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This article was originally posted on 8/19/2020. It has been updated to reflect news and updates as of 6/21/2022. 

6/21/2022 Update: The Washington State Court of Appeals, Division 1, ruled in Greater Seattle Chamber of Commerce v. City of Seattle that the Seattle payroll expense tax is a lawful excise tax on businesses imposed under powers vested in the City by the state legislature and the state constitution. It did not accept the Seattle Chamber of Commerce’s argument that the tax is an unlawful levy on an employee’s right to earn a living by working for wages. In so ruling, the Washington Court of Appeals affirmed the decision reached by King County Superior Court in 2021.

6/24/2021 update: The Seattle City Council have made changes to the existing law. Read about the new “hours method” here

On July 6, 2020, the Seattle City Council passed City Ordinance Number 126108, imposing a payroll expense tax on persons engaging in business in Seattle. The ordinance takes effect at the start of 2021 and sunsets at the end of 2040. The tax will be imposed on businesses and organizations with at least $7 million of Seattle annual “payroll expense.”

Filing Frequency

The 2021 payroll expense tax annual return and payment will be due January 31, 2022. After 2021, the payroll expense tax will be due and payable on a quarterly basis, but businesses may be assigned as annual filers at the city’s discretion. We expect the city to announce a specific threshold for annual filing.

Tax Imposed

The payroll expense tax applies to the compensation of each Seattle employee that equals or exceeds $150,000. The definition of “employee” includes individuals who are treated as independent contractors for purposes of Seattle business license tax. Compensation paid in Seattle to an independent contractor whose compensation is included in another business’ payroll expense are exempt from the payroll expense tax. The tax rate ranges between .7% and 2.4% and is based on both the annual compensation paid to each employee and the total Seattle payroll expense of the business. The table below shows the applicable tax rates.

As shown in the table above, for businesses with annual Seattle payroll expense greater than $7 million, either a .7% or 1.4% tax rate will apply on the payroll expense of Seattle employees with annual compensation greater than $150,000 but less than $400,000. A tax rate of 1.7%, 1.9%, or 2.4% will apply on the payroll expense of Seattle employees with annual compensation of $400,000 or more.

Payroll Expense Definition

The term “payroll expense” means compensation paid to a Seattle employee. Compensation is defined as remuneration (including commissions and bonuses), net distributions, or incentive payments, including guaranteed payments, whether based on profit or otherwise, earned for services rendered or work performed, whether paid directly or through an agent, and whether in cash or in property or the right to receive property.

Compensation does not include payments to an owner of a pass-through entity that are not earned for services rendered or work performed, such as return of capital, investment income, or other income from passive activities.

Compensation is paid to a Seattle employee if:

  • The employee is primarily assigned within Seattle;
  • The employee is not primarily assigned to any place of business for the tax period and the employee performs 50% or more of his or her service for the tax period in Seattle; or
  • The employee is not primarily assigned to any place of business for the tax period, the employee does not perform 50% or more of his or her service in any city, and the employee resides in Seattle.

The ordinance defines “primarily assigned” as “the business location of the taxpayer where the employee performs his or her duties.” However, there may be significant complexities and material tax consequences for businesses with employees working in multiple jurisdictions, as the definition above highlights. (See our article on the tax implications of working remotely.)

Exemptions

The following are excluded or exempted from the Seattle payroll expense tax:

  • Businesses with annual Seattle payroll expense less than $7 million;
  • Grocery businesses;
  • Businesses that are preempted from taxation by cities pursuant to federal or state statutes or regulations, such as insurance agents, motor vehicle fuel manufacturers and sellers, liquor distributors and sellers, federal and state government agencies, and local governmental entities;
  • For the period of January 1, 2019 through December 31, 2023, non-profit healthcare entities are exempted from the tax on the payroll expense of employees with annual compensation below $400,000. (Read more about the non-profit healthcare entity exemption here.)

Comparison to Repealed Seattle Employee Hours Tax

In 2018, the Seattle City Council passed a similar tax, known as the employee hours tax or “head tax,” that imposed a tax on businesses with Seattle gross taxable income in excess of $20 million per year. For taxpayers above the minimum threshold, the employee hours tax was to have been imposed on all employee hours worked within the City (or all Seattle full-time equivalent employees) at a full-time equivalent rate of $275 per employee per year. The tax was retroactively repealed less than a month after it was enacted due to the significant amount of opposition it received from Seattle businesses and citizens.

Seattle Mayor Jenny Durkan did not veto the ordinance imposing the new payroll expense tax, but chose not to sign the legislation. The mayor expressed concerns about the impacts of the tax on Seattle’s economy and growth in a letter to the City Council. The Seattle City Council’s 7-2 vote in favor of the Seattle payroll expense tax indicates that the City Council could have overridden a veto from Mayor Durkan.

Legal Challenge

In December, the Seattle Chamber of Commerce filed a lawsuit challenging the constitutionality of the payroll expense tax. The lawsuit alleges that the Seattle City Council imposed the payroll expense tax on “the right to earn a living” as opposed to a permissible excise tax on “the privilege of doing business.” Under state law, a city excise tax must be imposed on a “substantive privilege granted or permitted” by the city. Because the Seattle business license tax is already imposed on the privilege of engaging in business, the Chamber argues that no additional privilege of doing business is available upon which to impose the payroll expense tax. The Chamber cites as precedent Cary v. City of Bellingham, in which the state Supreme Court ruled that a city cannot tax the ability to earn a living.

Conclusion

It’s important that Seattle employers understand the impact the Seattle payroll expense tax will have on their businesses prior to when it takes effect in 2021. If you have any questions about the Seattle payroll expense tax and how it will affect your business, please contact any member of the Clark Nuber State and Local Tax group.

Yoandra Cortez is a senior in Clark Nuber’s State and Local Tax Services Group.

© Clark Nuber PS and Developing News, 2020. 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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Common Concerns and Solutions for Grantmaking Foundations

Foundations have experienced exponential growth in their philanthropy efforts and grant sophistication over the last 10 years. And while this expansion is exciting, many are discovering it comes with growing pains. Having worked closely with dozens of grantmaking foundations through this process, we’ve found the three most common concerns are now related to their grant compliance process, accounting software functionality, and cybersecurity practices.

Grant Compliance Process

Socially-minded foundations are increasingly looking to make an impact in more creative ways, leading to more sophisticated methods of funding and grantmaking. In the last several years, we’ve seen an evolution in philanthropy as organizations pivot to more program-related investments and grants to for-profits, individuals, and nonpublic charities. This new approach has created many exciting opportunities for foundations, but the disruption comes with the danger of falling out of compliance while distributing grants. Third-party firms such as Clark Nuber are increasingly relied upon to provide insight and best practices for grant compliance in complex situations. Reviews like these are especially important if foundations are making charitable gifts to non-501(c)(3) public charities or program-related investments. Established foundations, and organizations embarking on the next phase of their philanthropy journey, should be aware of common pitfalls and check that their compliance process is in proper shape and protected from scrutiny by the IRS, state officials, or media.

Accounting/Enterprise Resource Planning (ERP) Software

As foundations have grown in complexity, many have discovered their staff are spending extra time working in Excel spreadsheets and manually entering the same data into multiple systems rather than in a dedicated accounting/ERP system. This duplication of effort results in inefficient practices, inconsistent financial reports, and no time for analysis. To speed up their processes, foundations we’ve worked with have begun transitioning away from manually entering data into their accounting system and toward automation. One common solution for foundations is determining gaps in their existing accounting or ERP system and replacing it with a modern cloud-based solution. These systems offer built-in workflows, integrate with other third-party applications, and provide friendlier user interfaces. These features can be customized to meet the unique needs of each organization to fit the processes and workflow of their accounting departments. As with their grant compliance solutions, a large number of foundations are reaching out to CPA firms, software vendors, and consultants to evaluate their existing technology and determine if now is the time to change software providers. Certified ERP partners can work with your foundation to find the gaps in your existing software and select the software best equipped to fill them for the entire organization.

Cybersecurity

Cybersecurity remains a top risk identified for foundations of all shapes and sizes. Recent high-profile breaches around the world have organizations wondering if they are not only protecting their own data within their various systems, but also the data of their grantees. Unfortunately, it can be difficult for organizations to know where to begin when building up their cyber defenses. Different security goals will require different solutions, and, as with all risks, cybersecurity should be optimized to ensure the benefits outweigh the costs. As a solution, foundations can consult with IT professionals to discuss their current cybersecurity state, recurring pain points, and build a roadmap to a more secure future state. Some firms also offer staff training on common threats and penetration testing, a practice where a benevolent hacker attempts to access a client’s system to discover where the weaknesses lie.

Next Steps

The past ten years have seen foundations evolve in impressive ways to meet local, national, and global needs. Now is the time to examine those creative solutions, invest in the processes you created, and become a more resilient and influential organization. To meet the needs of the grantmaking foundation community, Clark Nuber now offers a three-in-one service bundle to assess the strengths of an organization across the areas discussed above. Our high-level assessment is designed to give foundations peace of mind over their grantmaking compliance, the efficiency of their accounting software, and the state of their cybersecurity. If you’d like to learn more about how this service can help strengthen your organization and its mission, visit our bundled assessment page. © Clark Nuber PS, 2022. All Rights Reserved.

Schedule of Expenditures of Federal Awards (SEFA): What is the SEFA and What Federal Expenditures Are Included?

This article has been updated since its original publication to reflect 2022 SEFA standards.  With the influx of federal grant programs in the last few years, many organizations are, for the first time, determining whether or not they are subject to the Single Audit. The first step in doing so is preparing a Schedule of Expenditures of Federal Awards (SEFA). So, what is the SEFA? And what is the basis for determining which federal expenditures are included in the Single Audit threshold determination?

What is the SEFA?

The SEFA is a supplemental schedule to the audited financial statements that determines the applicability and scope of the Single Audit. The Single Audit requirement is triggered when the federal expenditures reported on the SEFA exceed $750,000 or more over the organization’s fiscal year. Getting the SEFA right is required to determine when a Single Audit is required and, if required, the proper scope of the Single Audit. The SEFA is required to be completed in accordance with the Uniform Guidance (2.CFR.200.502). The federal expenditures that are included on the SEFA are to be based on determining when a federal award is considered “expended.” Unfortunately, the name federal expenditures on the schedule can be misleading. It seems to imply that the schedule only includes the value of costs the organization incurred that were paid for with federal funding. However, in reality, it is much more involved than that.

Defining Expenditures

The following is a listing of different types of federal awards and how Uniform Guidance defines them as being expended:

Grants, Cost-based Contracts under Federal Acquisition Regulations (FAR), Cooperative Agreements, and Direct Appropriations

Federal funds received as a recipient or subrecipient are determined to be expended when the activity related to the federal award occurs. The SEFA can be presented on the accrual or cash basis of accounting. In addition to federally funded awards, cost-reimbursement federal contracts under the Federal Acquisition Regulation (FAR) are included. However, the Uniform Guidance explicitly excludes from the SEFA firm, fixed-price contracts under the Federal Acquisition Regulation (FAR) as noted in the table at 2 CFR Part 200.101. Another type of award defined in the Uniform Guidance is a Fixed Amount Award. The Fixed Amount Award, as defined at 2 CFR Part 200.201, is a type of grant or cooperative agreement under which the federal awarding agency or pass-through entity provides a specific level of support without regard to actual costs incurred under the federal award. The Uniform Guidance at 2.CFR.200.102(c) states that a federal awarding agency may apply less restrictive requirements when making fixed amount awards, except for those requirements imposed by statute or in Subpart F of Uniform Guidance (Single Audit). As such, organizations should review any fixed cost awards carefully for possible inclusion on the SEFA.

Disbursement of Funds to Subrecipients

If an organization uses their federal funding to further pass down to another organization through a subrecipient relationship, the federal funds are determined to be expended when the organization becomes obligated to the subrecipient for payment. Generally, that is when the disbursement is made to the subrecipient.

Loans and Loan Guarantees

The basis for including loans and loan guarantees is defined at 2 CFR Part 200.502 as:
  • Value of new loans made or received during the audit period; plus
  • Beginning of the audit period balance of loans from previous years for which the federal government imposes continuing compliance requirements; plus
  • Any interest subsidy, cash, or administrative cost allowance received.
As noted, if there are continuing compliance requirements, such as specific use of a facility that was purchased using a federal loan, the loan will remain on the organization’s SEFA until the continuing compliance requirement period ends. The notes to the SEFA are where the outstanding principal balance of the federal loans and loan guarantees would be disclosed.

Donated Personal Protective Equipment (PPE)

Organizations that received donated PPE should provide the fair market value of the PPE at the time of receipt as a stand-alone footnote accompanying their SEFA. The amount of donated PPE should not be counted for purposes of determining the threshold for a Single Audit.

Receipt of Property

This would relate to donated property and must be valued in the SEFA at fair market value at the time of receipt or the assessed value provided by the federal agency.

Receipt or Use of Program Income

This would be reported when the program income is received from the federal source or used by the organization.

Distribution or Use of Food Commodities

The basis for determining when this federal funding is expended is based on when the food commodities are used or distributed.

Medicare and Medicaid

Medicare or Medicaid payments received for providing patient care services are not considered federal awards expended (i.e. not included in the SEFA). However, there may be an exception to this if the organization’s state requires the Medicaid payments to be considered federally funded due to their own regulations on treatment of those types of payments on a cost-reimbursement basis.

Endowment Funds

Endowment funds that are federally funded are reported on the SEFA at the cumulative year-end balance as long as the restriction applies.

Insurance, Surplus Property, Interest Subsidies

Federal awards can come in other forms of federal assistance as identified at 2 CFR Part 200.502.

For-Profit Companies and the SEFA

With the significant output of relief programs during the COVID-19 pandemic, there were a number of for-profit or commercial companies that received federal funding. Because of this, many for-profit companies began questioning whether they were subject to uniform guidance and the Single Audit under Subpart F. And, by relation, if they needed to create a SEFA. In general, Subpart F of the Uniform Guidance does not apply to for-profit companies. However, certain federal agencies, such as the Department of Health and Human Services and the Department of Energy, incorporated commercial audit requirements into their implementation of the Uniform Guidance. In addition, specific federal programs, for example the Shuttered Venue Operators Program, may impose an audit requirement for commercial recipients. As a result of these complexities, if a for-profit company receives federal funding, they should check with the funder, their CPAs, and others that are knowledgeable about Uniform Guidance to understand if they are subject to the Single Audit requirement and need to produce a SEFA or equivalent.

Presentation of the SEFA

In addition to determining the amount of federal expenditures, the Uniform Guidance also has specific requirements as to how these amounts are to be reported in the SEFA. Under Uniform Guidance, the organization is required to list individual federal programs by federal agency, including grouping a cluster of programs together. The organization is also required to note the name of the pass-through entity and any identifying number if the organization received federal funds that are passed through another entity. Conversely, if the organization passes through any of the federal funds to other entities, they are also required present the total amounts passed through to subrecipients for each federal program on the face of the SEFA. The totals on the SEFA are required for each federal program and Assistance Listing (AL) number (formerly the Catalog of Domestic Assistance, CFDA). If the AL number is not available, organizations may use another identifying number. Totals are also required for each cluster reported on the SEFA.

Required SEFA Footnotes

Lastly, the SEFA also requires specific footnotes. As discussed previously, the organization must disclose the outstanding balance of any loan and loan guarantees reported on the SEFA as of the end of the audit period. Additionally, organizations are required to disclose whether or not they utilized the de minimis indirect recovery during the year. A SEFA Disclosure Checklist published by the AICPA’s Government Audit Quality Center is helpful in applying the SEFA disclosure requirements.

SEFA Internal Controls

An important element to the accuracy of the SEFA is having appropriate internal controls over its preparation. This includes proper grant intake (i.e. federal grant and contract identification), reconciliation to related financial statement amounts, and internal review and approval. Organizations entering into federal grants and contracts must understand their responsibility for complying with the Single Audit requirements of the Uniform Guidance. Key to this is understanding the SEFA requirements and having appropriate controls in place to ensure its completeness and accuracy. For further information on SEFA preparation, contact Clark Nuber, your CPA, or review 2 CFR Part 200 Subpart F. © Clark Nuber PS, 2022. All Rights Reserved.

Fiscal Sponsorships: What They Are and How to Use Them

As a new nonprofit, you may be considering fiscal sponsorship as an option to get you up and running. Or perhaps you have a temporary project with a nonprofit mission needing support for a specified time. While a fiscal sponsorship arrangement has its benefits, there are certain considerations to keep in mind before committing to it. The following article will help you understand both the benefits and the drawbacks of a fiscal sponsorship so your organization or project can be best prepared.

What is a Fiscal Sponsorship?

A fiscal sponsor is a nonprofit with 501(c)(3) exempt status that provides fiduciary oversight, financial management, and administrative services to support new, temporary, or small charitable initiatives or projects. One common example is seen when a nonprofit moves its project into a fiscal sponsorship arrangement. Fiscal sponsorships are an alternative to forming a stand-alone nonprofit. And they provide an opportunity for the charitable project to pass its costs through to the fiscal sponsor, while also receiving grants and charitable contributions. The criteria for a fiscal sponsorship arrangement includes:
  • The fiscal sponsor must ensure that creating a fiscal sponsorship arrangement is consistent with its own tax-exempt mission.
  • The fiscal sponsor will manage the donated funds as, per the IRS, it must maintain complete discretion and control so that it ensures the funds are used for the purpose of the fiscal sponsor’s tax-exempt mission.
  • The fiscal sponsor must have financial control and oversight, including review of financial statements on a recurring basis.
  • A written fiscal sponsorship agreement is required and should detail the key areas mentioned above.

The Models of Fiscal Sponsorship

There are several models of fiscal sponsorship that can be considered when developing a fiscal sponsorship arrangement. Two of the most common models are the Comprehensive model, where assets, liabilities and exempt activities stay inside the fiscal sponsor, and the Pre-Approved Grant Relationship model, where the project is funded by the fiscal sponsor, but the project is run as a separate entity. Additionally, the book Fiscal Sponsorship: 6 Ways to Do It Right lays out six specific models that can be used in arranging a fiscal sponsorship agreement.

Why Use a Fiscal Sponsorship?

For organizations seeking sponsorship, the most important benefit is the ability to solicit and receive tax-exempt contributions and grants without the costs and administrative responsibilities of starting a tax-exempt organization. Starting a new nonprofit can be slow and requires a deep understanding of the IRS rules. A fiscal sponsorship arrangement is typically quick to start, gives the new project time to build infrastructure, and gives a temporary project the support it needs while in existence. It also leverages the nonprofit experience of the sponsor to help with the set-up and maintenance of the project.

This Sounds Amazing, but What Are the Drawbacks?

There are a few things to keep in mind when seeking sponsorship:
  • Often, the control will remain with the sponsor, likely resulting in an oversight of its finances and activities. Maintaining accurate reports and financials will aid in providing the sponsor the necessary information to feel that activities are conducted in purposes of the mission and funds are being spent appropriately.
  • An administrative fee may be charged by the sponsor, reducing the funds available to use toward the project.
  • It can be more difficult to find a sponsor than to apply for tax-exempt status.

Key Takeaways

When choosing whether or not to use a fiscal sponsor, you should consider the timing of your project, the support that you will need, the expertise that you have in the nonprofit sector, and the ability to fundraise to obtain the contributions necessary to fund your project. Depending on these elements, a fiscal sponsor may or may not be in your best interest. As a best practice, you should consult legal counsel and your tax adviser when starting down the path of obtaining a fiscal sponsor. Reach out to a Clark Nuber representative if you have any questions. © Clark Nuber PS, 2022. All Rights Reserved.

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