The CPA Desk

A Thought Leader Production by PKFTexas

How the “Commerciality Doctrine” Can Trip Up Your Not-for-Profit

The commerciality doctrine was created along with the operational test to address concerns over not-for-profits competing at an unfair tax advantage with for-profit businesses. But even business activities related to your exempt purpose could fall prey to the commerciality doctrine, resulting in the potential loss of your organization’s exempt status.

Several Factors Considered
The operational test generally requires that a not-for-profit be both organized and operating exclusively to accomplish its exempt purpose. It also requires that no more than an “insubstantial part” of its activities further a nonexempt purpose. Your organization can operate a business as a substantial part of its activities as long as the business furthers your exempt purpose.

But under the commerciality doctrine, courts have ruled that some organizations’ otherwise exempt activities are substantially the same as those of commercial entities. They consider several factors when evaluating commerciality, including:

  • Whether an organization has set prices to maximize profits,
  • The degree to which it provides below-cost services,
  • Whether it accumulates unreasonable reserves,
  • The use of commercial promotional methods such as advertising,
  • Whether the business is staffed by volunteers or paid employees,
  • Whether it sells to the general public, and
  • The extent to which the not-for-profit relies on charitable donations. (They should be a significant percentage of total support.)

No single factor is decisive for courts or the IRS.

Possible UBIT Issues
There’s another risk for not-for-profits operating a business. You could pass muster under the commerciality doctrine but end up liable for unrelated business income tax (UBIT).

Revenue that a not-for-profit generates from a regularly conducted trade or business that isn’t substantially related to furthering the organization’s tax-exempt purpose may be subject to UBIT. Much depends on how significant the business activities are to your organization as a whole. There are also several exceptions.

Seek Advice First
If you’re thinking about launching a new business to drum up additional revenues, consult your advisors first. They can help reduce the risk that your organization will run into potential exemption or UBIT issues.

Potential Benefits of Catch-Up Retirement Plan Contributions

Will you be age 50 or older on December 31? Are you still working? Are you already contributing to your 401(k) plan or Savings Incentive Match Plan for Employees (SIMPLE) up to the regular annual limit? Then you may want to make “catch-up” contributions by the end of the year. Increasing your retirement plan contributions can be particularly advantageous if your itemized deductions for 2018 will be smaller than in the past, because of changes under the Tax Cuts and Jobs Act (TCJA).

Catching Up
Catch-up contributions are additional contributions beyond the regular annual limits that can be made to certain retirement accounts. They were designed to help taxpayers who didn’t save much for retirement earlier in their careers to “catch up.” But there’s no rule that limits catch-up contributions to such taxpayers.

So catch-up contributions can be a great option for anyone who is old enough to be eligible, has been maxing out their regular contribution limit and has sufficient earned income to contribute more. The contributions are generally pretax (except in the case of Roth accounts), so they can reduce your taxable income for the year.

More Benefits Now?
This additional reduction to taxable income might be especially beneficial in 2018 if in the past you had significant itemized deductions that now will be reduced or eliminated by the TCJA. For example, the TCJA eliminates miscellaneous itemized deductions subject to the 2% of adjusted gross income floor — such as unreimbursed employee expenses (including home-off expenses) and certain professional and investment fees.

If, say, in 2018 you have $5,000 of expenses that in the past would have qualified as miscellaneous itemized deductions, an additional $5,000 catch-up contribution can make up for the loss of those deductions. Plus, you benefit from adding to your retirement nest egg and potential tax-deferred growth.

Other deductions that are reduced or eliminated include state and local taxes, mortgage and home equity interest expenses, casualty and theft losses, and moving expenses. If these changes affect you, catch-up contributions can help make up for your reduced deductions.

2018 Contribution Limits
Under 2018 401(k) limits, if you’re age 50 or older and you have reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a SIMPLE instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.

But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do. Also keep in mind that additional rules and limits apply.

Additional Options
Catch-up contributions are also available for IRAs, but the deadline for 2018 contributions is later: April 15, 2019. And whether your traditional IRA contributions will be deductible depends on your income and whether you or your spouse participates in an employer-sponsored retirement plan.

New Opportunity Zone Program Provides Tax Incentives

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m here with Martin Euson, a director on our tax team. Martin, welcome back to the Playbook.

Martin: Thanks, Jen. I’m glad to be here.

Jen: So, I’ve heard a little bit about the Opportunity Zone Program. What is it?

Martin: The Opportunity Zone Program is a new program that was created as a result of the Tax Cuts and Jobs Act that, as we know, was signed into law last December, and the program is really aimed at encouraging private investment and development into areas that are historically distressed communities or low-income communities across the United States. And in exchange for that, investors are given some pretty significant tax benefits.

Jen: We’re in Houston – are there areas where we can feel the impact locally?

Martin: Oh, absolutely. In Houston, alone, there are more than 100 Opportunity Zone designations. If you look at a map of inside the Beltway, most of Downtown Houston has the Opportunity Zone designation and much of the area to the east of Downtown. So, more than 100 areas inside of Houston, across the state of Texas more than 600 areas were designated Opportunity Zones, and so, it should have a very significant impact at the local level.

Jen: So, Martin, what kind of incentives exist for investment in these Opportunity Zones?

Martin: So, the incentive, Jen, really is a tax incentive. Investors who invest in Opportunity Zones can benefit from three different types of tax incentives:

  • The first one being deferral of gain from a recent sale or exchange transaction when that gain is reinvested into an Opportunity Zone area. And that gain can be deferred as long as December 31 of 2026, and so, that’s a pretty significant deferral just that length of time.
  • The second tax benefit comes from investors being able to eliminate up to 15% of the gain on the investment or the gain that they’re reinvesting into a qualified Opportunity Zone.
  • And the third tax benefit that investors can receive is avoiding tax on the gain associate with the investment in the Opportunity Zone and avoid paying tax all together if the investment’s held for at least 10 years.

Jen: So where can our viewers find out more information about where these Opportunity Zones are?

Martin: The IRS website has put together a very comprehensive FAQ section that addresses a lot of questions associated with the program. There’s also a map of the United States, and it can be scaled down to Texas and down to Houston.

Jen: Okay, perfect.

Martin: That provides a lot of good information, and as always viewers can go to the PKF Texas website for more information or connect with me directly on LinkedIn.

Jen: Sounds good. Now is there any specific industry that this impacts, or it’s pretty much anybody can invest in these Opportunity Zones?

Martin: There are some prohibited investments when you get into recreation and entertainment, things like that, and there are a lot of nuances that go along with it from a tax perspective and from the type of investment perspective. So, the best thing to do would be either to check out the FAQ sections or to consult with your PKF tax advisor.

Jen: Come talk to you. All right, perfect. We’ll get you back to talk a little bit more about it, sound good?

Martin: All right, thanks, Jen.

Jen: This has been another Thought Leader production brought to you by PKF Texas The Entrepreneur’s Playbook. Tune in next week for another chapter.

What to Know About Accounting Standards Update 2018-17

Under the amendments in Accounting Standards Update 2018-17, a private company will be able to elect not to apply Variable Interest Entities (VIE) guidance to legal entities under common control (including common control leasing arrangements) if both the parent and the legal entity being evaluated for consolidation are not public business entities, simply by adopting a new accounting policy election – all current and future legal entities under common control will have to follow the same practices.

There will still be a need to provide detailed disclosures about a company’s involvement with and exposure to the legal entity under common control.

By adopting this guidance, private companies will have the same result as the previous alternative not to apply VIE guidance under common control leasing arrangements with all other legal entities under common control.

This accounting alternative is expected to provide more useful and meaningful information to the users of private company financial statements – as many of the stakeholders aren’t necessarily concerned with common control entities.

For entities other than private companies, the amendments in this Update are effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The amendments in this Update are effective for a private company for fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021. All entities are required to apply the amendments in this Update retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. Early adoption is permitted.

Click here for additional details on Accounting Standards Update 2018-17.

For more information, visit www.fasb.org.

Best Practices – 5 Delegation Tips for Not-for-Profit Leaders

Done well, delegation allows not-for-profit executives to focus on their most important tasks, helps to build bench strength and gets staffers out of the office before midnight. But done poorly, it can create more burdens than it eases. Here are five practices all not-for-profit leaders should adopt.

1. Choose Tasks Wisely
Always try to devote your time to the projects that are the most valuable to your organization and can best benefit from your talents. On the other hand, delegate tasks that frequently reoccur, such as sending membership renewal notices, or tasks that require a specific skill in which you have minimal or no expertise, such as reconciling bank accounts.

2. Pick the Right Person
Before you delegate a task, consider the person’s main job responsibilities and experience and how those correlate with the project. However, keep in mind that employees may welcome opportunities to test their wings in a new area or take on greater responsibility. Be sure to consider staffers’ schedules and whether they actually have time to do the job well.

3. Perfect the Handoff
When handing off a task, be clear about the goals, expectations, deadlines and details. Explain why you chose the individual and what the project means to the organization as a whole. Also let the employee know if he or she has any latitude to bring his or her own methods and processes to the task. A fresh pair of eyes might see a new and better way of accomplishing it.

4. Keep in Touch — to an Extent
Delegation doesn’t mean dumping a project on someone else and then washing your hands of it. Ultimately, you’re responsible for the task’s completion, even if you assign it to someone else. So stay involved by monitoring the employee’s progress and providing coaching and feedback as necessary. Remember, however, there’s a fine line between remaining available for questions and micromanaging.

5. Acknowledge the Help
A good delegator never takes credit for someone else’s work. Be sure you generously — and publicly — give credit where credit is due. This could mean verbal praise in a meeting, a note of thanks in a newsletter or a letter to the person’s manager. If the project’s size and scope warrant it, consider offering extra time off or a special gift.

Fraud Awareness Week 2018

It’s Fraud Week, everyone!

For the week of November 11 – 17, supporters around the globe are promoting anti-fraud awareness and education to minimize the impact of fraud.

There’s a lot of information and resources out there, but what is imperative to know about fraud, how to detect it and what to do if there is fraud happening? We’ve done a series of videos on this topic, as well as published articles and informative pieces, but here are five key things to always keep in mind:

  1. Small- and medium-sized businesses are particularly at risk, and what makes them susceptible is the struggle with having enough resources (cash, time, and/or expertise) to have traditional controls and segregation of duties. For more details, click HERE.
  2. Some common indicators of employee fraud include: overly close relationship with suppliers, vendors or customers; destruction of files without proper authorization, resistance to providing information to auditors; and much more. For more details to see if your company is a victim of fraud, click HERE.
  3. The hotline is the number one way for tips to be reported, and that is the number one method of detecting fraud. Having a hotline reduces the median loss for profit by about half. For more details, click HERE to watch this episode of Entrepreneur’s Playbook.
  4. One of the first steps to take when you detect fraud is, assuming you’re in the position to be the head of the company, you need to call your attorney first. Getting the attorney involved on the front end can help prevent missteps through the investigation process, which you can accidentally do illegal things as you investigate the fraud. For more details, click HERE to watch this episode of Entrepreneur’s Playbook.
  5. One of the most effective methodologies to reduce the risk of fraud, according to the ACFE, is having a proactive data monitoring process. That reduces your risk of median amount of loss, as well as the duration of the loss by over 50%. For more details, click HERE to watch this episode of Entrepreneur’s Playbook.

Stay committed to not commit fraud!

For more information, visit PKFTexas.com or contact me at dcheek@pkftexas.com.

This blog post contains general information only. Pannell Kerr Forster of Texas, P.C. (PKF Texas) is not rendering accounting, business, financial, investment, legal, tax or other professional advice or services. This blog post is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The views expressed are mine and mine alone and do not represent the views of PKF Texas. PKF Texas is not be responsible for any loss sustained by any person who relies on this blog post.

How to Handle Mutual Funds with Care at Year End

As we approach the end of 2018, it’s a good idea to review the mutual funds holdings in your taxable accounts and take steps to avoid potential tax traps. Here are some tips.

Avoid Surprise Capital Gains
Unlike with stocks, you can’t avoid capital gains on mutual funds simply by holding on to the shares. Near the end of the year, funds typically distribute all or most of their net realized capital gains to investors. If you hold mutual funds in taxable accounts, these gains will be taxable to you regardless of whether you receive them in cash or reinvest them in the fund.

For each fund, find out how large these distributions will be and get a breakdown of long-term vs. short-term gains. If the tax impact will be significant, consider strategies to offset the gain. For example, you could sell other investments at a loss.

Buyer Beware
Avoid buying into a mutual fund shortly before it distributes capital gains and dividends for the year. There’s a common misconception that investing in a mutual fund just before the ex-dividend date (the date by which you must own shares to qualify for a distribution) is like getting free money.

In reality, the value of your shares is immediately reduced by the amount of the distribution. So you’ll owe taxes on the gain without actually making a profit.

Seller Beware
If you plan to sell mutual fund shares that have appreciated in value, consider waiting until just after year end so you can defer the gain until 2019 — unless you expect to be subject to a higher rate next year. In that scenario, you’d likely be better off recognizing the gain and paying the tax this year.

When you do sell shares, keep in mind that, if you bought them over time, each block will have a different holding period and cost basis. To reduce your tax liability, it’s possible to select shares for sale that have higher cost bases and longer holding periods, thereby minimizing your gain (or maximizing your loss) and avoiding higher-taxed short-term gains.

Think Beyond Just Taxes
Investment decisions shouldn’t be driven by tax considerations alone. For example, you need to keep in mind your overall financial goals and your risk tolerance.

But taxes are still an important factor to consider.

Small Reporting Companies Get Expanded Definition

Jen: This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back with Ryan Istre, an Audit Director and a member of the PKF Texas SEC team. Ryan, welcome back to the Playbook.

Ryan: Thanks for having me, Jen.

Jen: So, I’ve heard that the SEC has made some amendments about the definition of a smaller reporting company. What do these companies need to know?

Ryan: The SEC is in process of expanding the definition of what a small reporting company is. The way a public company determines whether it’s a smaller reporting company is at June 30th of each year, it has to calculate its public float. Public float means how many common shares does the company have outstanding multiplied by the trading price of the shares on that date. Historically $75 million was the cutoff, so if a company’s public float was less than $75 million, it was considered a smaller reporting company. So, the changes that the SEC has made has increased the amount of public float to $250 million, so a lot more companies are going to fall under the definition of a smaller reporting company.

Jen: So, if they’re not actively traded, what if there’s no public float? How do they determine that?

Ryan: That’s a good question. The SEC has also included in the definition of a smaller company a smaller reporting company with no public float annual revenues less than $100 million.

Jen: Okay. Are there any benefits to this to smaller reporting companies?

Ryan: Definitely. In normal public company filings for accelerated filers, you have to include three years of historical financial statement – two years of balance sheets, three years of income statements. And in smaller reporting company rules, you only have to include two years of historical income statements. That doesn’t sound like a lot that they’re dropping off from the requirements, however, in each of the financial statement footnotes and all of the sections of the NDNA, for example, anything under 10 K, because of the amount of disclosures necessary for public companies, dropping off an entire year is actually…

Jen: That’s huge.

Ryan: Definitely, definitely. It’s a big help. The SEC staff actually assumed that about 960 filers will be able to benefit from these expanded rules of smaller reporting companies.

Jen: That’s great. We’ll get you back to talk about it a little bit more.

Ryan: Sure.

Jen: Thank you. For more about this topic, visit PKFTexas.com/SECdesk. This has been another Thought Leader production brought to you by PKF Texas The Entrepreneur’s Playbook. Tune in next week for another chapter.

Fiscal Sponsorships – How They Work for Charities

Fiscal sponsorships occur when an established charity provides a kind of legal and financial umbrella to a charitable project that lacks 501(c)(3) status. This type of arrangement can benefit both groups. But before agreeing to be a sponsor, be sure you understand how these arrangements work and the risks involved.

Mutually Beneficial
In a fiscal sponsorship, the 501(c)(3) sponsor is legally responsible for the charitable project. It acts as employer to the project’s paid workers and manages all of its funds. Donations and grants are made directly to the fiscal sponsor, thus qualifying their donors for a charitable deduction (if the donors itemize deductions and other applicable requirements are met).

It’s easy to see why small charitable projects seek fiscal sponsorships. Such relationships can provide much-needed infrastructure and fiscal management to a project. By making it possible to receive charitable donations, sponsorships can make more funds available. Plus, associating with an established charity can enhance the project’s credibility.

These arrangements benefit sponsors, too. A sponsorship can provide greater exposure for the 501(c)(3) organization, possibly resulting in new donors for established programs. When you choose a project that shares your mission and basic objectives, it can enhance your own program offerings with minimal monetary outlay. Although a sponsorship isn’t intended to be a source of income for the sponsor, nonprofits often charge a nominal fee to offset their overhead costs.

Prime Candidates
Projects that can best benefit from a fiscal sponsorship generally include those that are:

  • Too small to have staff or much infrastructure,
  • Temporary or periodic,
  • Waiting to secure 501(c)(3) status, but that want to operate sooner, or
  • Based outside the United States.

When you find a good candidate, make sure you thoroughly discuss each partner’s expectations and roles. Mutually agree on start and termination dates and decide which group will make decisions about what. Because nothing causes conflict like money issues, be sure to decide on the sponsorship charge (up to 10% is typical), how disbursements will be handled and who will handle audit and reporting requirements.

Both parties must understand the key responsibilities in the relationship. First and foremost, the fiscal sponsor is responsible because the project and its sponsoring nonprofit are legally one entity.

Consult Advisors
Keep in mind that any fiscal sponsorship involves some risk to your organization’s finances and reputation. So it’s important to discuss your plans with legal and financial advisors before entering into one of these arrangements.

Buying Business Assets Before Year End Can Reduce 2018 Tax Liability

The Tax Cuts and Jobs Act (TCJA) has enhanced two depreciation-related breaks that are popular year-end tax planning tools for businesses. To take advantage of these breaks, you must purchase qualifying assets and place them in service by the end of the tax year. That means there’s still time to reduce your 2018 tax liability with these breaks, but you need to act soon.

Section 179 Expensing
Sec. 179 expensing is valuable because it allows businesses to deduct up to 100% of the cost of qualifying assets in Year 1 instead of depreciating the cost over a number of years. Sec. 179 expensing can be used for assets such as equipment, furniture and software. Beginning in 2018, the TCJA expanded the list of qualifying assets to include qualified improvement property, certain property used primarily to furnish lodging and the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.

The maximum Sec. 179 deduction for 2018 is $1 million, up from $510,000 for 2017. The deduction begins to phase out dollar-for-dollar for 2018 when total asset acquisitions for the tax year exceed $2.5 million, up from $2.03 million for 2017.

100% Bonus Depreciation
For qualified assets that your business places in service in 2018, the TCJA allows you to claim 100% first-year bonus depreciation, compared to 50% in 2017. This break is available when buying computer systems, software, machinery, equipment and office furniture. The TCJA has expanded eligible assets to include used assets; previously, only new assets were eligible.

However, due to a TCJA drafting error, qualified improvement property will be eligible only if a technical correction is issued. Also be aware that, under the TCJA, certain businesses aren’t eligible for bonus depreciation in 2018, such as real estate businesses that elect to deduct 100% of their business interest and auto dealerships with floor plan financing (if the dealership has average annual gross receipts of more than $25 million for the three previous tax years).

Traditional, Powerful Strategy
Keep in mind that Sec. 179 expensing and bonus depreciation can also be used for business vehicles. So purchasing vehicles before year end could reduce your 2018 tax liability. But, depending on the type of vehicle, additional limits may apply.

Investing in business assets is a traditional and powerful year-end tax planning strategy, and it might make even more sense in 2018 because of the TCJA enhancements to Sec. 179 expensing and bonus depreciation.