Today's CPA MarchApril 2013

Today’sCPA MAR/APR 2013

T E X AS S O C IET Y OF

C E RT I F I E D P U BL IC AC C OU N TANT S

Charitable Contributions vs.

Charitable Contribution Deductions IRS Takes Action on Deceased Spouse Unused Exemption Sale-Leaseback Transactions For the New Millennium Substantiation for R&D Credit

STRATEGIC COST MANAGEMENT: WHAT CPAS NEED TO KNOW

Also: Resources for Business and Industry Members

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Contents

CHAIRMAN

MARCH/ APRIL 2013

VOLUME 40, NUMBER 5

Fred Timmons, CPA

EXECUTIVE DIRECTOR/CEO John Sharbaugh, CAE

EDITORIAL BOARD CHAIRMAN

24

Arthur Agulnek, CPA

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

38

TECHNICAL EDITOR C. William Thomas, CPA, Ph.D. Bill_Thomas@baylor.edu

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COLUMN EDITORS Greta P. Hicks, CPA Mano Mahadeva, CPA, MBA James F. Reeves, CPA C. William (Bill) Thomas, CPA, Ph.D.

WEB EDITOR Wayne Hardin whardin@tscpa.net

cover story

columns

24 Strategic Cost Management:

5 Chairman’s & Executive Director’s Message

What CPAs Need to Know

CONTRIBUTORS Ali Allie, Melinda Bentley; Jerry Cross, CPA; Anne Davis, ABC; Donna Fritz; Chrissy Jones, AICPA; Rhonda Ledbetter; Craig Nauta; Kim Newlin; Catherine Raffetto; Katey Selph; Patty Wyatt

DIRECTOR, MARKETING & COMMUNICATIONS Janet Overton Design/Production/Advertising The Warren Group thewarrengroup.com custompubs@thewarrengroup.com

society features 13 Spotlight on CPAs

Ladybug, Ladybug … Fly Away Home South Texas CPA Finds Fulfillment in Diverse Life

20 Capitol Interest

Pay Now or Pay Later?

CLASSIFIED Donna Fritz Texas Society of CPAs 14651 Dallas Parkway, Suite 700 Dallas, Texas 75254-7408 972-687-8501 dfritz@tscpa.net

Editorial Board Arthur Agulnek, CPA-Dallas; Kristan Allen, CPA-Houston; James Danford, CPAFort Worth; Greta Hicks, CPA-Houston; Baria Jaroudi, CPA-Houston; Tony Katz, CPA-Dallas; Jeffrey Liggitt, CPA-Dallas; Mano Mahadeva, CPA-Dallas; Alyssa Martin; CPA-Dallas; Dawne Meijer, CPA-Houston; Ty Moore, CPA-Houston; Jan Taylor Morris, CPA-Houston; Winford Paschall, CPA-Fort Worth; Marshall Pitman, CPA-San Antonio; Mattie Porter, CPA-Houston; Kamala Raghavan, CPA-Houston; James Reeves, CPA-Fort Worth; Barbara Scofield, CPA-Permian Basin; Brinn Serbanic, CPA-East Texas; Paul Willey, CPA-Dallas. © 2013, 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.

Today’sCPA

| MARCH/APRIL 2013

technical articles 30 Charitable Contributions & Charitable Contribution Deductions: Not Created Equal 34 IRS Takes Action on Portability of Deceased Spouse Unused Exemption

Connections and Resources for Business and Industry Members

6 Tax Topics

PTIN – Who Needs One?

8 Business Perspectives

Real Estate – An Alternative Investment

9 Accounting and Auditing

FRF-SMEs: New Reporting Alternative for Small- to Medium-Sized Businesses

10 Emerging Issues The 44 Percent Solution

11 Chapters

Chapter Presidents Share Experiences in Business, Industry and Education

departments

38 CPE: Sale-Leaseback Transactions, Now & Then

15 Take Note

45 Proper Substantiation for the R&D Credit

46 CPE Calendar

44 Classifieds

See the digital version of

Today’s CPA online at tscpa.org.

3

Risk Assessment

REMEMBER WHEN YOU FIRST WANTED TO BE A CPA? Maybe it was when you realized how good you are with numbers. Or when you developed a passion for order and accuracy. Or when you recognized that you excel at solving problems.

You’re now an accounting professional. Ethical. Objective. Committed. Competent. Joining the AICPA will put you in ®

the company of nearly 386,000 like-minded professionals — sharing knowledge, connecting to critical information and using exclusive discounts on everything from CPE to personal and professional insurance.

For details, or to join, visit aicpa.org/iamcpa or call 888.777.7077.

13031-312

Chairman’s & Executive Director’s Message

By Fred Timmons, CPA | TSCPA Chairman & John Sharbaugh, CAE | TSCPA Executive Director/CEO

Connections and Resources for Business and Industry Members TSCPA offers members resources and information that can enhance their skills, knowledge and professional development in a variety of interest areas. This issue of Today’s CPA is devoted to highlighting business and industry members and the services that TSCPA provides for them.

We hope you enjoy reading this issue of the magazine.

The Business & Industry Center on TSCPA’s website at tscpa.org was created to give members links to the latest professional news, research information, relevant CPE, connections with other members, and much more. The site has specialized neighborhoods, including Manufacturing, Service Industry, Internal Auditors, CFOs, Healthcare, Energy, Nonprofit, Education and Government. There is an “Ask a Question” area on the site for members who have a question and want to reach out to other B&I members who have experience and are willing to answer questions.

Also accessible from the Business & Industry Center is the Industry Issues blog. The blog provides a convenient way to keep current on pertinent issues and opportunities facing the profession. Bill Schneider, CPA-Dallas, is the author. Schneider is a member of TSCPA’s Business & Industry Committee, as well as AICPA’s Risk Management and Internal Control Advisory council and is a former member of the AICPA Board of Directors.

In addition, there are links to TSCPA’s other blogs from the Business & Industry Center.

They are the CEO/Executive Director (the

Sharblog) and Federal Tax Policy blogs, and new posts are added regularly.

Links to TSCPA’s groups on Facebook, Twitter and LinkedIn are available as well.

A LinkedIn group was created especially for B&I members as a way to connect and start discussions with other members.

Another benefit for B&I members is a free subscription to the monthly Business & Industry E-ssentials. The e-newsletter contains news and information for industry CPAs. TSCPA continues to deliver a variety of CPE programs specific to industry. To learn more about them, please visit the CPE area of the website at tscpa.org. The Industry Institute is offered by the TSCPA CPE Foundation and the Accounting CPE Network (ACPEN) for CPAs who work in business and industry environments. The Industry Institute has an extensive catalog of accredited webcast courses. To view the online catalog, go to http://tscpa.acpen.com/ category/acpen-industry-institute.

We would also like to make sure you’re aware of the Chartered Global Management Accountant (CGMA) designation. AICPA and the Chartered Institute of Management Accountants (CIMA) created the CGMA designation for CPAs working in business, industry and government. The designation was established to give management accountancy a higher profile in the United States, and it provides new and important management accounting tools.

Benefits include access to research, reports, surveys, the CGMA magazine and newsletter, professional development products, and a global network of peers via CGMA’s online community and networking events. The designation is meant to be a strategically vital complement to your CPA credential to help broaden your expertise and assist you in your career path. To learn more about the CGMA designation, including the qualifications and costs, please visit their website at cgma.org.

TSCPA members receive a discounted fee to obtain the CGMA designation.

A DIVERSE GROUP If you work in business, industry, government, or education, you’re part of a sizable, diverse group of TSCPA members and have specialized needs in your job as a CPA. You can look to TSCPA for a collection of resources designed to help advance your career and contribute to your organization’s success. ■

Fred Timmons will share some interesting stories or facts about Texas in each issue of Today’s CPA during his year as TSCPA chairman.

Dr Pepper was invented in Waco in 1885, and there is no period in Dr Pepper.

Jalapeno Jelly originated in Lake Jackson, Texas in 1978.

The world’s first frozen margarita machine was invented in Dallas in 1971.

Fred Timmons can be contacted at ftimmons@tbsacpa.com. John Sharbaugh can be contacted at jsharbaugh@tscpa.net.

Today’sCPA

| MARCH/APRIL 2013

5

Tax Topics

By Greta Hicks, CPA | Column Editor

Preparer Tax Identification Number – Who Needs One? A Preparer Tax Identification Number (PTIN) must be obtained by all tax return preparers who are compensated for preparing or assisting in the preparation of all, or substantially all, of any U.S. federal tax return, claim for refund, or other tax form submitted to the Internal Revenue Service (IRS). This requirement began Jan. 1, 2011. Attorneys, CPAs and Enrolled Agents (EAs) who are active and in good standing with their licensing agency are required to register annually for a PTIN and pay an annual fee. The PTIN is then placed in the preparer section of the Form 1040. The following questions and answers will assist you in determining who needs to obtain a PTIN. Is an attorney or a CPA required to obtain a PTIN if the attorney or CPA only advises a client regarding an issue that is reflected on a claim for refund?

An attorney or CPA is required to obtain a PTIN if the attorney or CPA prepares, or assists in preparing, all or substantially all of a return or claim for refund. Under the authority of section 1.61092(h), however, an attorney or CPA will not be required to obtain a PTIN if the attorney or CPA only advises a client regarding an issue that is reflected on a claim for refund, and neither the attorney or CPA nor any person in the firm of the attorney or CPA signs or is required to sign the claim for refund under Treasury Regulation sections 301.7701-15(b)(1) and 1.6695-1(b).

The attorney or CPA in question is still a non-signing tax return preparer subject to penalty under section 6694 if the attorney or CPA has prepared all or a substantial portion of the claim for refund within the meaning of Treasury Regulation section 301.7701-15(b)(3).

What is the difference in a supervised preparer and a nonsupervised preparer?

A supervised preparer is a non-signing preparer who is employed by a law firm, CPA firm or other recognized firm (a firm that is at least 80 percent owned by attorneys, CPAs or enrolled agents). The returns they prepare are signed by a supervising attorney, CPA or enrolled agent at the firm. A supervised preparer does need a PTIN but must provide their supervisor’s PTIN on their own PTIN application or renewal.

For additional guidance on supervised preparers, see IRS Notice 2011-6.

I own a tax preparation business, and I review and sign all the returns my employees prepare. Do they need PTINs? Yes. Anyone you hire to prepare tax returns needs a PTIN regardless of whether you review and sign the returns. If they qualify as a supervised preparer, there are no further education requirements.

I am a tax return preparer and have a PTIN. Every tax filing season, I hire two paid interns from the accounting program at a local university to help me during the busy season. The interns perform data entry from the tax organizer that my clients fill out and assemble the documentation that the clients have submitted.

Where clients have submitted incomplete information or more information is needed, the interns may call clients to gather information missing from the tax organizer, but they are not allowed to provide advice or answer tax law questions. I prepare and sign all my clients’ returns. Do my interns need to have PTINs? No, the interns are not tax return preparers and are not required to have PTINs. Same facts as above, but to help my interns get exposure to the tax system, I allow them to work with clients who have very simple tax situations and prepare the Form 1040-EZ. I review the forms carefully and sign them. Are my interns required to have PTINs? Yes, the interns are tax return preparers and are required to have PTINs, whether or not they sign the returns.

Please see the chart, facing page, for an overview of the various categories of individuals who may prepare federal tax returns for compensation.

■

Greta Hicks, CPA, is a consultant on IRS problems, seminar discussion leader, author of continuing education courses and web content provider. She can be reached at gretahickscpa@yahoo.com or www.gretahicks.com.

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Today’sCPA

| MARCH/APRIL 2013

PTIN

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BACKGROUND CHECK

IRS TEST

CONTINUING EDUCATION

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Registered Tax Return Preparers

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Proposals Pending

Proposals Pending

CPAs

Yes

Yes

Proposals Pending

No

Varies

Unlimited

Attorneys

Yes

Yes

Proposals Pending

No

Varies

Unlimited

Supervised Preparers

Yes

Yes

Proposals Pending

No

No

Limited

Non-1040 Preparers

Yes

Yes

Proposals Pending

No

No

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Today’sCPA

| MARCH/APRIL 2013

7

Business Perspectives

By Mano Mahadeva, CPA, MBA | Column Editor

Real Estate – An Alternative Investment Investors are searching for ways to take advantage of the real estate sector, which is showing relative strength in an otherwise tepid economy. After selling off sharply due to the housing bubble and subprime mortgage fiasco a few years back, real estate equity has rebounded quite positively, as measured by the FTSE EPRA-NAREIT Global Index and the S&P/Case-Shiller 20 city index.

In a climate of an overheated bond market, low interest rates, minimal growth and high volatility, where can an investor turn? The answer could be alternative asset classes.

Traditional alternatives include real estate, private equity, commodities, hedge funds, managed futures and distressed securities.

Real estate is most likely the one people have a basic understanding about and are likely to consider.

Real estate can be classified as direct and indirect. Direct investment in real estate includes the investing in, and the management of, homes, land, and commercial real estate. It is a tangible asset, one that can be felt and seen as opposed to that of a paper claim. The process is relatively simple; you find what you like, you get a loan or mortgage, pay fees and commissions at a close, and you are a proud owner! As an owner, you have direct control of the asset, can deduct associated expenses, geographically diversify (as part of a large portfolio) and are able to leverage returns.

The downside of direct ownership is the lack of divisibility of a large asset (which may consume a large portion of your total wealth), high closing costs, potentially high operating and maintenance expenses, possible neighborhood deterioration, and the political risk of a tax code change.

Indirect investments in real estate exclude any direct involvement in managing properties, with investments in companies which develop and manage real estate, in infrastructure funds, in real estate investment trusts or commingled real estate funds. In the indirect route, the managers invest your

money across various properties they deem suitable. They manage the properties, pay all expenses, and sell them at the appropriate time to maximize profits. Indirect investments in real estate offer highly liquid investments and no management responsibility.

Infrastructure funds specialize in developing projects such as toll roads, which are regulated by local government, produce predictable cash flows and offer stable long-term returns. Real estate investment trusts are publicly traded equity shares in a portfolio of real estate. Commingled funds are pooled investments, managed by professionals, and used by institutions and wealthy investors.

Investments in real estate provide suitable benefits for the appropriate portfolio. They offer significant diversification in a stock and bond portfolio; i.e., they offer lower portfolio volatility for a higher return per unit of risk.

Unlike stocks and to some extent, bonds, a direct investment in real estate is backed by tangible real property. Real estate also offers an inflation hedge by its ability to pass on inflationary effects to tenants and incorporate some of it in the form of capital appreciation. And the Affordable Care Act enacted into law offers some future tax benefits to REITs associated with medical office buildings.

Some disadvantages of real estate investing include the following. Direct investing results in a high cost associated with the due diligence, which involves research and monitoring. Commissions, fees and other professional services lead to high transaction

costs. Real property is immobile, has low liquidity and may have a large cost of carry until an upswing in the business cycle.

Similar to the situation in the 1980s, political or tax risks loom large as Congress wrestles with finding ways to fund the new health law.

Like other assets, valuation of direct real estate investment focuses on intrinsic value. Appraisals are used for estimating the investment value of properties. The market value is independent of any one investor, but the investment value depends on the particular use the investor plans for the property. One of four approaches or a combination of approaches is used to estimate a property’s value. They are the cost, sales, income or discounted after-tax cash flow approach.

Real estate returns are comprised of two components, a capital return and an income return. The capital return is the percent change in the value of the property after capital improvements and sales. The income return is the net investment income earned over a period divided by total capital invested. As such, the total return is the sum of the capital and income returns.

For those investors who may be interested in taking the plunge into real estate investments, it is important that they be aware of economic factors, impending shifts in public policy and future demographic changes. They also need to consider their appetite for risk, return and time horizon before investing. Real estate investing consumes a considerable amount of an investor’s time, but the benefits could be well worth the effort.

■

Mano Mahadeva, CPA, is Chief Financial Officer with Solis Health in Addison, Texas. He serves on both the Editorial Board and the Business and Industry Issues Committee for TSCPA. Mahadeva can be reached at mmahadeva@solishealth.com.

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Today’sCPA

| MARCH/APRIL 2013

Accounting and Auditing

By C. William (Bill) Thomas, CPA, Ph.D. | Column Editor

FRF-SMEs: New Reporting Alternative for Small- to Medium-Sized Businesses For the past few years, a Blue-Ribbon Panel has been conducting research into the financial reporting needs of small- and medium-sized businesses. Based on their recommendations, an American Institute of CPAs (AICPA) task force issued an exposure draft in November 2012 titled Proposed Financial Reporting Framework for Small- and Medium-Sized Businesses.

The framework, referred to below as FRF-SME, is intended for entities that are not required to prepare financial statements in accordance with Generally Accepted Accounting Principles (GAAP). Geared for simplicity to meet the needs of users of financial statements of SMEs, particularly banks, the proposed framework emphasizes the use of historical cost over fair value, avoids complexities where possible, and allows the CPA, working alongside the owner-manager of the SME, to tailor financial presentations to the needs of financial statement users.

For those who are familiar with the term, the FRF-SME fits into the general definition of “other comprehensive basis of accounting” than GAAP (OCBOA), along with the cash basis, tax basis and regulatory bases of accounting, all of which use a definite set of logical, reasonable criteria applied to all material items appearing in the financial statements. The FRF-SME is not an authoritative document. Similarly, AICPA has no authority to require use of FRF-SME; its use is entirely optional.

It is expected that entities that use FRFSME have no expectation of going public.

FRF-SME is not intended as a substitute for GAAP, but merely another comprehensive basis of accounting that may be used at the owner-manager’s discretion to provide relevant, reliable and cost-beneficial information to users when GAAP-based financial statements are not required.

WHY THE NEED FOR FRF-SME?

Before the issuance of FRF-SME, no comprehensive and consistent financial reporting alternative has existed for SMEs to report financial information to users, principally bankers, who did not need – and in most cases, preferred not to receive – information that was largely irrelevant for their needs in making lending and equity decisions. The only acceptable FRFs were GAAP, International Financial Reporting Standards (IFRS), and a rather narrowly defined set of frameworks, none of which were totally acceptable. In addition, the complexities

associated with some GAAP disclosures make them cost prohibitive for certain entities, particularly those that are owner-managed. The result has been a great deal of frustration and complaint expressed by SMEs and CPAs who serve them. The FRF-SME has been developed to serve the substantial marketplace where OCBOA financial statements are insufficient and where GAAP financial statements are unnecessary.

A FEW OF THE PARTICULARS

The exposure draft containing the framework is about 200 pages long, so if it might apply to you, read it completely (www.aicpa.org/FRFSME). In addition, an excellent article written

by Ken Tysiac appears in the December 2012 issue of the Journal of Accountancy. Here are a few highlights: • FRF-SME is principles-based and usable across a broad spectrum of industries by both incorporated and unincorporated entities; • only financial statement matters that are typically addressed by SMEs are addressed in the FRF; • disclosures are reduced, while still providing users with reliable information that is relevant for their needs; • FRF-SME consists of a blend of traditional accounting methods and accrual income tax accounting; historical cost is emphasized over fair value, and corporate

•

•

• •

•

preparers will find that it reduces the number of Schedule M differences between book and taxable income; FRF-SME is designed particularly for owner-managers and for users who deal directly with them in making financial decisions; these users are interested in interpreting cash flows, so the framework is particularly designed to provide this information; FRF-SME contains no concept of variableinterest entities; preparers have the option of presenting parent-only financial statements; FRF-SME does not include a concept of other comprehensive income; FRF-SME does not require complicated accounting for derivative financial instruments such as interest rate swaps; these will be handled largely through footnote disclosures; financial statements issued under FRFSME include a footnote similar to other OCBOA-prepared financial statements, referring to the financial framework used and how it differs from GAAP.

EFFECTIVE DATE

Because FRF-SME is not authoritative, it is expected to have no effective date. However, the final version of the FRF is expected to be issued in mid-2013.

■

C. William Thomas, CPA, Ph.D., is the KPMG/Thomas L. Holton Chair and the J.E. Bush Professor of Accounting in the Hankamer School of Business at Baylor University in Waco. Thomas can be reached at Bill_Thomas@baylor.edu.

Today’sCPA

| MARCH/APRIL 2013

9

Emerging Issues

By James F. Reeves, CPA | Column Editor

The 44 Percent Solution Once again, we find ourselves in the throes of a national debate concerning how to fund the federal budget while putting the nation on a more sustainable fiscal course over the long haul. In theory, most of the players agree with the recommendation of President Obama’s bipartisan National Commission on Fiscal Responsibility and Reform, aka Simpson-Bowles, which garnered a lot of attention a few years ago with its blueprint involving lower rates for both individuals and corporations, and reducing the size and number of “tax expenditures” – including income exclusions, exemptions and deductions from gross income plus credits, preferential tax rates and tax deferrals – which total about $1.1 trillion annually according to the Joint Committee on Taxation. To put that in perspective, the total of all individual income tax revenue collected in FY 2013 is $1.36 trillion.

Both parties seem to agree that the U.S. corporate tax rate is too high, making U.S. businesses less competitive relative to companies in jurisdictions with lower rates. Both parties seem to agree in principle that lowering the U.S. corporate tax rates and broadening the base is the way to make U.S. businesses more competitive. Of course, the devil is in the details and as the debate heats up and lobbyists and special interests weigh in, we’re going to hear more noise from both the right and the left about “corporate welfare.” This is an important issue, and before we let the media frame the debate, let’s take a deeper dive.

WHAT IS CORPORATE WELFARE?

The term corporate welfare has been around as long as I can remember, and is also called “crony capitalism” by some. To a certain extent, corporate welfare is a subset of the broader concept of tax expenditures, although it could extend to other forms of government assistance as well, including grants and subsidies. It generally includes tax breaks and other government aid benefitting specific businesses or industries, often the result of intense lobbying efforts on behalf of these “special interests,” and I’ve seen estimates of corporate welfare in the federal budget in the range of $100 - $125 billion a year.

It is not necessarily a left versus right issue, as both parties are critical of the practice but end up supporting it, perhaps for different reasons. It is also not limited to incentives and subsidies provided by the federal government, as states and municipalities certainly extend tax breaks and other types of incentives to businesses to encourage desirable types of economic behavior.

Commonly cited examples of corporate welfare include farm subsidies, research and development tax credits, tax deductions for oil and gas companies and for domestic manufacturers, and alternative energy incentives. Lesser known examples include wind energy tax credits, accelerated depreciation for motorsports entertainment complexes (i.e., NASCAR tracks), an enhanced charitable deduction of food inventory, special expensing rules for U.S. film and television productions, and a rebate of excise taxes for certain rum distillers, all of which were included in the recent fiscal cliff legislation.

Critics claim these incentives misallocate resources, drive up the deficit, benefit only special interests who can afford the lobbyists, drive up tax rates for everyone else, are often added on to last-minute, must-

pass bills at the 11th hour, and are often reflexively extended without any meaningful review or oversight (i.e., the “extenders”). Conversely, supporters argue that these incentives stimulate investment, boost the economy, correct market imbalances, and create jobs. And paradoxically, eliminating targeted corporate tax breaks to broaden the base and lower the rates to make U.S. businesses more competitive with other multinationals could backfire in a way. Advocates of so-called corporate welfare maintain that American businesses are competitive globally precisely because of the governmental support they’ve received.

THE TAXPAYER ADVOCATE’S SOLUTION

In January, National Taxpayer Advocate Nina Olsen, in her 2012 annual report to Congress, identified tax reform as the number one priority in federal tax administration. In her report, Olsen echoed the near universal sentiment that “the tax code is broken and needs to be fixed.” One of the more interesting parts of the report includes her thoughts on tax expenditures, suggesting that if Congress were to eliminate all tax expenditures, it could cut individual income tax rates by 44 percent and generate the same amount of revenue.

Olsen advocates fundamental tax reform, not merely ad hoc simplification, beginning with a general premise that tax expenditures for both individuals and businesses should be eliminated unless a compelling case can be made that the benefits of the expenditure outweigh the complexity burden it creates for taxpayers and the Internal Revenue Service (IRS). Further, the report suggests public policy objectives such as increasing retirement savings, increasing health insurance coverage and providing incentives for certain industries may be better accomplished through direct expenditures rather than through the tax code. She recommends that Congress apply a zero-based budgeting approach to comprehensive tax reform, an approach also proposed by the National Commission on Fiscal Responsibility and Reform.

What a novel idea – dealing with the nation’s public policy objectives in an open and transparent way, which ultimately empowers the voters, while improving the ability of individuals and businesses to make sound economic decisions. Don’t hold your breath.

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James F. Reeves, CPA, is Senior Vice President, New Product Development at the Tax and Accounting business of Thomson Reuters. Contact him at jim.reeves@thomson.com, or visit his blog at http://jamesfreeves.blogspot.com.

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Today’sCPA

| MARCH/APRIL 2013

Chapters

By Rhonda Ledbetter | TSCPA Chapter Relations Representative

Chapter Presidents Share Experiences in Business, Industry and Education In keeping with the theme of this issue, the column focuses on chapter presidents who work outside of the public practice realm. They provided responses to questions ranging from their first jobs as CPAs to their advice to those entering the profession in the future, as well as how their experiences working in industry have helped them in their current volunteer position.

Those participating were, in alphabetical order: Guy Draper, CPA-Austin; Rodney Horrell, CPA-Brazos Valley; and Tony Riley, CPA-South Plains.

CPA CAREER, JOB RESPONSIBILITIES

Guy Draper CPA-Austin

Rodney Horrell CPA-Brazos Valley

Tony Riley CPA-South Plains

Two of the three who were interviewed currently work in the business side of higher education – one at a community college and one at a large statewide university system. The third person has a wealth management company where he is a registered representative for a securities firm.

Their career paths have been varied. Horrell started, as many do, at a Big Four public accounting firm. An unusual job duty involved an inventory at a shared warehouse where contents included dinosaurs used as props in the Jurassic Park movies.

The actual products being counted were upscale kitchen and home accessories, but the dinosaurs made a great photo-op for a group of young staff auditors.

He goes on to talk about “spending significant time evaluating internal controls in Indian gaming, where I developed a deep love for, and appreciation of, Indian Country. Tribes served included the Potawatomi in Kansas, Seminole tribe in south Florida, and Santa Ana Pueblo in New Mexico. We worked directly with tribal gaming commissioners.

Earning trust was more difficult than for any of the clients I’ve ever served; but once earned, I was family and experienced a warmth not felt from more traditional clients.”

Riley’s first job as a CPA was as controller for a textile manufacturing plant. The part of the job he remembers most was managing the employee credit union, in a bad situation that was dumped on him.

The previous manager, who had already left the company, kept no records on withdrawals

and had only a printout from the payroll department showing year-to-date deposits for each employee.

Riley remembers: “I was looking through his office and found a textile machinery crate filled with what I assumed was trash. The ‘trash’ turned out to be employee account withdrawal slips numbering more than 2,000. I pulled two of my staffers and we spent every afternoon for almost six weeks establishing accurate employee account balances.

Once we finished that, I hired a new manager, and bought software for credit union management and recordkeeping that was developed by a fellow CPA.” He continues: “At that time, the credit union had $65k in assets, too small of a balance to make loans. Because loan interest is the primary source of income for a credit union, we had no income for awhile. As time passed and we were able to restore the member confidence in the credit union, our assets grew and we were able to start making loans again. When I left the company, the asset balance in the credit union was $500k.”

Draper had various accounting roles for big publicly traded companies the first decade of his CPA career. There was a four-year stretch in which he worked for a large real estate investment trust company as a senior in their Securities and Exchange Commission (SEC) Reporting department, taking the company public.

He goes on to say: “My most memorable role was staff accountant in the tax department of a publicly traded electric utility company that was in bankruptcy. FAS 109 was pretty new, and my job was to calculate and book valuation allowance against net operating losses. The company had such a large tax asset on the balance sheet and not much net income projected into the future that the asset did not have much real value. Nearly all of my working hours, continued on next page

Rhonda Ledbetter is the TSCPA chapter relations representative. Contact her at 972-687-8508 or at rledbetter@tscpa.net.

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Chapters continued from page 11

which were many, were spent creating and operating a model that would calculate this for us. So two years of my career were spent on one accounting standard.”

When asked about their current busy season, the two in the business side of education talk about starting the budget process in February for a fiscal year beginning September 1, and then fiscal year-end and annual financial reporting from September to November. In the financial planning industry, busy time coincides with tax season, with annual portfolio reviews and retirement and financial plan updates.

WORK/VOLUNTEER SKILLS AND CHAPTER INVOLVEMENT The conversation turned to skills different from those used in the public practice/financial advisor arena that have helped as a chapter volunteer leader.

Riley feels that his experience setting up information systems for employers has helped him be able to quickly understand the chapter’s processes and projects. He adds: “Working with governing board members at the college has directly prepared me for the chapter presidency.

I understand the behind-the-scenes tasks that have to be meshed into a comprehensive plan for meeting the needs of those we serve, whether it’s education for individuals starting out or for experienced CPAs who are updating their knowledge.”

A skill that takes these chapter presidents out of the realm of the usual was gained from supervising employees in jobs unrelated to the financial area.

An employer’s core values of excellence, integrity, leadership, loyalty, respect, and selfless service are found to be extremely helpful in volunteer leadership.

Becoming involved in the chapter was attributed to CPA mentors. Horrell says, “Sandy Brown and Joe Dunn, two former bosses and former Brazos Valley Chapter presidents, were instrumental in my initial involvement in the chapter.” He started as Public Relations Committee chair and served for two years, helping migrate

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advertising expenditures from traditional print to a mix of traditional and online.

John Pearce, a recent president of the Austin Chapter, was cited by Draper for helping and encouraging him.

CAREER REWARDS AND CHALLENGES The career rewards discussed were diverse. One person talked about the satisfaction of seeing his team succeed and being able to reward excellent performance. Riley related that teaching was the most personally satisfying job he has ever had. He taught Accounting Principles at the community college level, and also upper division and graduate accounting courses at a local university.

He says: “I really enjoy helping people to succeed and teaching gave me the opportunity to do that. I felt that it helped me in nonteaching areas by improving my skills in communicating with subordinates, peers and superiors. Also, I found this old adage to be true: If you want to really know a subject, teach it.”

A large part of Draper’s work is designing distribution strategies for those at or approaching retirement. He uses a word from the Dr. Seuss story The Lorax to explain. “Our culture is so focused on ‘biggering’ that there is very little focus on how to take what you have and make it last. All the talk is about grow, grow, grow. Growing is important, but we almost never hear anyone on television talking about how to position assets in a way that will allow us to withdraw them over time without running out too soon.

So, when I cover this with folks, their eyes light up and I can see that some peace has replaced a bit of fear, and I know that I have helped make their life better in some small way.”

Both of the participants from higher education are keenly aware of their job challenges related to severe reductions in state funding, while attempting to keep tuition and fee rates affordable but still find money for necessary capital expenditures. Compounding the problem

is the nation’s unquenched appetite for debt and the resulting impairment of long-term economic growth, further exacerbating the current fiscal challenges faced by state and local governments.

The participants then looked into the future and discussed the one big thing they foresee as the game-changer for CPAs in industry during the next 10 years. Changes in law and regulation, specifically changes to the Internal Revenue Code (IRC), were cited.

ADVICE TO STUDENTS CONSIDERING A CAREER IN ACCOUNTING The first suggestion is to learn about what CPAs’ work really involves – looking beyond the clichés – and make sure there’s true enjoyment of that as a career rather than focusing on the earnings potential and steady employment.

Then, upon meeting the 150-hour requirement, develop a plan to become a CPA … and stay with it. No matter what segment of business or accounting that’s pursued, being a CPA gives a leg up on competition in the job market.

Horrell stresses: “It’s very important to understand that you must earn your pay and career advancements. There are best practices, but no shortcuts to success.” He adds: “That said, build your career around your life goals. I’ve seen too many friends and family sacrifice far too much for jobs that pay well but give them far too little in terms of happiness. Find an employer who fairly values your contribution and also respects your need to flourish in your ‘real job,’ outside of your career. And remember that you owe your employer every bit as much as they owe you.”

Those are thoughts from three of our current chapter presidents. Just like them, you have unique experiences and skills that can be a great asset to your chapter.

If you’re not already involved, please volunteer. A complete list of chapter contact data is available through the Chapters section of the TSCPA website at tscpa.org.

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Today’sCPA

| MARCH/APRIL 2013

Spotlight on CPAs

By Anne McDonald Davis, ABC

Ladybug, Ladybug … Fly Away Home South Texas CPA Finds Fulfillment in Diverse Life

For additional information: www.TZoneConsulting.com www.TXLadybugs.com

Today’sCPA

| MARCH/APRIL 2013

After firing up the crowd with a classic bluesy he-done-her-wrong song, “Alligator Mouth,” the Ladybugs launch into a soulful gospel number: “Deep cold water … You gotta swallow your pride, Got the good Lord on your side.”

But wait. Who is that playing bass guitar in the all-female Hill Country band? Why, it’s Melinda Day-Harper, CPA-San Antonio, longtime TSCPA member in business and industry, CGMA (Chartered Global Management Accountant), consultant, entrepreneur, motivational speaker and writer, public financial literacy advocate, animal rescuer.

Day-Harper may be an open book … but there are a lot of chapters. Where to start?

Chapter One was growing up in the grand metropolis of Anson, Texas, 20 miles south of Abilene. “That’s ‘Anson’ as in ‘No Dancin’ in Anson,’” laughs Day-Harper, referring to the anthropological book written by Richard Ainslie in the mid-90s. She even ruefully acknowledges that Anson was the basis for the movie Footloose.

For Day-Harper, the aforementioned “no dancin’” didn’t keep her from having a fine time on her great grandparents’ farm among “the chickens, cows and cotton.” She reminisces: “I just loved it. My brothers and I … the three of us were holy terrors and I have all the scars on my legs to prove it. I was always the one who got in trouble because they always got me to do it first. Like when I was five or six, there was a race to see who could get across the pasture first.”

That was the pasture with the mean bull.

“Made it by the skin of my teeth; learned to be fast,” she grins. “Got my first speeding ticket driving a Lincoln from New Mexico to my father’s dealership in Fort Worth doing 90 in a 70. Well, I would have gotten a ticket if I’d had my license. I was 12.”

An athletic, outgoing girl, young Melinda Day was a baseball player, gymnast, cheerleader, and is proud of being one of the first Powder Puff football players in the ’60s

when her family moved to Fort Worth. She attributes her propensities to growing up in a gregarious family oriented to sports and music.

She explains: “Dad had a baseball scholarship to college and even played pro ball for a while. Got into the car business after winning the nationals in 1959 in drag racing.

Mom raced twin engine go-carts, usually finished toward the top. My brothers raced motocross.”

And there was always music. Her grandmother, father and siblings traveled for a time as gospel performers. “My uncle has made a living his whole life in music – David Day and the Ace High Straights opened for George Strait back in the early days, and he even had his own club, Pintos, in Fort Worth,” says Day-Harper.

Yet somehow, amid all that, an intrepid little business person was blooming. “When I was five or six years old, I got a cotton candy machine for Christmas,” recalls Day-Harper.

“Me? I put it in my little red wagon and went up and down the street selling cotton candy! I was always good with numbers and business.

My granddad was a bookkeeper his whole life and my great aunt was a CPA – one of the first women in the profession.”

NOW FOR THE HARD PART Although Day-Harper says accounting came naturally for her, two years into her college studies at Stephen F. Austin, she got married, moved to San Antonio and soon became a mother. It would take her seven more years working full-time and going to night school at UTSA before becoming a CPA. She says she had support all along the way. “I worked with some CPAs and finance executives who took me under their wing,” she enthuses. “They had me working on consolidated financial statements before I even had my degree. That’s how I got started and it just felt right.” continued on next page

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Spotlight on CPAs continued from page 13

That stage of Day-Harper’s life led to a long career in business and industry, first at Frost Bank in the mid-70s; then at Conroy, Inc., for nine years; next at Alamo Lumber Company; and then 11 years at NTS Technical Services, with Day-Harper ultimately serving as CEO and president.

“I helped grow that company close to 300 percent in four years,” she says proudly. “We established eight offices around the country before the parent company merged with another in Los Angeles.”

CFO of Delta Produce and Superior Tomato-Avocado from 2000 until the beginning of last year, Day-Harper still consults for the companies, which are undergoing a reorganization. But she had been contemplating her own consulting firm for some time.

She chuckles: “I guess I just really don’t like to be bored. So I started putting together seminars to help people understand personal finance. This isn’t rocket science, but so many out there don’t know how to manage money.”

Toward this end, Day-Harper covered the basics in an e-book, Feng Shui Finance, that eventually became a chapter in a cooperative book written by women who are experts in their respective fields, Wake Up Women. Today her firm, T-Zone Consulting, provides a myriad of services to businesses and individuals of both genders, from the motivational to the nuts and bolts of finance.

The Hill Country musician and CPA also felt that at this point in her career, it was important to claim a new label for the abilities and knowledge acquired over the past threeplus decades.

She asserts: “The CGMA designation indicates a broader expertise than just finance – it requires top-level business

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acumen, marketing and more. For instance, I understand production. More and more these days, corporations are in need of somebody at the top who is hands-on, someone who can communicate across the entire organization and facilitate cooperation between departments, which are too often at cross purposes. It takes a leader to tie them together, to help them understand that they all have the same objective even though they don’t speak the same language. The CGMA designation indicates a diversity of skill sets beyond numbers, an operational understanding.”

AT HOME Daughter Lacey Day Harper is now 34 and out of the nest, but the south Texas CPA has plenty of company at home with husband, Morgan Harper, and their four dogs and five cats. Two of Day-Harper’s best friends got her involved with Life Savers Animal Rescue in San Antonio, although she admits that she is not allowed to volunteer on-site because she wants to adopt all of them.

“But I help with the adoption events; we saved 1,000 dogs in the past year,” she informs. “San Antonio has a terrible record for euthanizing animals, one of the worst in the country. So we transport them out to our ranch in Boerne to get them vetted and quarantined, and have even transported hundreds to the Northeast where they don’t seem to have our problems.”

Morgan and Lacey are also guitar players, but Day-Harper is the one who truly loves performing. “We’re all songwriters,” she adds.

“My husband is really a singer/songwriter who can play almost any instrument. We perform with several bands as they need us. I’ll play bass and he’ll play lead. I have a blast with the Texas Ladybugs, my number-one band.”

The Ladybugs just got started in early 2010; all the women involved had played with each other off and on with various bands over the years. Day-Harper says fellow musician Katherine Dawn called her up one day and said, “OK, I’m thinking of starting an all-female band” and Day-Harper replied immediately, “I’m in!”

The group has released their first album, “Shake What Yer Mama Gave Ya’” and DayHarper expresses a bit of surprise over the press they’ve received. (In addition to other coverage, the group was featured in Episodes 1 and 9 and the TV show Texas Troubadours.)

She explains: “Our youngest member is 40, next is 50, I just turned 60, our percussion and harmonica players are in their early 60s.

We appeal to a wide variety of people, but especially our generation. We write about 90 percent of our songs.”

The group begins performing again in the spring, including Austin’s blow-out South

by Southwest in March. “We take some time off during winter … we don’t like to play in the cold,” laughs Day-Harper. “If you have a warm place to play, we’re there. Otherwise, forget it.”

When asked the secret to her life force and determined spirit, Day-Harper is unexpectedly serious. She cites a quote from Dr. Wayne Dyer: “Be independent of the good opinion of others.”

She explains further, quietly: “I’ve lost a lot of family. I’m the last surviving member of my original family. So I’ve learned that the people you love and the things you have can be taken away from you at any time.

There are two things I possess that can never be taken away from me – faith and my personal integrity. And shame on me if I ever compromise either one of those.”

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Today’sCPA

| MARCH/APRIL 2013

Take Note Nominations for TSCPA Awards

Membership Recruitment Campaign: Think you know TSCPA? CPAs have a different definition of cool. It’s an important kind of cool where CPAs join forces, take responsibility for their profession and the profession takes responsibility for them. This is the essence of TSCPA membership. Encourage your nonmember colleagues to join today so they can take advantage of the benefits that TSCPA provides, such as protecting the CPA certificate, keeping members updated and competent, safeguarding ethical obligations, giving members opportunities to take leadership roles and increase their visibility in the profession, and much more. It’s cool to be part of this community. Send your nonmember colleagues to www.tscpa.org.

Ask a Member Program Have you used TSCPA’s Ask a Member program? Through this program, you can call or e-mail when you have a question, concern or situation outside your area of expertise.

Volunteers will provide quick, informal assistance on an as needed basis. It’s your opportunity to connect with your peers to exchange ideas, knowledge and resources. More details about the program are available on the website at tscpa.org. Under the Resource Center tab, scroll down and select Ask a Member. A log in is required to see a listing of other members who have volunteered to provide assistance.

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If you know members who are making outstanding contributions to TSCPA, the profession and/or the community, be sure to nominate them for a TSCPA service award. The TSCPA Awards Committee is seeking nominations for the 2012-13 year. Categories include Meritorious Service to the Accounting Profession in Texas, Distinguished Public Service, Honorary Fellow, Outstanding TSCPA Committee Chairman, Young CPA of the Year, and Honorary Member. The deadline for nominations is April 26, 2013. For more information, go to TSCPA’s website at tscpa.org/eweb/DynamicPage. aspx?webcode=ABTawards or contact Melinda Bentley at mbentley@ tscpa.net; phone 800-428-0272, ext. 279 or 972-687-8579 in Dallas.

CGMA Designation for Management Accounting The Chartered Global Management Accountant (CGMA) designation was created by AICPA and the Chartered Institute of Management Accountants (CIMA) for CPAs who work in business, industry and government. It provides a variety of resources, research information, career tools and access to a global community of management accountants.

The CGMA is available to qualifying AICPA members. Members of TSCPA who are also members of AICPA receive a discount. To learn more, visit their website at cgma.org.

2012 Outstanding Educator Award Recipients Recognized TSCPA recognized four top Texas accounting professors with the organization’s 2012 Outstanding Accounting Educator Award. These awards are presented to accounting educators in Texas who have demonstrated teaching excellence and have distinguished themselves through active service to the profession.

Congratulations to the recipients: • Tracie Nobles – Austin Community College (Community College) • Kathy Kapka – University of Texas at Tyler (Small) • Valrie Chambers – Texas A&M University – Corpus Christi (Medium) • James Deitrick – University of Texas at Austin (Large) The award ceremony was held during the TSCPA Accounting Education Conference. For more information about the Outstanding Accounting Educator Award, please go to TSCPA’s website at tscpa.org and click on Students – Educators – Accounting Educator Award.

What’s New on the TSCPA Website: Updates in Tax Issues Community and Federal Tax Policy Blog TSCPA’s Tax Issues Community is an online resource available to assist you during tax season and year-round. The community offers a variety of links to tax-related information, and you can access TSCPA’s Federal Tax Policy Blog for important updates. To visit the Tax Issues Community, go to tscpa.org. Under Resource Center, scroll down to Member Communities, select Tax Issues, and log in as a member. TSCPA also offers the free Tax Issues electronic newsletter. To sign up to receive the Tax Issues e-newsletter, please contact TSCPA’s Patty Wyatt at pwyatt@tscpa.net.

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Take Note Consents to Use or Disclose Tax Information – New Changes to Section 7216 Rules

Participate in Survey for Nonprofit Organizations

The IRS has modified its guidance regarding under what circumstances a tax return preparer must get a signed written consent to disclose or use a client’s tax information and the requirements of such a consent. The modified consent requirement only applies to individual tax returns, the Form 1040 series. (The rules on disclosure and uses of information for other tax returns remain unchanged.) It is also clear no consent is necessary if you are using the taxpayer information to solicit tax preparation services. However, a signed written consent is necessary if the taxpayer’s information is disclosed or used for any other purpose. This includes using your contact list or newsletter to solicit any business other than return preparation.

Rev. Proc. 2013-14 section 5.04(1)(a) provides the specific language you need for a general consent to disclose tax return information; section (b) contains the language you need if you expect to disclose tax return information to another preparer to assist in the preparation of the return; section (c) provides the specific language you need for a consent to use tax return information; section (d) provides the language to accompany all consents; and section (e) provides additional language if the tax return information will be disclosed outside the United States. The Rev. Proc. also provides information regarding other requirements for all consents.

Unless the consent specifies otherwise, it must be signed by the taxpayer annually. The rules for electronic signatures in section 6 generally require that the taxpayer enter a unique PIN assigned by the preparer or manually type the taxpayer’s name and push “enter” to authorize consent.

The consent language required by Rev. Proc. 2013-14 differs from the language that had been required previously under Rev. Proc. 2008-35, and you may have already used that language to prepare your consents. Rev. Proc. 2013-19 provides that either the original or revised language is acceptable for consents obtained this year, but the language cited above of Rev. Proc. 2013-14 must be used after 2013.

Violation of section 7216 rules can result in civil penalties and, if a preparer knowingly or recklessly disregards these rules, criminal penalties.

For a more detailed explanation, go to Rev. Procs. 2008-35, 2013-14 and 2013-19. They are available on the IRS website at http://www.irs.gov/irb/2008-29_IRB/ar13.html; http://www. irs.gov/irb/2013-03_IRB/ar09.html; and http://www.irs.gov/pub/irs-drop/rp-13-19.pdf.

The Greater Washington Society of CPAs is working with the Urban Institute and other national nonprofit groups on the Form 990 E-Filing Initiative. The goal of the initiative is to increase the percentage of electronically filed Form 990s from 30 percent to 70 percent over the next five years. If you work in or for nonprofit organizations, TSCPA encourages you to participate in an important survey to help them gain an understanding of why Form 990 e-filing is so far behind individual federal return e-filing. For more information about the initiative, please visit TSCPA’s website at tscpa.org/eweb/DynamicPage. aspx?webcode=GENform990. To take the survey, go to https://surveys.urban.org/cb/ form990.aspx.

Practice Management Institute TSCPA offers members assistance with their succession planning needs through the Texas Society Practice Management Institute. It was developed in partnership with the Succession Institute, LLC and focuses on firm management and practice management issues. Through this resource, members have access to free material and content on succession planning. There are also CPE self-study course offerings available at a discounted rate if you would like to receive CPE credit. For more information, go to the CPE section of the TSCPA website at tscpa.org, scroll down and select Practice Management Institute CE.

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Accountants Confidential Assistance Network

TSCPA’s Accountants Confidential Assistance Network (ACAN) was created to help Texas CPAs, CPA candidates and accounting students dealing with alcohol, chemical dependency and mental health issues. A 24-hour hotline is available at 1-866-766-ACAN to help people who need assistance. You can also contact TSCPA’s Craig Nauta at cnauta@tscpa.net. By law, all information, communications, reports received, gathered or maintained by ACAN are strictly confidential, so there’s no risk to call. To learn more about the program, please go to TSCPA’s website at tscpa.org, select Resource Center, and then scroll down and click on Accountants Confidential Assistance Network.

Today’sCPA

| MARCH/APRIL 2013

Take Note

By Rhonda Ledbetter | TSCPA Chapter Relations Representative

TSCPA Midyear Board of Directors Meeting

Charlotte Jungen, CPA-Southeast Texas; Brad Brown, CPA-Southeast Texas; Rep. John Otto, CPA-Southeast Texas; and Bob Owen, CPADallas, TSCPA Managing Director, Regulation and Legislation.

Paul Damerow, CPA-Corpus Christi; Rep. Todd Hunter and his staff; and Susie Sullivan, CPA-Corpus Christi.

Members of the TSCPA Board of Directors met in Austin January 29-30 to conduct Society business, obtain profession information and meet with legislators.

CHAIRMAN’S REPORT

TSCPA Chairman Fred Timmons, CPA-San Antonio, summarized progress on the organization’s Strategic Plan objectives, which are the foundation for programs, initiatives and activities developed on behalf of members. The objectives are: • Professional Competency – provide members with access to trusted resources and continuing professional education to maintain their professional competency; support members in the delivery of quality services to their employers or clients; • Advocacy – serve the professional interests of TSCPA members by being the advocate for Texas CPAs to public policy makers, regulators, and standards-setters; promote the profession to the public at large; • Operational Excellence – operate TSCPA in an effective and efficient manner by assuring that the appropriate level of resources, technology, and volunteer leadership is available to deliver excellent member service; • Recruitment and Retention – attract and retain competent individuals to become CPAs by promoting the career opportunities that the CPA profession provides; retain existing members and recruit all eligible candidates to TSCPA by promoting the benefits of membership.

To enhance professional competency, the TSCPA CPE Foundation has increased onsite course sales due to more interest in that mode of delivery. The Foundation responded quickly to the fiscal cliff decision at the beginning of January by adding a new webinar and webcast addressing the new legislation and health care laws.

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TSCPA’s 2012-13 Chairman Fred Timmons, CPA-San Antonio; AICPA’s Senior Vice President for Congressional and Political Affairs, Mark Peterson; and TSCPA Executive Director/CEO John Sharbaugh.

TSCPA is working with AICPA to encourage members to acquire and maintain the Chartered Global Management Accountant designation. The CGMA is a new global designation that elevates management accounting, and it globally recognizes the experience and skills of CPAs in business, industry and government. The goal for Texas was 919 CGMAs; there were more than 2,000 as of August 21.

The needs of members who work in business and industry are a focus of the strategic plan. There are now nine neighborhoods in the B&I online resource center. Personal visits will continue to companies across the state, with an emphasis on those with former members who haven’t renewed. A brochure detailing the value of membership is provided for them to pass along to their employers. The Industry Issues blog is updated each week.

CPA advocacy activities include work at the state and national levels. The Legislative Advisory Committee obtained TSCPA Executive Board approval for the legislative agenda detailed in the January/February 2013 issue of this publication. Since June 2012, the Professional Standards Committee has responded to six exposure drafts issued by FASB, GASB, AICPA Professional Ethics Executive Committee, and PCAOB. The Federal Tax Policy Committee has taken a series of actions since the beginning of the 2012-13 fiscal year, including: • issued comments to the IRS on implementation of return preparer enforcement actions; • along with AICPA and other state societies, sent letters to members of Congress asking for cosponsors on H.R. 2383 (and companion S. 845) Tax Reform Due Date Simplification and Modernization Act; • issued comments to the IRS on proposed regulations to disclose return information under section 6103 to carry out eligibility requirements for health insurance affordability programs; • sent letters to Sens. Cornyn and Hutchison requesting that they cosponsor S. 3485, the Mobile Workforce State Income Tax Simplification Act; • issued letter to the IRS on concerns with changes to Individual Taxpayer Identification Number (ITIN) application procedures;

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Take Note • issued comments to the IRS on Forms 1099-B cost basis reporting rules and on proposed regulations to Circular 230 governing written tax opinions and other ethical standards for practice before the IRS. To help achieve the objective of operational excellence, work is being done to continue progress made under the leadership of 2011-12 Chairman Donna Wesling, CPA-Austin, involving young CPAs in TSCPA at the chapter and state levels. The Leadership Development Task Force determined that a program to train future TSCPA leaders should be held in the 2012-13 fiscal year. A maximum of 25 participants will be accepted into the multi-day program, which will take place this May culminating with the annual TSCPA Leadership Day. For the second year, TSCPA’s Rising Stars program will showcase members age 40 or under who have proven to be innovative leaders within the profession and in their communities. Recognition will occur at the annual meeting in June.

Addressing the Strategic Plan objective of recruitment and retention, a three-phase recruitment campaign has added 743 members since the beginning of September, with a focus on prospects who have been licensed in Texas during the last three years. The first-year-free membership program continues. Members who have belonged for five years or less were surveyed to learn why they join, what their needs are, and their levels of awareness of various programs and services.

To encourage future CPAs, TSCPA hosted an event for high school accounting/business teachers with a national-level program that provided free accounting curriculum and in-depth training. National Meet the Firms Week was promoted to help firms and students connect. There will be events for community college students to learn more about pursuing the CPA designation.

There has been a variety of other initiatives. TSCPA nominated member Billy Atkinson, CPA-Houston, who was selected to chair the Financial Accounting Foundation’s recently created Private Company Council. The PCC will work with FASB on issues relating to private company financial reporting.

TSCPA financially supported and promoted the Comeback America Initiative, which sought to educate the public about our nation’s debt and the sensible nonpartisan solutions that could restore fiscal sanity.

The initiative was founded by former U.S. Comptroller General David Walker. The $10 Million a Minute Bus Tour around the country included a stop in Dallas.

TEXAS 83RD LEGISLATURE

TSCPA’s Managing Director for Regulation and Legislation, Bob Owen, CPA-Dallas, shared insights into the major issues in the 2013 legislative session affecting CPAs. The 2012 elections produced a conservative Legislature, including almost 50 new representatives and senators, the largest freshman class in many years. Developing working relationships with new legislators is a priority. The Republicans remain in firm control of the Legislature, although they no longer have a super-majority in the House.

The conservative agenda shaping up for the session is unlikely to include any new taxes, and Gov. Rick Perry’s session-opening speech

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even suggested tax cuts. The good news is that there appears to be no budget shortfall. The state comptroller’s revenue estimate indicates $29 billion more revenue available than last session. While the revenue estimate gives legislators plenty of room to develop a budget, the state’s constitutional limit on budget growth might come into play for the first time in several years.

However, the state’s current and long-term needs might make any surplus short-lived. There is a $5 billion Medicaid shortfall for the current biennium and Medicaid growth is estimated at $11 billion for the next two years. To restore funds cut from education last session, $5 billion would be needed and enrollment growth for education is estimated at $2 billion. The state has also lost the first round of the school district lawsuits claiming education funding is unconstitutional and awaits final outcome of appeals to the Supreme Court. The financial impact of the outcome won’t be known until after the regular session ends. Roads, water and energy are also demanding attention, costing billions.

Legislative Advisory Committee chair Leroy Bolt, CPA-Abilene, and Legislative Regional Coordinators Committee chair Larry Edgerton, CPA-Permian Basin, prepared members for visits with legislators and their staff at the State Capitol. They outlined the Society’s 2013 legislative agenda, explaining that TSCPA will focus its efforts in three areas: • support several changes to the Texas Public Accountancy Act, including strengthening accountant-client privilege and TSBPA investigation confidentiality; • support extension of Self-Directed, Semi Independent (SDSI) legislation for the Texas State Board of Public Accountancy; • be available as a resource to legislators for any proposed franchise tax legislation and be prepared to recommend changes when the opportunity arises.

For more information about the legislative session, please see the Capitol Interest article in this issue of Today’s CPA.

WASHINGTON UPDATE An overview of the changing political landscape, fiscal uncertainties and regulations facing the profession was presented by AICPA’s Senior Vice President for Congressional and Political Affairs, Mark Peterson.

The outcome of recent elections was the first topic covered. One sign of a changing political landscape is that the power of incumbency is not what it used to be and re-election is more of an uncertainty; therefore, there are more new people to get to know. This poses a significant challenge for the profession to help educate members of Congress, so lines of communication are being established.

In addition to TSCPA members Mike Conaway, CPA-Permian Basin, and Bill Flores, CPA-Brazos Valley, the Congressional Caucus on CPAs and Accountants includes two newly elected representatives: Tom Rice of South Carolina and Patrick Murphy from Florida. Two of the key groups that AICPA works with are the House Committee on Financial Services, now chaired by Texan Jeb Hensarling, and the Senate Banking Committee.

A few details of the recent fiscal cliff resolution were spotlighted, including extension of income tax, capital gains, and dividend rates for

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households with incomes below $450,000, and permanent estate tax relief. There are several more cliffs on the horizon. The debt ceiling/ debt limit issue looms. If there is a ratings downgrade, the potential negative market reaction is a concern.

The discussion then moved to profession issues. CPAs support the investor protections included in Section 404(b) of the SarbanesOxley Act and oppose further exemptions for affected businesses. As significant as SOX was, with its 66-page document, 16 rulemakings and six studies, the Dodd-Frank Act causes it to pale in comparison.

Not only does it weigh in at 2,307 pages, 355 rulemakings and 68 studies, its impact is huge. Just a few of the items affecting CPAs are: • implementation is at 30 percent, but has slowed to a crawl; for example, the SEC alone had roughly 100 activities required by Dodd-Frank and has failed to meet statutory deadlines for a host of required regulatory actions; • The Act provides authority to PCAOB to expand its oversight and inspections; • there could be additional regulation of financial planners; • AICPA will continue to work for a provision in the Whistleblower program to require internal reporting and get crucial information to auditors and audit committees, in addition to that provided to the SEC. Regarding the IRS’s return preparer registration program, Peterson shared information about the January 2013 district court ruling that the IRS lacks the authority to regulate tax return preparers other

Figure 1. TSCPA Leaders for 2013-14 Chairman-elect (Chairman in 2014-15)

Mark D. Lee (Houston)

Treasurer-elect (Treasurer in 2014-15)

James R. Oliver, Jr. (San Antonio)

Secretary (One-year term – 2013-2014)

Susan S. Roberts (Fort Worth)

Executive Board (Three-year term – 2013-2016)

Christina A. Mondrik (Austin) Jerry D. Spence (Corpus Christi)

Director-at-Large (Three-year term – 2013-2016)

Katy Avenson (Austin) C. Wayne Barton (East Texas) Thania D. Gonzalez (El Paso) D.D. Holmes (Fort Worth) Charlotte M. Jungen (Southeast Texas) Larry S. May (Abilene) Carol S. McIntosh (Central Texas) Benjamin Peña (Rio Grande Valley) Marshall K. Pitman (San Antonio) Tracy B. Stewart (Brazos Valley) Michael W. Young (Panhandle)

Russell J. Chimeno (Southeast Texas) was selected as a two-year Director-at-Large replacement (2013-2015) for Susan S. Roberts (Fort Worth), who is elected as Secretary and was serving as a Director-at-Large through 2015.

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than CPAs, attorneys and enrolled agents. As a result, the IRS has temporarily suspended registration, testing and continuing education for noncovered preparers.

AICPA has a task force framing its advocacy on the tax reform issue.

The Institute’s actions include Congressional testimony and resources, policy white papers and a comprehensive review of simplification positions.

The What’s At Stake project demonstrates the profession’s commitment to helping the public understand complex financial issues. A nonpartisan video, distributed to members of Congress by state CPA societies, shows how the data in the U.S. government’s financial statements can be used for better understanding the nation’s fiscal health.

OTHER BUSINESS The Annual Meeting of the Accounting Education Foundation was conducted and trustees with terms beginning June 2013 were elected.

The results of TSCPA’s electronic election for officers, Executive Board members, directors-at-large, and Nominating Committee positions were announced. Also, the Board of Directors voted to ratify the Chairman-elect’s appointees. See Figure 1 for the names of 201314 leaders.

The 2013 Annual Meeting of Members will be held in Las Vegas at Caesars Palace June 28-29. The Hilton Garden Inn at South Padre Island is the site for the next Midyear Board of Directors Meeting, Jan. 31-Feb. 1, 2014.

Committee on Nominations (One-year term – 2013-2014)

Michael L. Brown (Central Texas) Sandra Kay F. Brown (Brazos Valley) Chris W. Busch (Southeast Texas) Lorena Castillo (Rio Grande Valley) Michele M. Heyman (Austin) Brian C. Jones (Houston) Lynn S. Kupper (San Antonio) Alyssa G. Martin (Dallas) Steven G. Newcom (Fort Worth) Susie Sullivan (Corpus Christi)

As immediate past chairman of TSCPA in 2013-2014, Fred J. Timmons (San Antonio) will automatically serve as the Nominating Committee Chair.

AICPA Council – 3-Year Term (2013-2016) The following names will be submitted to the AICPA Nominating Committee as recommendations from Texas to serve on the AICPA Council:

Fred J. Timmons (San Antonio)

Stephen G. Parker (Houston)

E. Leroy Bolt (Abilene)

Dora J. Dyson (Central Texas) AICPA Council – 1-Year Designee: William H. Hornberger (Dallas) Chairman-elect Appointees ratified by vote of the Board of Directors at this meeting Executive Board (One-year term – 2013-2014)

Ryan G. Bartholomee (Permian Basin) Kirby H. Jackson, Jr. (Dallas) Joan E. Schwartz (San Angelo)

Committee on Nominations

C. Jeff Gregg (Wichita Falls)

19

Capitol Interest

By Bob Owen, CPA | TSCPA Managing Director, Regulation and Legislation

Pay Now or Pay Later?

Several years back, I recall a television commercial advertising brake repairs. It encouraged you to bring your car in for a brake check because if you repair brakes before the lining wears out, it’s much cheaper than after the brakes are seriously damaged. The ending tag line was “pay me now, or pay me later.” The Texas Legislature finds themselves in the same spot. While there is an actual budget surplus for the current biennium and evidently enough money to craft a budget for the next two years, long-term infrastructure issues need to be addressed and the longer they wait, the more expensive it gets.

ELECTION CONSEQUENCES Given the choice, almost everyone chooses to pay later, whether it’s fixing the brakes or the state highways. Don’t expect the legislators to be any different. A current sitting congressman once told me that legislators don’t do anything until there is a burning platform. Texas legislators are beginning to feel the heat, but they can’t yet see the flames.

Now that the school lawsuits have been decided for the plaintiffs

by Judge Dietz in the Travis County District Court, it looks like more education funding might ultimately be required. Dietz estimated the state needed $11 billion in additional school funding. That’s a lot of money. As the late Sen. Everett Dirksen once said, “a billion here, a billion there, before long you’re talking about real money!” While it might take a trillion dollars to be real money at the federal level, billions still mean something here in Texas. Add the Transportation Department’s admission that they are flat out of money for roads, the continuing Texas drought that makes water conservation and development more urgent, the seemingly unending upward spiral of Medicaid costs, and you can feel the heat indeed.

Evidence that politicians realize there are impending disasters was Gov. Rick Perry’s State of the State speech in which he suggested using $4 billion of the Economic Stabilization Fund, commonly referred to as the Rainy Day Fund, to fund road and water projects. Until that day and that speech, Perry had been a strong opponent of using the Rainy Day Fund for addressing Texas’ ongoing funding problems.

While Perry’s remarks did draw some opposition from the budget hawks, most legislators seemed to welcome his willingness to at least begin addressing these important long-term concerns. According to the Texas Tribune, legislative insiders in Austin overwhelmingly

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believe Perry’s suggestions will be embraced by the Legislature.

Speaker Joe Straus (R-San Antonio) has stated the water issues must be addressed during this session.

Perry also called for $1.8 billion in tax refunds for the current biennium and a constitutional amendment to ensure budget surplus refunds in the future. The insiders were not so sure that the constitutional amendment idea would fly. Constitutional amendments need a two-thirds vote by legislators to make it to a voter referendum.

Perry called for the public to provide input on tax cut options on his website. The options he listed with the estimated associated revenues were: • lower the sales tax rate from 6.25 percent to 6.00 percent ($1 billion); • additional sales tax holiday weekend ($130 million); • increase homestead property tax exemption by $5,000 ($600 million); • increase homestead property tax exemption by $10,000 ($1.2 billion); • lower the 1 percent franchise tax rate to .75 percent ($1 billion); • allow a franchise tax compensation deduction for payments to independent contractors ($280 million); • make the $1 million revenue exemption for franchise tax permanent ($166 million); • franchise tax credit for research and development ($60 million); • sales tax research and development exemption ($300 million); • exempt business inventories from school property tax ($1.4 billion); and • communication sales tax exemption ($600 million).

Even before Perry put up his tax reduction website, the Texas Association of Business responded to his State of the State message with its own tax reduction ideas: • making permanent the $1 million franchise tax exemption for businesses; • allowing all businesses to exempt the first million dollars of gross receipts for business taxation; • decreasing the franchise tax rate by a quarter percent; • creating a research and development tax credit; and • passing targeted sales tax exemptions for consumers, including college textbooks and computers.

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Legislators may be reluctant to enact tax refunds with the uncertainty over education funding looming. While Dietz has ruled at the district court level, the case will have to go to the Supreme Court before the Legislature is mandated to do something – that will be the burning platform. That won’t likely happen until after the current session. Until then, they just have to keep in mind the fire is approaching and try not to use all the water on the other burning issues.

CPAS VISIT THE CAPITOL CPAs weren’t the only visitors to the Capitol on Tuesday, Jan. 29, 2013, but they were there in force. Several legislators indicated they had CPAs streaming through their offices and they all seemed to appreciate the visits. Even legislators and staff who were not visited noticed CPAs roaming the halls. This day is always fun and interesting, but it is also important in keeping CPAs’ visibility alive and well among legislators. Thanks to all the CPAs who made the trek and presented TSCPA’s positions and offers of help.

A number of legislators expressed interest in TSCPA’s franchise tax recommendations and follow-up visits were made with those legislators to give them an in-depth briefing about our proposals. By the time you read this, we hope that a number of those proposals will be included in franchise tax bills that have been filed.

The day ended with a reception for legislators, staff and state officials. Attendees included Supreme Court justices, a CPA railroad commissioner, and all the CPA House members along with several House committee chairs and vice-chairs.

FRANCHISE TAXES What a difference two months can make. Two months ago, it didn’t appear there was much appetite for making franchise tax changes. Now, after surprisingly high revenue estimates for the next biennium, franchise tax legislation seems viable for the first time since the law was originally passed. During the last legislative session, virtually all franchise tax bills were DOA in the House Ways and Means Committee. That doesn’t appear to be the case this session.

Legislators have even filed bills to eliminate the tax altogether! Over 20 franchise tax bills have already been filed as I write and there will be more by the time you read this article. The bills include provisions to make specific businesses taxable at the lower retail and wholesale rate (automotive repair shops and furniture and equipment rental or leasing companies); make the $1 million revenue exemption permanent; increase the minimum revenue exemption to $5 million (which would eliminate the majority of franchise tax payers); eliminate the $1 million revenue exemption; establish an R&D credit; establish a credit for wages paid to employees serving on juries; apportionment guidance for Internet hosting companies; offering a constitutional amendment to require franchise tax refunds whenever the state experiences a budget surplus; and as mentioned above, eliminating the franchise tax entirely, either at one time on Jan. 1, 2014, or phased out over time through 2018.

One of the bills eliminating the franchise tax by 2018 also calls on the state comptroller to study revenue generating methods and to recommend to the Legislature one or more methods “that would be

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most effective in meeting the needs of the state.” Specific revenuegenerating ideas that must be studied and compared one to another by the comptroller include: • transaction tax; • value-added tax; • eliminating exemptions from sales taxes; • increasing the sales tax rate; • developing sales tax brackets that vary according to the sales price of the items; • imposing a business sales tax; • any other method the comptroller can imagine.

The most likely change to be passed this session is to make the $1 million revenue floor permanent. It’s on everybody’s list. But the most likely franchise tax bill to pass has not yet been filed as of the date I’m writing this article. Watch for a bill or bills filed by House Ways and Means Committee Chairman Harvey Hilderbran (R-Kerrville).

Hilderbran’s bill will likely be the bill that includes any changes that will be seriously considered.

THE CPA PROFESSION TSCPA is supporting legislation that makes a few changes to the Accountancy Act. Two identical bills have been filed by two CPA legislators, SB 228 by Sen. Tommy Williams (R-The Woodlands) and HB 608 by Rep. John Otto (R-Dayton). The bills embody TSCPA’s recommendations (see the Capitol Interest article in the January/ February issue of Today’s CPA for the details).

SB 228 was assigned to the Senate Business and Commerce Committee, chaired by Sen. John Carona (R-Dallas). During our CPA Day at the Capitol, Carona told CPAs he expected to hold a committee hearing shortly and he did so the next week. The bill was voted favorably from the committee on Tuesday, Feb. 5, 2013, and was recommended for the Senate Local/Consent Calendar. This calendar is used for non-controversial bills where no debate is anticipated or allowed. Hopefully, by the time you read this, the bill will have passed the Senate and be working through the House process.

One bill has been offered this session that would deregulate professional licensing to some extent. The bill is not aimed specifically at CPAs, but would apply to CPAs and the Texas State Board of Public Accountancy (TSBPA), which administers the Accountancy Act and oversees CPAs practicing in Texas. The bill, which is a reprise from last session, says an individual has a right to engage in a profession without being subject to a state agency’s rules, policies or practices that are substantially burdensome and unnecessary. The bill appears to give an unlicensed practitioner an avenue to seek to practice a profession without being duly licensed to do so.

Since the rules that CPAs must follow are substantially burdensome on their face, it would appear to give an unlicensed individual the basis for challenging rules that keep them from performing services now reserved to CPAs. If the individual is able to prove that the professional rules are substantially burdensome, the agency must prove the rules necessary, but at a higher standard of proof than must be met by the individual. The bill allows the individual to seek

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Capitol Interest continued from page 21

a declaratory judgment and injunctive relief. It seems to take the prerogative of who should be licensed away from the Legislature and put it in the hands of the judiciary. We are actively seeking to get the bill author to withdraw or modify the bill.

There is another bill that would affect TSBPA’s ability to reject CPA candidates based on prior criminal convictions. The bill removes conviction of a Class C misdemeanor as a justification for disallowing issuance of a business or professional license. Like the previous bill, it is not specific to CPAs, but would affect all Texas licensing agencies. TSBPA would not likely deny a candidate the right to take the CPA exam for most Class C misdemeanors, but such crimes can include petty theft and writing bad checks. It might be appropriate to deny a candidate permission to take the exam if there was a pattern of multiple convictions of these types of crimes.

We are hoping the bill author will modify the language somewhat to give TSBPA the flexibility it needs to make reasoned judgments.

SUPPLEMENTAL APPROPRIATION In the last biennial balanced budget, the Legislature failed to fund Medicaid for the full 24 months. If a supplemental appropriations bill is not passed by March 1, 2014, there will be no funds available to pay Medicaid bills. Rep. Jim Pitts (R-Waxahachie), Chairman of House Appropriations, authored HB 10 as the supplemental appropriations bill to fund the $4.5 billion Medicaid shortfall, and it passed out of his committee unanimously on Feb. 11, 2013. There will be other supplemental appropriations bills to meet the following additional budget shortfalls: • Foundation School Program: reverse deferral – $1.75 billion; • Foundation School Program: fully fund FY 2013 – $317 million; • Texas A&M Forest Service: wildfire costs – $155 million; • Department of Criminal Justice: correctional managed care – $39 million.

Pitts hoped to get the bill passed during the following week, which would require a four-fifths majority to pass during the first 60 days of the session (a constitutional requirement).

TRANSPARENCY Transparency has become a popular theme during the current session. It started with Perry and Straus calling for eliminating the time-honored practice of raising revenue for a specific purpose and then not spending the money for that purpose. The unspent funds are stockpiled and now total $5 billion; it helps balance the budget.

Straus appointed a special committee to figure out how to unwind the deception, but the most we’ve heard out of that group is to try to keep the amount from growing.

But why limit transparency to tax collections and spending? Straus appointed another Select Committee to study transparency in state government departments. The committee is to “oversee transparency in the reporting of financial transactions of judicial and executive state agencies and affiliated entities.” Legislation has already been filed to give the public access to more information about spending and government debt. Another bill has been filed demanding more

transparency from the public pension system and yet another requires more disclosure from insurance companies to customers.

FEWER BILLS FILED Writing before the March 8 bill filing deadline, it appears legislators are not filing as many bills as in prior sessions. There is no obvious reason for the decline, but we can speculate that perhaps it’s because of so many new legislators and experienced legislators have learned that the more bills you file, the more fodder for your primary opponent in the next election. Of course, they may catch up by the filing deadline.

THE OFFICIAL SEA TURTLE OF TEXAS Each Legislature includes a number of resolutions designating “official Texas” something or other. Even these resolutions are fewer this year. Here are the new proposed “official” designations, so far: • February 16 as Texas Home Made Pie Day; • the Saturday before the first Wednesday in February as Texas Academic College Scholarship Day (to compete with college football’s national signing day); • Jewett as the Sculpture Capitol of Texas; • Gregg County the Balloon Race Capital of Texas; • Nacogdoches as the official Garden Capital of Texas; and • the Kemp’s ridley sea turtle as the Official Sea Turtle of Texas.

RANDOM BILLS Here is a sampling of random bills, listed just to show the diversity of legislation filed so far this session: • legislators have offered a number of gun bills; most are not gun control bills, but might be characterized as anti-gun control bills, including arming teachers and students, training for armed teachers, and bills that prohibit Texas officials from cooperating with the feds in enforcing federal gun controls; • reduces required high school tests for graduation from 15 to five; • eliminates double dipping by legislators – no pensions while you are still in the Legislature; • bans on texting while driving; one bill bans texting only, but you can read a text while you drive; • a new sales tax on sweetened beverages; dubbed the soda tax; • authorizing legislators or former legislators with more than 20 years in the Legislature to perform marriage ceremonies, limited to 12 per year; • a new category of law enforcement officers called School Marshals, an armed and trained volunteer force to protect schools.

If you want to keep tabs on legislation, you can go to the Governmental Affairs page on TSCPA’s website, tscpa.org, and click on “Legislation of Interest to CPAs” to see a list of bills with links to the bill text. You can also check the Governmental Affairs blog at tscpa.typepad.com to read continuing commentary on the legislative session.

■

Bob Owen, CPA, is TSCPA’s managing director of regulation and legislation. Contact him at bowen@tscpa.net.

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Cover Article

STRATEGIC COST MANAGEMENT: WHAT CPAS NEED TO KNOW

By Richard J. Barndt, Ed.D., CPA; Peter F. Oehlers, DBA, CPA, CMA; and Joseph M. Hargadon, Ph.D., CPA, CMA 24

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Economic pressures are motivating every organization to control prices, while managing costs to maximize profits. The CPA can play an integral role in identifying the type of information necessary for better decision-making in this setting.

Accordingly, CPAs need to understand the well established and emerging costing systems that are available.

T

he purpose of this article is to familiarize CPAs with Strategic Cost Management (SCM). SCM requires that an entity develop and monitor business metrics that are aligned with the entity’s strategy rather than those that might be considered “core” and taught to all accountants as necessary for all business.

This article provides a basis for CPAs to re-evaluate and re-examine managerial accounting systems, and recommend or implement changes to provide management with the information needed to make better decisions in today’s business environment.

STRATEGY Strategy is the way in which a company, firm or organization chooses to position itself (who are my customers and what are my markets?) and distinguish itself from its competitors. It is generally recognized that companies distinguish themselves from competitors by broadly focusing on differentiation, cost leadership or timeliness.

Differentiation, broadly defined, includes product features, product performance reliability, and after-sale support and service. Similarly, cost includes all costs of the producer, including their upstream suppliers and downstream, after-sale service and support. Timeliness suggests that goods or services are provided when customers need them, and innovative new products and features get to market quickly. Although a company, firm or organization may focus on one area, given the contemporary environment of business, it is likely it will need to balance and compete on all three of these strategies at the same time.

STRATEGIC COST MANAGEMENT Managers everywhere are charged with responsibility for planning, organizing, directing and controlling the business with cost information playing a role at each step. This basic cycle has been adapted to become the strategic management cycle with the goal being the continuity of the firm. The steps in this cycle are formulating strategies (planning), communicating those strategies, developing and carrying out tactics to implement the strategies, and developing and implementing controls to monitor the success of the implementation and success in meeting the strategic objectives. SCM can be defined as the managerial use of cost information directed at one or more of the steps in the strategic management cycle.

SCM is composed of three principal sections: Value Chain Analysis, Strategic Position Analysis and Cost Driver Analysis (Shank 1989). We add a Balanced Scorecard (BSC) to the SCM model as a deliverable that can help provide the needed focus.

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VALUE CHAIN ANALYSIS The value chain for any company, firm or organization is a linked set of value-creating activities necessary to create, deliver and support its product or service. A basic, high level value chain for a boat builder is given at Figure 1.

Figure 1. Boat Builder’s Value Chain Materials

Suppliers

Service & Support

Boat Builder

Distributors

Customer

Labor & Overhead

The link represented by the boat builder is the traditional focus of cost accountants and can be expanded to include the particular processes enabling implementation of activity based costing, the identification of non-value added processes, and possible opportunities for outsourcing.

Value chain analysis presents a firm in the context of the overall chain of value-creating activities of which it is only a part, from basic raw materials to end-use consumers. Combining the valuechain perspective with just-in-time inventory management, for example, helps both suppliers and purchasers realize the effects of the overall production scheme. Further, value chaining can help organizations respond better to changing customer needs by keeping the end consumer in mind, instead of the next business in the chain.

The value-chain concept indicates that for all organizations, the costs incurred need to be recognized for each activity and, in this respect, it is similar to activity-based costing (ABC). The valuechain perspective suggests that there is a need for organizations to look not only within the organization, but also to look at the entire picture for the effects cost decisions have on products up and down the product chain.

The key point being made is that business can be viewed as a chain in which the firm is a link. As such, firms need to recognize that changes they implement may have an impact on other links up the chain (upstream) or down the chain (downstream). The CPA continued on next page

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Strategic Cost Management

ACTIVITY-BASED COSTING AND THE COST DRIVER CONCEPT

continued from page 25

plays a vital role in helping develop the value chain and identifying opportunities to exploit the linkages with others in the chain.

STRATEGIC POSITIONING ANALYSIS Strategic Positioning Analysis defines how a firm chooses to compete: by having lower costs (cost leadership) or superior products (product differentiation). SCM’s focus is not to differentiate itself from traditional cost management, but rather to shift focus to the strategic perspective with the goal of ensuring the sustainability of the firm. Just as the different business strategies require different management mindsets, so will the different strategies require different cost analysis perspectives.

Consider the impact of standard product costs on a textile mill weaving a price sensitive, commodity-type fabric and a manufacturer of high quality fiberglass sport fishing boats sold through an exclusive dealer network. The textile mill management will require a highly developed set of product cost standards where fractions of a cent are important. The boat manufacturer, conversely, is positioned with high quality products marketed through an exclusive dealer organization. Accordingly, the boat builder’s need for a set of highly developed standard costs is much less critical to his/her strategic success. CPAs can help determine where firms want to be in their industry by providing assistance in developing the organization’s mission, and articulating its strategy, goals and tactics.

Traditional costing systems allocate overheads to goods or services on the basis of output by dividing estimated overhead for a period by an output based denominator, direct labor hours or machine hours, resulting in an application rate. Overhead is then allocated to goods and services on the basis of their consumption of the denominator activity. This approach has been a long-accepted method of assigning the indirect, difficult to trace, costs of overhead to products. Increased product offerings and changes in the elements of overhead, however, suggest this approach may not provide the best information for business decision purposes.

ABC is based on the premise that goods or services do not consume resources. Rather, activities consume resources; the goods and services that firms offer consume activities. This view of cost is different from the traditional view of product costs in that it affords the opportunity to develop product costs that are more reflective of actual resource consumption in a multi-product environment.

Implementation of ABC requires a thorough understanding of the business processes by first documenting the activities a firm goes through in manufacturing its good or providing its service.

These activities will likely be many and will need consolidation to a manageable number. The functional categories of overhead (supplies, indirect labor, utilities, etc.) are then allocated into pools of costs associated with providing each of the identified activities.

Once a pool of costs is associated with each activity, a cost driver can be identified that links the consumption of the activity with the

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good or service. Each of the goods or services can then be costed reflecting each good’s actual consumption of the activity. The resulting good or service cost should be reflective of how resources are actually consumed by the good or service, and be a superior tool for managing costs and setting selling prices.

The main benefit of activity-based costing can be understood in ABC’s hierarchy of costs: unit, batch, product and facility. Unit level costs occur each time a good is made or a service is provided (direct material). Batch level costs (process setup costs) are not sensitive to the number of units being produced; rather these are related to the group of units being produced. Product level costs are assigned to all units of a product produced regardless of the number of batches (product design change orders). Facility level costs occur regardless of the number of goods or services offered. ABC treats facility level costs (building depreciation) as period costs since traceability of these costs is weak. Any attempt to allocate these costs to products would be arbitrary and take away from the competency of the ABC product cost.

SCM embraces the fact that product costs are influenced by other levels of drivers. ABC allocates cost to a good or service on the basis of how the cost object consumes unit-, batch- and product-level activities. Good and service costs are also influenced by cost drivers viewed from a higher or “structural” level that can be linked to, and are the result of, an entities choice of strategy. A change to the structural cost drivers may require an entity to modify the way it has chosen to compete. The five categories of structural cost drivers defined by Shank (1989) are presented at Figure 2.

Figure 2. Structural Cost Drivers Category

Example

Scale

How big an investment to make in manufacturing, R&D, marketing.

Scope

Degree of vertical integration.

Experience

How many times in the past the firm has already done what it is doing again. Hiring of employees with certain skill levels.

Technology What process technologies are in use at each step of the firm’s value chain.

benefit the least from an ABC model. Product costs calculated from the ABC model compared with those done using the traditional output-based method of applying overhead would likely be very similar.

THE BALANCED SCORECARD A BSC helps focus on strategy and monitor success in achieving objectives by presenting metrics in four basic areas of business key to sustainability: knowledge and innovation, operations, customer and financial. Once a strategy is determined, specific objectives or critical success factors should be defined in each area. Finally, specific metrics must be defined and monitored on a routine basis linking management’s daily activities to specific objectives, and providing feedback on attaining those objectives. The business metrics selected must focus precisely on measuring strategic success. This implies that some metrics that are classically monitored may be of little importance here and ignored.

Let’s consider the boat manufacturer as an example. The company manufactures high quality fiberglass sport fishing boats that are sold through a select national dealer network. The company has provided a quality product with innovative features for over 30 years and is a recognized manufacturer among serious saltwater sport fishermen.

A chain or strategy map linking the high-level objectives for this boat builder is presented at Figure 3.

Figure 3. The Boat Builder’s Strategy Map

Improved Cash Flow

Improved Gross Profit

Continued Owner Satisfaction

High Dealer Satisfaction

Highest Product Quality

High Manufacturing Efficiency

Highest Shipment Quality

Complexity How wide a line of goods or services to offer to customers.

Product costs are also influenced by “executional” drivers; those drivers that define a firm’s ability to execute successfully, and relate to actual processes and norms or the way management utilizes its operating and productive resources. Basic executional drivers might include: • work force involvement (participation), • total quality management, • capacity utilization, • plant layout efficiency, • product configuration, • exploiting linkages with suppliers and customers.

Companies that offer multiple differentiated goods or services will find the cost numbers provided by ABC to be significantly different.

This is more likely to be the case in contemporary business where customized goods and services with shorter life cycles are more the norm. Alternatively, companies that offer a limited number of goods or services all with similar levels of complexity and value will likely

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Improved Employee Skills

Design Innovations

Once the objectives are identified and mapped, specific metrics can be devised that measure the boat builder’s success in achieving the objectives. These metrics become the basis for the BSC presented in Figure 4. The BSC is enhanced by providing targets for each chosen metric; what the metric should look like when strategic success is achieved.

The selection of a strategy, the preparation of a value chain, the selection and mapping of objectives, and the implementation of a BSC that matches specific metrics with the identified objectives provides a theoretical, aligned foundation on which a sustainable enterprise can be built. Failure to achieve the desired outcomes may suggest the need for a change in strategy. Use of a BSC constantly tests a firm’s strategic theory. continued on next page

27

Strategic Cost Management continued from page 28

THE CPA’S ROLE

Figure 4. Boat Builder’s Balanced Scorecard Critical Success Factor

Measurement

Target Performance

Actual Performance

Improved Gross Profit

Percentage Increase in GP Over Base Year

25%

10%

Improved Cash Flow

Percentage Increase in Free Cash Over Base Year

25%

12%

High Dealer Satisfaction

Dealer Survey

95% Overall Rating

81%

Continued Owner Satisfaction

New Owner Survey

95% Overall Rating

85%

FINANCIAL

CUSTOMER

INTERNAL PROCESS Highest Product Quality

Decrease in Quality Costs from Base Year

50%

18%

High Manufacturing Efficiency

Manufacturing Cycle Efficiency

50%

24%

Highest Shipment Quality

Dealer Complaints

0

5

LEARNING, GROWTH, INNOVATION Improve Employee Skills

In-house Training Hours per Employee

100

35

Design Innovations

Product Design Changes per Year

5

5

THE IMPACT OF TECHNOLOGY ON COSTING SYSTEMS Computer technology has enabled organizations to capture the increased amount of information necessary to take full advantage of ABC and SCM. The large numbers of cost pools and drivers caused by increased product diversity and decreased batch sizes requires that accounting personnel, along with information systems personnel, continually monitor the entity’s ability to support the increased demand for data. Various computer applications can be implemented to enhance SCM and ABC. Enterprise Resource Planning Systems (ERPs) integrate data from across the organization and allow for improved information flow and better tracking of costs. In addition to the traditional components of accounting, finance, sales and operations, other components such as business intelligence systems and dashboards for select company data are available. ERPs require a comprehensive chart of accounts with a coding system to allow data to be viewed in many ways.

Organizations need a clearly stated strategy. As they require better, more timely information, the managerial accounting system needs to continually adapt to serve the needs of the organization. Strategic positioning analysis, in conjunction with value chain analysis, can be used to formulate the desired direction of a company while the implementation of a BSC can focus management on the critical metrics needed to monitor success in attaining its goals.

Those who see cost behavior in strategic terms are clear that output volume alone does not typically catch enough of the richness of cost. How unit cost changes as output volume changes in the short run is seen to be a less interesting question than how cost position is influenced by the firm’s comparative position on the various drivers that are relevant in the competitive situation. ABC seems to be an important step on the road to improving managerial information.

CPAs can assist organizations during these times of change to make better decisions based on improved system design, which should ultimately lead to better cost information.

1) First, the CPA can play an important role in strategic positioning analysis by helping to formulate a focused business strategy, given the rapidly changing environment of business. CPAs can help determine where organizations want to be in their industry by providing assistance in developing the organization’s mission and articulating strategy, objectives and tactics.

2) The CPA plays a vital part in helping develop the value chain and identifying opportunities to exploit the linkages with others in the chain. The CPA’s accounting knowledge and business and management skills, along with the knowledge of the organization’s operations and industry, qualify the CPA to examine and articulate the relationships between the organization, suppliers and customers.

3) CPAs have an opportunity to present the benefits of ABC by first evaluating the firm’s need for ABC, and comparing the costs of implementation and maintenance to the benefits it could provide to the organization in terms of competent good and service costs.

4) Once strategy, objectives and tactics are established, the CPA can help structure the BSC by selecting those metrics that are in alignment with and support the objectives.

5) Finally, the CPA can provide guidance on the level of technology necessary to support the SCM system. Computer solutions ranging from simple to complex are available. The CPA can play a key role in identifying, selecting and implementing a solution that is appropriate and affordable.

■ For more information Johnson, H. T. and R. S. Kaplan. 1987. Relevance lost: the rise and fall of management accounting. (Boston: Harvard Business Press) Shank, J. 1989. Strategic cost management: new wine or just new bottles? Journal of Management Accounting Research (Fall): 47-65.

Richard J. Barndt, Ed.D., CPA, is an assistant professor of accounting at West Chester University in Pennsylvania. He can be reached at rbarndt@wcupa.edu. Peter F. Oehlers, DBA, CPA, CMA, is an associate professor of accounting at West Chester University. He can be reached at poehlers@wcupa.edu. Joseph M. Hargadon, Ph.D., CPA, CMA, is a professor of accounting at

Widener University in Pennsylvania. He can be reached at jmhargadon@wcupa.edu.

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Feature

By Marcus J. Brooks, J.D., and Kristen A. Mynar, J.D.

Charitable Contributions and Charitable Contribution Deductions: Not Created Equal Section 170(c) of the Internal Revenue Code1 (IRC) provides that the term “charitable contribution” means a contribution or gift to, or for the use of, a governmental entity made exclusively for public purposes or a qualified charity to be used exclusively for its charitable purposes. Section 170(c) is not, however, the end of the inquiry in determining whether a charitable contribution deduction can actually be claimed. Section 170(a)(1) provides that a “charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary.”

Thus, to take a charitable deduction, the taxpayer must be able to substantiate the donation. Many taxpayers and their advisors assume that an indisputable gift to a charitable organization automatically qualifies for a charitable contribution deduction. In fact, in addition to intuition that an undisputed contribution should not be refused a deduction, there is older case law that provides some basis for that view; e.g., Buck v. Commissioner, T.C. Memo 1978-324 (1974) (taxpayers tithed to their church, but did not receive records from the church regarding all of their tithes; Tax Court concluded based on the tithe record notations on taxpayers’ calendar that the taxpayers

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had made charitable contributions in excess of those allowed by the Internal Revenue Service (IRS)).

However, the statutory and regulatory regime under section 170 has tightened, and the IRS has recently been aggressive in requiring, as far as possible, strict compliance with all substantiation requirements, even where such substantiation is simply for the substantiation’s sake. In particular, the contemporaneous written acknowledgement requirement of section 170(f)(8), discussed further below, is statutory and thus not subject to substantial compliance arguments. For example, in Durden v .Comm’r, T.C. Memo 2012-140, the taxpayers

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claimed a deduction of $25,171 for contributions made to their church, supported by cancelled checks and a contemporaneous letter from the church. The letter from the church, however, failed to include a statement that no goods or services were provided in consideration for the contributions to the church (the church did furnish such a statement after the IRS’s first audit inquiry). The Tax Court held that the deductions were properly disallowed because the first written acknowledgment did not state that no goods or services were provided, and the second acknowledgment was not contemporaneous. Do not make the mistake of assuming that because your client indisputably gave money or property to a charity, the IRS will not challenge a deduction. Full substantiation of the deduction is required to insulate your client’s deduction from challenge.

The Code itself and Regulations issued by the Secretary thus now form a minefield that must be successfully navigated to substantiate and confidently claim a charitable deduction. In this context, where the IRS is aggressively seeking to disallow deductions based not on challenges to the contributions themselves but instead based wholly on substantiation deficiencies, CPAs must be more diligent than they may have been in the past with respect to making certain that substantiation requirements are met.

SUBSTANTIATION DEPENDS ON CONTRIBUTION AMOUNT AND TYPE (E.G., MONEY OR PROPERTY) The means by which a taxpayer must substantiate a charitable donation varies depending on the value of the donation and whether the donation was property or money. The substantiation rules are detailed and complex, but following them to the letter can save a great deal of time and money. Note also that the Code section and corresponding regulations are often not identical. This article is intended to provide a basic outline of the substantiation rules and the general considerations that should be given to the claiming of a charitable contribution deduction, but it is not an exhaustive treatise on all possible substantiation rules and should not be taken as such.2 Contributions of Money of Under $250 The Code provides that “[n]o deduction shall be allowed … for any contribution of a cash, check or other monetary gift unless the donor maintains as a record of such contribution a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution.” §170(f)(17). Thus, in order to substantiate a charitable contribution of money under $250, the taxpayer must maintain at least one of the following for each charitable contribution: (i) a cancelled check or (ii) a receipt from the donee charitable organization showing the name of the donee, the date of the contribution, and the amount of the contribution. §1.170A-13(a)(1)(i)-(ii).3 Contributions of Property Under $250 To substantiate a charitable deduction for contributions of property valued less than $250, the taxpayer must maintain a receipt from the donee for each contribution that includes all of the following: (i) the name of the donee; (ii) the date and location of the contribution; and (iii) a description of the property in detail reasonably sufficient under the circumstances (the fair market value of the property need not be stated on the receipt). §1.170A-13(b)(1). However, in circumstances where it is impractical to obtain a receipt from the donee organization (e.g., by depositing property at a charity’s unattended drop site),

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the taxpayer must maintain reliable written records with respect to the donated property to substantiate the charitable contribution. §1.170A-13(b)(1); also see §1.170A-13(a)(2) and §1.170A-13(b)(2)(ii) (detailing such requirements).

Contributions of Money or Property of $250 or More: Section 170(F)(8) Contemporaneous Written Acknowledgement Requirement The Code provides that “no deduction shall be allowed … for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization…” §170(f)(8)(a). A contemporaneous written acknowledgement is an acknowledgement of the donor’s contribution that usually consists of a letter from the donee organization to the donor, but may be in any form so long as it is contemporaneous and contains the requisite information.

A contemporaneous written acknowledgement must include the following information: (i) the amount of cash and a description (but not value) of any property other than cash the taxpayer transferred to the donee organization; (ii) a statement of whether or not the donee organization provides any goods or services in consideration, in whole or in part, for any of the cash or other property transferred to the donee organization; (iii) if the donee organization provides any goods or services other than intangible religious benefits (as described in section 170(f)(8)), a description and good faith estimate of the value of those goods or services; and (iv) if the donee organization provides any intangible religious benefits, a statement to that effect. §1.170A-13(f)(2) and §170(f)(8)(B). A written acknowledgement is contemporaneous if it is obtained by the taxpayer before the earlier of: (i) the date on which the taxpayer files a return for the taxable year in which the contribution was made, or (ii) the due date (including extensions) for filing such return. §1.170A-13(f)(3).

“Goods or services means cash, property, services, benefits, and privileges.” §1.170A-13(f)(5). Certain goods or services that have insubstantial values may be disregarded and excluded from a contemporaneous written acknowledgement. §1.170A-13(f)(8). Goods or services provided in consideration for a taxpayer’s payment include items the taxpayer expects to receive in a future year. §1.170A-13(f)(6).

Contributions of Money of $250 or More If a charitable deduction is taken for contributions of money of $250 or more, the taxpayer must, for each contribution, maintain either (i) a cancelled check or (ii) a receipt from the donee charitable organization showing the name of the donee, the date of the contribution and the amount of the contribution. §1.170A-13(a)(1) (i)-(ii). In addition, the taxpayer must have a contemporaneous written acknowledgement from the donee organization. §170(f)(8)(A).

Contributions of Property of $250 to $500 If a charitable deduction is taken for contributions of property valued from $250 to $500, the taxpayer must maintain a receipt for each contribution that includes the name of the donee, the date and location of the contribution and a description of the property in detail reasonably sufficient under the circumstances. §1.170A-13(b) (1). In addition, the taxpayer must have a contemporaneous written acknowledgement from the donee organization. §170(f)(8)(A). continued on next page

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Charitable Contributions & Charitable Contribution Deductions continued from page 31

Contributions of Property in Excess of $500 but Less Than $5,0004 If a charitable deduction is taken for contributions of property in excess of $500 but less than $5000, the taxpayer must maintain a receipt for each contribution that includes the name of the donee, the date and location of the contribution and a description of the property in detail reasonably sufficient under the circumstances. §1.170A-13(b) (3). In addition, the taxpayer must have a contemporaneous written acknowledgement from the donee. §170(f)(8)(A). The taxpayer must also maintain written records that include the manner in which and the date on which the taxpayer acquired the property, and the cost or other adjusted basis of the property, and must state any such information in his/her income tax return if required by the return form or its instructions. §1.170A-13(b)(3).

Under section 170(f)(11), no deduction for a contribution in excess of $500 shall be allowed unless “the individual, partnership or corporation includes with the return for the taxable year in which the contribution is made a description of such property and such other information as the Secretary may require.” §170(f)(11)(B). However, such requirements do not apply to a C corporation that is not a personal service corporation or a closely held C corporation. §170(f) (11)(B).

Contributions of Property in Excess of $5,000 If a charitable deduction is taken for contributions of property in excess of $5,000, the taxpayer must: (i) obtain a qualified appraisal

for the contributed property; (ii) attach a fully completed appraisal summary to the tax return on which the deduction for the contribution is first claimed by the donor; and (iii) maintain all of the information required for written records. §1.170A-13(c)(2). In addition, the taxpayer must have a contemporaneous written acknowledgement from the donee organization. §170(f)(8)(A).

Under section 170(f)(11), no deduction for a contribution in excess of $5000 shall be allowed unless “the individual, partnership, or corporation obtains a qualified appraisal of such property and attaches to the return for the taxable year in which such contribution is made such information regarding such property and such appraisal as the Secretary may require.” §170(f)(11)(C).

Contributions of Money or Property in Excess of $500,000 Under section 170(f)(11), no deduction for a contribution in excess of $500,000 shall be allowed unless “the individual, partnership, or corporation attaches to the return for the taxable year a qualified appraisal of such property.” §170(f)(11)(D).

A qualified appraisal is defined in sections 170(f)(11)(E)(i) and 1.170A-13(c)(3); a qualified appraiser is defined in sections 170(f)(11) (E)(ii) and 1.170A-13(c)(5); and an appraisal summary is defined in section 1.170A-13(c)(4).

SUBSTANTIAL COMPLIANCE A taxpayer’s failure to substantiate a charitable contribution will

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generally result in the deduction being disallowed. However, the Code itself provides that a taxpayer may make a reasonable cause argument for failing to comply with the provisions under section 170(f)(11) (pertaining to information to be included with tax returns) discussed above if such failure is not the result of the taxpayers willful neglect.

Further, a taxpayer may make a substantial compliance argument if the taxpayer failed to comply with the requirements set forth in the regulations. The Tax Court has held that the reporting requirements of section 1.170A-13 of the regulations are directory and are subject to substantial compliance. Bond v. Comm’r, 100 T.C. 32, 41 (1993). Where requirements relate “to the substance or essence of the statute,” strict adherence to all statutory and regulatory requirements is mandatory; but where the requirements are procedural or directory in that they are not of the essence of the thing to be done but are given with a view to the orderly conduct of business, then they may be fulfilled by substantial compliance. Bond v. Comm’r, 100 T.C. at 41.

In Bond, the taxpayers donated two blimps to a charitable organization and in the same month, obtained a professional appraisal of the blimps. Though the appraiser completed the Form 8283 for inclusion with the taxpayers’ return, he did not provide a separate written report of the appraisal, and the Form 8283 did not include the appraiser’s credentials. The taxpayers did provide those credentials to the IRS at audit. The Tax Court held that the taxpayers had substantially complied with the regulations, despite the absence of a separate written appraisal report existing or being attached to the return. Id. at 42. Also see Simmons v. Comm’r, TC Memo 2009208. (The court found that appraisals, although not strictly qualified appraisals, substantially complied and that, combined with filing the Form 8283, the petitioner had complied with the substantiation requirements of section 170.) The Tax Court has declined to find substantial compliance where the taxpayers have failed altogether to obtain an appraisal. E.g., Hewitt v. Comm’r, 109 T.C. 258 (1997), affd.

166 F.3d 332 (4th Cir. 1998).

One important thing to be noted about cases such as Bond and Simmons is that, while the taxpayers were ultimately successful in establishing substantial compliance with the regulations, many other taxpayers have not been so fortunate. Additionally, the litigation required to establish such a finding is expensive and time consuming.

Substantial compliance may well be a valid position to take in a tax controversy, but it is not a sufficient substitute for strict compliance in planning and reporting.

SECTION 170(F)(8) – NOT SUBJECT TO SUBSTANTIAL COMPLIANCE As explained above, for a contribution of $250 or more, the taxpayer must also substantiate the contribution through a contemporaneous written acknowledgement by the donee organization. The writing must (i) describe the property donated, (ii) state whether the donee organization provided any goods or services in consideration for the property, and (iii) if so, a description and good faith estimate of the value of such goods or services. §170(f)(8).

Section 170(f)(8) can be a landmine for taxpayers, even if they have indisputably given money or property to a charitable organization.

E.g., supra, Durden v .Comm’r, T.C. Memo 2012-140. Because section

170(f)(8) is statutory, it is not subject to substantial compliance. Averyt, et al, v. Comm’r, TC Memo 2012-198.

Congress enacted the substantiation requirements of section 170(f) (8) because many organizations were failing to inform donors that portions of the amounts donors paid to those organizations were not deductible because they were part of quid pro quo exchanges.

Id. at *10. While the statutory requirements must be met, the acknowledgment “need not take any particular form.” Id. For example, in Averyt, the Tax Court held that, with respect to a conservation easement, the underlying deed itself was a “contemporaneous written acknowledgment” satisfying the section 170(f)(8) requirement.

Section 170(f)(8) raises a number of issues for taxpayers. First, where a taxpayer receives goods or services in partial consideration for a donation, such consideration must be described, and its value must be estimated. Additionally, if it is even discussed that the taxpayer might receive any preferences or considerations in exchange for the donation, the transaction must be carefully papered to document exactly what the taxpayer did or did not receive. Any discussions about potential consideration that is not ultimately exchanged could wholly disqualify a donation if the taxpayer cannot prove to the IRS’s or the court’s satisfaction that the potential consideration was not ultimately received.

AN OUNCE OF PREVENTION IRS enforcement in the area of charitable contributions is very active. As unfair as it may seem, taxpayers, their advisors and their tax return preparers should not assume that an indisputable gift to a charity necessarily qualifies for a charitable deduction.

Following the substantiation steps is very important, especially given that the IRS’s current posture is to disallow undisputed gifts to charities based on nothing but substantiation failures. Certain requirements are statutory in nature and not subject to substantial compliance arguments, and even where substantial compliance arguments can be made, an ounce of prevention is worth a pound of cure.

■ FOOTNOTES 1. All section references herein are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder, unless otherwise noted.

2. By way of example, in addition to the requirements enumerated here, there are many special rules that apply to specific types of deductions (e.g., conservation easements, contributions of property that constitutes inventory, contributions of capital gain property, contributions of scientific property used for research, contributions of stock for which market quotations are readily available, etc.).

3. This regulation also provides in (iii) that the contribution may be substantiated by maintaining “other reliable written records.” This regulation has not been amended to reflect the addition of section 170(f)(17) by the Pension Protection Act of 2006.

Subsequent to its passage, the recordkeeping requirements may not be satisfied by maintaining other written records, such as a log of contributions. Joint Committee Staff, Technical Explanation of Pension Protection Act of 2006 (JCX-38-06), at p. 305 (8/3/2006) Revenue (September 22, 2009) T.C. Memo. 2009-220 United States Tax Court 4. For purposes of determining the threshold amounts of $500, $5,000 and $500,000, all similar items of property (e.g., paintings, books, coin collections, land, clothing, etc.) donated to one or more donee shall be treated as one property and the values shall be aggregated. §170(f)(11)(F).

Marcus J. Brooks, J.D., and Kristen A. Mynar, J.D., are tax attorneys with the law firm of Naman, Howell, Smith & Lee, PLLC,

which has offices in Austin, Fort Worth, San Antonio and Waco. Brooks also serves as an adjunct professor at Baylor Law School and in Baylor’s Masters of Taxation program. They can be contacted at brooks@namanhowell.com and mynar@namanhowell.com.

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Feature

By Robin R. Patterson, J.D., and Darlene Pulliam, Ph.D., CPA

IRS Takes Action on Portability of Deceased Spouse Unused Exemption A classic part of estate planning has been to carefully use the unified credit of both spouses. This was accomplished by carefully retaining sufficient assets in both spouses’ estates to use up their respective unified credits. Since the marital deduction reduces the net estate, care had to be taken not to transfer too much to the surviving spouse. Provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act) will allow the unused portion of a decedent’s unified credit to be used upon the subsequent death of the surviving spouse.

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ENACTMENT OF THE PROVISION The Act accomplished several estate and gift tax objectives: • The Act reunified the estate and gift taxes. Prior law had provided different amounts of unified credit for estates and gifts.

The Act restored the same unified credit for both estates and gifts.

• The Act fixed the amount protected by the unified credit at $5 million – to be indexed annually – through Dec. 31, 2012.

• The Act set the maximum gift, estate and generation-skipping tax at 35 percent.

• The Act allows for the portability of the unified credit for surviving spouses as discussed below.

The American Taxpayer Relief Act of 2012 permanently extended the portability election. It also permanently extended the $5,000,000 estate tax exemption ($5,120,000 in 2012 and $5,250,000 in 2013 after indexing) and increased the top tax rate for estate, gift and generation-skipping tax to 40 percent. (PL 112-240, 1/2/2013) New Internal Revenue Code (IRC) Section 2010(c) defines some new terms. Under IRC Sec. 2010(c)(3)(A), the basic exclusion amount is $5,000,000. That is, the unified credit will reduce the estate tax due down to zero on a taxable estate of $5,000,000. The applicable exclusion amount is indexed for inflation for decedents dying after 2011. Under IRC Sec. 2010(c)(2), the applicable exclusion amount is the sum of the basic exclusion amount and, in the case of a surviving spouse, the deceased spousal unused exclusion amount. Under IRC Sec. 2010(c)(4), the deceased spousal unused exclusion amount is the lesser of the basic exclusion amount or the excess of the basic exclusion amount of the last such deceased spouse over the tentative tax of the deceased spouse.

Section 2010(c)(5)(A) goes on to require that the deceased spouse unused exclusion cannot be taken into account unless the executor of the estate of the deceased files an estate tax return computing the tax and making an election to make the unused exclusion available to the surviving spouse’s estate.

Section 2010(c)(5)(B) also allows such returns upon which such an election has been made to be examined after the statute of limitations has expired. The deceased spousal unused exclusion can be reduced or eliminated with thus examination. However, no additional taxes can be assessed on the original return after the statute has expired.

TEMPORARY REGULATIONS Temporary and proposed regulations under IRC Sec. 2010(c) were issued in June 2012. The purpose of the regulations was to resolve issues on electing and using the portability of the unused exclusion amount. Other questions answered include how the unused exclusion will be computed and how to use the unused exclusion on the surviving spouse’s estate return after that spouse’s death.

Election The executor of the first spouse to die must make an election to take the unused exclusion into account by the estate of the surviving spouse. This means that a 706 must be filed even if the estate of the

The American Taxpayer Relief Act of 2012 permanently extended the portability election. deceased spouse would not otherwise be required to file a return.

The only way to make the election is to file a 706 by the due date or extended due date.

Although Temp. Reg. 20.2010-2T(a)(7)(i) requires that returns must be complete and properly prepared, Temp. Reg. 20.2010-2T(a) (7)(ii)(A) indicates that returns that are filed only to make the election (small estates) and to determine the amount of the unused exclusion can be filed using estimates of the total value of the gross estate for purposes of determining the marital deduction or a charitable deduction. Actual values must be used to determine other amounts on the 706 and the value of property passing to heirs other than the spouse.

The election is irrevocable. Only the properly appointed executor can make the election. This could include a non-appointed executor such as the person who is in possession of the decedent’s property.

The regulations contain provisions for the possibility of more than one non-appointed executor. For the most part, the election made first by one of the non-appointed executors will be honored.

An executor can opt out of making the election. Even though it might appear that a small estate should not incur the expense of filing a 706, this decision should be carefully considered. It could be argued that the executor is not performing his/her fiduciary responsibility and could be in jeopardy of being successfully sued by the surviving spouse’s estate if it becomes evident that the earlier 706 should have been filed.

Computation Temp. Reg. 20.2010-2T(c)(1)(i) requires that the deceased spouse’s unused exclusion be computed using the basic exclusion amount in effect the year of the death of the first spouse, less the tentative tax determined under IRC Sec. 2001(b)(1) on the estate of this spouse. continued on next page

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IRS Takes Action on Portability of Deceased Spouse Unused Exemption continued from page 35

A surviving spouse may use only the deceased spouse’s unused exclusion of the last deceased spouse. Remarrying will not have any effect unless the surviving spouse also survives the second spouse. As pointed out in Temp. Reg. 20.2010-3T(a)(3), a major planning strategy of a surviving spouse for whom a portability election has been made and who has remarried would be to make gifts to use up the unused exclusion of the deceased spouse. Of course, this must happen before the death of the new spouse; multiple marriages could seriously complicate the computations related to this strategy. Temp.

Reg. 25.2505-2T contains ordering rules for the use of the exclusion to shelter gifts.

Form 706 (as of Oct. 11, 2012) – Detailed Summary of Changes for Portability On Aug. 16, 2012, the Internal Revenue Service (IRS) released a draft version of Form 706 – United States Estate (and Generation Skipping Transfer Tax Return) – that includes the statutory enactments under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312, and its associated temporary regulations, which shall apply to decedents dying in

36

2012. On Oct. 4, 2012, the final Form 706 was released along with its instructions.

The following is a detailed summary of the changes to Form 706 by the IRS that deal with the Deceased Spousal Unused Exclusion (DSUE).

Page 1: Part 2 – Tax Computation Changes: 9 Removed maximum unified credit (applicable credit amount) against estate tax and replaced it with the following provisions: • 9a Basic Exclusion amount; • 9b Deceased spousal unused exclusion (DSUE) amount from predeceased spouse(s) if any (from Section D, Part 6 – Portability of Deceased Spousal Unused Exclusion); • 9c Applicable exclusion amount (add lines 9a and 9b); and • 9d Applicable credit amount (tentative tax on the amount in 9c from Table A in the instructions).

Part 2 Explanation: This change reflects the statutory definition of applicable exclusion amount under IRC Sec. 2010(c)(2) and Temp.

Reg. 20.2010-1T(d) and 20.2010-2T(c). The

specifics of the calculation for subsection b are addressed in the pertinent sections below.

Page 4: Part 6 – Portability of Deceased Spousal Unused Exclusion (DSUE) Part 6 Explanation: Part 6 is an addition to Form 706 that provides a mechanism to elect or opt out of the portability of the Deceased Spousal Unused Exclusion, a formula for calculating the DSUE amount to be portable to a surviving spouse, and a formula for calculating the DSUE amount received from a predeceased spouse.

Specifically, Section A provides that a decedent with a surviving spouse automatically elects portability unless he/ she opts out by checking the box next to “Denial of Portability.” Section B states the preliminary nature of valuation of property being transferred to a qualified domestic trust (QDOT). Section C calculates the amount of DSUE that will be portable to the surviving spouse in accordance with Temp. Reg. 20.2010-2T(c) as follows: • Section C Line 1 equals the applicable exclusion amount that is defined as the basic exclusion amount plus any DSUE from a predeceased spouse (if any) (Part 2 Line 9c from page 1 of the Form 706); the DSUE amount from a predeceased spouse is calculated in Part 6 Section D; • Section C Line 2 equals the taxable estate plus adjusted taxable gifts (Part 2 Line 5 from page 1 of the Form 706); • Section C Line 3 equals the available exclusion amount calculated by subtracting as follows: (Basic Exclusion Amount + DSUE from predeceased spouse) – (Taxable Estate + Adjusted Taxable Gifts); • Section C Line 4 equals total gift tax paid or payable; • Section C Line 5 equals the adjusted gift amount calculated as follows: (Gift Tax Paid or Payable)/(35 percent); • Section C Line 6 equals the available exclusion amount (Section C Line 3) plus the adjusted gift amount (Section C Line 5); and • Section C Line 7 equals the DSUE amount portable to the surviving spouse that is equal to the lesser of Section C Line 6 (decedent’s available exclusion amount) or the basic exclusion amount from Part 2 Line 9a on page 1 of Form 706.

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Section D calculates the DSUE amount received from a predeceased spouse in accordance with Temp. Reg. 20.2010-3T. Part 1 provides for a list of information from the decedent’s last deceased spouse, including name, date of death, whether the portability election was made by spouse, amount of DSUE received from spouse, DSUE amount applied by decedent to lifetime gifts, date of gifts, and remaining DSUE amount (DSUE amount received minus DSUE amount applied to lifetime gifts). Part 2 provides for a list of the same information from decedent’s other predeceased spouses and used by decedent on lifetime gifts. Temp. Reg. 20.2010-3T(b) provides a special calculation rule for decedents with multiple deceased spouses with previously applied DSUE amounts.

According to the regulation, when a surviving spouse has previously applied the DSUE amount of one or more deceased spouses who were not the decedent’s last deceased spouse to taxable gifts, then the DSUE amount to be included in determining the applicable exclusion amount of the surviving spouse is calculated as follows: DSUE Amount of Surviving Spouse’s Last Deceased Spouse + DSUE amount applied

by Decedent to lifetime gifts from other predeceased spouse(s). The result of that calculation is the bottom line of Part 6 (which is carried forward to Part 2 Line 9b).

OTHER CHANGES As noted earlier, Temp. Reg. 20.20102T(a)(7)(ii)(A) indicates that returns that are filed only to make the election (small estates) and to determine the amount of the unused exclusion can be filed using estimates of the total value of the gross estate for purposes of determining the marital deduction or a charitable deduction. Form 706 reflects that rule in several places, including: • Part 1 Line 11; • Part 5 – Recapitulation Note Line 10 Line 23;

• Schedule A – Real Estate; • Schedule B – Stocks and Bonds; • Schedule C – Mortgages, Notes, and Cash; • Schedule D – Insurance on Decedent’s Life; • Schedule E – Jointly Owned Property; • Schedule F – Other Miscellaneous Property Not Reportable Under Any Other Schedule; • Schedule G – Transfers During Decedent’s Life; • Schedule H – Powers of Appointment; • Schedule I – Annuities; • Schedule M – Bequests, etc., to Surviving Spouse; and • Schedule O – Charitable, Public, and Similar Gifts and Bequests.

Explanation. Part 1 Line 11 notifies the IRS – by checking the box – that estimates are being used on the Form 706 for the purpose of electing portability. Parts 5, as well as the affected schedules above, reflect the requirement in the regulations that Form 706 includes a dollar value corresponding to a particular range within which the executor’s best estimate of the total gross estate falls. The dollar value representing the range will be found in the instructions to Form 706. Each particular schedule listed above shall include the appropriate assets but shall not include any values. The value of those assets shall instead be included on Part 5, Line 10, and Part 5, Line 23, of the Form 706 based on the executor’s best estimate after exercising due diligence. Complying with this regulation will ensure effective election of portability on the decedent’s Form 706.

NEW PORTABILITY CHANGES GOALS The new portability provisions change the basic estate planning goals for married couples. Practitioners must become familiar with these changes to successfully serve their clients.

■

Robin R. Patterson, J.D., is an adjunct instructor of Business Law, and Darlene Pulliam, Ph.D., CPA, is Regents Professor and McCray Professor of Business in

the College of Business at West Texas A&M University. They may be contacted at rpatterson@wtamu.edu and dpulliam@wtamu.edu respectively.

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A FULL SERVICE LAW FIRM SINCE 1917

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Business Entities/ Transactions Keith E. Gamel Trenton Hood

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Wills, Trusts, & Probate Kristen Mynar Franklin L. Tuttle

Offices in Amarillo (by appointment), Austin, Fort Worth, San Antonio, and Waco

(800) 765-1470 www.namanhowell.com 37

CPE Article

By Josef Rashty and John O’Shaughnessy

SALE-LEASEBACK TRANSACTIONS, NOW AND THEN

Curriculum: Accounting and Auditing Level: Intermediate Designed For: Business and Industry, Public Practice and Tax Practitioners.

Objectives: To discuss the impact of the recent revenue and lease exposure

drafts on sale-leaseback transactions.

Key Topics: Lease accounting and revenue recognition.

Prerequisites: None Advanced Preparation: None

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Today’sCPA

| MARCH/APRIL 2013

Companies use sale-leaseback transactions to unlock the equity that they have in their assets, such as machinery and equipment, and convert it to cash. They accomplish this by conveying the title of their assets at fair value to a third party (usually a financial institution) in exchange for lump-sum cash payments. The third party then leases back the assets to the company. However, there are proposed changes to the current accounting for sale-leaseback transactions, which may limit some of its financial advantages.

In August 2010, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) jointly released an exposure draft (ED), Leases, and proposed an accounting model that would significantly change lease accounting. One of the objectives of this ED is to ensure assets and liabilities arising from leasing transactions are reflected on the company’s statement of financial position. The subsequent comment period produced significant concern about the complexity of the guidance. As such, the two Boards announced in July of 2011 they would re-expose the proposed leasing standard in 2012 and issue the final standard by late 2013.

The Boards also jointly issued another ED in June 2010, Revenue from Contracts with Customers, to supersede virtually all existing revenue guidance under U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The comment period for this ED ended in October 2010. The Boards decided to re-expose their revenue proposal in November 2011 subsequent to deliberations. The comment period for the revised ED was 120 days and ended on March 13, 2012. The Boards plan to continue their re-deliberations and outreach on the revised revenue recognition ED and issue the final standard by mid-2013.

The proposed lease and revenue guidance have important business implications for sale-leaseback transactions. The planned recognition of significantly more assets and liabilities along with related amortization and interest expense in financial statements would impact the contract negotiations, financial ratios, and business systems for public and private entities. The objective of this article is to analyze the impact of the lease and revenue EDs on sale-leaseback transactions.

SALE-LEASEBACK TRANSACTIONS A sale-leaseback transaction involves the sale of an asset and leaseback of the same asset by a seller/lessee. In a typical sale-leaseback

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transaction, the seller sells an asset to the purchaser, yet retains the right for a long-term continued use of the asset through a leasing arrangement. Essentially, the transaction is arranged so that the purchaser/lessor relinquishes control over the asset through a leasing arrangement, which gives the seller/lessee the same control and responsibility over the asset. The seller/lessee retains a future interest in the asset (generally through options to purchase), so that after a certain time period, the seller/lessee may repurchase the asset.

Under such an arrangement, the seller/lessee secures capital, while retaining use of the asset, and the purchaser/lessor, as owner, may receive tax benefits such as depreciation deductions and interest deductions arising from loan indebtedness. The seller/lessee may take deductions on rental payments. The benefits of these deductions generally outweigh the loss of tax benefits related to depreciation deductions that the seller/lessee foregoes by relinquishing ownership of property.

The rental payments made by the seller/lessee over the course of the lease term typically match the purchaser/lessor’s principal plus interest on the loan for the property. The purchaser/lessor typically retains a reversionary interest, subject to future options to purchase, or extensive lease renewal options by the seller/lessee.

Entities, such as airline and real estate companies, have traditionally entered into sale-leaseback transactions for a variety of reasons and purposes, including the following: • alternative financing, • tax considerations, • strengthening the balance sheet.

Alternative Financing Sale-leaseback transactions can provide a source of financing and liquidity. For example, Southwest Airlines raised $381 million from sale-leaseback transactions during 2009, greatly contributing to its 2009 ending cash balance of $1.1 billion. (http://sec.gov/Archives/ edgar/data/92380/000119312512049647/d293991d10k.htm) Sale-leaseback transactions can provide more funds than a comparable loan using the same asset as collateral since it allows the seller/lessee to raise cash for the full value of the asset, whereas the collateralized loan allows the entity to raise funds typically less than 100 percent of the asset’s value.

Tax Considerations Sale-leaseback transactions have several tax advantages for the lessees compared to collateralized loans discussed in the previous paragraph. For example, lease payments are fully deductible in saleleaseback transactions, whereas only the interest portion of their collateralized loan payments may be deducted.

Sale-leaseback transactions can create capital gains and losses for the seller/lessee, which potentially diminish the impact of unexpected tax situations. For example, during the recent financial crisis, many continued on next page

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CPE Article continued from page 39

For example, Southwest Airlines leases a good portion of its assets, some of which are the results of sale-leaseback transactions.

The majority of Southwest’s terminal operations space, as well as many of its aircrafts, were classified as operating leases as of Dec. 31, 2011. Total rental expenses for operating leases in 2011 and 2010 were $847 million and $631 million, respectively. Future operating rent expense commitments were $5,583 million at the end of fiscal year 2011, while current liabilities and long-term debt net of current portion at the end of the fiscal year 2011 were $4,533 million and $3,107 million, respectively. (http://www.sec.gov/Archives/edgar/ data/92380/000119312512049647/d293991d10k.htm)

THE CURRENT U.S. GAAP GUIDANCE AND SALE-LEASEBACK TRANSACTIONS companies accumulated significant capital losses, potentially offsetting capital gains created by sale-leaseback transactions.

If seller/lessees cannot take full advantage of accelerated depreciation, they may structure a deal with a third-party leasing company to sell their assets and lease them back. Both seller/lessee and purchaser/lessor may benefit from such transaction. The purchaser/ lessor can possibly pass the benefits that it receives from accelerated and bonus depreciation, and Section 179 expensing to the seller/ lessee through lower lease payments, while seller/lessee may benefit by possibly receiving capital gains and securing alternative financing.

Structuring a genuine sale-leaseback transaction amenable for tax purposes requires careful planning. Historically, the Internal Revenue Service (IRS) has considered sale-leaseback transactions as “sham” transactions, lacking any economical substance and thus void for tax purposes.

Some companies have used crafty financial maneuvering to make risk for both parties nonexistent. For example, the purchaser/lessor would take out a loan from a third party and use the loan proceeds to pay for the purchase of the assets. The seller/lessee, on the other hand, uses those proceeds to make rent payments for the use of its sold assets. The purchaser/lessor uses those rent payments to pay back its loan, rendering the financial arrangement almost entirely circular and off-setting. The IRS may question such sale-leaseback transactions on the grounds that the true ownership does not reside with purchaser/ lessor, particularly where the seller/lessee is obligated to pay for improvements and maintenance, property taxes, and insurance (only a true owner normally undertakes such responsibilities).

Strengthening the Balance Sheet A few years ago, the Securities and Exchange Commission (SEC) estimated the undiscounted amount of off-balance-sheet lease obligations at approximately $1.25 trillion (http://www.sec.gov/news/ studies/soxoffbalancerpt.pdf). One of the advantages for the seller/ lessee in a sale-leaseback transaction under the current guidance is the possibility that the lease may be recognized as an operating lease with off-balance-sheet liabilities. Solvency metrics such as the current ratio, as well as other metrics such as debt to equity, return on equity, and interest coverage, are all affected positively with such an accounting treatment.

40

Under the current guidance in a lease arrangement, the lessee can potentially account for leases either as operating or capital leases depending on certain circumstances. In an operating lease, the lessee reflects the lease rentals in the statement of operations on a straight-line basis. In a capital lease, on the other hand, the lessee measures the liability based on the estimated lease term at the present value of the estimated future lease payments, discounted using the lessee’s incremental borrowing rate or, if it cannot be readily determined, the rate the lessor charges the lessee.

This provision is available to a seller/lessee in a sale-leaseback arrangement.

The current guidance treats a sale-leaseback arrangement as a financing transaction in which any profit or loss on the sale is deferred and amortized by the seller/lessee. The seller/lessee amortizes the deferred profits and losses over the lease term or the leased items’ economic life for capital leases; for operating leases, the seller/lesser amortizes deferred profits and losses in proportion to the rental payments over the period of asset use.

An exception to deferring the profit and loss occurs when the seller/lessee relinquishes the right to substantially all of the remaining use of the property sold. In that case, the sale and the leaseback shall be accounted for as separate transactions, and the lessee recognizes gains and losses immediately.

The sale-leaseback rules do not impact the purchaser/lessor’s accounting. A purchaser/lessor involved in a sale-leaseback transaction usually accounts for the transaction as the acquisition of an asset and either a corresponding financing or operating lease out.

THE PROPOSED GUIDANCE AND SALE-LEASEBACK TRANSACTIONS Under the current guidance, sale-leaseback transactions can result in off-balance-sheet liabilities for the seller-lessee when a sale is recognized and the lease is classified as an operating lease.

The lease ED, on the other hand, proposes that sale-leaseback transactions would no longer be off-balance sheet since lessees would be required to recognize all leases in their balance sheets (Rashty and O’Shaughnessy, “The Ever-Changing Lease Exposure Draft,” Today’s CPA, November/December 2011). Sale-leaseback transactions may also be affected by the Revenue from Contracts with Customers ED re-exposed in November 2011.

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TABLE 1.

1

Call options (IG40)

Seller/lessee has an unconditional right to repurchase the leased asset

If the repurchase price is equal or higher than original selling price, the transaction is a financing arrangement.

If the repurchase price is less than original selling price, the transaction is within the scope of Lease guidance.

2

Forward rights (IG40)

Seller/lessee has an unconditional obligation to repurchase the leased asset

If the repurchase price is equal or higher than original selling price, the transaction is a financing arrangement.

If the repurchase price is less than original selling price, the transaction is within the scope of Lease guidance.

3

Put options – the repurchase price is equal or higher than original selling price

Purchaser/lessor has an unconditional right If the repurchase price is equal or greater than expected market value of the to require the seller/lessee to repurchase asset, the transaction is a financing arrangement (IG46). the asset If the purchaser/lessor does not have significant economic incentives to exercise the put option, then transaction is a sale with a right of return and within the scope of Revenue Recognition guidance (IG45).

4

Put options – the repurchase price is less than original selling price

Purchaser/lessor has an unconditional right If the purchaser/lessor has a significant economic incentive to exercise the to require the seller/lessee to repurchase put option, the transaction is within the scope of Lease guidance (IG43). the asset If the purchaser/lessor does not have significant economic incentive to exercise the put option, the transaction is a sale with a right of return and is within the scope of Revenue Recognition guidance (IG45).

The Boards have tentatively decided that a seller/lessee would now apply the guidance in the revenue recognition standard to determine whether to recognize a sale of the underlying asset. If the revenue recognition standard’s requirements for sale accounting are met, the transaction would be accounted for as a sale and leaseback of the underlying asset; otherwise, the transaction would be accounted for as a financing of the underlying asset, requiring the asset to remain on the seller/lessee’s balance sheet.

Generally, a sale-leaseback transaction that does not qualify as a sale would be accounted for as a financing of the underlying asset. A sale-leaseback transaction that is accounted for as a sale and leaseback would result in de-recognition of the underlying asset by the seller/ lessee and recognition of a gain or loss for the difference between the consideration received from the purchaser/lessor and the carrying value of the underlying asset.

The amount of the gain or loss would be adjusted to reflect current market rates for the lease of the underlying asset if the transaction price is not at market price. If the transaction qualifies as a sale, a gain or loss would be recognized immediately. The Boards have also proposed that if the sale or leaseback is not established at fair value, the asset, liability and gain or loss would be adjusted to reflect current market rentals. The seller/lessee would recognize a right-of-use asset and a lease liability for the leaseback of the underlying asset in transactions that qualify as sales.

The proposed guidance treats short-term leases (leases of 12 months or less) similar to operating leases under the existing guidance. Table 1 summarizes the impact of the repurchase provision in sale-leaseback transactions under the Revenue Recognition ED paragraphs IG38-IG48.

LATEST DEVELOPMENTS In June 2012, the Boards announced that they support a principle for classifying leases based on whether the lessee acquires and

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consumes more than an insignificant portion of the underlying asset over the lease term. Based on that decision, leases would be classified as either leases of property (i.e., land, building or part of a building), recognized as straight-line leases, or leases of assets other than property (e.g., equipment), recognized as accelerated leases.

Lessors would apply operating lease accounting to straight-line leases and the Receivable & Residual (R&R) approach to accelerated leases (Rashty and O’Shaughnessy, “The Ever-Changing Lease Exposure Draft, Part II – Lessor Accounting,” Today’s CPA, May/ June 2012). Lessors following operating lease accounting would neither recognize a lease receivable nor derecognize a portion of the underlying asset even though the lessee would recognize a liability for future lease payments and a corresponding right-of-use asset.

ILLUSTRATION Entity S (the seller/lessee) sells equipment with a fair market value and book value of $37,000 to Entity P (the purchaser/lessor).

Assume that fair market value is equal to book value to simplify the illustration.

Entity P enters into a three-year lease agreement with Entity S. The carrying value (CV) of the equipment is $37,000, which is equal to its fair market value (FV) at the commencement of the lease, and the equipment is estimated to have a residual value of $5,000 at the end of the three-year lease. The total lease receivable (LR) at the commencement of the lease was $32,832. Entity S has an unconditional right to repurchase the equipment (a call option) at $5,000 and exercises this option at the end of the lease term. Assume that residual value is equal to fair market value to simplify the illustration.

Entity P charges Entity S a monthly lease payment of $1,000 in arrears, which is equal to 6.08 percent return (the implicit rate in the lease agreement). The lease receivable for $32,832 is equal to the continued on next page

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CPE Article continued from page 42

EXHIBIT I Receivable and Residual Approach – Sale/Leaseback – Purchaser/Lessor’s Perspective Journal Entries: Year

Cash

0

($37,000) (a)

0

$-

$32,832 (d)

$4,168 (f)

1

$12,000 (b)

($10,287) (e)

$261 (g)

($1,713) (i)

($261) (g)

2

$12,000 (b)

($10,931) (e)

$277 (g)

($1,069) (i)

($277) (g)

3

$12,000 (b)

($11,614) (e)

$294 (g)

($386) (i)

($294) (g)

3

$5,000 (c)

a. b. c. d. e.

Lease Receivable Residual Asset

Underlying Asset Lease Revenue

Interest Income

$37,000 (a) ($37,000) (h)

$-

($5,000) (c)

Purchase of equipment from lessee for $37,000.

Annualized monthly lease payments of $1,000.

Sale of equipment to lessee for $5,000 at the end of the lease due to lessee’s exercise of call option.

Lease receivable is equal to the present value of an ordinary annuity of $1,000 discounted at 6.08 percent over 36 months.

Collection of lease receivable amortized using the effective method at 6.08 percent.

f. g. h. i.

Residual asset represents the rights to the underlying asset retained by the lessor and is equal to CV – (CV X (LR/FV)) or $37,000 – ($37,000 X ($32,832/$37,000)) = $4,168.

The residual asset is accreted using 6.08 percent interest rate to arrive at $5,000 residual value at the end of the lease.

De-recognition of asset due to leaseback.

The lease revenue on the lease receivable, which is amortized using the effective method at 6.08 percent.

EXHIBIT II Receivable and Residual Approach – Sale/Leaseback – Seller/Lessee’s Perspective Journal Entries: Year

Cash

0

$37,000 (a)

0

Right to Use Assets

Underlying Asset

Liabilities

Amortization Expense

Interest Expense

($37,000) (a) $32,832 (d)

($32,832) (d)

1

($12,000) (b)

($10,944) (e)

$10,287 (f)

$10,944 (e)

$1,713 (g)

2

($12,000) (b)

($10,944) (e)

$10,931 (f)

$10,944 (e)

$1,069 (g)

3

($12,000) (b)

($10,944) (e)

$11,614 (f)

$10,944 (e)

$386 (g)

3

($5,000) (c)

a. b. c. d.

$5,000 (c)

Sale of equipment from lessee for $37,000.

Annualized monthly lease payments of $1,000.

Purchase of equipment from lessor for $5,000 at the end of the lease due to lessee’s exercise of call option.

Right to use assets and liabilities are equal to the present value of an ordinary annuity of $1,000 discounted at 6.08 percent over 36 months.

present value of the lease payments discounted at 6.08 percent. The Exhibits I and II reflect the journal entries in purchaser/lessor and seller/lessee books.

POSSIBLE DETERRENT The new guidance would undoubtedly impact the structure and most likely the number of future sale-leaseback transactions.

e. f. g.

Amortization of the right to use assets.

Lease payments less applicable interest.

Applicable interest at 6.08 percent.

The proposed guidance that sale-leaseback transactions no longer be considered off-balance-sheet items may serve as a deterrent to companies’ decisions to engage in such transactions. Nevertheless, sale-leaseback transactions will continue to appeal to many companies, in one form or the other, as an alternative source of financing with potential tax advantages.

■

Josef Rashty, CPA, has held managerial positions with several publicly held technology companies in the Silicon Valley region of California. He is a member of the Texas Society of CPAs and can be reached at jrashty@sfsu.edu. John O’Shaughnessy, Ph.D., CPA (inactive), is an accounting professor at San Francisco State University. He can be reached at joshaun@sfsu.edu.

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CPE Quiz Today’s CPA offers the self-study exam below for readers to earn one hour of continuing professional education credit. The questions are based on technical information from the preceding article. Mail the completed test by April 30, 2013, to TSCPA for grading.

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. The answers for this exam will be posted in the next issue of Today’s CPA. Answers to last issue’s self-study exam: 1. C 2. D 3. B 4. D 5. A 6. B 7. B 8. D 9. C 10. B

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Sale-Leaseback Transactions, Now and Then

BY JOSEF RASHTY AND JOHN O’SHAUGHNESSY

1 In a typical sale-leaseback transaction, the seller sells an asset to the purchaser, yet retains the right for a long-term continued use of the asset through a leasing arrangement.

A. True B. False

2 Companies enter into sale-leaseback transactions for which of the following reasons: A. Alternative financing B. Tax consideration C. Strengthening the balance sheet D. All of the above

3 When compared to a comparable collateralized loan, sale-leaseback transactions can provide more funds because the sale-leaseback allows the seller/lessee to raise cash for the full value of the asset.

A. True B. False

4 Sale-leaseback transactions provide lessees with certain tax advantages such as:

7 Under the proposed guidance, a seller/lessee would now apply revenue recognition standards to determine whether to recognize a sale of the underlying asset. If the sales recognition standards are met: A. The transaction could be accounted for as a sale and leaseback of the underlying asset.

B. The seller/lessee would de-recognize the underlying asset.

C. The seller/lessee would recognize a gain or loss immediately.

D. All of the above.

8 When a seller/lessee has an unconditional right to repurchase the leased asset, this is considered a: A. Call option.

B. Forward rights C. Put option D. None of the above

9 In the latest developments (June 2012), the Boards announced that they support a principle for classifying leases based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term. As such, the Boards would support classifications for leases as either straight-line or accelerated depending upon the type of property.

A. Lease payments are fully deductible in saleleaseback transactions.

B. Sale-leaseback transactions can create capital gains and losses.

A. True C. Both of the above.

B. False D. None of the above.

5

Under existing GAAP, the seller/lessee amortizes deferred profits and losses: A. for capital leases over the lease term or the leased items’ economic life.

B. for capital leases in proportion to the rental payments over the period of asset use.

C. for operating leases over the lease term or the leased items’ economic life.

D. None of the above.

10 As illustrated in Exhibit II of the illustration, the total effect on the seller/ lessee’s first year’s expenses come from the following source/s: A. Amortization of the right-of-use asset B. Interest on the lease liability and amortization of the right-of-use asset C. Lease payments D. Interest on the lease liability

6 Under existing GAAP, sale-leaseback transactions can result in off-balancesheet liabilities for the seller-lessee when the lease is classified as an operating lease. However, the lease ED would require that lessee recognize all leases on their balance sheets.

A. True B. False

43

Classifieds Classifieds Positions Available In Dalhart Texas, junior/senior accountant with 5 years minimum tax experience. Salary starting at $75k depending on experience plus benefits with partnership opportunity after proven success. E-mail resumes to chad@gaskillpharis.com, or mail to Gaskill, Pharis & Pharis, LLP. PO Box 1060, Dalhart, TX 79022.

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44

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Retirement minded CPA looking to merge Tarrant County CPA practice with another CPA firm. Please reply to File Box #5200, Texas Society of CPAs, 14651 Dallas Parkway, Suite 700, Dallas, TX 75254

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Today’sCPA

| MARCH/APRIL 2013

Feature

By Long Thai, Attorney at Law, and Saqib Dhanani, Attorney at Law, Paradigm Partners

Proper Substantiation for the R&D Credit The Credit for Increasing Research Activities (I.R.C. § 41, the R&D Tax Credit) offers companies engaging in research and development activities the opportunity to lower their tax liability. Following proper procedures, the R&D Tax Credit can be accurately calculated and defended even without formal project accounting. As courts have held that tax credits are a matter of legislative grace, taxpayers bear the burden of proving they qualify for the R&D Tax Credit. The taxpayer claiming the R&D Tax Credit must retain substantiation records in sufficiently usable form and detail to meet the burden of proving credit eligibility.

A recent case, Basim Shami and Rania Ardah, et al. v.

Commissioner of Internal Revenue, demonstrates the critical importance of proper procedure and methodology when claiming the R&D Tax Credit. In this case, the U.S. Tax Court held that wages paid to a company’s shareholders, CEO and the marketing chief were not qualified expenses under the R&D Tax Credit. The company in question, Farouk Systems, Inc., is well-known for its hair, skin and nail products, including the BioSilk line of products, the CHI hair coloring systems and flat irons.

Farouk Systems’ research and development staff ranged from 18 to 27 employees during the relevant tax years: 2003, 2004 and 2005.

The research and development staff included chemists, technicians and a vice president of research and development. Generally, a high percentage of wages for these types of employees working for similar companies engaged in product development will be deemed qualified expenses for purposes of the R&D Tax Credit. Indeed, the R&D Tax Credit maintains the “substantially all” rule, which was designed primarily for engineers, designers, scientists, and programmers. The rule allows companies to capture 100 percent of an employee’s salary if that employee spent 80 percent or more of his/her time performing qualified work.

Farouk Systems’ R&D study claimed that the company’s CEO and marketing chief spent up to 80 percent of their time engaged in qualified work. Due to the “substantially all” rule, this captured their entire salaries for certain years, and effectively qualified wages in the amount of: $8,735,727, $7,988,310, and $3,335,373 for the CEO; and $5,722,699 and $1,839,581 for the marketing chief. While the R&D Tax Credit does not require that the CEO and marketing chief wore lab coats for the majority of the year, there is a requirement of substantiation of time spent performing qualified services.

The court found that the study failed to adequately substantiate the wage allocations for the CEO and marketing chief. The study did not provide any documentation that established how much time these individuals spent performing research and development activities. Mere testimony that was offered to substantiate the time claimed was general, vague, and conclusory, and, therefore, inadequate. The court ultimately held that the insufficient

substantiation prevented any amount of the relevant wages from qualifying for the R&D Tax Credit.

To prevent outcomes such as the aforementioned case example, Paradigm’s studies establish a detailed “nexus” of qualified research expenditures to qualified research activities. One of the IRS’s biggest concerns is that some “engineering” reports are in fact written by individuals with no engineering or scientific background, and that no nexus is established between a company’s qualifying expenditures and qualifying activities. Each company’s documentation should directly connect the project to the employee and the estimated time spent on that project to each of the years under engagement.

To ensure that the requisite statutory requirements are satisfied, there is a series of steps that a company should follow. Start by collaborating internally to analyze the technical and financial information necessary to qualify relevant projects. Once this is done, the company can determine the qualifying R&D activities performed by analyzing the types of operational activities each company performs.

The project identification phase of the study consists of identifying potential projects to be evaluated. Following the initial identification, the projects must be further evaluated to ensure the final list of projects includes only the projects that meet each of the requisite elements of qualified research. During the data collection phase, the company needs to ensure that each study satisfies the substantiation requirements of the R&D Tax Credit. This is accomplished through identification and utilization of various pieces of documentation, both financial and technical.

After thoroughly evaluating all the documentation, the next step is to perform an extensive interview process with individuals possessing direct knowledge of the company’s research activities.

These interviews and associated notes are used to supplement the documentary record. Paradigm’s comprehensive project-by-project methodology conducted by our production staff of engineers and IP attorneys is the most thorough methodology accepted by the IRS today.

■

Saqib Dhanani and Long Thai are both with Paradigm Partners. Dhanani received a B.S. in computer science from the University of Houston and a J.D. from South Texas College of Law. He can be reached at SDhanani@ParadigmLP.com or 281-558-7100. Thai received a J.D. from South Texas College of Law and an M.S. from Texas A&M University. Paradigm Partners is a national consulting firm specializing in complex federal and state tax and funding incentives. For more information on the company’s core consulting portfolio, please go to www.ParadigmLP.com.

Today’sCPA

| MARCH/APRIL 2013

45

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