Getting A Divorce? Be Aware Of Tax Implications If You Own A Business

If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.

Tax-free property transfers

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:

A year after the date the marriage ends, or
Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

More tax issues

Later on, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Plan ahead to avoid surprises

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce.

Updated accounting rules for long-term leases took effect in 2019 for public companies. Now, after several deferrals by the Financial Accounting Standards Board (FASB), private companies and private not-for-profit entities must follow suit, starting in fiscal year 2022. The updated guidance requires these organizations to report — for the first time — the full magnitude of their long-term lease obligations on the balance sheet. Here are the details.

Temporary reprieves

In 2019, the FASB deferred Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), to 2021 for private entities. Then, in 2020, the FASB granted another extension to the effective date of the updated leases standard for private firms, because of disruptions to normal business operations during the COVID-19 pandemic.

Currently, the changes for private entities will apply to annual reporting periods beginning after December 15, 2021, and to interim periods within fiscal years beginning after December 15, 2022. Early adoption is also permitted.

Most private organizations have welcomed these deferrals. Implementing the requisite changes to your organization’s accounting practices and systems can be time-consuming and costly, depending on its size, as well as the nature and volume of its leasing arrangements.

Changing rules

The accounting rules that currently apply to private entities require them to record lease obligations on their balance sheets only if the arrangements are considered financing transactions. Few arrangements are recorded, because accounting rules give lessees leeway to arrange the agreements in a way that they can be treated as simple rentals for financial reporting purposes. If an obligation isn’t recorded on a balance sheet, it makes a business look like it is less leveraged than it really is.

The updated guidance calls for major changes to current accounting practices for leases with terms of a year or longer. In a nutshell, ASU 2016-02 requires lessees to recognize on their balance sheets the assets and liabilities associated with all long-term rentals of machines, equipment, vehicles and real estate. The updated guidance also requires additional disclosures about the amount, timing and uncertainty of cash flows related to leases.

Most existing arrangements that currently are reported as leases will continue to be reported as leases under the updated guidance. In addition, the new definition is expected to encompass many more types of arrangements that aren’t reported as leases under current practice. Some of these arrangements may not be readily apparent, for example, if they’re embedded in service contracts or contracts with third-party manufacturers.

Act now

You can’t afford to wait until year end to adopt the updated guidance for long-term leases. Many public companies found that the implementation process took significantly more time and effort than they initially expected. Contact us to help evaluate which of your contracts must be reported as lease obligations under the new rules.

There may be a tax-advantaged way for people to save for the needs of family members with disabilities — without having them lose eligibility for government benefits to which they’re entitled. It can be done though an Achieving a Better Life Experience (ABLE) account, which is a tax-free account that can be used for disability-related expenses.

Who is eligible?

ABLE accounts can be created by eligible individuals to support themselves, by family members to support their dependents, or by guardians for the benefit of the individuals for whom they’re responsible. Anyone can contribute to an ABLE account. While contributions aren’t tax-deductible, the funds in the account are invested and grow free of tax.

Eligible individuals must be blind or disabled — and must have become so before turning age 26. They also must be entitled to benefits under the Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) programs. Alternatively, an individual can become eligible if a disability certificate is filed with the IRS for him or her.

Distributions from an ABLE account are tax-free if used to pay for expenses that maintain or improve the beneficiary’s health, independence or quality of life. These expenses include education, housing, transportation, employment support, health and wellness costs, assistive technology, personal support services, and other IRS-approved expenses.

If distributions are used for nonqualified expenses, the portion of the distribution that represents earnings on the account is subject to income tax — plus a 10% penalty.

More details

Here are some other key factors:

An eligible individual can have only one ABLE account. Contributions up to the annual gift-tax exclusion amount, currently $15,000, may be made to an ABLE account each year for the benefit of an eligible person. If the beneficiary works, the beneficiary can also contribute part, or all, of their income to their account. (This additional contribution is limited to the poverty-line amount for a one-person household.)
There’s also a limit on the total account balance. This limit, which varies from state to state, is equal to the limit imposed by that state on qualified tuition (Section 529) plans.
ABLE accounts have no impact on an individual’s Medicaid eligibility. However, ABLE account balances in excess of $100,000 are counted toward the SSI program’s $2,000 individual resource limit. Therefore, an individual’s SSI benefits are suspended, but not terminated, when his or her ABLE account balance exceeds $102,000 (assuming the individual has no other assets). In addition, distributions from an ABLE account to pay housing expenses count toward the SSI income limit.
For contributions made before 2026, the designated beneficiary can claim the saver’s credit for contributions made to his or her ABLE account.

States establish programs

There are many choices. ABLE accounts are established under state programs. An account may be opened under any state’s program (if the state allows out-of-state participants). The funds in an account can be invested in a variety of options and the account’s investment directions can be changed up to twice a year. Contact us if you’d like more details about setting up or maintaining an ABLE account.

Updated August 17, 2021.

Are you a business owner thinking about hiring? Be aware that a recent law extended a credit for hiring individuals from one or more targeted groups. Employers can qualify for a tax credit known as the Work Opportunity Tax Credit (WOTC) that’s worth as much as $2,400 for each eligible employee ($4,800, $5,600 and $9,600 for certain veterans and $9,000 for “long-term family assistance recipients”). The credit is generally limited to eligible employees who began work for the employer before January 1, 2026.

Generally, an employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:

Qualified members of families receiving assistance under the Temporary Assistance for Needy Families (TANF) program,
Qualified veterans,
Qualified ex-felons,
Designated community residents,
Vocational rehabilitation referrals,
Qualified summer youth employees,
Qualified members of families in the Supplemental Nutritional Assistance Program (SNAP),
Qualified Supplemental Security Income recipients,
Long-term family assistance recipients, and
Long-term unemployed individuals – unemployed for more than 27 weeks

You must meet certain requirements

There are a number of requirements to qualify for the credit. For example, for each employee, there’s also a minimum requirement that the employee must have completed at least 120 hours of service for the employer. Also, the credit isn’t available for certain employees who are related to or who previously worked for the employer.

There are different rules and credit amounts for certain employees. The maximum credit available for the first-year wages is $2,400 for each employee, $4,000 for long-term family assistance recipients, and $4,800, $5,600 or $9,600 for certain veterans. Additionally, for long-term family assistance recipients, there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit, over two years, of $9,000.

For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth employees is $1,200 per employee.

The employer must obtain certification that an individual is a member of the targeted group by filing Form 8850, Pre-Screening Notice and Certification Request with the Michigan Unemployment Insurance Agency within 28 days after the eligible worker begins work. After hiring the job seeker, the employer must complete the U.S. Department of Labor’s ETA Form 9061 – Individual Characteristics Form.

Certification deadline extended

On August 11, the IRS issued Notice 2021-43 which extends the 28-day deadline by which employers must request certification of employees hired between January 1 and October 8 of this year who are members of the Designated Community Resident or Qualified Summer Youth Employee targeted groups. Certain employers now have until November 8, 2021, to submit required certification requests. To be certified as a Designated Community Resident or a Qualified Summer Youth Employee under the WOTC, an employee must have a principal place of residence within an Empowerment Zone where the employee continuously resides.

A valuable credit

There are additional rules and requirements. In some cases, employers may elect not to claim the WOTC. And in limited circumstances, the rules may prohibit the credit or require an allocation of it. However, for most employers hiring from targeted groups, the credit can be valuable.

Read more about the WOTC:

Targeted groups and the Michigan Department of Labor requirements
Unemployment Insurance Agency’s WOTC Fact Sheet
IRS guidance for the WOTC

Contact your Yeo & Yeo payroll professional for assistance with completing the forms required as the individual is hired, and obtaining the credit.

What if you decide to, or are asked to, guarantee a loan to your corporation? Before agreeing to act as a guarantor, endorser or indemnitor of a debt obligation of your closely held corporation, be aware of the possible tax consequences. If your corporation defaults on the loan and you’re required to pay principal or interest under the guarantee agreement, you don’t want to be blindsided.

Business vs. nonbusiness

If you’re compelled to make good on the obligation, the payment of principal or interest in discharge of the obligation generally results in a bad debt deduction. This may be either a business or a nonbusiness bad debt deduction. If it’s a business bad debt, it’s deductible against ordinary income. A business bad debt can be either totally or partly worthless. If it’s a nonbusiness bad debt, it’s deductible as a short-term capital loss, which is subject to certain limitations on deductions of capital losses. A nonbusiness bad debt is deductible only if it’s totally worthless.

In order to be treated as a business bad debt, the guarantee must be closely related to your trade or business. If the reason for guaranteeing the corporation loan is to protect your job, the guarantee is considered closely related to your trade or business as an employee. But employment must be the dominant motive. If your annual salary exceeds your investment in the corporation, this tends to show that the dominant motive for the guarantee was to protect your job. On the other hand, if your investment in the corporation substantially exceeds your annual salary, that’s evidence that the guarantee was primarily to protect your investment rather than your job.

Except in the case of job guarantees, it may be difficult to show the guarantee was closely related to your trade or business. You’d have to show that the guarantee was related to your business as a promoter, or that the guarantee was related to some other trade or business separately carried on by you.

If the reason for guaranteeing your corporation’s loan isn’t closely related to your trade or business and you’re required to pay off the loan, you can take a nonbusiness bad debt deduction if you show that your reason for the guarantee was to protect your investment, or you entered the guarantee transaction with a profit motive.

In addition to satisfying the above requirements, a business or nonbusiness bad debt is deductible only if:

You have a legal duty to make the guaranty payment, although there’s no requirement that a legal action be brought against you;
The guaranty agreement was entered into before the debt becomes worthless; and
You received reasonable consideration (not necessarily cash or property) for entering into the guaranty agreement.

Any payment you make on a loan you guaranteed is deductible as a bad debt in the year you make it, unless the agreement (or local law) provides for a right of subrogation against the corporation. If you have this right, or some other right to demand payment from the corporation, you can’t take a bad debt deduction until the rights become partly or totally worthless.

These are only a few of the possible tax consequences of guaranteeing a loan to your closely held corporation. Contact us to learn all the implications in your situation.

Someone might have once told you that human beings use only 10% of our brains. The implication is that we have vast, untapped stores of cerebral power waiting to be discovered. In truth, this is a myth widely debunked by neurologists.

What you may be underusing, as a business owner, is your accounting software. Much like the operating systems on our smartphones and computers, today’s accounting solutions contain a multitude of functions that are easy to overlook once someone gets used to doing things a certain way.

By taking a closer look at your accounting software, or perhaps upgrading to a new solution, you may be able to improve the efficiency of your accounting function and discover ways to better manage your company’s finances.

Revisit training

The seeds of accounting software underuse are often planted during the training process, assuming there’s any training at all. Sometimes, particularly in a small business, the owner buys accounting software, hands it over to the bookkeeper or office manager, and assumes the problem will take care of itself.

Consider engaging a consultant to review your accounting software’s basic functions with staff and teach them time-saving tricks and advanced features. This is even more important to do if you’re making major upgrades or implementing a new solution.

When accounting personnel are up to speed on the software, they can more easily and readily generate useful reports and provide accurate financial information to you and your management team at any time — not just monthly or quarterly.

Commit to continuous improvement

Accounting solutions that aren’t monitored can gradually become vulnerable to inefficiency and even manipulation. Encourage employees to be on the lookout for labor-intensive steps that could be automated and steps that don’t add value or are redundant. Ask your users to also note any unusual transactions or procedures; you never know how or when you might uncover fraud.

At the same time, ensure managers responsible for your company’s financial oversight are reviewing critical documents for inefficiencies, anomalies and errors. These include monthly bank statements, financial statements and accounting schedules.

The ultimate goal should be continuous improvement to not only your accounting software use, but also your financial reporting.

Don’t wait until it’s too late

Many business owners don’t realize they have accounting issues until they lose a big customer over errant billing or suddenly run into a cash flow crisis. Pay your software the attention it deserves, and it will likely repay you many times over in useful, actionable data. We can help you assess the efficacy of your accounting software use and suggest ideas for improvement.

The IRS has published new guidance on the Employee Retention Credit (ERC). The credit was created in March 2020 to encourage employers to keep their workforces intact during the COVID-19 pandemic. Notice 2021-49 addresses various issues, particularly those related to the extension of the credit through 2021 by the American Rescue Plan Act (ARPA).

The guidance comes as Congress weighs ending the ERC early to help offset the costs of the pending infrastructure bill. As of now, the credit is worth as much as $28,000 per employee for 2021, or $7,000 per quarter.

ERC essentials

The CARES Act generally made the ERC available to employers whose:

Operations were fully or partially suspended due to a COVID-19-related government shutdown order, or
Gross receipts dropped more than 50% compared to the same quarter in the previous year (until gross receipts exceed 80% of gross receipts in the earlier quarter).

The credit originally equaled 50% of “qualified wages” — including health care benefits — up to $10,000 per eligible employee from March 13, 2020, through December 31, 2020. As a result, the maximum benefit for 2020 was $5,000 per employee.

And initially, businesses couldn’t benefit from both the ERC and the popular Paycheck Protection Program (PPP). Most opted for the PPP, which, among other advantages, put money into their pockets more quickly than the credit.

In December 2020, the Consolidated Appropriations Act (CAA) provided that employers that receive PPP loans still qualify for the ERC for qualified wages not paid with forgiven PPP loans. It also extended the credit through June 30, 2021.

In addition, the CAA raised the amount of the credit to 70% of qualified wages, beginning January 1, 2021, and boosted the limit on per-employee qualified wages from $10,000 per year to $10,000 per quarter — so employers could obtain a credit as high as $7,000 per quarter per employee.

The CAA also expanded eligibility by reducing the requisite year-over-year gross receipt reduction from 50% to only 20%. And it increased the threshold for determining whether a business is a “large employer,” and therefore subject to a more stringent standard when computing the qualified wage base, from 100 to 500 employees.

The ARPA extended the ERC through the end of 2021. It also made some changes that apply solely to the third and fourth quarters of 2021.

Guidance on ARPA changes

The majority of the IRS guidance deals with issues raised by the ARPA’s ERC-related provisions, including:

Applicable employment taxes. Under the CARES Act, employers could claim the ERC only against Social Security taxes. The guidance states that, for the third and fourth quarters of 2021, employers are entitled to claim the credit against their share of Medicare taxes, with the excess refundable.

Maximum amount. The maximum credit of $7,000 per employee per quarter for the first and second quarters of 2021 continues to apply to the third and fourth quarters. A separate limit applies to so-called “recovery startup businesses,” though.

Recovery startup businesses. The ARPA expanded the pool of ERC-eligible employers to include those that:

Began operating after February 15, 2020, and
Have average annual gross receipts for the three previous tax years of less than or equal to $1 million.

These employers can claim the credit without suspended operations or reduced receipts, up to $50,000 total per quarter for the third and fourth quarters of 2021.

The guidance clarifies that a taxpayer hasn’t begun operating until it has begun functioning as a going concern and performing those activities for which it was organized. It also provides that the determination of whether a taxpayer is a recovery startup business is made separately for each quarter.

Qualified wages. The ARPA directs extra relief to “severely financially distressed employers” with less than 10% of gross receipts for 2021 when compared to the same calendar quarter in 2019. These businesses may count as qualified wages any wages paid to an employee during any calendar quarter — regardless of employer size.

Note that the ARPA prohibits “double dipping.” Wages taken into account for several business tax credits (for example, the research, empowerment zone and work opportunity tax credits, as well as credits for COVID-related paid sick and family leave) can’t also be taken into account for purposes of the ERC.

Interplay with shuttered venue and restaurant revitalization grants. According to the guidance, recipients of a Shuttered Venue Operator Grant or a Restaurant Revitalization Fund grant may not treat any amounts reported or otherwise taken into account as payroll costs for those programs as qualified wages for ERC purposes. Such employers must retain documentation that supports the ERCs they claim.

Miscellaneous issues

The guidance addresses several other lingering issues related to the ERC for 2020 and 2021. For example, it clarifies the definition of a “full-time employee.”

The notice explains that employers needn’t include full-time equivalents when calculating the average number of full-time employees for purposes of determining whether an employer is a large or small eligible employer. But, for purposes of identifying qualifying wages, an employee’s status is irrelevant, so wages paid to non-full-time workers may be treated as qualified wages (assuming all other applicable requirements are met).

The guidance also sheds further light on the:

Treatment of tips and the Section 45B credit,
Timing of qualified wage deduction disallowance,
Alternative quarter election for 2021,
Gross receipts safe harbor, and
Exclusion of wages paid to the majority owners of corporations.

The rules regarding the last item above, which attribute ownership to owners’ family members, could significantly reduce the amount of the ERC for family-owned corporations. A footnote in the guidance indicates that even the wages paid to minority owners might end up excluded from the ERC computation.

ERC’s future is uncertain

The U.S. Senate has passed infrastructure legislation that would eliminate the ERC for the fourth quarter of 2021. However, the House of Representatives is on recess until the fall, so the fate of the credit remains uncertain. Contact us for additional information regarding the latest ERC guidance.

If your child is fortunate enough to be awarded a scholarship, you may wonder about the tax implications. Fortunately, scholarships (and fellowships) are generally tax free for students at elementary, middle and high schools, as well as those attending college, graduate school or accredited vocational schools. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.

Requirements for tax-free treatment

However, scholarships are not always tax free. Certain conditions must be satisfied. A scholarship is tax free only to the extent it’s used to pay for:

Tuition and fees required to attend the school and
Fees, books, supplies and equipment required of all students in a particular course.

For example, expenses that don’t qualify include the cost of room and board, travel, research and clerical help.

To the extent a scholarship award isn’t used for qualifying items, it’s taxable. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Maintain records (such as copies of bills, receipts and cancelled checks) that reflect the use of the scholarship money.

Payment for services doesn’t qualify

Subject to limited exceptions, a scholarship isn’t tax free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research or other services is taxable, even if the child uses the money for tuition or related expenses.

What if you, or a family member, are an employee of an education institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse or your dependents by the school at which you work isn’t included in your income and isn’t subject to tax.

What is reported on a tax return?

If a scholarship is tax free and your child has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, and any portion of the award that’s taxable must be reported, even if no Form W-2 is received.

These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. As we approach the new academic year, best wishes for your child’s success in school. Contact us if you’d like to discuss these or other tax matters further.

If your business receives large amounts of cash or cash equivalents, you may be required to report these transactions to the IRS.

What are the requirements?

Each person who, in the course of operating a trade or business, receives more than $10,000 in cash in one transaction (or two or more related transactions), must file Form 8300. What is considered a “related transaction?” Any transactions conducted in a 24-hour period. Transactions can also be considered related even if they occur over a period of more than 24 hours if the recipient knows, or has reason to know, that each transaction is one of a series of connected transactions.

To complete a Form 8300, you’ll need personal information about the person making the cash payment, including a Social Security or taxpayer identification number.

Why does the government require reporting?

Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”

You should keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.

What’s considered “cash” and “cash equivalents?”

For Form 8300 reporting purposes, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders.

Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.

Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.

Can the forms be filed electronically?

Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.

The IRS also reminds businesses that they can “batch file” their reports, which is especially helpful to those required to file many forms.

How can we set up an electronic account?

To file Form 8300 electronically, a business must set up an account with FinCEN’s Bank Secrecy Act E-Filing System. For more information, visit: https://bsaefiling.fincen.treas.gov/AboutBsa.html. Interested businesses can also call the BSA E-Filing Help Desk at 866-346-9478 (Monday through Friday from 8 am to 6 pm EST). Contact us with any questions or for assistance.

The term “fund balance” is often confused with the amount of cash a government has available to spend. A government’s fund balance and cash balance are rarely the same. Fund balance includes cash balances in its calculation, but it also includes all other assets and liabilities the government has. Fund balance simply represents the difference between the assets and liabilities a government holds.

There are five distinct categories of fund balance:

Nonspendable – items such as prepaid expenditures and inventories.
Restricted – resources that have imposed restrictions, such as specific tax levies or grants.
Committed – amounts that have been internally constrained by the government’s highest-level decision-making body, such as a city council or board of trustees.
Assigned – amounts designated for specific purposes by an authorized individual, often the finance director.
Unassigned – all remaining fund balances that do not fall into the categories above.

Each government should adopt a fund balance policy that defines the above categories.

Governments often find it helpful to assign minimum and/or maximum thresholds to fund balance categories to maintain a comfortable reserve balance. That is, to ensure a rainy-day fund for unforeseen costs and restrict too much accumulation of fund balance. In most cases, the minimum or maximum thresholds are presented as a percentage of annual expenditures or as a set number of months of expenditures. For example, a government may determine that the unassigned fund balance in the General Fund should not fall below 25% of expenditures. In this case, the government has set 25% as its minimum fund balance policy and should be careful to comply with the internal policy when assigning or committing fund balance. Each government should determine what is an appropriate minimum to fit its specific situation.

The policy should identify and designate who, or which position, is authorized to assign fund balance.

Many governments identify spending prioritization, although it is not required. The Governmental Accounting Standards Board (GASB) has included in GASB Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, the assumption that absent any policy, expenditures would reduce the most constrained type of fund balance category allowable for the expenditure.

If your government entity needs assistance with drafting a fund balance policy, contact your Yeo & Yeo CPA.

It seems like ages ago that the lease accounting standard, FASB Topic 842, was first introduced.

However, after multiple years of delayed implementation for nonpublic entities, including nonprofit organizations, it’s time to start planning seriously to adopt this new standard again.

As a refresher, the 30,000-foot view is that organizations will be required to recognize assets and liabilities on the Statement of Financial Position for their operating leases. This is a significant change from the current Generally Accepted Accounting Principles (GAAP), which require disclosure of these leases but not recognition on the Statement of Financial Position.

On the surface this may seem simple enough, but organizations should take several steps now to ensure a seamless adoption of this upcoming standard.

Effective date

The effective date of the standard, which was last deferred by Accounting Standards Update (ASU) No. 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities, is for December 31, 2022, reporting (said another way, fiscal years beginning after December 15, 2021). Early adoption is permitted.

What to consider

Start a log of your organization’s current leases. (Refer to our Nonprofit Quick Tip: Lease Inventory Policy.)
Be alert for embedded leases (leases contained in larger arrangements, such as the right to a dedicated server in a larger IT-related contract).
Determine if software is needed to manage leases.
Differentiate lease components from non-lease components (i.e., maintenance services) in existing lease agreements.
Determine if you have any debt covenants that changes to the balance sheet could impact.
Begin educating stakeholders (lenders, grantors, etc.) and board members on potential changes to the financial statements.
Consider necessary changes to policies, procedures and internal controls related to the new standard.

Common places to look

In general, the standard applies to all leases with terms over 12 months and includes, but is not limited to:

Office space and real estate
Copiers and other office equipment
Phone systems
Automobiles

Impact of implementation

The new guidance intends to provide financial statement users with a more complete picture of the extent of an organization’s right-of-use assets and the impact on its future cash flows. The change will improve the understanding and comparability of a lessees’ financial commitments regardless of the manner they choose to finance the assets.

With the implementation of the new guidance, expect to see enhanced footnote disclosures and new line items added to the statement of financial position to reflect the lease liability and asset.

Additionally, many nonprofits choose to present comparative financial statements; if so, the comparative year financial statement column will need to be restated to reflect the adoption of the new standard.

If you have questions or need assistance with accounting for your organization’s leases, please contact your local Yeo & Yeo professional.

The legality of marijuana or cannabis varies from one state to another. In some states, it’s legal to use marijuana for any purpose while in other states, it’s only legal for medical use. There are only a handful of states where it’s illegal to use marijuana in any way.

This has created tax challenges for businesses in the marijuana industry because they may be in compliance with their states’ laws — but the federal government considers them to be engaging in an illegal activity.

The IRS has released answers to some frequently asked questions that taxpayers have about marijuana businesses. Here are some of them.

Q1: My business is a marijuana dispensary that I operate in compliance with my state’s laws. The federal government considers this an illegal activity. Do I have the same income and employment tax filing obligations as any other business?

Yes. Income from any source is taxable. Internal Revenue Code § 61(a). The Supreme Court has long held that income from illegal sources is taxable and is not exempt from taxation. James v. United States, 366 U.S. 213, 218 (1961). More recently, federal courts have consistently upheld Internal Revenue Service determinations that state compliant marijuana dispensaries have taxable income. E.g., Olive v. Commissioner, 792 F.3d 1146 (9th Cir. 2015); Feinberg v. Commissioner, 916 F.3d 1330 (10th Cir. 2019); Beck v. Commissioner, T.C. Memo. 2015-149. Similarly, illegal businesses have no exemption from their employment tax obligations.

Q2: If I can’t fully pay the amount I owe, are payment plans available that I can afford?

If you can’t pay the amount you owe in full, you may qualify for one of several options available to help taxpayers pay their balance over time or to temporarily delay collection until your financial situation improves. Visit the following links for more information about:

Payment Plans – To meet your taxpayer obligation in monthly installments by applying for a payment plan. Most taxpayers will qualify to apply for a payment plan online.
Temporary Delays of Collection – If you cannot pay any of your tax debt, you can request the IRS temporarily delay collection until your financial situation improves.

Q3: What penalties or additions to tax could a participant in the marijuana industry be subject to if adjustments are made during an income tax audit?

A participant in the marijuana industry is subject to the same penalties and additions to tax as any other business. A non-exhaustive list of penalties and additions to tax that might apply include: additions to tax under 6651 if a return is filed late or payments are made late; a penalty for failure to make estimated tax payments if sufficient estimated tax payments are not made; accuracy related penalties; and, in cases of fraud, penalties under section 6663. See generally Alternative Health Care Advocates v. Commissioner, 151 T.C. 225 (2018).

Q4: Will penalties under section 6662 be proposed if an audit ends with the IRS proposing adjustments for a participant in the marijuana industry?

Penalties will be considered on a case by case basis. The Tax Court has previously upheld a negligence penalty under section 6662 where a participant in the marijuana industry failed to keep adequate books and records. See Olive v. Commissioner, 139 T.C. 19 (2012), aff’d, 792 F.3d 1146 (9^th Cir. 2015). The Tax Court more recently upheld section 6662 penalties when petitioners did not prove they had reasonable cause for significant omissions of income on their returns. Alternative Health Care Advocates v. Commissioner, 151 T.C. 225 (2018); Richmond Patients Group v. Commissioner, T.C. Memo. 2020-52.

Q5:I operate a business that consists of selling marijuana. Can I claim deductions to determine my taxable income?

Internal Revenue Code section 280E disallows all deductions or credits for any amount paid or incurred in carrying on any trade businesses that consist of illegally trafficking in a Schedule I or II controlled substance within the meaning of the federal Controlled Substances Act. This applies to businesses that sell marijuana, even if they operate in states that have legalized the sale of marijuana, because trafficking marijuana remains illegal under the federal Controlled Substances Act. United States v. Oakland Cannabis Buyers’ Co-op., 532 U.S. 483 (2001). Accordingly, section 280E disallows all deductions or credits for a business that sells or otherwise traffics marijuana. N. California Small Bus. Assistants Inc. v. Commissioner, 153 T.C. 65 (2019).

Section 280E does not, however, prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income. The Internal Revenue Service takes the position that section 280E-affected taxpayers must calculate their cost of goods sold pursuant to Internal Revenue Code section 471 and the associated Treasury Regulations. Generally, this means taxpayers who sell marijuana may reduce their gross receipts by the cost of acquiring or producing marijuana that they sell, and those costs will depend on the nature of the business. For more detail, see Chief Counsel Advice 201504011 PDF (released 1/23/2015).

Accordingly, a marijuana dispensary may not deduct, for example, advertising or selling expenses. It may, however, reduce its gross receipts by its cost of goods sold, as calculated pursuant to Internal Revenue Code section 471.

Q6: What do I need to do for cash payments over $10,000 concerning information returns?

Trades or Business, including marijuana related businesses, must comply with IRC § 6050I and the regulations thereunder. These businesses must report cash receipts greater than $10,000, in a single transaction and/or related transactions.

The business(es) must also:

Develop policies and procedures reasonably designed to identify and report cash receipts as required.
Include in their policies and procedures the requirement to obtain and verify certain customer information to ensure the information included on the report is accurate and complete.
Retain copies of forms filed for a period of five years. Depending on the type of business, other regulatory requirements may exist regarding how long certain documents must be retained.

More information can be found at About Publication 1544, Reporting Cash Payments of Over $10,000.

To read all of the Q&As, visit the IRS website here.

The Small Business Administration (SBA) has launched its own online, consumer-facing forgiveness platform to make it easier for millions of employers to have their Payroll Protection Program (PPP) loans forgiven. Borrowers may have the opportunity to apply for forgiveness directly through the SBA portal.

The new initiative aims to encourage borrowers with loans of $150,000 or less — accounting for more than 90 percent of the pandemic-era program — to apply for loan forgiveness.

Rather than forcing borrowers to apply for loan forgiveness through banks, the SBA forgiveness site will accept applications from small borrowers directly.

Lenders must opt in to the new system, and will still have a say in whether individual PPP loans should be forgiven. Overall, the intent is to reduce the time and effort banks must invest in the process.

The due date for first-round PPP loans to apply for forgiveness is ten months after the end of the covered period, which has occurred or is approaching for many borrowers. If you received a PPP loan and must now apply for forgiveness, the following links will help you get started.

For more information, read our recent blog articles:

Contact Yeo & Yeo for assistance with applying for PPP loan forgiveness.

Auditors typically deliver financial statements to calendar-year businesses in the spring. A useful tool that accompanies the annual report is the management letter. It may provide suggestions — based on industry best practices — on how to fortify internal control systems, streamline operations and reduce expenses.

Managers generally appreciate the suggestions found in management letters. But, realistically, they may not have time to implement those suggestions, because they’re focusing on daily business operations. Don’t let this happen at your company!

What’s covered?

A management letter may address a broad range of topics, including segregation of duties, account reconciliations, physical asset security, credit policies, employee performance, safety, Internet use and expense reduction. In general, the write-up for each deficiency includes the following elements:

Observation. The auditor describes the condition, identifies the cause (if possible) and explains why it needs improvement.

Impact. This section quantifies the problem’s potential monetary effects and identifies any qualitative effects, such as decreased employee morale or delayed financial reporting.

Recommendation. Here, the auditor suggests a solution or lists alternative approaches if the appropriate course of action is unclear.

Some letters present deficiencies in order of significance or the potential for cost reduction. Others organize comments based on functional area or location.

What elements are required?

AICPA standards specifically require auditors to communicate two types of internal control deficiencies to management in writing:

1.Material weaknesses. These are defined as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the organization’s financial statements will not be prevented or detected and corrected on a timely basis.”

2.Significant deficiencies. These are “less severe than a material weakness, yet important enough to merit attention by those charged with governance.”

Operating inefficiencies and other deficiencies in internal control systems aren’t necessarily required to be communicated in writing. However, most auditors include these less significant items in their management letters to inform their clients about risks and opportunities to improve operations.

Have you improved over time?

When you review last year’s management letter, consider comparing it to the letters you received for 2019 (and earlier). Often, the same items recur year after year. Comparing consecutive management letters can help track the results over time. But, be aware: Certain issues may autocorrect — or worsen — based on factors outside of management’s control, such as changes in technology or external market conditions. If you’re unsure how to implement a particular suggestion from your management letter, reach out to your audit team for more information.

Many businesses are spending more time and resources on supporting the well-being of their employees. This includes recognizing and addressing issues related to diversity, equity and inclusion (DEI).

A thoughtfully designed DEI program can do more than just head off potential conflicts and disruptions among coworkers; it can help you attract good job candidates, retain your best employees and create a more engaged, productive workforce.

Strategic objectives

Essentially, DEI programs are formal efforts to help employees better understand, accept and appreciate differences among everyone on staff. Differences addressed typically include race, ethnicity, gender identification, age, religion, disabilities and sexual orientation. They may also include education, personality types, skill sets and life experiences. A program can comprise training courses, seminars, guest speakers, group discussions and social events.

Strategic objectives may vary depending on the business. Some companies wish to improve collaboration and productivity within or among teams, departments or business units. Others are looking to attract more diverse job candidates. And still others want to connect with growing multicultural markets that don’t necessarily respond to “traditional” messaging.

Think of implementing a DEI program as an investment. It should include specific goals and achievable, measurable returns.

Key components

Many DEI programs fail because of lack of consensus regarding their value or faulty design. Begin with executive buy-in. Successful programs start with the support of ownership and senior leadership. If they’re not committed to the program, it probably won’t last long (if it gets off the ground at all). Typically, a champion will need to build the case of why a DEI program is needed and explain how it will positively impact the organization.

You’ll also need to assemble the right team. Form a DEI committee to identify objectives and give the program its initial size and shape. If you happen to employ someone who has been involved in launching a DEI program in the past, learn all you can from that employee’s experience. Otherwise, encourage your team to research successful and unsuccessful programs. You might even engage a consultant who specializes in the field.

For clarity and consistency, put your DEI program in writing. The committee needs to develop clear language spelling out each goal. The objectives can then be reviewed, discussed and revised. Ensure the objectives support your strategic plan and that you can accurately measure progress toward each. Don’t launch the program until you’re confident it will improve your organization, not distract it.

How work is done

Events of the last year or so have led most businesses to reconsider the size, composition and operational approach of their workforces. In many industries, DEI awareness and training is playing an important role in this reckoning. We’d be happy to help you assess the costs and feasibility of a program for your business.

The Small Business Administration (SBA) has released new guidance intended to expedite the forgiveness process for certain borrowers under the Paycheck Protection Program (PPP). The simplified process generally is available for loans of $150,000 or less, which the SBA reports account for 93% of outstanding PPP loans. The guidance comes at a time when many borrowers are nearing a critical deadline regarding their applications for forgiveness.

Forgiveness basics

PPP loans generally are 100% forgivable if the borrower allocates at least 60% of the funds to payroll and eligible nonpayroll costs. Borrowers may apply for forgiveness at any time before their loans’ maturity date. Loans made before June 5, 2020, generally have a two-year maturity; loans made on or after that date have a five-year maturity.

However, if a borrower fails to apply for forgiveness within 10 months after the last day of the “covered period,” its PPP loan payments will no longer be deferred. (The covered period is eight to 24 weeks following disbursement during which the funds must be used.) Such loans will become standard loans, and borrowers will be responsible for repaying the full amount plus 1% interest before the maturity date — unless the loan is subsequently forgiven. The 10-month period soon will expire for many so-called “first-draw” borrowers.

SBA’s process improvements

The popularity of the PPP, as well as the requirement that lenders make forgiveness determinations within 60 days of receiving an application, has left many smaller lenders overwhelmed. Some are even limiting the time periods during which they’ll accept forgiveness applications. This, in turn, has created confusion and concern among borrowers.

In response, the SBA recently issued an Interim Final Rule (IFR). The rule streamlines the forgiveness process for smaller loans through two avenues:

1) Direct borrower forgiveness. The SBA is providing a direct borrower forgiveness process for lenders that choose to opt in. At the time the guidance was released, more than 600 banks had opted in, enabling more than 2.17 million borrowers to apply through a new online portal scheduled to launch on August 4, 2021.

Participating lenders will receive notice when a borrower applies through the SBA platform and will review applications and issue forgiveness decisions inside the platform. The SBA hopes this will reduce the wait time and uncertainly associated with applying through lenders.

2) COVID Revenue Reduction Score. The IFR also creates an alternative process for “second-draw” borrowers with loans of $150,000 or less to document their reduced revenue. To qualify for such loans, a borrower must have experienced a revenue reduction of at least 25% during one quarter of 2020 compared with the same quarter in 2019. If a borrower didn’t produce the necessary documentation when applying for the loan, it must do so on or before the date of application for forgiveness.

To make the revenue reduction confirmation process easier for such loans, an independent SBA contractor will assign every eligible second-draw loan a score based on several factors, including industry, geography, business size and current economic data. The score will be stored in the forgiveness platform and visible to lenders to document revenue reduction. If a borrower’s score doesn’t meet the value required to confirm the reduction, the borrower must provide documentation. If it does, no documentation is required.

Appeals and deferments

The IFR also extends the loan deferment period for borrowers who timely appeal a final SBA loan review decision. Under the previous rule, an appeal didn’t extend the period so borrowers had to begin making payments of principal and interest on the unforgiven amount.

The IFR amends that rule to extend the deferment period until the SBA’s Office of Hearings and Appeals issues a final decision. Appeals must be filed within 30 calendar days of receipt of the final SBA loan review decision, and borrowers should notify their lenders of appeals.

More to come

The SBA will release additional guidance regarding both the direct borrower forgiveness option and the COVID Revenue Reduction Score. We can help with your forgiveness application process and answer any questions you may have about your PPP loan.

If you have a parent entering a nursing home, you may not be thinking about taxes. But there are a number of possible tax implications. Here are five.

1. Long-term medical care

The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that is provided under care administered by a licensed healthcare practitioner.

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.

2. Long-term care insurance

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.

Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2021 limit on deductible long-term care insurance premiums is $4,520, and for those over 70, the 2021 limit is $5,640.

3. Nursing home payments

Amounts paid to a nursing home are deductible as a medical expense if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.

4. Head-of-household filing status

If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.

5. The sale of your parent’s home.

If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale, and used the home as a principal residence for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.

These are only some of the tax issues you may deal with when your parent moves into a nursing home. Contact us if you need more information or assistance.

Perhaps you operate your small business as a sole proprietorship and want to form a limited liability company (LLC) to protect your assets. Or maybe you are launching a new business and want to know your options for setting it up. Here are the basics of operating as an LLC and why it might be appropriate for your business.

An LLC is somewhat of a hybrid entity because it can be structured to resemble a corporation for owner liability purposes and a partnership for federal tax purposes. This duality may provide the owners with the best of both worlds.

Personal asset protection

Like the shareholders of a corporation, the owners of an LLC (called “members” rather than shareholders or partners) generally aren’t liable for the debts of the business except to the extent of their investment. Thus, the owners can operate the business with the security of knowing that their personal assets are protected from the entity’s creditors. This protection is far greater than that afforded by partnerships. In a partnership, the general partners are personally liable for the debts of the business. Even limited partners, if they actively participate in managing the business, can have personal liability.

Tax implications

The owners of an LLC can elect under the “check-the-box” rules to have the entity treated as a partnership for federal tax purposes. This can provide a number of important benefits to the owners. For example, partnership earnings aren’t subject to an entity-level tax. Instead, they “flow through” to the owners, in proportion to the owners’ respective interests in profits, and are reported on the owners’ individual returns and are taxed only once.

To the extent the income passed through to you is qualified business income, you’ll be eligible to take the Code Section 199A pass-through deduction, subject to various limitations. In addition, since you’re actively managing the business, you can deduct on your individual tax return your ratable shares of any losses the business generates. This, in effect, allows you to shelter other income that you and your spouse may have.

An LLC that’s taxable as a partnership can provide special allocations of tax benefits to specific partners. This can be an important reason for using an LLC over an S corporation (a form of business that provides tax treatment that’s similar to a partnership). Another reason for using an LLC over an S corporation is that LLCs aren’t subject to the restrictions the federal tax code imposes on S corporations regarding the number of owners and the types of ownership interests that may be issued.

Review your situation

In summary, an LLC can give you corporate-like protection from creditors while providing the benefits of taxation as a partnership. For these reasons, you should consider operating your business as an LLC. Contact us to discuss in more detail how an LLC might benefit you and the other owners.

A complete set of financial statements for your business contains three reports. Each serves a different purpose, but ultimately helps stakeholders — including managers, employees, investors and lenders — evaluate a company’s performance. Here’s an overview of each report and a critical question it answers.

1. Income statement: Is the company growing and profitable?

The income statement (also known as the profit and loss statement) shows revenue, expenses and earnings over a given period. A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product.

Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.

It’s important to note that growth and profitability aren’t the only metrics that matter. For example, high-growth companies that report healthy top and bottom lines may not have enough cash on hand to pay their bills. Though it may be tempting to just review revenue and profit trends, thorough due diligence looks beyond the income statement.

2. Balance sheet: What does the company own (and owe)?

This report provides a snapshot of the company’s financial health. It tallies assets, liabilities and “net worth.”

Under U.S. Generally Accepted Accounting Principles (GAAP), assets are reported at the lower of cost or market value. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Intangible assets (such as patents, customer lists and goodwill) can provide significant value to a business. But internally developed intangibles aren’t reported on the balance sheet. Intangible assets are only reported when they’ve been acquired externally.

Net worth (or owners’ equity) is the extent to which the value of assets exceeds liabilities. If the book value of liabilities exceeds the book value of the assets, net worth will be negative. However, book value may not necessarily reflect market value. Some companies may provide the details of owners’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.

3. Cash flow statement: Where is cash coming from and going to?

This statement shows all the cash flowing in and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. Watch your statement of cash flows closely. To remain in business, companies must continually generate cash to pay creditors, vendors and employees.

Read the fine print

Disclosures at the end of a company’s financial statements provide additional details. Together with the three quantitative reports, these qualitative descriptions can help financial statement users make well-informed business decisions. Contact us for assistance conducting due diligence and benchmarking financial performance.

Businesses rely on internal controls to help ensure the accuracy and integrity of their financial statements, as well as prevent fraud, waste and abuse. Given their importance, internal controls are a key area of focus for internal and external auditors.

Many auditors use detailed internal control questionnaires to help evaluate the internal control environment — and ensure a comprehensive assessment. Although some audit teams still use paper-based questionnaires, many now prefer an electronic format. Here’s an overview of the types of questions that may be included and how the questionnaire may be used during an audit.

The basics

The contents of internal control questionnaires vary from one audit firm to the next. They also may be customized for a particular industry or business. Most include general questions pertaining to the company’s mission, control environment and compliance situation. There also may be sections dedicated to mission-critical or fraud-prone elements of the company’s operations, such as:

Accounts receivable,
Inventory,
Property, plant and equipment,
Intellectual property (such as patents, copyrights and customer lists),
Trade payables,
Related party transactions, and
Payroll.

Questionnaires usually don’t take long to complete, because most questions are closed-ended, requiring only yes-or-no answers. For example, a question might ask: Is a physical inventory count conducted annually? However, there also may be space for open-ended responses. For instance, a question might ask for a list of controls that limit physical access to the company’s inventory.

3 approaches

Internal control questionnaires are generally administered using one the following three approaches:

Completion by company personnel. Here, management completes the questionnaire independently. The audit team might request the company’s organization chart to ensure that the appropriate individuals are selected to participate. Auditors also might conduct preliminary interviews to confirm their selections before assigning the questionnaire.
Completion by the auditor based on inquiry. Under this approach, the auditor meets with company personnel to discuss a particular element of the internal control environment. Then the auditor completes the relevant section of the questionnaire and asks the people who were interviewed to review and validate the responses.
Completion by the auditor after testing. Here, the auditor completes the questionnaire after observing and testing the internal control environment. Once auditors complete the questionnaire, they typically ask management to review and validate the responses.

Enhanced understanding

The purpose of the internal control questionnaire is to help the audit team assess your company’s internal control system. Coupled with the audit team’s training, expertise and analysis, the questionnaire can help produce accurate, insightful audit reports. The insight gained from the questionnaire also can add value to your business by revealing holes in the control system that may need to be patched to prevent fraud, waste and abuse. Contact us for more information.

This method of using internal control questionnaires to gain an understanding of the internal control environment is also used during our internal controls studies. This consulting service is singularly focused to examine the key policies and processes that drive your organization and allow it to function day in and day out. It analyzes each one, measures it against industry best practices, and yields recommendations that can help you strengthen what you currently do, change what warrants changing, and implement new systems, policies and procedures. All recommendations are made with the intention of making your organization stronger, more efficient, more resilient, more accurate, more profitable (if applicable) and less susceptible to fraud or error.