Download Accounting for Income Taxes Issues for Exempt Organizations

25th Annual Health
Sciences Tax Conference
Accounting for income taxes – exempt
organizations
December 9, 2015
Disclaimer
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of Ernst & Young Global Limited, each of which is a separate legal entity.
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This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not
provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and
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accounting advice.
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Accounting for income taxes – exempt organizations
Presenters
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Terence M. Kennedy
Ernst & Young LLP
Cleveland, OH
[email protected]
+1 216 583 1504
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Michael P. Vecchioni
Ernst & Young LLP
Detroit, MI
[email protected]
+1 313 628 7455
Raymond Lee
Ernst & Young LLP
Austin, TX
[email protected]
+ 1 512 473 3446
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Accounting for income taxes – exempt organizations
Agenda
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Accounting for income taxes of exempt organizations
Uncertain tax positions
Deferred taxes and valuation allowances
Affordable Care Act tax exposures
Recent accounting pronouncements
Regulator focus on audited financial statements
Error corrections versus changes in accounting estimates
Income tax-related financial statement concerns
Tax provision best practices
Questions?
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Accounting for income taxes – exempt organizations
Accounting for income taxes of exempt
organizations
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Accounting for income taxes – exempt organizations
Accounting Standards Codification (ASC)
Topic 740
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ASC 740 addresses financial accounting and reporting for
the effects of income taxes that result from an entity’s
activities during the current and preceding years.
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Exempt organizations – May not have any income tax effects
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Taxable subsidiaries and unrelated business income activities
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Still document exempt status
ASC 740 still applicable
Financial statement impact depending on materiality
Accounting for income taxes – exempt organizations
Review of overall exempt status
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Current documentation
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Public charity status
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Compliance with Section 509(a)(3) reporting requirements
Transactions with officers, directors, trustees and key
employees
Governance issues
IRC Section 501(r) compliance
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IRS Select Check review
Hospital specific
Lobbying activities
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Accounting for income taxes – exempt organizations
Taxable subsidiaries and unrelated business
income tax calculations
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Unrelated business income taxes
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New revenue sources/businesses
Estimated unrelated business taxable income
Alternative and foreign investments
Taxable subsidiaries
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Consolidated groups
Tax sharing agreements
Accounting for income taxes – exempt organizations
Non-income tax considerations
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Indirect taxes
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Property
Sales and use
Medical device excise tax
Other non-income taxes
Tax-exempt financing
Compliance requirements
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Compensation reporting
State filing requirements
Accounting for income taxes – exempt organizations
Uncertain tax positions
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Accounting for income taxes – exempt organizations
Accounting for uncertainty in income taxes
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Benefit recognition model
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Tax position must meet minimum recognition threshold before
being recognized in financial statements
ASC Topic 450 is not applicable to income taxes
Applies to all companies, including non-public entities
Determination that exempt status is highly certain
Review of less-than-highly certain positions
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Accounting for income taxes – exempt organizations
Uncertain tax positions
Presentation
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Difference between tax benefit as (or to be) reflected in the income
tax return and the amount recorded in the financial statements should
be classified as either:
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A current or non-current liability
Or
A reduction of deferred tax assets (DTAs) for a temporary difference, a net
operating loss (NOL) carryforward, similar tax loss or a tax credit
carryforward
The amount expected to be paid in the next year should be classified
as a current liability.
Indirect tax effects on other tax positions:
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State taxes often have an indirect effect on federal taxes.
Indirect tax effects on other tax positions are not included in the
unrecognized tax benefit (UTB) tabular rollforward disclosure.
Accounting for income taxes – exempt organizations
Uncertain tax positions
Presentation – Accounting Standards Update (ASU) 2013-11
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Assume tax position is disallowed at the reporting date
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If net settlement of a net operating loss, similar tax loss or tax credit
carryforward and an unrecognized tax benefit is required or expected,
present liability associated with uncertain tax benefit as a reduction to
related DTA for net operating loss, similar tax loss or tax credit
carryforward
If net settlement is not required or expected, present uncertain tax benefit
as a liability; not combined with DTA
Not expected to change DTA realizability assessment
Does not change disclosure requirements of uncertain tax positions
Effective for fiscal years and interim periods beginning after:
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Public entities: December 15, 2013
Non-public entities: December 15, 2014
Accounting for income taxes – exempt organizations
Uncertain tax positions
Documentation
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Nature and extent of documentation required may vary
based upon the character of the uncertain income tax
position
Distinguish between “highly certain” tax positions and tax
positions for which greater uncertainty is present
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Highly certain tax positions are based on clear and unambiguous
tax law
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Clearly meets more-likely-than-not recognition standard and there is a
greater than 50% likelihood that 100% of benefit will be sustained
Accounting for income taxes – exempt organizations
Deferred taxes and valuation allowances
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Accounting for income taxes – exempt organizations
Evaluating the need for a valuation
allowance
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DTAs represent future tax deductions (or tax
carryforwards/tax credits)
Reduced by a valuation allowance (VA) if it is more likely
than not (>50%) that some portion, or all, of the DTAs will
not be realized
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Evaluation is made on a gross basis – common pitfall
Based on weight of all available evidence
Depends on sufficient taxable income
Consider four sources of income
Not existence of DTA; only realizability – common pitfall
Consider presentation of valuation allowance
(current/non-current)
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Accounting for income taxes – exempt organizations
Evaluation of positive and negative evidence
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Weight given to evidence should be commensurate with the ability to
objectively verify it
Examples of positive and negative evidence include:
Negative evidence
Positive evidence
Cumulative pretax losses in recent history
(generally three years) or projections of
cumulative pretax losses – common pitfall
Existing contracts or firm sales backlog
History of carryforwards expiring unused
Strong earnings history, exclusive of loss that
created the future deductible amount, coupled
with evidence that the loss is an aberration
Brief carryback, carryforward periods
Implemented cost reduction plans that can be
objectively verified (however, consider any effects
on revenues)
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Accounting for income taxes – exempt organizations
Cumulative losses in recent years
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Calculation
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Not an “on/off” switch
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Cumulative pretax income or loss for three years (current year and
two preceding)
Annual calculation – common pitfall
Exclude only the cumulative effect of accounting changes
Does not, in itself, result in a conclusion of the realizability of
deferred tax assets – common pitfall
Quantitative considerations
Qualitative considerations
Significant piece of negative evidence that is often difficult
to overcome
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Accounting for income taxes – exempt organizations
Releasing a valuation allowance
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What framework do I apply when determining whether to
release a valuation allowance?
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Same framework
Change in circumstance causes change in judgment about
realization in future years
Key considerations
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Return to profitability
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Extent of positive and negative evidence that exists
Ability to rely on future projections of income
Not an “on/off” switch
No quarterly rolling reversal
Accounting for income taxes – exempt organizations
Recap of common pitfalls
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Is the timing of reversal of deferred tax losses (DTLs) considered?
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“Naked tax credits” resulting from indefinite-lived intangible assets
Does a tax planning strategy result in a projection of future
taxable income?
Are DTAs recognized based on projections of future taxable income,
when the company is in a cumulative loss position, has a going
concern opinion or has recently emerged from bankruptcy?
Is the company considering a rolling reversal of valuation allowance
upon sustained profitability?
Has a cumulative loss been considered a bright line or “on/off” switch
requiring a valuation allowance?
Is the valuation allowance presented appropriately on the balance
sheet (current vs. non-current)?
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Accounting for income taxes – exempt organizations
Key takeaways
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Must consider all sources of income in assessing
realizability
Determination of whether a company is, or is not, in a
cumulative loss position does not, in itself, result in a
conclusion as to the realizability of deferred tax assets
Avoid common valuation allowance pitfalls
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Accounting for income taxes – exempt organizations
Affordable Care Act tax exposures
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Accounting for income taxes – exempt organizations
Affordable Care Act (ACA) considerations
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Employer mandate is generally effective January 1, 2015
Significant excise tax penalties for ACA failures
A company may need to recognize an accrual for the
resulting loss contingency
Employers should account for uncertainties resulting from
a lack of clarity in the provisions of the employer mandate
(e.g., certain aspects of the definition of a full-time
employee) under the loss contingencies accounting
guidance (ASC 450)
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Accounting for income taxes – exempt organizations
ACA considerations
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Key questions:
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Have all potential full-time employees been identified and how?
Is there a system in place to appropriately track hours of service?
Is it compliant with ACA rules?
Was the population of contingent workers, interns, transfers,
international assignees, etc. reviewed under the “common law”
definition of employee?
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Form 1099 workers may be considered employees for the ACA.
Do any potential employee categories signal a risk under the ACA?
Is the coverage offered considered “affordable” and does it provide
minimum value?
Has the company taken any steps to mitigate the risks associated
with contingent workers?
Accounting for income taxes – exempt organizations
ACA considerations
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The ACA imposes a nondeductible fee on each covered entity
engaged in the business of providing health insurance for US
health risks.
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A covered entity is generally any entity with net premiums written for
health insurance for US health risks during the fee year that is:
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A health insurance issuer within the meaning of Internal Revenue Code (IRC)
Section 9832(b)(2)
A health maintenance organization within the meaning of IRC
Section 9832(b)(3)
An insurance company subject to tax under Subchapter L or that would be so
subject to tax but for being exempt under IRC Section 501(a)
An insurer that provides health insurance under Medicare Advantage, Medicare
Part D or Medicaid
A non-fully insured, multiple-employer welfare arrangement
The permanent nondeductible fee can be a material item.
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Accounting for income taxes – exempt organizations
Recent accounting pronouncements
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Accounting for income taxes – exempt organizations
ASU 2013-06, Not-for-Profit Entities (Topic 958):
Services Received from Personnel of an Affiliate
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Recipient not-for-profit should recognize all personnel
services received from all affiliates (both for profit and
not for profit) that directly benefit the recipient not for profit
entity and for which the affiliate does not seek
compensation
Generally measured at the cost recognized by the affiliate
in providing those services
If cost measure significantly overstates or understates the
value of those services, may elect to measure those
services at fair value
Effective for fiscal years beginning after June 15, 2014,
and interim and annual periods thereafter
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Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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Developed to:
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Improve comparability of revenue recognition practices across companies,
industries, jurisdictions and capital markets
Provide more useful information to users of financial statements through
improved disclosure requirements
Replaces virtually all existing US generally accepted
accounting principles (GAAP) guidance on revenue recognition
Uses broad principles rather than prescriptive guidance
Requires more estimates and judgments than current guidance
Financial Accounting Standards Board (FASB) and International
Accounting Standards Board (IASB) Joint Transition Resource
Group and other implementation groups have been created
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Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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As modified by the FASB in ASU 2015-14, the effective date for
public business entities, certain not-for-profit entities and
certain employee benefit plans is for annual periods beginning
after December 15, 2017, and interim reporting periods within
that reporting period.
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This effective date applies to a not-for-profit entity that has issued, or is a
conduit bond obligor for, securities that are traded, listed or quoted on an
exchange or an over-the-counter market.
Non-public entities are required to adopt the new guidance for
fiscal years beginning after December 15, 2018, and interim
periods within fiscal years beginning after December 15, 2019.
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Non-public entities are not required to apply the guidance in the new
standard in interim periods within the year of adoption.
Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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Core principle: recognize revenue to depict the transfer of
promised goods or services to customers in an amount that
reflects the consideration to which the entity expects to be
entitled in exchange for those goods or services
Step 1:
Identify the contract(s) with the customer
Step 2:
Identify the performance obligations in the contract
Step 3:
Determine the transaction price
Step 4:
Allocate the transaction price to the performance obligations
Step 5:
Recognize revenue when (or as) each performance obligation is satisfied
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Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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Health care implementation issues
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Application of Steps 1 and 3 for self-pay patients
Determination of the transaction price for third-party settlements
Application of the portfolio approach
Consideration received before Step 1 criteria are met
Changes in disclosure requirements from ASU 2011-07
Identifying performance obligation(s) and accounting for
refundable and nonrefundable entrance fees of continuing care
retirement communities
Prepaid health services
Contract acquisition costs
Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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Tax technical considerations
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Taxpayers will need to determine when and how any change in
revenue recognition for financial reporting purposes is recognized
for tax purposes.
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For taxpayers applying a deferral method for advance payments, the
amounts deferred for tax purposes are determined by reference to the
amounts deferred for financial statement purposes.
Taxpayers should consider whether a change in revenue recognition
for financial statement purposes is also a permissible method for tax
purposes.
Taxpayers may need to review the methodology for compiling
sales apportionment data.
Accounting for income taxes – exempt organizations
ASU 2014-09, Revenue from Contracts with
Customers (Topic 606)
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Income tax accounting considerations
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Current and deferred tax consequences of the cumulative effect
adjustment reported in the period of adoption
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New temporary differences may arise or existing temporary
differences may be computed differently
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Companies may need to revise their processes and data collection
tools
Valuation allowance considerations may change
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Requires careful consideration of the income tax accounting effect of
individual items included in the cumulative effect adjustment
Changes in deferred tax assets, temporary difference reversals or
expected future taxable income may affect judgments regarding the
realizability of deferred tax assets
Accounting for income taxes – exempt organizations
FASB proposed ASU – presentation of financial
statements of not-for-profit entities and health care
entities (Topics 954 and 958)
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Objective is to reexamine existing standards for not-for-profit
(NFP) financial statement presentation with a focus
on improving:
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Net asset classification requirements
Information about liquidity, financial performance and cash flows
Proposed amendments would require NFPs to:
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Present two classes of net assets: with donor restrictions and without
donor restrictions
Present intermediate measures of operations
Use the direct method of reporting cash flows provided or used by
operating activities
Accounting for income taxes – exempt organizations
Status of the FASB’s proposals on changes
to simplify income tax accounting
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Companies that present classified balance sheets
currently are required to classify deferred tax assets and
liabilities as current or non-current, based on how the
related assets or liabilities are classified.
If a deferred tax asset or liability is not related to an asset
or liability for financial reporting purposes (e.g., a deferred
tax asset related to a net operating loss carryforward), the
deferred tax asset or liability is classified as current or
non-current based on the expected reversal date of the
associated temporary difference.
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Accounting for income taxes – exempt organizations
Status of the FASB’s proposals on changes
to simplify income tax accounting
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The FASB reaffirmed its proposal to require companies
to classify all deferred tax assets and liabilities as
non-current.
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In addition, under this proposal, companies would no longer be
required to allocate valuation allowances between current and
non-current deferred tax assets because those allowances also
would be classified as non-current.
While the FASB’s decision would change the way deferred
taxes are classified on the balance sheet, companies
would still be required to offset deferred tax assets
and liabilities for each taxpaying component within a
tax jurisdiction.
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Accounting for income taxes – exempt organizations
Regulator focus on audited financial
statements
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Accounting for income taxes – exempt organizations
Regulator focus – realizability of deferred tax
assets
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How evidence was weighted
Cumulative losses
Consideration of the four sources of taxable income,
including the prominence of each source and the material
uncertainties, assumptions or limitations associated with
each source
Timing and reason for changes in valuation allowance
Consistency of assumptions
Consistency of accounting with management discussion
and analysis (MD&A) disclosures
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Accounting for income taxes – exempt organizations
Error corrections versus changes in
accounting estimates
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Accounting for income taxes – exempt organizations
Return-to-provision adjustments – change in
estimate or correction of an error?
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A temporary difference is defined as:
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A difference between the tax basis of an asset or liability
(computed in accordance with ASC 740) and its reported amount
in the financial statements
In preparing its tax return, a company may identify a
difference between the tax basis used to compute a
temporary difference and the tax basis used for the tax
return.
Differences may also arise related to income taxes
payable, tax credit carryforwards or other income tax
accounts.
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Accounting for income taxes – exempt organizations
Change in accounting estimate
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Results from new information
Accounted for in the period of change or the period
of change and future periods if the change affects
multiple periods
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No retrospective adjustment or restatement
May require disclosure depending on materiality and
whether the change is expected to affect future periods
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Accounting for income taxes – exempt organizations
Correction of an error
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Examples include:
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A change from an accounting principle that is not generally
accepted to one that is generally accepted
Corrections of mistakes in the application of US GAAP
Corrections of mathematical mistakes
Oversight or misuse of facts that existed at the time the financial
statements were prepared
Requires restatement of prior period financial statements
(if material) or correction in current period if immaterial
Determine if there are deficiencies in internal control
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Accounting for income taxes – exempt organizations
Key takeaways
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A change related to a prior period that did not result from
new information is an error and requires additional
consideration under ASC 250.
Refer to EY’s Financial Reporting Developments: Guide
on accounting for income taxes, accounting changes and
error corrections for additional information.
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Accounting for income taxes – exempt organizations
Income tax-related financial restatement
concerns
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Accounting for income taxes – exempt organizations
Income tax-related financial restatement
concerns
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General causes:
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Application of tax technical rules
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Tax basis
Intraperiod tax allocation
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Interim periods
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Accounting for outside basis differences
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Realizability of deferred tax assets
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Tax planning strategies
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Deferred tax liabilities as source of income
Income tax errors continue to be a
leading cause of restatements.
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Accounting for income taxes – exempt organizations
Income tax-related financial restatement
concerns – realizability of DTAs
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Same framework
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Establishing a valuation allowance for the first time
Determining whether a valuation allowance continues to
be necessary
Have all four sources of taxable income been considered?
Future reversals of existing taxable temporary differences
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Evaluate DTAs on a gross basis
Consider the timing of reversal of existing taxable temporary
differences
Common pitfall: DTAs evaluated on a net basis
Common pitfall: naked credits are used as a source of taxable
income
Accounting for income taxes – exempt organizations
Tax provision best practices
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Accounting for income taxes – exempt organizations
Tax provision best practices
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Accelerate work during quarters and interim:
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Evaluate and record return-to-provision adjustments
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Prove out deferred tax assets/liabilities, current taxes payable/receivable
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Prepare analysis before filing tax return to identify errors in the return
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Document/analyze state tax rates, including apportionment changes and
the impact on deferred taxes, and foreign tax rates for changes
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Document outside basis differences, including indefinite reinvestment
assertions and prepare outside basis difference calculations (consider
previously taxed income and unrecaptured Subpart F income)
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Document valuation allowance considerations (four sources of taxable
income) and prepare position paper
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Document uncertain tax positions
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Consider tool to improve efficiency and accuracy of computations
Accounting for income taxes – exempt organizations
Tax provision best practices
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Institute regular meetings with external auditors regarding contemporaneous
issues (significant transactions, changes in business, etc.)
Annually challenge prior year processes to identify areas for improvement
Simplify, standardize and add controls to existing Excel templates
Address technical issues early and prepare white papers for consideration by
management and external audit
Implement standardized global procedures
Consider the tax provision process a year-round area of continued focus
Identify a third party to assist with preparation or review of the provision (preaudit review) or co-source/outsource to free up internal time for review
Obtain assistance researching and documenting issues or preparing white
papers on tax accounting positions
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Accounting for income taxes – exempt organizations
Questions?
Page 50
Accounting for income taxes – exempt organizations
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