How Tax Reform Will Impact Construction

By Maureen McGetrick

Every type of industry is impacted by the passing of the bill known as the Tax Cuts and Jobs Act (TCJA), and the construction industry was not left out of the party. However, the precise impact will depend upon the structure of the business and the nature of its operations. For construction businesses organized as C corporations, the most significant changes are the reduction in the corporate tax rate, the 100-percent bonus depreciation deduction, the elimination of the corporate AMT, modifications of rules for use of certain accounting methods, and the limitations on interest expense deductions. A number of these items also impact construction companies organized as pass-through entities, either S corporations or Limited Liability Corporations taxed as partnerships (including General Partnerships, Limited Partnerships or Limited Liability Partnerships), but there are also considerations specific to flow-through structures, including the applicability of the deduction for qualified business income, also referred to as the Section 199A deduction. This article focuses on a high-level discussion of the important considerations construction companies should focus on in the wake of tax reform.

Choice of Entity

Given the wide sweeping changes to both the corporate and individual tax systems brought on by the TCJA, it’s an opportune time for construction businesses to reconsider the tax structure chosen for the business, especially since construction businesses tend to be closely held and therefore organized as flow-through entities. This can be a complex analysis, and would largely be driven by determining the net effective rate as a C corporation versus the rate as a pass-through entity, which will be influenced by many factors including:

  • The state(s) in which the corporation does business (i.e. state effective rate);
  • Whether the owners materially participate in the business;
  • The level of compensation paid or required to be paid to any owners who provide services to the business to ensure reasonable amount of compensation;
  • Whether the entity makes distributions or profits regularly, or whether it would prefer to accumulate profits to grow the business;
  • Whether there is a planned exit from the business in the near future;
  • Whether the business has any international operations; and
  • Whether the business would be eligible for the 199A deduction (discussed below in more detail).

Other factors should be considered in the choice of entity analysis as well, including legal implications and the associated compliance costs of each structure.

199A Deduction

The TCJA provides a 20-percent deduction for pass-through entities which generate “qualified business income,” subject to certain limitations. Qualified business income is generally active income from a qualified trade or business (this definition generally excludes investment income as well as any income for personal services provided by an owner or shareholder). A qualified trade or business is typically defined as any trade or business other than a specified service business which includes the following industries: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investment management and brokerage services. There is also a broad category included in the definition of trade or business that applies to any business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. Architecture and engineering were specifically excluded from the qualified trade or business definition. There is much uncertainty around these definitions, and the practitioner community has requested guidance from the IRS and Treasury on these items quickly given that these changes will apply for 2018.

While most construction businesses might seem to fall within the definition of a qualified trade or business, it is uncertain how the law will be interpreted at this point. Assuming that you get over the hurdle for a qualified trade or business, the deduction for qualified business income will be limited to the greater of either: 1) 50 percent of W-2 wages with respect to the trade or business, or 2) 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis of qualified property. Qualified business property would generally include assets held at the end of the year, used in the trade or business during the year, and for which the depreciable period has not ended. The depreciable period is the later of 10 years from the original placed in service date or the last day of the last full year in the recovery period under Section 168.

Assuming a construction business is eligible for the 199A deduction, it could reduce the top federal rate on business income from 37 to 29.6 percent, therefore making a pass-through structure an attractive alternative. However, companies must first evaluate the many planning considerations as summarized above to understand the full impact of tax reform on their business.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

 

Transportation Fringe Benefits Are Now Ubi—Effective Jan. 1, 2018

By Laura Kalick, JD, LLM in Taxation

Does your tax-exempt organization provide transportation and parking benefits to employees? If so, you may have another commuter headache: a new tax. Under the Tax Cut and Jobs Act of 2017 (the Act), a provision was added to the Internal Revenue Code that is likely to require many tax-exempt organizations to pay unrelated business income tax (UBIT). Certain costs of qualified transportation, including transit passes, qualified parking and more, will now be taxed as unrelated business income at 21 percent.

The Act added the following provision to the Internal Revenue Code: Internal Revenue Code (IRC) Section 512(a)(7): Increase in unrelated business taxable income by disallowed fringe.

This provision was an attempt to put exempt organizations on the same footing as taxable organizations that will no longer be able to deduct these costs. The provision is effective for amounts paid or incurred after Dec. 31, 2017.

Under this provision, certain qualified transportation fringe benefits, including those relating to parking garages, must be reported as unrelated business income (UBI). All tax-exempt organizations (and a college or university owned and operated by a state or other governmental unit) will have to include as unrelated business taxable income any amounts paid or incurred for any qualified transportation fringe benefit, including the following:

• A ride in a commuter highway vehicle between the employee’s home and workplace.
• A transit pass.
• Qualified parking.

Qualified parking is parking you provide to your employees on or near your business premises. It includes parking on or near the location from which your employees commute to work using mass transit, commuter highway vehicles, or carpools. If an organization has its own garage that is used for parking that is already reported as UBI (e.g., parking for the general public), then the percentage of those costs attributable to the amount already included in its UBI does not have to be included in the amount treated as UBI under the new provision.

The UBIT on these employer costs is 21 percent at the federal level and state taxes may apply as well. Organizations should consider making estimated tax payments on these taxes.

These employee fringe benefits are still excluded from an employee’s income. Employers can generally exclude the value of transportation benefits provided to an employee during 2018 from the employee’s wages up to the following limits:

• $260 per month for combined commuter highway vehicle transportation and transit passes.
• $260 per month for qualified parking.

See IRS Publication 15-b for more information.

Even if the benefit is provided under a compensation reduction agreement, the payment will still result in UBIT for the organization. The only way the organization can avoid counting these benefits as UBI is to have the employee pay for the benefits with after-tax dollars.

COMPENSATION REDUCTION AGREEMENT EXAMPLE:

For 2018, the monthly limit on the amount that may be excluded from an employee’s income for qualified parking benefits is $260. Commuter employees can receive both the transit and parking benefits up to $520 per month tax-free.

On a per employee basis, for commuter and transit passes only, $260 monthly is $3,120 annually, and the UBI tax on this amount at 21 percent is $655 plus state taxes, if applicable. With 100 employees, the federal tax alone would be $655 per employee and approximately $65,500 in total. To the extent your organization provides a commuter benefit of up to $520 per month, the UBI tax can be much more.

Next Steps:

• Organizations should determine whether they provide these transportation and parking benefits, and if so, to how many employees, what kind and how much?
• Calculate the estimated tax payments for Federal UBI and the state, if applicable.
• If your organization has not filed Form 990-T in the past, enroll the organization in the Electronic Federal Tax Payment System in order to remit the taxes.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Bonus Depreciation Tax Reform Changes Make Cost Segregation Studies Essential

By Grant Keppel
With the recent passage of the bill known as the Tax Cuts and Jobs Act (TCJA), owners of commercial real estate now qualify for significant tax benefits, some of which are retroactive to the 2017 tax year.

Under the new tax regime, most owners who purchased either residential or non-residential property and closed on or after Sept. 28, 2017, can see significant tax benefits as a result of the bonus depreciation being applied to “used” property. For the first time since initial bonus depreciation provisions were passed in the Job Creation and Worker Assistance Act of 2002, owners and investors who acquire used property (property that has been used by previous owners) are now on an equal playing field as owners and investors who constructed or purchased “new” property. Under the new tax regime, qualifying assets that have a tax recovery period of 20 years or less, new and used, can now qualify for the 100-percent bonus depreciation provision in the assets’ first year of service (Note: While the term “bonus” is often misunderstood to mean an added benefit beyond the asset’s depreciable tax base, it is a boost to accelerate the tax depreciation in the first year the asset is placed in service).

The original intent of the bonus depreciation provision was to stimulate job growth and investment back into the economy. When first enacted, bonus depreciation was applied at 30 percent in the asset’s first year, but only to those that were new and had a tax recovery period of 20 years or less. Since most traditional assets, such as a brick-and-mortar building, would have a tax recovery period under the Modified Accelerated Cost Recovery System (MACRS), they would be classified as either a 39-year period for non-residential real property or a 27.5-year period for residential real property. Thus, those asset classifications would not qualify for this added incentive.

Prior to the passage of federal tax reform, owners or investors in used commercial property would have had to initiate depreciation recovery at the standard 39-year MACRS period, although there may have been hidden assets with the real estate component with lower recovery periods (usually at five, seven or 15 years). Now under the TCJA, those used non-building assets that have recovery periods of 20 years or less qualify for the 100-percent bonus in the asset’s first year of service (if in service after Sept. 27, 2017). While used qualifying assets placed in service before Sept. 28, 2017 would not qualify for the new bonus provision, there may still be assets with short tax recovery periods that will not receive the 100-percent first year bonus provision, but rather their normal MACRS depreciation rates over the five, seven and 15-year tax lives. The good news is there are many assets within the real estate component itself that can have shorter recovery periods.

In most cases where there are assets within a recently purchased used building, owners need to identify and reallocate the purchase price to take advantage of the lucrative bonus depreciation provisions. To do this, they should undertake a cost segregation study, which employs both engineering and tax professionals to assist in asset identifications. When only the lump sum cost of an asset, such as a parcel of real estate, is available at purchase, cost estimating techniques may be required to categorize individual components of the property as land, land improvements, buildings, equipment, or furniture and fixtures. Those assets traditionally allocated as land improvements, equipment, and furniture and fixtures placed in service after Sept. 27, 2017 would now qualify for the 100-percent first year bonus provision.

Take the following example: If a taxpayer acquires an existing shopping center on Sept. 27, 2017, under prior tax law, the taxpayer could allocate the purchase price via a cost segregation study to the various asset components. In this case, let’s say the taxpayer allocated 20 percent of the purchase price to land (non-depreciable), 15 percent to land improvements (15-year recovery period) and 12 percent to equipment (five-year recovery period), and the balance to the building asset (39-year recovery period). Before the passage of the TCJA, by employing a cost segregation study, the taxpayer’s first-year depreciation deduction would be approximately $150,000. This is opposed to an approximately $30,000 depreciation deduction if an allocation was not completed, and the taxpayer left the entire asset in the standard 39-year tax recovery period.

Now, using the same situation as above, if the closing date was instead Sept. 28, 2017, the land improvement and equipment assets identified in the cost segregation study would now be eligible for a 100-percent depreciation deduction. In calculating the depreciation under the new tax regime, the first-year depreciation would be approximately $1.1 million, nearly $1 million more than what the taxpayer would be entitled to prior to the bill’s passage.

While this implementation of bonus depreciation can create a significant expense in the asset’s first year, taxpayers must now consider if those deductions can be used to offset taxable income, to ensure there is sufficient taxable income to absorb the added deductions in the current year. The new tax law does allow for taxpayers to step down the deduction, using the prior tax provision for bonus at a 50-percent depreciation rate. Alternatively, they can also elect out of bonus entirely and just take the traditional MACRS depreciation on the allocated assets in their respective recovery periods (i.e., without first-year bonus depreciation).

With the corporate and individual tax rates reduced by the TCJA, taxpayers also need to consider if they should use the benefits on the added depreciation in 2017 or in future years. If the taxpayer can use the depreciation deductions in 2017, it makes more sense to accelerate those deductions with a cost segregation study while the tax rates are at their highest. As most real estate is held in pass-through entities (S corporations, limited liability companies and partnerships), the income is taxed at the shareholders,’ members’ or partners’ individual tax rates. Thus, if real estate is held in a pass-through entity and an individual is in the highest tax bracket, the benefit would be approximately 2.6 percent higher in 2017 than in 2018. For those companies that hold real estate in a C corporation, with the tax rate shifting from 35 percent to 21 percent, this one-time benefit can be as high as 14 percent in 2017.

Regardless of a taxpayer’s structure, the new tax law provides a boon for any owner or investor of a used property. To maximize savings, it’s critical to consider a cost segregation study to identify all qualifying assets. Savvy taxpayers will determine their ability to use the new bonus depreciation provisions and will assess when and how to implement them as a part of their overall tax strategy.

This article originally appeared in Bloomberg BNA’s Daily Tax Report. Reproduced with permission from Copyright 2018 The Bureau of National Affairs, Inc. (800-372-1033) www.bna.com.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Privacy Is a Must‑Have These Days– Guide to Implementing a Holistic Privacy Program

By Karen Schuler, CFE, IGP, IGP and Taryn Crane, PMP

Notwithstanding the EU General Data Protection Regulation (GDPR)—the most sweeping change to data privacy in 20-plus years, with extraterritorial scope that went into effect on May 25, 2018—there are numerous privacy laws that are often  overlooked.

Earlier this year companies like Facebook have come under fire for privacy violations while Congress is looking for ways to protect the privacy of American citizens. These movements are just the beginning of widespread change that we expect for privacy laws over the next several years.

As discussed in the Spring 2018 issue of the Nonprofit Standard in an article entitled “The Integration of Data Privacy into a Data Governance Program,” nonprofits can’t afford to ignore regulations like GDPR as many organizations are impacted due to their global reach. But now that May 25, 2018 has passed and GDPR officially went into effect, it’s time to think about your holistic privacy program—or implementing a Privacy Operational Life Cycle that helps your organization keep employees apprised of new privacy requirements, embraces recordkeeping and sound data protection practices while offering enhanced data privacy for your donors, employees, and constituents.

Think about these areas to develop a sound Privacy Operational Life Cycle:

  • Develop an organizational privacy vision and mission, and document the program’s objectives.
  • Identify legal and regulatory compliance challenges that are relevant to your organization.
  • Locate and document where personal information resides throughout your organization or across third parties (e.g., hosting vendors, outsourced applications).
  • Develop a privacy strategy that identifies stakeholders, leverages key functions throughout the organization, creates a process for interfacing within the organization, and outlines a data governance strategy.
  • Conduct a privacy awareness workshop to highlight to the entire organization the goals of the program.
  • And, finally, develop a structure for your privacy team with a governance model that is clear and consistent for the size of your organization.

The above-mentioned items are a starting point, but there is more to do after you develop your initial structure and communicate the purpose of the program. Below is a guide to developing the Privacy Operational Life Cycle.

Develop and Implement a Framework

The framework should provide you with an implementation road map that outlines your privacy procedures and processes. Developing a framework helps you identify high risk areas, reduce data loss, and provide a measurement against compliance to laws, regulations, and standards. Frameworks that provide initial guidance include the AICPA and CICA Privacy Framework, ISO 17779/BD7799, or OECD Privacy Guidelines.

Develop Privacy Policies

Once you have selected an overall framework to govern your privacy program, look at your existing policies, procedures, and guidelines. During this phase you should evaluate the goals of the privacy program and determine what business initiatives are the baseline of the privacy program. Just remember, as you look to update policies, procedures and guidelines for the organization, ensure that there is a mechanism to enforce these policies. And don’t forget to review the current website privacy notice. This has become a critical target of privacy watchdogs to ensure that you can fulfill the commitment of the statements in that notice.

Develop Mechanisms to Measure Performance

Within your privacy life cycle, it will be important to develop the ability to measure performance of the program. To implement metrics, consider your audience—will it be the board, external parties, regulatory agencies, or the staff? Determine how you will report on these metrics that you have identified. Decide what measurements you are interested in sharing with your audience and how this could impact funding positively or negatively. Next, determine how you will measure progress toward the organization’s business goals and objectives. Do your best to limit improper metrics that do not support the organization’s mission. And finally, determine the best methods to collect the data you need. Your goal is to demonstrate compliance while establishing the privacy program’s return on investment (ROI).

Develop the Privacy Operational Life Cycle

The Privacy Operational Life Cycle should consider measurement, improvements, and the ability to sustain and support the program. To effectively do this, develop an operational life cycle that considers the assessment, protection, governance, and response phases. Some tips to consider for each aspect of the life cycle:

  • Assess – embed Privacy by Design (PbD) into the design of technology, business practices, and physical design of new programs. In addition to PbD, regularly evaluate third-party compliance, as well as internal program compliance.
  • Protect – ensure that information life cycle management (ILM) is built into your data protection strategy. While it is important to ensure that your data protection strategies mitigate the risk of a data breach, you need to consider sound ILM practices to promote the organization’s data protection strategies. Remember, the less you have, the less you have to protect.
  • Govern – while it’s important to be able to evaluate and protect information, you also need to monitor, audit, and communicate the privacy framework. Develop a strategy and operational procedures that allow your organization to maintain a transparent and visibly sound program. And don’t forget to monitor regulatory changes that impact your organization. Develop ongoing processes that allow you to measure the privacy program’s effectiveness.
  • Respond – traditionally privacy and security teams viewed their ability to respond as responding to a security event. Today that has changed – it’s much broader and requires the ability to respond to complaints, requests for information, corrections of inaccurate data, clarifications of privacy matters and access requests. When developing your response capabilities, take into consideration these items in addition to your ability to respond to a security event.

Holistic privacy program development is the wave of the future, especially in a competitive world where data is at the core of every business or organization. Establish a program that fits your organization to ensure that you remain ahead of the curve and out of the sight of regulators.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Tax Reform and Partnerships: What You Need To Know

By Jeffrey N. Bilsky & William J. Hodges

The new tax law contains a number of provisions that will have a significant impact on partnerships and their partners. While businesses across many different industries are structured as partnerships, the structure is particularly common in the real estate and private equity sectors. The following discussion outlines several key partnership-related provisions and highlights several consequences these provisions may have on partners both in terms of annual operations as well as future capital transactions. The specific partnership-related tax reform provisions include:

Deduction for Qualified Business Income of Pass-Through Entities (Section 199A);

  • Recharacterization of Certain Long-Term Capital Gains (Sections 1061 and 83);
  • Taxation of Gain on the Sale of Partnership Interest by a Foreign Person (Sections 864(c) and 1446);
  • Repeal of Technical Termination Rules under Section 708(b)(1)(B);
  • Modification of the Definition of Substantial Built-in Loss in the Case of a Transfer of a Partnership Interest (Section 743(d));
  • Charitable Contributions and Foreign Taxes Taken into Account in Determining Basis Limitation (Section 704(d)); and
  • Like-Kind Exchanges of Real Property under Section 1031.

Deduction for Qualified Business Income of Pass-Through Entities (Section 199A)

General Rule

An individual partner’s distributive share of ordinary business income is generally subject to tax at the individual’s applicable income tax rate. Under the new tax law, the highest individual income tax rate is 37 percent. The law can effectively reduce the income tax rate applicable to an individual partner’s distributive share of qualified trade or business income to a maximum rate of 29.6 percent. This rate reduction is achieved by providing taxpayers other than corporations a deduction for each taxable year equal to the sum of:

  1. The lesser of (A) the taxpayer’s “combined qualified business income amount” or (B) 20 percent of the excess of the taxpayer’s taxable income for the taxable year over any net capital gain plus the aggregate amount of qualified cooperative dividends, plus
  2. The lesser of (A) 20 percent of the aggregate amount of the qualified cooperative dividends of the taxpayer for the taxable year or (B) the taxpayer’s taxable income (reduced by the net capital gain).

A taxpayer’s combined qualified business income amount is generally equal to the sum of (A) 20 percent of the taxpayer’s qualified business income (QBI) with respect to each qualified trade or business plus (B) 20 percent of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.

Limitation Based on Wages & Capital

The portion of the deduction attributable to 20 percent of the taxpayer’s QBI cannot exceed the greater of (1) 50 percent of their share of W-2 Wages paid with respect to the QBI or (2) the sum of 25 percent of their share of W-2 Wages plus 2.5 percent of the unadjusted basis of qualified property determined immediately after its acquisition of such qualified property. This limitation does not apply to taxpayers with taxable income not exceeding $315,000 (joint filers) or $157,500 (other filers). The limitation is phased-in for taxpayers with taxable income exceeding these amounts over ranges of $100,000 and $50,000, respectively.

The term W-2 Wages is defined to mean the sum of total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the taxable year of the taxpayer. W-2 Wages do not include any such amount that is not properly allocable to qualified business income.

Definition of Qualified Property

The term qualified property is generally defined to mean, with respect to any qualified trade or business, tangible property of a character subject to depreciation under section 167 that is (i) held by and available for use in the qualified trade or business at the close of the taxable year, (ii) used at any point during the taxable year in the production of QBI, and (iii) the depreciable period for which has not ended before the close of the taxable year. Importantly, the new tax law defines the term “depreciable period” to mean the later of 10 years from the original placed in-service date or the last day of the last full year in the applicable recovery period determined under section 168.

Illustration of W-2 Wages & Capital Limitation

Assume a taxpayer (who files a joint tax return and has taxable income of more than $415,000) operates a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. Further, assume the taxpayer generates $20,000 of QBI resulting in a QBI deduction amount of $4,000.

The Section 199A(b)(2)(B) limitation is the greater of (a) 50 percent of W-2 wages, or $0, or (b) the sum of 25 percent of W-2 wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition ($100,000 * 2.5 percent = $2,500). The amount of the W-2 Wages & Capital Limitation for the year is $2,500. Therefore, the taxpayer would be entitled to a Section 199A deduction equal to $2,500 (the lesser of $4,000 or $2,500).

If the taxpayer’s taxable income for the year is $375,000 (an amount above the $315,000 threshold but below $415,000), the Section 199A(b)(2)(B) limitation is subject to phase-in. The phase-in occurs over $100,000 for joint filing taxpayers, resulting in a phase-in percentage equal to 60 percent (($375,000 – $315,000)/$100,000). Under Section 199A(b)(3)(B)(iii), the taxpayer’s allowable deduction is $3,100 ($4,000 – (($4,000 – $2,500) * 60 percent)).

As a general rule, the phase-in percentage of taxpayers filing a joint return will be one percent per $1,000 of taxable income in excess of $315,000. For other taxpayers, the phase-in percentage is two percent per $1,000 of taxable income in excess of $157,500.

Definition of Qualified Business Income

QBI includes the net domestic business taxable income, gain, deduction, and loss with respect to any qualified trade or business. QBI specifically excludes the following items of income, gain, deduction, or loss: (1) Investment-type income such as dividends, investment interest income, short-term & long-term capital gains, commodities gains, foreign currency gains, and similar items; (2) Any Section 707(c) guaranteed payments paid in compensation for services performed by the partner to the partnership; (3) Section 707(a) payments for services rendered with respect to the trade or business; or (4) Qualified REIT dividends, qualified cooperative dividends, or qualified PTP income.

Carryover of Losses

The new tax law provides rules regarding the treatment of losses generated in connection with a taxpayer’s qualified trades or businesses. Under these rules, if the net amount of qualified income, gain, deduction, and loss with respect to qualified trades or businesses of the taxpayer for any taxable year is less than zero, such amount shall be treated as a loss from a qualified trade or business in the succeeding taxable year. In practice, this will mean that a taxpayer’s net loss generated in Year 1 will be carried forward and reduce the subsequent year’s section 199A deduction.

For example, assume a taxpayer generates a $1,000 loss from a qualified trade or business during the year-ended December 31, 2018. During the year-ended December 31, 2019, the taxpayer generates $1,500 of qualified business income. Under the carryover loss rule, and ignoring other limitations, the taxpayer would calculate a Section 199A deduction of $100 as follows:

Section 199A Deduction Amount Deduction Percentage Allowable Deduction
Qualified Business Income $1,500 20% $300
Carryover Loss Amount ($1,000) 20% ($200)
Total Section 199A Deduction $100

 

Definition of Qualified Trade or Business

A qualified trade or business includes any trade or business other than a “specified service trade or business” or the trade or business of performing services as an employee. A specified service trade or business includes any business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, and investing and investment management, trade, or dealing in securities, partnership interests, or commodities. The specified service trade or business exclusion does not apply to the extent the taxpayer’s taxable income does not exceed certain thresholds: $415,000 (joint filers) and $207,500 (other filers). Application of this exclusion is phased-in for income exceeding $315,000 and $157,500, respectively.

Illustration of Specified Services Exception Calculation

Assume the taxpayer has taxable income of $375,000, of which $200,000 is attributable to a specified services trade or business. Under Section 199A(d)(3), the taxpayer has an applicable percentage of 40 percent (1 – (($375,000 – $315,000) / $100,000)). Therefore, in determining includible QBI the taxpayer takes into account only $80,000 ($200,000 * 40 percent).

Special Rules for Partnerships & S Corporations

The new tax law provides that the Section 199A deduction is to be applied at the partner or shareholder level. Consequently, each partner or shareholder is required to take into account each person’s allocable share of QBI. Additionally, each partner or shareholder is treated as having W-2 wages and qualified property in an amount equal to such person’s allocable share of the W-2 wages and qualified property of the partnership or S Corporation.

Comprehensive Example

Taxpayer “A” files a joint return reporting taxable income of $375,000 (determined without regard to any potential Section 199A deduction). A is allocated business income, W-2 Wages, and unadjusted basis of qualified property, respectively, from the three separate business activities summarized in Table 1:

Table 1
Summary Data
Activity #1 Activity #2 Activity #3
Business Income                150,000                 35,000                  30,000
W-2 Wages                100,000                 10,000                  10,000
Qualified Property             1,500,000                 75,000                100,000

 

Activities #1 and #2 meet the definition of a qualified trade or business under Section 199A(d)(1). Activity #3, however, is a specified services business within the meaning of Section 199A(d)(2). Additionally, during the year, A received qualified REIT dividends ($25,000), qualified PTP income ($35,000), and net capital gains ($15,000). Finally, A has a net carryover qualified business loss of $100,000. Based on these facts, A will be entitled to a Section 199A deduction in the amount of $29,960. The calculation of this deduction pursuant to Section 199A(a) is illustrated in Table 2.

 

Table 2
Calculation of Section A Qualified Business Income Deduction
Deduction Amount
Sum of:

(1) Lesser of (A) or (B)

(A)   Combined QBI (see Table 3)

(B)   20% of Excess T.I. over Capital Gain plus Qual. Coop. Div.

$29,960

$72,000

$29,960
(1) Lesser of (A) or (B)

(A)   20% of Qualified Coop. Div.

(B)   Taxable Income (reduced by net capital gain)

$0

$360,000

$0
Section 199A Deduction (sum of lesser of (1) or (2))   $29,960

 

Table 3
Combined QBI Amount
 
Qualified trade or business amount – Activity 1 $30,000
Qualified trade or business amount – Activity 2 5,800
Qualified trade or business amount – Activity 3 2,160
Qualified trade or business amount – Carryover Loss (20,000)
Net qualified trade or business amount (see Table 4) $17,960
Qualified REIT dividends 5,000
Qualified PTP income 7,000
Section 199A(a) Combined QBI Amount $29,960

 

Table 4
Deductible Amount for Each Trade or Business
Activity #1 Activity #2 Activity #3 Carryover QBL Total
Net Qualified Business Income per Qualified Trade or Business 150,000 35,000 30,000 -100,000 115,000
Reduction for Specified Services Trade or Business Income* 0 0 -18,000 0 -18,000
Allowable Qualified Business Income per Qualified Trade or Business 150,000 35,000 12,000 -100,000 97,000
Deduction Percentage 20% 20% 20% 20% 20%
Qualified Trade or Business Amount (Pre-Wages and Capital Limitation) 30,000 7,000 2,400 -20,000 19,400
Limitation Based on Wages & Capital 0 -1,200 -240 0 -1,440
Qualified Trade or Business Amount 30,000 5,800 2,160 -20,000 17,960
*Application of the applicable percentage with respect to a specified service business is being illustrated as a reduction in QBI

Discussion of Relevant Components in Illustrative Example

20 Percent of Qualified REIT Dividends & Qualified PTP Income

A generated $25,000 of qualified REIT dividends and $35,000 of qualified PTP income. Pursuant to Section 199A(b)(1)(B), combined QBI includes 20 percent of the aggregate amount of qualified REIT dividends and qualified PTP income of the taxpayer for the taxable year. Consequently, A’s combined QBI will be increased by $12,000 (($25,000 + $35,000) * 20 percent).

Qualified Trade or Business Amount – Activity 1

A’s QBI from Activity 1 is $150,000, 20 percent of which is $30,000 ($150,000 * 20 percent). A’s allocable share of W-2 Wages paid with respect to Activity 1 is $100,000, 50 percent of which is $50,000 ($100,000 * 50 percent). Further, 25 percent of the W-2 Wages plus 2.5 percent of A’s allocable share of the unadjusted basis in qualified property is $62,500 (($100,000 * 25 percent) + ($1,500,000 * 2.5 percent)). As A’s taxable income is above the threshold amount of $315,000 but not above the $415,000 threshold amount over which the limitation would apply fully, application of the wage limitation for Activity 1 is subject to phase in.  However, since the Section 199A(b)(2)(B) limitation amount of $62,500 (the greater of $50,000 or $62,500, calculated above) exceeds the QBI amount of $30,000, calculation of the phase-in amount is unnecessary. A will be entitled to include the entire $30,000 in determining his overall Section 199A(a) deduction.

Qualified Trade or Business Amount – Activity 2

A’s QBI and W-2 Wages from Activity 2 are $35,000 and $10,000, respectively. 20 percent of the QBI for Activity 2 is $7,000 ($35,000 * 20 percent). 50 percent of the W-2 Wages allocated to A during the year is $5,000 ($10,000 * 50 percent); 25 percent of W-2 wages allocated to A plus 2.5 percent of A’s allocable share of the unadjusted basis in qualified property is $4,375 (($10,000 * 25 percent) + ($75,000 * 2.5 percent)). As A’s taxable income is above the threshold amount of $315,000, application of the wage limitation for Activity 2 is subject to phase in. Since the applicable limitation amount of $5,000 is less than the QBI amount, A’s Section 199A deduction will be limited. Accordingly, the $7,000 amount is reduced by 60 percent of the difference between $7,000 and $5,000 (the greater of the wage limitation amounts calculated above), or $1,200 resulting in a deductible amount for Activity 2 of $5,800.

Qualified Trade or Business Amount – Activity 3

A’s QBI and W-2 Wages from Activity 3 are $30,000 and $10,000, respectively. Because Activity 3 is a specified services business the general rule provides that no portion of A’s allocable share of income is generated from a qualified trade or business. Therefore, none of the income would generally be considered QBI. However, because A’s taxable income is above the threshold amount of $315,000 but below the phase out limit of $415,000, a portion of the income allocated from Activity 3 will be treated as QBI. For purposes of determining the amount of qualified business income, A has an applicable percentage of 40 percent (1 – (($375,000 – $315,000) / $100,000)) resulting in QBI of $12,000 ($30,000 * 40 percent). 20 percent of the QBI for Activity 3 is $2,400 ($12,000 * 20 percent), representing the maximum deduction for this activity. The allowable deduction is the lesser of this amount or the greater of the amounts described in section 199A(b)(2)(B). The 50 percent wage limitation is $2,000 (($10,000 * 50 percent) * 40 percent) and the 25 percent wages plus capital limitation is $2,000 ((($10,000 * 25 percent) + ($100,000 x 2.5 percent)) * 40 percent). The taxpayer is subject to application of the wage limit due to their taxable income being in excess of the threshold amount but below the maximum phase-in amount of $415,000. As a result, the $2,400 preliminary amount must be reduced by 60 percent of the difference between $2,400 and the wage limitation of $2,000, or $240 (($2,400 – $2,000) * 60 percent). The resulting deductible amount for QBI with respect to activity 3 is $2,160 ($2,400 – $240).

Qualified Trade or Business Amount – Carryover Loss Amount

A also has a carryover qualified business loss of $100,000 that must be taken into account when calculating the current year Section 199A deduction. Accordingly, 20 percent is applied to the carryover qualified business loss which leads to a decrease in the current year eligible deduction by $20,000.

Observation: Taxpayers eligible to claim the full 20 percent deduction on QBI will incur a maximum effective rate of 29.6 percent on the QBI. While this rate reduction is beneficial, it is important to consider the decrease in corporate tax rates from 35 percent to 21 percent. This rate differential is likely to cause taxpayers to reevaluate their choice of entity decisions. There are a number of factors that need to be considered but, from a simple after-tax cash flow perspective, a key determinative factor is the likelihood of the entity distributing vs. retaining operating earnings.

 

Observation: While a common thought is to consider possibly incorporating an existing partnership in order to benefit from the 21 percent corporate tax rate, a corporate-to-partnership conversion should not be dismissed. When corporate tax rates were 35 percent, the tax liability imposed on gain recognized under Section 311(b) was typically prohibitive in a conversion transaction. However, with corporate rates dropping to 21 percent, consideration should now be given to the possible liquidation of a corporation and re-formation as a partnership, especially in situations where the corporation has net operating loss carryovers that could shelter the recognized Section 311(b) gain.

 

Observation: The determination of the combined QBI amount is dependent upon the QBI generated from each qualified trade or business activity. Further, the wages and capital-based limitations are determined with reference to wages and qualified property that is allocable to a particular qualified trade or business activity. It is not clear from the statute whether and the extent grouping rules under sections 469 may be applicable.

 

Observation: Properly tracking partner income and loss allocations will take on greater importance in order to accurately determine a partner’s annual net business income allocations and carryover loss amounts. This importance will be further magnified as a result of the potential imputed underpayment obligations that could arise under the new partnership audit rules that went into effect for tax years beginning after December 31, 2017.

 

Observation: Complexities are likely to arise in situations where a partnership operates multiple activities. Maintaining adequate information and documentation will be necessary to support application of the lower rates. Consequently, partners and partnerships will need to consider the extent to which additional information will be maintained, how it will be communicated to partners, and whether any incremental administrative costs should be borne by the benefiting partners.

 

Recharacterization of Certain Long-Term Capital Gains (Sections 1061 & 83)

Under general rules, gain recognized by a partnership upon disposition of a capital asset held for at least one year was characterized as long-term capital gain. Further, the sale of a partnership interest held for at least one year generated long-term capital gain except to the extent section 751(a) applies. Under the new tax law, long-term capital gain will only be available with respect to “applicable partnership interests” to the extent the capital asset giving rise to the gain has been held for at least three years.

An applicable partnership interest is any partnership interest transferred, directly or indirectly, to a partner in connection with the performance of services by the partner, provided that the partnership is engaged in an “applicable trade or business.” An applicable trade or business means any activity that is conducted on a regular, continuous, and substantial basis consisting of raising or returning capital and either (1) investing in, or disposing of, specified assets (or identifying specified assets for such investing or disposition) or (2) developing such specified assets. For purposes of this provision, specified assets include securities, commodities, real estate held for rental or investment, cash or cash equivalents, options or derivative contracts with respect to any of the foregoing, and an interest in a partnership to the extent of the partnership’s proportionate interest in any of the foregoing.

Consistent with the intent to limit applicability of these rules, the law provides that applicable partnership interests do not include (A) a partnership interest held directly or indirectly by a corporation or (B) a capital interest in a partnership commensurate with the partner’s capital contributions or the value of the interest subject to tax under Section 83 upon receipt or vesting. However, the fact that an individual may have recognized taxable income upon acquisition of an applicable partnership interest or made a Section 83(b) election with respect to such applicable partnership interest does not change the three-year holding period requirement.

The provision is applicable to taxable years beginning after December 31, 2017.

Observation: Based on the definitions of applicable partnership interests, applicable trades or businesses, and specified assets, it appears that this rule is primarily targeted at hedge funds and real estate funds with relatively short-term holding periods, i.e., more than one year but less than three years. Private equity and venture capital funds generally have a longer holding period and are unlikely to be affected to the same degree. However, care will need to be taken to ensure the holding period requirements are satisfied in all cases. Further, determination of a partner’s share of capital gains “commensurate with the amount of capital contributed” will likely require detailed record-keeping and tracking of partner Section 704(b) and tax basis capital accounts. This provision is estimated to increase revenues by $1.1 billion over the 10-year period following enactment.

 

Taxation of Gain on the Sale of Partnership Interest by a Foreign Person (Sections 864(c) and 1446)

Revenue Ruling 91-32 generally provides that a foreign partner will recognize effectively connected income (ECI) on a sale of a partnership interest to the extent a sale of underlying partnership assets would give rise to an allocation of ECI to the transferor partner. The revenue ruling effectively adopts an aggregate approach to determining ECI notwithstanding the entity approach mandated by Section 741. In the recently decided case of Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, the Tax Court ruled that the taxpayer’s gain on sale of its partnership interest was not ECI despite the fact that a sale of the partnership’s assets would have generated ECI allocable to the partner, effectively rejecting Rev. Rul. 91-32. The Tax Court’s decision applied the entity theory to the sale of a partnership interest and found the IRS’ position in the revenue ruling lacked the “power to persuade”.

The new tax law effectively codifies the holding in Rev. Rul. 91-32 and overturns the Tax Court’s decision in Grecian Magnesite. In particular, the law treats the gain recognized on the sale or exchange of a partnership interest as ECI to the extent the transferor would be allocated ECI upon a sale of assets by the partnership. This provision effectively recharacterizes otherwise non-ECI capital gain from the sale of partnership interest into ECI.  Additionally, the law provides that the Treasury shall issue regulations as appropriate for application of the rule in exchanges described in sections 332, 351, 354, 355, 356, or 361 and may issue regulations permitting a broker, as agent for the transferee, to deduct and withhold the tax equal to 10 percent of the amount realized on the disposition.  The provision treating gain or loss on the sale of a partnership interest as ECI is effective for transactions on or after November 27, 2017, while the provision related to withholding is effective for sales or exchanges after December 31, 2017.

Observation: This proposal effectively codifies the holding Revenue Ruling 91-32 and reverse the Tax Court’s decision in Grecian Magnesite. As a result of the coordination of allocable gain on a hypothetical sale of partnership assets with total ECI, accurate tracking of Section 704(c) built-in gain and losses will become significantly more important. This provision is estimated to increase revenues by $3.8 billion over the 10-year period following enactment.

 

Repeal of Technical Termination Rules under Section 708(b)(1)(B)

Under the new tax law, the technical termination rules under Section 708(b)(1)(B) is repealed for tax years beginning after 2017. No changes are made to the actual termination rules under Section 708(b)(1)(A).

Observation: Repeal of the technical termination rule is generally a favorable development since it will eliminate the need to restart depreciation upon the sale or exchange of more than 50 percent capital and profits interest in a partnership. Additionally, the law alleviates the common occurrence of failing to properly identify transactions giving rise to technical terminations which leads to late filing of required tax returns, failure to make appropriate elections, and imposition of penalties. However, technical terminations are sometimes used to eliminate unfavorable elections, and the creation of a “new” partnership entity is oftentimes required in connection with international investments in U.S. joint ventures. While it may be possible to continue structuring transactions to achieve these objectives, the simplicity of triggering a technical termination has been eliminated. This provision is estimated to increase revenues by $1.6 billion over the 10-year period following enactment.

 

Modification of the Definition of Substantial Built-in Loss in the Case of a Transfer of a Partnership Interest (Section 743(d))

Section 743(b) provides for an adjustment to the basis of partnership property upon the sale or exchange of a partnership interest providing the partnership has a Section 754 election in effect or where the partnership has a substantial built-in loss. Section 743(d) currently provides that a partnership has a substantial built-in loss with respect to a transfer of an interest in a partnership if the partnership’s adjusted basis in all of its property exceeds the fair market value of such property by more than $250,000. Under this existing rule, it’s possible that a transferee partner could acquire a partnership interest with respect to which there is a built-in loss of more than $250,000 without there being a mandatory basis adjustment because the partnership does not have an overall built-in loss meeting the threshold.

The new tax law modifies the definition of a substantial built-in loss for purposes of section 743(d). Under the law, a substantial built-in loss also exists if the transferee partner is allocated a loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest. This provision applies to transfers of partnership interests occurring after December 31, 2017.

Observation: It is not clear whether a relatively high number of partnership interest transfers will be captured under this rule. However, given the negative consequences of a potential downward basis adjustment it will become even more critical that partnerships properly track each partner’s Section 704(b) and tax basis capital accounts. Failure to accurately track capital accounts could lead to incorrect downward adjustments resulting in increased exposure to both the transferring and non-transferring partners. This provision is estimated to increase revenues by $500 million over the 10-year period following enactment.

 

Charitable Contributions and Foreign Taxes Taken into Account in Determining Basis Limitation (Section 704(d))

Under the general rules of Section 704(d), a partner’s ability to deduct its distributive share of partnership losses is limited to the extent of the partner’s outside tax basis in the partnership interest. However, this limitation does not apply to a partner’s allocable share of charitable contributions or foreign tax expenditures. As a result, a partner may be able to deduct its share of a partnership’s charitable contributions and foreign tax expenditures even to the extent they exceed the partner’s basis in its partnership interest.

The new tax law modifies the section 704(d) loss limitation rule to take into account charitable contributions and foreign taxes. However, in the case of a charitable contribution of property where the fair market value exceeds the adjusted tax basis the Section 704(d) basis limitation does not apply to the extent of the partner’s allocable share of this excess. This provision applies to taxable years beginning after December 31, 2017.

Observation: This rule change will increase the importance of ensuring accurate calculation of a partner’s tax basis. Although partners are generally required to determine their own tax basis, it’s not uncommon for partners to look to the partnership to provide relevant data including tax basis capital and liability allocations. The increased importance of outside tax basis calculations will place more pressure on partnerships to accurately track partner capital as well as determining proper liability allocations under Section 752. This provision is estimated to increase revenues by $1.2 billion over the 10-year period following enactment.

 

Like-Kind Exchanges of Real Property (Section 1031)

Application of Section 1031 is limited to transactions involving the exchange of real property that is not held primarily for sale. Section 1031 no longer applies to any other property including personal property that is associated with real property. This provision is effective for exchanges completed after December 31, 2017. However, if the taxpayer has started a forward or reverse deferred exchange prior to December 31, 2017, Section 1031 may still be applied to the transaction even though completed after December 31, 2017.

This article originally published in Bloomberg BNA’s Daily Tax Report and Bloomberg BNA’s Real Estate Journal.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Pay Data for ‘Similarly Qualified Persons in Comparable Positions at Similarly Situated Organizations’ — We’ve got that… don’t we?

By Michael Conover

Valid information on competitive pay levels and practices for “… similarly qualified persons in comparable positions at similarly situated organizations” has long been the basis for responsible management, and Internal Revenue Service (IRS) enforcement, of appropriate pay practices among all tax-exempt organizations.

When the IRS Intermediate Sanctions (Internal Revenue Code 4958) were enacted, the importance of good comparative data was underscored by its inclusion as one of the three elements of the protection offered in the Rebuttable Presumption of Reasonableness. The data provides a critical context for determining how much and how to pay a nonprofit’s executives.

Regardless of its importance, however, many organizations fail to devote the attention to this important element of their compensation program that it deserves. We regularly work with organizations that have difficulty describing or producing the data used as the basis for executive pay decisions. References are made to “a report done a while ago,” “a survey we had,” or “some Form 990s from organizations like us.” Examining the Form 990s and Schedule Js of these same organizations, we find they have checked all the appropriate boxes related to these data sources and yet there is little or nothing to be found.

Another group of organizations we find has a different competitive data issue. They have competitive data to offer as the basis of compensation decisions, but there are serious issues about the quality and comparability of the data being used. The data may be drawn from organizations that are not at all comparable, positions that are marginally similar or based on such a small sample that the data’s validity is very questionable. In these situations, this poor data may be as bad, or possibly worse, than having no data at all because it may lead to problematic pay decisions.

Obtaining and properly using good data for compensation purposes requires some thoughtful examination of your organization, its positions, and the requirements for individuals holding those positions. Only after accurately understanding your own circumstances can a search begin for the sources of valid data needed. Areas that need to be explored include:

  • Details of your organization: This information includes the type of service(s) your organization performs as well as the broad organizational metrics that reflect its size and scope (e.g., revenue, operating budget, total assets, number of employees, etc.). These are usually among the factors most readily used for identifying similar organizations.
  • Primary role(s) of your position(s): Competitive data sources (surveys, Form 990s, etc.) usually offer only brief descriptions of positions and generic titles for job-matching purposes so the focus here is on the central focus and impact of your position in terms of overall impact on the organization. The chief/principal executive officer and chief/principal financial officer positions tend to be very similar from one organization to another and are Disqualified Individuals from an Intermediate Sanctions perspective. Therefore, they are routinely included in competitive data needs. Ensure you note any significant difference in the role played by your position vs. the typical benchmark. The presence of an additional role not associated with the typical benchmark for the position (or the absence of some portion of the role commonly associated with it must be taken into account to ensure appropriate comparisons will be made.
  • Position requirements: The emphasis on position requirements is intentional. The purpose is to focus on the essential education, expertise, and experience required to perform the role, not what the current incumbent happens to have or acquired in the role. For example, the fact that the current receptionist has five years of experience at the front desk does not mean that five years is a requirement for a qualified incumbent. On the other hand, your position may require a type of professional certification, education, or experience that is unique and essential for successfully performing the role. For example, an individual holding the position of executive director in an association of athletic coaches and involved with external organizations regulating the conduct of the sport must have credible experience in the sport.

Armed with an accurate understanding of your own organization and the positions that will be examined in the competitive compensation assessment, attention now is focused on the identification of the data that will be sought for use in the analysis. The process follows the same criteria referenced above in the descriptors of your organization and positions, as follows:

  • Organizations selected for inclusion in the analysis: Typically, these are organizations offering the same types of services that your organization provides. In some instances, there are other types of organizations, perhaps even for-profit ones that employ and compete for executive resources that are very similar to your specific organization. These can also be included in the search for competitive data. Compensation surveys are conducted among many different types of nonprofit organizations (e.g., higher education, social service organizations, professional/trade organizations, philanthropic foundations, etc.). In addition, Form 990 filings from other organizations like yours are also a source of competitive data. If necessary, a custom survey and/or consultant may be required to obtain data for specialized/hard-to-find sources of data.

The size and scope of organizations included in the analysis must be comparable to your organization. Revenue and budget levels for a group of organizations ranging from 50 percent to 200 percent of your size are typically viewed as reasonable for inclusion. Of course, care must be taken to avoid “skewing” the data in the direction of organizations much larger than your own.

I often explain the objective for identification of comparable organizations as comparing “apples to apples” but doesn’t necessarily need to be as specific as comparing McIntosh to Fuji.

  • Selection of benchmark positions: Positions selected for comparisons should closely resemble the role described in your organization. Titles alone may not fully describe a position’s role or they may be misleading. A controller may be the chief/principal financial officer or a subordinate, depending on the data source in question. In those cases where a significant difference has been identified between your position and the external benchmark, it may be advisable to make adjustments (upward or downward) to competitive data to appropriately compare them.
  • Special position requirements: Bona fide requirements for your organization’s position that are not typically associated with the benchmark position may also require an adjustment to competitive data in order to produce an appropriate comparison.

Collecting this information about your organization and the external benchmarks planned for use prior to an analysis of competitive compensation is not the end of this process. Two critical steps remain. First, it is important to engage the organization’s governing body (e.g., board, compensation committee) and involve them in a review of this information and affirmation/modification of it for use in the analysis. Involving the independent members of the organization in the process performs a very helpful educational role about compensation and the importance of good competitive data. It also enlists individuals with a critical oversight role in the governance of pay in an independent validation of the plan to secure the data before it is collected. A sound rationale has been prepared and ratified for the analysis of competitive data which board and management should view as valid for this purpose.

Second, this description of your organization and positions, as well as the external benchmark criteria or the comparative framework, should be documented. It will become part of the other important documents maintained to support the compensation program (e.g., board minutes, compensation strategy/guiding principles, etc.). The framework should be reviewed periodically and updated as needed to ensure its continued relevance to your organization as well as the external marketplace(s) in which you compete for executive resources.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Economic Turbulence Ahead? Global Reits Confident They’ll Weather the Storm

By Stuart Eisenberg, national leader of BDO’s Real Estate & Construction practice

“What goes up, must come down.” That familiar refrain echoes in the back of economists’ mind every time the Dow soars to new record-breaking heights, a quasi-regular occurrence last year. After more than 70 record closes in 2017, the markets fell in early February and major indices posted their worst weekly declines in more than two years. REITs declined in tandem, with the FTSE Nareit All Equity REITs Index hitting its lowest level in 14 months.

Steep declines were short-lived, and the market started posting gains within the week. While indexes bucked the downturn in the immediate term, the dip is expected to usher in a period of increased volatility to an uncharacteristically calm market.

The culprit for the sudden drop? A culmination of economic factors stirred the pot with two core concerns bubbling to the surface: interest rates and inflation. Tax cuts, a plan for increased federal spending, and strong monthly wage growth in January reported by the U.S. Bureau of Labor Department stoked investors’ inflation anxieties. The 10-year Treasury note—an important indicator for the market—also reached a four-year high of 2.88 percent.

In an environment with newly-ignited market jitters, what is the overall sentiment for REITs? Data suggests that the global real estate market could be reaching the end of its upward climb as well. More than two-thirds of global REIT executives (68 percent) felt that the real estate cycle in their market was at or past its peak, according to the BDO Global REIT Report. The recently published report takes the pulse of the international REIT landscape, surveying 35 REIT executives at companies with a combined market capitalization of $130 billion.

Continued low yields for prime assets and interest rate concerns are likely contributing to the expectation that real estate is reaching its peak. Two-thirds of the global respondents said the movement of interest rates would have the greatest short-term impact on REITs. The U.S. Federal Reserve forecasted three gradual rate increases throughout the remainder of the year.

Interest rate increases are almost always a double-edged sword for REITs. The potential negatives include steeper financing costs and depreciation of real estate values. Rising rates can also lead investors to reallocate their shares to bonds and other assets whose returns see a bump with increased rates. In response to the market movement and expected rate increases, some publicly-traded REITs have started refinancing debt and taking other measures to reduce their exposure.

Conversely, the Federal Reserve sets interest rate programs based on the overall health of the economy and rate increases suggest renewed economic confidence. An environment of strong economic fundamentals is overwhelmingly positive for REITs, leading to increased rents and occupancy rates that could offset the negatives.

Despite a consensus that the good times can’t keep rolling forever, 87 percent of REIT executives expressed confidence in their business prospects and ability to meet any challenges or market shifts head on. REITs have demonstrated steady growth over the last decade. According to NAREIT, the sector’s market capitalization more than tripled in that span, reaching $1 trillion. Nearly half of the global REIT executives (46 percent) expect continued growth in the next two years.

The bottom line for the industry? Come what may, REITs are ready.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

 

An Introduction to Robotic Process Automation for Nonprofits

By Joe Sremack, CFE

Robotic process automation is helping both for-profit and nonprofit organizations do more with less. Robotic Process Automation (RPA) is transforming the way organizations across different industries do business. It allows organizations to automate certain types of work processes to reduce the time spent on costly manual tasks and increase efforts to deliver mission-critical work. RPA is helping organizations do more with less, helping them automatically process and store data without having to perform manual data entry, generate financial status reports without spending considerable amounts of time in Excel, and execute outreach campaigns without spending hours in a customer relationship manager (CRM) program. These types of optimizations have been made a reality through RPA, with organizations just beginning to scratch the surface of the possibilities.

RPA Defined

RPA is the use of software that automates manual tasks. It eliminates the need for employees to perform repetitive tasks by integrating software that performs the same set of steps the employee does. The software is designed to perform routine tasks across multiple applications and systems within an existing workflow. It performs specific tasks to automate the transfer, editing, reporting and/or saving of data.

At least some portion of white collar employees’ time is spent on repetitive computer tasks. That includes the CEO’s time–about 25 percent of the CEO’s tasks could be automated  and RPA can help achieve this. Repetitive work typically involves the collection of data from one or more sources, performing a data manipulation—such as applying data formulas in Excel—and then exporting or saving the information to a readily available location. These are just some of the kinds of work that RPA automates.

One of the main differentiators of RPA from other solutions is that it performs tasks that do not require deep cognitive capabilities. RPA is the automation of a process, but the software is not improved or changed based on the inputs or its results. This is different from machine learning or artificial intelligence (AI) software, which can learn and improve based on the continuous evaluation of its inputs and results. Instead, RPA software simply repetitively performs the same task(s) based on business requirements.

RPA provides several major benefits. The most immediate impact from RPA is that routine tasks are performed in an error-free, consistent manner. RPA also provides an audit trail of work performed, which can be valuable in regulated industries or when the output of a process produces an unexpected result. In addition, RPA solutions can be configured to identify anomalies or red flags that may not be identifiable to an employee.

The long-term benefits are also valuable. Perhaps the most important benefit is increased job satisfaction. When employees are asked which parts of their jobs they dislike the most, the tasks they list usually involve a type of manual work that is a good candidate for an RPA solution. [1] This increased job satisfaction results in a better work environment and more productive employees. Moreover, the results of the formerly manual processes become better and the cost savings can be recognized.

Applications of RPA

The list of potential uses for RPA is robust. Most manual computer-based tasks performed by employees can be automated with RPA. RPA is often used for back office functions but can extend to customer relationship management, data analysis, and other key areas that involve manual work.

The best way to understand RPA is to learn about the kinds of problems RPA can solve. For example, an RPA program–called a “bot”–can be used to manage customer email inquiries. The bot monitors a sales inquiry email account and automatically imports the information into the CRM, sends alerts to the sales team, sends an automated message to the customer, and imports the information into other systems that are used to track employee availability and sales campaign successes. This works well when timely responses to customers are required.

An example of a nonprofit-specific use of an RPA solution is the management of fundraising campaigns. In many organizations, this process involves pulling past donor information, generating marketing materials, contacting past and new donors, collecting donor payment information, and entering it into an accounting software, updating financial information, and updating a donor database. Most of these steps are performed manually, slowing down the process and introducing the risk of error. With an RPA solution, most of this process can be automated, allowing the organization to spend more time interfacing with donors and working on other mission-critical tasks.

The following is a chart that lists several types of tasks that can be automated by department in most organizations:
HR New employee forms Employee termination documentation Employee benefits
Finance / Accounting AR/AP tracking Financial reporting Vendor management
IT New user setup Employee termination Inventory tracking
Sales / Marketing Email sales campaign management Outreach campaigns CRM automation
Others Executive analysis reports Regulatory compliance documentation Inventory management

 

While the list above appears to be limited to single-department tasks, many of these are cross-department tasks in nature. Consider a process where the finance department needs to work with IT and sales to request multiple data sets, get input, and share the results. Rather than emailing those departments to pull the same data set every quarter to develop an Excel-based report, an RPA solution automatically performs the data pull and generates the entire Excel report. This not only saves time and effort across the various departments, it also enables the finance team to spend more time doing meaningful analysis of the reports and develop projections and deeper insights.

RPA and Nonprofits

RPA is well-suited for solving problems encountered by nonprofits since they face many of the same challenges associated with reducing the time employees spend on manual tasks as for-profit organizations. Whether the work involves manually entering accounts receivable and accounts payable data in accounting software, generating compliance reports, or performing outreach campaigns, time is being spent by employees on less valuable work. Employees would agree that they would rather work on mission-specific tasks rather than repetitive tasks.[2]

  • Several examples of the types of nonprofit processes an RPA solution works well with are:
  • Pledge campaigns.
  • Recurring donation management.
  • Digital and print marketing campaigns.
  • Outreach campaigns.
  • Government and regulatory issue tracking.
  • Volunteer management.

Service providers and software developers have begun offering solutions geared toward nonprofits. Several major RPA software developers have recently launched commercial software solutions specifically designed for nonprofits, and service providers who understand the nonprofit sector are able to implement tailored RPA solutions.

Implementing RPA

RPA solutions can be implemented in several ways. The most common method for organizations is to implement individual bots. These are single programs that perform tasks automatically. The bot can be accessed through a desktop or web-based application. The second method is to implement a server that controls a set of bots within a department or across the organization. The server-based approach is a more robust system that is typically employed when there are a larger number of bots utilized throughout an organization that need to be managed centrally, whereas the individual bot method is appropriate when only several bots are used.

The cost of an RPA solution, a common concern for any organization, depends on these factors:

  • Complexity
  • Number of bots.
  • Time to develop and implement.
  • Level of customization.

An enterprise-wide RPA solution of hundreds of bots can be expensive. A smaller implementation with only ten 10 bots or less, however, can be implemented relatively inexpensively and within a short period of time. Companies who sell RPA solutions often have a suite of pre-built bots that can be quickly customized and implemented without requiring a new bot to be developed. As the RPA market matures, the cost will continue to decline.

The key steps for determining whether an RPA solution is appropriate are to:

  • Identify where most time and effort is being expended on manual tasks.
  • Identify bottlenecks of key processes—specifically identifying manual tasks.
  • Implement a pilot program to tackle a high-value discrete task that can have immediate value.

RPA is an exciting new way for organizations to improve their operations while also improving employee job satisfaction. RPA solutions have become a widely adopted strategy for enhancing various parts of organizations’ operations by allowing employees to focus their time and efforts on more high-value and meaningful work. It has helped organizations do significantly more with less while reducing errors, increasing workforce job satisfaction, and better ensuring that deadlines are met. These benefits have been possible with relatively small capital investments and IT resources. While RPA is not applicable to all types of work, it is a good option for reducing hours spent on routine, manual tasks.

BENEFITS OF RPA

  • Error-free, consistent results
  • Employees can be utilized for higher‑value work
  • Increased job satisfaction (not spending time doing repetitive, low‑value work)
  • Faster, more predictable delivery timing
  • Documented trail of work performed
  • Identify anomalies or other red flags

 

[1]    Gartner Research, “Role of Machine Learning in Accelerating Automation,” 2016.

 

[2]    L. Willocks and M. Lacity, Service Automation: Robots and the Future of Work 2016, 2016.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

The Potential Impacts of Tax Reform to Reits and Real Estate & Construction Companies

On December 22, President Trump signed the tax reform bill, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” into law, marking the largest change to U.S. tax policy since the 1980s.

With most of the provisions already in effect, it’s important that real estate and construction executives review the changes that occurred during the conference process to understand the impact to their companies.

To help them navigate the key provisions affecting the real estate and construction industries, we’ve summarized the top considerations and implications below.

PROVISION SUMMARY OF CHANGES IMPLICATIONS FOR REAL ESTATE AND CONSTRUCTION COMPANIES IMPLICATIONS FOR REITS
Reduce the corporate tax rate Reduces the top corporate tax rate from 35 to 21%.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Positive

What’s at stake: Reduced tax burden for real estate and construction companies.

Industry View: Positive

What’s at stake: REITs won’t see direct tax relief, but REITs that have taxable REIT subsidiaries (TRS) will see a positive impact.

Lower Taxes on Pass-Through Business Income Creates a deduction available to pass-through filers of 20% on pass-through income subject to certain limitations. This includes “qualified real estate investment dividends.” Qualified REIT dividends do not include any portion of a dividend to which capital gain tax rates are applied. Industry View: Positive

What’s at stake: Reduced tax burden for real estate and construction companies structured as pass-through entities. This is a big win for real estate.

Industry View: Positive

What’s at stake: Reduces the overall effective tax rate on REIT dividends received by individuals.

Changes to the Depreciation of Commercial Assets Eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and provides a general 15-year recovery period for qualified improvement property, unchanged from current law. Depreciable life of commercial assets is unchanged from current law.

Retains the existing 40-year alternative depreciation system (ADS) cost recovery period for nonresidential real property, but would contain a reduced 30-year ADS period for residential property and a 20-year ADS period for qualified property improvement.

Expands bonus depreciation for new qualified property investments to 100% from 50%. Applies to both new and used property.

Effective date: Effective for property placed in service

Industry View:  Positive-to-Neutral

What’s at stake: The impact of this provision differs based on a real estate company’s cost recovery structures.

The change is positive for real estate companies that rely on full expensing for personal property and new qualified improvement property with a 15-year recovery period and bonus depreciation.

For real estate companies with cost recovery structures under regular depreciation, this change is neutral.

Taxpayers that have elected to use the real property trade or business exception to the interest limitation would be required to use the longer ADS periods for depreciation.

Additionally, if the property is depreciated under ADS, it is not eligible for a bonus.

Industry View: Positive-to-Neutral

What’s at stake: Since REITs are limited in the amount of tangible personal property owned, the expensing for equipment is not a huge win for REITs. Furthermore, REITs generally elect ADS for tax depreciation purposes, so it would continue to depreciate over the longer lives, with the exception of REITs that hold residential property.

REITs that have elected to use the real property trade or business exception to the interest limitation would be required to use the longer ADS periods for depreciation and would not be eligible for the bonus.

There is no real impact from bonus depreciation as REITs generally elect out of bonus depreciation.

Expansion of Section 179 deduction Expands the definition of qualified real property to include improvements to nonresidential real property including roofs, heating, ventilation, air conditioning, fire protection, alarm systems, and security systems.

Increases the amount companies can deduct in purchases from the current ceiling of $510,000 to $1 million and increases the phase out threshold to $2.5 million.

Industry View: Positive

What’s at stake: Eases the tax burden of financing property improvements.

Industry View: Neutral

There is no real impact from the increased Section 179 deduction as REITs generally do not elect Section 179 expensing.

Limitations on Interest Deductibility Revises Section 163(j) and expands its applicability to every business, including partnerships. Generally, caps deduction of interest expense to interest income plus 30% of adjusted taxable income, which is computed without regard to deductions allowable for depreciation, amortization, or depletion. Disallowed interest is carried forward indefinitely. Contains a small business exception.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Neutral

What’s at stake: Real property trades or businesses are allowed to elect out of the limitation since they do not benefit from full expensing provided to tangible personal property.

Generally, any real property trade or business, including ones conducted by widely-held corporations and REITs, may be considered real property trades or business. Taxpayers electing to use the real property trade or business exception to the limitation on interest deductibility would be required to use ADS methods for depreciation for residential, nonresidential, and qualified improvement property.

Industry View: Neutral

What’s at stake:  Consistent with the impact to real estate and construction companies. The limitation would not generally apply to REITs to the extent that they elect out.

Eliminate ability to carryback Net Operating Losses (NOLs) Generally, eliminates taxpayers’ abilities to carryback NOLs, and will limit the use of NOLs to 80% of taxable income. NOLs will no longer have an expiration period.

Effective date: The elimination of carrybacks is effective in taxable years after Dec. 31, 2017.

Industry View: Negative

What’s at stake: Potential cash flow obstacle.

Industry View: Neutral-to-Negative

What’s at stake: REITS are not taxpaying entities and most likely would only have NOL carryforwards if they have historically been operating at a loss. For REITs that have been historically operating at a loss, this provision would have a negative impact.

Limit 1031 “like-kind” exchanges to real property Eliminates the exemption for like-kind exchanges except for real property.

Effective date: Effective for taxable years after Dec. 31, 2017.

An exception is provided if the property in the exchange is disposed of or received by the taxpayer on or before December 31, 2017.

Industry View: Neutral-to-Negative

What’s at stake: No material impact for straight real estate sales or replacements such as land for land. However, many transactions involve multi-asset exchanges where a taxpayer sells both real and personal property. Without the deferral for personal property, taxpayers are more likely to recognize some amount of taxable gain. This will put pressure on the allocation of purchase price to minimize potential taxable gain. Additionally, taxpayers may avoid an exchange depending on the amount of recognized taxable gain attributable to personal property.

Industry View: Neutral-to-Negative

What’s at stake: Same challenges with multi-asset exchanges.

Limits Mortgage & Property Tax Deductions Under current law, taxpayers can take a combined acquisition and home equity indebtedness interest expense deduction on $1,100,000 of debt. The new legislation only permits the deduction of interest on acquisition indebtedness not exceeding $750,000 and repeals the additional interest deduction for home equity indebtedness through 2025.

Effective date: Effective for taxable years after Dec. 31, 2017.

Debt incurred on or before Dec. 15, 2017, is grandfathered into the limitations under current law. Taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchase such residence before April 1, 2018, are also eligible for the current higher limitations.

Industry View:Neutral-to-Positive

What’s at stake:For commercial real estate and construction companies, this could be a positive in the long term. The limited deductions could reduce the attractiveness of homeownership, which could lead to increased demand for single and multifamily rentals.

However, homebuilders and residential land developers may see a reduction in demand.

Industry View:Neutral-to-Positive

What’s at stake:For REITs that hold multifamily rental properties, this could be a positive in the long term. The limited deductions could reduce the attractiveness of homeownership, which could lead to increased demand for single and multifamily rentals.

Scale Back the State and Local Tax Deduction for Individuals Limits the itemized deduction for state and local taxes to $10,000 for the aggregate sum of real property taxes, personal property taxes, and either state or local income taxes or state and local sales tax. Currently, each of those state and local taxes is a separate itemized deduction with no limitation.

Effective date: The bill prohibits a deduction in excess of the $10,000 limitation for 2018 state and local taxes actually paid in 2017.

Industry View: Neutral-to-Positive

What’s at stake: Similar to the above, could reduce the attractiveness of homeownership in high-tax states, which could lead to increased demand for single and multifamily rentals in those areas.

However, homebuilders and residential land developers may see a reduction in demand.

Industry View: Neutral-to-Positive

What’s at stake:  Similar to the above, could reduce the attractiveness of homeownership in high-tax states, which could lead to increased demand for single and multifamily rentals in those areas—a boon to REITs in the multifamily rental space.

Carried Interest Changes Carry from investments held for under three years will be taxed at the higher ordinary income rate rather than the lower capital gains rate. Previously, the threshold was one year. The capital gains tax rate was kept as is, at a maximum of 20%.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Negative

What’s at stake: This would potentially have a negative impact for service partners of real estate investment funds that sell property that has less than a three-year holding period or service partners who sell their partnership interest without holding it more than three years.

Industry View: Negative-to-Neutral

What’s at stake: This would potentially have a negative impact on service partners of REIT’s lower tier partnerships. However, it would likely not affect the REIT itself as corporations are not subject to this provision.

Expansion of Cash Method of Accounting Raises the average annual gross receipts threshold from $5 million to $25 million for C corporations, partnerships with a C corporation partner, or a tax-exempt trust or corporation with unrelated business income, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Positive

What’s at stake: Reduced tax and recordkeeping burden for smaller real estate and construction companies.

Industry View: Positive

What’s at stake: This provision is unlikely to affect REITs since most REITs would still likely be over the increased threshold limits. However, smaller private REITs may see reduced tax and recordkeeping burdens from this provision.

Expansion of Exemption from Percentage-of-Completion Method (PCM) Raises the average annual gross receipts threshold from $10 million to $25 million to exempt small construction contracts from the requirement to use the PCM.  Contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected to be completed within 2 years of contract commencement and (2) is performed by a taxpayer who meets the $25 million gross receipts test.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Positive

What’s at stake: Reduced tax and recordkeeping burden for smaller real estate and construction companies. Increased ability to use completed contract method, exempt-contract percentage-of-completion method, or any other permissible method.

Industry View: Neutral

What’s at stake:  This provision is unlikely to affect REITs, since REITs generally don’t enter into long-term contracts due to restrictions on the type of income they can generate. However, REITs that have taxable REIT subsidiaries (TRS) that do enter into long-term contracts could potentially benefit from this provision.

Exemption from Requirement to Keep Inventory Exempts taxpayers that meet the $25 million average annual gross receipts threshold from the requirement to account for inventories under Section 471. Those taxpayers may use a method of accounting for inventories that either (1) treats inventories as non-incidental materials and supplies or (2) conforms to the taxpayer’s financial accounting treatment of inventories.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Neutral-to-Positive

What’s at stake: Most real estate companies don’t generally have inventories. However, certain segments such as hospitality have limited inventories and may see reduced tax and recordkeeping burden as a result of this provision.

Industry View: Neutral

What’s at stake:  This provision is unlikely to affect REITs since REITs generally don’t carry inventory due to restrictions on the type of income they can generate. However, REITs that have taxable REIT subsidiaries (TRS) that do have inventory could potentially benefit from this provision.

Expansion of Exemption from Uniform Capitalization Rules (UNICAP) Raises the average annual gross receipts threshold from $10 million to $25 million for any resellers (as well as producers) to be exempted from the application of UNICAP under Section 263A.

Effective date: Effective for taxable years after Dec. 31, 2017.

Industry View: Positive

What’s at stake: Reduced tax and recordkeeping burden for smaller real estate and construction companies.

Industry View: Neutral

What’s at stake: This provision is unlikely to affect REITs since most REITs would still likely be over the increased threshold limits.  However, smaller private REITs may see reduced tax and recordkeeping burdens from this provision.

Tackling Tax Reform: 5 Initial Steps Companies Can Take Now

  1. Assess impact. Tax professionals will likely need to review the bill text manually and measure their company’s specific circumstances against it to assess the impact of each provision, as well as the holistic effect on their company’s bottom line.
  2. Assemble a team. While the heaviest burden may fall on accountants, companies and their finance teams will have an important role to play to gather all the necessary data.
  3. Dig into the data. Assessing the impact of tax reform requires a substantial amount of data to be readily available. Companies need to move from modeling the impact of tax reform to focusing on data collection and computations as soon as possible.
  4. Establish priorities. When considering which aspects of tax reform to tackle first, focus on the areas that could have the greatest impact on your company. For REITs, real estate and construction companies, landmark provisions include: changes that could influence entity choice (reduced corporate tax rates and lower taxes on pass-through business income) and the elimination of NOL carrybacks. As a preliminary step, taxpayers operating in the real estate and construction industries should consider their overall choice of entity to minimize tax liabilities under the new law.
  5. Initiate tax reform conversations with your tax advisor. Tax reform of this magnitude is the biggest change we’ve seen in a generation, and will require intense focus to understand not only how the changes apply at a federal level, but also navigate the ripple effect this is likely to have on state taxation as well.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Summer 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

The Great Act – Transforming How the Government Uses Grant Reporting Data

By Lee Klumpp, CPA, CGMA

The 115th Congress has been busy with tax reform but has managed to introduce a proposed bill H.R. 4887 (“Grant Reporting Efficiency and Agreements Transparency Act of 2018” or “GREAT Act” or the “Act”) on Jan. 29, 2018, by Representatives Foxx (R-N.C.), Gomez (D-Calif.), Issa (R-Calif.), Quigley (D-Ill.), and Kilmer (D-Wash.). Three other members have signed on to the bill since it was introduced. The bill is currently before the House Committee on Oversight and Government Reform.

The sole objective of the Act is to modernize federal grant reporting by standardizing the information recipients submit to agencies. It is believed by its sponsors that the GREAT Act will transform federal grant reporting from disconnected documents into open data by directing the executive branch to adopt a standardized data structure for the information grantees must report to agencies. By replacing outdated documents with open data, the GREAT Act is intended to deliver transparency for grant-making agencies and the public and allow grantees to automate their reporting processes, thereby reducing compliance costs.

The GREAT Act would require the creation of a comprehensive and standardized data structure, or “taxonomy,” covering all data elements reported by recipients of federal awards, including both grant and cooperative agreements.

The sponsors of the Act believe that it can achieve and accomplish the following:

  • Modernize reporting by recipients of federal grants and cooperative agreements by creating and imposing data standards for the information that grants and cooperative agreement recipients must report to the federal government.
  • Implement the recommendation by the Director of the Office of Management and Budget, under Section 5(b)(6) of the Federal Funding Accountability and Transparency Act of 2006 (31 U.S.C. 6101 note), which includes the development of a “comprehensive taxonomy of standard definitions for core data elements required for managing federal financial assistance awards”.
  • Reduce burden and compliance costs of recipients of federal grants and cooperative agreements by enabling technology solutions, existing or yet to be developed, by both the public and private sectors, to better manage data recipients already provide to the federal government.
  • Strengthen oversight and management of federal grants and cooperative agreements by agencies through consolidated collection and display of and access to open data that has been standardized and, where appropriate, transparency to the public.

The proposed legislation tasks the Director of the Office of Management and Budget (OMB) and a leading grant agency, that will be designated when the bill has passed, with implementation. The implementation goals are as follows:

  • Within one year: Establish government-wide data standards for information related to federal awards reported by recipients of federal awards.
  • Within two years: Issue guidance to grant-making agencies on how to leverage new technologies and implement the new data standards into existing reporting practices with minimum disruption.

The bill directs OMB and a leading grant agency to publish grant reporting information, once transformed into open data, on a government-wide website, such as the existing grants.gov portal. It provides exceptions and restrictions, including:

  • No personally identifiable or otherwise sensitive information will be published.
  • Information not subject to disclosure under the Freedom of Information Act (Title 5, Section 552) will not be publicly disclosed.
  • The OMB Director to permit exceptions on a case-by-case basis.

The Act would require each grant-making agency to begin collecting grant reports using the new data standards within three years.

Benefits

The sponsors of the GREAT Act believe that the federal government, the funding agencies, recipients and the public will all benefit from the Act’s implementation in the following ways:

  • Reduce recipient compliance costs by automating the compilation and submission of reports to federal agencies.
  • Create a single consolidated data set of post-award reports for federal grant recipient information applicable to all grant-making agencies and programs.
  • Foster increased federal and public oversight and transparency into the distribution of federal funding.
  • Facilitate the adoption of modern technologies for grant reporting.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com