frisco | october 10, 2018 - whitley penn...asu 2015-17 income taxes: balance sheet classification of...

Frisco | October 10, 2018

Corporate Standard Setter Update

September 2018

ASUs Effective For Nonpublic Companies in Calendar Year 2018

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ASU 2015-17 Income Taxes: Balance Sheet Classification of Deferred Taxes

• Classify all deferred tax items on the balance sheet asnon-current assets or liabilities

• Must still separate by deferred items applicable todifferent taxing jurisdictions

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• Example:

Old Standard New Standard

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• Effective Date and Transition Requirements:

–PBEs: fiscal years beginning after December15, 2016

–Nonpublic companies: fiscal years beginning after December 15, 2017

–Early adoption is permitted

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ASU 2018-05 – Income Taxes

• Results from SEC Staff Accounting Bulletin No. 118 andaddresses implications of the Tax Cuts and Jobs Act

• Focus is on appropriate accounting given ASC 740 does notaddress certain circumstances that may arise as a result ofthe Act

• Considered appropriate to record a reasonable estimate, ifdeterminable

• If reasonable estimate cannot be determined apply ASC 740based on the provisions of the tax laws in effect immediatelyprior to the Act

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ASU 2018-05 – Income Taxes

• Measurement period (similar concept as business combinationguidance) = begins in the reporting period enacted, ends when anentity has obtained, prepared, and analyzed info needed tocomplete theaccounting

• Measurement period should not extend beyond one year fromenactmentdate

• Measurementperiod adjustments– updatestoprovisionalamountsidentifiedduringmeasurementperiod

– Included in income from continuing operations as an adjustment to taxexpense/benefitinthereportingperiodtheamountsaredetermined

• Transition = effectiveuponissuance(i.e., March 2018)

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New IRS Partnership Rules

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Overview• Partnership Representative vs. Tax Matters Partner

• Taxes due after an IRS audit can be collected from the partnership instead of flowing through to the partners

– Financial statement and disclosure impact

• Applies to ALL Companies taxed as Partnerships but there is an opt-out election if <100 partners

New IRS Partnership Rules

• Effective for partnership tax years beginning after December 31, 2017

• Consider updating partnership agreement

• Work closely with your tax advisor to determine if

– 1) the partnership qualifies to opt-out

– 2) the partnership made the annual election

– 4) FIN 48 Implications

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ASU 2016-09 Stock Compensation

• Affects all entities that issue share-based payment awards toemployees.

• Main provisions impacted:

– Accounting for income taxes when awards vest or aresettled

– Statutory withholdings

– Forfeitures

– Provides practical expedients for nonpublic entities.

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• Determine if deduction for tax and financial reporting results in tax benefit or liability.

• Benefits recognized in APIC, liabilities recognized as an offset to any benefits or in the income statement.

• Benefits are not recognized until the deduction reduces taxes payable.

• All tax benefits and liabilities should be recognized in the income statement.

• Tax effects of exercised/vested awards reported in the period they occur.

• Excess tax benefits recognized regardless if they reduce taxes payable in current period.


Current GAAP Simplification

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Income Taxes when Awards Vested are Settled

• Rate for each employee in the jurisdiction

• Could create a liability

• Accruals of compensation cost are based on the number of awards that are expected to vest

• When calculating withholdings, apply one max rate to all employees in that jurisdiction

• Avoids liability classification

• Option to account for forfeitures as they occur


Current GAAP Simplification

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Statutory Withholding


• Elect to estimate the expected terms for all awardswith performance/service conditions that meetcertain conditions

• Make a one-time accounting policy to switch frommeasuring liability-classified awards at fair value tointrinsic value

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Private company practical expedient


Management Considerations

• ASU intended to simplify, reduce cost and complexity ofaccounting

• ASU will likely result in significant changes to net income and earnings per share

• Expect administrative and other challenges to implement the guidance for companies with significant share-based payment activities

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• Effective Date and Transition Requirements– PBEs:fiscalyearsbeginningafterDecember15,2016

– Nonpubliccompanies:fiscalyearsbeginningafterDecember15,2017

– Earlyadoptionpermitted.

– Amendmentsappliedonaprospectivebasis

– Modifiedretrospectivetransitionmethod

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• Impacts entities that make any modifications toshare-based payments

• Modifications that would not require modificationaccounting or disclosure per ASC 718 would beones which result in:– No change in fair value of award

– No change to vesting

– No change to classification

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• Modifications to awards that would generally requiremodification accounting and disclosure would include:

– Repricing of options that changes the value

– Changing service, performance or market conditions

– Changing terms that result in a reclassification of the award(equity to liabilityor vice versa)

– Adding an involuntary termination provision in anticipationof a sale of a business unit that accelerates the vesting ofthe award

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• A company grants an employee an award for 10,000 share options onJanuary 1, 2017. The share options cliff vest onDecember 31,2019. Afterthe grant date, the share options become significantly out of the money.On February 1, 2018, the company modifies the award by reducing theexercisepriceandthenumberofshareoptions asfollows:

– 1/1/2017Grant:• 10,000shares,$8/shareoptionFV,$8,000totalFV

– 1/1/2018Modification:• 5,000share,$16/shareoptionFV,$8,000totalFV

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• However, just because a modification may berequired, additional compensation cost will not alwaysbe the result (but this fact will need to be disclosed)

• When disclosures are required about modifications,they will be the same as what is required today

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• Effective Date and Transition Requirements:– PBEs: fiscalyears beginning after December 15, 2017

– Nonpublic companies: fiscal years beginning after December 15, 2017

– Early adoption is permitted

– Prospective adoption to awards modified on or after theadoption date.

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ASU 2016-15: Classification of Certain Cash Flows

• Separately identifiable cash flows and application of the predominance principal– First attempt to apply specific GAAP– If no specific GAAP:

• First, separate into identifiable sources/uses based on nature of the underlying cash flows

• Then classify each identifiable source/use based on nature

• If cannot be separated, classify based on predominant source or use

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• Debt prepayment/extinguishment costs = Financing

• Settlement of zero rate (or insignificant rate) debt:– Portion of payment relating to accreted interest = Operating– Portion of payment relating to principal = Financing

• Contingent Consideration Payments Made After a BC:– If not made soon after acquisition date:

• Payment up to contingent liability amount = Financing• Any excess = Operating

– If made soon* after acquisition date = Investing*Interpreted as occurring within three months of the date of the acquisition.

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• Proceeds from Insurance Claims = based on nature of loss

• Corporate-owned life insurance:– Premium payments = Operating, Investing, or some

combination of both

– Proceeds = Investing

• Beneficial Interest in Securitization Transactions:– Noncash activity when initially recorded by transferor

– Subsequent cash receipts received by transferor = Investing

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• Distributions received from equity method

investees:

–Nature of the distribution approach

• Return on investment –Operating

• Return of investment – Investing

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• Effective Date and Transition Requirements:–PBEs - fiscal years beginning after December

15, 2017

–Nonpublic companies – fiscal years beginning after December 15, 2018


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ASU 2016-01 Financial Instruments

• Classification/Measurement Changes:

– Equity investments to be measured at FV with changes in FV recognized in net income

– Measurement Alternative (no readily determinable FV):

• Measure at cost minus impairment, if any, plus/minus changes resulting from observable price changes for the identical or similar investments of the same issuer

– If no readily determinable FV, qualitative assessment to identify impairment; if impaired, measure at FV

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• Scope Exceptions:

– Equity investments accounted for under equity method or those that result in consolidation of investee

– Entities in certain industries with specialized accounting practices that include accounting for substantially all investments at FV (e.g., broker-dealers, EBPs, Investment companies)

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Before:

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After:

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Management Considerations:

• If a significant amount of AFS securities are held, this ASU could result inearningsvolatility

• Identifying observable price changes for equity investments withoutreadilydeterminable FVcouldbechallenging inpractice

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–PBEs – fiscal years beginning after December 15, 2017

–Non-PBEs – Effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019

–Non-PBEs - may early adopt for fiscal years beginning after December 31, 2017

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ASU 2018-03 Clarification of ASU 2016-01

• Issue – Equity Securities without a Readily Determinable FV -Adjustments:

– Area for Clarification: when an observable transaction occurs for a similar security, adjustments made should reflect the current FV of the security

– Issue: should adjustments reflect FV as of observable transaction date or current reporting date?

– Clarification: should reflect FV as of observable transaction date

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• Issue – Transition Guidance for Equity Securities without a Readily Determinable FV:

– Issue: is a prospective transition approach required for all equity securities without a readily determinable FV, including those for which the measurement alternative is not applied upon transition

– Clarification: this transition approach is meant only for instances in which the measurement alternative is applied

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– Same as ASU 2016-01

– Early adoption is permitted as long as ASU 2016-01 has been adopted

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ASU 2016-18: Restricted Cash

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Before:

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After:

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Before (Disclosure):

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After (Disclosure):

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–PBEs - fiscal years beginning after December 15, 2017

–Nonpublic companies – fiscal years beginning after December 15, 2018


–Retrospective to each period presented

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ASU 2018-02 Reporting Comprehensive Income

• Disproportionate income tax effects (“stranded tax effects”) in AOCI result when adjusting DTAs/DTL for a change in tax laws through net income (i.e., original deferred tax recorded through AOCI at old tax rate remains despite that the related DTA/DTL updated through net income to reflect new rate)

• Can reclassify these stranded tax effects to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recorded

• Must disclose:– Whether or not they elect to reclassify the stranded income tax effects from the Tax

Cuts and Jobs Act– Accounting policy for releasing income tax effects from AOCI– Info about the other income tax effects that are reclassed

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ASU 2018-02 Reporting Comprehensive Income

• Transition– Effective for all entities for fiscal years beginning

after 12/15/18

– Early adoption permitted

– Should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized

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ASU 2017-01 Business Combinations (Topic 805)

• This update will:

- clarify the definition of a business

- provide guidance as to whether a business or merely

assets that have been acquired (or disposed).

• Effective years beginning after December 15, 2017 for public entities and December 15, 2018 for private

• Early adoption is permitted, but there are specific guidelines to follow.

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ASU 2017-01 Business Combinations (Topic 805)

• Under new definition

– Added a screen test, substantially all the fair value of the assets acquired concentrated in a single asset or group of similar assets (Change)• If meet this “screen” then no further analysis required

– Next evaluate whether the assets include an input and a substantive process that together significantly contributes to create an output• Still have the three elements of a business

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• Do inputs and a SUBSTANTIVE PROCESS generate an output– Not all processes are required to be included– The ability to generate an output (change)– Employees that when applied to an acquired

input could generate an output (change)– If they are critical to generating an output– Cannot be replaced without significant costs– Output generate is considered unique or scarce

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ASU 2017-01 Business Combinations (cont.)

• Updated the definition of an output

– Previously defined as providing a return or economic benefit

– Now provide goods or services to customers, investment income or other revenues

• Still must perform from the view of a market participant

• Eliminated the requirement to evaluate replacing missing elements (change)

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• This new ASU will have a large impact in theexploration and production (E&P) Industry.

• Specifically, companies will often acquire a land leaseand related mineral rights. Typically the mineral rightsshould be combined with the intangible lease rightsto be considered a single asset.

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ASU 2017-08: Receivables – Nonrefundable Fees and Other Costs

• Shortens the amortization period for certain callable debt securities held at a premium

• Premium to be amortized to the earliest call date

• Any unamortized premium amount at call date recorded as a loss

• No change for securities held at a discount

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ASU 2017-08: Receivables – Nonrefundable Fees and Other Costs

• Transition:

–PBEs – Annual periods beginning after 12/15/18

–All others – annual periods beginning after 12/15/19


–Modified retrospective approach – cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption

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ASU 2017-12 Derivatives and Hedging

• What has changed?

– Eliminates the requirement to separately measure and report hedge ineffectiveness (Still have the hedge effectiveness threshold)

– Generally the total income statement effect will now be presented on a single line item

– Reduces the complexity in fair value hedges of interest rate risk

– Eases documentation and assessment requirements

– Requires a new table in disclosures to summarize an all encompassing impact to earnings from hedging activities

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• Other Simplifications:

–Allows Company to perform initial quantitative assessment up until the end of the quarter in which the hedge was designated (Change from current GAAP that this had to be done immediately)

–Allows Company to subsequently assess hedge effectiveness qualitatively unless facts and circumstances have changed (Change current GAAP that this had to be done ongoing basis)

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• Effective Date and Transition Requirements:– Effective for public companies with years beginning after December 15,

2018

– Effective for public companies with years beginning after December 15, 2019


– The modified retrospective approach with an adjustment to opening retained earnings

– All presentation and disclosure requirements are prospective

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Lease Update (Lots of ASU’s and Keep Growing)

• Current lease guidance has been criticized for allowing leased assets and the obligations to be excluded from the balance sheet.

• ASC 842 retains a dual model that includes financing leases, similar to capital leases, and operating leases.

• Under this dual model, determining whether a lease is a finance or operating lease will be based on guidance similar to current GAAP, but without the “bright lines.”

• Operating leases will now be included in the balance sheets as both an asset and liability

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• Definition of a Lease at inception of a contract:

o A contract that conveys the right to control the useof PP&E for a period of time in exchange for consideration.

o Control over the use of the identified asset means that the customer has both

• (1) the right to obtain substantially all of the economic benefits from the use of the asset and

• (2) the right to direct the use of the asset.

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• Financing Lease:– Most leases other than property (e.g., equipment, aircraft, cars,

trucks)

– A non-property lease is considered a Financing lease unless:• Lease term is for an insignificant part of the total economic life of

the underlying asset, OR (75% bright-line is acceptable)

• PV of lease pymts is insignificant relative to the FV of the underlying asset at commencement. (90% bright-line is acceptable)

– If either of the above are met, the lease is Operating (mostly land, building, office space, plant, etc)

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• Accounting for operating leases: oRecognize a right-of-use (“ROU”) asset and a Lease liability, initially

measured at the PV of the lease payments

• ROU asset = initial direct costs + prepaid amts + lease liability–lease incentives

• Lease liability = PV of lease payments not yet paid

oAmortization of ROU asset and interest expense combined and reported as Lease Expense

oClassify all cash payments within operating activities in the statement of cash flows

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• Accounting for financing leases:

o Recognize a ROU asset and a lease liability, initially measured at the PV of the lease payments

o Recognize interest expense on the lease liability separately from amortization of the ROU asset

o Classify repayments of the principal portion within financing activities and payments of interest within operating activities in the SOCF.

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Example

Facts:

• 10‐year lease, option to extend 5 years

• LP = $50K/year (initial term); $55K/year (optional period)

• No significant economic incentive to exercise option to extend, therefore, lease term = 10 years

• Payments due at beginning of each year

• Initial direct costs (IDC) = $15K

• Lessee’s incremental borrowing rate = 5.87%

• PV of remaining LP after payment of 1st year rental & IDC = $342,017

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Example

• Journal entry to record lease assets & liabilities at commencement (same for Financing and Operating):

Right‐of use Asset $407,017

Lease Liability $342,017

Cash (lease payment) $50,000

Cash (initial direct cost) $15,000

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Example

• Journal entry to recognize lease expense if Financing in year one:

Interest expense $20,076


Amortization expense $40,702

Right‐of‐use asset $40,702

• Interest expense calculated as (5.87% X 342,017)

• Amortization expense calculated as (407,017/10)

– Amortization period = shorter of 1) lease term or 2) useful life• If significant economic incentive to exercise PO then amort. period = useful life

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Example

• Journal entry to recognize lease expense if Operating in year one:

Lease expense $51,500


Right‐of‐use asset $31,424

• Lease expense calculated as ( (500,000 +15,000)/10 )

• Interest expense calculated as (5.87% X 342,017)

• Right‐of‐use asset calculated as (51,500 –20,076)

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• One year or less

– For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities.

• Lessor leases largely unchanged

– ASU 2018-11 has provided some relief/clarity that lessor may elect to combine lease and nonleasecomponents provided that the nonleasecomponent(s) otherwise would be accounted for under the new revenue guidance in ASC 606

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Example #2

Facts:

• Asset: Truck

• Term: 2 years

• Asset economic life: 12 years

• Lease payments (LP): $9K per year

• PV of LP: $16.7K (using rate lessor charges lessee)

• Fair value of truck at commencement: $60K

Is this a Financing or Operating lease?

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Example #2 - Answer

Answer: Financing

Reasons

• The underlying asset is not property.

• The lease term is for more than an insignificant part of the total economic life of the equipment.

• The present value of the lease payments is more than insignificant relative to the fair value of the equipment at the commencement date.

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• Presentation for lessees Balance Sheet

• Either present separately or combine with appropriate class of assets and liabilities with proper disclosure

• No co-mingling of Financing and Operating leases

Income Statement• Financing –Present interest separately from amortization

• Operating –Present interest and amortization together in lease expense

Statement of Cash Flows• Operating Activities

– Interest on financing leases

– Payments on operating leases

• Financing Activities

– Principal repayments on financing leases

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• Effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for:

• PBEs• NFPs that have issued securities that are traded, listed, or quoted

on an exchange or an OTC market• EBPs that file financial statements with the SEC

• All others = Effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020

• Early adoption is permitted

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• Transition ASC 842 requires a modified retrospective approach to each lease that existed at the beginning of the earliest comparative period presented in the financial statements (full retrospective approach prohibited).

• ASU 2018-11

– Transition Relief: Option to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in the FS

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• Transition Relief (Cont.):

– Therefore, a PBE with a calendar year-end could elect to have a date of initial application of January 1, 2019. In doing so, the entity would:

• Apply ASC 840 in the comparative periods

• Provide disclosures required by ASC 840 for all periods that continue to be presented in accordance with ASC 840

• Recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of January 1, 2019

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ASU 2018-09 Codification Improvements

• Update applies to several different subtopics within the codification. The following are considered the main provisions:

• Subtopic 220-10, Income Statement –Reporting Comprehensive Income –Overall:– Original guidance notes state taxes not payable in cash are required to be

reported as a direct adjustment to APIC, not comprehensive income– This conflicts with other guidance (i.e., ASC 740, 805, and 852) which

notes these items are to be recognized in income– This update clarifies the guidance in subtopic 220 by removing the

generic phrase “taxes not payable in cash” and adding guidance that is specific to certain quasi-reorganizations

• Transition: PBE = annual periods starting after 12/15/18, All Others = 12/15/19

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ASU 2018-09 Codification Improvements (cont.)

• Subtopic 470-50, Debt –Modifications and Extinguishments:

– Original guidance notes that the difference between the reacquisition price of debt and the net carrying amount of extinguished debt be recognized in income in the period of extinguishment

– This does specifically address extinguishments of debt when the FV option is elected

– This update clarifies that:• When FV option has been elected, the net carrying amount equals it FV

• Related gains/losses in OCI must be included in net income upon extinguishment


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• Subtopic 480-10, Distinguishing Liabilities from Equity - Overall:

– Original guidance prohibits the combination of freestanding financial instruments within the scope of subtopic 480-10 with NCI, unless combination is required by ASC 815 (derivatives and hedging)

– Examples in subtopic 480 conflict with ASC 815 and FASB Statement No. 150

– This update conforms subtopic 480 accordingly


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• Subtopic 805-740, Business Combinations – Income Taxes:

– Original guidance provided a list of 3 methods for allocating the consolidated tax provision to an acquired entity

– Guidance is inconsistent with ASC 740 (specifically, the 3 methods for tax allocation do not follow the broad principles of being systematic, rational, and consistent)

– This update removes the allocation methods and conforms this subtopic with ASC 740


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• Subtopic 815-10, Derivatives and Hedging -Overall:

– Provides additional clarification on circumstances in which derivatives may be offset

– Under certain specific conditions, derivatives may be offset if 3 of 4 criteria in 210-20-45-1 are met

– Paragraph 815-10-45-4 is potentially misleading because it states derivatives may only be offset when all 4 conditions are met

– This update supersedes paragraph 815-10-45-4


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• Subtopic 820-10, Fair Value Measurement - Overall:

– 820-10-35-16D included the sentence “a reporting entity shall ensure that the price of the asset does not reflect the effect of a restriction preventing the sale of the asset”

– This sentence is not in alignment with the Board’s decisions on that measurement issue

– This update clarifies how an entity should account for those restrictions

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• Subtopic 820-10, Fair Value Measurement – Overall (cont.):

– Guidance allows portfolios of financial instruments and nonfinancial instruments accounted for under ASC 815 to use the portfolio exception to valuation

– ASU 2011-04 (ASC 820) unintentionally excluded nonfinancial instruments from the portfolio exception

– This update provides updated wording to explicitly include nonfinancial instruments


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ASU 2017-11 Down Round

• Eliminates the requirement to consider the “down round” featurewhenconsidering if instrumentsare indexedto anentity’sown stock

– Current GAAP was to record a derivative liability based on the fairvalueof this feature andsubsequentchanges inearnings

• For EPS Purposes, recognize the effect of a down round feature in afreestandingequityclassified instrument whentriggered

– When a triggering event occurs, this will be recognized as adividendandareduction to income inbasicEPS calculation


• New disclosures

– Terms that change exercise or strike prices of financialinstruments, including those related to down round feature

– The actual changes to exercise or strike prices that occurduring the reporting period

– When triggered, entities are required to disclose that factand the value of the effect of the down round feature



– Effective for public companies with yearsbeginning after December 15, 2018

– Effective for nonpublic companies with yearsbeginning after December 15, 2019


– Full or modified retrospective approach

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• Applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards to nonemployees

• Does not apply to share-based payments 1) which provide financing, or 2) are issued when selling good or services accounted for under ASC 606

• Transition:– PBEs = annual periods starting after 12/15/18– All Others = after 12/15/19– Early adoption permitted, but no earlier than adoption of ASC 606

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• Measurement Amount

– FV of equity instrument to be issued at grant date

• Measurement Date

–Measured at grant date

–Grant date is the date at which a grantor and grantee reach a mutual understanding of the key terms and conditions

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• Awards with Performance Conditions:

– Consider the probability of satisfying performance conditions (same process as for EE stock awards)

• Specific Amendments for NPBEs

– Can use historical volatility of relevant industry-sector index when volatility is not practicable to estimate

– Can make one-time election to switch from measuring liability-classified awards at FV to intrinsic value

– Regardless of election, awards are still subject to re-measurement until exercised

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ASU 2018-13: Fair Value Measurements Disclosures

• The ASU is effective for all entities for fiscal yearsbeginning after December 15, 2019, including interimperiods therein.

• Early adoption is permitted for any eliminated ormodified disclosures upon issuance of this ASU.

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ASU 2018-13: Fair Value Measurements Disclosures

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and Beyond

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ASU 2016-13 Measurement of Credit Losses on Financial Instruments

• There has been concern that current GAAP was delaying the recognition expected credit losses

• Who is affected by this update?

–Applicable to all financial instruments that are not accounted for at fair value through net income• Loans, debt securities, mortgages, credit cards, trade AR

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• Main provisions of the update:

– Requires a financial asset (or asset group) measured at amortized cost basis to be presented at the net amount expected to be collected. (Current GAAP based on probable incurred losses)

– Requires available-for-sale securities to determine if all or part of unrealized loss is a credit loss.

– Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses.

– Disclosures:

• More information on how losses developed

• More disaggregated information

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• Transition

– Mostly will be required to use the modified retrospective approach with an adjustment to opening retained earnings

• Effective:– Effective for public companies with years beginning after December

15, 2019

– Effective for public companies with years beginning after December 15, 2020


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ASU 2017-04: Goodwill Impairment

• Removes Step 2 of the goodwill impairment test

– In Current GAAP, Step 2 measures impairment loss bycomparing implied fair value of the goodwill

• Now will apply one-step quantitative test

– Impairment recorded as the excess of carrying amountover fair value (i.e. based on current Step 1)

• Does not amend the qualitative assessment

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• For tax deductible goodwill, calculate impairment charge anddeferredtax effectusingsimultaneousequationsmethod– This is a result of a Company having the potential to have second

impairment charge immediately after the first due to the tax effectof the initial impairment

– Grossupthegoodwill chargetoaccount for thedeferredtax assetsrelated to tax deductiblegoodwill

• If reporting unit has zero or negative carrying amount, eliminated therequirementsto performaqualitative assessment.

• Required to disclose the amount of goodwill allocated to eachreporting unitwith a zero or negativecarrying amountofnetassets.

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–Public companies (SEC filers) with fiscal years beginning after December 15, 2019

–Public companies (Non-SEC filers) with fiscal years beginning after December 15, 2020

–Nonpublic companies with fiscal years beginning after December 15, 2021


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ASU 2018-15 Cloud Computing Arrangement

• Amendsthedefinition ofahosting arrangement.

• Requires a customer in a cloud computing arrangement that isa service contract to follow the internal-use software guidanceinASC350-40– Determine which implementation costs to capitalize as

assetsor expenseas incurred.

• Amortization ofcapitalized implementation costs

• Presentation anddisclosure

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ASU 2018-15 Cloud Computing Arrangement


–Calendar-year public business entities in2020.

–For all other calendar-year entities, it iseffective for annual periods beginning in2021 and interim periods in 2022.

–Early adoption is permitted.

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Managing Cybersecurity Through SOC Reporting

JOHN WILLIAMSON, CIA, CISA

RISK ADVISORY SERVICES

AgendaOverview of SOC Reporting

Latest Developments

A “How To” Guide to Using SOC Reports

Overview of SOC Reporting

- SOC History

- SOC Suite of Services

- How SOC Reports are Used

SOC History

Organizations are increasingly outsourcing systems, business processes, and data processing to service providers.

SAS 70 reports became a widely-used method to evaluate controls in place at service organizations. These reports were geared toward operational controls.

SAS 70 reports are retired and replaced by SOC reports under SSAE 10 and SSAE 16.

Three types of SOCreports:

-SOC 1, SOC 2, and SOC 3

Where we are Today

A broader suite of “System and Organization Control” reports are now offered which include mapping to other frameworks, or opinions issued for other additional SOC 2+ criteria and other standards.

SOC Suite of Services

• Report on Controls at a Service Organization Relevant to User Entities’ Internal Control over Financial Reporting (ICFR)

SOC 1 – SOC for Service Organizations: ICFR

• Report on Controls at a Service Organization Relevant to Security, Availability, Processing Integrity, Confidentiality or Privacy

• SOC for Service Organizations: SOC 2+ (CSA STAR, ISO 27001, HIPAA Security Rule, GDPR, NIST CSF, COBIT, HITRUST)

SOC 2 – SOC for Service Organizations: Trust Services Criteria

• These reports are designed to meet the needs of users who need assurance about the controls at a service organization.

SOC 3 – SOC for Service Organizations: Trust Services Criteria for General Use Report

• A reporting framework for communicating information about the effectiveness of cybersecurity risk management program to a broad range of stakeholders

New: SOC for Cybersecurity

• An internal controls report on a vendor’s manufacturing processes for customers of manufacturers and distributors to better understand the cybersecurity risk in their supply chains.

Under Development: SOC for Vendor Supply Chains

SOC 2/SOC 3 Criteria

Security The system is protected against unauthorized access, use, or modification.

Availability The system is available for operation and use as committed or agreed.

Confidentiality Information designated as confidential is protected as committed or agreed.

Processing Integrity System processing is complete, valid, accurate, timely, and authorized.

PrivacyPersonal information is collected, used, retained, disclosed, and destroyed in conformity with the

commitments in the entity’s privacy notice and with criteria set forth in generally accepted privacy

principles (GAPP)

PrincipleDomain

CyberSecurity

(Security)

Business

Outsourcing

Services

(Security,

Processing

Integrity)

Data Managementand

Analysis Services

(Security, Availability,

Confidentiality,

ProcessingIntegrity)

Client Due

Diligence

Purposes

(Security,

Availability)

HIPAA Business

Associates

(Security,

Confidentiality,

SOC 2+HIPAA)

Billing and Claim

Payment Services

(Security,

Processing

Integrity)

Processing Centers

(Security,

Processingintegrity)

Third Party

Relationships

(All)

Data Center

Hosting

(Securityand

Availability)

AssetManagement

(Security,

Confidentiality)

Electronic

Banking

(Security,

Confidentiality)

Corporate

Services, Fiduciary

AssetManagement,

and ClientAccounting

Services (Securityand

Processing

Integrity)

Infrastructure

(Availability,

Security)

How SOC 2 reports are being used

Knowing Your Compliance RequirementsDo you store or process the following:

- Credit Card Numbers (PCI-DSS)

- Protected Health Information (HIPAA/HITECH)

- Personal Information Belonging to EU Citizens (GDPR)

Are you a Cloud Provider? (CSA CCM)

Are you a Financial Institution? (FFIEC/INTREX)

Do you do business with the following:

- Federal Agencies (FISMA/FEDRAMP)

- European Entities (ISO 27001)

- Covered Entities as Defined by HHS (HIPAA)

- Institution of Higher Learning (FERPA)

- State Agencies (NIST 800-53)

SOC 2+/Enhanced Reporting

ISO 27001 HIPAA Security Rule GDPR PCI-DSSNIST 800-53 COBIT 5 Cloud Controls Matrix HITRUST

Latest Developments in SOC Reporting

- SSAE 18

- New SOC 2 Criteria

- SOC for Cybersecurity

The Auditing Standards Board (ASB) undertook a multiyear project to redraft all of the attestation standards that it issues into a new “clarity format.” The intent of this format is to address concerns over the clarity, length, and complexity of its standards.

• Statement on Standards for Attestation Engagements No. 18 (SSAE 18):In April 2016, the ASB issued SSAE 18 –Attestation Standards: Clarification and Recodification

• SSAE 18 in includes:• All SOC reports• Agreed-upon procedures• Examination engagements• Compliance examination engagements• Review engagements• Pro Forma Financial Statement engagements

SSAE 16 to SSAE 18

The below summary includes the more significant revisions to the attestation standards that directly affect SOC 1®

reporting. These revisions include the following topics:

SSAE 18 - Changes

Summary of revisions

— Complementary subservice organization controls

(CSOC)

— Completeness and accuracy of information produced

by the service organization

— Complementary user entity controls (CUECs)

— Review of internal audit reports and regulatory

examinations

— Risk assessment

— Materiality language in management’s assertion

— Management’s assertion versus

management’s description

— Obtaining evidence regarding the design of controls

Summary of revisions

— Switch from 7 common criteria to 9 common criteria

— The new SOC 2 criteria include all principles of internal

control from COSO 2013

— Greater emphasis on entity-level controls

— A new domain has been added that includes vendor

management

— Restructures supplemental criteria to better

address cybersecurity risks

— Additional description criteria

— Obtaining evidence regarding the design of controls

Effective for reports with periods then end after December 15, 2018:

New SOC 2 Criteria

Released in 2017

Examination over:

A description of the entity’s cybersecurity risk

management program

Design and/or effectiveness of the controls within that

program to achieve the entity’s cybersecurity

objectives

General Use Report

Can select any suitable framework for controls (SOC 2,

NIST, etc.)

SOC for Cybersecurity

A “How To” Guide on using SOC reports

- SOC Reports for Service Providers: Winning New Business

- SOC Reports for Customers: 3rd Party Risk Management

What is the Return on

Investment?

— Know your customers and their requirements

— Understand the competitive landscape and whether a SOC report is a differentiator or a “ticket to play” in

the industry

— Understand how your services or products affect your customers and be familiar with the requirements

— Engage a reputable service provider: Demonstrating your capabilities to your customers vs. “Checking the

Box”

What Report is Right

for You?

— Know your compliance requirements and the types of sensitive data you process or store

— What type of report will help you engage with your customers and win more business?

— Know when to “push back”

What does it involve? — Identification and scoping of report subject matter and selection of criteria

— Define the scope of the system including infrastructure, software, people, procedures and data

— Perform a Diagnostic/Readiness Assessment

— Remediate items identified during the Diagnostic Assessment

— Perform and document controls consistently

— Execute the SOC engagement

SOC for Service Providers: Winning New Business

SOC for Customers: 3rd Party Risk ManagementAssess vendor risks

— Assess the key risks associated with significant outsourced vendors

— Know your data and your compliance requirements

Identify relevant reports

— Determine whether a SOC 1 report is required for financial reporting purposes.

— Determine whether detailed SOC 2 reports or other SOC reports are required for key service providers. Also determine which principles should be covered within the SOC 2 reports

Contractual provisions

— Assess what, if any, specific audit reports are required by contract, and whether contracts have right to audit clauses.

— Determine how any historical SAS 70/SSAE 16/SSAE 18 references should be updated to the relevant types of SOC report.

— Determine whether SOC reports should be required by contract.

Vendor monitoring

— Determine the frequency with which key outsourced vendors will be assessed.

— Build the process of obtaining and reviewing SOC reports, and following up on any areas of concern into the vendor monitoring process.

SOC for Customers: 3rd Party Risk Management

Review the Report

— What is the scope of the report?

— What is the period covered and is it suitable for you?

— Is a subservice organization disclosed, was the “Inclusive” or “Carve-out” method used?

— Was the opinion unqualified or qualified?

— Understanding the system and its related processes and determining is relevance.

— Do the control objectives and controls (SOC 1), principles, and criteria (SOC 2/3) address the risks relevant to your environment?

— To achieve the stated control objectives, or principles and criteria, does the report highlight specific control activities for which the user entity or subservice organization is responsible?

— Were these complementary user entity controls present and operating effectively during the period?

— Is there a SOC report for the carved out subservice organization that addressed the CSOCs?

— Does the report cover all of the relevant control objectives and criteria purposes?

— Do the controls and testing adequately support the objectives or criteria?

— Does the report cover the relevant control objectives, principle(s) and criteria?

— Do the controls and testing adequately support the objectives/criteria?

— Does the report need to include the service auditor’s test procedures and associated results?

— Were there exceptions noted by the service auditor; how might the exception(s) impact your risk assessments?

The Tax Cuts & Jobs Act –Finalized Legislation

Jon P. KarpSeptember 25, 2018

Disclaimer

• This presentation and related materials are designed only to provide generalinformation regarding the subject matter discussed during this presentation. Thestatutes, authorities, andother laws cited inthispresentation are subject to change.

• This presentation and related materials are not intended to provide tax, accounting,legal, or other professional advice to any specific person or entity. Any advice oropinion regarding the application of the subject matter for a specific person or entityshould be provided by a competent professional advisor based on an application ofthe appropriate law and authorities to the facts and circumstances applicable to thatpersonor entity.

Conference Committee Reconciles Legislation Passed Separately by House &Senate

• On December 15, 2017, the Conference Committee released its Conference Report on the Tax Cuts & Jobs Act. This legislation is the most sweeping, categorical change to the Code in over 30 years. This writing refers to the Act by its former and commonly used name – the Tax Cuts and Jobs Act

• Generally, the Tax Cuts and Jobs Act takes effect 1/1/18 unless otherwise noted in materials

• Many of the sunset provisions made it into this final legislation. As such, a number of individual provisions are temporary, generally expiring as of 1/1/26

Accounting Today – July 3

Preparers share their initial problems with the TCJA

• “It’s difficult to offer planning with so many unanswered questions,”

• “This makes it virtually impossible to offer meaningful tax planning for our clients and those who are starting new businesses.”

• “This law is so big and was passed so swiftly that the IRS hasn’t had an opportunity to share documentation on how some of the new credits will actually fall on the tax return. This leads to all type of speculation and guesstimating when I’m creating tax plans for clients.”

Accounting Today – July 3

• Certain aspects of tax prep – from paperwork to niche clients – stand out as needing more attention post-reform, preparers say.

– “I spent a great deal of time talking about W-4s this year compared with recent years.”

• “Providing guidance to my small-business owners as a result of the changes caused by the TCJA has been the biggest problem to date”

Individual Marginal Tax Rates

• New law includes 7 individual brackets with the following taxable income thresholds for the respective filing statuses. Phase out 1/1/2026

7

RateFor Unmarried Individuals, Tax Income Over

For Married Filing Joint Returns, Taxable Income Over

For Heads of Households, Taxable Income Over

10% $0 $0 $0

12% $9,525 $19,050 $13,600

22% $38,700 $77,400 $51,800

24% $82,500 $165,000 $82,500

32% $157,500 $315,000 $157,500

35% $200,000 $400,000 $200,000

37% $500,000 $600,000 $500,000

Estate Tax Rates

• Estates and Trusts (Only 4 Rates)

– 10%, up to $2,550;

– 24%, $2,550 to $9,150;

– 35%, $9,150 to $12,500;

– 37%, $12,500 and up.

Kiddie Tax

• Taxable income of a child attributable to earned income would be taxed under the rate for single individuals, while income attributable to net unearned income would be taxed under the trust and estate rates

Standard Deduction; Personal Exemptions; HOH Due Diligence

• The law increases the standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. The current-law additional standard deduction for the elderly and blind would be retained. Phase out 1/1/2026

• The deduction for personal exemptions is effectively suspended to zero. Phase out 1/1/2026

• The due diligence requirements imposed on the earned income credit, child tax credit, and American opportunity credit will also include due diligence for paid preparers filing a taxpayer as Head of Household

Capital Gains

• The Act retains 0%, 15%, and 20% rates

• Breakpoints between the 0% and 15% rates and the 15% and 20% rates are the same amounts as the breakpoints under present law indexed for inflation

• For 2018, the 15% breakpoint is $38,600 for Single and $77,200 for MFJ. The 20% breakpoint is $425,800 for Single and $479,000 for MFJ

• Conference agreement also left in place the 3.8% NII tax.

Pass-Through Income

• For tax years after 12/31/17 and before 1/1/26, a new Code §199A allows a non-corporate taxpayer, including a trust or estate, with qualified business income (QBI) from a partnership, S corporation, or sole proprietorship to deduct:a) The lesser of: (1) the “combined qualified business income amount” of the

taxpayer, or (2) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the sum of net capital gain and the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year; plus

b) The lesser of: (1) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (2) taxable income (reduced by the net capital gain) of the taxpayer for the tax year

Code Section 199A – Qualified Business Income Deduction

• Deduction equals 20% of qualified business income

• Generally available to owners of pass-through businesses (including real estate)

• Limited for specified service trades or businesses (SSTB)

• Limited by the business owner’s taxable income

Eligible Taxpayers

Business Classifications and Limitations

Determining the deduction

20% Deduction for Certain Pass-through Income

• Individuals are now allowed a deduction for 20% of their domestic qualified pass-through business income, subject to the following limitations:– Greater of:

• 50% of wages paid with respect to the qualified trade or business• Sum of 25% of wages with respect to the qualified trade or business plus 2.5% of their unadjusted basis

• The 50% wage limitation does not apply to a taxpayer in the following scenarios:– Married filing jointly, income of $315,000 or less– Single filer, income of $157,500 or less– Phase out over the next $100,000 of taxable income for MFJ filers. $50,000 for single filers

• A qualified business generally does not include professional service companies– However, deduction may apply to income from a PSC if taxable income doesn’t exceed $315,000 for MFJ filers

or $157,500 for other individuals

Pass-Through Income

• The “combined qualified business income amount” means, for any tax year, an amount equal to:– The deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the

taxpayer’s QBI subject to the W-2 wage limitation); plus– 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified

publicly traded partnership income of taxpayer for the tax year• As such, an individual taxpayer generally may deduct 20 percent of qualified business income from a

partnership, S corporation, or sole proprietorship. As we’ll see, a limitation based on W-2 wages paid is phased in above a threshold amount of taxable income. A disallowance of the deduction with respect to specified service trades or businesses is also phased in above the threshold amount of taxable income

• QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer

Pass-Through Income

• The W-2 wage limit phase out starts at $315,000 for MFJ and $157,500 for others, so the wage limitation does not apply to taxpayers under these thresholds. The W-2 wage limit is phased in for individuals with taxable income exceeding these thresholds, over the next $100,000 of taxable income for MFJ and $50,000 for other individuals

• The deduction is only allowed to service businesses (lawyers and accountants, but not engineers or architects) where taxpayer’s income is under the $315,000 MFJ/$157,500 for all others threshold. The deduction for service businesses is phased out over the next $100,000 of income for MFJ and $50,000 for all others. Therefore, it is completely phased out at $415,000 MFJ and $207,500 for all others

• This pass-through rate specifically does not apply to the business of being an employee

• Let’s look at this in a real life situation.

– A manufacturing company has a net profit of $2M in 2018 and pays $500,000 in wages to its employees during the year. That company would only be able to take the qualified business income deduction for $250,000 since 50% of the total employee wages ($500,000 x 50% = $250,000) are less than 20% of the net income of the business ($2M x 20% = $400,000).

Pass-Through Income

Wage Limitation Phase-out

• The wage and basis limitations do not apply to a taxpayer in the following scenarios:– Married filing jointly, income of $315,000 or less– Single filer, income of $157,500 or less– Phase out over the next $100,000 of taxable income for MFJ filers. $50,000 for single filers

• If taxable income is within the phaseoutrange ($315,001-$415,000) then the deduction is reduced based on the percentage of income which falls within the phaseoutrange

• Example: Single filer has $150,000 of pass-through income and total taxable income of $182,500. Business paid $40,000 of W-2 wages during the year. – Pass-through deduction w/out limitation: .20 x $150,000 = $30,000– Maximum limitation if outside phase-out range: .5 x $40,000 = $20,000 ($10,000 reduction)– Limitation within phase-out range: ($182,500 -$157,500) / $50,000 = 50% within phaseoutrange

• Actual deduction: $30,000 -($10,000 x .5) = $25,000

Specified Service Phase-out

• A qualified business generally does not include professional service companies– However, deduction may apply to income from a PSC if taxable income doesn’t exceed $315,000 for MFJ filers

or $157,500 for other individuals• Same phase-out ranges as wage limitation• If business income exceeds the phase-out range, no deduction is allowed• If income falls within the phase-out range, deduction is calculated using only a pro-rata share of all amounts from the

business(W-2 wages, income, etc.)• Example: Single filer with $150,000 of pass-through income and $170,000 of taxable income, 25% of phase-out

range. Business paid $40,000 of W-2 wages– Pass-through deduction w/out wage limitation: .75 * .2 * $150,000 = $22,500– Maximum limitation if outside phase-out range: .75 * .5 * $40,000 = $15,000 ($7,500 reduction)

• Actual deduction: $22,500 -($7,500 * .25) = $20,625

Qualified Property Limitations

• Mary and John Smith –married couple• Taxable income in excess of $415,000• Own a business that generates $100,000 of QBI for a deduction of $20,000 ($100,000 x 20%)• Property and equipment is not fully depreciated, but purchased 10 years ago for $500,000. There are

no employees; the QBI deduction is limited to $12,500 because the amount of qualified property is insufficient.

Calculation: Lesser of – A) 20,000 or– B) greater of

• $0 (W-2 wages x 50%) or $12,500 ([$0 W-2 wages x 25%] + [$500,000 property x 2.5%])

Loss Limitation Rules Applicable to Individuals

• Excess business losses of a taxpayer are not allowed for the taxable year

• Such losses are carried forward and treated as part of the taxpayer’s NOL carryforward in subsequent taxable years. This applies after the passive loss rules

Loss Limitation Rules Applicable to Individuals

• An excess business loss for the tax year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount

• The threshold amount for a taxable year is $500,000 for married individuals filing jointly, and $250,000 for other individuals. Ability to offset passive income with losses from an active trade or business affected by threshold amounts

• The $500,000 and $250,000 thresholds are indexed for inflation

Excess Business Loss Limitation - Example

• In 2018, John, an unmarried individual, has $200,000 of gross income and $500,000 of deductions from his consulting business

• John’s net business loss is $300,000

• John also has $300,000 of nonbusiness income from interest and capital gains

26

Excess Business Loss Limitation - Example

• John’s loss deduction is limited to $250,000

• Remaining loss of $50,000, an EBL, is carried forward to 2019

• John is able to use $250,000 of the loss to offset $250,000 of nonbusiness income

• John’s unused EBL of $50,000 is considered an NOL and carries forward to 2019 where it would then be subject to the 80% NOL limitation rules going forward

27

Reform of the Child Tax Credit

• Child tax credit increased to $2,000 per qualifying child. Phase out 1/1/26

• Income phase out is $400,000 for MFJ and $200,000 for all other taxpayers

• $500 nonrefundable credit for qualifying dependents other than qualifying children

• The proposal lowers the earned income threshold for the refundable child tax credit to $2,500

• The refundable portion (payable even without tax liability) is $1,400 per child

Education-Related Provisions

• The contribution limitation to ABLE (Achieving a Better Life Experience) accounts, regarding contributions made by the designated beneficiary, is increased, and amounts from 529 plans are able to be rolled over to an ABLE account without penalty as long as the ABLE account is owned by the designated beneficiary of the 529 plan or a member of such designated beneficiary’s family. Phase out 1/1/26

• For distributions after 12/31/17, qualified higher education expenses for 529 plan purposes include tuition at an elementary or secondary public, private, or religious school, up to $10,000 per year

• Certain eligible student loans discharged on account of death or total/permanent disability are excluded from gross income. Phase out 1/1/26

Repeal of the Pease Limitation on Itemized Deductions

• Suspends the Pease limitation on itemized deductions. Phase out 1/1/26

• Pease limit amounted to a 1.18% tax (3% x 39.6%) on high-income taxpayers

Home Mortgage Interest

• Deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to debt of up to $750,000 ($375,000 for MFS). Phase out 1/1/26. Limit does not apply to any acquisition loan incurred before December 15, 2017

• Taxpayer who entered binding written contract before December 15, 2017 to close before January 1, 2018, and who purchases by April 1, 2018, shall qualify for acquisition loan incurred before December 15, 2017

• $1M/$500,000 limitation generally applies to refinancing existing debt incurred before December 15, 2017, but subject to indebtedness provision

• As a concession to the real estate industry, the deduction is available for both new mortgages on first and second homes on debt up to $750,000

State and Local Taxes

• State, local, and foreign property taxes and state and local sales taxes are allowed as a deduction only when paid or accrued in carrying on a trade or business or an activity described in §212 (relating to expenses for the production of income)

• Exception: $10,000 ($5,000 for MFS) itemized deduction for the aggregate of (a) state and local property taxes and (b) state and local income taxes (or sales taxes in lieu of income taxes). Foreign real property taxes are not deductible

• 2017 deduction for pre-paying 2018 taxes is specifically outlawed

Repeal of Deduction for Personal Casualty Losses; Disaster Relief

• Deduction for personal casualty losses suspended but deduction for personal casualty losses incurred in a federally declared disaster not affected. Phase out 1/1/26

• If an individual has a net disaster loss, the standard deduction is increased by the net disaster loss. Phase out 1/1/26. For tax years 2016 and 2017, the $100 per casualty floor is increased to $500

• For tax years 2016 and 2017, there is an exception to the retirement plan 10% early withdrawal tax for up to $100,000 of qualified 2016 disaster distributions. Income from a qualified 2016 disaster distribution can be included ratably over three years

Charitable Contributions/AGI Limitations for Cash Contributions

• 50% limit for cash contributions to public charities and certain private foundations increased to 60%. Phase out 1/1/26

• Five-year carryover period retained to the extent that the contribution amount exceeds 60% of the donor’s AGI

Miscellaneous Itemized Deductions Subject to 2% Floor

• Act suspends all miscellaneous itemized deductions that are subject to the 2% floor under present law. Examples are tax preparation expenses, safe deposit boxes, and unreimbursed employee expenses. Phase out 1/1/26

Moving Expenses

• Both the exclusion for qualified moving expense reimbursements and the deduction for moving expenses are suspended, except for members of the Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station. Phase out 1/1/26

• Businesses recruiting talent would face higher cost after taking into account the gross-up for taxes.

AMT

• The individual AMT survives. The exemption amounts are increased to $109,400 for MFJ and surviving spouses, $70,300 for single filers, and $54,700 for MFS. Phase out 1/1/26

• These amounts are reduced to an amount equal to 25% of the amount by which the alternative taxable income of the taxpayer exceeds the phase out amounts, increased as follows: $1M for MFJ and surviving spouses and $500,000 for all other taxpayers except estates and trusts

• For trusts and estates, the base figure of $22,500 and phase out amount of $75,000 are unchanged

• The JCT estimates that this will decrease revenues by $637 billion over the next 10 years.

Medical Expenses

• Preserves medical expense deduction and reduces the floor to 7.5% for all taxpayers for tax years beginning after December 31, 2016, and ending before January 1, 2019

IRA Recharacterization

• Eliminates ability to recharacterize a ROTH IRA conversion after December 31, 2017

• As such, recharacterization can only be utilized to unwind a ROTH conversion through December 31, 2017

Alimony

• For a divorce or separation agreement executed after December 31, 2018, or one executed before December 31, 2018 but modified after it (as long as the modification expressly provides that the new amendments apply), alimony and separate maintenance are not deductible by the payor and are not included in the income of the payee

• So if divorce or separation agreement is pre- 12/31/18 and not modified, payor still gets deduction and payee declares it as income

Section 199 Domestic Production Activities Deduction

• This section of the Code is repealed

Like-Kind Exchanges

• Law eliminates like-kind exchanges for tangible personal property

• Law modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property not held primarily for sale with a transition rule if taxpayer has either disposed of the relinquished property or acquired the replacement property on or before 12/31/2017

Carried Interest

• The law imposes a three-year holding period requirement for qualification as long-term capital gain with respect to certain partnership interests received in connection with the performance of services

• If the three-year period is not met, gain will be treated as short-term gain taxed at ordinary rates

Repeal of Individual Mandate

• The amount of the ACA individual shared responsibility payment is zero after December 31, 2018. The repeal is permanent

• There are no changes to the 3.8% net investment income tax or the 0.9% Medicare tax

Increase in Estate and Gift Tax Exemption

• The law doubles the estate and gift tax exemption amount – $5 million to $10 million

• The $10 million amount is indexed for inflation occurring after 2011 ($11.2 million in 2018). Phase out 1/1/26

• A married couple is therefore able to shield $22.4M from estate tax

Reduction in Corporate Tax Rate

• Corporate tax rate is flat 21% beginning in 2018

• The law reduces the 70% dividends received deduction to 50% and the 80% dividends received deduction to 65%

• Fiscal year Corporations will have a blended rate.

• JCT has estimated that this rate reduction would decrease revenues by $1.35 trillion over 10 years

Tax Rate Structure for Corporations

• Let’s compare the 21% corporate rate to some other countries’ top rates:

Argentina 35% Ireland 12.5%

Bahamas 0% Italy 31.4%

Canada 26.1% Mexico 30%

France 33.3% Spain 25%

Iceland 20% U.K. 19%

Corporate AMT

• Corporate AMT is repealed for tax years beginning after December 31, 2017

Increased Expensing

• The law extends and modifies the additional first-year depreciation deduction through 2022 (through 2023 for longer production period property)

• The 50% allowance is increased to 100% for property placed in service after 9/27/2017, and before 1/1/2023

• In subsequent years, the first year bonus depreciation deduction would phase down as follows: 80% for property placed in service after 12/31/2022 and before 1/1/2024, 60% for property placed in service after 12/31/2023 and before 1/1/2025, 40% for property placed in service after 12/31/2024 and before 1/1/2026, and 20% for property placed in service after 12/31/2025 and before 1/1/2027. Phase out 1/1/27

• For first tax year ending after 9/27/17, taxpayer can elect to claim 50% bonus first-year depreciation

• Proposal maintains the §280F increased amount of $8,000 for passenger automobiles placed in service after 12/31/2017

Increased Expensing/Listed Property

• For passenger automobiles placed in service after 12/31/17, maximum amount of allowable depreciation is:

– $10,000 for the year in which the vehicle is placed in service;

– $16,000 for the second year;

– $9,600 for the third year; and

– $5,760 for the fourth and later years in the recovery period

• Removes computer or peripheral equipment from the definition of listed property

Expansion of §179 Expensing

• The law increases the maximum amount a taxpayer may expense under §179 to $1 million, and increases the phase out threshold amount to $2.5 million

• Expands the definition of §179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging

Expansion of §179 Expensing

• Definition of qualified real property eligible for §179 expensing includes any of the following improvements to nonresidential real property after the date such property was first placed in service:

– Roofs;

– Heating, ventilation, and air-conditioning property;

– Fire protection and alarm systems; and

– Security systems

Cash Method of Accounting

• The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior tax years to use the cash method

• Exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations are retained –meaning they are allowed to use the cash method without regard to the $25 million gross receipts test

Converting to a corporation

• The tax law aims to make converting to a C corporation a little easier for companies that do so in the next two years.

– First, if the conversion requires the company to change its accounting method, and that results in more taxable income, that income is spread out over six years, rather than four (as was the case the end of December)

– Secondly, a new C corporation that distributes previously earned income can do so indefinitely under favorable pass-through instead of just in the year after the conversion.

Accounting for Inventories

• TCJA exempts certain taxpayers that meet the $25 million gross receipts test from accounting for inventories under §471:

– Treats inventories as non-incidental materials and supplies; or

– Conforms to the taxpayer’s financial accounting treatment of inventories

• This provision results in a change of accounting method for purposes of §481

Exception from UNICAP

• Businesses with average gross receipts of $25 million or less fully exempt from UNICAP. Exemptions from UNICAP that are not based on gross receipts are retained

• This provision results in a change of accounting method for purposes of §481

Completed Contract Method of Accounting

• The TCJA expanded the exception for small construction contracts from the requirement to use the percentage-of-completion method

• Contracts within this exception are those contracts for the construction or improvement of real property if the contract:

– Is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract, and

– Is performed by a taxpayer that (for the taxable year in which the contract was entered into) meets the $25 million gross receipts test

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Business Interest

• Act limits business interest deductions to 30% of adjusted taxable income. For tax years before 1/1/22, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. Each business would be generally subject to a disallowance of net interest in excess of 30% of the adjusted taxable income of the business

• Businesses with average annual gross receipts for the three-tax year period ending with the prior tax year that do not exceed $25 million would be exempt

• Any interest amounts disallowed would be carried forward to the succeeding taxable year. Business interest may be carried forward indefinitely

Business Interest Limitation

• In determining the amount of the limitation, adjusted taxable income is taxable income computed without regard to:– Any item of interest, gain, deduction or loss that is not properly allocable to a trade or business

– Any business interest or business interest income

– The amount of any net operating loss deduction

– The §199A deduction

– In the case of tax years beginning before 1/1/22, any deduction allowable for depreciation, amortization or depletion (EBITDA)

– In the case of tax years beginning after 12/31/21, any deduction allowable for interest and taxes (EBIT)

59


• Until 2022, the limit is based on EBITDA

• After 2021, the limit is based on EBIT

• EBITDA: Earnings before interest, taxes, depreciation and amortization

• EBIT: Earnings before interest and taxes

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• Taxpayers operating a “real property trade or business” may irrevocably elect to opt out of the business interest limitation

• The consequence of such an election is that all of the taxpayer’s residential rental property, nonresidential real property and qualified improvement property used in such real property trade or business must be depreciated using the alternative depreciation system (ADS)

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• ADS versus MACRS:

– Nonresidential property 40 years/39 years

– Residential rental property 30/27.5 years, and

– Qualified interior improvements 20/15 years

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Net Operating Loss Deduction

• For net operating losses arising in tax years ending after Dec. 31, 2017, the law repeals the two-year carryback and the special carryback provisions (except for certain farming losses). For losses arising in tax years beginning after Dec. 31, 2017, the law limits the net operating loss deduction to 80% of taxable income (determined without regard to the deduction)

• Carryovers to other years would be adjusted and could be carried forward indefinitely

Golden Era of C Corporations

- Consider the following fact pattern:

- Husband and Wife own a manufacturing business. Both materially participate in the business.

- The business earns $3,000,000 annually before wages or distributions

- Should the business be a C corporation or S corporation?

- Case study #1:

- Corporation would pay $500,000 out as wages to H&W and the remaining $2.5M is distributed

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Tax on $500,000 of wages: old law:

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Tax on $500,000 of wages: proposed law:

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Fact pattern 1: $500,000 of wages, remainder of $2.5 million distributed: old law

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As you can see, the double taxation of C corporations was extremely punitive.


Fact pattern 1:

$500,000 of wages, remainder of $2.5 million distributed: current law

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The gap has narrowed significantly. And that is with FULL access to cash.

Case Study #1, Current Law

• Variation: what if the corporation leaves the $2.5M in?

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Subject to the AET and PHC taxes, there is a lot of motivation to leave

cash in the C corporation, at a 20% rate.


• Variation: what if the corporation makes only a $1M dividend?

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• Variation: what if this were an accounting firm and all cash were paid out?

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The default is that service business get no benefit from the 20% deduction.


• Variation: what if this were an accounting firm and only $500K is paid out in wages?

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Leaving cash in (at least in part) offers a significant advantage to a C over a service business S corporation. 21% versus 45.6%.


• Variation: what if this were an accounting firm and $1,000,000 is distributed?

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Why did this happen?

• Corporate rate down to 21%

• All of the S corporation income is taxed at ordinary rates

• That means the gap between corporate tax rate and top individual rate has gone from 4.6% to 16.0%.

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• But here’s the kicker: Only C corporations are eligible for Section 1202 benefits. – Gain from the sale of “qualified small business stock” eligible for 100% exclusion (subject

to limitations)– MUST be a C corporation – Must have assets less than $50M – Can’t be a service business (accounting, law, etc…)– Must acquire stock at original issuance

• If you couple Section 1202 with lowered rates on corporate income and still-reduced rates on dividend income, suddenly C corporations look pretty good!

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Assume a shareholder is considering a new business, and will invest $500,000. It will earn $200K annually, distribute half its earnings as a dividend, and the s/h expects the business to be worth $3M in five years. • 2007 Landscape: • Corporate rate: 35%• Dividend rate: 15%• Section 1202: limited benefit (50% exclusion but remaining 50% taxed at 28%)1. Entity-level tax: $1,000,000 * 35% = $350,000 2. Dividend tax: $500,000 * 15% = $75,0003. Tax on sale of stock: $2,500,000 * 15% = $375,000 TOTAL TAX OVER LIFECYCLE: $800,000

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• 2018 Landscape• Corporate rate: 21%• Dividend rate: 23.8%• Section 1202: 100% exclusion

1. Entity-level tax: $1,000,000 * 21% = $210,0002. Dividend tax: $500,000 * 23.8% = $119,0003. Tax on sale of stock: $0!

TOTAL TAX OVER LIFECYCLE: $329,000

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Entertainment, etc…Expenses POP Quiz

• After 12/31/17, can your company deduct the cost of:

Entertainment, etc., Expenses

• 50% limit expanded to meals provided through an in-house cafeteria or otherwise on employer’s premises

• Deductions for employee transportation benefits (parking, mass transit) are denied, but employee exclusion from income is retained

• For tax years beginning in 2026, law disallows deduction for meals provided for the convenience of employer on the employer’s premises

• No deduction allowed for other entertainment expenses

New Credit for Employer-Paid Family and Medical Leave

• The law allows businesses a general business credit of 12.5% of the amount of wages paid to qualifying employees on family and medical leave if the rate of payment is 50% of the wages normally paid to the employee

• The credit is increased by .25 percentage points (not above 25%) for each percentage point by which the rate of payment is over 50%

• The change is effective for wages paid in tax years beginning after 12/31/17, but is not applicable to wages paid in tax years beginning after 12/31/19

Repeal of Technical Termination of Partnerships; Other Provisions

• The partnership technical termination rule is repealed

• Partnership is treated as continuing even if more than 50% of the total capital and profits interests of the partnership is sold or exchanged

• The law made other changes to partnership provisions including look-through rules for gain on sales of partnership interests and the treatment of S corps converted to C corps

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Bipartisan Budget Act /Partnership Audit Adjustments

Streamlined audit procedures –Tax years after 2017

Tax Matters Partner replaced by Partnership Representative, does not need to be a partner

Partnership Liable for tax on adjustments

Assumed at highest rates, option to demonstrate lower rates, or issue adjusted information returns, (not amended K-1).

100 or fewer partners can opt out, use general rules

Adjustments flow through to the partners

for the “adjustment”year, rather than the “reviewed” year under audit

Bipartisan Budget Act /Partnership Audit Adjustments

Streamlined audit procedures –Tax years after 2017

• In lieu of taking the adjustment into account at the partnership level, a partnership may issue adjusted information returns (i.e., adjusted Forms K-1) to the reviewed-year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment yearthrough a simplified amended-return process.

– In short: IRS will charge the partnership, and will not “do the leg work” to adjust each partner’s return.

– If the partnership chooses, they may “do the leg work”, calculate the adjustment per partner, and issue an Adjusted K-1 (not Amended).

– Provisions apply for partnership returns for tax years after 2017; however, partnership may elect to apply new procedures within 30 days of notice of audit. Proposed Regulations were withdrawn in January, 2017 but reissued with little change in summer of 2017.

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Disclaimer

• This presentation and related materials are designed only to provide generalinformation regarding the subject matter discussed during this presentation. Thestatutes, authorities, andother laws cited inthispresentation are subject to change.

• This presentation and related materials are not intended to provide tax, accounting,legal, or other professional advice to any specific person or entity. Any advice oropinion regarding the application of the subject matter for a specific person or entityshould be provided by a competent professional advisor based on an application ofthe appropriate law and authorities to the facts and circumstances applicable to thatpersonor entity.

Revenue Recognition ASC 606 Implementation

& Disclosure

Five Step Approach

• Public companies – Interim reporting periods within annual reporting periods beginning after December 15, 2017• Calendar year-end companies adopted January 1, 2018

and have been making disclosures for first two quarters of 2018

• Private companies – Annual reporting periods beginning after December 15, 2018

Effective Dates for Implementation

• Greater than 50% of private companies have not assessed impact• 17% - Implementation complete• 26% - Implementation in progress• 40% - Assessing the impact• 17% - Have not started

• Highest level of complexity• Contract reviews• Accounting policies• Business processes• Human capital

• Accounting challenges• Disclosures• Identifying performance obligations• Variable consideration

*June 2018 PwC accounting change survey

Survey Results

• Full Retrospective Method• Cumulative adjustment to opening retained earnings for

earliest period presented

• Contracts for all income statement periods presented are under new standard

• Certain practical expedients available

• Modified Retrospective Method• Two methods available (disclose method used) –

• Apply to all contracts

• Apply to contracts not completed as of adoption date

• Disclosures regarding comparability

Adoption Methods

• Full retrospective method• Nature and reason for change

• Method of adoption including description of prior period information that has been adjusted

• Cumulative impact change on earliest period

• Transition practical expedients used

Transition Disclosures

• Modified retrospective method• Nature and reason for change

• Method of adoption including description which application used

• Amount by which each financial statement line item is affected in the current reporting period compared to prior guidance

• Explanation of reasons for significant changes in above

• Transition practical expedient

• Approximately 85% of public companies adopted using modified retrospective


• More in-depth qualitative and quantitative disclosures

• Revenue from contracts with customers to be disclosed separately from its other sources of revenue

• Impairment losses from receivables or contract assets

• Disaggregation of revenue

• Contract assets and liabilities

• Performance obligations

• Significant judgments

• Costs to obtain or fulfill a contract

• Accounting policies for taxes and shipping and handling costs

Primary Disclosure Areas

• Quantitative information – categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors

• Relationship between segment reporting and disaggregated revenue

• Non-public entities must at a minimum have quantitative disclosure covering revenue from point in time versus over time

• Non-public entities must provide qualitative information regarding how economic factors affect nature, amount, timing and uncertainty of revenue and cash flows

• Contemplate others outside the company• One’s used by CODM• Other information used by those that evaluate the entities

financial performance

Disaggregation of Revenue

• Disaggregation of revenue – examples• Type of good or service

• Geographic

• Market or type of customer

• Type of contract

• Contract duration

• Timing of transfer of goods or services

• Sales channels

• Public companies typically have had greater detail than shown in segments


• Contract balances• Opening and closing receivables, contract assets and

liabilities if not separately disclosed

• Revenue recognized in the reporting period that was a beginning liability

• Timing of satisfaction of performance obligations relates to timing of payments and impact on contract assets and liabilities

• Explanation of significant changes in balances (qualitative and quantitative)

Contract Assets and Liabilities

• Timing of when obligations are satisfied (i.e., over time or point in time)

• Significant payment terms including financing components, variable consideration, constrained estimate

• Nature of goods and services to be transferred or arrange to be transferred in an agent relationship

• Obligations for refunds/returns etc.

• Warranties and similar obligations

• Transaction price allocated to remaining performance obligations

• Expected timing of revenue recognition of remaining obligations

Performance Obligations

Performance Obligations

• Significant judgments include determining transaction price (variable consideration including if it is constrained), allocation of price, measuring obligations for returns, refunds and other obligations

• Performance obligations met over time detail methods used to recognize revenue including inputs or outputs and why they are appropriate measures

• Performance obligations met at a point in time discuss any significant judgments involved in determining when customer obtains control

Significant Judgments

• Costs to obtain or fulfill a contract• Not required for private entities

• Public entities – Judgments used, amortization method and period, closing assets by category, amortization and impairment losses recognized in period

Capitalized Costs

• Disaggregation of revenues

• Performance obligations • Timing

• Payment terms

• Distinct goods and services

• Principal vs. agent considerations

• Transaction price and allocation

• Costs to obtain and fulfill a contract

SEC Comment Letter Areas

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