FASB Issues ASU On Contributed Nonfinancial Assets

By Tammy Ricciardella, CPA

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

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

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

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

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

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

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

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

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

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

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

Gift Acceptance Policy

By Tammy Ricciardella, CPA

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

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

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

What types of assets will the entity consider accepting?

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

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

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

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

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

What are the timelines for the liquidation of illiquid gifts?

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

What gifts will the entity not accept?

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

How will the organization handle donor tax questions?

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

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

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

What is the gift acknowledgment process?

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

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

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

Challenges with Gifts-In-Kind

By Tammy Ricciardella, CPA

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

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

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

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

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

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

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

1 Year After Wayfair: What Nonprofits Need To Know

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

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

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

The Wayfair Domino Effect

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

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

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

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

Automation Offers a Potential Solution

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

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

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

Marketplace Facilitator Laws, The Next Frontier

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

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

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

Don’t Forget Purchasing Exemptions

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

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

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

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

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

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

Don’t Turn Your Back on CECL

By Amy Guerra, CPA

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

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

Incurred Loss Model

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

Expected Loss Model

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

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

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

Estimating Credit Losses

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

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

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

Effective Date and Follow Up

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

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

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

 

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

By Susan Friend, CPA

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

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

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

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

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

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

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

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

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

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

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

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

IRS Expands Self-Correction and Determination Letter Programs for Retirement Plans

By Norma Sharara, JD, and Joan Vines, CPA

The IRS recently expanded two existing programs for tax-qualified retirement plans—the Employee Plans Compliance Resolution System (EPCRS) and the determination letter (DL) program for individually designed plans. Generally, an individually designed plan is a retirement plan drafted to be used by only one employer. A DL expresses the IRS’s opinion on the tax-qualified status of the plan document. These new changes to the EPCRS and DL programs could be a great help to employers, since they offer opportunities to increase compliance while reducing costs and burdens.

EPCRS

EPCRS is an IRS correction program that has existed since 1992. Its purpose is to give employers a path to voluntarily correct plan mistakes at a cost that is less than it would be if the failure were caught by the IRS on audit. For some errors, employers can simply self-correct and keep documentation in their files under the Self-Correction Program (SCP) component of EPCRS. But other (more serious) types of failures require a formal Voluntary Correction Program (VCP) application seeking IRS approval, which also requires paying a user fee of up to $3,500.

With each new iteration of EPCRS, the IRS has expanded the types of errors that qualify for self-correction. Rev. Proc. 2019‑19 significantly expands SCP. The current iteration responds to requests from the retirement plan community for self-correction of a greater number of more common missteps without having to file a VCP application and pay a user fee (where the cost of the filing often outweighed the cost of correction). Beginning April 19, 2019, employers with tax-qualified retirement plans and 403(b) plans can now self-correct more plan document and loan failures and retroactively amend plans to fix more operational failures without filing anything with the IRS. Employers can use the new SCP features immediately.

Plan document failures

For many years, the SCP allowed employers to correct certain significant operational failures (if the plan had a DL) and most insignificant operational failures without paying any user fees or penalties. But until now, the SCP was generally not available to self-correct plan document failures (instead, employers had to submit a VCP application to the IRS and pay a user fee to correct such failures). A plan document failure is a plan provision (or the absence of a provision) that causes a plan to violate the qualified plan or 403(b) plan rules. Plan document failures are considered “significant” failures. So employers using SCP to fix plan documents must have a DL and complete the correction by the end of the second plan year after the failure occurred.

The new and improved EPCRS now allows these types of failures to be self-corrected if certain requirements are met:

  • The plan document must have a favorable IRS letter covering the most recent mandatory restatement.
  • The error is not a failure to timely adopt the plan’s initial document.
  • The failure is corrected before the end of the correction period, which is generally no later than end of the second plan year following the year in which the plan document failure occurred.

Retroactive plan amendments

Although prior versions of EPCRS allowed employers to retroactively amend their plans to fix a very limited number of operational failures,[1] the new program adds other types of failures that may be corrected in this way, including (under certain conditions), correcting operational failures with retroactive plan amendments. SCP now provides that the following errors may be corrected through retroactive plan amendment:

  • Defined contribution plan allocations that were based on compensation in excess of the Internal Revenue Code (IRC) Section 401(a)(17) annual compensation limit.
  • Early inclusion of employees who had not yet satisfied the plan’s eligibility requirements.
  • Loans and hardship distributions under plans that don’t provide for them.
  • Loans exceeding the number of loans that are permitted under the plan.

Besides those situations, under the new SCP, employers may now also retroactively amend their plans to correct other operational failures, but only if: (i) the plan amendment would increase a benefit, right or feature; (ii) the increased benefit, right, or feature is available to all eligible employees; and (iii) increasing the benefit, right or feature is permitted under the IRC and satisfies EPCRS’s general correction principles. If those conditions are not satisfied, the error may still be corrected by filing a VCP application with the IRS and paying a user fee.

Plan loan failures

Making loans to plan participants seems like it should be simple, but there are a lot of ways to make mistakes. Even though loan failures are pretty common, correction has always been quite burdensome and costly, requiring a lengthy application for IRS approval for what is often a very small dollar amount. Plan loan rules fall under both IRS and U.S. Department of Labor (DOL) authority. The DOL does not recognize self-correction, so in the past the IRS required even the simplest and smallest loan failures to be formally submitted for approval.

BDO Insight

The IRS has always been very hesitant to allow correction by retroactive plan amendment (for example, to align the plan document with the plan’s operation). When it has been allowed, the IRS generally required a VCP filing. So expanding EPCRS to allow retroactive plan amendments is perhaps the greatest area of relief for employers.

The initial failure to adopt a qualified plan or the failure to adopt a written 403(b) plan document timely cannot be corrected by SCP.

Demographic and employer eligibility failures still cannot be corrected under SCP.

Also, the SCP expansion does not apply to Simplified Employee Pensions (SEP) and SIMPLE IRAs. Rather, as under Rev. Proc. 2018-52, SCP is available to correct only insignificant operational failures for SEPs and SIMPLE IRAs.

Although Rev. Proc. 2019-19 replaces Rev. Proc. 2018-52, it does not make any changes to the recently updated filing methods under EPCRS. Keep in mind that only electronic VCP filings will be accepted on or after April 1, 2019.

Employers may now use SCP to correct plan loan failures if the participant defaults or the loan is administered incorrectly. But, employers still cannot use SCP to correct plan loan terms that violate the maximum permissible loan amount and repayment period and level amortization repayment rules (since those are statutory violations, so sponsors must use VCP to correct those failures).

Until now, employers could voluntarily correct loan defaults by filing a VCP application and paying a user fee. Now employers can also use SCP. Under both programs, the default can be corrected by a single-sum repayment (including interest on missed repayments), re-amortization of the outstanding loan balance or a combination of the two. But employers that want the protection of a no-action letter under the DOL’s Voluntary Fiduciary Correction Program (VFCP)[2] will still need to use the IRS’s VCP program to correct the error. DOL will not issue a no-action letter for a loan default unless the VFCP application includes proof of payment of the loan and an IRS VCP compliance statement approving the correction.

Employers can now use SCP to correct failures to obtain spousal consent for a plan loan when the plan requires such consent. (For example, if distribution of a participant’s benefit requires spousal consent under the qualified joint and survivor annuity (QJSA) rules, spousal consent is also required for a plan loan.) The sponsor must notify the participant and the spouse and give the spouse an opportunity to consent. If the spouse doesn’t consent, the sponsor can still correct the error under VCP (which generally requires the employer to make a QJSA available to the spouse for the full amount of the participant’s plan benefit, as if the loan had not been made to the participant).

Prior versions of EPCRS generally required employers to report deemed distributions resulting from loan failures on IRS Form 1099-R in the year of failure. However, depending on the type of loan failure, employers could request the following relief:

  • No reporting of deemed distributions caused by loan defaults and violations of the maximum permissible loan amount, maximum repayment period and requirement to repay loans over a level amortization period.
  • Reporting of deemed distributions caused by other loan failures in the year of the correction (instead of the year of the failure).

Under the new EPCRS, sponsors no longer have to request this relief; rather, they can simply self-correct and use such relief without an IRS filing.

Determination Letter (DL) Program

Rev. Proc. 2019-20 opens the IRS’s DL program for one year (starting Sept. 1, 2019) for individually designed “hybrid” retirement plans (like cash balance or pension equity plans). It also opens the DL program to merged plans, so long as the DL is requested within a proscribed timeline.  The guidance also extends the remedial amendment periods for these plans[3] and offers penalty relief for plan document failures discovered during the DL review. Since 2017, the IRS has accepted DL applications only from new or terminating individually designed plans, but reserved the right to open the DL program for other circumstances. This is the first time the IRS has opened the program for such “other circumstances.”

Hybrid plans

Fortunately, since IRS curtailed the DL program in 2017, there have been very few changes in the law that would require plan amendments. But there have been required amendments for cash balance and other hybrid plans based on final regulations, so the IRS is allowing a one-year review period for those plans. As part of this process, the IRS will review the entire plan for compliance with the 2016 and 2017 Required Amendments Lists and all Cumulative Lists issued before 2016.[4]

The IRS will not impose any sanctions for document failures it discovers during the DL review that are related to plan provisions required to meet the hybrid plan regulations. For plan document failures that IRS discovers during the DL process that are unrelated to the hybrid plan regulations (but that satisfy certain conditions), the IRS will impose a reduced sanction equal to either the amount the employer would have paid under EPCRS if the plan sponsor had self-identified the error or 150 percent or 250 percent of the EPCRS user fee (depending on the duration of the failure). So employers should correct any failures under EPCRS before filing under the DL program to avoid having to pay more than the regular EPCRS user fee.

Even if an employer is confident that the hybrid plan does not have any document failures, obtaining a new DL provides important protection if the IRS audits a plan and could reduce some of the complications that could arise with aging DLs.

Merged plans

Beginning on Sept. 1, 2019, the IRS will accept DL applications for individually designed “merged plans” — i.e., single-employer, individually designed plans that result from consolidating two or more plans maintained by unrelated entities in connection with a corporate merger, acquisition or other similar transaction. An employer can request a DL on the merged plan if:

  • The plan merger occurs no later than the last day of the first plan year that begins after the effective date of the corporate transaction.
  • The DL application is filed with the IRS by the last day of the merged plan’s first plan year that begins after the effective date of the plan merger.

The IRS will review a merged plan for compliance with the Required Amendments List issued during the second full calendar year before the DL application and all earlier Required Amendment and Cumulative Lists.

Plan mergers typically require amendments related to eligibility, vesting and maintaining protected benefits, etc. If an employer does not submit a merged plan for a DL under the expanded program, the employer could not rely on the plan’s prior DL for changes made to the plan to effectuate the merger.

Although it is not clear, it appears that the expanded DL program would be available when a preapproved prototype or volume submitter plan is merged into an individually designed plan. Often larger employers have individually designed plans while smaller employers have preapproved plans, and larger employers often acquire smaller employers and merge the smaller employer’s preapproved plan into the larger employer’s individually designed plan. But employers should keep in mind that the merged preapproved plan can cause a plan document failure for the individually designed plan (for example, if signed and dated plan documents and amendments for the acquired plan cannot be located).

The IRS will not impose any sanctions for document failures related to plan provisions intended to effectuate the plan merger. For plan document failures unrelated to the plan merger that satisfy certain conditions, the IRS will impose a reduced sanction equal to either the amount the employer would have paid under EPCRS if the plan sponsor had self-identified the error or 150 percent or 250 percent of the EPCRS user fee (depending on the duration of the failure). As noted above, employers should correct any failures under EPCRS before filing under the DL program.

BDO Insight

Plan mergers before July 2018 may not be eligible for the expanded DL program, since the DL application for the merged plan must be submitted within one year after the plan merger. Since IRS curtailed the DL program in 2017, such plans may be left without access to a DL on a merged plan even under the expanded program.

Employers who merged plans in July 2018 (or later) should consider hurrying to file a DL application before the one-year filing window permanently closes. But keep in mind that a Notice to Interested Parties must be given in advance of a DL filing.

The new guidance does not restrict the number of times that employers could request a DL on a merged plan, so presumably, an employer could file a new DL request for every plan merger.

Key takeaways

Employers considering whether to use the expanded SCP or DL program should consult with their tax advisers to ensure that the plan is eligible for the program (and that any other potential qualification issues are considered before requesting a DL). BDO can help.

Article adapted from the Nonprofit Standard blog.

[1] See Section 2.07 of Appendix B of Rev. Proc. 2018-52 (prior EPCRS).

[2] DOL’s Voluntary Fiduciary Correction Program is described here.

[3] Rev. Proc. 2019-20 extends any remedial amendment period that is still open on the date an employer becomes eligible to submit a DL until the later of: (i) the last day the employer can submit a DL application under Rev. Proc. 2019-20; or (ii) 91 days after the IRS issues a DL (in accordance with Treas. Reg. § 1.401(b)-1(e)(3).

[4] Notice 2017-72; Notice 2016-80; and the Cumulative Lists issued prior to 2016.

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

 

Don’t Be a CF-No: How Nonprofit CFOs Can Collaborate with Senior Leadership

By Laurie De Armond, CPA, and Adam Cole, CPA

In a recent insight, we explored the concept of “Nonprofit Heart, Business Mindset”–which, put simply, is the belief that nonprofit organizations must pursue business-oriented management practices to thrive long-term, without losing sight of their core mission. Nonprofit chief financial officers (CFO) are uniquely positioned to embody this philosophy and bring it to life.

As you’ve likely heard before, there’s a misconception that the role of a nonprofit CFO is somehow less intense than the equivalent in the corporate world. We know that couldn’t be further from the truth – nonprofit CFOs have the unique challenge of ensuring financial well-being, while simultaneously making sure the organization is advancing its mission.

Sometimes, it’s not just those outside the nonprofit sector that view things differently from nonprofit CFOs; it’s often their colleagues and peers who have differing opinions and conflicting perspectives. We have observed this firsthand with clients throughout the years.

Here are the four key areas where we see a divergence in opinions between CFOs and other executives in the nonprofit sector:

  • Views on Financial Challenges: Nonprofit CFOs and other leaders often express differing sentiments around liquidity. The majority of finance chiefs we work with characterized it as a high or moderate challenge. But among other executives, fewer felt this way. We are firmly in the finance chiefs’ corner and believe liquidity can be the one key performance indicator that makes or breaks a nonprofit’s success. Generally, establishing at least six months of operating reserves is a prudent target for the sector. In our experience, about half of organizations surpass that six-month target, while the other half fall short. Unfortunately, some nonprofits have no operating reserves at all, meaning they are incredibly vulnerable if there are funding interruptions and/or reductions.
  • Views on Overhead: Rising overhead costs is another area of greater concern for nonprofit finance chiefs, compared to their other executive colleagues. Given these differing perceptions, now may be the time for CFOs to educate other stakeholders about the importance of communicating mission outcomes and impact to outside stakeholders, particularly donors. CFOs understand all too well the risks of the “starvation cycle”–a situation in which an organization prioritizes high programmatic spending over necessary infrastructure like new technology, employee training and fundraising expenses. CFOs understand that spending on infrastructure is necessary, but outside stakeholders and donors may not.
  • Views on Regulation: CFOs are often also much more attuned to the difficulty of dealing with regulatory and legislative changes. While it’s likely that CFOs could bear the brunt of new regulatory and legislative changes, these issues will ultimately impact the entire organization’s future strategy:
  • When federal tax reform passed more than a year ago, many nonprofits were left wondering how to handle changes like the new excise tax on executive compensation, taxes on fringe benefits and personal tax changes that impact charitable giving.
  • New regulations around how nonprofits recognize revenue mean organizations need to review and assess all their revenue streams to determine how to record them in annual financial statements.
  • Views on Cybersecurity: CFOs are often somewhat less concerned about cybersecurity than other nonprofit executives. While IT is often not under nonprofit CFOs’ immediate purview, the security of financial technology systems—including donor databases—is a crucial element of a nonprofit’s long-term sustainability, meaning more and more CFOs will get involved in cybersecurity strategy as they understand the risks. Alternatively, when information technology does fall under CFOs’ responsibilities, they are often more secure in the risk mitigation tactics they are taking to protect the organization.

It’s clear from our experience in working with our clients that there is often a mismatch between the priorities of CFOs and other senior leaders, but it’s critical they work together to make decisions and develop strategies that balance the organization’s mission with its financial health. As the financial leader, the CFO has to make a convincing business case. Sometimes that means employing a little–or a lot–of style, to go along with substance.

For example, our co-presenter in our January webinar, Susan Pikitch, CFO at the United States Golf Association, said her biggest advice to nonprofit CFOs is to view their role as part-educator, part-fact-bearer. Like all other relationships, it’s all about cultivating a creative business partnership where ultimately your guidance is a value-add. She cautioned against being viewed as a “CF-No.” Those perceived to be CF-Nos can be thought of as roadblocks and left out of important conversations to the detriment of their organization. Unfortunately, that’s how some brilliant CFOs get cut out of the decision-making process.

On a tactical level, CFOs should go beyond presenting facts and figures, and tell their organization’s financial story using visuals to communicate insights. It’s important to address the audience as clearly and simply as possible, being aware that not everyone has the same understanding of finance. The most important best practice to achieving that goal is ensuring constant, open communication between the CFO and other stakeholders.

The most effective nonprofit CFOs will look past the differences with other key leaders. By prioritizing working together, they can ensure their organizations maintain a nonprofit heart and business mindset, and set them up for long-term success.

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

ASU 2016-14 – Liquidity and Availability Disclosure Issues

By Tammy Ricciardella, CPA

As calendar-year-end nonprofits have worked through the implementation of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, we have seen quite a bit of diversity in the preparation of the liquidity and availability disclosure required by the ASU.

To improve the ability of financial statement users to assess a nonprofit entity’s available financial resources and the methods by which it manages liquidity and liquidity risk, the ASU requires specific disclosures including:

  • Qualitative information that communicates how a nonprofit entity manages its liquid available resources to meet cash needs for general expenditures within one year of the statement of financial position (balance sheet) date
  • Quantitative information that communicates the availability of a nonprofit’s financial assets to meet cash needs for general expenditures within one year of the statement of financial position date. Items that should be taken into consideration in this analysis are whether the availability of a financial asset is affected by its (1) nature, (2) external limits imposed by grantors, donors, laws and contracts with others, and (3) internal limits imposed by governing board decisions

The following information can be displayed either on the face of the statement of financial position, or in the notes to the financial statements, unless otherwise required to be on the face of the statement of financial position:

  • Relevant information about the nature and amount of limitations on the use of cash and cash equivalents (such as cash held on deposit as a compensating balance)
  • Contractual limitations on the use of particular assets. These include, for example, restricted cash or other assets set aside under debt agreements, assets set aside under collateral arrangements or assets set aside to satisfy reserve requirements that states may impose under charitable gift annuity arrangements
  • Quantitative information and additional qualitative information in the notes, as necessary, about the availability of a nonprofit’s financial assets at the statement of financial position date

An entity can provide additional information about liquidity in any of the following ways:

  • Sequencing assets according to their nearness of conversion to cash and sequencing liabilities according to the nearness of their maturity and resulting use of cash
  • Classifying assets and liabilities as current and noncurrent
  • Disclosing in the notes to financial statements any additional relevant information about the liquidity or maturity of assets or liabilities, including restrictions on the use of particular assets

Liquidity is defined in the Accounting Standards Codification (ASC) Master Glossary as “an asset’s or liability’s nearness to cash. Donor-imposed restrictions may influence the liquidity or cash flow patterns of certain assets. For example, a donor stipulation that donated cash be used to acquire land and buildings limits an entity’s ability to take effective actions to respond to unexpected opportunities or needs, such as emergency disaster relief. On the other hand, some donor-imposed restrictions have little or no influence on cash flow patterns or an entity’s financial flexibility. For example, a gift of cash with a donor stipulation that it be used for emergency-relief efforts has a negligible impact on an entity if emergency relief is one of its major programs.”

Based on this definition, an entity will have to carefully look at its assets and consider any donor-imposed restrictions that may exist when determining the presentation of liquidity.

A simple measure of liquidity per the ASU is the availability of resources to meet cash needs for general expenditures within one year of the date of the statement of financial position. The ASU does not define general expenditures but does provide some suggestions regarding limitations that would preclude financial assets from being available for general expenditures. Some of these items noted in the ASU include:

  • Donor restrictions on the use of assets for particular programs or activities
  • Donor restrictions on the time period in which assets are used
  • Board designations that commit certain assets to a particular purpose
  • Loan covenants that require certain reserves or collateralized assets to be kept on hand
  • Compensating deposit balances required by financial institutions

To provide the liquidity and availability disclosure, entities should likely consider combining both a narrative description of their method for managing revenue with donor restrictions and a table that lists the dollar amounts expected to be released from various sources. Entities should develop a liquidity management program that allows them to determine what portions of donor restricted funds will be released from restriction and available for both direct program costs as well as shared expenses that support those programs.

In addition, entities should have a program in place to assess what resources are available. These should only include the portion of funding commitments that are expected to be received in the next year. To assist in this determination, as well as the overall liquidity management, entities should consider utilizing a rolling cash flow projection that covers at least a 12-month period.

Entities should also provide, in the qualitative component of the disclosure, information about other methods they use to manage liquidity and maintain financial flexibility. Examples of these could include:

  • The use of lines of credit
  • Established operating reserve policies
  • Cash management process

It is important to develop this disclosure to present an accurate picture of the liquidity and availability of resources utilizing both financial information and supporting narrative to fully explain the financial health of the organization.

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

From Idea to Impact: 4 Fundamental Elements for Sustainability

By Laurie De Armond, CPA, and Adam Cole, CPA

The world needs nonprofits to continue striving for meaningful impact on a wide range of social, economic and human rights issues, and it needs them to remain financially healthy. To do so, organizations need to balance a nonprofit heart with a business mindset.

Your mission is the heartbeat of your nonprofit. Just as the human heart sustains a body, your mission is the driving force of your organization’s work. But the heart can’t do it on its own. One clogged artery puts stress on another element of the system—and while it may go undetected for some time, eventually that stress starts to show. A healthy heart and a strong organization rely on fully functioning support systems.

Like the four chambers of the heart, following are four critical elements for sustainability that can take your mission from idea to impact:

  1. People: From the Governing Board to the C-suite team to employees and volunteers, supporting the people behind the nonprofit is vital. While the typical nonprofit professional is highly motivated and engaged, it’s critical for the organization’s leadership team to ensure the skills of its people align with the present and future needs of the organization. If you don’t have the right people or maintain proper engagement and focus on the organization’s mission—or don’t treat your people well—it could ultimately harm your ability to fulfill your mission.
    • Retention: Nonprofits who take a business mindset to their recruitment and retention policies will work with their best assets—highly impactful and rewarding work—to promote internally and externally the holistic value of a nonprofit career.
    • Succession Planning: Successful organizations have strong leaders at the helm, but they also plan ahead for the inevitable day when a change in leadership must occur. Unfortunately, leadership succession planning can be neglected in the nonprofit world, where devoted leaders often stay for long tenures and can be hesitant to pass the reins to a new leader.
    • CFO/Financial Leaders: While the CEO and executive director are critical leaders who set the tone and mission of the organization, nonprofits cannot overlook the importance of their financial leadership.
  1. Operational & Financial Management: Nonprofits must look at their operations with a more critical business mindset to find the appropriate balance between programmatic spending and the investments (both capital and programmatic) required for continued growth and stability. Prioritizing programmatic spending is a given, but nonprofits that place equal focus on long-term scalability and sustainability will maximize their impact.
    • Tackling the Overhead Myth: Charity rating sites have put additional pressure on organizations to minimize their overhead spending. The unfortunate consequence is that many donors now assume, incorrectly, that low overhead costs are a good measure of a nonprofit’s performance—what is commonly referred to as the “overhead myth.” Low overhead may serve as a nice, short-term talking point for donors, but it’s an unsustainable strategy.
    • Avoid the Starvation Cycle: In reality, high ratios of programmatic spending could mean the organization is underfunding critical areas necessary for long-term growth—a phenomenon known as the “starvation cycle,” which creates an unhealthy environment for the organization. Failing to invest in infrastructure, such as new technology, security, employee training and fundraising capabilities, can be detrimental to organizational growth.
  1. Transparency & Communication: Prospective donors are increasingly thinking like discerning shoppers—researching organizations as they would a major purchase. They are seeking convenience, and fewer clicks to donate. Meeting these demands requires new skill sets, enhanced training and education, and creates opportunities for automation to improve and streamline processes.
    • Digitizing Donor Relations: It’s not enough to create an annual report and share it online, or to send regular email and mail communications on impact and outcomes. Donors expect near real-time reporting, with frequent updates. A large number of nonprofits already use social media to communicate with external stakeholders and that is only likely to increase.
    • Communicating Clearly & Often: It’s no secret that budgets have been constrained by economic and donor and funding shifts. To mitigate surprises down the line, start the budgeting process early and make projections to give a realistic picture of how the organization’s financial situation could shake out. By planning ahead and communicating early and often, stakeholders will be better prepared to advise and respond.
  1. Governance & Compliance: Lack of compliance with a regulation or insufficient board oversight on a key risk like cybersecurity can erase great mission-driven outcomes, sever trust with stakeholders and put the entire organization in jeopardy. The professionals in and outside of a nonprofit organization who proactively plan for risk, digest and implement new regulations, and prepare for compliance changes are unsung heroes who do behind-the-scenes, labor-intensive work to ensure the broader organization can focus on its mission without the worry of hitting costly roadblocks.
    • Staying Cyber Secure: Nonprofits can’t maximize their impact if they are constantly responding to data privacy breaches or cyberattacks. A hack can take down a great organization by erasing trust and diverting resources from the mission. Nonprofits should think of these efforts as their secret weapon, not a financial anchor weighing them down. Even with limited resources, nonprofits must take a proactive approach to regulatory compliance and risk mitigation because the alternative could mean betraying donor and public trust and resulting in financial ruin.
    • Managing Your Data Plan: Consider a holistic data privacy strategy as part of your data governance program. A Privacy Operational Life Cycle that helps keep employees apprised of new privacy requirements, embraces recordkeeping and sound data protection practices, and offers enhanced data privacy for stakeholders is crucial with the General Data Protection Regulation in effect and other state and national laws in motion.
    • Tax-Exempt, not Tax-Blind: Nonprofits also know that tax-exempt doesn’t mean they can ignore taxes. Tax reform provided another significant shift in rules for nonprofits to address. Major changes to unrelated business income, executive compensation, endowment taxes for higher education institutions and changes to charitable giving deductions, among other items, impacted nonprofits and created significant compliance work for internal and external teams. Assessing guidance and understanding total tax liability is critical to strategic tax planning and maintaining operations. With changes to the tax code still a possibility in the future (including the release of additional guidance), this may be a moving target of sorts for nonprofit leaders, but it’s one that can’t be ignored.

When each of these elements, like the four chambers of the heart, are considered and given priority in setting and executing strategy, nonprofits are poised for greater success and long-term impact.

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