that brings you joy and peace. As for me, I think it’s time to get a hobby! 

If you have any questions about your specific situation, please feel free to contact our not-for-profit tax team.

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990 filing: Five post-deadline considerations for hospitals