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Accounting and Tax Planning

The State of Things

By Jonathan Cohen-Gorczyca, CPA

Very rarely do court cases related to state taxation make national news. South Dakota v. Wayfair Inc. (2018) was a Supreme Court case that decided in a 5-4 vote that states can charge and collect tax on out-of-state sellers, allowing the new precedent to supersede the physical-presence standard that most states were practicing.

Jonathan Cohen-Gorczyca

Typically, when a case is decided, states react quickly in order to increase tax revenues. While this case predominately affects Internet retailers who exceed a certain amount of shipments to a state or a certain dollar threshold of sales, it should cause all businesses to rethink what state tax filings and business registrations they are required to complete in order to maintain compliance with state tax laws and reduce exposure. In addition, pass-through entities, such as partnerships and S corporations, could have partners and shareholders that may also have tax-filing requirements in these states.

Businesses should maintain records of the number of completed transactions as well as the dollar amount of sales to each of the 50 states. Since each state has different laws that could trigger nexus for income or sales tax, this is a starting point to determine if additional state filings are required or if they should have been filed in prior years.

Nexus is the amount and degree of a taxpayer’s business activity that must be present in a state before the taxpayer is required to file a return and pay tax on income earned in the state. Individual states determine what degree of nexus triggers a tax-return filing requirement, and those rules can vary from state to state. Other questions that should be asked and analyzed include, but are not limited to, the following:

• How much property and equipment does the company own in another state?

• How much payroll is paid to employees that are in another state?

• If the company is selling tangible property, how is the property delivered? Are they using a third-party carrier? Are they sending company employees to make the delivery?

• Are employees or hired independent contractors installing the property once it is delivered in another state?

While these questions relate to the more traditional physical-presence standard in various states, the answers should be looked at in conjunction with the number of completed transactions and the dollar sales in a state. For example, Connecticut and New York have implemented a factor-based nexus standard (also known as a bright-line nexus test) for sales, payroll, and property (even if the taxpayer does not have a substantial physical presence in the state) in an attempt to increase tax revenue.

If, during the tax year, sales exceed $500,000 to Connecticut or $1 million to New York, a company located in Massachusetts with very little or no physical presence would be required to file tax returns in these states. Various states are now collecting income and sales tax revenue when an out-of-state company is not even setting foot into the state.

“Individual states determine what degree of nexus triggers a tax-return filing requirement, and those rules can vary from state to state.”

In order to help businesses determine if a sales or income-tax nexus exists in a particular state, states will commonly post a nexus questionnaire on their Department of Taxation’s website. Numerous questions will be asked about current and prior business activity in the state, such as sales amounts, how items are shipped, if employees are traveling to the state, and many other questions. Once submitted, the state will decide on whether sales or income-tax nexus exists in the state and what filings would be required. You should consult with your accountant or attorney prior to filling out these questionnaires because, if they are filled out incorrectly, it could cause a state to make an incorrect determination.

In addition to the questionnaires, many states have set up voluntary disclosure programs. If it is clear that a business has established nexus in a state in the current year but also failed to make this determination in prior years, there is the risk of exposure and potential tax audits, which could lead to additional taxes due plus penalties and interest.

By disclosing prior years’ sales, activities, and other connections to the state, the state may potentially waive penalties and interest through its voluntary disclosure program. Once again, the voluntary disclosure program should only be entered into after a determination is made by your accountant or attorney.

The states’ changes in nexus standards, which determine when a company may become subject to sales or income taxes in outside states, should be cause to review and analyze a company’s annual activities in other states. As these state laws may change every year, a company is responsible for maintaining tax compliance in each respective state and should review the nexus standards every year in order to stay compliant.

Jonathan Cohen-Gorczyca, CPA, MSA is a tax supervisor in Melanson Heath’s Greenfield office; (413) 773-5405.

Accounting and Tax Planning

New Rules of the Road

By Julie Quink, CPA

Tax-IncentivesIn 2018, nonprofit organizations face implementation of the first major overhaul of accounting standards in two decades. The goal of the overhaul is to improve the communication of financial results for donors and other outside stakeholders and to emphasize transparency in financial reporting.

With these changes, nonprofit organizations can expect significant changes in financial reporting practices. Donors and outside stakeholders can expect enhanced information on liquidity, access to cash and endowments.

What are the significant financial reporting changes for nonprofits?

Some of the major changes in the new standards encompass net asset classification, liquidity and availability, investment returns, reporting of functional expenses, and presentation of statement of cash flows.

Net Assets

The new accounting standards focus on the existence or absence of donor restrictions as opposed to the type of restriction. The new rules provide for two classes of ‘net assets’ — with donor restrictions and without donor restrictions. Previously, nonprofits have reported three required classes of net assets — unrestricted, temporarily restricted, and permanently restricted.

Julie Quink, CPA

Julie Quink, CPA

For underwater endowments, in which the fair value of the endowment at the reporting date is less than the original gift or the amount required to be maintained by the donor or by law, the cumulative amount of losses is netted in assets with donor restrictions under the new classifications. Previously, the accumulated losses were included in unrestricted net assets.

Disclosures relative to underwater endowments now encompass the aggregate amount of original gifts required to be maintained, endowment spending policies, and discussion of actions taken or strategy relative to the underwater status of the endowment. For the nonprofit, a concern may be that the status of and strategy of managing underwater endowments is highlighted in the new financial-statement disclosures.

The goal of the change is to simplify tracking and reporting of donor restrictions and also to enhance disclosures on the nature, amounts, and types of donor restrictions.

Liquidity and Availability

Quantitative and qualitative information is required under the new standards relative to liquidity and availability of liquid assets, which are typically cash and investments.

The qualitative disclosures require analysis of how the organization manages its liquid assets to meet cash needs for expenditures within one year of the statement of financial-position date. The quantitative information regarding the liquid assets and their availability to meet the current-year needs can be presented on the face of the financial statements or in the notes to the financial statements.

Donors, grantors, creditors, and other stakeholders want to understand that these nonprofit organizations that they are evaluating have adequate financial resources to meet obligations as they become due. For the nonprofit organization, a concern is that this liquidity information can highlight potential liquidity shortfalls, which may affect future donations and grants.

Investment Returns

Investment income is to be reported net of internal and external investment expenses. This has been an optional presentation under current standards. The requirement to disclose investment expenses net in investment income has been removed. The netting of fees against income does not suggest that nonprofits should not still manage and monitor investment fees, but assists in eliminating the burden of trying to identify embedded investment fees.

Functional Expenses

Currently, only health and welfare organizations are required to report expenses by function. Under the revised standards, all nonprofits must report expenses by function and must disclose the methodology used for the allocations to program and overhead expenses in the notes to the financial statements.

Nonprofit organizations should have been allocating expenses to programmatic and administrative expenses even though not required to detail the expenses by function. The requirement for functional reporting and disclosures may require nonprofits to review their allocation policies for consistency.

Statement of Cash Flows

The new rules continue to allow nonprofits to choose the method, direct or indirect, by which they present operating cash flows. The new guidance does eliminate the need to add an indirect reconciliation if using the direct method in presenting operating cash flows.

By streamlining the requirements, it is believed that the statement of cash flows will be a more useful statement and result in a reduction of costs to the nonprofit to prepare the financial statements.

Conclusion

The new accounting and reporting standards are intended to provide more transparency to donors and other stakeholders. These changes may, however, have a significant time and financial impact on nonprofit organizations as they implement the new requirements.

Julie Quink, CPA is the managing principal of Burkhart, Pizzanelli, P.C., specializing in the accounting and consulting aspects of the practice. She is also a certified fraud examiner.

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