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Bob

JD, LLM | Shareholder

Whether it’s brewing craft beer, mastering Bobby Flay’s throw downs, or playing classical guitar, Bob’s devotion to learning has us convinced that, in a past life, he must have been a wandering scholar.

On December 4, 2017, the Department of Treasury issued Notice 2017-73, indicating Treasury’s thinking of what the Proposed Regulations on Donor Advised Funds (DAFs) might be. The Notice asks for input by March 5, 2018, on areas Treasury is considering issuing Regulations. A Notice is a way to request informal feedback prior to issuing Proposed Regulations.

The Notice requests input in four areas:

  1. Two examples where distributions from DAFs may provide more than “incidental” benefit to a donor, donor advisor or related person;
  2. Circumstances under which a distribution may be made from a DAF without consideration of whether there was a personal pledge outstanding to the grantee from the donor, donor advisor or related person;
  3. Circumstances under which grants made out of a DAF must be attributed back to the donor, donor advisor or related person to calculate excess contributions under the public support test of IRC 509(a)(1) or excluding contributions from disqualified persons for IRC § 509(a)(2) public support.
  4. The final area is a catch-all for any area not specifically addressed in the Notice’s examples.

The Notice will have impact beyond sponsors of DAFs and contributors to DAFs.  Recipients of DAF funding may see a significant increase in burden and a chilling effect on DAF giving if the Notice becomes Regulations.

Please watch for upcoming articles on all four areas. We will use these articles to provide insights from an audit and tax perspective.

Please contact or email us at info@clarknuber.com if you have specific questions on the notice or would like assistance in drafting feedback to the IRS and how the proposed changes would affect you or your organization.

© Clark Nuber PS and Developing News, 2017. 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 Developing News with appropriate and specific direction to the original content.

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Big Data, IT Controls, and Offsite Work: The Future of Auditing?

Some sources talk about changes to professional standards that would allow auditors to rely more on data analysis as direct audit evidence. Others foresee more automation, such as linking the accounting transactions from the general ledger directly to outside sources like bank records. And still others talk about Bitcoin, Blockchain, and the challenges and opportunities that digital currency brings – a topic that Clark Nuber Shareholder Ron Rauch addressed in a recent article. It’s clear that the auditing process and procedures, like the rest of the business world, will need to be refurbished to keep up with the ever-changing environment. But before we say goodbye to sampling forms and confirmations, what kinds of changes can we expect to see in the more immediate future?

Big Data

Data analytics are here to stay. Analytical procedures have always been a part of the audit process, but new technologies allow us to slice and dice transactions in more ways than ever. The Rutgers AICPA Data Analytics Research Initiative (RADAR), is studying integration of data analytics into the audit process, with the goal of demonstrating how this can lead to advancements in the public accounting profession. This fall, they will issue an update to the AICPA Analytical Procedures Guide that discusses audit data analytics at a foundational level, and provides examples of how to integrate tools and techniques into the audit process. Some plans for the future include developing a framework to sort through large populations of data to identify possible exceptions, researching process mining techniques to evaluate internal control effectiveness, and determining how to generate visualizations that can be used as audit evidence.

IT Controls

One constantly changing area is information technology. Accounting processes and related controls look a lot different than they used to, and so should auditing procedures over those processes. Gone are the days when auditors can review the physical cancelled check for a disbursement. First, no one gets cancelled checks back from the bank any more. Second, much of the cash disbursements and receipts process has gone paperless. There is no “signature” to review. Instead, auditors should look at who has authorization and access to generate an electronic funds transfer. Are multiple people needed to complete the transfer, or can one person make a payment single-handedly? Auditors should be testing various controls over your IT systems, including access controls, change management (for example, who can add a new user), and security protocols. Auditors need to be testing through the computer and no longer testing around it.

Direct Access to Transactional Details

Currently, your auditor probably requests a trial balance report from your general ledger (G/L), leaving the rest of the prepared-by-client schedules up to you to complete. This means you summarize the annual activity of various accounts into an easy-to-read roll-forward format. You also provide transactional detail of selected accounts, and the auditors make their requests for testing individual items from that detail. What if your auditor requests an accountant’s copy of your entire G/L package up front? Your auditor could use that detail to fulfill some of their own requests on the pre-audit list. For example, you wouldn’t need to export and send them a list of contributions for the year, nor would you need to prepare a roll-forward of pledges receivable. Data analysis on the entire population can be considerably more informative than just testing a sample of transactions. By utilizing analysis procedures in their audit planning and risk assessment, the auditor may be able to hone in on risk areas with the click of a button. Samples can then focus on the higher risk areas, providing more meaningful audit evidence instead of spending time testing less risky transactions. Giving your auditor all of the detail at once also often allows them to answer some of their own questions by diving in to the underlying transactions.

Offsite Fieldwork

Everyone in your office knows when the audit is going on. The best conference room is reserved for a week or two, the accounting department is working late, and the audit team has so many questions for so many people. While that may be a tried-and-true model for many organizations, not all of them like putting their day jobs aside for the duration of fieldwork. What if your auditors instead began the work from their own office, using the G/L detail you’ve provided as a starting point? They can gather questions and make requests for supporting documents before coming to your office. Their onsite time is then focused on staff interviews, reviewing source documents, and tying up loose ends.

The Bottom Line

For now, the financial statement audit process will likely continue to include vouching to external support, confirming balances with third parties, and sampling. But you can expect to see a larger emphasis on data analytics, IT controls, and creative ways of shaping the fieldwork process.

Questions?

Please contact Victoria Kitts at info@clarknuber.com if you have questions or would like more information about this topic. © Clark Nuber PS, 2017. All Rights Reserved

How Will New IRS Audit Procedures Impact Tax Exempt Partners?

Background

As part of the desire to diversify portfolios, tax exempt organizations have increased their exposure to alternative investments. Many of these investments are pass-through investments either partnerships or limited liability companies taxed as partnerships. Because they are taxed as partnerships, that is what is relevant for purposes of this new law and this discussion. Partnership investments are unique because income, expenses, and other separately-stated tax items are collected by the partnership level and reported to the partners. The partners then report the separately stated items on their tax returns. For tax exempt organizations, most of the income earned through these investments is passive income (interest, dividends, capital gain, etc.). It is thus statutorily exempt from federal and state income tax. If the exempt organization is a private foundation, it may be subject to the one or two percent excise tax on net investment income. This co-investment between taxable and tax-exempt partners in investment partnerships has worked well for many years, since public charities won the landmark case allowing them to co-invest with for-profit investors.1 Each partner received their distributive share and reported based upon their tax circumstances.

What Can Tax Exempt Partners Expect?

As stated above, the new IRS audit rules are expected to have significant impact on this happy co-investment existence. To avoid unfavorable consequences, partnership operating agreements must be carefully reviewed today and may require revisions to mitigate the impact of the new rules. Provisions which may have a negative impact on tax exempt partners include:
  • The IRS may assess and collect additional taxes, interest, and penalties directly from the partnership, rather than through auditing each partner. The tax could be collected at the highest individual tax rate even though there are tax exempt partners invested in the partnership, which would have no tax on the adjusted income.
  • Current partners could be liable for the taxes of prior investment partners. If those partners were for-profit investors and the purchase price of the investment incorporated no contingent liability or payback provision to the tax-exempt investor, there is potential for private benefit from the tax-exempt organization paying the tax liability of a prior for-profit investor.
  • Additionally, private foundations may co-invest with disqualified persons. Because the adjustment in tax will happen at the partnership level, there is the potential for self-dealing if the private foundation is assessed taxes owed by disqualified persons.

Important questions to ask:

  • How many partners are in the partnership? If there are 100 or fewer partners, the partnership may make an annual election to opt-out of the new audit provisions. The election must be made on a timely filed Form 1065.
  • Does your partnership agreement identify a partnership representative (formerly known as a tax matters partner)? If not, the document likely needs to be updated to rename this person and give them authority to:
    • Represent the partnership before the IRS;
    • Make the opt-out provision (if applicable and desirable as described above)
    • Carry out any other decisions or responsibilities that require specific identification
  • Who is the partnership representative? Do they know there are tax exempt organizations? Do they know the issues which may arise with a mixed pool of taxable and tax-exempt partners? The partnership representative has the authority to bind the partnership and the partners during an IRS examination. It is important they are informed as to the diversity of their investor constituency.
Partnerships continue to be a valid alternative investment in an exempt organization’s well-balanced portfolio. However, it is more important than ever to carefully review the partnership agreements. This allows organizations to ascertain if:
  1. They’re current with the latest tax laws,
  2. Their partnership representative is identified and familiar with tax exempt organizations, and
  3. The representative is prepared to make good decisions regarding the partnership interests they are charged with representing.

What Precautions Should Tax Exempt Partners Take?

  • Ensure the partnership agreement is up-to-date with current tax laws (uses the term “partnership representative”);
  • Be sure you have filed a Form W-9 expressing you are a tax-exempt partner;
  • If you are a tax-exempt partner, co-invested with disqualified persons, making sure your partnership representative is aware of this fact to avoid any inadvertent acts of self-dealing;
  • Inform the partnership representative that you do not wish them to pay any taxes on your behalf. The exempt organization is not liable for at the partnership level.

Questions?

Please call us or email us at info@clarknuber.com if you would like to discuss the changes in the partnership audit rules or to review your planning opportunities. 1 In Plumstead Theatre Society, Inc. v. Commissioner, 74 T.C. 1324 (1980), aff'd, 675 F.2d 244 (9th Cir. 1982) © Clark Nuber PS, 2017. All Rights Reserved

Business Transition Due Diligence: Avoid Saying, “It was Like That When I Got Here!”

Buyer Due Diligence

Not surprisingly, “it was like that when I got here” is also sometimes heard in the world of business transition. When a buyer’s due diligence identifies deep, sometimes hidden issues, such as issues that affect employee morale or customer dissatisfaction, the seller may be faced with the unwanted reality of needing to sell their business for less than they hoped. Buy-side due diligence is designed to find problems that sellers may not appreciate as significant, but which buyers can use as negotiation points. Even in situations where business control is being transitioned from one generation to the next, the younger generation may not understand the nuances of key vendor relationships, or how the Company navigates regulatory issues. Owners can unwittingly saddle successors with issues that should have been dealt with earlier.

Using Due Diligence to Expose Hidden Issues

Certainly, it may be possible to overcome these issues, at least partially, with an orderly over-lap in the transition of management. That said, not all sellers want to stay involved after their business is sold. In these instances, the buyer is left with the grim reality of a negative situation where all she can say is, “It was like that when I got here.” While due diligence cannot uncover all issues – positive or negative – buyers want to know that due diligence procedures took place. These procedures should include a comprehensive review of the business’ value drivers. Value Drivers are the operating characteristics that underlie every business and form a crucial part of what gets transitioned from seller to buyer. Buyers can use this information to their advantage in negotiating the terms of the deal, as well as in prioritizing future plans for growth. Learn more about the drivers in the video below: [embed] https://vimeo.com/239726388 [/embed]

How Due Diligence Benefits the Seller

The flip side of this issue, of course, involves the seller. Sellers often have both the best and worst views of their business. Founders, especially, can have difficulty viewing their business objectively. Typically, a founder builds their business with themselves at the helm. While this means that a founder can navigate almost any circumstance, it does not mean their business is well tuned, or that someone could step into their role without missing a beat. To combat the above situation, it’s best to run your business as though it’s always ready to be sold - even if you are not planning to sell it. Here’s an analogy that shows why this is a smart approach: My house is not for sale, but I aspire to keep it in a condition that would provoke a would-be buyer to offer an unsolicited price that I could not refuse. Why not run a business that way? Operating a business that is well-tuned is much like driving a fine car. Or living in a beautifully maintained home. Its condition allows you to know how it will operate and allows you to assure potential buyers of its worth. It makes sense that a seller can become exhausted from years of building a business. They may feel that they do not have the energy to tune up the business before a transition – even though they may be leaving good money on the table. However, those who have the time and the willingness to view their business objectively, and make improvements, can maximize the financial return. They also benefit from walking away from their sale knowing they’ve provided the buyer with a sound purchase.

Due Diligence in Action

I was once accompanying a client on a tour of his new business. On the tour, I noticed that the plant was bustling with activity - employees would smile and say ‘hello’ as we walked by. It was already 15 minutes past quitting time, but the employees were still working. The owner said that the employees wanted to meet the goals for the day and were willing to put in the extra effort to do so. The client was feeling satisfied: the purchase was complete, and the transition had gone smoothly after a good negotiation and thorough due diligence process. I asked the owner what changes he had made since taking over the business. He replied, “Not much, it was like that when I got here.”

Questions?

Questions about due diligence? Contact Ron Rauch at info@clarknuber.com, or read more about due diligence and our Business Value Enhancement tool, CoreValue. © Clark Nuber PS, 2017. All Rights Reserved

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