Regulating Tax Return Preparers

Do you realize that hairdressers are more heavily regulated than a mom and pop tax shop who offers to prepare your tax return? There is even reported to be a Laundromat in the Bronx offering tax prep services.

In most states, anyone can set up shop and offer tax preparation services without needing to demonstrate any level of competency.  Currently, only three states (California, Maryland, and Oregon) have laws addressing the necessary qualifications to prepare federal or state income tax returns.

Shouldn’t you look for a well-qualified individual to prepare your taxes? After all, you are legally responsible for the information in your tax return whether you pay someone else to prepare it or not.

The Internal Revenue Service tried to regulate unregistered tax preparers but has been temporarily stopped as the result of U.S. District Judge James E. Boasberg’s ruling in favor of three independent tax preparers. The judge found the IRS had exceeded its statutory authority in imposing requirements for mandatory testing and continuing education for tax return preparers. Congress is considering giving the IRS that authority.

Not everyone is waiting on the IRS.  The state of New York, Department of Taxation and Finance, proposed amendments to its Personal Income Tax Regulations and Procedural Regulations to regulate New York tax return preparers. The proposed rules would add requirements imposing minimum standards on who can become a tax return preparer, instituting a continuing education requirement, and requiring a competency exam, all similar to the IRS‘s Registered Tax Return Preparer  (RTRP) program.

To further muddy the water, the new Commissioner of the IRS, John Koskinen, has come out in favor of a volunteer tax preparer certification. This is basically the RTRP approach only on a volunteer basis rather than a mandatory requirement.

Three approaches to regulating tax preparers have been offered:

1.     Wait until Congress gives the IRS authority to regulate tax preparers.
2.     Implement tax preparer regulations by state governments.
3.     Adopt a volunteer certification program.

Only time will tell which of these options will win. Which one do you think should be used?

State Governments to Regulate Unlicensed Tax Preparers

According to governmental regulators, tax return preparation problems are more likely to occur among small mom-and-pop tax return firms. In November 2013, The National Consumer Law Center, a consumer-advocacy group, reported on examples of unlicensed tax preparer problems and called for states to enact their own rules. The Internal Revenue Service’s attempt to regulate these unlicensed tax preparers was blocked by a law suit filed by a libertarian group opposing the federal regulations. (RTRP Rules Challenged) The Obama administration has appealed the ruling and a decision is expected in the near future. In addition, legislation has been introduced in Congress that would give the IRS the authority to impose regulations on unlicensed tax return preparers.

New York is now the fourth state to pass regulations governing unlicensed tax return preparers, joining the states of California, Oregon, and Maryland. New York will require independent preparers to pass a competency test and take continuing education classes before being allowed to prepare income tax returns for the public.

Among the new rules, New York preparers cannot charge “an unconscionable fee” and must adhere to “best practices” according to the New York Department of Taxation and Finance site. The state’s new rules became effective December 11, 2013 and carry possible criminal penalties.

New York taxpayers will eventually be able to look up tax preparers on the department’s web site to see if they are complying with the rules. A spokesperson for the department indicates that they will be investigating complaints, assessing penalties and seeking criminal prosecution.

What do you think? Should the states or the federal government be the authority to regulate unlicensed tax preparers? 

SEC Releases Proposed Rules on Crowdfunding for Security Offerings

The Jumpstart Our Business Startups Act (the JOBS Act) was signed into law in April 2012, and it created a new Section 4(6) of the Securities Act of 1933. This new section exempts crowdfunding security offerings from Securities Exchange Act of 1934 (the Exchange Act) registration and its periodic reporting requirements. The JOBS Act directed the SEC to adopt rules to implement various provisions of the crowdfunding security exemption.

On October 23, 2013, the SEC voted unanimously to release its proposed rules for the crowdfunding security exemption of the JOBS Act (Proposed Rulemaking Release No. 33-9470). The proposed rules appeared in the Federal Register on November 5, 2013, and the comment period runs through February 3, 2014.

Certified public accountants may be interested in these proposed rules if they have clients who desire to sell securities to investors through crowdfunding. In addition, some clients may be interested in purchasing securities that are offered by companies via crowdfunding.

Since the proposed rules are over 500 pages long, today I will only provide background information regarding the crowdfunding securities exemption and mention what entities do not qualify for the exemption and what limitations are placed on investors under the JOBS Act and the proposed rules.

Background

Crowdfunding is a method to raise money using the Internet and serves as an alternative source of capital to support a wide range of ideas and ventures, including charities, civic projects, creative projects, disaster relief, inventions development, and scientific research. When individuals or entities raise funds through crowdfunding, they typically seek small individual contributions from a large number of people. The crowdfunding campaign generally has a targeted amount to be raised and an identified use for those funds. Individuals interested in the campaign may share information about the endeavor with each other and use the information to decide whether or not to fund the campaign.

Crowdfunding has been used to fund, for example, artistic endeavors, such as films and music recordings, where contributions or donations are rewarded with a token of value related to the project. For example, a person contributing to a film's production budget is rewarded with tickets to view the film and is identified in the film's credits. A number of entities operate websites that facilitate crowdfunding, with some websites specializing in certain industries, such as music and the arts. Some of the more popular crowdfunding sites include Kickstarter, Indiegogo, Crowdfunder, RocketHub, Crowdrise, and appbackr.

The idea behind the crowdfunding security exemption in the JOBS Act is to allow private companies to raise relatively small amounts of capital from a large number of investors without having to register the securities issued with the SEC or under state blue sky laws. The proposal would let businesses use the Internet, mobile technology, and social media to raise up to $1 million a year from investors via crowdfunding. Under the JOBS Act, the SEC is required to adjust the $1 million dollar amount every five years to reflect changes in the Consumer Price Index.

Under the proposed rules, the crowdfunding security exemption would not be available to any of the following:

• Foreign issuers
• Issuers already subject to the periodic reporting requirements of the Exchange Act
• Investment companies
• Issuers not having a specific business plan or having indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies
• Issuers that have sold securities in reliance of the crowdfunding exemption during the previous two years but have not filed with the SEC and have not provided to investors the annual reports required by the crowdfunding regulation
• Issuers that are otherwise disqualified because they are associated with felons or other “bad actors”

Limitations for Investors

The original petition to create a crowdfunding securities exemption was submitted to the SEC in 2010 prior to the JOBS Act. Under the terms outlined in the petition, investors would have been allowed the opportunity to help entrepreneurs raise capital by creating an exemption from the federal filing requirements as long as the investors did not invest more than $100 per security offering. Although this petition did not succeed, it did spark an interest in the subject that was realized in the JOBS Act.

Under the JOBS Act and the proposed rules, individual investors who wish to invest in crowdfunded investments would be permitted to invest up to $2,000 or 5% of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.

Investors with annual income or net worth that is more than $100,000 would be allowed to invest up to 10% of their annual income or net worth, whichever is greater but with an annual cap of $100,000.

Investors would not be able to resell the securities for one year.

Investors have an unconditional right to cancel an investment commitment within 48 hours after making it. However, a cancellation during the final 48 hours of the crowdfunded offering is only permitted if there is a material change to the offering terms or to other information provided by the issuer with respect to the offering.

The annual income and net worth limitations have made the maximum allowable investments under the JOBS Act much higher than the cap of $100 per offering that was in the original petition. Perhaps Congress equates success with converting a simple idea to something much more complex? The increase in the investment amount has substantially increased the possible risk to investors. Given that the mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, this might explain the length of the proposed rules.

In my next blog, we will look at the use of intermediaries and the reporting and disclosure requirements associated with securities offered through crowdfunding.

Valuing and Accounting for In-kind Gifts

With the end of the year rapidly approaching and the holiday season close at hand, you may be thinking about how to get rid of clothes you haven’t worn in several years or that extra piece of furniture you no longer need. Your first thought is probably to give it to a charitable organization.

Have you ever wondered how a nonprofit organization accounts for noncash assets or in-kind gifts? Or maybe you are the accountant for a charity; trying to be sure you have properly accounted for and reported the in-kind gifts your organization received.

Nonprofit organizations receive varied donations from the public, including donations of cash and noncash assets. The accounting recognition and measurement requirements related to noncash contributions are generally the same as those for cash contributions. That is, they are measured at fair value and recognized as contributions when received by the nonprofit organization. There are however, accounting issues specific to certain types of noncash contributions including in-kind gifts. I will try to answer some questions about defining, recognizing, tracking, and finding help for valuing in-kind gifts.

What are in-kind gifts?

Donations such as thrift-store inventory, contributed advertising; and marketing media; donated items sold for fund-raising purposes; gifts of long-lived assets; and vehicles received in connection with vehicle donation programs are examples of in-kind gifts. In-kind gifts include contributions of tangible and intangible personal property. Tangible in-kind gifts include contributions of items such as clothing, furniture, equipment, inventory, pharmaceuticals, and supplies. Intangible in-kind gifts include contributions of items such as advertising, other services that aren’t considered personal services, patents, royalties, and copyrights.

When is an in-kind gift NOT an in-kind gift?

Even if the organization has decided to accept gifts-in kind, it may not be the recipient of a contribution. Sometimes, donated materials or supplies are passed from one organization to another at the request of the donor. If a donor doesn’t give the nonprofit organization the discretion to choose who will get the donated items, the nonprofit organization serves only as an agent, and the donated materials aren’t reported as contributions revenue when received. Likewise, when the nonprofit organization distributes the donated materials or supplies to the ultimate beneficiary, the transfer isn’t reported as a contribution made.

Do in-kind gifts have to be tracked?

Although it can be challenging to track and value in-kind gifts, the difficulty in doing so isn’t an acceptable reason for not recognizing them. FASB ASC 958-605-30-11 states that in-kind gifts that can be used or sold should be measured at fair value. Thus, it isn’t appropriate to state in the notes to the financial statements that the value of noncash contributions isn’t reflected in the financial statements because it is impracticable (or difficult) to estimate the value. It also isn’t appropriate to state that in-kind gifts aren’t recognized because there is no objective means of valuing them. A good faith attempt to determine value results in better information in financial statements about an organization’s level of contributions and programs than no value at all.

Where can I find help valuing in-kind gifts?

Locating resources to assist organizations in valuing in-kind gifts, other than property, isn’t always easy. Authoritative literature provides only broad, general guidance, and many organizations struggle to find useful guidelines to help value donated assets. Four resources providing guidance on valuing various types of in-kind-gifts are as follows:

·       Online prices.

·       Salvation Army’s Donation Valuation Guide.

·       TurboTax® Its Deductible® Software or Book Edition

·       IRS Publication 561, Determining the Value of Donated Property.

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Health Care Reform Raises Rates and Reduces Exemptions

Effective for 2013, new rules have increased taxes or reduced exemptions on higher earning taxpayers, making effective year-end tax planning even more important.

Under the Affordable Care Act there is a higher payroll tax and surtax on unearned income of higher-income individuals. Under the American Taxpayer Relief Act of 2012 higher tax rates apply to ordinary income, capital gains and dividends, while at the same time limitations are imposed on the use of the personal exemption and itemized deductions.

For tax years beginning after Dec. 31, 2012, the following new rules apply:

• Increased payroll tax.  A new 0.9% hospital insurance tax (FICA payroll tax) applies to wages received in excess of $250,000 for joint returns; $125,000 for married filing separate; and $200,000 for all other taxpayers. The additional 0.9% tax also applies to self-employment income that meets or exceeds the above thresholds.
• Surtax on unearned income. An unearned income Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the tax is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over $250,000 for a joint return or surviving spouse, $125,000 for married filing separate, and $200,000 for all others.
• Higher individual income tax rates. The income tax rates for most individuals stay the same as in 2012. However, a new 39.6% rate applies for 2013 income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
• Increased capital gain and dividend tax rates. The top 2013 tax rate for capital gains and dividends rises to 20% for taxpayers with incomes exceeding $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
• Personal exemption phase out. There is a personal exemption phase out  for 2013 with a beginning threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Under the phase out, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's adjusted gross income exceeds the above threshold.
• Limited itemized deductions for high earners. There is a limit on itemized deductions for 2013 for earners with a threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Thus, the itemized deductions of taxpayers subject to this limitation will be reduced by 3% of the amount by which their adjusted gross income exceeds the threshold amount. The reduction will not exceed 80% of otherwise allowable itemized deductions..

Year-end tax planning may be especially productive this year because timely action by the taxpayer could secure significant tax breaks.

What do you think?

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Bankrupt Local Governments

Local governments of all sizes are facing significant budget deficits and have been for years. These deficiencies have eroded municipalities’ ability to pay their debts. As a result some municipalities have resorted to filing for bankruptcy protection under Chapter 9, Title 11, of the United States Code. Chapter 9 is available exclusively to municipalities to assist them in restructuring their debts. Most recently the city of Detroit, Michigan took advantage of Chapter 9 and became the largest municipal bankruptcy in U.S. history with debts totaling over $18 billion. Detroit replaced Jefferson County Alabama, as the largest municipal bankruptcy with debts of over $4.2 billion.

According to the website Governing, municipal bankruptcy remains relatively rare. A Governing analysis estimated that only one of every 1,668 eligible general-purpose governments (counties and cities) filed for bankruptcy protection over the past five years. One of the reasons for this low level of bankruptcy filings is that states must have in place laws authorizing municipal bankruptcy before a municipality can take advantage of Chapter 9. Only about half of the states have enacted such laws. The state then must approve of the municipality entering bankruptcy. States that have not enacted such laws often have other measures providing financial relief.

The cause of most municipal bankruptcies can frequently be attributed to the accumulation of large amounts of debt, usually from one or more of the following:

• Unfunded pension liabilities
• Unfunded health care benefits
• Mismanagement
• Over-budget capital projects
• Reduced state and federal aid
• Reduced tax revenues

According to the Wall Street Journal, “Detroit’s municipal pension funds awarded retirees, in some years, more than a 20% return on their annuities even as the funds lost value” contributing to the financial crisis. The pension debt has ballooned to nearly one-fifth of the city’s total debt. CNN reported that “Detroit spends roughly 38 percent of its annual budget on these types of ‘legacy’ costs leaving only 62 percent of spending for education, infrastructure, police and firefighters.”

Municipal bankruptcies are handled at the federal level, so constitutional issues prevent the judge from dictating how a municipality is run. Thus, the judge cannot mandate actions such as tax increases, budget cuts, asset sales or the removal of local politicians.

I think that there should be a mandatory requirement for all politicians, including the ones in Washington, D.C., to take, and pass, a course on fundamental accounting before being allowed to take office. It seems that no one understands the basic concept that if you spend more than you take in, year after year, you will eventually end up like the city of Detroit--bankrupt!

What do you think?

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CRIMINAL ACCOUNTANTS

Embezzlement – The theft or misappropriation of funds placed in one’s trust or belonging to one’s employer.

It seems like all you have to do these days is pick up a newspaper and you will find an article about an embezzlement similar to the following one reported by WFAA.com: “Former Collin Street Bakery accountant accused of embezzling more than $16 million from the renowned fruitcake maker.” What concerns me most about this crime is that the embezzler was the accountant.

The accountant for Collin Street Bakery worked for the company for fifteen years and was a trusted employee. He allegedly spent the last eight of those years embezzling $16.65 million dollars from his employer. The money was used to support an extravagant lifestyle that included 43 luxury automobiles and a house in New Mexico. The person who committed the embezzlement was the employee who understood how the accounting system worked and used that knowledge to cause 888 fraudulent checks to be sent to his personal creditors, according to the FBI.

When I began my accounting career, I pledged to adhere to a Professional Code of Conduct. I also pledged to adhere to my employer’s Code of Business Conduct and Ethics. I take both pledges seriously. Evidentially there are a growing number of accountants who do not feel that codes of conduct apply to them.

In the past few months, I have seen the term embezzlement used too often along with the title “Accountant.” The connection is usually in a newspaper article about an alleged embezzlement committed by an accountant.

Why Are Embezzlements Happening So Often?

According to a survey conducted by the Association of Certified Fraud Examiners (ACFE), instances of fraud are increasing nationwide, both in number of incidents and the dollar amount of the losses.   

Unfortunately this is nothing new. My first audit as a junior auditor forty-five years ago, uncovered an embezzlement of over $75,000 by the accountant. It was not the last audit assignment in which I encountered embezzlement. It may just be better media coverage that has brought this topic to our attention, but it seems to me that embezzlement is more common today than in the past. Maybe it is not just embezzlement. Maybe it is dishonesty in general.

Embezzlements by Accountants

The following examples of embezzlements by accountants in the last five years shows that everyone— Fortune 100 companies, public companies, governmental entities, and small private companies—is susceptible to this crime.

·       Citigroup                                            $19.20  million in losses                   2011

·       Collin Street Bakery                           $16.65  million in losses                   2013

·       South Carolina Education Lottery        $ 226.4 thousand in losses               2012

·       Kemp Construction                            $ 208.0 thousand in losses               2009

In each of these cases, the alleged fraud was perpetrated by a trusted accountant.

How Can these Crimes be Prevented?

Someone once said that “Trust is not an internal control it’s only a feeling.” In all of the examples listed above management or owners of the business trusted their accountant.

Our inherent desire to believe that all of our employees are trustworthy gives us a false sense of security. Add a lack of resources or desire to implement necessary controls and you have a recipe for embezzlement.

The solution to this problem is simple to identify, but often difficult to implement. Separation of duties and implementation or execution of a few internal controls could have prevented or at least reduced the losses in each of the embezzlements listed above. If a company does not have the resources to develop and maintain appropriate internal controls, it is virtually impossible to prevent embezzlement. However, with just a small amount of effort, a company can hold its losses to a minimum.

What do you think?


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