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With a wide-ranging and highly curious intellect, it comes as no surprise that Dan’s passion is learning.

When it comes to fraud, it is true that we live in a technological age of cyber-threats, such as ransomware and account hacking.  However, one should always remember that the opportunity to commit fraud can be as simple as not having basic internal controls.

This fraud story comes to us from Brownsville, Pennsylvania and involves a treasurer for a volunteer ambulance organization who seems to have taken advantage of an internal control oversight. The treasurer was tasked with writing checks for the nonprofit and sending the financial records to the independent accounting firm.

The problem? He allegedly wrote or deposited 132 checks into his own personal account or to the account of his own business. He is also alleged to have changed the financial records to cover that up. If the accounting firm (or anyone else at the nonprofit, really) had access to the original bank statements or could see the banking activity online, this may not have gone on for four years to the tune of approximately $136,000.

The article also states that the alleged fraudster had previously been charged in the early 2000s with insurance fraud while serving as the same nonprofit’s treasurer. Though we don’t know all the circumstances and he was admitted to a rehabilitative program for the earlier fraud charge, that bit of history should have served as a signal to institute strong internal controls.

So, what are the lessons? For starters, any organization, large or small, should have overarching controls (entity-level controls and information technology controls) and transaction controls focusing on the cash disbursement cycle, the cash receipt cycle, and the month-end closing and financial reporting. For example, the transaction control of reviewing monthly statements outside of the accounting department theoretically would have immediately raised red flags. This article, written by my colleague Sarah Wine, dives into 10 easy-to-adopt controls.

While technology threats are real, it pays to have strong internal controls to catch the non-technology fraud that can fly under the radar. If you haven’t already, start instituting these controls now. If you need assistance, please contact Victoria Kitts to get started.

© Clark Nuber PS and Focus on Fraud, 2019. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Focus on Fraud with appropriate and specific direction to the original content.

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Articles and Publications

Hospitality Industry Outlook for 2020

As we approach the year’s end, this is a good time to consolidate plans for next year. For the hospitality industry, the Lodging Conference kicks that process off. I recently attended the 25th annual Lodging Conference, where hotel owners and executives meet to strategize and learn about development, finance, management and operations.  I returned with beneficial information to share as you plan for 2020.

Economic Outlook

The conference began with an economic and geopolitical outlook presented by Bernard Baumohl, Chief Global Economist of The Economic Outlook Group.  He addressed the worries many of us have: Is a recession near? Are we at the peak of the business cycle? Bernard noted the following as common causes of past recessions.
  • High interest rates that shut down borrowing and spending
  • Major geopolitical eruption that causes oil prices to spike
  • Acts of human foolishness (bad decisions leading to economic disaster)
Considering these causes, what could bring about a downturn in our current economy?  Bernard felt that, if the trade war with China continued, the world economy would be in danger of shutting down as global exports shrink, and countries devalue currencies. He also felt that the Fed’s lowering of interest rates would not offset the effects of the trade war.  Consumers and businesses may scale back on spending due to uncertainty of the impact the 2020 presidential election will have on trade, tax and spending policies.  Overall, he predicted the risk of recession at 35%.

2020 U.S. Hotel Forecast

Vail Ross, Senior VP, Global Business Development and Marketing, of STR provided a U.S. outlook for 2020.  The following table shows the percentage change over the prior year in the following metrics: [table id=6 /] In Seattle, STR forecasts the 2019 year-end Revenue per Available Room (RevPAR) growth at -3% to 1%, while the 2020 year-end RevPAR growth forecast is estimated to be 1% to 3%.  The significant factor influencing the RevPAR decline in the Seattle area in 2019 is the 6.6% supply growth that has occurred.

Threats on the Horizon

Vail also noted the following possible threats on the horizon:
  • Slower profitability growth – owners are finding it harder to push up room rates.  Expenses, particularly in labor costs, are rising at greater rates than RevPAR.
  • Week growth in Average Daily Rates (ADR) – as additional room supply comes into the market, the ability to increase room rates becomes a challenge.
  • Low unemployment – with fewer people available, owners are forced to increase wages and benefits to attract and retain talent.
  •  Overall economy – uncertainty in the market causes consumers to reduce their spending.  This can affect the hospitality industry as the industry relies heavily on discretionary spending.

How Should You Prepare?

The overall message from many presenters at the conference was that we are headed for a slowdown, not a downturn.  Knowing there are threats on the horizon, how should owners and finance leaders ensure their companies can survive a downturn in the economy?
  • Cost control – as room rates remain flat and expenses continue to rise, protecting margins will be a challenge.
    • Working with the leadership team and department heads to review costs and identify cost-control measures should be prioritized.
    • Managing costs and reviewing them on a regular basis can also improve the hotel’s long-term financial health.  Are there fixed costs that can be evaluated for savings that will improve your profit margin?
  • Stress tests – developing financial plans that include adverse hypothetical scenarios will assist in identifying areas at risk during a downturn.
    • What if room rates do not increase at the rate predicted?  What if occupancy rates drop substantially?  How will this affect your financial plans?
    • Consider how these adverse scenarios may affect your debt covenant requirements.
    • Proactively plan for the “what-if” scenarios by developing a contingency plan that will address a slowdown in the economy.  Having a plan in place will reduce your response time and possibly lessen the impact on the bottom line.
  • Improve efficiencies – as hotels are required to do more with less, improving efficiencies will be necessary in order to operate profitably.
    • Identify where technology advancements can be incorporated to improve productivity.  Are there areas in your operations that can be automated?  Are you using your current systems to their full potential?
    • We are now seeing many hotel brands incorporating keyless room entry, robots to delivering towels and cleaning bathrooms and adding Alexa in rooms to order room service or answer frequently asked questions.  Technology will not necessarily replace employees but will assist them in working more efficiently; allowing them to focus on providing a superior customer experience.
A recession may not be in the immediate horizon, but a slowdown in the economy is likely. Companies should have a well-prepared plan in place so that they are better equipped and can respond quickly when the market starts to slow.  What will you include in your plan to help mitigate the risks from a downturn? © Clark Nuber PS, 2019. All Rights Reserved

Changes to Washington’s Real Estate Excise Tax Could Result in Surprise Tax Liabilities from Controlling Interest Transfers

Updated 9/18/2019, 9:15 PM

What Changed?

The Washington legislature recently enacted legislation that dramatically changes aspects of the state’s Real Estate Excise Tax (REET). Unless real property is classified as timberland or agricultural land, the REET rate structure will be changing on January 1, 2020. The current flat rate of 1.28% for the state portion of the REET will be replaced with a graduated rate. The new rates will be:
  • 1.1% on the first $500,000 of the selling price;
  • 1.28% on the portion of the selling price between $500,000 and $1.5 million;
  •  2.75% on the portion of the selling price between $1.5 million and $3 million; and
  •  3% on the portion of the selling price over $3 million.
Flat rates for the local portion of the REET will remain; they generally vary from .25% to .5%, depending on the city or county in which the real estate is located. Also beginning on January 1, 2020, the “controlling interest” transfer period expands from 12 months to 36 months. This expanded period could significantly increase the risk of inadvertently triggering REET liability with multiple transfers of minority ownership interests in entities that own real property in Washington. The new legislation also authorizes the Washington Department of Revenue (“DOR”) to disregard the structure of a transaction or series of transactions designed to avoid REET liability, and to determine the proper treatment based on the substance of the transaction(s). For example, the DOR may treat multiple sales as a single sale based on an appearance that the parties engaged in a plan intended to reduce the tax rate.

What Is a Controlling Interest Transfer?

There must be a “sale” for there to be REET liability. The current definition of a “sale” includes the direct transfer of an interest in Washington real property and “the transfer or acquisition within any twelve-month period of a controlling interest in any entity with an interest in real property located in this state for a valuable consideration.” A DOR regulation attempts to simplify the above definition by outlining the following components of a taxable controlling interest transfer:
  1. The transfer or acquisition of a controlling interest occurs within a 12-month period (expanded to 36 months beginning 1/1/2020);
  2. The controlling interest is transferred in a transaction or series of transactions by one person, or the controlling interest is acquired by a single person or group of persons acting in concert;
  3. The entity has an interest in Washington real property;
  4. The transfer is made for valuable consideration; and
  5. The transfer is not otherwise exempt.
The REET issues often involved in controlling interest transfers include:
  1. whether a taxable transfer occurs if multiple owners acquire their ownership interests during a 12-month (or 36-month) period,
  2. the amount of REET due when there is a controlling interest transfer, and
  3. if a controlling interest transfer is exempt from the REET.

Multiple Owners Acquiring Ownership Interests

A controlling interest in a corporation is 50% or more of all voting stock. A controlling interest in any other type of entity is 50% or more of the capital, profits, or beneficial interest in the entity. If two or more persons acquired, together, more than 50% of the interests in an entity during a 12-month period (or a 36-month period beginning 1/1/2020), the DOR generally presumes persons are acting in concert when there is a relationship where one person has control or influence over the other through common ownership. If there is no common control, the DOR will look for a united purpose for the transfers.

REET Measure on Controlling Interest Transfers

The statutory term “total consideration paid” encompasses anything of value, including a direct transfer of compensation, but also the amount of any lien, mortgage, contract debt, or other encumbrance. Thus, a transfer in exchange for debt relief or release of a lien constitutes valuable consideration. Notwithstanding the type or amount of consideration exchanged, the measure of the REET when there is a controlling interest transfer is the “selling price,” which is the full market value of the underlying real property. The tax on a controlling interest transfer is NOT measured by the selling price of the ownership interests in the entity nor is it measured by the proportionate interest in the underlying real property represented by the ownership transferred. If there are multiple transfers of minority interests within a 36-month period that comprise a controlling interest transfer, this involves the issue of applying the proper rate and dividing liability for the REET between minority interest holders – especially if the market value of the real property fluctuates during the relevant period. Unanswered questions regarding the new legislation include how to allocate REET liability among the transferors/transferees in a transfer of controlling interest occurring over time.

Exempt Transfers

There are numerous exclusions from the REET, and the DOR construes them narrowly. Also, there are some exceptions to the exclusions. The exclusions applicable to controlling interest transfers include transfers by gift, inheritance, and devise; transfers to a revocable trust; and transfers involving a “mere change in form or identity where no change in beneficial ownership has occurred.” Transfers involving a mere change in form or identity could include the following:
  1. a transfer for purposes of entity formation or liquidation that does not involve the recognition of gain or loss for federal income tax purposes;
  2. a transfer by an individual or tenants in common of an interest in real property to an entity if the entity receiving the ownership interest receives it in the same pro rata shares as the individual or tenants in common held prior to the transfer; and/or
  3. a transfer by an entity of its interest in real property to its wholly owned subsidiary or vice versa.

Expanded Period Impacts

The DOR and the Washington Secretary of State have not yet issued any guidance regarding changes to controlling interest transfers. Pursuant to the recently-enacted legislation, beginning January 1, 2020, entities with Washington real property will not only be required to annually report to the Secretary of State the transfer of a controlling interest, but also the transfer of “an interest that amounts to at least one-third of a controlling interest” (i.e., 16.67% beneficial interest), or the grant of an option to acquire said interest. Given the reporting requirements, entities with Washington real property and multiple owners (including indirect beneficial owners) would be wise to closely track transfers of ownership interests. Without any issued guidance at this point regarding the additional 24 months added to the controlling interest period, there is a possibility that the DOR or Secretary of State will require entities to consider transfers made prior to 2019. If multiple transfers of ownership interests were made, the entity should also consider the relationships between the parties. We recommend contacting a tax professional familiar with REET issues if there are any questions concerning the aggregation of multiple transfers. Notably, the newly-enacted legislation has not changed the requirement to submit a REET affidavit to the DOR when there is a controlling interest transfer, including controlling interest transfers that are exempt from REET.

Additional Guidance

The new legislation encourages the DOR to provide additional guidance on the new tax avoidance provision described above, and it is expected the DOR will also provide guidance on other REET matters. Currently, the DOR anticipates adopting a rule interpreting the tax avoidance provision during the second quarter of 2020, and a meeting to receive public comments is scheduled next month on October 16th. Other REET guidance from the DOR is anticipated throughout 2020. It would be helpful if such guidance provides a structure for allocating REET liability for controlling interest transfers involving minority interest holders and addresses whether the expanded 36-month period encompasses interest transfers prior to 2019. If you have any questions regarding Washington’s Real Estate Excise Tax, please contact a member of Clark Nuber’s State and Local Tax Group. Jennifer Hill Clark Nuber Co-author Jennifar Hill is a manager in Clark Nuber's State and Local Tax Group. © Clark Nuber PS, 2019. All Rights Reserved

2019 Compliance Supplement – A Summary of Major Changes: What Auditees Need to Know

Each year, the Office of Management and Budget (OMB) issues a 2 CFR Part 200, Appendix XI Compliance Supplement (Compliance Supplement). The Compliance Supplement provides a road map auditors should follow when performing a Single Audit (established under the Single Audit Act of 1984) and explains how to test the various applicable compliance requirements. Each year the Compliance Supplement is updated by both the OMB and the related federal agencies which issue funds that fall under Single Audits. In 2018, the OMB released a skinny version of the Compliance Supplement which included only changes to the supplement. Thus, auditors had to use the 2017 and 2018 Compliance Supplements in conjunction when performing audits. The 2019 Compliance Supplement, released in July 2019, returned to the full stand-alone supplement, highlighting key changes within. Some of the more significant changes include the requirement for federal agencies to reduce the applicable compliance areas from 12 down to 6, and the re-addition of internal controls. This supplement applies for fiscal years beginning after June 30, 2018. It supersedes the previous Compliance Supplements. An overview of the Compliance Supplement and other changes in it worth noting follows below:

Part One:

The Compliance Supplement comprises eight parts. Part One describes the background, purpose, and applicability of the Compliance Supplement. The Compliance Supplement can be used as a tool by auditees to better understand the audit process and what the auditors will be testing. This area only included minor updates related to the 2019 Compliance Supplement.

Part Two:

Part Two covers the matrix of compliance requirements for various programs designated by the program’s Catalog of Federal Domestic Assistance (CFDA) number. This section saw significant changes in the 2019 Compliance Supplement. Each year, federal agencies must submit a matrix detailing which of the 12 compliance requirements are applicable for a specific CFDA. The 12 compliance requirements consist of:
  • activities allowed or unallowed;
  • allowable costs/cost principles;
  • cash management;
  • eligibility;
  • equipment and real property management;
  • matching, level of effort, earmarking;
  • period of performance;
  • procurement suspension and disbarment;
  • program income;
  • reporting;
  • subrecipient monitoring; and
  • special tests and provisions.
The federal agencies submit this information for CFDAs that have a high level of federal assistance issued from the agency, but it does not include all CFDAs that have been issued. Each year, CFDAs are added to this matrix and removed. The 2019 Compliance Supplement reflected these normal changes. However, the OMB also required that federal agencies identify six compliance requirements that are subject to audit. The purpose was to reduce the audit burden on auditors and auditees of the various programs. For the six compliance requirements, allowable activities and allowable costs were considered “one” compliance area. This is a significant change from prior years and will have an impact on the planning and performing of Single Audits in the next year. For many programs, the compliance requirements removed were not historically considered direct and material, so the impact on the Single Audit is yet to be known.

Part Three:

Part Three of the Compliance Supplement covers the 12 previously mentioned compliance requirements, except for special tests and provisions. It details the audit objectives and provides suggested audit procedures such as sampling and reviewing policies. It also covers the requirement to obtain understanding and test the effectiveness of internal control over the compliance requirement.  As special tests and provisions are unique to the specific program, the compliance supplement does not give guidance on how to test them, only that testing must be covered. This part only included minor updates.

Part Four:

Part Four covers the federal agencies’ specific program requirements for CFDAs included in the Compliance Supplement. Federal agencies can include guidance in this area key for the auditors to be aware of when testing the related programs. This part is updated regularly in the Compliance Supplement with any changes in federal programs. It is recommended that users of the Compliance Supplement review this area in detail for programs under audit. There may have been significant changes from prior years.

Part Five:

Part Five of the Compliance Supplement covers the same areas as Part Four, but instead of individual programs, it focuses on the clusters included in the Compliance Supplement, such as the Research and Development cluster. Again, it is recommended that users of the Compliance Supplement review this area in detail for clusters under audit.

Part Six:

Part Six of the Compliance Supplement covers internal controls. Organizations receiving federal assistance must maintain a system of internal controls that provides reasonable assurance of compliance with federal requirements. Under Single Audits, the auditor must gain an understanding of these controls and audit the controls. Part Six covers an example control structure that organizations can adopt. It includes controls under the “Standards for Internal Control in the Federal Government” (Green Book) which is issued by the Government Accountability Office. It also includes the “Internal Control Integrated Framework” (COSO Framework), issued by the Committee of Sponsoring Organization of the Treadway Commission. Under 2 CFR Part 200, the Green Book and the COSO Framework are recommended internal controls structures, but not required. Part Six provides examples of controls using these structures. In previous Compliance Supplements, this part had been removed as OMB worked to incorporate changes in the Green Book and COSO Framework. The 2019 Compliance Supplement has added this section back in and the OMB has significantly expanded guidance in this area. Auditees can use the section to help evaluate their own controls against the Green Book and COSO Framework.

Part Seven:

Part Seven of the Compliance Supplement guides when a CFDA is not included in the Compliance Supplement and how the program should be audited. This area saw only minor edits from the prior supplements.

Part Eight:

Part Eight of the Compliance Supplement includes the appendices to the Compliance Supplements. The appendices include:
  • Federal Programs Excluded from the A-102 Common Rule and Portions of 2 CFR Part 200 (Appendix I);
  • Federal Agency Codification of Government-wide Requirements and Guidance for Grants and Cooperative Agreements (Appendix II);
  • Federal Agency Single Audit, Key Management Liaison, and Program Contacts (Appendix III);
  • Internal Reference Tables (Appendix IV);
  • List of Changes for the 2019 Compliance Supplement (Appendix V);
  • Program-Specific Audit Guides (Appendix VI);
  • Other Audit Advisories (Appendix VII);
  • Examinations of EBT Service Organizations (Appendix VIII); and
  • Compliance Supplement Core Team (Appendix IX).
These appendices had minor changes as they related to the updates for each new Compliance Supplement. For a full listing of the changes from the 2017/2018 Compliance Supplement, users of the 2019 Compliance Supplement should perform a detail review of Appendix V, which covers all the changes in the new supplement. If you require help when preparing for a Single Audit, contact a Clark Nuber professional.
© Clark Nuber PS, 2019. All Rights Reserved

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