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CPA, CFE | Principal

Matt is one of several Clark Nuber professionals who are musically inclined. But he’s not just a musician, he’s a music fanatic. When he’s not making music, he’s making spreadsheets that rank his favorite albums and songs. Spreadsheets – it must be an accountant thing.

When it comes to fraud and theft, manufacturers are inherently at risk because of the nature of their operations. Not only do manufacturers have traditional fraud risks associated cash management processes as well as cyber-security risks facing everyone today, they also have non-cash assets that can be valuable.

In this article, a manufacturer carried inventory that is enjoyed by consumers far and wide – chocolate bars. A risk assessment for this company would highlight several issues, but without a formal assessment it would be easy to miss some of the key risks featured in this case.

Several prevention techniques unique to a manufacturing operation are discussed in the article, many of which are mainstays of prevention techniques espoused by the Association of CFEs:

  • Segregation of duties – this is a tried-and-true strategy for fraud and/or error prevention. The opposite would be a concentration of duties and represents a risk. Always try to separate the custody, authorization, and recordkeeping aspects of operations.
  • Operational data – marrying up operational data with financial data is critical. Accounting and finance executives should look for any and all data to assist in the analysis of a company’s performance and search for fraud or errors, as well as trends.
  • Surprise audits – in this case, the company conducted a surprise stock count that resulted in discovering and bringing down the fraud. Proactive and unpredictable measures can zoom in on a specific element of an operation. The existence of surprise controls provides a beneficial by-product as well. If employees never know what’s coming, they may be less inclined to initiate a fraud scheme for fear of getting caught by the next surprise.
  • Underqualified supervision – Particularly with small and medium sized enterprises, the person tasked with oversight of the finance function may not have adequate training and experience in supervising subordinates in those roles. In this article, the CEO was focused on a few operational aspects of inventory, but disregarded several others. After the fact, they started to focus their inventory management conversations on multiple KPIs. In cases where a supervisor may not have adequate training, it is advisable to take a team approach to supervision of key areas. In this case, the facts and results may have been different if the CEO continued to ask about his concerns, while another individual focused on the others.

Another key element in this case relates to the magnitude of a discrepancy. The differences noted in the production numbers was consistently 10 kg of chocolate under-reported – modest in most respects, but consistent. The relatively small discrepancy per order added up to a much larger amount in the end, and likely contributed to the length of the fraud.

Maintaining high standards in data accuracy and production performance is critical to preventing fraud but perhaps, more importantly, you also have to trust your gut. When something just doesn’t feel right, follow your intuition and don’t let anyone dismiss an issue until you are satisfied that everything checks out. You may not only prevent a fraud, but you may learn something about your operation along the way.

© 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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Articles and Publications

Changes to the Qualified Improvement Property (QIP) Classification under the Tax Cut and Jobs Act

Where We Were…

Qualified Improvement Property (QIP) isn’t entirely new. The 2015 PATH Act created qualified improvement property, which is “any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service.” Excluded from QIP is any enlargement to the building, improvements to escalators or elevators and internal structural framework.  Under the 2015 PATH Act, QIP was eligible for bonus depreciation and depreciated over 39 years. In addition to QIP, there was also qualified leasehold improvement property, qualified retail improvement property and qualified restaurant improvement property. These types of qualified improvements were generally eligible for bonus depreciation and depreciated over 15 years. QIP opened up new doors for certain taxpayers who didn’t qualify under the three other improvement property types mentioned above. Companies who were leasing to related companies or who owned their own building could accelerate depreciation through bonus depreciation deductions on the improvements that qualified. QIP also removed the three-year wait period and no longer restricted the accelerated depreciation be limited to leased space; common spaces also qualified.

So What Changed with QIP?

Under the TCJA, the other three types of improvement property were removed and only the QIP classification was left for assets purchased after December 31, 2017. In removing the code sections related to the three previous types of improvement property (qualified leasehold, retail and restaurant), the TCJA neglected to also add in new code sections for QIP, which was interlinked with the old improvement property code sections. The short of it means that qualified improvement property is no longer eligible for bonus depreciation and is depreciated over 39 years. A House Ways and Means spokesperson has commented that Joint Explanatory statement reflects the intent of the House and Senate, and the error will be addressed with technical corrections. The TCJA did add that QIP is now eligible for Section 179 deduction, which is completely new for improvement property.

Next Steps

We are waiting for technical corrections to be made to match up the intention of the House and Senate to the laws for QIP, allowing the improvements to be depreciated over 15 years. In the meantime, we recommend that you work with your CPA to estimate your taxable income under the current law. If you were able to previously use a 15-year life and bonus depreciation on improvements, you should plan for the 2018 impact to taxable income under the current 39 year life/no bonus depreciation rule in case a technical correction is not made. Work with your CPA to identify other opportunities to reduce taxable income as appropriate. If you have any questions or would like more information, contact your Clark Number advisor or Jamie Witt. Jamie Witt is a senior manager in the Tax Services Group. © Clark Nuber PS, 2018. All Rights Reserved

The Change in the Standard Deduction Affects Charitable Giving

Let’s take the case of a married couple and their three basic deductions: state and local taxes, home mortgage interest, and charitable contributions. Of these three most common deductions, only the charitable deduction allows for flexibility or tax planning; the remaining are relatively fixed deductions. Our first couple earns $200,000, has $24,000 of mortgage interest and $10,000 in state in local taxes. For this couple, a $1,500 charitable contribution would reduce their taxable income and reduces their marginal tax rate from 24 to 22%. Because $165,000 taxable income is the break point between the 22 and 24 % marginal tax rate for married filing jointly taxpayers, this couple’s $1,500 deduction brings taxable income below $165,000.

Grouping Donations

Another couple, similar to the one above, but who do not have large mortgage interest, would require a larger charitable deduction to reduce taxable income to the 22 % bracket. In their case, it may be more advantageous for this couple to group their charitable contributions into one year and take the standard deduction in subsequent tax years. In order to know for certain, a tax planner would need to do the calculation based upon the fixed amounts of interest and taxes and adjusting the variable amount of charitable contribution the taxpayer is considering making. The change enacted by the Tax Cuts and Jobs Act of 2017 suspended or sharply curtailed most itemized deductions for tax years 2018 through 2025. State and local tax deductions are limited to $10,000 for the year, and home mortgage interest is limited to purchase and improvement debt up to a maximum threshold of $750,000 ($375,000 for married filing separately). These all affect taxable income before the charitable deduction, which is key to planning for the optimal benefit from charitable deductions. Each taxpayer must look at their own tax situation to determine whether total itemized deductions will provide more tax savings than the standard deduction. If the sum of the two fixed itemized deductions, mortgage interest and taxes are close to the standard deduction amount, grouping charitable contributions may be an effective tax savings strategy. The Pease amendment, which limited itemized deductions for adjusted gross income above certain thresholds, was also repealed so taxpayers must compare the full amount of itemized deductions to the increased standard deduction. Continuing with our examples above, suppose the married couple are baby boomers who are likely in their higher income years to have a dwindling mortgage, but still have high state and local taxes. With no charitable contribution, and solely considering the deductions for state and local taxes and mortgage interest, they are better off with the standard deduction. However, with a $10,000 charitable contribution deduction, itemizing is more beneficial because it is more than the standard deduction. By grouping or bundling charitable contributions into a single tax year, they can obtain even more benefit from their contributions. Instead of contributing $10,000 per year for 2018 and 2019, the couple contributes $20,000 in 2018 and nothing in 2019. This will also allow the taxpayers to qualify for the lower 24% marginal tax rate. $315,000 is the break point between the 32 and 24 percent income tax rate for individuals in 2018.

Donor Advised Funds

If a taxpayer has no preferred charity to which they normally contribute, or wants to defer deciding which charity to support, a donor advised fund (DAF) can be an ideal way to manage the grouped or bundled contributions. A DAF allows contributors to make a completed gift in one year and advise to whom distributions are made from the DAF in future periods. There are restrictions on how a DAF may be used. DAFs may not make distributions to any natural persons, may not satisfy a personal pledge (except as outlined in IRS Notice 2017-73), and may not be used to purchase memberships or tickets to fundraising events the donor/donor advisor uses to attend. However, so long as none of these restrictions are a barrier, a DAF can be an excellent tool to accommodate bundling of contributions to take advantage of the larger standard deduction created by the Tax Cuts and Jobs Act of 2017. If you have questions on how the changes in the tax law affect your personal circumstances, please call or email to make an appointment with your Clark Nuber tax advisor. We are always happy to meet with you to discuss your individual goals and help you minimize your tax liability. © Clark Nuber PS, 2018. All Rights Reserved

Cloud-Based Services, Sales Tax, and the Slow March of Recognition

For accounting professionals and many of their clients, the software or other digital services they use daily are no longer stored on local hard drives or overheated servers stuffed in a back closet. The professional world has moved on to using the cloud, but most states have still not affirmatively recognized this new-ish elephant in the computing room. In terms of the sales and use tax treatment for cloud-based services, many regional governments leave vendors, purchasers, and their advisors in a haze when searching for answers about accounting for cloud services.

Buying and Selling Cloud-Based Services

In dealing with sales tax, one of the principal tasks for any vendor is to determine the proper tax treatment for the items or services they sell in the jurisdictions where they are obligated to comply. This process is rarely simple, even with established products or services. The U.S. sales and use tax universe of 46 states and hundreds of localities often prefer to put their own stamp on the taxation of specific transactions. Cloud-based services have certainly established themselves in the marketplace, but they remain identified as specifically taxable or exempt in less than a quarter of the sales tax states. The dearth of direct guidance on the treatment of cloud-based services for sales and use tax affects sellers and buyers. Vendors struggle to determine with certainty whether cloud-based services should be taxed at all, while purchasers are left wondering if they are being overcharged or, especially in the case of business consumers, is there a use tax obligation that must be accrued?

What are States Doing About Cloud-Based Services?

As we alluded to above, there are really three varieties of states in this area: states who affirmatively identify cloud-based services, states who use existing rules to shoehorn some cloud services into existing categories of other taxable goods or services, and states who seem to ignore the existence of the cloud all together. Since lack of clarity creates fear, uncertainty, and doubt, we commend the minority of states who are on the record when it comes to sales tax and the cloud. It is important to note here that when a state affirmatively defines cloud-based services, they do not automatically apply the tax to them; some states define and impose, others define and exempt. In New Jersey, for example, the state has defined SaaS, PaaS, and IaaS, finding that none of these cloud-based service types are subject to sales tax. Indiana recently followed a similar path for SaaS. On the other hand, Washington defines “remote access software” as a SaaS type model and finds sales of it are taxable, while “digital automated services” are construed as to describe most cloud-based services and are also taxable in the Evergreen State. More commonly, states have addressed only limited factual circumstances with regards to the cloud, and many of the states in this category have only addressed SaaS. For example, Connecticut finds a service that provides remote access to information includes the provision of SaaS and is taxable as a data processing service. In West Virginia, where most services are taxable generally, the delivery of cloud-based services enjoys no specific exemption and is likely taxable at the general rate. Finally, a portion of states do not define cloud services but have yet to apply existing rules to determine taxability. For example, in Nevada, since almost no services are taxed at all, the state’s silence on the cloud implies these services are exempt as well.

A Friendly Use Tax Reminder to Cloud Loving Businesses and Professionals

As your company adopts more and more cloud-based solutions, it also runs the risk of incurring use tax obligations on those expenditures. These purchases are for services that are “consumed” in the furtherance of your company’s operations, they are typically not bought for resale. Use tax compliance should not be a new thing (if it is a new thing, the following message is even more vital), but use tax obligations regarding cloud-based services come with a twist. Many providers of cloud-based services are not collecting sales taxes, even when the services are taxable in your state. Cloud-based or not, we can all agree that vendors who don’t collect sales taxes avoid doing so for their own special reasons. With cloud-based services, the reason they don’t collect is often related to the nature of the cloud itself: the delivery of cloud-based services can be made without traditional indicia of sales tax nexus. This hearkens back to Sales Tax 101: without a physical presence, a vendor is not obligated to collect sales taxes, leaving the purchaser to self-remit use tax. One of the main selling points of the cloud is its lack of physicality in the hands of its users, so providers of cloud services often lack the physical presence in states where they sell that would otherwise obligate them to collect.

The Take-Away

The pace of legislative and administrative progress is plodding mainly by design. Deliberative bodies and bureaucrats are rarely able or advised to rush into new territory; the slow march to recognition of the cloud is only another chapter in this book. That said, the risk and consequences of poor compliance remain very real for vendors and purchasers as sales of cloud-based services continue to grow. For companies with the resources and experience to plot this minefield, carry on and keep watching for the incremental but inevitable march to clarity. If marching to the beat of the sales tax band is not your thing, consider finding a specialist who can help you and your clients avoid tripping over their own feet on the sales tax dance floor. Clark Nuber has experienced staff on hand to help you sort out cloud-based (or other types of) sales tax headaches. Contact us via our website for professional insight into your company’s situation. © Clark Nuber PS, 2018. All Rights Reserved

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