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Archives for August 2022

Evaluating “going concern” concerns

Under U.S. Generally Accepted Accounting Principles (GAAP), financial statements are normally prepared based on the assumption that the company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting may be used instead.

It’s up to the company’s management to decide whether there’s a so-called “going concern” issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management’s assessment. Here are the factors that go into a going concern assessment.

Substantial doubt and potential for mitigation

The responsibility for making a final determination about a company’s continued viability shifted from external auditors to the company’s management under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The updated guidance requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

  • Recurring operating losses,
  • Working capital deficiencies,
  • Loan defaults,
  • Asset disposals, and
  • Loss of a key franchise, customer or supplier.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Aligning the guidance

After the FASB updated its guidance on the going concern assessment, the Auditing Standards Board (ASB) unanimously voted to issue a final going concern standard. The ASB’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was designed to promote consistency between the auditing standards and accounting guidance under U.S. GAAP.

The updated guidance requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. It also addresses uncertainties auditors face when the going concern basis of accounting isn’t applied or may not be relevant.

For example, SAS No. 132 doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts, or items of a financial statement. Some auditors contend that the evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level.

Prepare for your next audit

With increased market volatility, rising inflation, supply chain disruptions, labor shortages and skyrocketing interest rates, the going concern assumption can’t be taken for granted. Management must take current and expected market conditions into account when making this call — and be prepared to provide auditors with the appropriate documentation. Contact us before year end if you have concerns about your company’s going concern assessment. We can provide objective market data to help evaluate your situation.

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Reel in job candidates with a relocation package

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Competition among employers for many types of employees remains fierce. For hard-to-fill positions, you might need to expand the search beyond your organization’s local geographic area. You may even have to offer financial incentives to lure applicants.

Although signing bonuses are an obvious choice, a strong relocation package could give you an edge in reeling in the best job candidates.

Costs to consider

The purpose of a relocation package is to ease the financial and logistical strain of moving on a new hire. This benefit can range from a simple cash reimbursement to a lavish array of perks most often reserved for top execs.

When creating a package, it’s critical to establish a firm budget for the costs you’re willing and able to cover. Generally, relocation packages include coverage for moving services and transportation (such as airfare). But there are many other perks you could add, including:

  • Packing and unpacking services,
  • Storage expenses,
  • Short-term housing, and
  • Spousal employment assistance.

The size and shape of a relocation package tends to depend on an employer’s industry. The benefit you offer must be competitive with those of similar organizations in your area or it probably won’t give you the hiring edge you’re looking for.

Tax impact 

Relocation expenses are currently deductible for the employer and taxable to the employee, similar to how bonuses are treated.

Before the Tax Cuts and Jobs Act (TCJA) of 2017, the way that moving expenses were reported — and the tax impact — depended on the type of plan that an employer used. “Accountable” plans, which followed certain IRS rules, allowed employers to fully deduct payments while employees weren’t subject to taxation, including payroll tax. This made such plans highly favorable from a tax perspective, though they required more administrative effort.

Under a “nonaccountable plan,” pre-TCJA relocation payments were treated similarly to how a bonus would be reported and much like how the payments are now treated. That is, they were taxable compensation subject to both income tax and payroll tax. Employees could, however, deduct moving expenses — which substantially mitigated the tax impact.

The TCJA eliminated the moving expense deduction for all employees other than active-duty military members. Keep in mind, though, that this TCJA provision is scheduled to sunset after 2025.

Going the extra mile

Nowadays, employers often have to go the extra mile to win over optimal job candidates — many of whom could live hundreds or even thousands of miles away. Our firm can help you decide whether a relocation package is a good benefits choice for your organization.

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How to avoid the early withdrawal tax penalty on IRA distributions

When you take withdrawals from your traditional IRA, you probably know that they’re taxable. But there may be a penalty tax on early withdrawals depending on how old you are when you take them and what you do with the money.

Important: Once you reach a certain age, you must start taking required minimum distributions from your traditional IRAs to avoid a different tax penalty. Previously, the required beginning date (RBD) was April 1 of the year after the year in which you turn 70½. However, a 2019 law changed the RBD to 72 for individuals who reach age 70½ after 2019.

But what if you want to take an “early” withdrawal, defined as one taken before age 59½? You’ll be hit with a 10% penalty tax unless an exception applies. This 10% early withdrawal penalty tax is on top of the regular income tax you’ll owe on the distribution.

Exceptions to the general rule

Fortunately, there are several exceptions to the early withdrawal penalty tax if you use the money for certain things. Common examples include:

  • Paying for medical costs that exceed 7.5% of your adjusted gross income,
  • Withdrawals up to the amount of qualified higher education expenses for you, your spouse, or the children or grandchildren of you or your spouse, and
  • Withdrawals to buy or build a first home for a parent, grandparent, yourself, a spouse, or you or your spouse’s child or grandchild. This exception for first-time home purchases is subject to a lifetime limit of $10,000. A first-time homebuyer is someone who hasn’t had an ownership interest in a home in the last two years before buying a new home.

There’s also an exception to the early withdrawal penalty tax if you take annuity-like annual withdrawals under IRS guidelines. If distributions are made as part of a series of “substantially equal periodic payments” over your life expectancy or the life expectancies of you and your designated beneficiary, the tax doesn’t apply.

Be careful with rollovers

Be aware that the early withdrawal penalty may come into play if you’re moving funds out of an account. You can roll over funds from one IRA to another tax-free so long as you complete the rollover within 60 days. What if you miss the deadline? You may owe tax and the early withdrawal penalty if you’re younger than age 59½. (The IRS may waive the penalty if there are extenuating circumstances.)

We can help

We can tell you if you’re eligible for the exceptions described above or other exceptions to the 10% early withdrawal penalty tax. Be sure to keep good records so you can prove your eligibility.

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Three tax breaks for small businesses

Sometimes, bigger isn’t better: Your small- or medium-sized business may be eligible for some tax breaks that aren’t available to larger businesses. Here are some examples.

1. QBI deduction

For 2018 through 2025, the qualified business income (QBI) deduction is available to eligible individuals, trusts and estates. But it’s not available to C corporations or their shareholders.

The QBI deduction can be up to 20% of:

  • QBI earned from a sole proprietorship or single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
  • QBI passed through from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes or S corporation.

Pass-through business entities report tax items to their owners, who then take them into account on their owner-level returns. The QBI deduction rules are complicated, and the deduction can be phased out at higher income levels.

2. Eligibility for cash-method accounting

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Under the cash method, you generally don’t have to recognize taxable income until you’re paid in cash. And you can generally write off deductible expenses when you pay them in cash or with a credit card.

Only “small” businesses are potentially eligible for the cash method. For this purpose under current law, a small business includes one that has no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2022, the limit is $27 million.

3. Section 179 deduction 

The Sec. 179 first-year depreciation deduction potentially allows you to write off some (or all) of your qualified asset additions in the first year they’re placed in service. It’s available for both new and used property.

For qualified property placed in service in tax years 2018 and beyond, the deduction rules are much more favorable than under prior law. Enhancements include:

Higher deduction. The Sec. 179 deduction has been permanently increased to $1 million with annual inflation adjustments. For qualified assets placed in service in 2022, the maximum is $1.08 million.

Liberalized phase-out. The threshold above which the maximum Sec. 179 deduction begins to be phased out is $2.5 million with annual inflation adjustments. For qualified assets placed in service in 2022, the phase-out begins at $2.7 million.

The phase-out rule kicks in only if your additions of assets that are eligible for the deduction for the year exceed the threshold for that year. If they exceed the threshold, your maximum deduction is reduced dollar-for-dollar by the excess. Sec. 179 deductions are also subject to other limitations.

Bonus depreciation

While Sec. 179 deductions may be limited, those limitations don’t apply to first-year bonus depreciation deductions. For qualified assets placed in service in 2022, 100% first-year bonus depreciation is available. After this year, the first-year bonus depreciation percentages are scheduled to start going down to 80% for qualified assets placed in service in 2023. They will continue to be reduced until they reach 0% for 2028 and later years.

Contact us to determine if you’re taking advantage of all available tax breaks, including those that are available to small and large businesses alike.

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Employer violated ERISA by terminating employee

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Many employers offer health care plans and other benefits that fall under the purview of the Employee Retirement Income Security Act (ERISA). A recent federal court decision serves as a reminder that employers need to know their legal rights and limits regarding employee terminations and ERISA-protected benefits.

Plaintiff’s argument

In Kairys v. S. Pines Trucking, Inc., a former employee brought a discrimination case contending, among other things, that he was terminated in retaliation for substantial medical expense claims and anticipated future use of his employer’s self-insured ERISA health plan.

The plaintiff argued that his employer violated Section 510 of ERISA, which makes it unlawful to:

  • Discharge, fine, suspend, expel, discipline or discriminate against a participant for exercising a right to which the participant is entitled under an employee benefits plan, or
  • Interfere with attainment of any right to which a participant may become entitled under the plan.

The employer claimed that the employee’s position was eliminated, and that his job was intended to be temporary and had become unnecessary.

Court’s decision

The U.S. District Court for the Western District of Pennsylvania rejected the employer’s argument. It held that the employer retaliated against the employee for exercising his rights to ERISA-protected benefits. Under Sec. 510, the court explained, the employee must show that there was a causal connection between his termination and his use of an employee benefits plan. The court determined that the employer’s explanation was pretextual (false) for several reasons.

For starters, the employee was never told that his job was temporary and, less than two months after his termination, another employee was borrowed from within the company to perform his duties. Furthermore, the employee showed that the employer closely tracked invoices for its self-insured, ERISA plan and that, though the information was “de-identified,” it would be easy for the employer to identify participants because there were so few employees. The plaintiff also demonstrated that the employer was aware that he’d need further costly medical care.

Noting that the employee was terminated shortly before a new benefits year started, the court concluded that the evidence showed retaliation for use of benefits and specific intent to prevent future use of benefits. The court awarded the employee equitable relief in the form of reasonable attorneys’ fees and costs, as well as $67,500 in front pay — roughly the difference between the compensation he’d have received in his former position and that he’d receive with his new employer for a five-year period. The employer has appealed.

Notable outcome

Most Sec. 510 claims against ERISA welfare plans are unsuccessful. When a participant does prevail, a court is generally permitted to award only appropriate “equitable” relief, such as reinstatement, to remedy the violation. Monetary damages are usually unavailable.

Where reinstatement is impractical or not feasible, an employee may be left without a remedy because some courts have rejected claims for lost benefits and back pay. Notably, however, the court in Kairys found “it most appropriate to determine a front pay period by analogizing it as closely as possible to reinstatement — the preferred remedy this award seeks to approximate.”

Work with your legal and benefits advisors to ensure you stay in compliance with ERISA plans and other employee benefits.

Kairys v. S. Pines Trucking, Inc., No. 2:19-CV-1031-NR, March 31, 2022 (U.S. District Court, W.D. Pennsylvania)

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How to account for collaborative agreements

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Today, many companies share research or technology to develop new products. For example, manufacturers might enter into a joint venture to conduct scientific research to design a new medical device. Or a watchdog group might work with a production company to create and distribute a documentary film.

How revenue and other payments between the parties are reported can have a major impact on a participant’s income statement. So, it’s important to get it right. Unfortunately, the accounting rules for so-called “collaborative arrangements” remain somewhat murky, despite updated guidance from the Financial Accounting Standards Board (FASB).

The basics

Companies set up collaborative arrangements largely to share costs. Accounting Standards Codification (ASC) Topic 808, Collaborative Arrangements, provides guidance for income statement presentation, classification and disclosures related to collaborative arrangements. It lists three requirements for collaborative arrangements:

  1. They involve at least two parties (or participants),
  2. All parties involved are active participants in the activity, and
  3. All participants are exposed to significant risks and rewards dependent on the commercial success of the activity.

Topic 808 doesn’t provide comprehensive recognition or measurement guidance. Often, the accounting for these arrangements is based on an analogy to other accounting literature or an accounting policy election.

As companies began implementing Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), calls for clarity on collaborative arrangements increased. So, the FASB added this topic to its agenda in 2016.

Narrow-scope solution

In November 2018, the FASB issued an updated standard that went into effect in fiscal year 2020 for public companies and in fiscal year 2021 for private organizations. But the final version of the guidance was scaled back from what the FASB initially proposed. Items that didn’t make the final version of the updated guidance include:

  1. Transactions with a collaborative arrangement participant that are directly related to third-party sales of either participant in the arrangement, and
  2. Nonrevenue transactions between the participants.

Although the updated guidance doesn’t solve broader problems about the accounting for collaborative arrangements, it does address concerns related to revenue recognition. Specifically, ASU No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction Between Topic 808 and Topic 606, states that when a collaborative participant is a customer, the contract should be accounted for under Topic 606, including the recognition, measurement, presentation and disclosure requirements. But the parts of a collaborative arrangement that aren’t in the scope of the revenue recognition standard should be presented separately.

Lingering uncertainty 

The FASB has acknowledged that questions will likely continue about the guidance for collaborative arrangements. If you’re uncertain how to report these transactions, we can help you determine whether transactions are covered by other accounting literature and, if not, develop a reasonable, consistent accounting policy for them. Contact us for more information.

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