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IRS unrelated business taxable income update: The good news and the missing news

04.29.20

Read this if you are a tax-exempt organization.

The IRS recently issued proposed regulations (REG-106864-18) related to Internal Revenue Code Section 512(a)(6), which requires tax-exempt entities to calculate unrelated business taxable income (UBTI) separately for each unrelated trade or business carried on by the organization.

For years beginning after December 31, 2017, exempt organizations with more than one unrelated trade or business are no longer permitted to aggregate income and deductions from all unrelated trades or businesses when calculating UBTI. In August 2018, the IRS issued Notice 2018-67, which discussed and solicited comments regarding various issues arising under Code Section 512(a)(6) and set forth interim guidance and transition rules relating to that section. 

The good news
The new proposed regulations expand upon Notice 2018-67 and provide for the following:

  • An exempt organization would identify each of its separate unrelated trades or businesses using the first two digits of the NAICS code that most accurately describes the trade or business. Activities in different geographic areas may be aggregated.
  • The total UBTI of an organization with more than one unrelated trade or business would be the sum of the UBTI computed with respect to each separate unrelated trade or business (subject to the limitation that UBTI with respect to any separate unrelated trade or business cannot be less than zero). 
  • An exempt organization with more than one unrelated trade or business would determine the NOL deduction allowed separately with respect to each of its unrelated trades or businesses.
  • An organization with losses arising in a tax year beginning before January 1, 2018 (pre-2018 NOLs), and with losses arising in a tax year beginning after December 31, 2017 (post-2017 NOLs), would deduct its pre-2018 NOLs from total UBTI before deducting any post-2017 NOLs with regard to a separate unrelated trade or business against the UBTI from such trade or business. 
  • An organization's investment activities would be treated collectively as a separate unrelated trade or business. In general, an organization's investment activities would be limited to its:
     
    1. Qualifying partnership interests
    2. Qualifying S corporation interests
    3. Debt-financed property or properties 

Organizations described in Code Sec. 501(c)(3) are classified as publicly supported charities if they meet certain support tests. The proposed regulations would permit an organization with more than one unrelated trade or business to aggregate its net income and net losses from all of its unrelated business activities for purposes of determining whether the organization is publicly supported. 

The missing news: Unaddressed items from the new guidance
With the changes provided by these proposed regulations we anticipate less complexity and lower compliance costs in applying Code Section 512(a)(6). While this new guidance is considered taxpayer friendly, the IRS still has more work to do. Items not yet addressed include:

  • Allocation of expenses among unrelated trade or businesses and between exempt and non-exempt activities.
  • The ordering rules for applying charitable deductions and NOLs.
  • Net operating losses as changed under the CARES Act.

The IRS is requesting comments on numerous key situations. Until the regulations are finalized, organizations can rely on either these proposed regulations, Notice 2018-67, or a reasonable good-faith interpretation of Code Sections 511-514 considering all the facts and circumstances.
We will keep you informed with the latest developments.

If you have any questions, please contact the not-for-profit consulting team

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Did you know that there was more than a 40% increase (from $4.3 billion to $6.0 billion) in civil penalties assessed by the IRS regarding employment tax, for the 2016 fiscal year?

A recent report from the Treasury Inspector General for Tax Administration calls for more cases to involve criminal investigation by the Department of Justice. This is significant because the requirements needed to prove a civil violation under Sec. 6672 are nearly identical to the requirements of a criminal violation under Sec. 7202, and a criminal violation can result, among other penalties, in imprisonment for up to five years.

The issue of employment taxes encompasses all businesses, even tax-exempt entities. For fiscal year 2016, employment tax issues were involved in over 26% of audits of exempt organizations. One main reason why employment tax is a major issue? Its role in funding our government: employment taxes make up $2.3 trillion dollars (70%) of the $3.3 trillion dollars collected by the IRS for fiscal year 2016.

And noncompliance is a major issue, with roughly $45.6 billion of unemployment taxes, interest and penalties still owed to the IRS as of December 2015. This trend of increasing noncompliance, combined with the vital role employment taxes has in funding our government helps explain why the IRS has increased focus and enforcement in this area.

Should your independent contractor truly be an employee? Did you properly report fringe benefits as taxable income to the individuals who received them? Knowing the answers to these questions can help you stay in compliance with the law. If you have any questions about your employment tax situation, or how we can help you ensure compliance on this and other tax issues, please contact your BerryDunn tax advisor.
 

Article
The IRS cares about employment tax—why you should too.

Many of my hospital clients have an increased incidence of providing temporary housing for locums, temps and some employees and, as a result, have questions regarding the proper tax reporting to these individuals.   

First things first: the employment status of the individual needs to be determined before anything else.

If the person is an independent contractor (for example, a locum paid through an agency), a Form 1099-Misc usually needs to be filed for payments made to the individual (or agency) of $600 or more. A 1099-Misc is not required in the following circumstances:

  • The payment is made to a corporation or a tax-exempt organization.
  • Payments for travel reimbursement are excluded as long as they are paid under an accountable plan (which itself can be another topic for a blog). For example, an independent contractor submits a timely expense report to you with their lodging receipts for reimbursement. The amounts for the expense reimbursement do not have to be included on the 1099-Misc. If you pay the travel expenses directly or provide the housing, you also do not have to include these payments on the 1099-Misc.

If the individual is an employee, you should follow the guidance in IRS Publication 15-B, which can be found on www.irs.gov.

The basic rule of thumb is that every fringe benefit provided to an employee is a taxable benefit unless there is an exclusion listed in Publication 15-B.

The lodging exclusion begins on page 15 (of the 2016 publication), and there is an example regarding a hospital listed near the bottom of that page in the left column. For lodging to meet the exclusion, it must pass three tests:

  1. The lodging must be furnished on your business premises. I’ve seen some guidance that allowed the exclusion when the lodging was in close proximity to the business premise (within a mile, etc.).
     
  2. The lodging is furnished for the employer’s convenience. The employer furnishing the lodging to the employee must have a substantial business reason for doing so other than to provide the employee with additional pay. For example, the employee is on call for emergencies 4 or 5 days a week, so must live in close proximity to the hospital.
     
  3. The employee must accept the lodging as a condition of employment. The employer must require the employee to accept the lodging because they need to live on your business premises to be able to properly perform their duties. We recommend including this condition of employment directly in the employee’s written employment contract.

If lodging does not meet all three of these tests, then it must be treated as a taxable fringe benefit with the appropriate payroll taxes withheld from the employee’s pay.

If you are also providing meals, the discussion on employer-provided meals also begins on page 15 of Publication 15-B, with the discussion for meals provided on your business premises starting on page 16.

A discussion related to transportation benefits begins on page 18. We have also had some questions from clients regarding transportation. For example, one client had an employee who dropped down to part-time status and moved from Maine to Florida. The employee agreed to continue working at the hospital one week a month, and the hospital agreed to pay for the flight back and forth. The individual continued to be treated as an employee. The flight is the employee’s commuting expense, and there is no exclusion for reimbursement of commuting expenses. Therefore, the flights had to be included in the employee’s compensation and reported on his W-2.

Many of these taxable benefits are being paid through an accounts payable system rather than payroll, and so can be easily missed. Withholding for these benefits at each pay period is much easier to accomplish rather than all at once at year end. It’s important for your HR department to communicate with the payroll office whenever unusual employment terms and benefits are being offered to employees to ensure proper tax treatment.

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When it comes to temporary housing for hospital employees, IRS publication 15-B can be your friend

Read this if you use QuickBooks. 

Want to break up an estimate into multiple invoices? QuickBooks Online supports progress invoicing.

If you do large, multi-part projects for customers, you may not want to wait until absolutely everything is done before you send an invoice. This can be especially problematic when you have to purchase a lot of materials for a job that will eventually be billed to the customers.

QuickBooks Online has a solution for this: progress invoicing. Once you’ve had an estimate approved, you can split it into as many pieces as you need, sending partial invoices to your customer for products and services as you provide them, rather than waiting until the project is complete. If cash flow is a problem for you, this can be a very effective solution. You might be able to take on work that you otherwise couldn’t because you’ll be getting paid periodically.

Setup Required

Progress invoicing requires some special setup steps. First, you’ll need to see whether QuickBooks Online is prepared for the task. Click the gear icon in the upper right and select Account and settings under Your Company. Click the Sales tab and scroll down to Progress Invoicing. It may just say On to the right of Create multiple partial invoices from a single estimate. If it doesn’t, click the pencil icon to the right and turn it on. Then click Save and Done.

You’ll also have to choose a different template than the one you use for standard invoices. Click the gear icon and select Custom form styles. Click New style in the upper right and then click Invoice. Enter a new name for the template to replace My INVOICE Template, like Progress Invoice. Then click Dive in with a template or Change up the template under the Design tab. Select Airy new by clicking on it. This is the only template you can use for progress invoicing.

When you’re creating a template for your progress invoices, you’ll have to select Airy new.

Now, click on Edit print settings (or When in doubt, print it out). Make sure there’s no checkmark in the box in front of Fit printed form with pay stub in window envelope or Fit to window envelope. Then click on the Content tab. You’ll see a preview of the template (grayed out) to the right. Click the pencil icon in the middle section. Select the Show more activity options link at the bottom of the screen.

If you want to Group activity by (Day, Week, Month, or Type), check that box and select your preference. Go through the other options here and check or uncheck the boxes to meet your needs. Then click Done. You’ll see your new template in the list of Custom form styles.

QuickBooks Online allows you to designate one form style as the default. This is the form that will open when you create a new invoice or estimate template. If you plan to send a lot of progress invoices, you might want to make that the default. To do this, find your new template in the list on this page and click the down arrow next to Edit in the Action column. Click Make default. If you leave your standard invoice as the default, you can always switch when you’re creating an invoice by clicking the Customize button at the bottom of the screen.

Creating a Progress Invoice


You can see what your options are for your progress invoice.

Invoice and estimate forms in QuickBooks Online are very similar. The only major difference is that estimates contain a field for Expiration date. To start the process of progress invoicing, select an estimate that you want to bill that way. Click the Sales tab and select All Sales. Find your estimate and click on Create invoice in the Action column. A window like the one in the above image will appear.

You can bill a percentage of each line item or enter a custom amount for each line.  If you choose the latter, the invoice that opens will have zeroes in the Due column. You can alter the amount due for any of these by either a percentage or an amount and/or leave them at zero if you don’t want to bill a particular product or service. Either way, the Balance due will reflect your changes. When you’ve come to the last invoice for the project, you’ll check Remaining total of all lines.

Once you’ve chosen one of these options, click Create invoice. Double-check the form and then save it. You can now treat it as any other invoice. To see a list of your progress invoices, run the Estimates & Progress Invoicing Summary by Customer report.

As you can see, there are numerous steps involved in creating progress invoices. Each has to be done with precision, so the customer is billed the exact total amount due at the end. We can help you accomplish this. We’re also available to help with any other QuickBooks Online issues you have. Contact our Outsourced Accounting team to set up a consultation.

Article
How does progress invoicing work in QuickBooks Online?

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

This article is the ninth 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

Employee benefit plan loan basics 

If your plan’s adoption agreement is set up to allow loans, participants can borrow against their account balance. Some participants may find this an attractive option as the interest they pay on the loan is returned to their retirement account as opposed to other loans where the interest is paid to the lender. 

Additionally, while interest is charged at the market rate, it may be lower than other options available to the participant, such as a credit card or other unsecured debt. Unlike hardship distributions, there are no restrictions on the circumstances under which a participant may take a loan. A potential downside is that if the borrower defaults on the loan or ends their employment and cannot repay the loan in full, it converts from a loan to a deemed distribution, potentially incurring taxes and penalties.

If a participant decides that an employee benefit plan loan is their best option, they will apply for the loan through your plan administrator. Loans are limited in both size and quantity. Participants may take loans up to 50% of their vested account balance with a maximum loan of $50,000. The provisions of a plan determine how many loans an employee may have at once; however, the combined loan balances cannot exceed 50% of the employee’s vested balance or $50,000. Furthermore, the $50,000 loan maximum must also consider payments made on loans within the previous 12 months.

Repayment of employee benefit plan loans

Repayment of employee benefit plan loans may be done through after tax payroll contributions, making it a relatively easy process for the participant. If a plan sponsor elects to provide this repayment option, they must ensure that repayments are remitted to the plan in a timely manner, just as they must with other employee funded contributions. The term of the loan is typically limited to five years and must be repaid in at least quarterly installments. However, a loan can be extended to as long as thirty years if specified within the plan’s loan policy. If the loan term is for longer than five years, the loan proceeds must be used to purchase a primary residence.

Like any source of debt, there are pros and cons to taking out an employee benefit plan loan, and it remains an important option for participants to understand. The benefits include the ease of applying for such a loan and loan interest that is then added to the participant’s retirement account balance. Potential pitfalls include lost earnings during the loan period and the risk of the loan becoming a deemed distribution if the participant is unable to repay within the allotted time. 

If you would like more information, or have specific questions about your specific situation, please contact our Employee Benefits Audit team.

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Retirement plan loans: A brief review

Read this if you have a blended workforce with both in-office employees and remote workers.

It is hard to believe it has been nearly a year and a half since we started our remote work journey. At the time, many thought the move to working remotely would be short term. Then, a couple of weeks turned into a month, a month into another month, another month into a year and, some employers are now finally considering re-opening their offices.

Back in April 2020, we provided some internal control challenges, and potential solutions, faced by working in a remote environment. These challenges included exercising appropriate tone at the top, maintaining appropriate segregation of duties, and ensuring timely review, amongst others. Although these challenges still exist, there are new considerations to address as we transition into (hopefully) a post-pandemic world.

Blended workforces

As we mentioned in that article, since people have now been forced to work in a remote environment, they will be more apt to continue to do so. For some employees, the perks of ditching that long commute outweighs the free coffee they receive in the office. Employers have a decision to make—do we allow our employees the option to continue to work from home or, do we require employees to work from the office, as was standard pre-pandemic? Now that employees have exhibited the ability to work from home efficiently and effectively, it may be difficult to move all employees back into the office. Requiring all employees to return to the office could result in employees seeking employment elsewhere, and the option to work remotely is a selling point for many recruiters. Furthermore, disallowing remote work could cause employees to feel distrusted or undervalued, possibly leading to less efficient and effective work.

However, remote work comes with many challenges. Although video chat has been instrumental in navigating the remote work environment, it still has limitations. Nothing can beat in-person conversations and the relationships they help build. Nearly every video chat has a purpose, and unfortunately, you can’t just “run” into somebody in a video chat as you can in the office. Building camaraderie and instilling your company’s culture is difficult in a remote environment. And, if your workforce is blended, with some working in the office while others work remotely, building culture may be even more difficult than if your entire workforce was remote. Employees in the office may be less apt to communicate with remote colleagues. If you have a task you wish to delegate, you may think of giving the assignment to someone in the office prior to thinking of your remote co-workers that may be just as able and willing to complete the assignment. It will be important to ensure all employees are provided with equal opportunities, no matter of where they work.

Remote work policy

Regardless of your company’s decision to allow employees to work remotely or not, we recommend developing a remote work policy addressing expected behaviors. When developing such a policy, consider:

  •  Will the policy’s provisions apply to the entire company or will there be different provisions by department? If the latter, consider what the implications may be on employee morale.
  • Will there be a minimum amount of days per week that must be spent in the office?
  • If employees are allowed to work remotely, do they need to work a set schedule or can the frequency, and which days they work remotely, change from week to week?
  • Who should the employee communicate their decision to? How will this information then be shared company-wide?
  • How do remote employees address document destruction? If they are handling sensitive and confidential documents, how should they dispose of these documents?
  • Similarly, what are the expectations for protecting sensitive and confidential information at home?
  • Are employees allowed to hook up company-provided equipment to personal devices, such as personal printers?
  • If an employee is customer/client facing, what are the expectations for dress code and backgrounds for video chat meetings?
  • What will staff development look like for individuals working remotely? Alternatively, what will their involvement look like in onboarding/developing new employees?
  • What are the expectations for meetings? Will all meetings be set up in a manner that accommodates in-person and remote attendees? Are there meetings where in-person attendance is mandatory?

The importance of these considerations will likely differ from company to company. Some of these considerations may be addressed in other, already existing policies.

Are your internal controls “blended workforce” ready?

If your company plans to allow employees to work remotely, you will need to assess if your internal controls make sense for both in-office and remote employees. Typically, internal controls are written in a manner irrespective of where the employee resides. However, there may be situations that require an internal control be re-worked to accommodate in-office and remote employees. For instance, do you have an internal control that references a specific report that can only be run in-office? If the control owner plans to transition to a hybrid work schedule, does the frequency of the internal control need to change to reflect the employee’s new schedule? Alternatively, does it make sense to transition this internal control to someone else that will be in the office more frequently?

Internal control accommodations

The transition to a remote environment was expeditious and many thought the remote environment would be over quickly. As a result, there may have been modifications to internal controls that were made out of necessity, although they were not ideal from an internal control standpoint. The rationale for these accommodations may have been the expectation that the remote environment would be short-lived. Although these accommodations may have made sense for a short amount of time, and posed little to no additional risk to your company, the longer these accommodations remained in effect, the greater the chance for unintended consequences. 

We recommend reviewing your internal controls and creating a log of any internal control accommodations that were made due to the pandemic. Some of these modifications may continue to make sense and, after operating under the new internal control for an extended period of time, may even be preferable to the previous internal control. However, for those modifications that do appear to have increased control risk, control owners should assess if the length of the pandemic could have resulted in inadequately designed internal controls. And, if so, what could the consequences of these poorly designed internal controls have been to the company?

Internal control vs. process

While reviewing your company’s internal controls, it will also be a good time to ensure your internal control descriptions actually describe an internal control rather than simply a process. Although having well-documented processes for your company’s various transaction cycles is important, a good internal control description should already incorporate the process within it. Think of your internal control descriptions as writing a story—the “process” provides background information on the characters and setting, while the “internal control” is the story’s plot.

For example: The Accounting Manager downloads the market values from the investment portfolio accounting system and enters the market values into the general ledger on a monthly basis. Once the journal entry is entered, the Accounting Manager provides the market value report and a copy of the journal entry to the Controller.

Although a savvy reader may be able to identify where the internal control points are within this process, it could easily be modified to explicitly include discussion of the actual internal controls. The text in bold below represents modifications to the original:

The Accounting Manager downloads the market values from the investment portfolio accounting system and enters the market values into the general ledger on a monthly basis. Once the journal entry is entered, the Accounting Manager provides the market value report and a copy of the journal entry to the Controller via email. This email serves as documentation of preparation of the journal entry by the Accounting Manager. The Controller then reviews the market value report against the journal entry for accuracy. Once approved, the Controller posts the journal entry and replies to the email to indicate their review and approval. The Accounting Manager saves the email chain as auditable evidence.

The text additions in bold font help provide a complete story. A new employee could easily read this description and understand what they need to do, and how to appropriately document it. Most importantly, the internal control is both in-office and remote environment friendly.

Transitioning back to the office has resulted in a mixture of excitement and anxiety. Routine office norms, such as shaking hands and having a spontaneous meeting over a cup of coffee need to be relearned. Likewise, policies and internal controls need to be revisited to address the changing landscape. The more proactive your company can be, the better positioned it will be to accommodate its employees’ demands, while also maximizing the effectiveness of its internal controls. Please contact David Stone or Dan Vogt if any questions arise.

Article
May the "blended workforce be with you": Policy and internal control considerations for a new era

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

This article is the eighth 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 Department of Labor regulations regarding service provider fee disclosures clarify that plan fiduciaries are responsible for assessing the reasonableness of fees charged to plans in relation to services performed. 

Before a plan fiduciary is able to assess the reasonableness of plan fees, the fiduciary has to receive required fee disclosures from their covered service provider. A covered service provider is considered a party that enters into an agreement with a covered plan to provide certain services. The range of services provided generally include recordkeeping services, investment adviser services, accounting services, auditing services, actuarial services, appraisals, banking, consulting, legal services, third party administration services, or valuation services provided to the plan.

In general, the covered service providers are required to provide the plan fiduciary a disclosure of the following information:

  • All expected services and fees, and
  • All direct and indirect compensation
    • Direct compensation are fees paid to the service providers from the plan
    • Indirect compensation are fees paid to the service providers from sources other than the plan, the plan sponsor, the covered service provider, or an affiliate 

Once the service provider fee disclosures are received, the responsible plan fiduciary must assess the reasonableness of the fees in relation to the services provided. There are numerous ways a plan fiduciary can determine if the fees are reasonable. The following are some of the most common ways to determine if the plan expenses are reasonable:

  • Complete a Request for Proposal (RFP) or Request for Information (RFI) process that compares at least two vendors.
  • Complete a plan “benchmarking” project. The responsible plan fiduciary can have an independent organization compare the fees charged to the plan to plans of similar size and characteristics. Failure to determine the reasonableness of the fees charged can result in a prohibited transaction. The responsible plan fiduciary should determine and document whether the fees are reasonable. Documentation should also include the steps taken to make this determination.

It is important to remember that failure to assess the reasonableness of the service provider fees can result in a prohibited transaction. Documentation of the assessment process, including steps taken to make a determination on fee reasonableness, is the best way to avoid having a prohibited transaction.

If you have any questions while assessing your service providers’ fees, please contact our Employee Benefits Audit team.
 

Article
Service provider fee disclosures: Understanding the process

Read this if you are an organization that received federal funding subject to the Uniform Guidance. 

We are excited to announce the OMB released the 2021 Compliance Supplement late last week. This long-awaited release is effective for audits of fiscal years beginning after June 30, 2020 and supersedes the 2020 supplement and subsequent addendum. We are continuing to evaluate the changes to the supplement, but a few things to note from our early look:

  • There will be an addendum to this supplement, to address certain COVID-related relief funding with changing regulations that were not in place in time for this supplement. 
  • Good news for higher education: Part 4 of the supplement related to the Higher Education Emergency Relief Funds (within assistance listing 84.425, section 2) is not expected to be amended by the addendum.
  • The supplement is making the formal shift away from the “Catalog of Federal Domestic Assistance” (or CFDA) language to the term “Assistance Listing” in describing the number used for each program.
  • To evaluate the changes in the supplement from the prior year, consider checking out the Matrix of Compliance Requirements in Part 2 and Appendix V.

The timing for the release of the anticipated addendum has not yet been confirmed, but your audit teams are excited to get started with the new supplement. If you have any questions or need help making sense of it all, contact our Single Audit team. We’re here to help.

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OMB 2021 compliance supplement released