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Rick

CPA | Shareholder

Rick is an eclectic person, which is possibly the reason he’s a successful part of several different areas in the firm’s tax practice.

This story, brought to us by irs.gov, illustrates a scheme that doesn’t often get a lot of attention, but it can provide fraudsters with an open door. In this case, the method used to cover up the fraud was to record automotive allowance payments to employees who were still listed as active in the accounting system, but who were no longer actually employed by the company. The payments were actually going to the fraudsters, and the amounts piled up after a while. A similar scheme can be used with vendors that are no longer used by a company, or even customers.

Regardless of the frequency of a particular scheme, the common theme in fraud is that a fraudster will identify and exploit a weakness in the internal control system. In this case, that weakness was a “messy house.”

When you are done cooking in the kitchen, you clean up and put the pots and pans away. When you are done playing a board game, you pack it up and put it away. The same habits need to apply here to keep your accounting “house” in order. A good habit to start is a periodic cadence of clean up. Going through the payroll roster, the approved vendor list, and the customer list at least quarterly will help keep things clean and defend against fraud schemes. Other controls, such as reviewing the chart of accounts for new accounts added, can be scheduled at this time as well.

A clean house is a healthy house. Having the discipline to scrub down your systems from time to time will help cut down opportunities for potential fraudsters.

© Clark Nuber PS and Focus on Fraud, 2016. 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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A Rose by Any Other Name: When is a Grant Deductible for Washington B&O Tax Purposes?

For those in the nonprofit community with activities in Washington, it often bears repeating that there is no general nonprofit exemption from the State’s business and occupation (“B&O”) tax. The B&O tax is a tax imposed on gross revenue for the privilege of doing business. The State’s definition of “business” is very broad, such that it is hard to imagine any human endeavor that isn’t captured by the definition. Therefore, it is prudent for a nonprofit organization to consider all amounts it receives as taxable and then look for a specific exemption or deduction that may apply. It may come as a surprise to many that there is no general B&O tax exemption for grants. A deduction is allowed, however, for donations or contributions received. Therefore, to be deductible, a grant must be considered a donation or contribution. According to the Department of Revenue, an amount will qualify as a donation or contribution if it is received with no strings attached. This means that the payment must not be received in exchange for any significant goods, services or benefits. But what does this mean in the context of a grant? The Department recognizes that it is common for a person who is making a contribution to impose restrictions on how funds are used – usually requiring some form of accountability as a condition of their contribution. Guidance from the Department explains that, if the contribution conditions don’t result in a direct benefit to the donor, the contribution will be deductible. Public acknowledgement of a contribution is not considered to confer a significant direct benefit on the donor. The Department will generally presume that a grant is a deductible donation or contribution when three conditions exist. First, as discussed above, the grantor cannot receive significant goods, services or benefits in return for making the grant. Second, the grantee must be a nonprofit or governmental entity. Although this condition is not stated in the deduction statute, the Department is skeptical that anyone would make a grant to a for profit business without expecting something substantial in return. Finally, the grant funds must be used to promote, advance, or fulfill “charitable purposes” (as such term is construed under Internal Revenue Code section 501(c)(3) and relevant treasury regulations), which may include offsetting an organization’s administrative expenses related to its charitable purpose. Grants that involve studies, such as medical or sociological research, are not deductible if the grantor has any rights to the findings or intellectual property resulting from the studies. Published reports that are available to the general public by the grantee organization, and not specifically for the benefit of the grantor, are generally not considered to be a significant good or service unless the findings are only of practical value to the grantor. For example, a study of alternative uses for a patented drug commissioned by the patent holder would be taxable even if the findings of the study were made widely available at no charge to the medical community. In addition to considering whether contribution conditions result in a direct benefit to the grantor, it is important to distinguish between a grant and a contract for services. While the label given to a document is not determinative, because many grant awards have contractual obligations, care should be exercised in evaluating any document bearing the title “agreement” or “contract.” At the very least, these titles can mislead a tax auditor into concluding that the arrangement doesn’t meet the requirements for deductibility. Sub awards can also be problematic because they often call for performing services for the benefit of the primary grant recipient to assist in carrying out its grant objectives. Such an arrangement would likely be treated as taxable fees for services and not a deductible donation or contribution. The bottom line is that a grant that is also a donation or contribution will be deductible. It is not always clear, however, whether a significant good, service or benefit is involved. Given the complexity of making this determination, nonprofit grant recipients are encouraged to contact a tax advisor for assistance in evaluating grants when there is a question about the tax implications. © 2016 Clark Nuber PS All Rights Reserved

Uniform Guidance: The De Minimis Indirect Cost Rate

The lack of indirect cost recovery from Federal grants is nothing new for Not-for Profits (NFPs). This has been especially true for those NFPs who do not have a federally negotiated indirect cost rate, as they receive all, or predominant amounts, of Federal grants from pass-through entities. The Office of Management and Budget’s (OMB) Uniform Guidance now recognizes that NFPs do indeed incur indirect costs and has made available use of the de minimis rate. In accordance with 2 CFR 200.414(f), NFPs who have not received a negotiated indirect cost rate previously can now utilize the de minimis rate. The Calculation The de minimis rate can be charged at 10% of Modified Total Direct Costs (MTDC). MTDC is defined at 2 CFR 200.68 as being: “All direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first $25,000 of each subaward (regardless of the period of performance of the subawards under the award). MTDC excludes equipment, capital expenditures, charges for patient care, rental costs, tuition remission, scholarships and fellowships, participant support costs and the portion of each subaward in excess of $25,000.” The first $25,000 of subawards can be taken when each subaward is initially issued, separately negotiated, or renegotiated over the Federal grant’s period of performance (i.e. not $25,000 for each entity’s fiscal year). Some NFPs have found it helpful to have two separate subaward general ledger accounts: one account that tracks the first $25,000 of subawards and another account that records costs in excess of the first $25,000. The NFP will want to ensure that direct costs of the Federal grant do not already include recovery of indirect costs (double charging) when using the de minimis rate. This type of issue is most prevalent when the NFP’s Federal grant supports a large majority, if not all, of the activities of the NFP. It could also occur, however, if the NFP has historically recovered indirect costs from Federal grants by means of direct allocations. The NFP must also be consistent in how direct and indirect costs are charged to Federal grants. Internal Controls Should the NFP enter into Federal grants that allow for use of the de minimis rate, it is important that the NFP establish a system of internal controls over the calculation of the de minimis rate. It is also important that the NFP monitor the calculation when invoicing the grant. Miscalculation will most often occur when those costs identified in the above definition (rental costs, subawards, etc.) are not properly deducted from total direct costs for purposes of calculating the de minimis recovery. NFPs may be able to automate calculation of the de minimis recovery in their accounting systems to reduce the risk of error. Alternatively, the NFP could develop a form to document the calculation of the de minimis recovery. This form would ensure that the grant billing preparer takes all deductions that arrive at the MTDC into consideration. It would also allow for easy review of the de minimis calculation prior to grant billing submission. Auditing the De Minimis Recovery It is not surprising that indirect costs recovered from a Federal grant would be subject to audit as part of the Single Audit (if required). The OMB has outlined the following suggested audit procedures, as noted in OMB’s 2015 Compliance Supplement, be performed over the de minimis recovery:
  1. Determine that the non-Federal entity has not previously claimed indirect costs on the basis of a negotiated rate. Auditors are required to test only for the three fiscal years immediately prior to the current audit period.
  2. Test a sample of transactions for conformance with 2 CFR section 200.414(f).
    1. Select a sample of claims for reimbursement of indirect costs. Verify that the de minimis rate was used consistently, the rate was applied to the appropriate base, and the amounts claimed were the product of applying the rate to a modified total direct costs base.
    2. Verify that the costs included in the base are consistent with the costs that were included in the base year, i.e., verify that current year modified total direct costs do not include costs items that were treated as indirect costs in the base year.
  3. For a non-Federal entity conducting a single function, which is predominately funded by Federal awards, determine whether use of the de minimis indirect cost rate resulted in the non-Federal entity double-charging or inconsistently charging costs as both direct and indirect.
Auditors will be performing these audit procedures, or a version of these procedures, so be prepared. A miscalculation could easily result in an over recovery of indirect costs and questioned costs being reported as a Single Audit finding. Other Options for Indirect Recovery The de minimis rate is just one of several options for recovering indirect costs. In addition to the de minimis option, NFPs may negotiate a Federal indirect cost rate or negotiate an indirect cost rate with the pass-through entity in accordance with Appendix IV to Part 200. For a NFP to negotiate a Federal indirect cost rate, it typically takes a direct relationship (direct award) with a Federal awarding agency and where that Federal awarding agency believes it to be worthwhile to negotiate a rate. Often times, a NFP has a federally negotiated indirect cost rate because it was required by a Federal funding agency, either currently or in the past. Pass-through entities have the option of negotiating indirect cost rates greater than the de minimis rate with subrecipients, but are not required to do so. However, pass-through entities are not allowed to force or bribe a subrecipient into accepting an indirect cost recovery below the de minimis rate unless it is limited by the Federal program’s statute. A Step Forward The de minimis rate can be a good start for NFPs to get paid for at least a portion of indirect costs incurred on Federal grants. In cases of limited Federal funding, NFPs may want to evaluate what is easier to fundraise and find other sources for – a shortfall in direct costs, or a shortfall in the recovery of indirect costs. The de minimis rate is a bright spot within the Uniform Guidance and deserves careful consideration by NFPs, though appropriate internal controls must be in place when the de minimis rate is being used. © 2016 Clark Nuber PS All Rights Reserved

Self-declared 501(c)(4) Organizations Must Provide Notice to IRS – PATH Part II

The Protecting Americans from Tax Hikes Act of 2015 (PATH) was signed into law December 18th and includes many provisions affecting charities. Last month, we focused on the permanent extensions in the bill. This month, we focus on the new notice requirements for self-declared 501(c)(4) social welfare organizations in Code Section 506, added by PATH. This legislation requires Section 501(c)(4) organizations, established after December 18, 2015, to notify the IRS of its formation and intent to operate as a 501(c)(4) social welfare organization. The notice and user fee must be submitted within 60 days of the organization’s formation and must include:
  1. Name, address, and taxpayer identification number of the organization;
  2. Date and State of formation; and
  3. Statement of the purpose of the organization.
The IRS may extend the 60-day deadline for reasonable cause. The IRS has not yet released the notice form but is expected to do so soon. Organizations already in existence on the effective date of PATH (December 18) that have not yet filed an application for exemption (Form 1024) or an annual Form 990 (or 990-EZ or 990-N) must provide the required notification to the IRS by June 15, 2016, 180 days from the effective date. To provide 501(c)(4) organizations with adequate time to comply with the new procedures, the IRS, in Notice 2016-9, provides a blanket extension for the 501(c)(4) notice requirement until further guidance is provided in temporary regulations. The due date for the notification will be at least 60 days from the date the temporary regulations are issued. Presumably, the regulations should extend the 60 days to 180 days for already existing organizations, but that was not mentioned in Notice 2016-9. Within 60 days of receipt of the organization’s registration notice, the IRS must send the organization an acknowledgment of receipt. This acknowledgement is not a determination that the organization qualifies for exempt status under Code Section 501(c)(4). However, the organization’s notification and receipt of the IRS’s acknowledgement have the same public inspection and disclosure requirements as Form 1024. An organization that fails to file a notice by the deadline is subject to a penalty equal to $20 per day, up to a maximum of $5,000. In addition, PATH requires certain specific information to be included in the organization’s first annual Form 990 (or Form 990-EZ, or Form 990-N), demonstrating that the organization qualifies for 501(c)(4) status. The specific information required is still unclear, but will be set forth in future treasury regulations. If an organization wants more certainty regarding its qualification under section 501(c)(4), it may voluntarily file a full Form 1024 with the IRS. This is in addition to, not in lieu of, filing the required notice discussed above. There has been speculation that the IRS may issue a new exemption application form specifically for 501(c)(4) organizations, however, nothing has been announced yet. Until the new form is released, organizations should continue using the existing Form 1024 if an IRS determination of exempt status is desired. If your organization is a social welfare organization exempt under Code Section 501(c)(4), please consult your tax advisor for more information. For questions, contact Karen Dunn at Clark Nuber, 425-454-4919.

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