Today's CPA Jul/Aug 2018

Today’sCPA JULY/AUG 2018

TE X AS SOCIETY OF

C E RT I F I E D P U B L I C AC C O U N TA N T S

Celebrity Clients: High Profile and High Risk Strategies to Protect Highly Appreciated Stock Positions A Good Day at the Office – Corporate Tax Rates Coming Down

Conversation with the Chairman

Take the CPE Quiz Online.

See Page 44 for details.

Also: A Practical Roadmap Through Section 199A

Today’s CPA Magazine is Going Digital!

Today’s CPA is going digital for September/October. Watch your inbox for details and enjoy the convenience of this valuable member resource on your device or home or office computer

TSCPA Conferences

Learning Opportunities in 2018 Make plans now to attend TSCPA conferences.

Come for the sessions, benefit from networking with your colleagues and leave with the knowledge you need to advance your career.

Galveston CPE Cluster July 30-August 1

Single Audits & Governmental Accounting Conference Austin, October 1-2

Texas State Taxation Conference Webcast, August 7

Texas CPA Tax Institute Addison, November 15-16 San Antonio, November 15-16

Advanced Estate Planning Conference & Pre-Conference Workshop San Antonio, August 15-17 Financial Institutions Conference Dallas/Addison, September 10-11

CPE EXPO Conference Dallas/Addison, November 29-30 San Antonio, December 3-4 Houston, December 10-11

Plus - did you know that TSCPA offers thousands (yes, literally thousands) of webcasts and on demand programs? With the huge variety of topic choices, chances are great that you’ll find the program you need.

For more information and to register for live and online learning opportunities, go to our website at tscpa.org or call 800-428-0272, option 1, for personal assistance.

CONTENTS

CHAIRMAN

VOLUME 46, NUMBER 1 JULY/AUGUST 2018

Stephen Parker, CPA

PRESIDENT/CEO Jodi Ann Ray, CAE, CCE, IOM

EDITORIAL BOARD CHAIRMAN Aaron Borden, CPA

Staff MANAGING EDITOR DeLynn Deakins ddeakins@tscpa.net 972-687-8550 800-428-0272, ext. 250

cover story 24 Conversation with the Chairman society features 12 Spotlight on CPAs Priscilla Soto, CPA-San Antonio

TECHNICAL EDITOR

16 Capitol Interest States Are Where the Legislative Action Takes Place

Brinn Serbanic, CPA, CFP® technicaleditor@tscpa.net

technical articles

COLUMN EDITORS Jason B. Freeman, CPA, JD Mano Mahadeva, CPA, MBA Don Carpenter, MSAcc/CPA

WEB EDITOR Wayne Hardin whardin@tscpa.net

CONTRIBUTORS Melinda Bentley; Rosa Castillo; Anne Davis, ABC; Roxanne LaDu; Rhonda Ledbetter; Craig Nauta; Kim Newlin; Catherine Raffetto; John Sharbaugh, CAE; Patty Wyatt

DIRECTOR, MARKETING AND COMMUNICATIONS Melinda Bentley, CAE

CLASSIFIED DeLynn Deakins Texas Society of CPAs 14651 Dallas Parkway, Suite 700 Dallas, Texas 75254-7408 972-687-8550 ddeakins@tscpa.net.

Editorial Board Arthur Agulnek, CPA-Dallas; Aaron Borden, CPA-Dallas; Melissa Frazier, CPA-Houston; Jason Freeman, CPA-Dallas; Michael Hallick, CPA-Dallas; Baria Jaroudi, CPA-Houston; Brian Johnson, CPA-Fort Worth; Jennifer Johnson, CPA-Dallas; Tony Katz, CPA-San Antonio; Joseph Krupka, CPADallas; Randy Lokey, CPA-Dallas; Mano Mahadeva, CPA-Dallas; Alyssa Martin, CPA-Dallas; Stephanie Morgan, CPA-East Texas; Marshall Pitman, CPA-San Antonio; Kamala Raghavan, CPA-Houston; Barbara Scofield, CPA-Permian Basin.

Design/Production/Advertising American Business Media www.ambizmedia.com

18 Celebrity Clients: High Profile and High Risk 28 Strategies to Protect Highly Appreciated Stock Positions, Part 1 34 A Good Day at the Office – Corporate Tax Rates Coming Down 40 CPE Article: What to Consider When Making an Accounting Change columns 4 Chairman’s Message No More Bubbles: All Texas CPAs Should Be Involved 6

Tax Topics A Practical Roadmap Through Section 199A

8 Business Perspectives An Eye for Detail 9 Accounting & Auditing Non-GAAP Measures: SEC Serves Notice That it’s Serious 10 Chapters 2018-2019 TSCPA Chapter Officers departments 14 Take Note 45 TSCPA CPE Course Calendar 46 Classifieds

© 2018, Texas Society of CPAs. The opinions expressed herein are those of the authors and are not necessarily those of the Texas Society of CPAs. Today’s CPA (ISSN 00889-4337) is published bimonthly by the Texas Society of Certified Public Accountants; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408. Member subscription rate is $3 per year (included in membership dues); nonmember subscription rate is $28 per year. Single issue rate is $5. Periodical POSTAGE PAID at Dallas, TX and additional mailing offices. POSTMASTER: Send address changes to: Today’s CPA; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408.

CHAIRMAN’S MESSAGE

No More Bubbles: All Texas CPAs Should Be Involved Editor’s Note: In this first Today’s CPA issue of the Society’s new fiscal year, incoming TSCPA Chairman Stephen Parker, CPA-Houston, discusses plans for 2018-2019.

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By Stephen Parker, CPA, 2018-2019 TSCPA Chairman

ot too long after my career began 30 years ago, I became involved with the Houston Chapter of TSCPA and realized something … I’d been living professionally in a bubble. An ambitious young man focused on the partner track with a large public accounting firm, I’d taken for granted the larger job our state Society does to protect our profession and our CPA certification, the advocacy component of the Society’s strategic plan.

I felt guilty then and I feel even more concerned now as I travel around the state.

While I am thoroughly enjoying meeting all kinds of great and interesting CPAs, some of them are, unfortunately, living in bubbles of their own.

This June marked the beginning of my 2018-19 year’s service as your TSCPA chairman. I wish I could walk in the door and flip a switch so that all of a sudden, all CPAs in Texas would understand the importance of the advocacy function at our state Society. This affects everyone. There is no firm too big or too small to be safe without this representation. This affects the sole practitioner, the industry CPA and the CPA in education or government.

This year will bring our sunset review process before the Texas Legislature. For those of you unaware of what this will entail, every aspect of how our profession functions in Texas will be on the table for discussion. TSCPA is preparing to explain why certification is necessary to protect the public in the practice of accounting. We will need to justify the existence of the Texas State Board of Public Accountancy, the agency that enforces professional standards. Unless we successfully defend the need to have only CPAs with licenses operating as accountants, and to have the State Board continue to issue those licenses and administer licensing requirements, our professional status is in jeopardy.

My job will be to stay informed about this process and be prepared to speak to the state legislature as necessary. That’s your job too and we’ll be informing you how to play a part as sunset approaches. It’s priority number one.

Growing the Younger Population of Members We also have to appeal to the younger members of our profession, those who will don the advocacy mantle in the future. My mentor brought me to my first TSCPA chapter meeting and I’m going to need more of you to step up to mentor new members.

It’s important to attract more students into the profession in the first place. Even if we convince them to study accounting, it’s not 4

automatic for them to get certified, to take the exam. As a Texas A&M University graduate, I've spent many years recruiting and emphasizing the importance of becoming a CPA to accounting students. Given that one of TSCPA’s pressing goals is to grow our younger population, it seems natural to expect me to do even more in that area.

So I have already called on A&M in some respects. I think I need to start there, but then make myself available to travel the state and talk to other institutions and any other student groups about what this great organization has to offer them. If you are interested in being part of our speakers’ bureau, contact TSCPA about your availability.

I know you’ll find working with schools and universities to develop future CPAs and TSCPA members very rewarding.

The Big Four TSCPA Comeback For decades, the larger public accounting firms were TSCPA’s biggest supporters and cheerleaders. However, it’s been almost 20 years since a Big Four partner like me served as Society chairman.

That’s no coincidence.

Maybe we got too big – or too busy. At the Big Four, we now provide our staff most of the continuing professional education they need and have also gotten great about sponsoring community service opportunities. At the end of the day, too many of our staff think: "I work all day with a bunch of CPAs. Why do I want to go join another group made up of a bunch of CPAs?" I get that, but the reality is that for many of our people, their time at PwC is going to be temporary; most of the young CPAs we hire leave our firm eventually. That's the case for all the big firms. Young professionals move on. While it’s great that they become our alumni, it’s through local and state association involvement that their network becomes larger each year and follows them as their careers progress.

There's no substitute for the ability to grow a professional network.

It's a huge benefit.

Finally, I think I'm in a unique position to go to the Big Four and say: "We need your help. You need to support the profession through TSCPA. You need to encourage membership among all the CPAs on your staff." I pledge to do that, to convince them that we share a responsibility to protect the CPA certificate and to give back to our profession. n

Stephen Parker, CPA

is a partner in PwC’s Houston assurance practice. He can be contacted at stephen.g.parker@pwc.com.

Today’sCPA

SPONSORED CONTENT FROM

& ABLE TAX ACCOUNTING PRACTICE SALES

So You Want to Buy or Sell an Accounting Practice?

Here Are The Keys

I understand how uncomfortable this process can be. I sold my practice in 2003 and handed over the keys to a business that I worked so hard to build.

I understand that it is far more than brick and mortar. The truth is that no two practices are the same in operation and to make it more serious, the sale of a practice is usually one of the largest assets in a seller’s retirement program. So the careful understanding of the seller’s practice is important to finding the best successor, both financially as well as operationally. In my experience, there are three “keys” to success when considering the sale of a practice.

PREPARATION In many instances, we find that the primary reason for practitioners selling their practice is because of the difficulty of managing and understanding paperless reporting systems. This is not a weakness of senior practitioners but an important and overwhelming concern for our industry. Boomers and the previous generations did not grow up with the Internet, while Millennials don’t know any other way of life. So how does a Post-WWII generation owner sell a significantly less tech-savvy client base and practice to a practitioner who is a product of the computer age and have some responsibility for the success? We accomplish this by working

constructively and exercising patience, inside the operating office, to phase in high tech processing with senior clients.

Assisting clients with this process early on helps to improve the marketability of a practice significantly and lays the groundwork for a successful transaction later.

COMMUNICATION To ensure a positive experience that benefits that buyer, seller and clients of a practice in transition, we find that open lines of communication and a thorough walk-through of all aspects of a practice are essential. Communication involves understanding the strengths and weaknesses of the seller’s practice, including the training level and experience of staff, the sophistication level of the reporting applications and the costs related to them. There must also be an understanding of the amount of operating and processing time that a buyer and staff would need to contribute to the new association. We must know which staff members of the selling unit would likely continue and which ones might be eliminated in the near term after consolidation and discuss any non-compete agreements that exist. It is important to find the seller’s comfort zone and conditions related thereto, and then the transfer is half completed.

BUYERS The last and most essential element of the acquisition process is buyers. Even after

Gary Hankins, CPA is the CEO of Able Tax & Accounting Practice Sales. He can be reached at 817.738.3287 or hankins@ableta.com. Learn more at www.ableta.com.

all the careful planning and preparations, negotiators are still vitally important to the success of a transfer. Most brokers already have identified and verified quality buyers, especially in the larger populated areas. They are usually skilled in negotiating and arranging financing and can help ensure a smooth transition and work tirelessly to get top dollar for clients. Remember, this is a relationship business and there will always be questions the negotiator should be prepared to address before making a final recommendation. As a general rule, the more buyer candidates being considered, the better the ultimate decision will be.

Sellers generally choose the buyer firm that, if they were 25 years younger, they would partner with.

In conclusion, partnering with an experienced, reputable broker is the best way to avoid the pitfalls of a practice transition. Timing is also critical when sellers are approaching that time to retire. The selling opportunity is usually limited to the May to November period following the tax season.

The key ingredient for sellers is to contact a qualified broker as soon as possible and preferably before the April 15th tax deadline.

TAX TOPICS

A Practical Roadmap Through Section 199A

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By Jason B. Freeman, JD, CPA | Column Editor

erhaps no other provision of the Tax Cuts and Jobs Act of 2017 has given rise to more speculation, debate and consternation than new Section 199A. The complex maze that is Section 199A introduces a set of rules and formulas that determine when a taxpayer qualifies to deduct 20 percent of certain income from pass-through trades or businesses.

The provision, which was designed to bring parity to such income, has widespread application – and many unresolved issues.

It is widely anticipated that the IRS will issue guidance in the near future. If and when that guidance is issued, this column will provide a second installment on this topic, diving deeper into the gray areas. For now, however, what follows is a practical roadmap without detours.

The General Rule Section 199A generally provides individuals, trusts and estates with a deduction equal to 20 percent of the taxpayer’s Combined Qualified Business Income (Combined QBI). The phrase Combined QBI is generally defined as the aggregate of the “deductible amount” (described below) for each “qualified trade or business” that flows to the taxpayer.

Read the prior sentence carefully, because it contains an important point: Combined QBI is determined on a “trade or business”by-“trade or business” basis. Unfortunately, what constitutes a distinct trade or business for Section 199A purposes is not entirely clear from the statute.

Qualified Trades or Businesses and Specified Service Trades or Businesses As a general rule, the phrase “qualified trade or business” does not include a “specified service trade or business” or the trade or business of performing services as an employee. Thus, again as a general rule, 6

income from a specified service trade or business is not eligible for the 20 percent deduction under Section 199A. A specified service trade or business is any trade or business that involves the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.

A specified service trade or business also includes any trade or business that involves the performance of services that consist of investing and investment management, trading or dealing in securities (as defined in section 475(c)(2)), partnership interests or commodities (as defined in section 475(e)(2)).

While income from a specified service trade or business is generally not eligible for the 20 percent deduction, there is

an exception for taxpayers with taxable income below certain threshold amounts.

The threshold amount is $157,500 (and $315,000 for taxpayers filing married filing joint).

As a result, taxpayers with taxable income below this threshold are not prohibited from taking the 20 percent deduction for income derived from activities that would otherwise be classified as a specified service trade or business.

For taxpayers with taxable income over the applicable threshold amount, but less than $207,500 (or $415,000 for taxpayers filing married filing joint), the specified service trade or business exclusion is “phased in,” allowing a partial benefit.

Once a taxpayer’s taxable income exceeds these amounts, the specified service trade or business rule effectively prohibits any Section 199A deduction for income that is attributable to the specified service trade or business.

Today’sCPA

Qualified Business Income The definition of “qualified business income” is central to the Section 199A deduction analysis. QBI is statutorily defined to include the net amount of “qualified items of income, gain, deduction and loss with respect to any qualified trade or business of the taxpayer.” This amount includes all such items (income, gain, deduction and loss) to the extent they are “effectively connected” with the conduct of a trade or business within the United States and included or allowed in determining taxable income for the year.

It specifically excludes, however, qualified investment income, including dividends, capital gain or loss, investment interest, commodities gains or losses, foreign currency gains or losses, and certain annuity amounts; REIT dividends, qualified cooperative dividends and qualified publicly traded partnership income; reasonable compensation paid to the taxpayer for services for the trade or business; Section 707(c) guaranteed payments paid to the taxpayer for services performed for the trade or business; or Section 707(a) payments to the taxpayer for services performed for the trade or business.

The Deductible Amount After determining the separate and distinct qualifying trades and businesses and their QBI, the next step in the Section 199A analysis is to determine the “deductible amount,” if any, that flows from such trades or businesses to the taxpayer in order to compute the taxpayer’s Combined QBI. The “deductible amount” for each “qualified trade or business” is generally equal to the QBI with respect to the qualified trade or business, although such amount is limited to the greater of (i) 50 percent of W-2 wages with respect to the qualified trade or business (the W-2 Wage Limitation) or (ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property (the Alternative Limitation). In other words,

Jason B. Freeman, JD, CPA Today’sCPA July/August 2018

the deductible amount for each trade or business cannot exceed the greater of these two possible limitations.

By way of example, if a qualified trade or business has (i) QBI of $100, (ii) W-2 wages of $150 and (iii) qualified property with an unadjusted basis of $200, then the “deductible amount” with respect to that trade or business would be $75. The deductible amount is calculated as the lesser of QBI ($100) or the limitation amount, which is equal to the greater of two amounts: (i) the W-2 Wage Limitation, which is 50 percent of $150 and thus equals $75 in the example and (ii) the Alternative Limitation, which here is $42.50 (25 percent of W-2 wages, which is $37.5, plus 2.5 percent of the unadjusted basis of qualified property, which is $5). The greater of the two possible limitations ($75 or $37.5) is, therefore, $75; and the lesser of QBI ($100) and the applicable limitation ($75) is $75, leaving a “deductible amount” of – you guessed it – $75.

The Limitations For purposes of the W-2 Wage Limitation, W-2 wages are defined as total wages paid by the qualified trade or business that are subject to withholding, elective deferrals and deferred compensation with respect to employment of employees. W-2 wages do not include any amount that is not properly allocable to QBI, nor do they include any amount that is not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date for such a return.

The term “qualified property” is defined as tangible property with respect to any qualified trade or business of a character that is subject to depreciation allowance under section 167 and that meets three tests: (i) it is held by, and available for use in, the qualified trade or business at the close of the tax year, (ii) it is used at any point during the tax year in the production of QBI and (iii) the depreciable period for the property has not ended before the close of the tax year. Notably, for these purposes, the property’s “depreciable period” is

defined as ending the later of the date that is 10 years from the date it was first placed in service by the taxpayer or the last day of the last full year in the applicable recovery period that would apply to the property under section 168.

Limitations on the Limitations The limitations don’t always apply.

Specifically, the W-2 Wage Limitation and the Alternative Limitation do not apply – that is, they do not limit the “deductible amount” – whenever the taxpayer’s taxable income is below a threshold amount.

That threshold amount is $157,500 (and doubled to $315,000 for taxpayers filing married filing joint). Thus, taxpayers with taxable income below the applicable threshold amount are simply not subject to these limitations.

For taxpayers with taxable income exceeding these threshold amounts, the limitations are “phased in.” Thus, the limitations are partially “phased in” over the next $50,000 of taxable income (or $100,000 for married individuals filing jointly) that exceeds the applicable threshold amount; they apply in full, however, for taxpayers with taxable income over the sum of the threshold amount and the phase-in amount (i.e., over $207,500 or $415,000 for married individuals filing jointly).

The Provisions are Complex Section 199A introduced a Byzantine set of rules and formulas that determine when a taxpayer qualifies to deduct 20 percent of certain income derived from pass-through trades or businesses. Its provisions, which were designed to bring parity to passthrough trade or business income, leave many open questions and have been the subject to much debate. The foregoing article provides an overview.

As for the many subtle and unanswered questions, expect to see guidance from the IRS in the near future addressing a number of those provisions. At that time, we intend to take up the task of further fleshing out those provisions in this column. n

is the managing member of Freeman Law PLLC, based in the DFW Metroplex, and an adjunct professor of law at Southern Methodist University’s Dedman School of Law. He can be reached at Jason@freemanlaw-pllc.com.

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BUSINESS PERSPECTIVES

An Eye for Detail

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By Mano Mahadeva, CPA, MBA | Column Editor

ongratulations! You have identified a company that offers you a platform to expand your strategy. You hire an adviser to help with this transaction. Your legal team drafts a letter of intent, which is sent to the target company for acceptance of your proposed buyout. Euphoria permeates in the board room with a great feeling of accomplishment!

Next begins the process of due diligence, a mysterious amoebic process. This takes many shapes and forms and typically includes: a quality of earnings exercise; tax, legal and regulatory due diligence; a series of meetings between the management teams and key board members; and the earnest scrutiny of many thousands of documents associated with the target and its recent history.

A high-quality strategic due diligence is a key component of a successful M&A strategy – it assesses the heart of the deal and helps answer questions of your investment thesis, such as: Is there truly a return on your investment? Is the potential realizable? Is the overall goal attainable? It really is an integrity check on all aspects of the target’s business model and its sustainability, team, product and plans. A well-managed due diligence process can also offer greater insight toward a seamless integration of the target into your company.

So, as a hive of activity begins on due diligence by teams of specialists, such as the quality of earnings exercise, many hundreds of calls between lawyers, consultants, owners and advisors, and several pairs of eyes poring over thousands of documents, does the acquiror spend sufficient time observing the activities of the target at its locations? This includes walk throughs and visits with personnel as part of the evaluation. If not, why not? Below are examples of why these activities are important and why they should be given fair time.

Company Culture. Sometimes we simply ignore, defer or underestimate the significance of people issues during the deal process. As a result, understanding the culture of the organization and the roles and responsibilities and attitudes of people may be cursory, at best. But we need to understand post-merger morale before we close to understand the collective attitude of the prospective employees to assess what they think about this deal and if they are pleased or scared about their future. Is the result a poor attitude that could undermine efforts to change the organization?

Customer Service. What about watching the activity around the reception desk? Are the receptionists focused on customers or are they playing with their smart phones? Do they greet customers well and courteously with a smile? When you walk through the administrative offices, do you see employees treating each other with respect? Do they seem focused on their activities or do they seem harried? These behaviors could provide more clues about the work environment and culture.

Mano Mahadeva, CPA 8

A STRATEGIC AND COMPREHENSIVE APPROACH THAT INCLUDES A CLEAR “VISION” WILL HELP YOU DELIVER ON THE RIGHT PRICE!

Asset Values. When we price a transaction based on a multiple of EBITDA, this would imply that the assets on the books generate the cash flows for some number of future years. What if the equipment is old and needs to be replaced immediately? Was the equipment bought as part of a prior transaction and revalued and restated on the books at an artificially higher asset value, creating a potential write off soon after we close the transaction?

One site I visited had fresh paint on equipment manufactured in 1970 to portray new equipment to its customers! What if the sites need a major facelift now? When does this get done and who pays for it? What about inventory? Would you change your mind about value if you went on site and saw unmarked, unlabeled items scattered across a site in various closets?

Compliance and Security. Think of a medical office – what if you walked through the clinic and found patient information lying around with the possibility that any person could pick up the patient information easily? What if you see laptops logged in, but the user and owner nowhere in sight? Would you have thoughts on discussion of protocols and procedures if you see specific treatments being given to patients with no physician seen in the room or proximity? What if you see used needles thrown in regular trash bags and not placed in special containers?

You get the idea – no amount of document reviews, phone conversations, in-person management conversations, disclosure statements or reps and warranties will provide such insights as described above. This can only be obtained by personal observation, interviews and walk throughs, critical in any due diligence, by experienced finance personnel.

The examples shown above will impact the way we think about valuation, due to additional capital outlays, expenditures for training and education, process and procedure realignment, and costs related to change management. A strategic and comprehensive approach that includes a clear “vision” will help you deliver on the right price! n

serves on the Editorial Board for TSCPA. He can be reached at manomahadeva@gmail.com.

Today’sCPA

ACCOUNTING & AUDITING

Non-GAAP Measures: SEC Serves Notice That it’s Serious

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By Don Carpenter, MSAcc/CPA and Elise Donaldson, MACC

or years, some public companies have asserted that GAAP results do not always accurately reflect their earnings and cash flow potential and have resorted to non-GAAP measures to “set the record straight” with investors and creditors. The Securities and Exchange Commission (SEC) has expressed concern over how these measures are being communicated and recently backed it up by imposing a significant penalty on one company. This signals that a refresher of relevant SEC guidance on non-GAAP measures might be in order.

Use of Non-GAAP Measures is Common Among Public Companies In earnings calls with analysts, many financial managers focus almost entirely on non-GAAP measures. Additionally, it is not uncommon for non-GAAP measurements to make their way into Management’s Discussion & Analysis.

One of the most common non-GAAP measures is free cash flow, which companies are free to define in a manner that they think best communicates with their constituents. Generally, free cash flow is a derivative of operating cash flow reduced by capital expenditures from the investing section of the cash flow statement. It is intended to give investors an indication of the entity’s ability to meet debt service and dividend requirements. Often, non-GAAP calculations of revenue growth and operating expenses are used to give investors an indication of what to expect in terms of recurring operational results. And with the emphasis on future expectations, this approach has some logic.

It is also common practice among publicly traded companies to “recompute” their quarterly and annual earnings to adjust for unusual or non-recurring items. This sends a stronger message to readers of the unusual nature of these adjusted items than just discussing these items or highlighting them in year-over-year reconciliations.

A review of the Fortune 100 found that 57 of them adjusted their 2017 earnings in their annual press releases, totaling a collective net income increase of over $113 billion. Even after normalizing these statistics for the impact of tax reform that resulted in material swings in 2017 earnings, half of the companies adjusted for additional items.

The most common adjustments related to the impact of acquisitionrelated costs, such as intangible amortization, increased depreciation and integration costs. But adjustments also related to restructuring charges, litigation settlements and stock compensation costs.

Notable in the earnings releases is the lack of uniformity regarding how earnings are adjusted for these items. Some releases expressed adjustments in terms of earnings per share while others adjusted operating income or income before income taxes. This makes it

difficult for readers to understand the full impact of the adjustments or compare results among companies within an industrial sector.

SEC has Long History of Non-GAAP Oversight Effective March 2003, the SEC released “Final Rule: Conditions for Use of Non-GAAP Measures” in compliance with the SarbanesOxley Act of 2002 (SOX). The release has subsequently been updated through a Q&A format on the SEC website under “NonGAAP Financial Measures.” The last update was as of April 4, 2018.

The overall theme of the SEC’s releases centers on the acknowledgement that non-GAAP measures may be meaningful metrics for measuring performance of business and industry specific measures. But balancing this acknowledgement is concern that non-GAAP measures are not standard, but rather tailored to each company. With lack of comparability, the potential for inaccurate or even misleading information is possible.

To address these concerns, the SEC has prescribed several boundaries that should be kept in mind when non-GAAP measures are presented: • A non-GAAP measure should not be featured more prominently than the nearest GAAP equivalent. Generally, the requirement can be met by presenting GAAP measures in releases or presentations prior to the inclusion of the non-GAAP equivalent. Use of fonts and other formatting tools should also be considered.

• When non-GAAP measures are presented, a schedule should be included in any communication that reconciles this measure to its non-GAAP equivalent.

• Consistency is required when adjustments to GAAP amounts, such as earnings per share, are adjusted to non-GAAP measures.

For example, a loss on the sale of assets or a business should not be adjusted in one period and a similar gain not be adjusted in the same or subsequent period.

• Adjustments should only be made for non-recurring items. The SEC suggested that if a similar item has occurred in the prior two years or is reasonably expected to occur in the next two years, it likely fails to meet this restriction. For example, many companies seem to be perpetual in restructuring. In this circumstance, it may not be appropriate to adjust earnings for restructuring charges.

With the continuing pressure to meet market expectations, companies often make adjustments to earnings for items to avoid reporting disappointing results. It is advisable to review these adjustments in light of SEC requirements prior to releasing them to the public. n

Don Carpenter

is clinical professor of accounting at Baylor University. Contact him at Don_Carpenter@baylor.edu.

Elise Donaldson

is a recent graduate of Baylor University’s Master of Accountancy program.

Today’sCPA July/August 2018

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2018-2019 TSCPA CHAPTER OFFICERS Abilene Chapter

El Paso Chapter

Jennifer K. Eller, President Chase B. Sims, President-elect Shelby Ebarb, Vice President Taylor Neatherlin, Secretary/Treasurer

Lorena H. Webb, President Tello A. Cabrera Madrid, President-elect Adrian A. Brito, Vice President Daniel Gomez, Vice President Ruth L. Elizondo Pavon, Vice President Mario Arenas, Secretary Jennifer A. Bierds, Treasurer

Austin Chapter Kristy K. Holmes-Hetzel, President Jennifer Brown, President-elect Lara Akinboye, Manager Alex Hernandez, Manager Paul B. Matthews, Manager Jeremy Myers, Secretary/Treasurer Bryan P. Morgan, Jr., Secretary/Treasurer-elect Brazos Valley Chapter A. J. Taylor, President Brian S. Kapchinskie, President-elect Emilee A. McKnight, Secretary Tara Blasor, Treasurer Central Texas Chapter Lindsey Skinner, President Sally W. Wolfe, President-elect Travis N. Skinner, Vice President Shelly R. Spinks, Secretary Scott Wiseman, Treasurer Corpus Christi Chapter Brett H. Morrison, President Kimberly N. Green, President-elect Jeffery Smith, Vice President Natalie K. Klostermann, Secretary/Treasurer Dallas Chapter Timothy S. Pike, Chair William H. Sims, Chair-elect Jennifer G. Johnson, Treasurer Janae Chamblee, Treasurer-elect East Texas Chapter Veronda F. Willis, President Keith Pfeffer, President-elect Amy L. Taylor, Vice President Thomas M. Seale III, Secretary/Treasurer

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Fort Worth Chapter Brandon R. Booker, President Norman B. Robbins, III, President-elect Jacob Briggs, Vice President Kathy DuBose, Vice President Darren A. Harriott, Vice President Sandra K. Bembenek, Secretary Mark K. Rich, Treasurer Ryan E. Scharar, Treasurer-elect Houston Chapter Mohan Kuruvilla, President J. Ramsey Womack, III, President-elect Kelly J. Hunter, Vice President Charlotte M. Jungen, Secretary Janelle M. Jones, Treasurer Lisa A. Pitts, Treasurer-elect Panhandle Chapter Karis Burgess, President Jodie Jones, President-elect Raymond Artho, Vice President Thomas Jacob Young, Secretary Taryn D. Sloan, Treasurer Permian Basin Chapter Rodrigo O. Aguilar, President Chad L. Valentine, President-elect John Michael Jaramillo, Vice President J. D. Faircloth, Vice President Derek D. Robinett, Secretary/Treasurer Rio Grande Valley Chapter Delia L. Chavez, President Delia L. Chavez, President-elect Gladys Martinez, Vice President Luis A. Lopez, Secretary Sandra Rios-Gonzalez, Treasurer

Today’sCPA

San Angelo Chapter

Southeast Texas Chapter, Continued

Sheila K. Alley, President Jacklyn Ochoa, President-elect Frances E. Grogan, Secretary Cara Barker, Treasurer

Jane Whitfield, Vice President David E. Rose, Secretary Nicholas C. Gammill, Treasurer Texarkana Chapter

San Antonio Chapter Arturo Machado, President Priscilla A. Soto, President-elect Steven K. Cannon, Vice President Gerald T. Muchando, Vice President Marina Polanco, Vice President Michael A. Meurin, Secretary/Treasurer South Plains Chapter Bryce D. Bowley, President Whitney S. Murley, President-elect Jeremy L. Stapp, Vice President Andrea L. Morgan, Secretary/Treasurer Southeast Texas Chapter Wendi C. Christian, President Chip Majors, President-elect Ryan C. Harkey, Vice President

Kevin Barnhart, President Shelley A. Brown, President-elect Selena G. Jefferies, Vice-President Tara D. Houck, Secretary/Treasurer Victoria Chapter Andrew J. Merryman, President Joshua Hanchett, President-elect Megan Bruchmiller Williams, President-elect Nominee Christopher Laughhunn, Secretary/Treasurer Wichita Falls Chapter Mark A. Anderson, President James K. Rowland, President-elect Susan B. Anders, Vice President Kathy D. Kabell, Secretary Kayla D. Heuring, Treasurer

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9/26/17 2:58 PM

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SPOTLIGHT ON CPAS

Priscilla Soto, CPA-San Antonio We recently caught up with Priscilla Soto, CPA-San Antonio, controller at Stumberg Management Group LLC. Read on to learn more about her background and a look at her volunteer spirit in action.

Where were you born and where did you grow up?

I was born in Brownsville, Texas, but grew up in Meadow, Texas – a very small town (population 571 at the time) in the Texas Panhandle, where high school football was six-man football and students got to participate in every sport or extracurricular event they wanted to! My graduating class was 13 and everyone was more family than friend. I remember playing outside until the sun went down, hoeing cotton during the summers, and waking up and turning in to the most beautiful sunrises and sunsets.

Tell us about your family. You're engaged to be married?

I grew up in a close family (and two large extended families) and was the only girl of four children to my parents. Mom was a teacher’s aide at Meadow ISD and dad was a cotton ginner and county road maintenance worker most of his life, and neither of them was a high school graduate. So, I knew early on how important it was to receive an education.

I have no children of my own, but I have two nieces and four nephews who I adore and love to spoil! I am engaged to be married, but have not yet set a date. My fiancé is a police officer with the San Antonio police department.

At what point in your life did you know you wanted to be a CPA? This may sound a bit clichéd, but I knew I wanted to be either an FBI Special Agent or a CPA when I was in the 5th or 6th grade.

What advice would you give students who aspire to become CPAs? I would advise them to focus and be studious in order to learn the technical aspects and master the skills necessary to pass the exam. It won’t be easy, but it will be worth it. However, at the same time, I would advise them to volunteer and/or work in the field so that they also gain the real work experience and feel of accounting and of a day in the life of a CPA. 12

Additionally, I recommend that they seek out mentoring and other forms of encouragement to help them pursue and obtain their CPA license.

I would tell them that becoming a CPA opens so many doors.

There are many challenges in our field of work, but along with challenges come opportunities. Having a CPA license will serve them well as a solid foundation regardless of which direction they want to take their career.

What work is on your desk today?

I have financial statements that will be reviewed and discussed at today’s monthly management meeting; a weekly cash flow summary; investment subscription and capital call/funding documents; various investment letters to review; charitable gift substantiation documents; and an economic census report to complete.

You're on TSCPA's Executive Board and have served in a number of roles for the San Antonio Chapter and TSCPA. Why is involvement in your chapter and TSCPA so important to you?

I have been a volunteer ever since I can remember. From my elementary and high school days, I have enjoyed volunteering and thought it important to be involved and to be an active contributor to whatever communities I was involved in. This was a gift instilled in me by my mom.

Being involved in the San Antonio Chapter is very important to me for many reasons. I am very proud and protective of my CPA license and the profession as a whole. To me, being involved is just a small way that I can give back to the profession for all the blessings and opportunities it has provided me.

Also, I believe that it is important to keep updated on the happenings of our profession and that one person can make a difference and affect change. Being involved with the local chapter is just one of the ways to get that up-to-date information and to be a part of leadership.

In addition, by being involved with the chapter, one is more aware of the many opportunities to attend and participate in various events that promote our profession and individual passions.

I am passionate about, and a champion of, education and educating others as much as possible.

My involvement with the chapter allows me to fulfill this passion through the Jr. Today’sCPA

Duel in Ol’ San Antonio program.

The Jr. Duel program is a financial literacy program and competition for high school students. My participation on the state level with the Nonprofit Organizations Conference Committee is another way that I feel I contribute to the education of others. The state committee also helps me to be in touch with another passion of mine – not-for-profit organizations.

Furthermore, involvement in the chapter and TSCPA helps to fill what I view as a necessity in my life – meeting new people. I truly enjoy meeting new people and getting to know them and their story. I have met many people throughout my career and I know that would not have been the case had I not become a CPA and had I not become involved with the local chapter and with TSCPA. I am truly grateful for the opportunity to have met some really talented, giving and exceptional colleagues.

I am honored and very privileged to be serving on the Executive Board in the next year. I am eager to continue learning and growing as I serve the TSCPA membership.

YOU’VE GOT THE INSIGHT. NOW MAKE AN IMPACT.

Your favorite vacation destination is: I really enjoy traveling! I am able to travel with TSCPA and that has been such a joy.

I also enjoy traveling with my fiancé. My girlfriends and I also travel together for at least two girls’ trips a year.

My fiancé and I enjoy traveling to destinations where we are able to hike and explore. Recently, we enjoyed hiking Camelback in Phoenix, AZ, the Manitou Incline in Manitou Springs, CO and the Grouse Grind in Vancouver, BC. My other favorite destination to travel to is New York City. I enjoy seeing all the sites and make it a point to visit something different every time I visit. I also appreciate learning about various historical sites and cultures, eating all the wonderful authentic food and just immersing myself in the city’s vibe when I am there. I actually considered moving to NYC a couple of years ago.

Finally, and of course, I enjoy traveling back home to the Lubbock area to visit my family. n

INTRODUCING THE CGMA PROGRAM DISCOVER A LIFELONG PROFESSIONAL LEARNING JOURNEY AT CGMA.org/Program ®

CGMA, CHARTERED GLOBAL MANAGEMENT ACCOUNTANT, and the CGMA logo are trademarks of the Association of International Certified Professional Accountants. These trademarks are registered in the United States and in other countries. 18652-326

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11/13/15 10:50 AM

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TAKE NOTE

TSCPA Welcomes New Accounting and Auditing Column Editor for Today's CPA Magazine TSCPA is pleased to welcome Don Carpenter, CPA-Central Texas, as the new editor for the accounting and auditing column in Today's CPA magazine. He will be taking over for C. William (Bill) Thomas, Ph.D., CPA-Central Texas, who has retired as column editor after more than 20 years.

Carpenter is an assistant clinical professor of accounting at Baylor University. He holds a BBA in accounting from Baylor University and a Master of Science in accountancy from the University of Houston. He has a 35-year career managing tax and accounting responsibilities, most recently working as Chief Accounting Officer and VP of Taxation for Waste Management, Inc. He has written articles for Today's CPA, including a series of articles he is currently co-writing for the magazine on the Tax Cuts and Jobs Act. Be sure to read his accounting and auditing column titled "Non-GAAP Measures: SEC Serves Notice That it’s Serious" and his article "A Good Day at the Office – Corporate Tax Rates Coming Down" in this issue of Today's CPA. n

TSCPA Recognizes 2018 Rising Stars TSCPA congratulates the 2018 Rising Stars honorees. A task force selected these 15 up-and-comers based on their contributions to the accounting profession and their communities. The 2018 Rising Stars will be featured in an upcoming issue of Today's CPA. They include: • • • • • • • • • • • • • • • 14

Rod Aguilar Heather Banks Katie Briggs Tello Cabrera Duncan Campbell, Jr. Grant Farrell Megan Gallien Randy Garcia Brandon Howard Tram Le Bryan Morgan, Jr. Rachel Ormsby Jennifer Perales Marelle Raksnis Scott Wiseman

Renewing Your Membership If you haven’t renewed your TSCPA membership, now is the time.

Dues renewal notices have been sent. Don’t miss out on the many benefits included in your annual membership investment!

You can access and update your records and pay your dues online.

If you have any questions, please contact Member Services at 800428-0272, option 1.

Don’t let this be your last Today’s CPA issue! Renew your membership today.

Today’s CPA Magazine – CPE Quiz Available Online!

TSCPA is excited to offer the self-study exam in this Today's CPA magazine online! Log in to take the quiz and earn one hour of continuing professional education credit. Please see the CPE article “What to Consider When Making an Accounting Change” in this issue of the magazine.

Also available online are the quizzes from the March/April and May/June issues of Today’s CPA. These online quizzes offer you the opportunity to earn two additional hours of continuing professional education credit if you have not previously completed the quiz. Go to the website at http://bit.ly/cpequiz to learn more and register for them. n

CGMA® Designation: Next Testing Windows for the Exam The Chartered Global Management Accountant (CGMA®) designation was created by AICPA and the Chartered Institute of Management Accountants (CIMA) to recognize U.S. CPAs and CIMA members who work in management accounting roles. The designation is a respected complement to your CPA license.

Candidates for the CGMA designation must pass a strategic and comprehensive examination. The exam is available four times a year during five-day testing windows. Candidates must register before the registration deadline for each testing window.

The next two testing windows are Aug. 21-25, 2018, and Nov. 20-24, 2018. To learn more about the program and register for the exam, go to the Become a CGMA section of their website at cgma.org. n Today’sCPA

Connecting on TSCPA’s Online Community: TSCPA Exchange

Submit an Article to Today’s CPA Magazine The editors of Today’s CPA are seeking article submissions for the magazine. Today’s CPA is a peer-reviewed publication with an Editorial Board consisting of highly respected CPA practitioners.

Have you visited our new online community, TSCPA Exchange?

Members are connecting and discussing critical accounting issues in real time. TSCPA Exchange is an excellent resource for members to use to ask questions and communicate with their accounting colleagues in a private, members-only forum.

The publication features articles and columns that focus on issues, trends and developments affecting CPAs in all facets of business. If you would like to submit an article for consideration or to learn more, please contact Managing Editor DeLynn Deakins at ddeakins@tscpa.net or Technical Editor Brinn Serbanic at technicaleditor@tscpa.net. n

We know the value our members place on belonging to this professional network and we’re excited to provide this online environment where you can connect with fellow TSCPA members as an industry resource. Go to exchange.tscpa.org today and join the discussion. n

Correction for Article on Tax Reform in May/June Today's CPA Issue The May/June 2018 issue of Today’s CPA magazine included an article titled “Pass-Through Entities Not Left Out of Tax Reform.” It was the second in a series of articles examining the Tax Cuts and Jobs Act. A section in the article defined “qualified property” as tangible personal property. Section 199A

specifically excludes land from the definition of “qualified property.” However, depreciable real property (e.g., commercial buildings) that meets the other requirements of Section 199A would also be considered “qualified property.”

Please note the correction. n

ACCOUNTANTS CONFIDENTIAL ASSISTANCE NETWORK

ACAN ACCOUNTANTS

CONFIDENTIAL ASSISTANCE NETWORK

The accounting profession is demanding of your

TIME, ATTENTION & ENERGY It shouldn't take a toll on your

MENTAL & PHYSICAL HEALTH

Call 866.766.2226 or visit www.tscpa.org/advocacy/acan If you are struggling with alcohol addiction, substance abuse or mental health issues, ACAN is here to help. ACAN provides a confidential conversation with CPA volunteers who have first-hand experience with these issues. ACAN helps you learn how to merge healthier living with your demanding accounting career, and can provide referrals to professionals who are familiar with your unique challenges. Don't hesitate to get the help you need today.

ACAN convenes regular meetings of CPAs, exam candidates & accounting students for mutual support & opportunities to assist others. Call or visit us online to learn more.

Today’sCPA July/August 2018

15

CAPITOL INTEREST

States

Are Where the Legislative

Action Takes Place

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By John Sharbaugh, CAE | TSCPA Managing Director, Governmental Affairs

hen it comes to public policymaking, a lot of our attention is drawn to Congress and the federal government. That is understandable, since the federal government drives the national media coverage and the debate on many of the major issues of our time. But if you look at the statistics, it’s at the state level where the bulk of the action takes place in terms of legislation being passed.

A greater volume of legislation moves faster and is passed at a higher frequency at the state level than the federal level.

State legislatures introduce 23 times the number of bills that the U.S. Congress does (totaling on average 128,145 bills per year). The states also pass a greater percentage of the bills

IN THE 2017 TEXAS LEGISLATIVE SESSION, 1,295 BILLS WERE PASSED BY THE LEGISLATURE.

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introduced compared to Congress – an average 25 percent pass rate for the states versus 4 percent for Congress. And finally, legislation generally moves much faster in the states, since the majority meet for a limited amount of time and are not full-time legislative bodies.

During President Barack Obama’s eight years in office, he signed 1,227 bills into law. Compare that with Texas, where in the 2017 legislative session alone 1,295 bills were passed by the legislature.

Gov. Greg Abbott signed 1,091 of them, vetoed 50 and 154 became law without his signature. So, in one legislative session Texas was more active in passing legislation than Congress was in eight years.

Add in all the other states and the amount of policymaking at the state level dwarfs what is happening at the federal level.

That is why it is important to be involved and monitor the legislative process at the state level. Through its advocacy efforts, TSCPA strives to do that on behalf of its members and the CPA profession in Texas. Let’s look at a few of the issues we may be facing in the 2019 legislative session.

Sunset Leads the Agenda As reported before in Capitol Interest, Sunset Review of the Texas State Board of Public Accountancy (TSBPA) and the Texas Public Accountancy Act (TPAA) is the number one Today’sCPA

legislative issue for TSCPA in 2019. Our top priority will be to assure a successful completion of the Sunset Review process and the reauthorization of TSBPA and the TPAA so the licensed profession in Texas will continue unabated.

Sunset Review is a regular occurrence for most state agencies in Texas. So, this issue is not a “surprise” and we have been working and will continue to do so to assure the process goes smoothly and we have a successful result.

Other Possible Issues There may be other legislative issues that arise in the next session that could also have an impact on the CPA profession, but are not visible until they are introduced. Part of our advocacy process is to also study issues that manifest themselves in other states around the country, so we are prepared to deal with them if they arise in Texas. A couple examples are highlighted below.

Occupational Licensing Reform and Exemption From Duplicative Regulatory Requirements An issue that has been getting traction and growing the past few years relates to the occupational licensing process in the states. Some groups and individuals feel that occupational licensing has gotten out of control and the states need to reform the process and eliminate the need for so many licenses to perform services, as well as develop better ways to permit license holders to move across state lines and continue to perform services. They note that today about 25-30 percent of Americans work in jobs that require an occupational or professional license compared to about 5 percent in 1950.

There is bipartisan support on some of the ways to deal with this issue and it also crosses ideological lines. If you would like more details on this issue, you can see information from the Institute of Justice study on the burdens of occupational licensing here: ij.org/report/license-work-2/report/executivesummary/ and a report from the Federal Trade Commission here: www.ftc.gov/policy/advocacy/economic-liberty. Or just Google “Occupational Licensing” and you can see a plethora of information on this issue.

While some reform in this area probably makes sense, the concern is that as legislators move to solve one problem, they could create another by how they implement change. This recently occurred in Louisiana where a bill was introduced in the legislature to try and deal with some of the issues described above relating to occupational licensing. Unfortunately, along the way the legislation was amended to also include a prohibition against anyone using the word “certified” or “certification” unless it was authorized in the laws, rules and regulations of the state entity regulating the profession and individuals possessing a “certification” from a voluntary program would have been banned from using it. If passed, this language would have prohibited many professionals (including CPAs) from using credentials they have legitimately earned John Sharbaugh, CAE

Today’sCPA July/August 2018

PART OF TSCPA’S ADVOCACY PROCESS IS TO STUDY ISSUES IN OTHER STATES, SO WE ARE PREPARED TO DEAL WITH THEM IF THEY ARISE IN TEXAS.

outside the scope of their professional license. Fortunately, after several groups (including the Society of Louisiana CPAs) objected, the bill was amended to eliminate the provisions of concern.

Issues can also arise from other occupational or professional regulatory requirements that can have an effect on CPAs and the services they offer. CPAs are often asked to provide services that may fall under another profession’s regulatory statutes.

One prime example of this is the provision of a forensic audit, which can sometimes be considered a regulated activity under a state’s private investigators statute. We experienced this in Texas a few years ago and fortunately were able to get licensed CPAs exempted from having to get a private investigator license for the routine forensic services they may provide to clients.

Other examples of professions where common CPA services may fall under those professions’ respective statutes include client services, which are also performed by real estate appraisers and financial management experts.

CPAs are already regulated by their state boards of accountancy for all services they provide to their clients, including those that may also fall under other regulatory statutes. To avoid duplicative licensure and regulation, we work to explicitly exclude CPAs from these types of requirements.

These are just two examples of the kinds of issues that can get introduced in the legislature that would have an impact on CPAs. There are others, as well. As noted at the beginning of this article, the states are where the greatest legislative activity takes place in our country and it happens at a brisk pace as the process occurs. To protect the interests of our members, TSCPA will continue to monitor the legislative process, so we can react quickly if proposals like this get introduced in the legislature. n

is TSCPA’s managing director of governmental affairs. Contact him at jsharbaugh@tscpa.net.

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FEATURE ARTICLE

Celebrity Clients

HIGH PROFILE and HIGH RISK

M

By Sarah Beckett Ference, CPA

oney and fame: the aspirations of many; the reality of few. From movie premiers, award shows and exotic vacations to dating rumors, scandals and wild antics, the lives of the rich and famous are on display for public consumption now more than ever. Celebrities are used to their names appearing in the headlines, for both good and bad reasons. However, when CPAs accompany their celebrity clients in the news, it’s usually related to the latter.

Consider the following claim scenario. An up-and-coming Los Angeles-based fashion designer received a big payday when his creation was worn by an A-list celebrity on the red carpet at a major movie premier and set the new summer trend. The designer’s collection was coveted by all and he was an overnight social media darling. Buzz throughout the fashion industry was positive.

To celebrate the increase in wealth and positive future outlook, he decided to undertake a major renovation of his home to include a private design studio and runway. The designer asked his longtime CPA to manage the construction process, as he was busy working on the next big idea and making appearances at star-studded events.

The cost of the renovations continued to rise as the designer’s preferences changed, despite the CPA’s verbal warnings that the changes would add significant cost. The end result of the project far exceeded the original budget.

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Soon after completion of the renovation, a major European design house offered the designer its lead creative role, which required a permanent move to their European headquarters. The designer immediately put his house up for sale. The only offers received were far below the asking price and, in the designer’s opinion, disrespectful to his “uniquely creative vision” expressed in the renovation. As a result, the designer took a significant loss on the ultimate sale of the house.

The designer brought a claim against the CPA alleging mishandling of the renovation, poor investment advice and mismanagement of funds.

You may have read about pop stars, actors and professional athletes being “driven to bankruptcy” due to the actions and advice of their accountants and financial advisers. When a celebrity or other high-profile individual or family experiences a decline in net worth, the CPA may be blamed for it.

Services provided to the rich and famous, as well as to wealthy individuals or families, may include a range of traditional accounting services, including tax planning and preparation, bookkeeping, payroll and financial planning. But what may start as a typical engagement could gradually expand to include nontraditional services, such as concierge services, administrative support for both business and personal assets, booking travel, overseeing Today’sCPA

construction on personal residences or vacation properties, or even walking the pooch (if only dog walking was a section of the CPA exam!).

While provision of services to high-profile clients provides the opportunity for interesting and rewarding work, CPAs should also be aware of the associated professional liability risks.

Claim Experience Claim experience of the AICPA Professional Liability Insurance Program suggests that high-profile clients are a higher risk than others. When a claim involving this type of client arises, a red flag is raised.

There is a greater likelihood that the claim will be complex, lengthy, costly and require special handling. Why? The amount of damages asserted is larger than typical claims and may include unreasonable or inflated estimates of the client’s loss. The larger claims can be attributed to the exponentially larger value of the client’s assets and transactions associated with their extravagant lifestyle. Unreasonable damage assertions and high-value transactions can both add layers of complexity to already sensitive claims.

These clients usually have significant resources to aggressively litigate and pursue claims. In addition, the client may feel betrayed or personally wronged by the CPA. These feelings combined with the financial wherewithal can make the defense of a claim challenging, longer and more drawn out than typical claims. Some clients may even pursue a claim until a settlement is in excess of the CPA’s insurance policy limit with the intention of making the CPA pay a portion of the settlement out of pocket as a “punishment.”

While the client may be used to seeing his/her name in tabloids or trending on social media, the CPA likely is not. A well-publicized claim could result in disparaging remarks about the CPA or accusations regarding the quality of his/her services. Bad press risks damage to a firm’s reputation.

Typical Client Profile Risky clients can come in all shapes, sizes, backgrounds and industries. Characteristics that may be common among claims involving high-profile clients include the following.

Client’s attitude regarding services. A client who merely shifts responsibility onto the CPA without ownership, accountability, oversight or even passing interest in the services, may lead to miscommunication and disputes. Clients who do not take the time to communicate with the CPA and understand the CPA’s services are higher risk.

Public’s perception of the client. A client with a public persona who draws admiration may garner sympathy in the court of public opinion, painting the CPA as a villain. Further, actors are trained to communicate their message effectively and may practice their talents on a judge or jury.

Clients’ perception of themselves. Whether real or perceived, clients’ view of themselves as a “celebrity” or someone important may lead to expectations of special treatment or a sense of entitlement.

Today’sCPA July/August 2018

CLAIM EXPERIENCE SUGGESTS THAT HIGH-PROFILE CLIENTS ARE A HIGHER RISK THAN OTHERS. Substantial assets at risk. High-net-worth clients, by definition, have income, assets or participate in transactions that are significantly higher in value than typical clients.

Common Quality Control Issues Any client or engagement involves some level of risk for a CPA and not all high-net-worth clients are high risk. However, a high-networth client is likely to be high risk if one or more of the above factors are present.

The following are common findings among claims related to highprofile clients: • The engagement letter covering the scope of agreed-upon services is insufficient or absent. An engagement letter may have been issued initially, but not reissued annually or revised for changes in scope.

• Services are rendered to multiple family members either as individuals, owners of businesses and/or beneficiaries of various trusts. This relationship complexity can result in potential and actual conflicts of interest that need to be properly identified and managed.

• Services are managed and even delivered by individual senior members of the firm, with minimal oversight by other firm personnel. This places unnecessary pressure on one person to resolve any problems that arise without the help of colleagues.

In addition, lack of monitoring prevents an important check on service quality.

• A partner’s book of business may consist of a handful of high-networth clients, each generating individually significant fees. For this reason, the partner may treat the client’s interests as paramount, creating a threat to his/her objectivity.

Risk Management Recommendations While services to high-profile clients present some unique challenges, the related risks can be mitigated. Consider the following quality control policies and procedures to help address professional liability risks.

Client acceptance and continuance. The sophistication of clients and their related knowledge of financial affairs can continued on next page 19

FEATURE ARTICLE continued from previous page vary widely. Clients may have inherited wealth, be successful entrepreneurs or be entertainers or athletes earning large sums over a short career. Be sure to understand clients’ service expectations, level of financial sophistication, and desire and availability to manage their financial affairs. CPAs should also conduct sufficient inquiry to determine who the clients will be now and who may become clients at a later time, particularly for large, affluent families.

Upon identifying prospective clients, screen them and determine their service needs. For example, do they require investment, tax and estate planning advice? If personal concierge services are desired, what will be the scope of services? Do they have other professional advisers? Are complex estate and trust matters involved? Is the prospective client responsive and cooperative or more dismissive and demanding in the acceptance process?

It is important to determine whether the firm has professionals on staff qualified to meet their service needs or the ability to develop the necessary expertise and identify the need for thirdparty service providers. Also consider requiring approval by a second partner or oversight committee before accepting or continuing high-profile client relationships.

Address conflicts of interest. Conflicts of interest can develop when CPAs serve a combination of multiple family members, their business interests or their trusts. Investment, tax and estate planning advice rendered to one family member may conflict with the interests of other family members. Thus, it may become necessary to refrain from rendering some services to family members and to advise them to engage their own advisers. CPAs should continuously monitor the situation as services expand and renew, and relationships change.

Execute the engagement. Restrict engagement activities to those defined in the engagement letter. An engagement letter loses its value if services expand beyond the original scope and an amendment to the engagement letter is not executed. If the client requests additional services or the scope changes, execute written change orders, make engagement letter amendments or send email correspondence. For major changes, execute a new engagement letter.

Oral advice or key decisions made by the client should be documented in the work papers and in a written communication to the client, noting the client’s responsibility for acting on recommendations made. Consider including both the meeting date and the names of participants in your documentation. Billing narratives should align with the services rendered, as they can provide additional evidence of the firm’s adherence to the agreedupon engagement parameters. Every aspect of the engagement should be documented in as much detail as possible to mitigate the risk of a client’s fuzzy memory.

Avoid the assumption of management duties. Clients may travel extensively or otherwise be unavailable to make day-to-day business decisions and they may expect the CPA to act on their behalf in their absence. The client may wish to delegate decisionmaking authority to the CPA under certain circumstances. If 20

Refine engagement letters.

The following suggested protocols may assist in defining engagement parameters: • Obtain a signed annual engagement letter defining the scope of all service needs.

• Consider using an appendix to the traditional engagement letter terms and provisions that lists, in table format, the menu of services and the respective service description, frequency, client responsibilities and deliverable.

• When practical, have the client designate an individual with sufficient time and expertise to oversee all services the CPA firm provides, communicate the day-to-day tasks to be performed, evaluate the adequacy and results of services rendered, and accept responsibility for all decisions made.

• Where permissible, include language in the engagement letter that limits damage or requires alternative dispute resolution, such as mediation or arbitration. In addition, consider including a waiver of the client’s right to a jury trial to mitigate the risk of the “dazzle” factor.

• Issue separate engagement letters for each individual and business and for each service, since these clients may own and operate multiple businesses for which tax, accounting and related services may be required. If a single engagement letter must be issued, clearly identify each business and the services to be rendered.

• Meet in person with the client at least annually to discuss the service needs, answer any questions and review the engagement letters. More complex engagements may require more frequent communication with the client.

• Document meetings with correspondence to the client to memorialize the discussion and identify any misunderstandings.

such responsibilities are contemplated, discuss it with the client and consult with legal counsel and your professional liability insurance carrier about documenting the agreement to make management decisions on the client’s behalf, including engagement letter provisions to help mitigate risk.

Professional liability insurance policies may limit or exclude coverage when a CPA assumes the role of management at a client.

Review the details of your policy with your insurance agent or broker.

Supervise the relationship. Often, services to high-net-worth individuals or families are managed or delivered by a CPA firm’s senior members. At the request of the client, the engagement team may be limited to a small number of staff to protect the client’s privacy. However, engagement monitoring and quality should not be sacrificed for a client’s desire for anonymity. continued on next page Today’sCPA

TSCPA Thanks 2018-2019 Group Billing Program Participants We are grateful for the support and commitment of these firms and companies that participated in TSCPA’s group billing program for membership renewals and activations in 2018-2019.

Abercrombie & Associates PC ABIP PC Adami Lindsey & Co LLP Akin Doherty Klein & Feuge PC Alexander Lankford & Hiers CPAs Inc Allman & Associates Inc American Quarter Horse Association Anderson Spector & Company PC Andre & Associates PC Armanino LLP Armstrong Backus & Co LLP Armstrong Vaughan & Assoc PC Arnold Walker Arnold & Co PC Asel & Associates PLLC Atchley & Associates LLP ATKG LLP Auldridge Griffin PC Axley & Rode LLP Bailes & Co PC Barg & Henson CPAs PLLC Barrett & Thomas PC Barry M Wuntch LLP Certified Public Accountants BDO USA LLP Beaird Harris & Co PC Beal & Wilkes PC Benton Duroy & Ivey PC Birdsong Adams Knight Carroll LLP BKD LLP BKM Sowan Horan LLP Bland Garvey PC Blazek & Vetterling Bock & Associates LLP Bolinger Segars Gilbert & Moss LLP Bolton Sullivan Taylor & Weber CPAs Brammer Begnaud & Lattimore CPAs Brewer Eyeington Patout & Co LLP Briggs & Veselka Co Bright & Bright LLP Brockway Gersbach Franklin & Niemeier PC Brown Graham & Company PC Bryant & Welborn LLP CPAs Buckley & Associates PC Bumgardner Morrison & Company LLP Burchell Denson & Morrison PC Burds Reed & Mercer PC Burnett Oil Co Inc Burton McCumber & Cortez Butterworth & Macias PC Calhoun Thomson & Matza LLP Calloway Stinson and Company Candy & Schonwald Cantrell & Associates A PC Carameros & Rawls Carpenter & Langford PC Carr Riggs & Ingram LLC Carter & Company Cavett Turner & Wyble LLP CD Bradshaw & Associates PC CHAN Healthcare Chapman Hickman-Riggs & Riggs PLLC Cherry Bekaert LLP Chilton Wilcox & Fortenberry Citizens National Bank City of Fort Worth CliftonLarsonAllen LLP Cohen Berg & Company PC Coleman Horton & Company LLP Collier Johnson & Woods PC Colonial Savings FA

Concho Resources Inc Condley and Company LLP Connor McMillon Mitchell and Shennum PLLC Cook Johnston & Company Cook Parker PLLC Cornelius Stegent & Price LLP Covenant Medical Group Crawford Carter & Durbin LLC Crowe LLP CrownQuest Operating LLC Cuellar Morales Gonzalez & Co PLLC Curtis Blakely & Company PC D Williams & Co PC Daniels & Erickson PC Darlene Plumly CPA Davidson Freedle Espenhover & Overby PC Dawson Geophysical Delta Centrifugal Corporation Desroches Partners LLP Dixon Hughes Goodman PLLC Donna Holliday Wesling CPA Durbin & Company LLP DWG CPA PLLC Eckert & Company LLP Edgar Kiker & Cross PC Edgin Parkman Fleming & Fleming PC EEPB, PC Eide Bailly LLP Erickson Demel & Company PLLC Faske Lay & Co LLP Fasken Oil & Ranch Ltd Fayez Sarofim & Co Ferguson Camp Poll PC First National Bank Texas Fisher Herbst & Kemble PC Fitts Roberts & Co PC Five Stone Tax Advisers, LLC Flieller Kruger Skelton & Plyler, PLLC FMW PC Fox Byrd & Company PC Freemon Shapard & Story Frierson Sola Simonton & Kutac PLLC Gage & Company CPAs LLP Gant McGee & Baber PC Garza & Morales LC Garza Gonzalez & Associates Gaskill Pharis & Pharis LLP GBH CPAs PC George Morgan & Sneed PC Gibson Ruddock Patterson LLC Gilliam Wharram & Company PC Glass & Company CPAs PC Glenn Prather & Co Goff & Herrington PC Goldman Hunt & Notz LLP Gollob Morgan Peddy PC Goodman Financial Corporation Gowland Strealy Morales & Co PLLC Grier Reeves & Lawley PC Guinn Smith & Company Inc Hagy & Associates PC Hahn & Oldham PC Ham, Langston & Brezina LLP Hampton Brown & Associates PC Harold W Shelburne CPA Harper & Pearson Company PC Harrison Waldrop & Uherek LLP Hartman Wanzor LLP Henry & Peters PC

If you’d like to participate in group billing and make your renewal process easier while increasing membership value to your organization, please contact Stephanie King (sking@tscpa.net or 800-428-0272, ext. 233).

Hess & Rohmer PC Hoak & Thorp CPAs PC Holtman Eckert Peterson & Wilson PC Horne LLP Howard Cunningham Houchin & Turner LLP HRSS LLP HSSK LLC Hudgins Crosier Sumpter PC Hupp Bauer Hanson & Lewis Huselton Morgan & Maultsby PC Ingram Wallis & Co PC J Taylor & Associates LLC Jaynes Reitmeier Boyd & Therrell PC Jefferson Harmon & Associates PC Jeffery A Davidson CPA PC Jennings Hawley & Co PC JLK Rosenberger LLP Joe R Nemec & Co PC Johnson & Sheldon PLLC Johnson Miller & Co CPAs PC Jones Hay Marschall & McKinney PC Judd Thomas Smith & Co PC Jungman Elley Williams & Johnson Co Keller & Associates CPAs PLLC Kelsey Seybold Clinic KHA Accountants PLLC Kimbell Art Foundation Kimberling McFarland and Associates Kurtz & Company PC Lain Faulkner & Company PC Lane Gorman Trubitt LLC Lange Poteet & Co LLP LaPorte CPAs & Business Advisors Lawrence Blackburn Meek Maxey & Co Lemert Holder Ohm Lewis Kaufman Reid Stukey Gattis & Co PC Lott Vernon & Co PC LSK CPAs Maddox Thomson & Associates PC Mark M Jones & Associates PC Mason Warner & Company PC Massey Itschner & Co PC Maxwell Locke & Ritter LLP Mazur & Vernon McCall Gibson Swedlund Barfoot PLLC McClanahan and Holmes LLP McClelland Samuel Fehnel & Busch LLP McIlvain & Associates LLC McMahon Vinson Bennett LLP Meador & Jones LLP Meadows Collier Reed Cousins Crouch & Ungerman LLP Melton & Melton LLP Mikeska Monahan & Peckham PC Mohle Adams Moore Camp Phillips & Patterson LLP Moore Truelove Pharis Meyers & Marsh CPAs PLLC Morris Ligon & Rodriguez Mosher Seifert & Company CPAs Moss Adams LLP MUFG Capital Analytics LLC MWH Group PC Navy Army Community Credit Union Nelda C & HJ Lutcher Stark Foundation Oliver Rainey & Wojtek LLP Oroian Guest & Little PC Pattillo Brown & Hill LLP Pena Briones McDaniel & Co PC

Perkins Dexter Sinopoli & Hamm PC Perry D Reed & Company Petro Hunt LLC PriceKubecka PLLC Prothro Wilhelmi & Co PLLC PSK LLP PYCO Industries Inc Pyke & Pyke PC Ratliff & Associates CPAs PC Ray & Company PC Reynolds & Franke PC Ridout Barrett & Co PC Robinson Burdette Martin & Seright LLP Robison Johnston & Patton LLP Roloff Hnatek and Co LLP RSM Rylander Clay & Opitz LLP Saville Dodgen & Co SBNG Seale & Associates PC Seefeld Lawson Moeller LLP Seidel Schroeder & Company Seidel Whittington and Company PC Snow Garrett Williams Sol Schwartz & Associates PC Sommerville & Associates PC Southside Bank Spies Kneese & Bailey LLC Spillar Mitcham Eaton & Bicknell LLP Sproles Woodard LLP Squyres Johnson Squyres Star of Hope Mission Stedman West Interests Inc Stewart Martin Dudley & Webb PC Sutton Frost Cary LLP Swank Salch & Henderson PC SWBC T J Hayes & Co PLLC TBK CPA PLLC Texas Farm Bureau Insurance Cos Texas Health Resources The Blum Firm PC The Houston Methodist Hospital System theKFORDgroup CPAs Thomas & Thomas LLP Thomas Edwards Group Thomas V Stephen & Co LLP Thompson Derrig & Craig PC Tiller & Ketterman LLC Todd Hamaker & Johnson LLP Traplena Sullivan & Reinke PC Turner Stone & Company LLP Tyler ISD United Way of Greater Houston Van Houten & Associates PC Vernon E Faulconer Inc Wagner & Brown Ltd Wathen DeShong & Juncker LLP Weaver Weinstein Spira & Company PC Werlein & Harris PC Whitley Penn LLP Whittington & Hubbard PC Wilf & Henderson PC Williams Crow Mask LLP Wind Energy Transmission Texas. LLC Wolfe and Company PC Woodland Advisors LLC Yeldell Wilson Wood & Reeve PC

FEATURE ARTICLE continued from previous page Firm management should institute appropriate controls to monitor the relationship with the client and the performance of services. When multiple services are delivered to one client, the client’s reliance on the CPA may increase and may raise the risk of compromising the practitioner’s objectivity. The requirement to adequately plan and supervise the performance of professional services extends to all firm personnel – even partners.

Another Claim Scenario Consider how a focus on quality and risk management could have changed the outcome of the following scenario. A CPA was engaged as the business and investment manager for a successful actor. In an effort to cultivate a tech-savvy reputation, the actor verbally instructed the CPA to “put some cash in start-ups.”

As directed, the CPA converted a portion of the client’s assets – cash, gold and precious jewels – into equity positions in a number of start-up companies. Among the investments were a promising mobile phone application, a recycler of outdated technology and, oddly, a real estate investment partnership. The plan was approved via a brief text message conversation while the actor was shooting on set in New Zealand.

Less than two years after the investment in the start-ups, the actor entered into divorce proceedings with his equally famous wife. As part of the divorce proceedings, the CPA was asked to complete a valuation of a number of the actor’s investments,

including the “tech start-ups.” While most of the investments maintained stable or modest increases in value, the real estate investment partnership value had declined significantly.

The actor asserted, through media interviews and later included in the claim against the CPA, that he never approved of the investments and that minimal due diligence was performed by the CPA on the start-up investments. The actor also alleged fraud, as there was a large discrepancy in the value of the gold and jewels sold to make the investments and the actual cash invested. The actor suggested the CPA had pocketed the difference in values, particularly when it was learned that the real estate investment partnership was established by the son of one of the CPA’s partners. The CPA, his partner and his partner’s son were all accused of syphoning the actor’s funds through the investment for personal enrichment.

Unfortunately, the CPA’s version of events presented a different reality than what was expressed by the actor and his attorney in interviews and written in the gossip columns. The CPA asserted he repeatedly requested an engagement letter and written instructions from the client throughout their years of working together, but the actor insisted he would only work with professionals that he could trust with a handshake. The CPA regularly requested inperson meetings to discuss strategies, results and outlook of the actor’s financial future, but was stonewalled by the actor’s agent or assistant. Instead, the CPA was forced to communicate with the actor through the ambiguity of text messaging.

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Today’s CPA is going digital for September/October. Watch your inbox for details and enjoy the convenience of this valuable member resource on your device or home or office computer

22

Today’sCPA

As for the real estate investment partnership, the CPA made the investment at the direction of the actor. The actor had met his partner’s son at the firm’s holiday party and, after a brief discussion, told the CPA, “The kid is going to make it big; let’s get in on the action.” The CPA was hesitant to make the investment on behalf of the actor, so a minimal contribution was made with the intent of pleasing the client. It was completed at the same time as the tech investments to lessen the impact of fees associated with converting non-cash assets to make the investments.

Finally, the fraud accusation was partially due to the attorney’s misunderstanding of the basis of accounting used in the actor’s personal financial statements versus the tax return and primarily due to a conversion loss on the non-cash assets used to make the investments. Unfortunately, due to the lack of documentation and the actor’s skillful ability to paint himself as the victim, the CPA’s version held little weight in final settlement of the claim.

Taking the Precautions All clients and engagements present some level of risk to a CPA firm. With the proper vetting and quality control procedures, those risks can be addressed.

In some instances, the engagement may involve more detailed procedures, engagement letter provisions that limit the CPA firm’s losses, a larger engagement team, more experienced staff or a more in-depth engagement quality review. Other engagements may be too risky and need to be avoided entirely.

Celebrities may have more money and fame than the average client, but that should not exclude them from the same level of the firm’s scrutiny in acceptance, continuance and execution of an engagement. Focus on risk management and leave the headlines to the celebrities! n Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional.

Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.

Sarah Beckett Ference

Today’sCPA July/August 2018

is a risk control director at CNA. She can be contacted at sarah.ference@ cna.com.

23

COVER

Conversation with the Chairman Incoming 2018-2019 TSCPA Chairman Says It’s All About Relationships

By Anne McDonald Davis

Stephen Parker, CPA-Houston, has worked in public accounting for over 30 years, 20 as a partner in PricewaterhouseCoopers’ (PwC) Houston assurance practice. He specializes in midstream energy, power, utility and nonprofit companies. In June, he began serving as 2018-2019 TSCPA chairman. As he began his term, Parker sat down to tell Society members a little bit about his professional and personal journeys.

Q: How and why did you become a CPA? A: I sometimes talk about this with students while recruiting. When I accepted a position at PwC, I really had no idea what the future would hold. Now, I did seek out a degree with a major in accounting, but I really didn't know a whole lot about the accounting profession, about what CPAs actually did. However, I believed that accounting studies were going to lay the best groundwork for me to build whatever career I decided to pursue.

I even tell my 19-year old, who just finished his freshman year at Texas A&M University in the College of Business, "I think an accounting degree is the best foundation for whatever it is you choose to do later in life.” He's the only one of my three kids who wants to be in business. I have to be careful with him, because I'm his dad and I don't want to have too loud a voice. I want him to make his own decisions.

Anyway, there I was with a degree in accounting and for me, it was time to obtain my certification. An analogy? Who goes to law school and doesn’t take the bar exam? It was just the obvious next step.

Q: What do you think about certification all these years later?

Looking back, I was ignorant about the difference between not being certified and being certified, the importance of it. I had joined one of the large firms, so it was simply expected that we would pursue certification.

The young folks who are graduating today, they certainly have opportunities. With an accounting degree, they can do a lot of different things; but I'm more convinced today that there is something special to obtaining that certification.

In the marketplace, certification speaks to a person's commitment to excellence, not just technical competency. Certification represents an intention to continue one’s professional education, to stay up-to-date.

Certification represents a decision to join a profession that prides itself on honesty, integrity and being trustworthy. There are very important principles represented by those initials after your name. I encourage every student with whom I interact to pursue certification.

Q: You seem comfortable discussing your past uncertainties with the students you recruit.

A: I don't mind telling young people about the mistakes I made and the ones I didn’t. Students these days can do so much research about our firms online that honestly, I don't spend much time talking with them about client bases or benefits or any of the information available on those websites. What I have to offer them personally is hindsight and experience.

I tell new accountants to look for a firm where the culture is a fit for them. We've all got good people, but we also have clear, distinct cultures.

They need to meet the people at the firm; it will be the people who will make the processes come to life.

I don't hesitate to tell students that I picked PwC because of the four Today’sCPA July/August 2018

partners I met. I didn't have a clue what I was actually going to do. I didn't even know what I was going to get paid, but I got the sense these guys would take an interest in my professional development and I was right. It's made for a phenomenal career.

Q: What do you look for when hiring for your firm now?

A: I look at someone’s grade point average for about five seconds. With most candidates, you can quickly check off the box for the necessary level of technical competence. The differentiator is their personality, their passions, their skill sets outside the technical. That's what makes them who they are. I can teach someone about business and accounting or auditing, but I know I’m not going to change anybody's personality.

That's what I'm really interested in. I want to get to know the person to determine whether I think they'd be a good fit in our firm.

Q: You’ve made the point that PwC was a great fit for you. Have there been any accomplishments or milestones of particular significance to you and why?

A: A couple come to mind. One is actually … well, I don’t want to label it a failure. It was certainly a little bit of a gut check, but it was necessary.

This experience taught me so much. I was put into the partner admissions process fairly early on. About a week before the announcement, I was told that my name was being taken out.

Two things happened. One is that I gave myself a 48-hour pity party. (laughs) I'd never been knocked off the mountain before and all of a sudden, I was the guy who didn't get in.

Then I kind of grew up a bit. I learned that things happen that are unexpected. I learned that I loved what I did at PwC and the people who worked with me there. I wasn't going to let a setback or hurt pride cause me to throw everything out the window.

That’s why I advise all new CPAs to give themselves a chance to fall in love with what they do. The first bad week or bad month, some of them will say: "I'm leaving. I'm looking for greener pastures." If they’re constantly turning over or changing jobs whenever they hit a bump, they’re never going to be at peace.

What also helped me get “back on the horse” was the number of partners who called me, who sought me out, who got in front of me and said: "Keep your head up. Don't worry about this. We've got your back.

We're going to make sure that your next year is not a repeat of your last one. We're going to give you more responsibility. We're going to give you more opportunity to develop." They were just overwhelmingly committed to my continued development in such a sincere way. There was just no way I would walk away from that.

Since that time, I’ve been blessed to sponsor, coach, watch over and mentor a lot of new partners myself. New Partner Announcement Day on June 1 is now one of my favorite days of the year. I get thanked a lot, which is not necessary at all, because they're going to pay my pension when I retire. (laughs) Q: What was the other experience?

A: The other memory I was going to share with you doesn’t necessarily have much to do with PwC. I’m an Aggie and I've been blessed to be in recruiting most of my career, especially with Texas A&M University. In continued on next page 25

COVER continued from previous page

Stephen Parker and his wife Merita

doing this, I had the occasion to meet and get to know many students who ultimately joined our firm and who were leaders in a group called Fish Camp.

Fish Camp is a student organization with over 1,000 student leaders.

Every year, they hold sessions for incoming freshman, about six different sessions during the summer. I loved my experience back when I was a freshman. Later when I was an upper classman, I got to speak at Fish Camp, but was never a counselor or a leader.

However, every year, each camp is given a namesake, which is a great honor. In 2009, there was a Camp Parker! I like recruiting so much. I'm inspired by these students’ energy and creativity, and then they gave me this gift that I was able to share with my entire family that whole spring and summer.

Q: Who has been the biggest influence in your life?

A: If I was smart, I'd tell you my wife and make you write all this great stuff about my lovely wife. It would be true, but I’ll talk more about her later.

While my parents certainly laid a great foundation for me, I have worked at PwC for longer than I lived under my parents’ roof. Of all my mentors at PwC … if I had to pick one who’s had the most influence, it's a guy named Billy M. Atkinson, Jr. I have learned an awful lot about life from Billy. He taught me about the importance of relationships. He taught me how to treat people. He taught me that in recruiting, and we recruit a lot of people, that you recruit one person at a time.

Billy introduced me to TSCPA. He's the guy who grabbed me by the arm and said: "I need you to come out to the Houston Chapter and help me with a five-year forecast. I need you to run the model and work it up."

He's the guy who really exposed me to TSCPA, helped me understand what the organization does, gave me an appreciation for how important it is for us as credentialed professionals to give back to our profession.

What's also great about Billy is that he didn't just take an interest in me.

He took an interest in my wife, as did his wife. They know all my boys. We know their kids. We know their grandkids. We consider them to be part of our family.

Another person I think about a lot is one of my uncles, my Uncle Jim, who we lost about 10 years ago to brain cancer. He was one of the best I've ever known when it comes to developing relationships. Uncle Jim was truly interested in people. Once a banker, he switched to the real estate business, because he wanted to help people find their dream homes. He just had a way of impressing on others how much he cared about them as 26

The Parker Family: Mason, Grant, Merita, Stephen and Garrett

individuals. I'll never be as good as him, but I like the challenge of trying to get better, just in his memory. I think he'd be happy about that.

Q: How has involvement with TSCPA affected your career and professional life?

A: It's been an incredible experience for me. I started here in the local chapter helping Billy on the strategic planning committee. (I encourage all students and new CPAs to join their local chapter as soon as they can.) Then I got involved in putting on a charity golf tournament to raise money for our chapter’s charity, the Make-A-Wish® Foundation of the Texas Gulf Coast and Louisiana. I have been very touched by the families I’ve met. My wife and I are blessed to have three very healthy boys and these families go through heartache that no family deserves. I'm in the last year of my second, six-year term on the Make-A-Wish board.

In the years since my first meeting at the Houston Chapter, I was elected to represent Houston on the TSCPA Board and of course this fiscal year, I will have the honor of serving as TSCPA chairman. It’s been about a couple of decades since a representative of the Big Four served as chairman and I feel a special responsibility to get the big firms more involved again with the Society. (Editor’s note: You can read more about this in the Chairman’s column of this Today’s CPA issue.)

Q: Any other professional activities or civic interests?

A: I serve on an advisory committee to the accounting department at Mays Business School at Texas A&M and on multiple committees at my church – finance committee, investment committee, administrative board, those kinds of things. I have for a long time. You have to discover your gifts. I don't know that I'm patient enough to teach a Sunday school class, but I don't mind trying to help us with our finances.

Q: Tell us about your family and other interests.

What are your activities when you’re not working?

A: My wife and kids are very, very special to me. My wife, her name is Merita, was class of '86 at Texas A&M. She was an education major and taught second grade for years. Luckily, I didn’t meet her when I was in school. If I had, we would probably not be married.

Q: Why is that?

A: I was young then and by the time we finally connected, Merita and I had so many mutual friends, it made building a social life together very easy. She and I are the proud parents of three boys. Our oldest son is Today’sCPA

Garrett, who just turned 25. He graduated from the College of Agriculture at Texas A&M and is working in Corpus Christi for a distributor of agricultural products. Our middle son is Grant, 22, and he just graduated from the College of Architecture at Texas A&M this May. He's going to work here in Houston for a year and then is probably going on to the University of Virginia to get his master's in Architecture. Our youngest son, Mason, 19, is in the honors program in the A&M College of Business. He’s working this summer at Camp Kanakuk up in Missouri.

He’s really looking forward to being a counselor.

All of us are active in sports, a big outdoors sports family. The five of us like doing a lot of things together. We all enjoy playing golf, even my wife. The four guys love to fish, to be outdoors on the water. We like to play board games, any kind of competitive game.

We are also into everything Aggie. Merita and I have brainwashed them completely. In the fall of every year on Saturdays, you will find all of us in College Station for home games. Our “tailgate” was originally salami and cheese and crackers in the Suburban on the way to the game with three little bitty tots in the back. Now my boys invite all their friends and we invite ours and feed anywhere from 30 to 70 people. That's not even that big. One of my other partners probably feeds over 200 people every home game! But Merita and I do it by ourselves, and with the help from cousins, and just love every minute of it – meeting new students and our kids' friends and just spending the day with everybody.

Q: Earlier, you said “more about my wife” later?

A: She’s one of the main reasons I am the person I believe I have become. I sometimes think she and Billy had some sort of side arrangement on how they were going to work me. (chuckles) I just know that when Merita married me, I had a lot more faults than I do today. My wife created a great environment at home and she’s always had the courage to remind me what really matters in this life. n Anne McDonald Davis, ABC is a freelance reporter, writer and editor based in Dallas, Texas.

Today’sCPA July/August 2018

Tax Season Cessation Program Experiencing: • Stress? • Lack of Sleep? • • IRS induced Nausea? •

We have helped thousands sell... and WE CAN HELP YOU!

North Texas Ryan Pannell 800-397-0249 Ryan@APS.net

Southeast Texas Wade Holmes 888-847-1040 x2 Wade@APS.net

Central & West Texas Bill Anecelle 800-859-8250 Bill@atp4s.com

Delivering Results - One Practice At a time 27

FEATURE ARTICLE

Strategies to PROTECT

Highly Appreciated

Stock Positions

PART ONE

I

By Thomas Boczar, LL.M., CPWA®, CFA®, and Elizabeth Ostrander, CFA®

nvestors with highly appreciated stock positions face a challenging environment. The stock market remains near record heights, interest rates are steadily increasing and geo-political risks are lurking nearly everywhere around the globe.

Investors also face a considerable tax bill if they sell their shares. Since 2013, the tax cost of selling outright has spiked, with the capital gains tax rate increasing almost 60 percent.1 With President Donald Trump 28

in office and a Republican-controlled Congress, many investors were hopeful that tax reform would include a reduction in the capital gains tax rate. Unfortunately, that didn’t happen. The Tax Cuts and Jobs Act (TCJA) maintains the top tax rate on long-term capital gains.2 However, the TCJA approximately doubled the estate, gift and generation skipping tax exemption for 2018 to $11.18 million.3 In addition, surprising many, the TCJA maintains Code Section 1014,

pursuant to which, on the investor’s death, shares of stock (and other property) received by his/her estate or beneficiary(ies) qualify for an adjusted tax-cost basis equal to the fair market value (FMV) of the shares. For those holding highly appreciated assets, the “step-up” in tax-cost basis to FMV offers investors both an opportunity and incentive to maintain ownership of their assets until death to effectively eliminate the capital gains tax on their Today’sCPA

accrued gains. The prospect of the “stepup,” compounded by the nearly doubled estate tax exemption in 2018, has caused many investors and their advisors to ask themselves, “Is it better to sell now and incur a sizeable capital gains tax – or wait until death to avoid paying the capital gains tax and possibly the estate tax, as well?”

Of course, some wish to hold onto some or all of their concentrated positions for reasons other than tax planning, such as an emotional attachment to the stock, a belief in the further upside potential of the stock, a dividend yield that compares favorably to current fixed income yields or restrictions on selling shares imposed by securities regulations or contract law (i.e., employment, IPO lock-up or merger agreement).

This two-part article explores a variety of tools and techniques – some old, some new, some obvious, some not so obvious – that investors might avail themselves of should the goal be to protect, and defer the tax on, their unrealized gains. This first part focuses on tools and techniques that investors might rely on if the goal is shorter-term or tactical protection. The second part will highlight strategies investors might wish to consider to help strategically manage their single-stock risk over a longer-term period.

Tactical Tools for Shorter-Term Protection What strategies might investors consider to tactically manage their single-stock risk over a short-term period? Puts, equity derivatives, short sales and permutations thereof are the primary tools investors can use to acquire shorter-dated protection.

Puts and Put Spreads The most basic form of protection is the purchase of a put. For example, as Exhibit I depicts, Investor A, who owns ABC Corp. stock, trading at $100 per share, pays $10 to acquire a one-year, “at-the-money” put option (i.e., a strike price of $100). The results are attractive – Investor A locks in 100 percent of Today’sCPA July/August 2018

Exhibit I: Purchase Put Options

Shareholder pays upfront premium of $10.00 and eliminates downside exposure below $100

Current Stock Price: $100.00

Stock

Put Strike: $100.00

Stock with Protective Put

Put Premium: $10.00 $40 $30 $20 $10

P/(L) $0 ($10) ($20) ($30) ($40)

$60

$70

$80

$90

$100

$110

$120

$130

Stock Price

Exhibit II: Zero Premium (Cashless) Collar

Shareholder eliminates downside exposure below $90 and foregoes appreciation above $105 with no upfront cash outlay

Current Stock Price: $100.00 Put Strike: $90.00 Call Strike: $105.00

Stock

Put Premium: $5.00 Call Premium: $5.00

Stock with Collar

$40 $30 $20 $10

P/(L)

$0 ($10) ($20) ($30) ($40)

$70

$80

$90

$100

$110

$120

$130

$140

Stock Price

his/her gain and defers the capital gains tax, while retaining all upside potential of the stock.

However, these benefits come at a price. Puts have always been expensive, but since the financial crisis they’ve become even more expensive for several reasons. First, the volatility skew has become, and remains, unfavorable (i.e., puts have become much more expensive relative to calls post-financial crisis).

Second, interest rates remain much

lower than historical norms. Third, the capital allocation ramifications of Dodd-Frank have been difficult and costly for derivative dealers to adapt to.

That said, many investors would like to reduce the cost of put protection, which can be accomplished several ways.

Shorter-dated puts (i.e., a maturity of three months to one year) are less expensive than longer-dated puts, and continued on next page 29

FEATURE ARTICLE continued from previous page

PUTS, EQUITY DERIVATIVES, SHORT SALES AND PERMUTATIONS THEREOF ARE THE PRIMARY TOOLS INVESTORS CAN USE TO ACQUIRE SHORTER-DATED PROTECTION.

therefore more practical to employ.

At-the-money puts (i.e., 100 percent protection below the current stock price) are the most expensive puts regardless of maturity and it’s simply not practical to use them uninterruptedly for an extended period of time.

Out-of-the-money puts (i.e., less than 100 percent protection below the current stock price, such as 90 percent protection below the current stock

price) are less expensive, but still too costly to utilize to strategically protect a stock position for a longer time period.

Put spreads do not completely protect the investor below the current stock price or put strike, but rather protect a range of value below the current stock price. For instance, Investor B is concerned about the potential impact of Warren Buffet’s death and feels the stock price of Berkshire Hathaway shares

might decrease up to 20 percent in the event of his demise. Investor B buys atthe-money puts, but to help offset the cost of acquiring such protection, sells puts struck at 80 percent of the current stock price. Investor B is protected below the strike price of the long puts down to the strike price of the short puts (i.e., 20 percent downside protection), but remains exposed below the strike price of the short puts.

Collars and Put Spread Collars Collars are another way to reduce the cost of downside protection and perhaps the tool most commonly used by investors to do so. For instance, as Exhibit II depicts, Investor C, who owns ABC Corp., trading at $100 per share, pays $5 to acquire one-year, out-of-themoney put options with a strike price of $90 and simultaneously receives $5 for selling one-year, out-of-the-money call options on the same number of shares

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Today’sCPA

with a strike price of $105. Because the $5 premium received on the sale of the calls fully finances the purchase of the puts and therefore no out-of-pocket expenditure is required by Investor C, this strategy is often referred to as a cashless collar.

The results are attractive. Investor C locks in his/her gain below $90, defers the capital gains tax and retains some of the upside potential of the stock, without incurring any out-of-pocket expenditure.

Most tax professionals believe that the constructive sale rules promulgated as Code Sec. 1259 pursuant to the Taxpayer Relief Act of 1997 (the “constructive sale rules”) require that a collar have at least a 15 percent band around the current price of the stock, as per an example in the legislative history to the statute.4 In the example above, Investor C was able to achieve the requisite 15 percent band while implementing a cashless collar.

However, given current market conditions, this is not always possible.

For instance, assume Investor C wishes to protect another stock, XYZ Corp., also trading at $100 per share, by acquiring one-year, out-of-the-money put options with a strike price of $90 and simultaneously selling one-year, out-of-the-money call options on the same number of shares with a strike price of $105. The XYZ puts cost $5, but the XYZ calls bring in only $4; therefore, to achieve the necessary 15 percent band, Investor C needs to pay $1 per share. This type of collar – which requires a cash investment from Investor C – is referred to as a debit collar. In this example, if Investor C wished to implement a cashless collar to protect his/her XYZ position by selling calls with a lower strike price (i.e., to generate an additional $1 of premium), doing so would likely trigger an immediate constructive sale for tax purposes. Care needs to be taken to assure that investors maintain at least a 15 percent band, even if that requires an out-of-pocket expenditure.

Subsequent to the financial crisis, many investors with formerly highly Today’sCPA July/August 2018

Exhibit III: Short Against the Box

Long Position Profit

Combined Long And Short Position

Current Stock Price

Loss

_

Short Position Stock Price

appreciated stock positions saw much of their unrealized stock gains evaporate.

Investors also quickly realized that market conditions had changed, such that if they used cashless collars to protect their stock positions, they would greatly limit their upside potential should their stock recover. Hence, many investors with concentrated positions made the “bet” that their stock would recover, along with the stock market, and held their shares naked long during the recovery.

Today, many of these investors are holding stocks that have appreciated dramatically since the depths of the financial crisis. Cashless collars still provide investors with very little upside potential, but do give them the ability to lock in their huge unrealized gains with little or no cash outlay and many investors are finding this to be attractive.

Current market conditions also require that investors wishing to use collars make other important decisions and trade-offs. For instance, when an investor protects a stock position with a collar, so long as the shares being protected were acquired after March 1, 1984 (i.e., in almost all instances), the combination of the stock and collar is deemed a “straddle” for tax purposes and the tax straddle rules apply.

+

As such, if an investor uses exchangetraded options, including Equity Flex options, to collar a stock position, some unfavorable tax consequences will arise.5 When implementing a collar using exchange-traded options, it’s typically executed as a “spread” order, meaning one leg of the collar can’t be executed if the other leg cannot be executed as per the order. However, if the spread order is filled, there will be two contracts – one for the puts purchased and another for the calls sold. The options exchanges do not yet permit “single-contract” collars and this can lead to tax inefficiency.

Referring to the collar depicted in Exhibit II, if the stock price of ABC Corp. at expiration of the collar is between the strike price of the put ($90) and call ($105), where both the puts and calls expire worthless, Investor C nevertheless must recognize $5 of shortterm capital gain (i.e., the premium received on the sale of the calls) and $5 of deferred, long-term capital loss on the puts. This “phantom” income – a result of the application of the straddle rules – can be eliminated by using over-thecounter (OTC) derivatives. Specifically, in the OTC market a collar can be structured as a single-contract collar continued on next page 31

FEATURE ARTICLE continued from previous page such that the premiums of the embedded puts and calls “net” for tax purposes.6 Therefore, in the example above, there would be no taxable event (i.e., no phantom income).

Prior to the financial crisis, exchangetraded options and OTC derivatives traded at approximately the same levels, with perhaps a slight nod going to OTC derivatives. However, subsequent to the financial crisis, exchange-traded options (including Equity Flex options) have generally become somewhat less expensive than OTC derivatives.

Hence, a new hedging dilemma has arisen: is it better for the investor to achieve a slightly better price for the collar by using exchange-traded options, but be subject to the possibility of recognizing phantom income on the collar? Or is it better to accept a slightly less robust price for the collar by using OTC derivatives,

but eliminate the possibility of recognizing phantom income on the collar? It is not necessarily an easy decision and there is no right or wrong answer.

In the rare event the investor is protecting shares that were acquired for tax purposes before March 1, 1984 (i.e., the straddle rules should not apply), it would appear prudent to utilize Equity Flex options.7 The investor would likely benefit from slightly better pricing for the collar and because the straddle rules should not apply, the investor should not be “whipsawed” by the straddle rules and the possibility of phantom income.

Put spread collars are yet another way to reduce the cost of protection. Put spread collars combine a put spread (described above) with the sale of out-of-the-money call options. For example, in the case of the Berkshire Hathaway put spread described above, Investor B might have also sold calls

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32

at 110 percent of the value of Berkshire Hathaway shares. The premium received would further offset or potentially eliminate the cost of the long put.

Short Against the Box Short against the box (SAB) was, at one time, a tool that investors heavily relied on for protecting highly appreciated single-stock positions. The constructive sale rules generally eliminated SAB as a long-term hedging and monetization solution.8 However, many investors and tax practitioners erroneously believe SAB was completely legislated away by the constructive sale rules. In fact, there is a short-term hedging exception to the constructive sale rules and SAB can still be used to achieve short-term protection.

SAB can be a useful risk mitigation tool.

Perhaps most importantly, SAB is less expensive than equity derivatives. That’s because there is no optionality; that is, SAB is a delta one hedge, so changes in the volatility skew (for better or worse) have no impact on the cost of SAB. Exhibit III depicts the payoff profile of SAB. The investor is completely hedged and therefore earns a money-market rate of return on the notional amount of stock being protected. Economically, the investor is completely “out of the stock” when SAB is in place; he/she has no upside potential, no downside risk and receives no dividends or distributions. It’s as if the stock was sold tax free and the proceeds immediately reinvested in a money-market account for the term of SAB. Although SAB can be a cost-effective tool to protect unrealized gains, there is a set of very mechanical tax rules that must be strictly complied with; otherwise, a constructive sale can inadvertently result.9 For instance, the investor must close out (i.e., settle) the short position no later than January 30 of the tax year subsequent to the tax year when SAB was established and then remain invested in those shares without any hedge for the next 60 days.

If the investor dies when SAB is open or during the subsequent 60 day unhedged period, the investor must likely forgo the step-up in tax-cost basis of the shares being hedged.10 Today’sCPA

Tax and Regulatory Considerations Tax and regulatory considerations regarding the use of equity derivatives and SAB should be carefully addressed. Equity derivatives and SAB are generally not tax efficient.11 First, what would have been long-term capital gain on the stock being protected is converted to short-term capital gain on the hedge, unless the protected shares are delivered (i.e., sold). Second, losses are capital losses, but are deferred and, therefore, effectively increase the tax-cost basis of the shares being protected. Thus, if the investor plans to hold the shares until death to take advantage of the step-up in tax-cost basis, the result is simply less tax forgiven at death (i.e., the deduction is never utilized).

Third, “qualified” dividends are “disqualified” and taxed as ordinary income. However, in the case of SAB, there is an exactly offsetting “in lieu of dividend payment” deduction.

The use of puts, collars or other equity derivatives by company insiders (i.e., “affiliates”) triggers a reportable event for securities law purposes. However, insiders are not permitted to short shares of company stock or engage in SAB unless the short sale is closed out within 20 days.12 Summary With the stock market at record highs, equity derivative strategies (such as puts, put spreads, collars and put spread collars) and the short against the box can be used by investors to tactically manage their single stock risk. The second part of this article will discuss strategies investors might consider to help them better strategically manage their single-stock risk. n

5.

6.

7.

Footnotes 1. The American Taxpayer Relief Act of 2012, enacted Jan. 2, 2013, increased the top tax rate on long-term capital gains to 20 percent for high-income earners.

In addition, beginning in 2013, long-term capital gains became subject to an additional 3.8 percent surtax, dubbed the net investment income tax (NIIT), enacted as part of the Health Care and Education Reconciliation Act of 2010.

2. The Tax Cuts and Jobs Act (TCJA) includes many changes that will impact individual taxpayers for 2018-2025. However, the TCJA maintains the status quo for tax rates on long-term capital gains and qualified dividends. But the way it did so was somewhat confusing. The TCJA retains the 0 percent, 15 percent and 20 percent rates on long-term capital gains and qualified dividends. However for 2018-2025, these rates have their own brackets that are no longer tied to the ordinary income brackets. The highest-income earners remain subject to the 3.8 percent NIIT. Therefore, the highest rate remains 23.8 percent (20 percent + 3.8 percent).

3. In Rev. Proc. 2018-18, the IRS announced that, pursuant to the newly adopted “chained CPI,” the revised exemption would be $11.18 million for 2018.

4. Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997, (JCS-23-97), Dec. 17, at 177-78 (hereinafter the “1997 Legislation

8.

9.

10.

11.

12.

Explanation”). “The Congress anticipated that the Treasury regulations, when issued, will provide specific standards for determining whether several common transactions will be treated as constructive sales. One such transaction is a ‘collar.’ In a collar, a taxpayer commits to an option requiring him to sell a financial position at a fixed price (the ‘call strike price’) and has the right to have his position purchased at a lower fixed price (the ‘put strike price’). For example, a shareholder may enter into a collar for a stock currently trading at $100 with a put strike price of $95 and a call strike price of $110. The effect of the transaction is that the seller has transferred the rights to all gain above the $110 call strike price and all loss below the $95 put strike price; the seller has retained all risk of loss and opportunity for gain in the price range between $95 and $110.”

Although the language does not explicitly state that this is an example of a collar that should not be considered “abusive,” most practitioners believe this was the reason the collar example was included in the legislative history.

Equity Flex options are exchange-traded options that can be customized allowing the writer and purchaser to negotiate the exercise style (European or American), strike price, expiration date and other significant features of the contracts. They were created to provide investors with greater flexibility in order to compete with the over-the-counter (OTC) equity derivatives market.

1997 Legislation Explanation, supra note ii, at 178. (“A collar can be a single contract or can be effected by using a combination of put and call options.”)

The literal language of the legislation relating to the effective date Code Sec. 1092(d) states that both “positions” (e.g., the stock position and the offsetting hedge position) must be acquired on or after the effective date (March 1, 1984) for there to be a straddle. Most tax practitioners who practice in this area point to the detailed discussion of this issue contained in: 1) Bradley L. Ferguson, “The Latest Stock Hedging Regulations,” 67 Tax Notes 1795 (1995) and 2) New York State Bar Association Tax Section, “Report on Proposed Regulation Sec. 1.1092(d)-2,” 95 Tax Notes Today 199 (1995). Each author concludes that a reasonable reading of the effective date language of Code Sec. 1092(d) is that the straddle rules do not apply to stock positions acquired before the effective date.

It remains possible in certain situations to establish a short against the box position that should not be subject to the constructive sale rules through merger arbitrage. If structured and executed properly, the investor will have no remaining economic exposure to the shares received in the merger, receive up to 100 percent of the value of their shares in cash when the deal closes (with no limitations on the use of those proceeds, including investing in other stocks) and the shares will receive a step-up in tax-cost basis at death, thereby not only deferring, but effectively eliminating the capital gains tax.

Code Sec. 1259(c)(3).

The investor’s tax year ends on the date of death and it is therefore impossible for the investor to hold the shares unhedged for the requisite 60-day period.

These unfavorable tax results are achieved because, in almost all instances, the stock position, when combined with the derivative hedging instrument, will be deemed a “straddle” under Code Sec. 1092. Further, the dividend holding period requirements of Code Sec. 1(h)(11)(B)(iii)(I) won’t be satisfied.

See 15 USC Sec. 78p(c).

Thomas Boczar, LL.M., CPWA®, CFA®

is Chief Executive Officer of Intelligent Edge Advisors, a New York City-based investment banking and capital markets firm.

Elizabeth Ostrander, CFA®

is SVP, Director of Business Development at Intelligent Edge Advisors, a New York City-based investment banking and capital markets firm.

Today’sCPA July/August 2018

33

FEATURE ARTICLE

A Good Day at the Office – Corporate Tax Rates Coming Down

T

By Don Carpenter and Tim Thomasson

his is the third article in a series that is examining the major changes to the tax code resulting from the new tax bill that was enacted at the end of 2017. This article focuses on the changes that affect corporations.

The perceived competitive disadvantage of U.S. business and the increased relocation of these businesses to low-taxed jurisdictions were driving forces behind tax reform. And as the legislation developed, much debate centered on the tax benefits of the bill’s provisions for “big business” relative to individual taxpayers.

The corporate rate was reduced to 21 percent from the 35 percent rate that had been in effect since 1993. Both houses of Congress had originally proposed at 20 percent corporate rate, but the Senate version would have delayed the reduction until 2019. Ultimately, a 21 percent rate was agreed upon, but effective from 2018.

Corporations with less than $50,000 of taxable income will see an increase in their tax liability as the 21 percent rate is a flat rate and eliminates the 15 percent rate on what was the initial tranche of the prior graduated rate schedule. Conversely, 34

professional service corporations, which are common in such professions as health services, accounting, engineering and law, are subject to tax at the highest rate in effect for corporations.

Accordingly, the tax rate for these entities is now reduced from 35 percent to the new rate of 21 percent.

Although not broadly applicable, corporations that receive significant dividends from investment in less than 80 percent owned corporations will not benefit from the rate reduction on these dividends. The dividends received deduction (DRD) from “20 percent to less than 80 percent owned corporations” was reduced from 80 percent to 65 percent and for “less than 20 percent owned” from 70 percent to 50 percent. The effective tax rate on these dividends remains at roughly 10 percent. This result is surprising given that other forms of passive income such

Figure 1 Prior Law

New Law

Dividend (79% owned)

$100

$100

DRD (80% / 65%)

(80)

(65)

Taxable Dividend

$20

$35

Tax (35% / 21%)

$7

$7

Today’sCPA

as interest and capital gains benefit from the rate reduction. The calculation in Figure 1 illustrates the above result.

Companies may also find that with the lower tax rate, tax credits may be limited. Under the general business credit computation, most tax credits are combined and available to offset up to 75 percent of tax liability. With a lower tax liability, taxpayers will see a lower cap on tax credit capacity, which can alter the economics of projects or tax credit driven transactions.

Domestic Production Activities Deduction Eliminated In conjunction with the corporate rate reduction, Congress eliminated the 9 percent deduction for taxable income from domestic production activities (DAP). This deduction was included in the American Jobs Creation Act of 2004 and was intended to encourage manufacturing and similar production activities in the United States. Although still beneficial, the current rate reduction is not as dramatic for businesses that qualified for the DAP deduction as illustrated in Figure 2.

Figure 2 DAP Qualified

Non-Qualified

Income

100

100

DAP Deduction

(9)

-

Net

91

100

Tax on Net at 35%

32

35

Tax on Gross at 21%

21

21

Tax Reduction

11

14

One Headache Gone – AMT is History The new tax act has been criticized for not achieving the simplification that was a major justification for tax reform. The repeal of the corporate alternative minimum tax (AMT) is a striking exception and is arguably the lone major simplification in the legislation. The corporate AMT was intended to ensure that corporations pay at least some level of tax by limiting or eliminating specified tax deductions and credits. Had the corporate AMT provisions been retained, the reduction in the corporate rate could have caused more corporations to be subject to the AMT. Prior to repeal of the AMT, corporations were allowed a credit against future regular tax liability for any AMT paid to ensure that AMT tax adjustments were not subject to both AMT and regular tax. Under the new law, any remaining AMT credit

Figure 3 Assume Company A ended 2017 with a $20mm AMT credit carryforward. The company has tax losses for 2018 and 2019 and has a tax liability in 2019 of $2mm. Under these assumptions, the credit would be utilized as follows:

Offset Liability

Excess Refunded

Total Used

2018

-0-

$10.0mm

$10.0mm

2019

-0-

$5.0mm

$5.0mm

2020

$2mm

$1.5mm

$3.5mm

2021 Total Today’sCPA July/August 2018

$1.5mm

$ 1.5mm $20.0mm

carryforward as of 2018 can be used to reduce tax liability for the 2018 to 2020 tax years. To the extent the credit exceeds the liability for these years, 50 percent of the excess is refundable, with any remaining balance being refundable in 2021. See the illustration in Figure 3.

But is AMT Really Gone?

The Use of Tax Losses Changes Considerably Although the complicated system of AMT tax preferences items was repealed, the new provisions retain the philosophy that every corporate taxpayer should pay a minimum level of tax. This is now achieved through a limitation on the deduction of net operating losses (NOLs). NOLs from any tax years beginning after Dec. 31, 2017, may only be deductible against 80 percent of a subsequent year’s taxable income.

Under prior law, NOLs could be carried back to the two previous years and carried forward for 20 years. During this period, the NOL was fully deductible to the extent of a corporation’s taxable income. For tax years ending prior to 2018, these rules still apply to NOLs generated before 2018. But for NOLs after that point, the calculation changes significantly.

For NOLs from tax years ending after Dec. 31, 2017, the two-year carryback provision has been eliminated. Henceforth, losses may only be carried forward. However, the carryforward

Figure 4 Assume that ABC, Inc. has an NOL of $500mm in 2018 due to tax deductions that it cannot control (i.e., legal settlement, pension funding, stock options exercised). The corporation regularly has about $150 of taxable income each year. The NOL would be utilized over four subsequent years:

2018 Taxable Income

2019

(500)

Utilization of 2018 NOL

2020

2021

2022

2023

150.0

150.0

150.0

150.0

150.0

(120.0)

(120.0)

(120.0)

(120.0)

(20.0)

Remaining Taxable Income

30.0

30.0

30.0

30.0

130.0

Tax (21%)

6.3

6.3

6.3

6.3

27.3

Had ABC, Inc. been able to accelerate the deductions that created the NOL into 2017, $300mm of the NOL would have resulted in an immediate refund of $105mm from carryback against the $150 taxable income in each of the two prior years and then carried forward to reduce the two subsequent years subject to the 80 percent limitation.

2015

2016

2017

2018

2019

Taxable Income

150.0

150.0

(500.0)

150.0

150.0

Utilization of 2017 NOL

(150.0)

(150.0)

(120.0)

(80.0)

Remaining Taxable Income

-0-

-0-

30.0

70.0

Tax (35% / 21%)

(52.5)

(52.5)

6.3

14.7

Two additional points are worth noting: 1. The language of the new law does not make clear how the 80 percent limitation on the deductibility of post-2017 NOLs will be calculated if a corporation also has pre-2018 NOLs. If the limitation is calculated in the current year’s taxable income without reduction for the earlier NOLs (which are not limited), the corporation will be able to deduct a larger portion of the later NOLs than if the 80 percent limitation is computed after deduction of the pre-2018 loss.

2. The underscore of “beginning” and “ending” above is to emphasize that the limitation of deductibility of NOLs and the carryback/carryforward periods are not identical for fiscal year corporations. NOLs for a fiscal year that began between Jan. 2, 2017 and Dec. 31, 2017 could only be carried forward, albeit indefinitely, but would be fully deductible against future years’ taxable income.

We will consider later how the interplay between the limitation on deductibility of NOLs and accelerated capital cost recovery might alter investment decisions.

continued on next page 35

FEATURE ARTICLE continued from previous page period is no longer limited to 20 years, but is indefinite. The new provisions do not address the carryback of capital losses, so presumably the three-year capital loss carryback remains in effect.

See Figure 4 for an illustration of the impact of this change.

Rethinking the Form of Doing Business One More Time In the previous article regarding the taxation of pass-through entities, we discussed how the new law might cause taxpayers to favor one type of pass-through entity in lieu of another.

But taxpayers should also consider the relative merits of passthrough entities as compared to corporations.

What if a business qualifies for the QBI deduction that was the subject of the prior article, but given the taxpayer’s income, the deduction is not available? With the reduced corporate tax rate, would a C corporation yield a lower effective tax rate, even with full distribution of after-tax profits? To illustrate, assume Ted is in the top marginal rate of 37 percent. He operates a CPA business through two alternative structures, an S corporation and a C corporation, both of which generate $200,000 taxable income after wages to employees. The total tax liability, whether paid by the entity or Ted, is shown in Figure 5.

Figure 5 Taxable Income

S Corporation

C Corporation

$200,000

$200,000

Tax at entity level (21%)

N/A

$42,000

Tax on distribution of profits

N/A

$ 37,604

Tax on flow-through profits

$74,000

N/A

Total tax liability

$74,000

$79,604

Based on the above, operation of the CPA firm through an S corporation results in a total lower tax burden for Ted, although the margin is very small. He would incur a $74,000 tax liability on his distributive share of S corporation income. As a C corporation, the business would incur corporate tax at a rate of 21 percent. Upon distribution of the after-tax profits, Ted would incur taxes of $37,604 based on a combined income and net investment tax rate of 23.8 percent. Therefore, the total tax liability would be $79,604.

Many other factors should be considered, however, including state income taxes, AMT, employment taxes and plans for distributions of profits. For example: • If Ted was able to benefit from the QBI, his tax liability under the pass-through would be even further reduced.

• If Ted did not plan to fully distribute all after-tax profits but rather re-invest them in the business, the C Corporation liability could be reduced even below the pass-through liability.

After considering the new deduction for pass-through entities and the lower tax rates for both individuals and corporations, a few additional items might alter a structuring decision in very specific circumstances: • If a corporation is likely to have significant dividends from less than 80 percent owned corporate investments, the relatively high effective corporate tax rate on these dividends might justify placing these investments in a pass-through entity.

• Likewise, the limitation on the deductibility of corporate NOLs might encourage an owner/ operator of a business to consider a pass-through entity.

• But the elimination of the AMT for corporations might tilt certain businesses to corporate form particularly if the business has material accelerated depreciation or percentage depletion, which remain preference items for individual AMT.

Everything Comes with a Cost Before we discuss the major changes that were made to capital cost recovery, we should consider three areas where corporations will see modifications to deductions that could increase taxable income and, in some circumstances, increase it significantly.

36

In conjunction with lowering the corporate tax rate, Congress made modifications to the limitations on deductibility of interest expense. The changes in this area are complex enough to justify an in-depth analysis and will be the subject of the next article in this series.

The deduction for meals, entertainment and other fringe benefits was also further restricted as part of the new law. These modifications are not limited to corporations.

In addition to club membership dues that have not been deductible for some time, expenses for entertainment or recreation, as well as costs for company-owned or leased recreational facilities, are no longer deductible. These costs are not deductible even if incurred in conjunction with the conduct of the taxpayer’s business.

In addition, any expenditures to provide or reimburse employees for commuting costs between their home and office are no longer deductible. This includes subsidies for public transportation and employer-provided parking.

The 50 percent limitation on the deduction for meals associated with conducting business has been retained and has been expanded to include most meal costs that were previously 100 percent deductible, such as meals provided on-premises and meals provided for the convenience of the employer. These costs are deductible if the employer elects to include them in the taxable income of employees.

The new law also expanded the disallowance for otherwise ordinary and necessary business expenses to include payments (included attorney fees) related to sexual harassment or abuse claims if the payments are subject to a nondisclosure agreement.

Deduction for Executive Compensation Changes Significantly In recent years, there has been considerable discussion regarding the level of executive compensation when compared to the compensation of lower and mid-level workers. The stagnation of wages since the 2008 financial crisis only helped to fuel the debate. The new law included revisions to the rules regarding the deduction for executive pay that makes it significantly more expensive to pay the level of compensation executives have come to expect in public companies.

There has been a long-standing restriction on the deduction for compensation to highly paid executives in public companies.

And it should be noted that these restrictions were limited to public companies. The new law expands the restrictions to companies with publicly traded debt and foreign companies traded on the exchanges using American Depository Receipts (ADRs).

But the real meat of the revisions addresses what types of compensation are included and whose compensation is included. Previously, public companies were limited to $1 million in compensation per year for its CEO and another four of its highest paid executives (called “covered employees”).

There was a major exception for any compensation that was “performance based,” which included bonuses, stock options Today’sCPA

THESE CHANGES IN TAX LAW SHOULD CAUSE BUSINESSES TO REVIEW THEIR FORM OF BUSINESS, COMPENSATION PACKAGES FOR HIGHLY COMPENSATED INDIVIDUALS AND THE TIMING OF ASSET PURCHASES. and restricted performance shares if the payment was based on individual or company performance criteria, such as earnings targets or stock appreciation. Generally, it was not difficult to structure around the $1 million limitation, since a large portion of executive compensation is or can be performance based.

The new provisions eliminate the performance-based exception. All compensation will now be included in the limitation. The new law does provide an exception for compensation granted under a written contract in existence as of Nov. 2, 2017 that is not discretional and cannot subsequently be altered. The example given in the law concerns a new employee who agrees to a deferred compensation plan prior to Nov. 2, 2017. Arguably, this provision will cover stock options and restricted performance shares granted before that date as well, but further clarification may be required.

When under prior law, the CEO and the next four highest compensated individuals were covered employees; the list of covered employees could and often did change annually.

Previously, the principal financial officer was excluded from the definition of covered employee, but will be included under the new law. Additionally, an individual was exempt from being a covered employee if he/she was not an employee at the end of the year. This last exception allowed large retirement or severance payments to be exempted from the $1 million limitation. Under the new provisions, the definition of covered employee will include the CEO, chief financial officer and the next three highest paid individuals. And once on the list, an individual remains on the list throughout the period of employment and into retirement. The list can and will grow, and forestalling payments until executives leave the employ of a company will not “cure” the payouts.

To illustrate, ExecuComp, Inc. will pay Ms. Cash (CEO), Mr. Rich (CFO) and Ms. Payme (VP Sales) identical compensation packages consisting of $900,000 of base pay and $3 million bonus that is payable on a sliding scale if the company meets certain earnings and cash flow targets. In addition, Mr. Rich intends to retire in November next year and will vest in a restricted stock grant worth $10 million.

Today’sCPA July/August 2018

Under the old provisions, the $1 million limitation would not reduce the total compensation deduction of $21.7 million for these three individuals. The $900,000 base pay for each of the individuals is not performance based, but is below the $1 million limitation. The bonuses are exempt as performancebased pay. Mr. Rich’s entire compensation package (including restricted stock) is also exempt since he is not an employee at the end of the year.

Under the new provisions and assuming the payments are not grandfathered, the compensation deduction will be limited to only $3 million for these individuals. The remaining $18.7 million is permanently non-deductible, resulting in an increase in tax of $3.9 million.

Potentially, these changes significantly increase the aftertax cost of executive compensation and may drive changes in compensation structure. Companies could consider the following: • Lengthening the vesting period for stock options and other performance-based compensation to average down the cost per year.

• Reducing total compensation, but increasing the base portion of the package. This would limit the upside for executives and also the risk, and allow companies to better plan both the earnings and cash flow implications of compensation and related taxes.

A Big Bonus in Bonus Depreciation For small and mid-size businesses, the provision to allow for expensing the purchase of business assets (Sec. 179) was increased. The $500,000 limit on expensing business assets has been increased to $1 million. Furthermore, the dollar-for-dollar phaseout of the deduction has been increased to $2.5 million of asset purchases from the previous $2 million. These limitations will be indexed for inflation.

But the Sec. 179 business asset expense will not be a major factor for most businesses for several years. The new law also increases the 50 percent bonus depreciation deduction to 100 percent for assets purchased from Sept. 27, 2017 until Dec. 31, 2022. The deduction will then reduce to 80 percent in 2023, 60 percent in 2024, 40 percent in 2025 and 20 percent in 2026. Taxpayers may elect 50 percent bonus depreciation for 2018 in lieu of 100 percent. We will discuss when this might be beneficial. The bonus depreciation provisions are elective by asset class, but if elected must apply to all assets in an asset class within a taxable year.

Most surprising is that bonus depreciation can now be applied to “used” property and equipment as long as it was not previously used by the taxpayer or acquired from a related party. This is a material change from prior bonus depreciation provisions and can have a significant impact on acquisitions and purchase price allocations.

The law excludes from bonus depreciation any assets used in the trade or business that is not subject to the net business continued on next page 37

FEATURE ARTICLE continued from previous page

interest expense limitations, which will be discussed in the next article in this series.

Contrary to the 100 percent bonus depreciation allowance, the new law restricts the deduction for research and experimental expenses (R&E), including software development costs. Previously, these costs were deducted as incurred regardless of whether a subsequent patent or commercial application was developed. For expenditures incurred after 2021, these costs must be capitalized and amortized over five years (15 years if conducted outside the United States). The costs continue to be recovered through amortization even if subsequently sold or otherwise disposed of.

Bonus Depreciation and NOL Utilization – Some Planning Needed The interplay between bonus depreciation and the limitation on the deduction of NOLs will require taxpayers with significant capital expenditures (or acquisitions) relative to taxable income to consider the cash flow implications.

For example, RampUp, Inc. has determined to significantly increase its purchase of delivery trucks as it sees major growth in the company’s markets in the next several years. RampUp expects taxable income of $1.0 million in the next two years (before depreciation), but will be acquiring $2 million of new and used equipment.

If the equipment is acquired in 2018, RampUp has two options: 1) Expense the $2 million under the bonus depreciation provisions.

2) Forego bonus depreciation and elect MACRS depreciation.

Depreciation would be: 2018

2019

Option 1

$2.0

-0-

Option 2

$0.4

$0.6

Neither of these options would eliminate the taxable income in the two years combined, as any NOL from 2018 could only reduce 2019 taxable income by 80 percent. However, if RampUp delayed the purchase of half of the trucks until Jan. 1, 2019, it could eliminate the taxable income for both 2018 and 2019, as the bonus depreciation for assets acquired within a taxable year is not subject to the same limitations as NOLs.

38

Challenging Assumptions – A Final Thought For companies that are considering possible acquisitions, the changes should cause a wholesale review of acquisition assumptions and models. Specifically: • Bonus depreciation for “used” property may allow an immediate deduction for a large portion of purchase price and further encourages asset or Sec. 338 synthetic asset acquisitions rather than stock acquisitions.

• The cash flows of profitable targets should increase as the rate reduction will generally reduce cash tax liabilities. This should also trigger review of long held multiple assumptions like “businesses in our industry sell for X times revenue or Y times EBIT.” • NOLs of targets will have lower valuations than under prior tax law given the reduction in corporate rates and the 80 percent deduction limitation. However, indefinite carryforward mitigates utilization risk.

• Financing costs increase as the tax benefit of interest expense is reduced. The interest expense limitation discussed in the next article must also be considered.

• The tax implications of golden parachutes and other compensation structures must be reviewed given new limitations on the deduction for executive compensation.

In summary, the passage of the new tax law was a good day at the office for business and particularly corporations. The lower tax rate and repeal of AMT have been objectives for American businesses for quite some time. But the limitation on the deduction of NOLs and performance-based executive compensation will have many tax departments and advisors back at the drawing board. Furthermore, the impact of the new law on acquisitions and valuations may change the playing field and redefine who are the winners and who are the losers.

Note that we excluded from the scope of this article major changes to the taxation of a corporation’s international operations, including the (1) transition towards a territorial tax system, (2) base erosion avoidance tax and (3) taxation of general low-taxed income. As noted above, we also excluded an analysis of the new limitation on the deduction of interest expense. All of these issues, which are worthy of more in-depth discussion and will be the subject of future articles, will have a significant impact on corporations with international operations and/or significant levels of debt. n

Don Carpenter, CPA

accepted the position of assistant clinical professor of accounting at his alma mater after a 35-year career managing tax and accounting responsibilities (most recently as chief accounting officer for Houston-based Waste Management Inc.). He received his BBA in accounting at Baylor University and his Masters of Science in accountancy at the University of Houston. Carpenter can be reached at Don_Carpenter@baylor.edu.

Timothy S. Thomasson, CPA, MTAX

is an associate clinical professor in the Hankamer School of Business at Baylor University, where he teaches multiple classes for the Accounting and Business Law Department. He is also a practicing CPA. Thomasson can be reached at Timothy_Thomasson@baylor.edu.

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CPE ARTICLE TTake this CPE quiz online http://bit.ly/cpequiz

CPE Article: What to Consider When Making

an Accounting Change

By Sunita S. Rao, Ph.D. and Barbara W. Scofield, Ph.D., CPA

Curriculum: Accounting and Auditing Level: Basic Designed For: Accountants in business and industry Objectives: Readers will be able to evaluate their alternatives for timing of adoption and transitions upon adoption when making either mandatory or voluntary accounting changes. Readers will be able to plan for GAAP requirements and consider the flexibility available in GAAP to best meet their company’s objectives.

Key Topics: Adopting mandatory and voluntary accounting changes, when changes should be adopted, transition methods, impacts on the company, label adopters vs. serious adopters, and valuation consequences Prerequisites: None Advanced Preparation: None

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Mandatory changes are scheduled for the next several years and companies will have to make some choices to adjust to new environments.

The process of making a smooth transition to a new accounting method involves careful consideration of Topic 250 Accounting Changes and Error Correction.

Today’sCPA

Companies should consider the following issues as they plan the pervasive mandatory changes, as well as the narrower accounting choices within GAAP. Many of the general principles in the area of accounting changes have exceptions and scope limitations that may prevent a company from making the changes that are preferred. A lack of awareness of the disclosures required can cause a delay. A lack of awareness of the market interpretations can result in unintended consequences.

Mandatory Accounting Changes Mandatory accounting changes are appearing in financial statements in a flurry over the next three years as changes in Financial Instruments, Revenue Recognition, Leases, Credit Losses, Derivatives and Hedging, and Goodwill Impairment occur (see Table 1). For each of these major issues, companies need to plan carefully to revise their accounting information systems to accommodate these changes.

However, even before the planning can begin, companies have decisions to make in order to have an orderly transition. The following three implementation issues will dictate the timing of the transition, the method of the transition and the preparation provided to financial statement users, investors and creditors.

1. When should the change be adopted? Some of the six upcoming accounting changes listed in Table 1 allow early adoption. In addition, private companies and not-for-profits have an additional year, offering a longer early adoption period. Factors to consider in opting for early adoption include the following.

Immediate simplification of accounting procedures – Some standards can prompt immediate cost savings. For example,

ASU 2017-13 on Derivatives & Hedging allows joint deferral and recognition of portions of a cash flow hedge. ASU 201704 eliminates the estimation of fair value of the net identifiable assets of business reporting units with goodwill when completing quantitative testing for goodwill impairment.

Clarity of the new standards – Some standards have little ambiguity and contain pertinent implementation guidance for certain business contexts. However, even the Financial Accounting Standards Board (FASB) anticipated difficulty interpreting ASU 2014-09 on Revenue Recognition.

Companies have submitted 125 issues to the Revenue Recognition Transition Resource Group (RRTRG), resulting in six ASUs on revenue recognition issued after the initial pronouncement and a one-year deferral of its effective date.

Only recently at the RRTRG’s November 2017 meeting did it conclude that there are no future expected changes. However, implementation issues are still being resolved for leases. For example, the exposure draft issued on Sept. 25, 2017 on land easements provides an alternative to assess land easements for the applicability of Topic 842 criteria on leases only prospectively.

Companies adopting ASU 2016-02 on leases may want to wait on resolution of this issue prior to scheduling adoption.

Benefits of leading or following – Early adopters exude transparency and competency, but later adopters can learn from the experience of the leading companies, especially when there are major changes. For example, Workday has promoted its early adoption of ASU 2014-09 Revenue Recognition as part of its strategy as an enterprise resource company to explicitly help continued on next page

Table 1 Year

Required Effective Date

Accounting Standards Update

Transition Method

2018

Annual periods beginning after 12/15/2017 and interim periods within those annual periods.

2016-01 Financial Instruments

• Cumulative-effect adjustment at the beginning of the fiscal year of adoption.

• Prospective approach for equity securities without readily determinable fair values.

2014-09 Revenue from Contracts with Customers

• Full retrospective or • Modified retrospective, which includes a cumulative effect adjustment to current period retained earnings.

• Adoption for annual periods beginning after 12/15/2016 allowed.

2016-02 Leases

• Modified retrospective with optional practical expedients.

• Early adoption allowed.

2017-12 Derivatives and Hedging

• Adjustment to hedging relationships existing as of the beginning of the fiscal year of adoption.

• Cumulative-effect adjustment to cash flow and net investment hedges for change in treatment of ineffectiveness.

• Early adoption allowed

Annual periods beginning after 12/15/2019 and interim periods within those annual periods.

2016-13 Financial Instruments – Credit Losses

• Modified retrospective.

• Some assets use prospective approach.

• Adoption for fiscal years beginning after 12/15/2018 allowed.

Impairment tests beginning after 12/15/2019.

2017-04 Intangibles – Goodwill and Other

• Prospective approach.

• Adoption for impairment tests after 1/1/2017 allowed.

2019

2020

Annual periods beginning after 12/15/2018 and interim periods within those annual periods.

Today’sCPA July/August 2018

41

CPE ARTICLE continued from previous page others in this same process. However, even Workday advocates that companies involve their auditors from the beginning of planning through implementation. In addition, networking groups, professional associations and trade groups can provide a check on implementation questions.

2. Which transition method should be used? Any combination of the three main transition methods for accounting changes may be designated in new ASUs. The retrospective treatment requires a complete restatement of prior financial statements so that all comparative financial statements use the same accounting method.

The prospective treatment begins using the new method in the period of adoption with no changes to past financial statements at all.

The modified retrospective treatment takes a middle approach with the new treatment in the period of adoption and a single cumulative effect adjusting beginning retained earnings to the value as if the new method had always been used.

When a choice of methods is offered, as with ASU 2014-09 Revenue from Contracts with Customers, the company needs to consider the tradeoffs. Full retrospective method has the greatest transparency and best trend information.

Methods that allow a cumulative effect require less research and documentation, but may lose the benefit of readily understandable trends through time. Thus, choices made to reduce information costs now may lock a company into a disadvantageous presentation of financial statement material long into the future.

3. Can the impact be estimated and disclosed prior to the adoption date? Long adoption windows mean long planning horizons. Staff Accounting Bulletin 74 (SAB 74) requires companies to provide information in anticipation of mandatory changes in accounting and greater transparency of these disclosures may ease the transition with investors and creditors.

Notifying users of the impending impact in footnotes prior to adoption can give the company a chance to make its case for any advantage or disadvantage that is expected. For example, Boeing announced its adoption of ASU 2014-09 Revenue Recognition in 2018, but acknowledged in its 2014 annual report that there would be possible changes in the “timing of revenue recognition for certain transactions.” Its 2016 annual report provided the stronger statement of expectation of “a material impact on our income statement and balance sheet.”

Scholars have looked at the phenomenon of early adoption of mandatory accounting standards from a different perspective. Are there any systematic characteristics that describe early adopters and separate them from those who only meet the deadline?

Not surprisingly, the decision to early adopt seems to have some systematic elements (Espahbodi and Hamer, 1996). Early adoption is more likely when the accounting change increases income and eases debt constraints. In addition, early adopters are more likely to smooth their income through early adoption. Early 42

adopters may jump on an accounting change that lowers (increases) their income if they anticipate a high (low) income from operations.

Voluntary Accounting Changes Voluntary accounting changes use alternatives already present in GAAP, allowing a company to improve its own accounting methods or adjust them to the company’s changing business context and needs. Companies may hesitate to make a change because of the cost of changing IT systems or to maintain consistency in methods. However, the requirement to retroactively adjust for most accounting changes preserves the consistency of comparative financial statements. Companies should carefully consider the following.

Some changes are not changes in accounting method at all. For example, since 2005 a change in depreciation method has been treated as a change in accounting estimate “effected by a change in accounting principle.” In addition, periodic changes in estimates of accruals due to economic and business conditions such as estimations of bad debt expense or warranty expense do not trigger GAAP for accounting method changes.

Some accounting changes have a broad scope and require the same accounting for similar items; others have a narrow scope and allow different accounting for similar items. For example, a company can separately consider fair value accounting for each investment in debt securities (ASC 825-10-25-2), but a company selecting successful efforts or full cost method of accounting for oil and gas activities must adopt one method for all of its operations and the operations of its subsidiaries (ASC 932-10-S99-1(b)).

Some accounting changes can only occur at the time of a particular event or period. The overall recommendation, but not requirement, in Topic 250 is to have accounting changes occur in the first interim period of a fiscal year. However, timing of accounting changes vary considerably with the type of change. For example, GAAP allows the adoption of pushdown accounting, which allows a subsidiary to adjust the valuation of its net assets to fair value to match the value used by its parent company only at the time of a change in control (ASC 805-50-05-9). In contrast, private company alternatives on intangible assets and derivatives issued in Updates 2014-02, 2014-03, 2014-07 and 2017-08 can be adopted initially at any time without the accounting change being subject to Topic 250.

Some reasons pass muster and some do not. Companies must disclose their reason for the change, considering preference from the point of view of its responsibility to financial statement users.

This concise quote from the 2016 annual report of Manitowoc Company, Inc. showcases the most common issues prompting accounting changes (emphasis added): The FIFO method is preferable as it results in uniformity across its global operations, aligns with how the Company internally manages inventory, provides better matching of revenues and expenses, and improves comparability with its peers.

Some accounting changes can be made without retroactive restatement. Topic 250 states that other transitions are allowed Today’sCPA

when restatement is impracticable. However, impracticability is a high standard. When information is unavailable despite every reasonable effort or when required judgments cannot be made objectively for past situations or when management intent cannot be independently substantiated (ASC 250-10-45-9), companies can use a cumulative adjustment to beginning retained earnings or, if necessary, companies can treat the change prospectively.

One final factor that companies should consider before making an accounting change is the perception of external stakeholders.

This topic has been of interest to accounting researchers for many years and results suggest that there are measurable market effects when accounting changes occur.

Daske, Hail, Leuz and Verdi, in their study titled “Adopting a Label: Heterogeneity in the Economic Consequences around IAS/IFRS Adoptions,” examine liquidity and cost of capital effects for two kinds of IFRS adopters: • firms that make very few accounting changes and adopt IFRS in name only, called label adopters, and • firms that adopt IFRS as a strategy to increase transparency, called serious adopters.

They find that serious adopters are associated with an increase in liquidity and a decrease in cost of capital, whereas label adopters are not. This study demonstrates that users could detect the difference between an accounting change in which true financial reporting improvement is achieved and one that just reshuffles numbers.

Linck, Lopez and Rees in their study titled “The Valuation Consequences of Voluntary Accounting Changes” examine

alternative motives behind voluntary accounting method changes.

While some managers claim that voluntary accounting changes are made to increase the informativeness of earnings, others argue that they are made to manage earnings and influence the stock price. Their findings suggest that voluntary accounting changes influence earnings informativeness to a small extent only. Further, the market recognizes the influence of accounting methods and efficiently processes the valuation implications, so that accounting changes alone do not increase company valuation.

Accountants can take this summary and help ensure that the company is addressing the right issues and risks and can adequately support the impact of accounting changes. n Works Cited Daske, H., L. Hail, C. Leuz, and R. Verdi. “Adopting a label: Heterogeneity in the Economic Consequences around IAS/IFRS Adoptions.” Journal of Accounting Research, vol. 51, no. 3, 2013, pp. 495-547.

Espahbodi, R., and M. M. Hamer. “On the Robustness of the Results of Adoption Date Choice Studies: the Case of Pension Accounting.” Review of Quantitative Finance and Accounting, vol. 6, no. 1, 1996, pp. 63-77.

Linck, J. S., T. J. Lopez, and L. Rees. “The Valuation Consequences of Voluntary Accounting Changes.” Review of Quantitative Finance and Accounting, vol. 28, no. 4, 2007, pp. 327-52.

Sunita Rao, Ph.D.

teaches accounting to undergraduate business students and MBAs at Washburn University, Topeka, Kansas. She can be contacted at sunita.rao@washburn.edu.

Barbara Scofield, Ph.D., CPA

teaches accounting to undergraduate business students and masters of accountancy students at Washburn University, Topeka, Kansas. She can be contacted at barbara.scofield@washburn.edu.

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Today’sCPA July/August 2018

43

CPE QUIZ

By Sunita S. Rao, Ph.D. and Barbara W. Scofield, Ph.D., CPA

CPE Article: What to Consider When Making an Accounting Change 1 What is the required effective date for public businesses adopting

6 Mandatory accounting changes for newly issued accounting standard updates:

Accounting Standards Update 2016-02 Leases?

A. B. C. D.

A. B. C. D.

December 15, 2018.

For fiscal years beginning after December 15, 2018.

For fiscal years ending after December 15, 2018.

For fiscal quarters beginning after December 15, 2018.

2 The serious adopters in the Daske, Hail, Leuz and Verdi study are associated with: A. B. C. D.

7 Retrospective treatment of an accounting change: A. B. C. D.

An increase in the cost of capital and an increase in liquidity.

An increase in the cost of capital and a decrease in liquidity.

A decrease in the cost of capital and an increase in liquidity.

A decrease in the cost of capital and a decrease in liquidity.

an accounting change?

procedures?

A. Modified retrospective treatment requires the company to make changes to only the comparative financial statements provided.

B. Modified retrospective treatment includes an adjustment to beginning net assets of the period of change.

C. Modified retrospective treatment is the same as prospective treatment.

D. Modified retrospective treatment is an allowed alternative for companies adopting ASU 2014-09 Revenue from Contracts with Customers.

ASU 2017-13 ASU 2016-13 ASU 2014-09 ASU 2016-02

4 Which transition method provides the best information for trend analysis?

A. B. C. D.

Modified retrospective method.

Full retrospective method.

Prospective method.

Change in estimate method.

9 All companies and organizations will be using the same accounting method for credit losses: A. B. C. D.

5 The Financial Accounting Standards Board helps companies implement new mandatory standards by: A. B. C. D.

Issuing clarifying accounting standard updates on relevant issues.

Previewing submissions before they are sent to the SEC. Ignoring feedback from companies once an ASU is issued.

Accepting no amendments to the codification topic until implementation is completed.

Take this CPE quiz online! Go to TSCPA’s website at Please note that when registration is complete, a confirmation email will be sent and provide a hyperlink to access the quiz.

NEW! No due date. Take the test online or mail to TSCPA for grading.

Today’s CPA offers the self-study exam above for readers to earn one hour of continuing professional education credit. The questions are based on technical information from the preceding article.

If you score 70 or better, you will receive a certificate verifying you have earned one hour of CPE credit – granted as of the date the test arrived in the TSCPA office – in accordance with the rules of the Texas State Board of Public Accountancy (TSBPA). If you score below 70, you will receive a letter with your grade.

To receive your CPE certificate by email, please provide a valid email address for processing.

44

Is rarely selected as the way to transition to a new accounting method.

Changes prior income statements, but not balance sheets.

Requires re-statement of past financial statements.

Is used when a company changes depreciation methods.

8 Which of the following is true about the modified retrospective treatment of

3 Which ASU can create immediate cost savings through simplified A. B. C. D.

Can always be adopted immediately.

Have a common adoption date for all organizations.

Usually offer less time prior to adoption for non-public business entities.

Often have required adoption dates that differ with the type of organization.

For fiscal years beginning after 12/15/2018.

For fiscal years beginning after 12/15/2019.

For calendar years beginning after 12/31/2018.

For calendar years beginning after 12/31/2019.

10 Delaying adoption of an accounting change until the required date has the advantage that: A. B. C. D.

The income effects will be smaller.

The auditor will have less experience with auditing the accounting change.

The company will be able to consult with its peers in planning for the change.

The company can avoid disclosing estimates of the impact of the accounting change before that date.

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Please mail the test (photocopies accepted) along with your check to: Today’s CPA; Self-Study Exam: TSCPA CPE Foundation Inc.; 14651 Dallas Parkway, Suite 700; Dallas, Texas 75254-7408. TSBPA Registered Sponsor #260 Name Company/Firm Address (Where certificate should be mailed) City/State/ZIP Email Address: Make checks payable to The Texas Society of CPAs ❑ $15 (TSCPA Member) ❑ $20 (Non-Member) Signature TSCPA Membership No:

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TSCPA CPE COURSE CALENDAR – AUGUST AND SEPTEMBER CPE COURSES For more information, number of CPE credit hours and to register, go to the CPE section of the website at tscpa.org or call the TSCPA staff at 800-428-0272 (972-687-8500 in Dallas) for assistance.

Date

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City

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New! Advanced Audits of 401(k) Plans: Best Practices and Current Developments

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New! A&A Hot Topics: Getting a Grip on the Big Issues Facing the Industry

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Revenue Recognition: Mastering the New FASB Requirements

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Annual Update for Accountants and Auditors

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New! Interpreting the New Revenue Recognition Standard: What All CPAs Need to Know

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Not-for-Profit Financial Reporting: Mastering the Unique Requirements

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Financial Statement Presentation and Disclosures: A Realistic Approach

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Personal & Professional Ethics for Texas CPAs

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Financial Statement Presentation and Disclosures: A Realistic Approach

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Personal & Professional Ethics for Texas CPAs

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ACCOUNTING BIZ BROKERS offers the following listings for sale: San Antonio, gross $345k S. Central TX I-35 corridor, gross $1.877M West of Katy CPA firm, gross $250k Greater Austin area CPA firm, gross $120k St. Thomas, Virgin Islands CPA firm, gross $75k Contact Kathy Brents, CPA, CBI Office 866-260-2793, Cell 501-514-4928 Kathy@AccountingBizBrokers.com Visit us at www.AccountingBizBrokers.com Member of the Texas Society of CPAs Member of the Texas Association of Business Brokers Texas Practices Currently Available Through Accounting Practice Sales: North America’s Leader in Practice Sales Toll Free 1-800-397-0249 See full listing details and inquire/register for free at www.APS.net.

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$78,000 gross. Allen CPA firm. Accntng/Bkkpg (80%), highquality client base, knowledgeable staff in place and seller available to assist with transition. TXN1472 $475,000 gross. SW Arlington CPA firm. Tax 55%, acctng 32%, misc. consulting 11%, strong fee structure, quality client base, experienced staff in place. TXN1474 $1,025,000 gross. Lewisville/Flower Mound area CPA firm. Revenues made up of 2/3 tax work and 1/3 acctng, knowledgeable team in place, turnkey practice. TXN1479 $360,000 gross. Champion Forest area CPA firm. Tax (25%), accounting/bkkpg (75%), knowledgeable staff, strong growth in recent years. TXS1191 $102,000 gross. Columbia-Sweeny-Lake Jackson-Brazoria area tax firm. Tax 96%, 4% bkkpg, staff and owner available for extended transition. TXS1193 $745,850 gross. SW Houston CPA firm. Tax (42%), accntng (35%), audit (20%), other (3%), high-net-worth clients, strong staff in place to assist with transition. TXS1201 $170,000 gross. W. Houston CPA firm. Tax (63%), accounting (5%), one audit client (15%), financial planning (17%), great location, solid billing rates. TXS1206 $165,000 gross. West Houston CPA firm. Income mix of tax, bkkpg and consulting, great location, loyal client base, good fee structure, turnkey practice. TXS1207 Today’sCPA

$679,750 gross. Rural SE Texas CPA firm. Tax (51%), acctng (23%), payroll (20%), other (6%), great local reputation, continuous referral work, turnkey practice. TXS1208 ACCOUNTING PRACTICE SALES For more information, call toll free 1-800-397-0249 See full listing details and inquire/register for free at www.APS.net.

Practices Sought Purchase of CPA Firm Small CPA firm seeking a retirement-minded CPA in the North Dallas area interested in discussing the sale of their practice immediately or preferably over a period of time to ensure a smooth transition for client satisfaction. Preference would be for a firm with a balanced mix of tax and bookkeeping services. Not a broker. Confidential responses at email: kagnewcpa@gmail.com.

Well rounded CPA with 20 years of experience in both corporate and public accounting seeks to purchase an accounting and tax practice from a retirement minded practitioner in the Houston area. I am not a broker.

Confidential response to PurchaseCPA@gmail.com.

Accounting Broker Acquisition Group “Maximize Value When You Sell Your Firm” You Sell Your CPA Firm Only Once!

Free Report: “Discover the 12 Fatal Errors You Must Avoid When You Sell Your Firm!”

Purchase • Sale • Merger Texas CPA Practices Our M&A Brokers Are 100% “Ex-Big Four” CPAs! Call or email now for Free Report 800-419-1223 X101 maximizevalue@accountingbroker.com accountingbroker.com

BUYING OR SELLING? First talk with Texas CPAs who have the experience and knowledge to help with this big step. We know your concerns and what you are looking for. We can help with negotiations, details, financing, etc. Know your options. Visit www.APS.net for more information and current listings. Or call toll-free 800-397-0249.

Confidential, no-obligation. We aren’t just a listing service. We work hard for you to obtain a professional and fair deal.

ACCOUNTING PRACTICE SALES, INC. North America’s Leader in Practice Sales

Today’sCPA July/August 2018

SEEKING CPA FIRM SELLERS - ACCOUNTING BIZ BROKERS has been selling CPA firms for over 13 years and we know your market. Selling your firm is complex. We can simplify the process and help you get the best results! We have a large database of active buyers ready to purchase. Our “Six Steps to Success” process for selling your firm includes a personalized, confidential approach to bring you the “winwin” deal you are looking for. Our brokers are Certified Business Intermediaries (CBI) specializing in the sale of CPA firms. We are here to assist you in navigating the entire sales process – from marketing to negotiating, to closing and successfully transitioning the firm. Contact us TODAY to receive a free market analysis!

Kathy Brents, CPA, CBI Office 866-260-2793 Cell 501-514-4928 Kathy@AccountingBizBrokers.com Visit us at www.AccountingBizBrokers.com Member of the Texas Society of CPAs Member of the Texas Association of Business Bankers

Miscellaneous Selling your practice?

Learn more about Poe Group’s Unique process, The Seamless Succession™ to help you get top dollar and find just the right buyer for your clients and staff. Please watch our video by visiting www.poegroupadvisors.com/video.

Buying a practice?

Registration is free and simple at www.poegroupadvisors.com/ buying Do you have questions about sales tax? Taxability issues? Audit defense? Refunds? Voluntary disclosure?

Let us be a resource for your firm and your clients. Our owner is a CPA with a BBA in Accounting and Master of Science in Taxation.

He spent 10 years in public accounting, working for both national and large, local CPA firms prior to forming Sales Tax Specialists of Texas in 2005. Feel free to contact us with any questions.

Stephen Hanebutt, CPA Sales Tax Specialists of Texas This firm is not a CPA firm 972-422-4530, shanebutt@salestaxtexas.com Michael J. Robertson, CPA Texas Sales Tax Solutions Need a specialist in Texas Sales Tax? Former Comptroller of Public Accounts - Audit Group Supervisor assisting accounting professionals with sales tax audits and client compliance issues. Is your client overpaying Texas sales tax?

Call 817-478-5788 x12 Texas Sales Tax Solutions

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