The Deductibility of Corporate Expenses Covered by Officers or Shareholders

Do you play a major role in a closely held corporation and sometimes spend money on corporate expenses personally? These costs may wind up being nondeductible both by an officer and the corporation unless proper steps are taken. This issue is more likely to arise in connection with a financially troubled corporation.

Deductible vs. nondeductible expenses

In general, you can’t deduct an expense you incur on behalf of your corporation, even if it’s a legitimate “trade or business” expense and even if the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since your corporation’s legal existence as a separate entity must be respected, the corporation’s costs aren’t yours and thus can’t be deducted even if you pay them.

What’s more, the corporation won’t generally be able to deduct them either because it didn’t pay them itself. Accordingly, be advised that it shouldn’t be a practice of your corporation’s officers or major shareholders to cover corporate costs.

When expenses may be deductible

On the other hand, if a corporate executive incurs costs that relate to an essential part of his or her duties as an executive, they may be deductible as ordinary and necessary expenses related to his or her “trade or business” of being an executive. If you wish to set up an arrangement providing for payments to you and safeguarding their deductibility, a provision should be included in your employment contract with the corporation stating the types of expenses which are part of your duties and authorizing you to incur them. For example, you may be authorized to attend out-of-town business conferences on the corporation’s behalf at your personal expense.

Alternatively, to avoid the complete loss of any deductions by both yourself and the corporation, an arrangement should be in place under which the corporation reimburses you for the expenses you incur. Turn the receipts over to the corporation and use an expense reimbursement claim form or system. This will at least allow the corporation to deduct the amount of the reimbursement.

Analytical software tools will never fully replace auditors, but they can help auditors do their work more efficiently and effectively. Here’s an overview of how data analytics — such as outlier detection, regression analysis and semantic modeling — can enhance the audit process.

Auditors bring experience and professional skepticism

When it’s appropriate, instead of manually testing a representative data sample, auditors can use analytical software tools to compare an entire data population against selected criteria. This process quickly identifies anomalies hidden in large amounts of data that can be tagged for further examination by auditors during fieldwork. Analytical software tools can test various kinds of data, including accounting, internal communications and documents, and external benchmarking data.

If unusual transactions or trends are found, auditors will investigate them further using the following procedures:

Interviewing management about what happened and why,
Conducting external research online and from industry publications to independently understand what happened or to verify management’s explanation, and
Performing additional manual testing procedures to determine the nature of the anomaly or exception.

In addition, confirmations and representation letters from attorneys, customers and other external parties may corroborate what management says and external research reveals.

Audit findings may require action

Often, auditors conclude that irregularities have reasonable explanations. For instance, they may be due to an unexpected change in the company’s operations or external market conditions. If a change is expected to continue, it may alter the auditor’s expectations about the company’s operations going forward. Sometimes, a change discovered while auditing one part of the financials may affect audit procedures (including analytics) that will be performed on other accounts.

Alternatively, auditors may attribute some irregularities to inadvertent mistakes or intentional fraud schemes. Auditors usually communicate with the audit committee or the company’s owners as soon as possible if they discover any material errors or fraud. These irregularities might require adjustments to the financial statements. The company also might need to take action to mitigate financial losses and prevent the problem from recurring.

For example, the controller may need additional training on recent changes to the tax and accounting rules. Or management may need to implement additional internal control procedures to safeguard against dishonest behaviors. Or the owner may need to contact the company’s attorney and hire a forensic accountant to perform a formal fraud investigation.

Audit smarter

Today, companies generate, process and store massive amounts of electronic data on their networks. Increasingly, auditors are using analytical tools on this data to conduct basic audit procedures, such as vouching transactions and comparing data to external benchmarks. This frees up auditors to focus their efforts on complex transactions, suspicious relationships and high-risk accounts. Contact us for more information about how our auditors use analytical software tools in the field.

Yeo & Yeo CPAs & Business Consultants is pleased to announce the promotion of Zaher Basha and Taylor Diener to Senior Manager.

Zaher Basha, CPA, CM&AA, has been promoted to Senior Manager. His areas of expertise include tax planning and preparation, business advisory services, business valuation, and mergers and acquisitions, with an emphasis on the healthcare industry. He is a member of the firm’s Healthcare Services Group and the Business Valuation and Litigation Support Services Group. As a Certified Merger & Acquisition Advisor, Basha provides clients with in-depth expertise on all aspects of the merger and acquisition process, from due diligence and financial modeling to business valuation, negotiations and transaction closing.

Basha is a member of the Michigan Association of Certified Public Accountants’ Healthcare Task Force, the Auburn Hills Chamber of Commerce and the Troy Chamber of Commerce. In the community, he serves as treasurer of the Muhammad Ali Center and the Syrian American Rescue Network. He also volunteers for The Syria Institute.

Taylor Diener, CPA, has been promoted to Senior Manager. Diener is a member of the firm’s Education Services Group and Audit Services Group. Her areas of expertise include audits for school districts, nonprofits, for-profit businesses and government entities.

Diener is a member of the Michigan School Business Officials (MSBO) and has presented at MSBO annual conferences. She is also a frequent contributor to the Yeo & Yeo blog, providing audit and compliance insights for education and nonprofit organizations. In the community, Diener serves as treasurer of the PartnerShift Network.

The COVID-19 pandemic has dramatically affected the way people interact and do business. Even before the crisis, there was a trend toward more digital interactions in sales. Many professionals predicted that companies’ experiences during the pandemic would accelerate this trend, and that seems to be coming to pass.

As this transformation continues, your business should review its remote selling processes and regularly consider adjustments to adapt to the “new normal” and stay ahead of the competition.

3 tips to consider

How can you maximize the tough lessons of 2020 and beyond? Here are three tips for keeping your remote sales operations sharp:

1. Stay focused on targeted sales. Remote sales can seemingly make it possible to sell to anyone, anywhere, anytime. Yet trying to do so can be overwhelming and lead you astray. Choose your sales targets carefully. For example, it’s typically far easier to sell to existing customers with whom you have an established relationship or to prospects that you’ve thoroughly researched.

Indeed, in the current environment, it’s even more critical to really know your customers and prospects. Determine whether and how their buying capacity and needs have changed because of the pandemic and resulting economic changes — and adjust your sales strategies accordingly.

2. Leverage technology. For remote selling to be effective, it needs to work seamlessly and intuitively for you and your customers or prospects. You also must recognize technology’s limitations.

Even with the latest solutions, salespeople may be unable to pick up on body language and other visual cues that are more readily apparent in a face-to-face meeting. That’s why you shouldn’t forego in-person sales calls if safe and feasible — particularly when it comes to closing a big deal.

In addition to video, other types of technology can enhance or support the sales process. For instance, software platforms that enable you to create customized, interactive, visually appealing presentations can help your sales staff meet some of the challenges of remote interactions. In addition, salespeople can use brandable “microsites” to:

Share documents and other information with customers and prospects,
Monitor interactions and respond quickly to questions, and
Appropriately tailor their follow-ups.

Also, because different customers have different preferences, it’s a good idea to offer a variety of communication platforms — such as email, messaging apps, videoconferencing and live chat.

3. Create an outstanding digital experience. Customers increasingly prefer the convenience and comfort of self-service and digital interactions. So, businesses need to ensure that customers’ experiences during these interactions are positive. This requires maintaining an attractive, easily navigable website and perhaps even offering a convenient, intuitive mobile app.

An important role

The lasting impact of the pandemic isn’t yet clear, but remote sales will likely continue to play an important role in the revenue-building efforts of many companies. We can help you assess the costs of your technology and determine whether you’re getting a solid return on investment.

If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.

The current rules

Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandmother bought stock in 1935 for $500 and it’s worth $1 million at her death, the basis is stepped up to $1 million in the hands of your grandmother’s heirs — and all of that gain escapes federal income tax.

The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Gifting before death

It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above example, if your grandmother decides to make a gift of the stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

Change on the horizon?

Be aware that President Biden has proposed ending the ability to step-up the basis for gains in excess of $1 million. There would be exemptions for family-owned businesses and farms. Of course, any proposal must be approved by Congress in order to be enacted.

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance. We’ll keep you up to date on any tax law changes.

Despite the COVID-19 pandemic, government officials are seeing a large increase in the number of new businesses being launched. From June 2020 through June 2021, the U.S. Census Bureau reports that business applications are up 18.6%. The Bureau measures this by the number of businesses applying for an Employer Identification Number.

Entrepreneurs often don’t know that many of the expenses incurred by start-ups can’t be currently deducted. You should be aware that the way you handle some of your initial expenses can make a large difference in your federal tax bill.

How to treat expenses for tax purposes

If you’re starting or planning to launch a new business, keep these three rules in mind:

Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
Under the tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t go very far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to start earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?

Eligible expenses

In general, start-up expenses are those you make to:

Investigate the creation or acquisition of a business,
Create a business, or
Engage in a for-profit activity in anticipation of that activity becoming an active business.

To qualify for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.

To be eligible as an “organization expense,” an expense must be related to establishing a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Plan now

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the election described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Marisa Ahrens, CPA, will lead the firm’s Employee Benefit Plan Audit Services Group.

Ahrens specializes in employee benefit plan audits and advisory services, including defined contributions, 401(k) and 403(b) plan audits, defined benefit plan audits, employee stock ownership plan (ESOP) audits, internal controls, and efficiency consulting. Ahrens is a Senior Manager based in Yeo & Yeo’s Saginaw office. She has more than 12 years of experience providing audits for nonprofits, healthcare organizations and for-profit companies, with specialized training and expertise in employee benefit plan audits.

“We are excited to have Marisa as the leader of our Employee Benefit Plan Audit Services Group,” said Principal and assurance service line leader Dave Youngstrom. “She is an experienced employee benefit plan auditor with deep expertise in the requirements of the American Institute of Certified Public Accountants (AICPA), Department of Labor, Employee Retirement Income Security Act (ERISA) and IRS. She has a strong dedication to serving our clients and is an outstanding mentor to members of the team.”

Ahrens is a member of the Michigan Association of Certified Public Accountants and the American Institute of Certified Public Accountants. She is the treasurer for the Mid-Michigan Children’s Museum and past treasurer for the Saginaw County Business & Education Partnership. She also coaches youth soccer in the Frankenmuth community.

Yeo & Yeo is a select member of the American Institute of Certified Public Accountants (AICPA) Employee Benefit Plan Audit Quality Center, a membership center for eligible CPA firms that perform quality employee benefit plan audits.

Soon you will receive, or you may have already received, a letter from the Michigan Department of Treasury titled “ESA – Statement/Payment Reminder.” This letter is related to your organization’s personal property tax return that was filed with the State in January or February 2021. Please be aware that this letter is legitimate and the taxes assessed will be accurate given that a personal property tax return was, in fact, timely filed on your behalf. The taxes have been assessed by your local assessor based on the cost of personal property held at your organization’s address.

When you receive the letter, please follow the steps within to log in to your MTO account and pay the amount due by August 15, 2021. If you have any questions, please contact us.

No matter the size or shape of a business, one really can’t overstate the importance of sound accounts receivable policies and procedures. Without a strong and steady inflow of cash, even the most wildly successful company will likely stumble and could even collapse.

If your collections aren’t as efficient as you’d like, consider these five ways to improve them:

1. Redesign your invoices. It may seem superficial, but the design of invoices really does matter. Customers prefer bills that are aesthetically pleasing and easy to understand. Sloppy or confusing invoices will likely slow down the payment process as customers contact you for clarification rather than simply remit payment. Of course, accuracy is also critical to reducing questions and speeding up payment.

2. Appoint a collections champion. At some companies, there may be several people handling accounts receivable but no one primarily focusing on collections. Giving one employee the ultimate responsibility for resolving past due invoices ensures the “collection buck” stops with someone. If budget allows, you could even hire an accounts receivable specialist to fill this role.

3. Expand your payment options. The more ways customers can pay, the easier it is for them to pay promptly. Although some customers still like traditional payment options such as mailing a check or submitting a credit card number, more and more people now prefer the convenience of mobile payments via a dedicated app or using third-party services such as PayPal, Venmo or Square.

4. Get acquainted (or reacquainted) with your customers. If your business largely engages in B2B transactions, many of your customers may have specific procedures that you must follow to properly format and submit invoices. Review these procedures and be sure your staff is following them carefully to avoid payment delays. Also, consider contacting customers a couple of days before payment is due — especially for large payments — to verify that everything is on track.

5. Generate accounts receivable aging reports. Often, the culprit behind slow collections is a lack of timely, accurate data. Accounts receivable aging reports provide an at-a-glance view of each customer’s current payment status, including their respective outstanding balances. Aging reports typically track the payment status of customers by time periods, such as 0–30 days, 31–60 days, 61–90 days and 91+ days past due.

With easy access to this data, you’ll have a better idea of where to focus your efforts. For example, you can concentrate on collecting the largest receivables that are the furthest past due. Or you can zero in on collecting receivables that are between 31 and 60 days outstanding before they get any further behind.

Need help setting up aging reports or improving the ones you’re currently running? Please let us know — we’d be happy to help with this or any aspect of improving your accounts receivable processes.

Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.

For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.

A trader vs. an investor

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:

The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

Profit in the short term

So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.

Throughout the pandemic, the government has strived to lessen the impact on employers. Through various pieces of legislation, credit and grant programs have emerged. One such relief program, the Employee Retention Credit, provides refundable credits to employers. And thanks to year-end legislation, employers who participated in the Paycheck Protection Program also became eligible to receive the ERC. Read more about how to qualify and claim the credit.

The interaction between various pandemic programs and other factors raises questions about how to account for the credit. Let’s take a closer look at GAAP reporting and considerations for nonprofit organizations.

Accounting for the ERC under US GAAP

Nonprofit entities following US GAAP must account for the credit under ASC Subtopic 958-605 as a nonexchange transaction with a governmental entity that is accounted for as a conditional contribution. Organizations must consider the circumstances as of the period end date. Certain conditions must be met to claim the credit, for example, a decline in gross receipts and incurring qualified payroll and health care costs. When an organization has a PPP loan, eligible expenses cannot be used for both PPP forgiveness and the ERC (in other words, no double-dipping). The same holds for other government grants in which a nonprofit organization participates. Management must carefully allocate specific wages between the programs to ensure expenses are used only once.

If the conditions for eligibility are met as of the period end date, then the credit would be recorded as grant revenue under Subtopic 958-605 and reflected as a refund receivable or reduction of payroll tax liabilities. On the statement of cash flows, the change in refund receivable and/or reduction in payroll tax liabilities would be reflected in cash flows from operating activities. Required disclosures include the accounting method used, significant terms of the credit program, relevant information about the line items and amounts included in the financial statements, and the conditions that have not been substantially met (if applicable).

Subsequent events

Organizations that received the PPP loan were originally not eligible to receive the ERC under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was passed in March 2020. However, the Consolidated Appropriates Act of 2021, which passed in late December 2020, later enabled PPP loan recipients to also claim the ERC. Newly eligible employers can retroactively claim the credit by filing amended Form 941 returns for 2020. Organizations with a 12/31/20 fiscal year-end or later should reflect the subsequently claimed credit as of the financial statement date if the financial statements haven’t been issued yet.

Suppose financial statements were already issued before claiming the refundable credit. In that case, management must assess the facts and circumstances to determine the appropriate way to reflect the change on the next financial statements. The change in prior period information would be considered a change in estimate. If the estimate was made in good faith, then the financial statements can reflect the change on a prospective basis. If the organization missed information readily available to them when the estimate was made, a prior period adjustment would be appropriate.

The fraud triangle was introduced by Donald Cressey in the 1970s. Those who lead nonprofit organizations should understand this model for explaining the factors that cause someone to commit fraud – it’s still relevant today.

An individual must feel pressure, something that makes them feel a financial burden that they can’t share. For example, this could be unexpected medical bills or a gambling problem. The individual must recognize an opportunity to use their position to ease their financial pressure and not get caught. Nobody else is looking or double-checking, and they have access to the organization’s assets. Most people don’t think of themselves as bad people, so they find ways to rationalize or justify their actions. They might tell themselves, “I’m just borrowing it; I’ll pay it back,” or “I work so hard for this organization, they owe me.

Organizations don’t have control over the pressure an employee is facing or whether or not the employee can rationalize their decisions. However, they can reduce the opportunity that employee has by implementing appropriate internal controls.

Contact Yeo & Yeo for help with implementing fraud prevention and detection measures in your nonprofit organization.

The Fraud Triangle

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Bradley DeVries, CPA, CAE, has been promoted to managing principal of the firm’s Lansing office.

DeVries succeeds Mark Perry, CPA, who has served as the managing principal of the Lansing office for more than 18 years, since 2003. While Perry is stepping down as office managing principal, he will remain an active member of the principal group helping to mentor and foster future leadership. He will continue to dedicate his time and expertise in providing audit, accounting and tax services for the firm’s real estate, nonprofit and government clients.

“I am grateful for Mark’s continued dedication to the firm and excited for Brad to lead the Lansing office as managing principal,” said president & CEO Thomas Hollerback. “Brad is a talented professional and a strong leader who is committed to helping Yeo & Yeo’s clients succeed.”

In his new role, DeVries is responsible for the day-to-day operations at Yeo & Yeo’s Lansing office, including office growth, personnel and client care. His expertise spans audit, consulting and tax services for nonprofit organizations, affordable housing agencies, trade associations and real estate entities. He is a member of the firm’s Nonprofit, Audit and Real Estate Services Groups. As a Certified Association Executive, DeVries provides clients with in-depth expertise in nonprofit and association management.

DeVries joined Yeo & Yeo in 2005 and was named principal in 2019. He is a member of the Michigan Society of Association Executives and the Michigan Nonprofit Association. He has authored numerous articles and presented at several conferences, including, most recently, the 2021 Michigan Society of Association Executives’ Operations Conference. He is a graduate of Leadership Lansing.

There’s a harsh tax penalty that you could be at risk for paying personally if you own or manage a business with employees. It’s called the “Trust Fund Recovery Penalty” and it applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages.

Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is aggressive in enforcing the penalty.

Wide-ranging penalty

The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a wide range of people involved in a business.

Here are some answers to questions about the penalty so you can safely avoid it.

What actions are penalized? The Trust Fund Recovery Penalty applies to any willful failure to collect, or truthfully account for, and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who is at risk? The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation’s officers, directors and shareholders under a duty to collect and pay the tax as well as a partnership’s partners, or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under some circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.

According to the IRS, responsibility is a matter of status, duty and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to pay them but instead make payments to creditors and others, you become a responsible person.

Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken entirely on his or her own after the penalty is paid. It isn’t part of the IRS collection process.

What’s considered “willful?” For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due the government is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to take care of the job yourself can be treated as the willful element.

Never borrow from taxes

Under no circumstances should you fail to withhold taxes or “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions about making tax payments.

During the COVID-19 pandemic, school districts received monetary relief from the federal government, but local businesses and communities also helped by donating materials such as personal protective equipment (PPE). How should a school district’s financial records reflect the donated materials received?

Treat the donated PPE similarly to donated commodities. GASB 33 and N50 Nonexchange Transactions in GASB’s Codification of Governmental Accounting and Financial Reporting Standards offer guidance on recording donated materials. The PPE should be recognized as revenue in the school district’s governmental fund statements in the period when all applicable eligibility requirements are met and the resources are available. The school district should record the expenditures following its supplies policy – either as supplies inventory or an expenditure when the revenue is recognized.

The school district should have documentation for how it determined the revenue it recognizes. Maintain records for the quantity of PPE received as accurately as possible – counts performed by the school district or lists provided by the donor are the best documentation to have available. Additionally, the school district should have a basis for valuing the PPE received. If the donor did not provide the value, the school district could use the market prices of similar PPE at the time of donation.

School districts should also maintain records and disclose any donated PPE the donor purchased with federal sources. Disclose the amount of donated federal PPE as a separate footnote in the Schedule of Expenditures of Federal Awards (SEFA) at the fair market value of time of receipt. The amount will not be considered for determining single audit thresholds and is not required to be audited as a major program.

We continue to receive many questions related to accounting for the 2021 school year, and we are here to help you navigate those challenges. Please reach out to your Yeo & Yeo professionals for assistance.

During the past year and a half, many government entities have experienced significant turnover in several positions. Some governments are left scrambling to continue with day-to-day operations while trying to find qualified applicants to fill vacant positions.

Unexpected events and uncertainties about the future make planning for turnover more important than ever, given the changes the pandemic has brought about in the workplace. Governments can take several steps to prepare for turnover and ensure that all duties will be covered during employee vacations, medical leaves, etc. Consider the following measures and create a plan to ensure that your government can continue to run smoothly, no matter what obstacles present themselves.

Accounting procedures are imperative to a well-functioning government. These are considered the “how” when performing accounting functions (cutting checks, processing payroll, etc.). While most government accounting personnel know what their duties are, these day-to-day accounting procedures are often left undocumented in a manual. While it is crucial to have the policies required by state laws approved by the council or board – such as a credit card acceptance policy and electronic transaction policy – it is just as important to document the complete procedures for actually processing transactions. Accounting procedures should be written for each key transaction cycle, typically those include disbursements, receipts, and payroll, to ensure that the day-to-day transactions are being processed and recorded correctly in the event of turnover. Further, it is recommended that these procedures be reviewed and updated frequently to reflect changes in the procedures that result from gaining efficiencies or changes in the software.

Once accounting procedures have been well documented, cross-train employees to ensure that all key transaction cycles are covered in the event of turnover and cover vacations or medical leave. Even during holidays, payroll will still need to be processed and checks cut. Cross-training allows employees to take time off without the government suffering as their duties have been well documented, and other departments have been trained to handle the processing of the transactions.

While cross-training is essential, it is also important to consider segregation of duties when determining which employees will cover which key transaction cycles in the event of vacations, turnover, etc. For example, the signer of the checks should not prepare the checks.

Well-documented accounting procedures and cross-training are very useful tools to ensure that the government’s operations can continue during interruptions such as turnover. However, management and the council or board should also know when to ask for external help. The pandemic has resulted in individuals retiring or taking different positions, which can adversely affect operations at the governments if they were responsible for many duties. Combined with a lack of documented procedures, this can cause the government to get behind on day-to-day transactions and annual audits, which may result in increased monitoring by the state and potentially the withholding of funding. Oversight by management and the council or board is necessary as a lack of timely financial reports can indicate that things are falling behind. Limited consulting services are often available through your audit firm, such as cash to accrual entries for audit preparation, capital asset tracking, etc. Discussion with your external auditor is always a good starting place as they work closely with firms that can assist with the day-to-day processing of transactions without impairing their independence.

Agility — or the ability to react quickly — is essential to surviving and thriving in today’s competitive landscape. Though agile techniques were originally used in the realm of software development, this concept has many applications in the modern business world, including how companies approach their internal audits. Here’s an overview of agile auditing and why many internal audit teams are jumping on the bandwagon.

The basics

Whereas a traditional audit requires extensive planning, fieldwork and reporting, an agile audit moves at a faster pace. An agile audit also allows the audit team to continually refocus their attention and efforts where they’re needed the most.

Agile auditing relies on the following key concepts:

Audit backlogs. The audit team keeps a backlog of reviewed and approved audit programs. As the environment evolves, the audit team can add, remove or reprioritize audit programs within the backlog. This dynamic approach ensures that the audit team focuses on the most pressing issues — and minimizes the likelihood that they’ll waste time on an issue from a previous audit plan that’s no longer relevant.

User stories. Auditors create user stories that are made up of:

A user,
An action, and
An outcome.

Each story corresponds to a unit of work related to the audit. The user is the individual responsible for performing critical tasks related to the story. The action is what the user must do to generate a desired outcome.

For example, a retailer (the user) wants to process credit card payments from customers online (the action), so they can order online (the outcome). Creating a story provides the audit team with an understanding of the user’s requirements and the desired outcome.

Audit sprints. With a story defined, the audit team can deliver their work in sprints. Each sprint is normally completed in one to four weeks. Sprints may include defined tasks and regular check-ins with stakeholders. A sprint has a planning phase and daily “scrums,” which are short meetings with the audit team and stakeholders. Items on the daily agenda include:

Yesterday’s progress,
The game plan for today, and
Potential challenges to completing the sprint.

Each sprint concludes with the delivery of preliminary results to stakeholders. Reviewing the results of each sprint gradually over the course of the audit helps minimize surprises when the final audit report is submitted to stakeholders.

Benefits abound

Agile auditing facilitates more frequent and timelier communications between auditors and stakeholders. This can lead to more robust partnerships and improvements in the accuracy and integrity of audit team’s findings. More frequent communication also allows the audit team and the business to identify and resolve problems quickly.

Contact us for more information. We can help you decide whether you’re ready to transition to a more agile auditing approach and, if so, guide your internal audit team through the implementation process.

As mitigation measures related to COVID-19 ease, it will be interesting to see which practices and regulatory changes taken in response to the pandemic remain in place long-term. One of them might be relief from a sometimes-inconvenient requirement related to the administration of 401(k) plans.

A virtual solution

In IRS Notice 2021-40, the IRS recently announced a 12-month extension of its temporary relief from the requirement that certain signatures be witnessed “in the physical presence” of a 401(k) plan representative or notary public.

The original relief, which appeared in IRS Notice 2020-42, was provided primarily to facilitate plan loans and distributions under the CARES Act. However, the relief could be used during 2020 for any signature that, under regulations, had to be witnessed in the physical presence of a plan representative or notary public. This included required spousal consents. The relief was subsequently extended through June 30, 2021, under IRS Notice 2021-03.

Under the notices, signatures witnessed remotely by a plan representative satisfy the physical presence requirement if the electronic system uses live audio-video technology and meets four requirements established under the original relief:

Live presentation of a photo ID,
Direct interaction,
Same-day transmission, and
Return with the representative’s acknowledgment.

Signatures witnessed by a notary public satisfy the physical presence requirement if the electronic system for remote notarization uses live audio-video technology and is consistent with state-law requirements for a notary public.

Comments requested

As mentioned, IRS Notice 2021-40 further extends the relief — subject to the same conditions — through June 30, 2022. The notice also requests comments regarding whether permanent modifications should be made to the physical presence requirement. Comments are specifically requested regarding:

The costs and other effects of the physical presence requirement and its temporary waiver,
Whether the relief has resulted in fraud, coercion or other abuses,
How the witnessing requirements are expected to be fulfilled as the pandemic abates,
What procedural safeguards should be instituted if the physical presence requirement is permanently modified, and
Whether permanent relief should use different procedures for witnessing by plan representatives or notary publics.

Comments should be submitted by September 30, 2021.

More information

Going forward, the need for a signature may often relate to spousal consents. If your business recently established a 401(k), the plan may be designed to limit or even eliminate the need for spousal consents.

However, plans that offer annuity forms of distribution are still subject to the spousal consent rules. And other 401(k) plans must require spousal consent if a married participant wants to name a nonspouse as primary beneficiary. Feel free to contact our firm for more information on the latest IRS guidance addressing employee benefits.

What is the Advance Child Tax Credit?

The American Rescue Plan Act (ARPA) increased the 2021 child tax credit from $2,000 to $3,000 for qualifying children ages 6 to 17 and $3,600 for qualifying children under age 6. This credit is fully refundable, and the IRS will begin sending automatic payments on July 15 to eligible recipients. The amount of the payments, known as the Advance Child Tax Credit, will be your total estimated 2021 Child Tax Credit divided by 12, which is $250 per month for the $3,000 credit and $300 per month for the $3,600 credit. There will be six monthly payments, and the IRS will send Letter 6419 in January 2022, which will show the total amount of Advance Child Tax Credit payments you received.

The Child Tax Credit begins to be reduced to $2,000 per child if your modified AGI in 2021 exceeds:

$150,000 if married and filing a joint return or if filing as a qualifying widow or widower;
$112,500 if filing as head of household; or
$75,000 if you are a single filer or are married and filing a separate return.

The Child Tax Credit won’t begin to be reduced below $2,000 per child until your modified AGI in 2021 exceeds:

$400,000 if married and filing a joint return; or
$200,000 for all other filing statuses.

What are the tax return implications of the Advance Child Tax Credit?

Like the Stimulus payments issued in 2020 and 2021, the amount of the credits you received will need to be reconciled on your 2021 tax return. The difference, however, is that overpayments of the Advance Child Tax Credit will need to be repaid. The IRS estimate of the credit is based on your 2020 tax return or your 2019 tax return if 2020 has not been filed. If your circumstances have changed for 2021, you can update your information on the IRS website so that they have the most accurate information. Keep in mind that the refund you would typically receive will be reduced by the Advance Child Tax Credit amount you receive. Also, if your normal refund is less than the Advance Child Tax Credit you received, then you could end up owing.

Reasons you may want to opt out of the Advance Child Tax Credit payments

You may want to opt out of the advance payments if your 2021 tax situation varies significantly from your 2020 tax return filing. This could include an increase in income over the thresholds or a decrease in the number of children you will be claiming. For example, divorced parents that alternate who claims a child every other year may want to opt out to avoid a surprise tax bill for the 2021 tax year. You can opt out by going to the IRS website. You can opt out of the program three days before the first Thursday of the month of payment. This means you would have had to opt out by June 28 to avoid the first payment, but you can still opt out of future payments. If you choose to opt out after receiving a few payments, the IRS will still send you Letter 6419 in January to reconcile the credit on your tax return. Your total refund will be reduced by the amount of the payments you received. The IRS will later update the Opt Out Tool to allow taxpayers to update their income estimates and dependent details.

For more information, refer to the IRS’s website pages:

Also refer to Yeo & Yeo’s article, Here Come the Child Tax Credit Payments: What You Need to Know.

The first advance payments under the temporarily expanded child tax credit (CTC) will begin to arrive for nearly 39 million households in mid-July 2021 — unless, that is, they opt out. Most eligible families won’t need to do anything to receive the payments, but you need to understand the implications and why advance payments might not make sense for your household even if you qualify for them.

Understanding the CTC, then and now

The CTC was established in 1997. Unlike a deduction, which reduces taxable income, a credit reduces the amount of taxes you owe on a dollar-for-dollar basis. While some credits are limited by the amount of your tax liability, others, like the CTC, are refundable, which means that even taxpayers with no federal tax liability can benefit. Historically, the CTC has been only partially refundable in that the refundable amount was limited to $1,400.

The American Rescue Plan Act (ARPA) significantly expands the credit, albeit only for 2021. Specifically, the ARPA boosts the CTC from $2,000 to $3,000 per child ages six through 17, with credits of $3,600 for each child under age six. Plus, the CTC is now fully refundable. It also affords taxpayers the opportunity to take advantage of half of the benefit in 2021, rather than waiting until tax time in 2022.

Note, however, that there are limits to eligibility. The $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers, and this continues under the ARPA — for the first $2,000. A separate phaseout applies for the increased amount: $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers.

Receiving advance payments

The ARPA directed the U.S. Treasury Department to begin making monthly payments of half of the credit in July 2021, with the remaining half to be claimed in 2022 on 2021 tax returns. For example, a household that’s eligible for a $3,600 CTC will receive $1,800 ($300 in six monthly payments) in 2021 and would claim the balance of $1,800 on the 2021 return. The payments will be made on the 15th of each month through December 2021, except for August, when they’ll be paid on August 13.

To qualify for advance payments, you (and your spouse, if filing jointly) must have:

Filed a 2019 or 2020 tax return that claims the CTC or provided the IRS with information in 2020 to claim a stimulus payment,
A main home in the United States for more than half of the year or file a joint return with a spouse who has a U.S. home for more than half of the year,
A qualifying child who’s under age 18 at the end of 2021 and who has a valid Social Security number, and
Earned less than the applicable income limit.

If the IRS has your bank information, you’ll receive the payments as direct deposits.

Because the IRS will base the payments on your 2020 tax return (or, if not yet available, your 2019 return), it’s possible that you could receive excess payments over the amount you actually qualify for in 2021. In that case — unlike excess stimulus payments — you’ll be required to repay the excess. The IRS will either deduct the amount from your 2021 refund or add it to the amount you owe.

Opting out

The IRS will automatically enroll taxpayers for advance payments, but it’s also providing an online portal at irs.gov where taxpayers can opt out. You might consider opting out if, for example, you were near the income limits in 2019 or 2020, expect to earn more in 2021, and want to avoid excess payments. Be aware that couples filing jointly must both opt out, otherwise the spouse who doesn’t will receive half of the joint payment.

It’s not only a change in expected income that could lead to excess payments; it’s also a change in the number of dependents. For example, divorced couples who share joint custody may alternate the years in which they claim their children as dependents for CTC purposes. If 2021 is your former spouse’s year, consider opting out (your former spouse won’t receive the advance payments based on his or her 2020 tax return but, if eligible, can claim the credit on the 2021 return). Parents of children who will turn age 18 in 2021 also should consider opting out.

The deadline to opt out of the first payment was June 28, 2021, but you can still opt out for future payments.

Estimating — and reducing — 2021 income

When deciding whether to opt out, you can estimate your 2021 income using multiple methods. You could simply look at your modified adjusted gross income on your most recent tax return. You also could project your income for the year and reduce it by the standard deduction (for 2021, it’s $12,550 for individual taxpayers and $25,100 for married couples filing jointly).

If you estimate that your income will be near the eligibility threshold but want to receive the advance payments, you can take measures to reduce your income before year end. You might, for example, increase your 401(k) plan contributions (the contribution limit for 2021 is $19,500). Taxpayers with high deductible health plans and health savings accounts (HSAs) can similarly reduce their income with contributions. The HSA contribution limits for 2021 are $3,600 for individual health plans and $7,200 for family health plans.

Beyond 2021

The expanded CTC is available only for 2021 as of now. President Biden has indicated that he’d like to extend it through at least 2025, and some Democratic lawmakers hope to make it permanent. But it’ll be challenging to pass a bill to make either of these proposals happen. We’ll keep you informed about any developments that could affect your tax planning.

Read our additional CTC resources: