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In recognition of October being Cyber Security Month, this blog post will cover IT risk management practices relating to data protection.

The saying goes that “cash is king” and when it comes to risk management and fraud, it often is. A fundamental risk management technique is to prioritize the protection of assets that either are cash or can easily be converted to cash. As a result, inventory or equipment with “street value” are frequent targets for theft because they have a readily available market. And, while many of the things found on a balance sheet do need to be safeguarded, some of the company’s most valuable assets won’t show up on the balance sheet. Your company’s data can be one of the richest targets for cyber criminals.

In the age of speed and convenience, data can be easily converted to cash. Consequently, risk managers need a bigger dashboard to stay ahead of the thieves.

The Importance of Data Security

Data held by a company is a relatively new risk of theft, and it needs to be managed. Reports of data theft are splashed across the newsfeeds on nearly a daily basis, and it is certainly on the minds of executives and board members. Protiviti in their 2018 Executive Perspectives on Top Risks survey noted that 2 of the top 10 risks being discussed by C-Suite executives and board members are related to IT threats: unpreparedness for cyber threats (ranked number 3) and  the amount of resources needed to adequately provide for security and privacy of data (ranked number 7).

Basic Principles of Data Security

Virtual assets need the same rigorous protection as physical assets; thankfully, many of the same tenets apply. Picture a vault that contains anything and everything a thief might want to get their hands on, physical or virtual. Someone responsible for the safe custody of those assets would certainly be considering the following, regardless of the form of the asset:

  • Location – Knowing the location of physical assets has long been a basic principle in risk management. Are those assets in the vault or not? What needs to be in the vault? Understanding the location of assets and the relative level of security of each location is critical to managing risk. With the advancement of technology solutions, RFID tagging for equipment and furniture has specifically become a much more prominent tool for understanding the location of physical assets. Do you have as strong of an understanding on the location of your virtual assets as you do your physical ones?
  • Security – How strong is that vault? What additional layers of security do you have around the physical structure? Do you have a human guard? Do you have monitored cameras? What is necessary based on the contents of the vault and the relative risks? The same questions need to be answered for virtual assets.
  • Access – Who has access to the vault and its contents? How do they get access? Do we need two-factor authentication? Are we tracking what comes and goes from the vault? Now, this last question can certainly be challenging. With physical goods you would likely notice if something was missing from the vault, data not so much. Not only that, virtual assets are much easier to copy than are physical assets. Nevertheless, these measures are just as important with virtual asset risk management and need to be monitored.

Answering these questions and implementing solutions is complex and will require the expertise of skilled IT security professionals. However, whenever tackling a new and/or challenging problem, it is always made simpler when you can visualize the solution in your mind’s eye as a first step.

If you have questions about protecting your data, please contact me or any of our IT Services team members.

© Clark Nuber PS and Focus on Fraud, 2018. 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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The IRS Draft Form 990-T Gives UBI Clues

  • The creation of UBI from the provision of non-taxable qualified transportation benefits to employees; and
  • The segregation of separate trade or business activities with losses when there is more than one trade or business activity.
Treasury may provide guidance through this mechanism because the Internal Revenue Code gives the Form 990 and its instructions authority similar to that of Treasury regulations — without the requirement to go through a change process necessary to issue new regulations. At this point, only the form is out with no accompanying instructions. Therefore, the following are high level observations based upon only the new form and its changes from the 2017 Form 990-T:
  • The header has changed so an organization now indicates on line H how many separate trades or businesses it has. The organization will also provide a NAICS code for its “primary” unrelated activity with a description of the primary activity. How the primary activity is measured is not yet known. Is it the largest by gross or net revenue? Perhaps the most significant by some other measure? Can the organization choose?
  • It is clear there will be a new Schedule M required for organizations that have more than one unrelated trade or business. However, no form or instructions have been released yet. It is likely this Schedule will report each separate trade or business and all direct expenses and allow for the carryforward of any losses not allowed to offset income from other segregated trade or business activities under 512(a)(6).
  • Finally, we know taxable fringe benefits are added at the bottom on line 34, after other ordinary and necessary business expenses have been deducted, such as tax preparation fees, legal fees, and the charitable contribution deduction. It is after current and subsequent net operating losses generated in current and subsequent tax. However, in 2017 the amount is reported above expenses and prior net operating loss carryforward.
This is all we have for guidance so far from Treasury. We do not have additional guidance on how to calculate the “cost” of providing parking benefits. However, we do now know Treasury does not plan to allow ordinary and necessary business expenses or charitable contribution deductions to reduce the unrelated business income created by the new tax law. If you have questions, please contact your tax advisor or the tax professionals at Clark Nuber. © Clark Nuber PS, 2018. All Rights Reserved

Washington State and Local Tax Compliance for Short-Term Vacation Rental Businesses

But first, let’s define a short-term rental business. For both tax and regulatory purposes in Washington, short-term rental business is typically defined as lodging provided by an owner or operator for less than 30 consecutive days in a dwelling or residential unit for a fee. The term therefore does not include hotel or motel lodging, residential rentals for 30 or more consecutive days, or residences operated by a charitable organization for specifically excluded purposes. “Short-term rentals” generally include short-term house, condo unit or apartment rentals, or renting a room in a house, condo unit or apartment.  If a property owner does any of the following, it is presumed to be conducting a “business” that may be subject to state and local taxes:
  1. Advertising a property for overnight accommodations on an online platform (for example, Airbnb and VRBO);
  2. Hiring a property manager to manage a property rental; or
  3. Selling three or more short-term rentals in one year.

Washington Business License

The State of Washington requires most businesses to obtain a state business license and to register with the Washington Department of Revenue, including businesses that will gross over $12,000 per year and those that will make any retail sales subject to sales tax.  Since short-term rentals are treated as retail sales (discussed below), any owner or operator of a short-term rental should obtain a state business license. State business license applications may be completed by filling out a paper form and submitting it by mail, or by completing an electronic application.  The paper form and electronic application are available through the Washington Business Licensing Service’s website. There is a one-time $19 application fee.  After registering, businesses are issued a unified business identifier (UBI) number that is used to identify taxpayer accounts with the Washington Department of Revenue.

Washington State Taxes and Tax Returns

Washington excise tax returns are filed monthly, quarterly or annually, depending on the frequency assigned by the Washington Department of Revenue.  One excise tax return form is used to report state business and occupation (B&O) taxes and most taxes collected from customers, including state and local sales taxes, local lodging taxes, and convention center taxes.  Monthly and quarterly filers are required to file electronically using the Department of Revenue’s online filing system. Washington imposes B&O tax on gross business income, including income from short-term rentals located within the state.  The state B&O tax has numerous classifications, each of which may have a different rate.  Gross revenue from short-term rentals is reported under the retailing B&O tax classification, which is imposed at a rate of .471%.  Importantly, a short-term rental business with less than $90,000 in annual gross income will likely owe no state B&O tax because a small business credit applies to reduce the B&O tax liability to $0. Short-term rentals are subject to state and local sales tax that is generally collected from customers.  The state sales tax rate is 6.5% and local sales tax rates differ by city, ranging from 1% to 3.9%.  Both the state and local portions of the tax are reported on the Washington excise tax return and remitted to the Department of Revenue. In addition to sales taxes, many localities in Washington impose hotel/motel taxes and convention center taxes that are also reported on the state excise tax return.  The tax rates and fees differ by locality.  The Department of Revenue publishes the local rates in a quarterly publication. Beginning January 1, 2019, short-term rental businesses located in Seattle must begin collecting a 7% convention center tax. Short-term rental businesses that advertise rentals on online platforms (for example, Airbnb, VRBO and HomeAway) should confirm whether the platform(s) they use collect and remit taxes on behalf of hosts.  It appears that most major online platforms currently collect Washington sales and lodging taxes on rentals booked through their respective platforms. B&O taxes are imposed directly on the property owner/operator and are not reported by the online platforms; therefore, short-term rental businesses should still file state excise tax returns.  The returns will report gross amounts for B&O tax as well as sales tax, hotel/motel and convention center tax, but if all rentals are made through a platform that reports the latter taxes directly, the owner/operator would deduct the full amount of such receipts so that they are not taxed more than once.

Local Tax Registrations

Many Washington cities and towns require short-term rental businesses to obtain a general business license, which is different from the regulatory permit or operator’s license that may be required. For example, the City of Seattle requires businesses operating in city limits to obtain a business license tax certificate from the city. Business license tax certificates must be renewed annually. Seattle’s renewal fees are determined according to the gross income of the business during the last complete calendar year.  Fees for 2019 business license tax certificates range between $55 and $2,400, with the minimum $55 fee charged if a business had less than $20,000 in annual gross income, increasing to $110 if the business had between $20,000 and $500,000 of gross income. Other Washington cities, like Bellevue, charge only a one-time registration fee ($90 in 2018), and the registration is valid for the life of the business (i.e., no renewal fees).

City B&O Taxes

More than 40 Washington cities and towns impose a local B&O tax, including most of the more populated cities like Seattle, Bellevue, Tacoma, Renton, Everett and Issaquah. The list of all Washington cities that impose a B&O tax is available here. Many cities have a minimum annual gross income threshold that must be reached before city B&O tax is due, and the thresholds vary by city.  For example, the threshold in Seattle is $100,000, Bellevue’s minimum threshold is $160,000, Everett’s is $20,000 and Tacoma’s is $250,000. Unless a city has expressly granted a taxpayer permission to not file a B&O tax return, short-term rental businesses should file returns with the city where the rental property is located, even when no city B&O tax is due. City B&O tax returns are typically due on a quarterly or annual basis, and they are filed directly with the applicable city. Some cities that impose a B&O tax allow taxpayers to file returns electronically.

Other City Fees

Many city governments have passed non-tax ordinances to restrict or regulate short-term rental activities within city boundaries. Furthermore, conversations amongst city officials, property owners and other stakeholders regarding short-term rental properties continue to occur, as increasing short-term rental activities create new dynamics in local housing markets. Notably, Seattle enacted regulations governing short-term rental businesses. Beginning January 1, 2019, short-term rental businesses located in Seattle must obtain an operator’s license from the city.  The annual fee for an operator’s license is $75. Seattle also passed an ordinance that would have imposed a per-night fee on short-term rentals within the City beginning on January 1, 2019; however, the short-term rental tax ordinance was repealed in June 2018.  As of the publication date of this article, we are not aware of any other Washington localities enacting a short-term rental tax.

What if your business has been offering short-term rentals in Washington without a state or local tax registration?

If your short-term rental business has not been complying with Washington and/or local tax requirements, we recommend that you discuss the issue with a state and local tax professional.  The Washington Department of Revenue and many of the B&O tax cities offer voluntary disclosure programs that may allow the business to avoid otherwise applicable penalties if it agreed to pay any taxes that would have been due for the prior four years and to remain in compliance going forward.

Questions?

Contact your Clark Nuber tax professional or our SALT team members if you have any questions on how state and local taxes may impact your short-term rental properties.   Jennifer Hill Clark Nuber Co-author Jennifar Hill is a manager in Clark Nuber's state and local tax practice team. © Clark Nuber PS, 2018. All Rights Reserved

Franchisors Seeing a Big Change in Revenue Recognition

The guidance under ASC 606 is effective for public entities with annual reporting periods beginning after December 15, 2017. For non-public entities, it is effective one year later, for years beginning after December 15, 2018.

Background of Franchise Agreements

Franchise agreements include a laundry list of deliverables that are provided to franchisees.  Those deliverables can include functions at the start of the contract, such as lease negotiations, assistance with location selection, hiring, training staff, and tenant improvements. The agreement typically includes the ability to use the brand name, ongoing advertising, menu support, as well as purchasing of goods. The franchisee normally pays an upfront fee as well as royalties over the franchise agreement based on a percentage of sales. Historically, the recognition of revenues was simple – upon completing the deliverables to start the contract (which usually coincides with the restaurant/hotel opening), the initial franchise fee was recognized as revenue. The royalty was recognized when sales took place.

What Will Change Under ASC 606?

Under ASC 606, franchisors can only recognize the initial franchise fee if any of the upfront activities performed are distinct services within the context of the franchise agreement.  Essentially, the franchisor needs to determine if any of the goods or services have stand-alone value. Certain delivered items are part of the brand and cannot be separated, while other items could be considered distinct.  For example, if the franchisee purchases furniture from the franchisor and the furniture is a key part of the brand (i.e., the same at every location) it is likely part of the overall franchise agreement. However, if the furniture is different at each location and could easily be purchased from a third party, it may be considered distinct. The franchisor should consider each promised good and service to determine whether any portion of the initial franchise fee may be allocated to it, allowing recognition of that portion of revenue at the time that the good or service is delivered. As the public company implementation has already occurred, there are numerous example disclosures related to the implementation. Following are two case studies.

Case Study 1: Hotel Franchisor

For our franchised hotels, we have a performance obligation to provide franchisees and operators a license to our hotel system intellectual property for use of certain of our brand names. As compensation for such services, we are typically entitled to initial application fees and ongoing royalty fees.

Our ongoing royalty fees represent variable consideration, as the transaction price is based on a percentage of certain revenues of the hotels, as defined in each contract. We recognize royalty fees on a monthly basis over the term of the agreement as those amounts become payable.

Initial application and relicensing fees are fixed consideration payable upon submission of a franchise application or renewal and are recognized on a straight-line basis over the initial or renewal term of the franchise agreements.

Case Study 2: Restaurant Franchisor

On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue Recognition (Topic 606), Revenue from Contracts with Customers” using the full retrospective transition method.

Under ASU No. 2014-09, revenue is recognized in an amount that reflects the consideration an entity expects to receive for the transfer of goods and services. The standard also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers.

Under the new standard, the Company recognizes gift card breakage proportional to redemptions, which are highest in the Company’s first fiscal quarter. Previously, under the remote method, the majority of breakage revenue was recorded in the Company’s fourth fiscal quarter, corresponding with the timing of the original gift card sale.

Advertising fees charged to franchisees, which were previously recorded as a reduction to other restaurant operating expenses, are recognized as franchise revenue. In addition, initial franchise and renewal fees are recognized over the term of the franchise agreements. As part of the adoption of ASU No. 2014-09, the Company applied the practical expedient to use the portfolio approach to assess contracts and performance obligations. In connection with adoption of ASU No. 2014-09, a cumulative effect adjustment of $33.1 million, net of tax, was recorded as a credit to the ending balance of accumulated deficit as of December 27, 2015.

Regarding franchise fees,  initial franchise and renewal fees are recognized over the term of the franchise agreement and renewal period, respectively. The weighted average remaining term of franchise agreements and renewal periods was approximately 15 years as of April 1, 2018.

Take Action Now

If you have not yet already done so, now is the time to begin assessing and evaluating the impact ASC 606 may have on your business. While the magnitude of changes to a franchisor’s current revenue recognition practices will vary, almost all franchisors will see changes upon adoption of the new guidance.  In addition to the topics covered here, franchisors need to consider the impact of ASC 606 on gift card revenue as well as advertising or brand fee revenue. Contact your Clark Nuber professional or Christie Streit for more information about revenue recognition for franchisors. © Clark Nuber PS, 2018. All Rights Reserved

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