Nonprofits Have Additional Time to Comply with New Lease Accounting Standards

By Lee Klumpp, CPA, CGMA

In 2016, the Financial Accounting Standards Board (FASB) updated its lease accounting rules (ASC 842) and closed a diversity in practice in the previous standard. The major change is that organizations must now include lease assets and liabilities on their balance sheets. The upshot is that despite a recently granted extension that applies to private companies and nonprofits, the task of becoming compliant is urgent and challenging. Impacted nonprofits don’t have a moment to spare.

Under the previous standards, operating leases were off-balance sheet. That essentially allowed companies to omit certain lease assets and liabilities from their balance sheets, potentially skewing their debt-to-equity ratio. In 2016, the International Accounting Standards Board estimated that public companies using either the International Financial Reporting Standards or accounting principles generally accepted in the United States of America (U.S. GAAP) had around $3.3 trillion of lease commitments, 85% of which were not recorded on their balance sheets. This, of course, makes it difficult for shareholders (stakeholders), investors and lenders to get a true sense of an organization’s financial health. Under the previous ASC 840 standard, operating leases were only required to be disclosed in the footnotes of the financial statements. Under ASC 842, the only leases that may be omitted from financial statements are short-term leases with an original term of fewer than 12 months. ASC 842 increases transparency and comparability among organizations that enter into lease agreements and provides a clearer picture of an organization’s liabilities related to leasing obligations. ASC 842 also includes extensive disclosures intended to enable users of financial statements to understand the amount, timing and judgment related to an entity’s accounting for leases and the related cash flows as well as disclosure of both qualitative and quantitative information about leases.

But what it also does is implement a one-size-fits-all accounting standard that significantly increases the reporting burden on smaller, nonpublic companies, including nonprofits. Implementation will involve significant challenges and require major investments in time, money and other resources. Fortunately at its Oct. 16, 2019 meeting, FASB affirmed its decisions on two proposed Accounting Standards Updates (ASUs) – one of which extended the implementation deadline for the new standards on leases that were not yet effective for private companies and nonprofits to the first fiscal year after Dec. 15, 2020, instead of Dec. 15, 2019, as originally mandated.

Subsequently, in June 2020 the FASB decided to provide near-term relief for the adoption of the leasing standards based on feedback from stakeholders regarding challenges with the adoption as a result of the current business and capital disruptions caused by the coronavirus (COVID-19) pandemic. As a result, the FASB issued ASU 2020-05 which provides an additional one-year deferral of the effective date of the leasing standards. As a result, the leasing standards will now be effective for private companies and private nonprofits for fiscal years beginning after Dec. 15, 2021. Public nonprofits who had not issued their statements as of June 3, 2020, can also opt to defer adoption until fiscal years beginning after Dec. 15, 2019. This is an elective deferral so entities can still choose early adoption if they wish.

This is good news for nonprofits, which now have extra time to implement these changes. However, it should also serve as a wake-up call, as many organizations weren’t even aware of the change and the need to become compliant. Even within this updated timeline, ensuring compliance will be a significant effort.

Nonprofits face multiple significant implementation challenges such as:

  • Identifying embedded leases in business arrangements
  • The number of business arrangements that were previously not identified as leases may now be identified as meeting the definition of a lease or embedded lease
  • Existing systems and processes may need to be modified or enhanced in order to provide information necessary to address the new reporting and disclosure requirements
  • Multiple departments across the organization will be affected by this standard, including information technology (IT), tax, legal, treasury, and financial planning and analysis, among others
  • Ongoing efforts to remain compliant might be more significant than the initial implementation effort

It’s clear that complying with ASC 842 is a time-consuming process. Organizations should develop an implementation timeline keeping several factors top of mind, including existing lease commitments, data governance maturity and cross-function coordination needs.

To get started, organizations should first learn one of the key lessons from public companies that have already gone through this process: The standard requires the collection of significant data from every lease and business arrangement that could contain an embedded lease that exists on, or will exist after, the effective date. Analyzing leases and business arrangements to identify and extract those details for inclusion in the organization’s financial reports requires substantial time and resources. It is crucial to identify the full population of leases upon adoption of ASC 842.

Nonprofits should also consider adopting the following best practices:

Solicit the involvement of the entire organization: Although the implementation of ASC 842 is primarily the responsibility of the organization’s accounting department, successful implementation requires support from across the entity, especially when an organization has a large real estate portfolio or embedded leases. This may mean seeking assistance from IT, legal or procurement departments. Soliciting executive sponsorship to champion implementation will also help to streamline the process.

Use technology to your advantage: Under the stress of deadlines, the compilation of lease terms and data can be daunting, especially within larger nonprofits where leases may exist across departments – and possibly internationally if the organization has international operations. For organizations that have developed a robust data governance program or specific procedures to collect and manage enterprise data, implementation should be considerably easier. However, for the many organizations that have yet to build out these structures, there are off-the-shelf and purpose-built technology solutions that can help standardize and aggregate the information.

Keep an open line of communication: Organizations that maintain a large physical footprint are impacted the most. They should factor in extra time for both implementation and keeping stakeholders informed. Unexpected roadblocks, such as a delay in receiving necessary data from external sources, should also be accounted for in the timeline. Benchmarking the organization’s progress on implementation against its timeline throughout the process is paramount in keeping on task and meeting goals.

The bottom line is that even with the extension, it will take a concerted effort to become compliant in time. Nonprofits need to start the implementation process now.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2020). Copyright © 2020 BDO USA, LLP. All rights reserved. www.bdo.com

IRS Proposes Excise Tax Relief for Exempt Organization Executive Compensation Under Code Section 4960

By Marc Berger, CPA, JD, LLM, Alex Lifson, MBA, MST, Norma Sharara, JD, and Joan Vines, CPA

In June 2020 the IRS proposed regulations under Internal Revenue Code (IRC) Section 4960 that, among other things, would allow certain tax-exempt organizations and related for-profit entities to avoid paying 21% excise taxes on certain executive compensation. Even better, taxpayers may rely on the proposed regulations until final regulations are issued. The new rules are generally consistent with, and build further on Notice 2019-09 (issued on Dec. 31, 2018), which provided helpful initial guidance on Section 4960. See our primer on 4960. With a few exceptions, the proposed regulations are consistent with the interim guidance provided in Notice 2019-09, so it seems likely that final regulations will not include any major changes to the proposed rules. Comments on the proposed rules were due by Aug. 10, 2020.

BACKGROUND

The Tax Cuts and Jobs Act of 2017 (Public Law 115-97) created IRC Section 4960. As a result, starting in 2018, most tax-exempt organizations and certain governmental units, as well as for-profit employers who “control” or who are “controlled by” an “applicable tax exempt organization” (ATEO), may owe a 21% excise tax on (1) annual “remuneration” over $1 million paid to “covered employees” or on (2) any “excess parachute payments” (even if those are under $1 million).

ATEOs of all sizes (and their related for-profit entities) might owe this tax if they paid any employee $125,000 or more during any year beginning on or after Jan. 1, 2018. So even if the ATEO never paid any employee more than $1 million, the tax on excess parachute payments made to “highly compensated employees” could still be owed.

Section 4960 introduced several important new defined terms, including the following:

“Excess parachute payments” are amounts that exceed three times the covered employee’s five-year average wages and are contingent on an involuntary termination of employment.

“Remuneration” generally means Code Section 3401(a) wages paid during a calendar year ending with or within the employer’s tax year, excluding (1) Roth, tax-qualified retirement plans, 403(b) plan and governmental 457(b) plan contributions and distributions and (2) amounts paid to a licensed medical professional for the direct performance of medical services, but including amounts required to be included in income under 457(f)’s special timing rules (i.e., amounts are generally taken into account for the 4960 excise tax in the calendar year when the amount vests, regardless of when it is paid or included in income).

  • The proposed rules confirm that this special timing rule for determining annual remuneration does not include the 457(f) exceptions for short-term deferrals, certain severance payments and earnings on vested nonqualified deferred compensation (so such amounts would be included when determining 4960 excise tax). For example, short-term deferrals under 457(f) and 409A may be included in an employee’s taxable income in a different year than the year that those amounts must be included in 4960 excise tax calculations. Likewise, subsequent earnings on vested 457(f) amounts would be included in taxable income in a different year than the year those amounts must be included in 4960 excise tax calculations (for 4960, subsequent earnings on vested amounts are treated as paid annually, even if the amounts are not actually paid until later).
  • Under the proposed rules, remuneration and parachute payments that vested before the date in 2018 that the rules became effective for the ATEO are generally exempt from 4960 taxes (but would still count for purposes of determining whether an employee is a covered employee).

BDO Insight:

This clarification attempts to take some of the sting out of the fact that 4960 does not have a “grandfather” rule (and the IRS will not create one, since the IRS said that it lacks authority to do so).

Any entity that paid the excise tax in the 2018 or 2019 tax year on a payment that was vested prior to the applicable effective date for that entity should file a refund request.

  • The proposed rules also clarify that remuneration includes taxable, below-market, compensation-related loans made to employees (which might arise, for example, in connection with certain split-dollar life insurance arrangements). The proposed rules clarify that nontaxable expense allowances and reimbursements (such as under an accountable plan) and other nontaxable benefits (like directors’ and officers’ liability insurance coverage) are not included in remuneration. The IRS asked for comments on whether certain taxable employee benefits (like group term life insurance over $50,000) should be included in remuneration.
  • The proposed rules create an administrative exception for payroll periods that cross over calendar years, which tracks the Form W-2 reporting rule. Specifically, regular wages are treated as paid when actually or constructively paid (not when vested). So, if a pay period ends on Dec. 30, 2020, but salary for that period is not actually paid until Jan. 6, 2021, then the salary is treated as paid in 2021 (and the salary is not treated as being vested in 2020). But that exception would not apply to bonuses or other irregular compensation, so if those amounts vest on Dec. 31, 2020, they are included in 4960 for 2020, even if they are not paid until 2021.

“Covered employee” means a common law employee (including any former employee) of an ATEO if the employee is one of the five highest-compensated employees of the organization for the taxable year or was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after Dec. 31, 2016. This means that ATEOs need to identify who their common law employees are under Code Section 3401 (i.e., for purposes of withholding federal income tax from paychecks).

BDO Insight:

Despite much publicity about highly paid, public university sports team coaches being subject to the $1 million tax, some of those schools may avoid paying the 4960 tax unless Congress enacts a technical correction.

NEW VOLUNTEER/LIMITED SERVICES EXCEPTIONS

 One of the most sought-after changes the IRS adopted in the proposed regulations is that certain employees of a related for-profit employer providing services to an ATEO will no longer be treated as a “covered employee,” provided that the individual’s remuneration or hours of service satisfy specific limits. Generally, the exception will apply if (1) the services provided by the individual for the ATEO are not more than 10% of the total hours of service that the individual performs for all related organizations and (2) neither the ATEO nor any other entity controlled by the ATEO pays the individual for such services. The proposed rules set out a safe harbor for individuals who do not work more than 100 hours per year for the ATEO.

Many stakeholders wanted this exception to avoid 4960 excise taxes on the compensation paid to executives of for-profit companies that volunteer at a related ATEO, perform minor services as unpaid officers, perform limited services, or work limited hours. For example, many for-profit executives serve as officers of a corporate foundation created by the for-profit entity and many corporations have employee-sharing arrangements with their corporate foundation. Under the statute and Notice 2019-09, those arrangements would have subjected their compensation from the corporation to 4960 excise taxes.

The proposed rules also set out a more complicated “non-exempt funds” exception that might rescue certain situations where the individual who primarily works for the for-profit entity provides no more than 50% of his/her services to the ATEO and other conditions are satisfied. The proposed rules also include details on how to count hours of service for purposes of these exceptions.

Further, the proposed rules confirm that 4960 taxes apply only to employees, not to independent contractors or members of the board of directors who are not also employees of the ATEO.

BDO Insight:

It is not clear whether for-profit entities that paid 4960 excise taxes on IRS Form 4720 (Schedule N) for 2018 or 2019 would be eligible to claim a refund for those amounts based on the new position set out in the proposed regulations, because it is not specifically stated that this provision is retroactive. For-profit entities that have paid 4960 excise tax should set up a reminder to check for updates each year and discuss whether it would be appropriate to file a protective refund claim before the statute of limitations closes on the Form 4720.

NEW CONTROLLED GROUP/PREDECESSOR RULES

Generally, the proposed regulations define “control” for 4960 excise taxes by using Section 512(b)(13) (i.e., the same rules for reporting related organizations on IRS Form 990). For example, the proposed rules provide that a person (or governmental entity) controls a nonstock corporation if (1) the person has the power to remove and replace more than 50% of the organization’s directors; or (2) more than 50% of the organization’s directors are “representatives” (trustees, directors, officers, employees or agents) of that person. But the proposed rules create a new exception, where an employee will not be considered a “representative” if the employee lacks authority commonly exercised by an officer, doesn’t actually act as a representative of the person, and this fact is reported on the organization’s Form 990. So, if a majority of lower-level corporate employees serve as directors or trustees of an ATEO, the for-profit entity would not be “related” to the ATEO for 4960 purposes. This alleviates concerns over “accidental control.” The IRS also clarified how “indirect control” and attribution principles work for 4960 purposes.

The proposed rules also confirm that the owner of a single member entity (such as an LLC) is the employer of the employees of that entity.

In addition, the proposed regulations clarify that federal government “instrumentalities” are subject to 4960, but requested comments on that issue.

Although the proposed rules say that a foreign organization that otherwise qualifies as an ATEO would be subject to 4960 excise taxes, the IRS has asked for public comments on whether foreign organizations that are related to an ATEO should be subject to 4960 excise taxes. The proposed regulations also clarify that a foreign organization that receives substantially all of its support from sources outside the United States would not be an ATEO.

Keep in mind that a “covered employee” includes any employee who was a covered employee of a predecessor ATEO. The proposed regulations outline when an entity is considered to be a predecessor ATEO, including asset acquisitions, corporate reorganizations and chains of predecessors.

NEW SHORT TAX YEAR RULE

The proposed regulations provide guidance for determining how to handle short tax years, such as the initial or final calendar year that the ATEO is subject to 4960. For 4960 purposes, the applicable year for measuring remuneration and excess parachute payments is the calendar year that ends “with or within” the ATEO’s taxable year. For example, for an ATEO with a fiscal year from July 1, 2021 to June 30, 2022, the applicable tax year is calendar year 2021 for determining who is a covered employee and what remuneration is subject to 4960 excise taxes.

BDO Insight:

Although this timing rule is generally the same method used for reporting compensation on Form 990, the definition of “remuneration” for 4960 differs from the definition of “compensation” reported on Form 990, so ATEOs cannot simply copy information reported on Form 990 for 4960 purposes.

ONLY ATEOS OWE PARACHUTE EXCISE TAX

The proposed regulations revise Notice 2019-09 by providing that only ATEOs could owe an excess parachute payment excise tax, based on a separation from employment with the ATEO. Notice 2019-09 implied that an ATEO or its related organizations are liable for excess parachute payment excise tax based on the aggregate parachute payments made by the ATEO and its related organizations, including parachute payments based on separation from employment from a related organization. Now it is clear that a separation from employment from a related entity that is not itself an ATEO would not trigger 4960 tax liability. Nevertheless, the proposed rules retained the concept that payments from for-profit related organizations must still be counted when determining the “base amount” and total payments that are contingent on involuntary separation from employment for 4960 excise tax purposes.

UNREASONABLE POSITIONS

In the proposed regulations, the IRS repeated the warning it gave in Notice 2019-09 by confirming that the following are not reasonable, good faith interpretations of 4960:

  • Related for-profit or governmental entities are not liable for their share of the 4960 excise taxes.
  • A covered employee ceases to be a covered employee after a period of time.
  • A group of ATEOs may have only five highest-compensated employees among all related ATEOs.

BDO Insights:

ATEOs that do not have 4960 tax liability for a year would still need to make a list of covered employees each year, since there is no minimum dollar test to be a covered employee, and once someone is a covered employee that individual remains so forever, even after termination of employment. The IRS declined to adopt any minimum dollar threshold, grandfathering rule or sunset rule for determining covered employees.

The proposed regulations may help ATEOs design and implement employment, deferred compensation, severance and other agreements. For example, they could spread out when remuneration is included in 4960 calculations on remuneration in excess of $1 million by using vesting schedules for deferred compensation arrangements and may be able to avoid 4960 entirely (such as with a split dollar life insurance arrangement). ATEOs may also want to consider whether changing existing management service arrangements among related entities may reduce 4960 liability exposure.

Since 4960 took effect on Jan. 1, 2018 (with no grandfather or transition rules), ATEOs should already be complying. Until final rules are issued, ATEOs can continue to apply a reasonable, good faith interpretation of 4960, except where the proposed regulations or Notice 2019-9 specifically identified what will not qualify as a good faith interpretation.

 

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2020). Copyright © 2020 BDO USA, LLP. All rights reserved. www.bdo.com

Is Your Organization Audit Ready?

By Barbara Finke, CPA

First, what is an audit (and what is it not)? The purpose of an audit, as defined by the American Institute of Certified Public Accountants (AICPA), is “to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. An auditor’s opinion enhances the degree of confidence that intended users can place on the financial statements.” An audit provides reasonable assurance, not absolute assurance, that the financial statements are correct (not materially misstated) within a defined threshold. The AICPA provides a set of standards that all audit firms are required to follow to achieve the appropriate level of assurance to issue the opinion. But an audit is not just a generic set of checklists. The auditor creates a tailored set of procedures based on a gained understanding of your organization that will mitigate the risk of material misstatements in your financial statements.

What might cause you to need an audit for the first time? New funding sources, whether debt or grants, may require an organization to submit financial statements audited in accordance with generally accepted accounting principles . Therefore, before any new grant or debt is signed, make sure someone in the accounting department is reviewing the requirements thoroughly. A first-time audit is not something you want to be surprised with!

During the COVID-19 pandemic, your organization may have taken on new debt that requires an audit. In addition, you may have received funding from the Coronavirus Aid, Relief, and Economic Security (CARES) Act or other pandemic related funding that may require an audit under Office of Management and Budget’s Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). To understand if the funding you received is subject to the Uniform Guidance, you should review the Assistance Listing available at https://beta.sam.gov/ or contact the funding source.

So, how can you ensure that your organization is prepared for the first audit? Follow these 10 steps:

1.  Gather all of your organizational documents and significant contracts into one central location (preferably electronically), including:

  • Articles of Incorporation
  • Bylaws
  • Corporate Operating Agreement
  • Internal Revenue Service (IRS) exemption determination letter
  • IRS Form 1023 or 1024
  • Applicable state tax determination letters
  • All significant contracts (customer/grants/leases/vendor/pledge agreements)
  • Board minutes from the year(s) under audit
  • Commercial insurance policies
  • Trust agreements (annuities, life insurance policies, split-interest agreements, etc.)
  • All pension and post-retirement plan documents
  • Legal titles for real property owned
  • Corporate organizational chart
  • Staff organizational chart
  • Organization policies and procedures manuals
  • Other organizational documents

2. Document your key financial statement processes and policies. During the documentation process consider if your organization has proper internal controls and if the performance of those controls is adequately documented. Remember to consider your controls and policies over information technology systems that support your accounting records.

  • For guidance around internal controls, certain resources are available from the Committee of Sponsoring Organizations of the Treadway Commission at www.coso.org or the Green Book published by the U.S. Government Accountability Office at www.gao.gov.2. Document your key financial statement processes and policies. During the documentation process consider if your organization has proper internal controls and if the performance of those controls is adequately documented. Remember to consider your controls and policies over information technology systems that support your accounting records.

3. Compile a list of related parties, including related entities, and clearly document the relationship with each related party including a listing of any related agreements between the parties.

  • Consider consulting with your legal counsel (internal or external) to ensure all legal relationships are properly documented.Compile a list of related parties, including related entities, and clearly document the relationship with each related party including a listing of any related agreements between the partiesReview your accounting records and ensure that reconciliations are available for any balance sheet account as necessary to reconcile sub-ledger data (or any data maintained outside of the ledger) to the trial balance.

4. Review your accounting records and ensure that reconciliations are available for any balance sheet account as necessary to reconcile sub-ledger data (or any data maintained outside of the ledger) to the trial balance.

5. Ensure that transactional data from the period under audit (proof of expenses, sales, contributions or payroll records) is organized and available for testing as requested.

6. Ensure that a full schedule of all property and equipment, and related depreciation and amortization, is available.

7. Obtain sample audited financial statements of similar organizations. Review the financial statements to gain an understanding of what data to have available to produce the required footnote disclosures. Sample financial statements can be found on a nonprofit’s website, www.Guidestar.org, or on the Federal Audit Clearinghouse website https://harvester.census.gov/facweb/ (if the nonprofit was required to have an audit performed in accordance with Uniform Guidance).

Once you’ve hired your firm of choice (and before any recurring engagement) you should:

8. Facilitate a meeting with the audit team and those individuals you have designated as your financial governance committee (audit committee, finance committee, board of directors, etc.) to set expectations and discuss specific risks related to your organization.

9. Hold a meeting with the audit team and your management to discuss timing and specific items that you will need to prepare based on the tailored approach prepared by the auditor. Finalize the timeline of all deliverables to ensure that your financial statements will be issued by the date required. Once you have received the specific list of items to be prepared by the organization, hold an internal meeting to assign responsibility for each task and consider how the information will be organized and reviewed prior to delivery to the auditor.

10. If your organization has inventory, ensure that you invite the audit team to the year-end count or the next scheduled perpetual count.

With careful consideration of these steps and allowing adequate time for your team to pull and organize this information, even a first-year audit should run smoothly.

And for recurring audits? In addition to Tips 8-10 above, consider:

  • After the initial audit, the relationship with your audit firm shouldn’t be just the yearly audit. Keep in touch throughout the year to discuss changes in your strategies, funding, processes, etc. so your auditors can advise if there are any potential accounting or compliance issues you should consider. A nonprofit’s financial statements are often public documents, so checking in on how new events and transactions may impact your audit and financial statement presentation can help mitigate unwanted surprises. Talk to your auditors about any changes in accounting controls or any new funding streams that might impact compliance requirements.
  • Stay informed about any changes to legislation, accounting pronouncements or other compliance updates that will impact your organization’s financial statement presentation or compliance rules. While it is often assumed that it is only the auditor’s job to keep up with changes, management is ultimately responsible for all the information in the financial statements and, therefore, should have a working knowledge of requirements. Keeping up with the changes will also ensure that the accounting system and records are set up to produce the required information the auditors will need to audit your organization’s adoption of new standards.
  • Stay organized! Create a logical electronic filing system to ensure that you can easily locate the information that has been requested and your team has prepared. Then, keep the files until the following year for reference.

The COVID-19 pandemic required many organizations to move office personnel to a remote environment. Some localities are still under shelter-in-place mandates, and some organizations have chosen not to bring the full team back into the office. In all likelihood a portion, if not all, of your audit in the coming months will be handled remotely. The keys to a successful audit under COVID-19 pandemic restrictions are communication and flexibility. Here are some additional considerations as you prepare for a remote audit:

  • Review what, if any, changes have occurred in the internal control processes to accommodate remote working. Are there changes in the check writing or depositing process? Are there changes to approval controls? Discuss these changes with your auditor ahead of the scheduled audit.
  • Discuss with your auditor what file repository system will be utilized for the remote sharing of data from your organization to your auditors in a secure manner. Ensure that the filing system will meet the cybersecurity requirements of your organization.
  • Discuss the timeline with your auditor well in advance this year. Consider if additional time may be required for your team to transfer physical files to electronic copies.
  • Consider using video technology to allow for the auditor to observe processes through the digital environment and allow for “in-person” meetings and interviews throughout the audit. An auditor could potentially even use digital methods to conduct a physical inventory count observation.
  • Consider safety protocols that your organization and the audit firm will require if in-person work or meetings are considered necessary. Ensure that each team understands the legal and organizational requirements for protective equipment and social distancing protocol.

The word audit can often be a source of fear and dread. However, if you follow the tips above, your organization can be audit ready. An organization that is well prepared will see the audit process as a helpful tool for financial health and not an exhaustive exercise in pulling data. Communication with your auditors has always been important but with the current COVID-19 restrictions both communication and flexibility will be even more critical to a smooth audit process.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2020). Copyright © 2020 BDO USA, LLP. All rights reserved. www.bdo.com

FASB Issues ASU On Contributed Nonfinancial Assets

By Tammy Ricciardella, CPA

On September 17th, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU), 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets. This ASU is intended to increase transparency on how contributed nonfinancial assets (also referred to as gifts-in-kind) received by nonprofits are to be used and how they are valued.

The ASU was issued to address stakeholder concerns about how nonprofit entities report contributed nonfinancial assets. Stakeholders expressed a need for additional transparency surrounding the amount of contributed nonfinancial assets and how they are used in a nonprofit’s programs and activities. Others noted the need for clarity in how these contributed nonfinancial assets were valued.

Though the update does not change the current recognition and measurement requirements in generally accepted accounting principles (GAAP), which is included in Accounting Standards Codification (ASC) 958-605, Revenue Recognition, the ASU is intended to improve current GAAP through enhancements to presentation and disclosures of contributed nonfinancial assets.

The scope of the ASU is limited to gifts of nonfinancial assets. The term nonfinancial assets includes fixed assets such as land, buildings and equipment; the use of fixed assets or utilities, materials and supplies such as food, clothing or pharmaceuticals; intangible assets; recognized contributed services; and unconditional promises of those assets. Many nonprofit organizations rely on these contributions to conduct their programs and mission-related activities.

The ASU requires that a nonprofit present contributed nonfinancial assets as a separate line item in the statement of activities apart from contributions of cash or other financial assets.

The ASU requires the following information be disclosed related to the contributed nonfinancial assets:

  • The contributed nonfinancial assets recognized in the statement of activities disaggregated by categories that depict the type of contributed nonfinancial assets.
  • Each category of contributed nonfinancial assets recognized as noted above should disclose the following:
    • Qualitative information about whether the contributed nonfinancial assets were either monetized or utilized during the reporting period.

–  If utilized, a description of the programs or other activities in which those assets were used.

    • The nonprofit’s policy (if any) about monetizing rather than utilizing contributed nonfinancial assets.
    • A description of any donor restrictions associated with the contributed nonfinancial assets. An example of this would be if an entity received contributed pharmaceuticals, and the donor restricted these for use outside of the United States.
    • The valuation techniques and inputs used to arrive at a fair value measure in accordance with the requirements in ASC 820, Fair Value Measurements, at initial recognition.
    • The principal market (or most advantageous market) used to arrive at a fair value measure if it is a market in which the recipient nonprofit is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial assets.

The amendments in the ASU should be applied on a retrospective basis and are effective for annual reporting periods beginning after June 15, 2021. Early adoption of the ASU is permitted.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2020). Copyright © 2020 BDO USA, LLP. All rights reserved. www.bdo.com

President Trump Signs into Law CARES Act – Tax Impacts for Business, Charities and Individuals

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

2020 Recovery Refund Checks for Individuals

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

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

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

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

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

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

Charitable Contributions

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

This above-the-line charitable deduction may not be used to make contributions to a non-operating private foundation or to a donor advised fund.

Modification of limitations on cash contributions: Currently, individuals who make cash contributions to publicly supported charities are permitted a charitable contribution deduction of up to 60% of their AGI. Any such contributions in excess of the 60% AGI limitation may be carried forward as a charitable contribution in each of the five succeeding years.

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

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

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

Compensation, Benefits, and Payroll Relief

The law temporarily increases the amount of and expands eligibility for unemployment benefits, and it provides relief for workers who are self-employed. Additionally, several provisions assist certain employers who keep employees on payroll even though the employees are not able or needed to work. The cornerstone of the payroll protection aid is a streamlined application process for SBA loans that can be forgiven if an eligible employer maintains its workforce at certain levels. Additionally, certain employers affected by the pandemic who retain their employees will receive a credit against payroll taxes for 50% of eligible employee wages paid or incurred from March 13 to December 31, 2020. This employee retention credit would be provided for as much as $10,000 of qualifying wages, including health benefits. Eligible employers may defer remitting employer payroll tax payments that remain due for 2020 (after the credits are deducted), with half being due by December 31, 2021, and the balance due by December 31, 2022. Employers with fewer than 500 employees are also allowed to give terminated employees access to the mandated paid federal sick and child care leave benefits for which the employer is 100% reimbursed by the government through payroll tax credits if the employer rehires the qualifying employees.

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

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

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

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

Deferral of Net Business Losses for Three Years

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

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

Section 163(j) Amended for Taxable Years Beginning in 2019 and 2020

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

Net Operating Losses Carryback Allowed for Taxable Years Beginning in 2018 and Before 2021

The CARES Act provides for an elective five-year carryback of net operating losses (NOLs) generated in taxable years beginning after December 31, 2017, and before January 1, 2021. Taxpayers may elect to relinquish the entire five-year carryback period with respect to a particular year’s NOL, with the election being irrevocable once made. In addition, the 80% limitation on NOL deductions arising in taxable years beginning after December 31, 2017, has temporarily been pushed to taxable years beginning after December 31, 2020. Several ambiguities in the application of Section 172 arising as a result of drafting errors in the Tax Cuts and Jobs Act have also been corrected. As certain benefits (i.e., charitable contributions, Section 250 “GILTI” deductions, etc.) may be impacted by an adjustment to taxable income, and therefore reduce the effective value of any NOL deduction, taxpayers will have to determine whether to elect to forego the carryback. Moreover, the bill provides for two special rules for NOL carrybacks to years in which the taxpayer included income from its foreign subsidiaries under Section 965. Please consider the impact of this interaction with your international tax advisors. However, given the potential offset to income taxed under a 35% federal rate, and the uncertainty regarding the long-term impact of the COVID-19 crisis on future earnings, it seems likely that most companies will take advantage of the revisions. This is a technical point, but while the highest average federal rate was 35% before 2018, the highest marginal tax rate was 38.333% for taxable amounts between $15 million and $18.33 million. This was put in place as part of our progressive tax system to eliminate earlier benefits of the 34% tax rate. Companies may wish to revisit their tax accounting methodologies to defer income and accelerate deductions in order to maximize their current year losses to increase their NOL carrybacks to earlier years.

Alternative Minimum Tax Credit Refunds

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

Technical Correction to Qualified Improvement Property

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

Effects of the CARES Act at the State and Local Levels

As with the Tax Cuts and Jobs Act, the tax implications of the CARES Act at the state level first depends on whether a state is a “rolling” Internal Revenue Code (IRC) conformity state or follows “fixed-date” conformity. For example, with respect to the modifications to Section 163(j), rolling states will automatically conform, unless they specifically decouple (but separate state ATI calculations will still be necessary). However, fixed-date conformity states will have to update their conformity dates to conform to the Section 163(j) modifications. A number of states have already updated during their current legislative sessions (e.g., Idaho, Indiana, Maine, Virginia, and West Virginia). Nonetheless, even if a state has updated, the effective date of the update may not apply to changes to the IRC enacted after January 1, 2020 (e.g., Arizona). A number of other states have either expressly decoupled from Section 163(j) or conform to an earlier version and will not follow the CARES Act changes (e.g., California, Connecticut, Georgia, Missouri, South Carolina, Tennessee (starting in 2020), Wisconsin). Similar considerations will apply to the NOL modifications for states that adopted the 80% limitation, and most states do not allow carrybacks. Likewise, in fixed-dated conformity states that do not update, the Section 461(l) limitation will still apply resulting in a separate state NOL for those states. These conformity questions add another layer of complexity to applying the tax provisions of the CARES Act at the state level. Further, once the COVID-19 crisis is past, rolling IRC conformity states must be monitored, as these states could decouple from these CARES Act provisions for purposes of state revenue.

Gift Acceptance Policy

By Tammy Ricciardella, CPA

Many nonprofits receive contributions of both cash and non-cash gifts and are often hesitant to refuse any donations offered. However, there are certain non-cash gifts that can cause issues and at times even cost the nonprofit money.

To prevent these situations, nonprofits should have a gift acceptance policy to standardize this process and ensure that only gifts that benefit the organization will be accepted.

Nonprofits should address the following considerations in developing a formal gift acceptance policy:

What types of assets will the entity consider accepting?

Consider listing the types of gifts that will be accepted, such as cash, publicly traded securities, closely-held business interests, real property, etc.

What is the process for determining whether a gift will be accepted?

Consider and/or determine who on the organization’s staff will be responsible for reviewing proposed gifts and when it may be necessary to engage additional expertise such as outside legal counsel or appraisers. Determine if the entity should establish a gift acceptance committee if it has a large volume of gifts.

What information is needed prior to final acceptance of a gift?

Consider documenting what due diligence is required for each type of donated property prior to acceptance. Establish guidelines for when qualified appraisals, environmental analyses, etc. are required for specific property types.

What are the timelines for the liquidation of illiquid gifts?

Establish a definition of a holding period for an illiquid gift. Establish policies to assess if there will be costs incurred during the holding period, as well as policies to address the expectations of donors if the illiquid asset cannot be liquidated in the original projected holding period.

What gifts will the entity not accept?

Clearly identity any donated assets an entity is not willing to accept.

How will the organization handle donor tax questions?

Consider clearly documenting a policy that encourages donors to obtain tax guidance from their own professional advisers. Nonprofits should avoid giving tax advice to donors.

Will the entity encounter additional work or costs related to an unusual gift or unusual gift restriction?

Establish a policy to assess whether additional time or funds will be incurred prior to the acceptance of a donation. Consider whether these unusual items enhance programs of the entity. Consider whether the entity needs to establish a minimum gift amount or whether these types of gifts should be included in the list of items that will not be accepted.

What is the gift acknowledgment process?

Establish a clear policy for the issuance of gift acknowledgment letters. Ensure these are drafted and reviewed by appropriate tax personnel to ensure all IRS guidelines have been met from both the organization’s and donor’s perspectives.

Having a clearly defined gift acceptance policy can help protect an organization against risks and unexpected costs and provide guidelines for board members or management to determine when it is appropriate to decline a donation. The main focus of a gift acceptance policy is to ensure donated gifts assist the organization in achieving its mission and do not detract from this focus.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Challenges with Gifts-In-Kind

By Tammy Ricciardella, CPA

Many nonprofit organizations receive a variety of gifts-in-kind (GIK) that provide them with resources to supplement their programming.

GIK represent a wide variety of non-cash items donated to nonprofits. Nonprofits must follow Accounting Standards Codification (ASC) Topic 820, Fair Value Measurement, to account for the GIK. This means that GIK must be recorded at fair value which is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This creates difficulties for many entities since they receive the goods as a contribution and not a market participant. This creates the question of how to value the items received. The entity must assess what market they would use if they were to sell the donated goods. This assessment must be performed in the process of determining the fair value even though the entity has no plans to actually sell the donated goods. Would the goods be sold in an exit market as a retailer, wholesaler or manufacturer, or in some other market? Once the market is determined, there can still be complications if the entity doesn’t have access to the valuation inputs in that market. The entity may have to use the inputs available to them to assess the fair value and then make an adjustment to the market they chose.

These are all complications faced by entities who receive GIK as they may not have prior transactions or the market experience to use as a resource for the fair value inputs. Under the ASC, entities must distinguish between the principal market and the distribution market. The principal market is defined as “the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability.” Based on this definition, the actual location in which the donated goods may be distributed at no cost is not necessarily the principal market.

Determination of the fair value also has to take into consideration if there are any legal restrictions either on the entity or the donated assets. Asset restrictions may limit the legal sale of GIK to certain markets which would affect the determination of the principal market. Since these legal restrictions on the asset restrictions would be considered by a potential buyer, the entity has to take this into account in the fair value assessment.

It is important to note that the value assigned by the donor of the goods may not relate to the principal exit market of the nonprofit. In addition, the donor’s tax values are not equivalent to the fair value under accounting principles generally accepted in the United States. In many cases, the nonprofit will not have access to the same market as the donor. The nonprofit must value the GIK based on the principal exit market from their perspective.

To assist in addressing these complications, entities should have a documented policy on accepting GIK and a policy on how the fair value assessments will be performed. The determination of fair value for each type of GIK received should be clearly documented, including management’s assessments and factors considered and the final conclusion reached.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

1 Year After Wayfair: What Nonprofits Need To Know

By Marc Berger, CPA, JD, LLM and Katherine Gauntt

It’s been more than a year since the Supreme Court announced the landmark decision in the South Dakota v. Wayfair case, opening the door for states to require organizations to collect and remit sales tax even if the organization has no in-state physical presence. The impact of the decision has proven to be far-reaching.

Since that time, organizations selling goods and services across state lines, including nonprofits, have had to navigate the fallout. While we covered this decision in depth earlier this year, it’s important as we mark the one-year anniversary of Wayfair, to take a look at what’s changed and what challenges may still be on the horizon for nonprofits.

The Wayfair Domino Effect

Prior to the Wayfair decision, most nonprofits selling goods and services didn’t have a physical presence in states beyond their home states and, thus, did not collect sales tax.

But the Wayfair decision had a domino effect: States began adding or revising statutory language to accommodate an economic nexus standard for remote sellers. Several states already had laws on the books that automatically went into effect following the decision. As of this article’s publication, all but three states (Florida, Kansas and Missouri) have enacted economic nexus rules. Organizations selling things like promotional items, event tickets or other goods or services are likely affected in some way.

Each state has differing economic thresholds that require organizations to collect sales taxes, and the deadlines for compliance vary state-by-state as well. Even if no tax is collected, the requirement to file a return remains. This patchwork of regulations and deadlines may leave many nonprofits struggling to understand where their obligations lie, and how quickly they need to address them.

Complicating matters, the state thresholds vary in terms of dollar amount and number of transactions required to trigger economic nexus and the deadlines to comply also vary. For nonprofits, knowing where and when they’re required to administer sales tax is often half the battle.

Automation Offers a Potential Solution

One possible option for monitoring the thousands of shifting tax rates that may apply in a post-Wayfair world is the use of automated software that monitors these changes in real time. Automated software solutions offer several benefits, including:

  • Tracking tens of thousands of tax rates in real time
  • Access to taxability information to determine how products and services are taxed in various jurisdictions
  • A history of transaction data that can be used to compile tax returns and provide a single source of information in the event of a sales tax audit
  • Assistance with managing exemption certificates for tax-exempt sales

For nonprofits, which typically have fewer resources than for-profit companies, a full-service automated solution might seem out of reach. However, there are many simple products that offer basic services—such as tax rate tracking—at a lower cost. Ultimately, while there are costs associated with these services, they may be eclipsed by the administrative and resource burden that comes with keeping pace with constant change without them.

Marketplace Facilitator Laws, The Next Frontier

While Wayfair had obvious effects on the e-commerce sector, its impact also extends to the middlemen of retail sales transactions. New sales tax laws are now requiring marketplace facilitators—third-party entities that facilitate sales, such as Amazon—to collect and remit sales and use taxes on behalf of retailers. These laws help to substantially reduce the number of remote sellers that state tax authorities may seek to audit. We expect nearly all states will enact marketplace facilitator tax laws soon.

By nature, marketplace facilitators don’t have intimate knowledge of the goods or services being sold as the retailers themselves do. This lack of familiarity could result in a fair amount of under-collected sales tax if these sales are not properly accounted for or mapped to the correct taxability classification. This under-collecting is compounded by the fact that there is a lack of regulatory clarity around who should ultimately be responsible for the correct amount of sales taxes collected and reported to the taxing agencies, whether it’s the retailer or the company facilitating the sale.

While nonprofits might not seem like marketplace facilitators, there is still a lot of confusion about what constitutes a dealer or seller under these laws. It is possible that nonprofits that maintain online marketplaces or facilitate online auctions could be considered facilitators. With so much up in the air regarding these laws, it’s critical that organizations keep a close eye on the latest developments in any state where they do business.

Don’t Forget Purchasing Exemptions

While much of the commentary around Wayfair has focused on selling, it highlights the importance of purchasing considerations, as well. As sellers begin to increasingly collect sales tax on purchases, nonprofits should be sure to understand and maximize any exemptions they qualify for due to their nonprofit status.

While the details vary, many states exempt nonprofits from paying sales tax on purchases if they are made exclusively for charitable purposes. According to the National Council of Nonprofits, more than half of U.S. states give broad sales tax exemptions for purchases by nonprofits, and an additional 15 states allow limited exemptions by certain types of nonprofits or specific organizations.

For nonprofits to take advantage of these exemptions, they need to keep track of where they exist, and work with their vendors to ensure they either do not pay sales tax on purchases or receive sales tax credits on applicable purchases. Ideally, every time an organization begins to work with a new vendor, they should determine if the purchase is exempt from sales tax and provide the vendor with applicable exemption certificates. It’s also important to note that some types of nonprofit organizations, like associations, generally don’t qualify for these exemptions.

When Wayfair was first decided, many nonprofits assumed they wouldn’t be affected, but in the year since have had to come to the realization they may be responsible for collecting and remitting sales taxes in states where they have economic nexus. While this has created concerns about the administrative burden nonprofits might face to stay Wayfair-compliant, it’s important to remember that sales tax is ultimately a cost to the buyer, not the nonprofit seller. That is, of course, provided the nonprofit is compliant. If they fail to collect and remit the sales tax, there could be an actual liability in the form of an audit assessment to the organization.

As the impact of Wayfair continues to unfold, it’s crucial that nonprofits stay up to date on the latest developments and take proactive steps to get—and stay—compliant.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Don’t Turn Your Back on CECL

By Amy Guerra, CPA

As calendar year end nonprofits have worked through the implementation of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, and turned their attention to implementing ASU 2014-09, Revenue Recognition, it’s important they don’t turn their back on another ASU.

ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, was issued in June 2016 and, at first pass, many nonprofits may glance over this standard, thinking there is no implication for them—but that’s certainly not true. When credit losses and current expected credit losses (CECL) are mentioned, most people think of financial institutions. While the new CECL model will impact financial institutions, nonprofits also fall within the scope of ASU 2016-13. Trade and financing receivables, including program-related investments, are two financial instruments common to nonprofits that will be impacted.

Incurred Loss Model

Under current generally accepted accounting principles (GAAP), most nonprofits follow the incurred loss methodology, which is based on historical losses. A loss is recorded only after a loss event has occurred or is probable. That is, an allowance is booked in anticipation of future losses based on historical events.

Expected Loss Model

ASU 2016-13 replaces the model based on historical events with the CECL model, which is an expected loss model. Nonprofits will estimate credit losses over the entire contractual term of an instrument. The expected loss model reflects management expectations based on past events, current conditions, and reasonable and supportable facts. At each reporting date, the allowance equals an estimate of all contractual cash flows not expected to be collected over the life of the financial asset. The changes in estimate are a result from, but not limited to, changes in:

  • Credit risk of assets held by the nonprofit
  • Conditions since previous reporting date
  • Reasonable and supporting forecasts about the future

Credit loss estimates under the expected loss model will require significant judgment.

Estimating Credit Losses

The CECL model gives management flexibility in selecting the most appropriate approach for their organization and the nature of its financial assets. Some possible methods for estimating expected credit losses include:

  • Probability of Default/Loss Given Default Method
  • Vintage Analysis Method
  • Discounted Cash Flow Method
  • Loss Rate Method

The new guidance does not set a threshold for recognition of an impairment allowance. Nonprofits need to measure expected credit losses for all financial assets, including those with a low risk of loss. Under GAAP, trade receivables which are current or not yet due may not require a reserve allowance but could now have an allowance for expected losses under ASU 2016-13.

Effective Date and Follow Up

The current effective date for ASU 2016-13 is for fiscal years beginning after December 15, 2020. On Aug. 15, 2019 the FASB issued a proposed Accounting Standards Update (ASU) to extend the effective date of ASU 2016-13 (among other ASUs—see related article on this page). The FASB has proposed a two-bucket approach to stagger the effective date for ASU 2016-13. All nonprofits, including those that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on an exchange or an over-the-counter market are included in bucket two. ASU 2016-13 would be effective for all entities classified in bucket two for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption will continue to be permitted. The comment period on the proposed ASU will end on September 16, 2019.

Until the final effective date is announced, acknowledging ASU 2016-13 applies and becoming familiar with the impact is the most important thing a nonprofit can do relating to CECL.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

 

Governmental Accounting Standards Board Statement No. 91, Conduit Debt Obligations

By Susan Friend, CPA

The Governmental Accounting Standards Board (GASB) issued Statement No. 91, Conduit Debt Obligations, in May 2019 to attempt to eliminate diversity in practice related to the accounting for conduit debt issues.

This Statement aims to improve the existing guidance for conduit debt that exists in GASB Interpretation No. 2, Disclosure of Conduit Debt Obligations, which allowed for variation in practice among governments that issued conduit debt, affecting the comparability of financial statement information. The variation was the result of the option for government issuers to either recognize a conduit debt obligation as a liability in their financial statements or disclose the obligation only. Statement No. 91 clarifies the definition of conduit debt and establishes that a conduit debt obligation is not a liability of the issuer. The Statement also establishes standards for accounting and reporting for additional commitments and voluntary commitments extended by issuers and arrangements associated with conduit debt obligations. Additionally, the Statement enhances required disclosures in the financial statements. The requirements of this Statement are effective for reporting periods beginning after December 15, 2020, with earlier application encouraged.

Pursuant to the Statement, for accounting and financial reporting purposes, a conduit debt obligation is a debt instrument issued in the name of a state or local government (the issuer) that is for the benefit of a third-party who is primarily liable for the repayment of the debt instrument (the third-party obligor). A conduit debt obligation has all the following characteristics:

• There are at least three parties involved, (1) an issuer, (2) a third-party obligor and (3) a debt holder or debt trustee.
• The issuer and the third-party obligor are not within the same financial reporting entity.
• The debt obligation is not a parity bond of the issuer (a bond with equal rights to the collateral as other bonds issued under a common bond indenture), nor is it cross-collateralized with other debt of the issuer.
• The third-party obligor or its agent, not the issuer, ultimately receives the proceeds from the debt issuance.
• The third-party obligor, not the issuer, is primarily obligated for the payment of all amounts associated with the debt obligation.

All conduit debt obligations involve the issuer making a limited commitment. In a limited commitment, no responsibility for debt service payments beyond the resources, if any, provided by the third-party obligor are assumed by the issuer. Some issuers extend additional or voluntary commitments of its own resources. When an issuer makes an additional commitment, the issuer agrees to support debt service payments only in the event the third-party obligor is, or will be, unable to do so. When an issuer provides a voluntary commitment, the issuer on a voluntary basis decides to make a debt service payment or request an appropriation for a debt service payment in the event the third-party obligor is, or will be, unable to do so.

Although government issuers will no longer report conduit debt obligations as liabilities, they may need to recognize a liability related to additional commitments they make or voluntarily provide associated with that conduit debt. The Statement requires a government issuer to recognize a liability associated with an additional commitment or voluntary commitment if qualitative factors indicate it is more likely than not it will support one or more debt service payments for a conduit debt obligation.

If the recognition criteria are met, the issuer should recognize a liability and an expense in the financial statements prepared using the economic resources measurement focus. The amount recognized for the liability and expense should be measured as the discounted present value of the best estimate of the future outflows expected to be incurred. If there is no best estimate available, but a range of estimated future outflows can be established, the discounted present value of the minimum amount in that range should be recognized. Under the current financial resources measurement focus, an issuer should recognize a fund liability and expenditure to the extent that the liability is normally expected to be liquidated with expendable available resources.

As long as the conduit debt obligation is outstanding, an issuer that has made an additional commitment should evaluate, at least annually, whether the recognition criteria have been met. If an issuer has made a limited commitment, they should evaluate the likelihood that it will make a debt service payment due to a voluntary commitment when there is an event or circumstance that causes the issuer to consider supporting debt payments for that conduit debt obligation. If an event or circumstance occurs, the issuer should apply the recognition and measurement criteria for recording a liability and an expense. For limited commitments, the issuer should annually reevaluate whether that recognition criteria continues to be met for that specific obligation.

This Statement also addresses arrangements that are associated with conduit debt obligations. In these types of arrangements, proceeds of the conduit debt are used to construct or acquire capital assets that will be used by the third-party obligors in the course of their activities. Payments from the third-party obligor are used to cover debt service payments and the payment schedule of the arrangement coincides with the debt service repayment schedule. During these arrangements, the title to the capital assets remains with the issuer, and at the end of the arrangement, the title may or may not pass to the third-party obligor. The Statement clarifies that these arrangements should not be reported as leases and provides that issuers should not recognize a conduit debt obligation or a receivable for the payments related to the arrangement. Additionally, the Statement provides that in an arrangement where the issuer:

• Relinquishes the title at the end of the arrangement, the issuer should not recognize a capital asset.
• Retains the title and the third-party obligor has exclusive use of the entire capital asset during the arrangement, the issuer should recognize a capital asset at acquisition value and an inflow of resources when the arrangement ends.
• Retains title and the third-party obligor has exclusive use of portions of the capital asset, the issuer should recognize the entire capital asset at acquisition value and a deferred inflow of resources at the inception of the arrangement. The deferred inflow of resources should be reduced, and an inflow of resources should be recognized in a systematic and rational manner over the term of the arrangement.

The Statement has also enhanced conduit debt note disclosures by requiring the issuer to disclose a general description of their conduit debt obligations, commitments and the aggregate outstanding principal amount of all conduit debt obligations that share the same type of commitments at the end of the reporting period. If the issuer has recognized a liability, disclosures should also include information about the amount recognized, changes in the liability during the reporting period, cumulative payments made on the liability and any amounts expected to be recovered from those payments.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com