Physician Time Studies during the

COVID-

19 Public Health Emergency

Read this if your CFO has recently departed, or if you're looking for a replacement.

With the post-Covid labor shortage, “the Great Resignation,” an aging workforce, and ongoing staffing concerns, almost every industry is facing challenges in hiring talented staff. To address these challenges, many organizations are hiring temporary or interim help—even for C-suite positions such as Chief Financial Officers (CFOs).

You may be thinking, “The CFO is a key business partner in advising and collaborating with the CEO and developing a long-term strategy for the organization; why would I hire a contractor to fill this most-important role?” Hiring an interim CFO may be a good option to consider in certain circumstances. Here are three situations where temporary help might be the best solution for your organization.

Your organization has grown

If your company has grown since you created your finance department, or your controller isn’t ready or suited for a promotion, bringing on an interim CFO can be a natural next step in your company’s evolution, without having to make a long-term commitment. It can allow you to take the time and fully understand what you need from the role — and what kind of person is the best fit for your company’s future.

BerryDunn's Kathy Parker, leader of the Boston-based Outsourced Accounting group, has worked with many companies to help them through periods of transition. "As companies grow, many need team members at various skill levels, which requires more money to pay for multiple full-time roles," she shared. "Obtaining interim CFO services allows a company to access different skill levels while paying a fraction of the cost. As the company grows, they can always scale its resources; the beauty of this model is the flexibility."

If your company is looking for greater financial skill or advice to expand into a new market, or turn around an underperforming division, you may want to bring on an outsourced CFO with a specific set of objectives and timeline in mind. You can bring someone on board to develop growth strategies, make course corrections, bring in new financing, and update operational processes, without necessarily needing to keep those skills in the organization once they finish their assignment. Your company benefits from this very specific skill set without the expense of having a talented but expensive resource on your permanent payroll.

Your CFO has resigned

The best-laid succession plans often go astray. If that’s the case when your CFO departs, your organization may need to outsource the CFO function to fill the gap. When your company loses the leader of company-wide financial functions, you may need to find someone who can come in with those skills and get right to work. While they may need guidance and support on specifics to your company, they should be able to adapt quickly and keep financial operations running smoothly. Articulating short-term goals and setting deadlines for naming a new CFO can help lay the foundation for a successful engagement.

You don’t have the budget for a full-time CFO

If your company is the right size to have a part-time CFO, outsourcing CFO functions can be less expensive than bringing on a full-time in-house CFO. Depending on your operational and financial rhythms, you may need the CFO role full-time in parts of the year, and not in others. Initially, an interim CFO can bring a new perspective from a professional who is coming in with fresh eyes and experience outside of your company.

After the immediate need or initial crisis passes, you can review your options. Once the temporary CFO’s agreement expires, you can bring someone new in depending on your needs, or keep the contract CFO in place by extending their assignment.

Considerations for hiring an interim CFO

Making the decision between hiring someone full-time or bringing in temporary contract help can be difficult. Although it oversimplifies the decision a bit, a good rule of thumb is: the more strategic the role will be, the more important it is that you have a long-term person in the job. CFOs can have a wide range of duties, including, but not limited to:

• Financial risk management, including planning and record-keeping
• Management of compliance and regulatory requirements
• Creating and monitoring reliable control systems
• Debt and equity financing
• Financial reporting to the Board of Directors

If the focus is primarily overseeing the financial functions of the organization and/or developing a skilled finance department, you can rely — at least initially — on a CFO for hire.

Regardless of what you choose to do, your decision will have an impact on the financial health of your organization — from avoiding finance department dissatisfaction or turnover to capitalizing on new market opportunities. Getting outside advice or a more objective view may be an important part of making the right choice for your company.

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

Read this if your company is considering outsourced information technology services.

For management, it’s the perennial question: Keep things in-house or outsource?

For management, it’s the perennial question: Keep things in-house or outsource? Most companies or organizations have outsourcing opportunities, from revenue cycle to payment processing to IT security. When deciding whether to outsource, you weigh the trade-offs and benefits by considering variables such as cost, internal expertise, cross coverage, and organizational risk.

In IT services, outsourcing may win out as technology becomes more complex. Maintaining expertise and depth for all the IT components in an environment can be resource-intensive.

Outsourced solutions allow IT teams to shift some of their focus from maintaining infrastructure to getting more value out of existing systems, increasing data analytics, and better linking technology to business objectives. The same can be applied to revenue cycle outsourcing, shifting the focus from getting clean bills out and cash coming in, to looking at the financial health of the organization, analyzing service lines, patient experience, or advancing projects.  

Once you’ve decided, there’s another question you need to ask
Lost sometimes in the discussion of whether to use outsourced services is how. Even after you’ve done your due diligence and chosen a great vendor, you need to stay involved. It can be easy to think, “Vendor XYZ is monitoring our servers or our days in AR, so we should be all set. I can stop worrying at night about our system reliability or our cash flow.” Not true.

You may be outsourcing a component of your technology environment or collections, but you are not outsourcing the accountability for it—from an internal administrative standpoint or (in many cases) from a legal standpoint.

Beware of a false state of confidence
No matter how clear the expectations and rules of engagement with your vendor at the onset of a partnership, circumstances can change—regulatory updates, technology advancements, and old-fashioned vendor neglect. In hiring the vendor, you are accountable for oversight of the partnership. Be actively engaged in the ongoing execution of the services. Also, periodically revisit the contract, make sure the vendor is following all terms, and confirm (with an outside audit, when appropriate) that you are getting the services you need.

Take, for example, server monitoring, which applies to every organization or company, large or small, with data on a server. When a managed service vendor wants to contract with you to provide monitoring services, the vendor’s salesperson will likely assure you that you need not worry about the stability of your server infrastructure, that the monitoring will catch issues before they occur, and that any issues that do arise will be resolved before the end user is impacted. Ideally, this is true, but you need to confirm.

Here’s how to stay involved with your vendor
Ask lots of questions. There’s never a question too small. Here are samples of how precisely you should drill down:

• What metrics will be monitored, specifically?
• Why do the metrics being monitored matter to our own business objectives?
• What thresholds must be met to notify us or produce an alert?
• What does exceeding a threshold mean to our business?
• Who on our team will be notified if an alert is warranted?
• What corrective action will be taken?

Ask uncomfortable questions
Being willing to ask challenging questions of your vendors, even when you are not an expert, is critical. You may feel uncomfortable but asking vendors to explain something to you in terms you understand is very reasonable. They’re the experts; you’re not expected to already understand every detail or you wouldn’t have needed to hire them. It’s their job to explain it to you. Without asking these questions, you may end up with a fairly generic solution that does produce a service or monitor something, but not necessarily all the things you need.

Ask obvious questions
You don’t want anything to slip by simply because you or the vendor took it for granted. It is common to assume that more is being done by a vendor than actually is. By asking even obvious questions, you can avoid this trap. All too often we conduct an IT assessment and are told that a vendor is providing a service, only to discover that the tasks are not happening as expected.

You are accountable for your whole team—in-house and outsourced members
An outsourced solution is an extension of your team. Taking an active and engaged role in an outsourcing partnership remains consistent with your management responsibilities. At the end of the day, management is responsible for achieving business objectives and mission. Regularly check in to make sure that the vendor stays focused on that same mission.

More and more emphasis is being put on cybersecurity by companies of all sizes. Whether it’s the news headlines of notable IT incidents, greater emphasis on the value of data, or the monetization of certain types of attacks, an increasing amount of energy and money is going towards security. Security has the attention of leadership and the board and it is not going away. One of the biggest risks to and vulnerabilities of any organization’s security continues to be its people. Innovative approaches and new technology can reduce risk but they still don’t prevent the damage that can be inflicted by an employee simply opening an attachment or following a link. This is more likely to happen than you may think.

Technology also doesn’t prepare a management team for how to handle the IT response, communication effort, and workforce management required during and after an event. Technology doesn’t lessen the operational impact that your organization will feel when, not if, you experience an event.

So let’s examine the human and operational side of cybersecurity. Below are three factors you should address to reduce risk and prepare your organization for an event:

1. People: Create and maintain a vigilant workforce
   Ask yourself, “How prepared is our workforce when it comes to security threats and protecting our data? How likely would it be for one of our team members to click on a link or open an attachment that appear to be from our CFO? Would our team members look closely enough at the email address and notice that the organization name is different by one letter?”
    

   According to the 2016 Verizon Data Breach Report, 30% of phishing messages were opened by the target across all campaigns and 12% went on to click on the attachment or link.

   Phishing email attacks directed at your company through your team range from very obvious to extremely believable. Some attempts are sent widely and are looking for just one person to click, while others are extremely targeted and deliberate. In either case, it is vital that each employee takes enough time to realize that the email request is unusual. Perhaps there are strange typos in the request or it is odd the CFO is emailing while on vacation. That moment your employees take to pause and decide whether to click on the link/attachment could mean the difference between experiencing an event or not.
   
   So how do you create and cultivate this type of thought process in your workforce? Lots of education and awareness efforts. This goes beyond just an annual in-service training on HIPAA. It may include education sessions, emails with tips and tricks, posters describing the risk, and also exercises to test your workforce against phishing and security exploits. It also takes leadership embracing security as a strategic imperative and leading the organization to take it seriously. Once you have these efforts in place, you can create culture change to build and maintain an environment where an employee is not embarrassed to check with the CFO’s office to see if they really did send an email from Bora Bora.

2. Plan: Implement a disaster recovery and incident response plan 
   Through the years, disaster recovery plans have been the usual response. Mostly, the emphasis has been on recovering data after a non-security IT event, often discussed in context of a fire, power loss, or hardware failure. Increasingly, cyber-attacks are creeping into the forefront of planning efforts. The challenge with cyber-events is that they are murkier to understand – and harder for leadership – to assist with.
   
   It’s easier to understand the concept of a fire destroying your server room and the plan entailing acquiring new equipment, recovering data from backup, restoring operations, having good downtime procedures, and communicating the restoration efforts along the way. What is much more challenging is if the event begins with a suspicion by employees, customers, or vendors who believe their data has been stolen without any conclusive information that your company is the originating point of the data loss. How do you take action if you know very little about the situation? What do you communicate if you are not sure what to say? It is this level of uncertainty that makes it so difficult. Do you have a plan in place for how to respond to an incident? Here are some questions to consider:
    
   1. How will we communicate internally with our staff about the incident?
   2. How will we communicate with our clients? Our patients? Our community?
   3. When should we call our insurance company? Our attorney?
   4. Is reception prepared to describe what is going on if someone visits our office?
   5. Do we have the technical expertise to diagnose the issue?
   6. Do we have set protocols in place for when to bring our systems off-line and are our downtime procedures ready to use?
   7. When the press gets wind of the situation, who will communicate with them and what will we share?
   8. If our telephone system and network is taken offline, how we will we communicate with our leadership team and workforce?

By starting to ask these questions, you can ascertain how ready you may, or may not be, for a cyber-attack when it comes.

3. Practice: Prepare your team with table top exercises  
   Given the complexity and diversity of the threats people are encountering today, no single written plan can account for all of the possible combinations of cyber-attacks. A plan can give guidance, set communication protocols, and structure your approach to your response. But by conducting exercises against hypothetical situations, you can test your plan, identify weaknesses in the plan, and also provide your leadership team with insight and experience – before it counts.
   
   A table top exercise entails one team member (perhaps from IT or from an outside firm) coming up with a hypothetical situation and a series of facts and clues about the situation that are given to your leadership team over time. Your team then implements the existing plans to respond to the incident and make decisions. There are no right or wrong answers in this scenario. Rather, the goal is to practice the decision-making and response process to determine where improvements are needed.
   
   Maybe you run an exercise and realize that you have not communicated to your staff that no mention of the event should be shared by employees on social media. Maybe the exercise makes you realize that the network administrator who is on vacation at the time is the only one who knows how to log onto the firewall. You might identify specific gaps that are lacking in your cybersecurity coverage. There is much to learn that can help you prepare for the real thing.

As you know, there are many different threats and risks facing organizations. Some are from inside an organization while others come from outside. Simply throwing additional technology at the problem will not sufficiently address the risks. While your people continue to be one of the biggest threats, they can also be one of your biggest assets, in both preventing issues from occurring and then responding quickly and appropriately when they do. Remember focus on your People, Your Plan, and Your Practice.

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

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

How will the phase-out impact financial institutions?

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

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

The importance of fallback language in loan agreements

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

• Non-existent or inadequate fallbacks
  According to the Alternative Reference Rates Committee, a group of private-market participants convened by the Federal Reserve to help ensure a successful LIBOR transition, "Most contracts referencing LIBOR do not appear to have envisioned a permanent or indefinite cessation of LIBOR and have fallbacks that would not be economically appropriate"⁴.
  
  For instance, industry regulators have warned that without updated fallback language, the discontinuation of LIBOR could prompt some variable-rate loans to become fixed-rate², causing unanticipated changes in interest rate risk for financial institutions. In a declining rate environment, this may prove beneficial as loans at variable rates become fixed. But in a rising rate environment, the resulting shrink in net interest margins would have a direct and adverse impact on the bottom line.

• No spread adjustment
  Once LIBOR is discontinued, LIBOR-indexed loans will need to be repriced at a new reference rate, which could be well above or below LIBOR. If loan agreements don’t provide for an adjustment of the spread between LIBOR and the new rate, that could prompt unexpected changes in the financial position of both borrowers and lenders³. Take, for instance, a loan made at the Secured Overnight Financing Rate (SOFR), generally considered the likely replacement for USD LIBOR. Since SOFR tends to be lower than three-month LIBOR, a loan agreement using it that does not allow for a spread adjustment would generate lower loan payments for the borrower, which means less interest income for the lender.
  
  Not allowing for a spread adjustment on reference rates lower than LIBOR could also cause a change in expected prepayments—say, for instance, if borrowers with fixed-rate loans decide to refinance at adjustable rates—which would impact post-CECL allowance calculations like the weighted-average remaining maturity (WARM) method, which uses estimated prepayments as an input.

What can your financial institution do to prepare?

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

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

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

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

Conclusion: Start assessing your LIBOR risk soon

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

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

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

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

A brief definition

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

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

Why does it matter? Audit quality.

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

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

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

Applying skepticism internally

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

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

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

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

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

Good fundraising and good accounting do not always seamlessly align. While they all feed the same mission, fundraisers work to meet revenue goals while accountants focus on recording transactions in compliance with accounting standards. We often see development department totals reported to boards that are not in line with annual financial statements, causing confusion and concern. To bridge this information gap, here are five accounting concepts every not-for-profit fundraiser should know:

Understanding the differences in how the development department and finance department track these gifts will allow for better reporting to the board throughout the year—and fewer surprises when you present financial statements at the end of the year. Stay tuned for parts two and three of our contribution series. Have questions? Please contact Emily Parker of Sarah Belliveau.

 

A common pitfall for inbound sellers is applying the same concepts used to adopt “no tax” positions made for federal income tax purposes to determinations concerning sales and use tax compliance. Although similar conceptually, separate analyses are required for each determination.

For federal income tax purposes, inbound sellers that are selling goods to customers in the U.S. and do not have a fixed place of business or dependent agent in the U.S. have, traditionally, been able to rely on their country’s income tax treaty with the U.S. for “no tax” positions. Provided that the non-U.S. entity did not have a “permanent establishment” in the U.S., it was shielded from federal income tax and would have a limited federal income tax compliance obligation.

States, however, are generally not bound by comprehensive income tax treaties made with the U.S. Thus, non-U.S. entities can find themselves unwittingly subject to state and local sales and use tax compliance obligations even though they are protected from a federal income tax perspective. With recent changes in U.S. tax law, the burden of complying with sales and use tax filing and collection requirements has increased significantly.

Does your company have a process in place to deal with these new state and local tax compliance obligations?

What has changed? Wayfair—it’s got what a state needs

As a result of the Supreme Court’s ruling in South Dakota v. Wayfair, Inc., non-U.S. entities that have sales to customers in the U.S. may have unexpected sales and use tax filing obligations on a go-forward basis. Historically, non-U.S. entities did not have a sales and use tax compliance obligation when they did not have a physical presence in states where the sales occurred.

In Wayfair, the U.S. Supreme Court ruled that a state is no longer bound by the physical presence standard in order for it to impose its sales and use tax regime on entities making sales within the state. The prior physical presence standard was set forth in precedent established by the Supreme Court and was used to determine if an entity had sufficient connection with a state (i.e., nexus) to necessitate a tax filing and collection requirement.

Before the Wayfair ruling, an entity had to have a physical presence (generally either through employees or property located in a state) in order to be deemed to have nexus with the state. The Wayfair ruling overturned this precedent, eliminating the physical presence requirement. Now, a state can deem an entity to have nexus with the state merely for exceeding a certain level of sales or transactions with in-state customers. This is a concept referred to as “economic nexus.”

The Court in Wayfair determined that the state law in South Dakota providing a threshold of $100,000 in sales or more than 200 sale transactions occurring within the state is sufficient for economic nexus to exist with the state. This is good news for hard-pressed states and municipalities in search of more revenue. Since this ruling, there has been a flurry of new state legislation across the country. Like South Dakota, states are actively passing tax laws with similar bright-line tests to determine when entities have economic nexus and, therefore, a sales and use tax collection and filing requirement.

How this impacts non-U.S. entities

This can be a trap for non-U.S. entities making sales to customers in the U.S. Historically, non-U.S. entities lacking a U.S. physical presence generally only needed to navigate federal income tax rules.

Inbound sellers without a physical presence in the U.S. may have very limited experience with state and local tax compliance obligations. When considering all of the state and local tax jurisdictions that exist in the U.S. (according to the Tax Foundation there are more than 10,000 sales tax jurisdictions), the number of sales and use tax filing obligations can be significant. Depending on the level of sales activity within the U.S., a non-U.S. entity can quickly become inundated with the time and cost of sales and use tax compliance.

Next steps

Going forward, non-U.S. entities selling to customers in the U.S. should be aware of those states that have economic nexus thresholds and adopt procedures so they are prepared for their sales and use tax compliance obligations in real time. These tax compliance obligations will generally require an entity to register to do business in the state, collect sales tax from customers, and file regular tax returns, usually monthly or quarterly.

It is important to note when an entity has an obligation to collect sales tax, it will be liable for any sales tax due to a state, regardless of whether the sales tax is actually collected from the customer. It is imperative to stay abreast of these complex legislative changes in order to be compliant.

At BerryDunn, our tax professionals work with a number of non-U.S. companies that face international, state, and local tax issues. If you would like to discuss your particular circumstances, contact one of the experienced professionals in our state and local tax (“SALT”) practice.

It’s that time of year. Kids have gone back to school, the leaves are changing color, the air is getting crisp and… year-end tax planning strategies are front of mind! It’s time to revisit or start tax planning for the coming year-end, and year-end purchase of capital equipment and the associated depreciation expense are often an integral part of that planning.

The Tax Cuts and Jobs Act (TCJA) expanded two prevailing types of accelerated expensing of capital improvements: bonus depreciation and section 179 depreciation. They each have different applications and require planning to determine which is most advantageous for each business situation.

100% expensing of selected capital improvements—bonus depreciation

Originating in 2001, bonus depreciation rules allowed for immediate expensing at varying percentages in addition to the “regular” accelerated depreciation expensed over the useful life of a capital improvement. The TCJA allows for 100% expensing of certain capital improvements during 2018. Starting in 2023, the percentage drops to 80% and continues to decrease after 2023. In addition to the increased percentage, used property now qualifies for bonus depreciation. Most new and used construction equipment, office and warehouse equipment, fixtures, and vehicles qualify for 100% bonus depreciation along with certain other longer lived capital improvement assets. Now is the time to take advantage of immediate write-offs on crucial business assets. 

TCJA did not change the no dollar limitations or thresholds, so there isn’t a dollar limitation or threshold on taking bonus depreciation. Additionally, you can use bonus depreciation to create taxable losses. Bonus depreciation is automatic, and a taxpayer may elect out of the bonus depreciation rules.

However, a taxpayer can’t pick and choose bonus depreciation on an asset-by-asset basis because the election out is made by useful life. Another potential drawback is that many states do not allow bonus depreciation. This will generally result in higher state taxable income in the early years that reverses in subsequent years.

Section 179 expensing

Similar to bonus depreciation, section 179 depreciation allows for immediate expensing of certain capital improvements. The TCJA doubled the allowable section 179 deduction from $500,000 to $1,000,000. The overall capital improvement limits also increased from $2,000,000 to $2,500,000. These higher thresholds allow for even higher tax deductions for business that tend to put a lot of money in a given year on capital improvements.

In addition to these limits, section 179 cannot create a loss. Because of these constraints, section 179 is not as flexible as bonus depreciation but can be very useful if the timing purchases are planned to maximize the deduction. Many states allow section 179 expense, which may be an advantage over bonus depreciation.

Both section 179 and bonus depreciation are crucial tools for all businesses. They can reduce taxable income and defer tax expense by accelerating depreciation deductions. Please contact your tax advisor to determine if your business qualifies for bonus depreciation or section 179 and how to maximize each deduction for 2018.

Section 179 and bonus depreciation: where to go from here

Both section 179 and bonus depreciation are crucial tools for all businesses. They can reduce taxable income and defer tax expense by accelerating depreciation deductions. Please contact your tax advisor to determine if your business qualifies for bonus depreciation or section 179 and how to maximize each deduction for 2018.

IRS Notice 2018-67 Hits the Charts
Last week, in addition to The Eagles Greatest Hits (1971-1975) album becoming the highest selling album of all time, overtaking Michael Jackson’s Thriller, the IRS issued Notice 2018-67—its first formal guidance on Internal Revenue Code Section 512(a)(6), one of two major code sections added by the Tax Cuts and Jobs Act of 2017 that directly impacts tax-exempt organizations. Will it too, be a big hit? It remains to be seen.

Section 512(a)(6) specifically deals with the reporting requirements for not-for-profit organizations carrying on multiple unrelated business income (UBI) activities. Here, we will summarize the notice and help you to gain an understanding of the IRS’s thoughts and anticipated approaches to implementing §512(a)(6).

While there have been some (not so quiet) grumblings from the not-for-profit sector about guidance on Code Section 512(a)(7) (aka the parking lot tax), unfortunately we still have not seen anything yet. With Notice 2018-67’s release last week, we’re optimistic that guidance may be on the way and will let you know as soon as we see anything from the IRS.

Before we dive in, it’s important to note last week’s notice is just that—a notice, not a Revenue Procedure or some other substantive legislation. While the notice can, and should be relied upon until we receive further guidance, everything in the notice is open to public comment and/or subject to change. With that, here are some highlights:

No More Netting
512(a)(6) requires the organization to calculate unrelated business taxable income (UBTI), including for purposes of determining any net operating loss (NOL) deduction, separately with respect to each such trade or business. The notice requires this separate reporting (or silo-ing) of activities in order to determine activities with net income from those with net losses.

Under the old rules, if an organization had two UBI activities in a given year, (e.g., one with $1,000 of net income and another with $1,000 net loss, you could simply net the two together on Form 990-T and report $0 UBTI for the year. That is no longer the case. From now on, you can effectively ignore activities with a current year loss, prompting the organization to report $1,000 as taxable UBI, and pay associated federal and state income taxes, while the activity with the $1,000 loss will get “hung-up” as an NOL specific to that activity and carried forward until said activity generates a net income.

Separate Trade or Business
So, how does one distinguish (or silo) a separate trade or business from another? The Treasury Department and IRS intend to propose some regulations in the near future, but for now recommend that organizations use a “reasonable good-faith interpretation”, which for now includes using the North American Industry Classification System (NAICS) in order to determine different UBI activities.

For those not familiar, the NAICS categorizes different lines of business with a six-digit code. For example, the NAICS code for renting* out a residential building or dwelling is 531110, while the code for operating a potato farm is 111211. While distinguishing residential rental activities from potato farming activities might be rather straight forward, the waters become muddier if an organization rents both a residential property and a nonresidential property (NAICS code 531120). Does this mean the organization has two separate UBI rental activities, or can both be grouped together as rental activities? The notice does not provide anything definitive, but rather is requesting public comments?we expect to see something more concrete once the public comment period is over.

*In the above example, we’re assuming the rental properties are debt-financed, prompting a portion of the rental activity to be treated as UBI.

UBI from Partnership Investments (Schedule K-1)
Notice 2018-67 does address how to categorize/group unrelated business income for organizations that receive more than one partnership K-1 with UBI reported. In short, if the Schedule K-1s the organization receives can meet either of the tests below, the organization may treat the partnership investments as a single activity/silo for UBI reporting purposes. The notice offers the following:

De Minimis Test
You can aggregate UBI from multiple K-1s together as long as the exempt organization holds directly no more than 2% of the profits interest and no more that 2% of the capital interest. These percentages can be found on the face of the Schedule K-1 from the Partnership and the notice states those percentages as shown can be used for this determination. Additionally, the notice allows organizations to use an average of beginning of year and end of year percentages for this determination.

Ex: If an organization receives a K-1 with UBI reported, and the beginning of year profit & capital percentages are 3%, and the end of year percentages are 1%, the average for the year is 2% (3% + 1% = 4%/2 = 2%). In this example, the K-1 meets the de minimis test.

There is a bit of a caveat here—when determining an exempt organization's partnership interest, the interest of a disqualified person (i.e. officers, directors, trustees, substantial contributors, and family members of any of those listed here), a supporting organization, or a controlled entity in the same partnership will be taken into account. Organizations need to review all K-1s received and inquire with the appropriate person(s) to determine if they meet the terms of the de minimis test.

Control Test
If an organization is not able to pass the de minimis test, you may instead use the control test. An organization meets the requirements of the control test if the exempt organization (i) directly holds no more than 20 percent of the capital interest; and (ii) does not have control or influence over the partnership.

When determining control or influence over the partnership, you need to apply all relevant facts and circumstances. The notice states:

“An exempt organization has control or influence if the exempt organization may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership. An exempt organization also has control or influence over a partnership if any of the exempt organization's officers, directors, trustees, or employees have rights to participate in the management of the partnership or conduct the partnership's business at any time, or if the exempt organization has the power to appoint or remove any of the partnership's officers, directors, trustees, or employees.”

As noted above, we recommend your organization review any K-1s you currently receive. It’s important to take a look at Line I1 and make sure your organization is listed here as “Exempt Organization”. All too often we see not-for-profit organizations listed as “Corporations”, which while usually technically correct, this designation is really for a for-profit corporation and could result in the organization not receiving the necessary information in order to determine what portion, if any, of income/loss is attributable to UBI.

Net Operating Losses
The notice also provides some guidance regarding the use of NOLs. The good news is that any pre-2018 NOLs are grandfathered under the old rules and can be used to offset total UBTI on Form 990-T.

Conversely, any NOLs generated post-2018 are going to be considered silo-specific, with the intent being that the NOL will only be applicable to the activity which gave rise to the loss. There is also a limitation on post-2018 NOLs, allowing you to use only 80% of the NOL for a given activity. Said another way, an activity that has net UBTI in a given year, even with post-2017 NOLs, will still potentially have an associated tax liability for the year.

Obviously, Notice 2018-67 provides a good baseline for general information, but the details will be forthcoming, and we will know then if they have a hit. Hopefully the IRS will not Take It To The Limit in terms of issuing formal guidance in regards to 512(a)(6) & (7). Until they receive further IRS guidance,  folks in the not-for-profit sector will not be able to Take It Easy or have any semblance of a Peaceful Easy Feeling. Stay tuned.