Source: https://www.cpataxmag.net/editor-blog-articles/49-aprilmay-cover-story
Timestamp: 2019-04-24 08:02:08+00:00

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Service Organization Control (SOC) engagements are seen as a growth area for CPA firms. John McLaughlin, CPA, Partner, Risk Advisory Services Leader, BDO in Philadelphia, stated rhetorically concerning the clients who need a SOC report, “Do you want to do it now and get some competitive advantage and be out in front and tell them, ‘I do care about security and confidentiality’”?
As part of an ongoing series on additional service practice areas for CPAs, CPA Magazine provides a glimpse into the practice of administering SSAE 16 audits by talking with one CPA with a CPA firm, one non-CPA with a CPA firm, and one non-CPA who helps CPAs handle the data security internal controls portion of the SSAE 16 audit. They are: John McLaughlin, CPA, partner, Risk Advisory Services Leader, BDO in Philadelphia, Brian Thomas, CISA, CISSP, partner in advisory services at Weaver, accounting firm, and Tony Scott, CISA, Technical Financial Solutions, LLC, data security internal control specialists, respectively.
For more information on SSAE 16 see “CPAs Expand Into SOC 2 After Death of SAS 70”. For more information on crowdfunding audits, see “Crowdfund & Small Firm Auditing”.
1. How did you get involved in SSAE 16/SAS 70 audits and what do you like about them?
John McLaughlin: I have been with BDO for two years in risk advisory practice. I was with Smart doing internal control and with PWC. I was also a controller with internal control responsibility. It is really process-oriented work and that is the way I am wired. I enjoy working with people. [In 2011] the AICPA changed the nomenclature. People are getting smarter about what they are asking. People asking for a SAS 70 really wanted a SOC 2 [Service Organization Control SSAE 16]. [It was necessary because] the needs for privacy, security and confidentiality needed to be addressed. People are becoming more aware. [For example] passwords expire and have several different characters and change every 60 days. The SAS 70 was a three-page CPA report. Attached were the controls and tests the CPA performed. In SOC reports management expresses its comfort of the controls working effectively signed by a senior officer of the company. The CEO or CFO must sign.
Brian J. Thomas: I first got involved with SAS 70 audits when I joined KPMG’s Information Risk Management practice 13 years ago and was responsible for performing IT audit procedures in support of the financial statement audit. That role evolved over time. When I came to Weaver in ‘06, I saw SAS 70s, now SSAE 16, as a good business development opportunity. I like SOC reporting because it is based on the nature of the services provided by the service organization. In other words, it is interesting because the scope and the controls are based on the nature of the service provided, and the methods by which the service organization (SO) provides its service to its customers. So, you learn a lot about the service being provided as a result of the examination.
Tony Scott: We are an IT audit firm working with CPAs. We also do SOC 2 engagements as well as HIPPA internal control audits.
2. How do you approach an SSAE 16 SOC 1 Type 2 audit engagement for a company that has not been audited before?
McLaughlin: For example, a sleeping disorder company is using sensitive health information. They gain contracts with large health systems. The health care company requires that they are maintaining the data with sufficient rigor and control. The cost is not baked into the contract. The CEO is thinking I have to spend several tens of thousands. He may as well get on board before more health companies begin demanding it. A smaller organization has a burden swallowing it, but it is not insurmountable. No one has ever said, “This was awful.” The cost could go down by a third in a year or two. There is an expansion of these service organizations. They may be privately held but are providing services for major companies. They are processing organizations. Exceptions are expected.
Thomas: If possible, these engagements should be approached with incremental progress. The worst-case scenario is that the SO has signed a contract obligating them to provide a SOC report immediately. In such cases, we are forced to perform the examination retroactively (looking backward at a period of time) and the results are what they are. These are often the most difficult reports and have a lot of findings/disclosures. It is best if the SO anticipates their future need for an SOC report and we are able to work with them in advance of any contractual or regulatory requirement. In those cases we are able to perform some preliminary gap assessment type procedures to help identify and remedy issues before the client begins their reporting period. Also, in such situations we are better able to consult with the client to define a reporting period that suits their needs (as opposed to having a reporting period dictated to them).
Scott: If a small to mid-sized firm needs a SOC audit but does not have an IT group, we get involved early as part of the sales cycle presenting to the client. We don’t bill for that. We work with the CPA firm as a team. We are going to take the framework of SOC, which is far more regimented. The Trust service principles (TSPs) are loaded up in a matrix, and then determine the tests to be performed. Most are very technical. The CPA will fold that in to their report utilizing their auditing workpapers from PPC or whoever. The CPA firm may be billing in six installments, we can bill the CPA firm based on work in progress on hours spent, or monthly billing.
3. Assuming the company has under 200 employees and $10,000,000 in revenue, how many and what type of staff are required to compete the audit through to the report?
McLaughlin: You have blended talents. You have people with a hybrid background from undergraduate. Many people cannot write well these days. Some are good at it. To be an IT auditor and process auditor you need to be able to write. When I recruit I am looking for writing skill in addition to the liberal arts skill of writing.
Thomas: This is not very easy to answer because it depends greatly on the nature of the services and the organization. However, as a broad guess, in this situation I would suggest that the number of staff involved on the client’s side would typically be five to ten key personnel providing the vast majority of the information to the auditor.
4. How long does it take on average?
McLaughlin: It depends on how much discipline management has, in program change control. How many people are new? How many programs do they run? How sophisticated is the work force. A SOC 1, Type 1 [report] anticipating a later Type 2 would include a scoping exercise, where gaps are identified by the company and the CPA. Type 1 is asserting that the controls were designed properly and worked on that day. If the company had decent controls it could be done in a couple of weeks. Section 3, describing management’s controls is time consuming.
Thomas: The minimum period that can be covered for a SOC 1 Type 2 report is six months. So, if we begin the examination May 1, the period will not be over until October 31. Reporting typically takes several weeks after that (six weeks is common).
5. How long do you need to be on-site?
Thomas: Again, this will depend heavily on the nature of the scope of the examination and the nature of the services provided by the SO. But, typically for an SO of this size, I would suggest a few days at the beginning of the reporting period; then a few days again during the middle of the reporting period; and then two to four weeks at the end of the reporting period.
Scott: We do business across the country. We do interim and final work; it takes about a week each time.
6. What problems do you encounter?
McLaughlin: Problems run the gamut. Many of these companies have not been around for 50 years. They are fast growing. They spend more time on growth than on structure of their processes.
Thomas: Common problems in smaller SOs include lack of segregation of duties, informal/undocumented procedures. Common problems in all first-time SOC reports involve whether the SO will have proper documentation to support the execution of a control activity over the entire reporting period.
7. What software helps with the internal control testing questions about the system?
McLaughlin: We use IDEA to make statistical selection and random number generation. We utilize segregation of duties analyzers we developed. We use our workpaper software application.
Thomas: Change control/versioning software; event logging; workflow documentation tools; IT ticketing systems.
Scott: We use a service called Ignite, as the file server for the client to upload files using Ignite with a secure log-in. Some CPA firms have their own binder for their audit engagement software for CPA firms.
8. What is the range of costs if there are no problems?
McLaughlin: In year one the heavy lifting includes the report on controls, which takes time and skill. Some companies say, “We will write Section 3 of the report”. [However] there is a style and skill necessary for other companies to understand the report. The detail takes a lot of time and focus. It takes a couple weeks to write the report depending on how much the client is available. Type 2 would take a year, sometimes 6 months. They can have an affiliation with a CPA firm somewhere. Do you have security processes and authorities documented and how do you hire? Is the change for these well documented and approved? They see the controls as slowing them down. We are looking for policies followed. I don’t know how they [a CPA firm] can quote a fixed cost.
Thomas: This varies wildly for a variety of reasons I cannot adequately disclose in this response.
Scott: SAS 70 was very competitive. Cost cutting could be half the price. A CPA could not reduce hours to that level. It takes more work now. It is [documenting] TSPs, and you have to cover them where they apply. Typically it is a 50/50 split [of work for the CPA firm and our firm]. We have done the lion’s share of the testing on the engagement. The CPA firms are happy with the engagement. It is solid work for us. The firms we are working with each have one client that returns each year. It is very meaningful for a small firm that does not want their client to go to a larger firm.
9. What is the exposure for risk? Does it require a special provision for professional liability insurance?
McLaughlin: I don’t know if there are lawsuits. If we are attesting to standards no matter what we are attesting to is based on clear and sufficient evidence. Do we feel comfortable to measure our own risks? It’s all risk reward. The greater fee may be necessary and we always consider due professional care.
Thomas: The risk is that a user of the report places reliance on the SO’s report and the controls therein. If the report is wrong, this could have an impact on the financials of the user organization.
Scott: The opinion is written on the CPA firm letterhead. It is their opinion. It is similar to a financial statement audit when they need IT expertise.
10. Do you also perform SOC 2 and SOC 3 attestations?
McLaughlin: The cost of SOC 3 is incremental. Section 1 is the CPA report. Section 2 is management’s assertion. Section 3 is the biggest part of the report that describes what management does, how controls are assembled and processed. Section 4 is where the tests are articulated within a matrix.
11. What software helps with the trust service criteria questions?
McLaughlin: For a SOC 2 we scope it with the five principles of trust service principles emphasizing which ones customers are most interested in. AT 101 to 801 from AICPA represents the framework.
Scott: PPC has a high-level framework. We use the trust service principles (TSP) loaded into a spreadsheet.
12. What situations do you find performing SSAE 16 pre-assessment engagements?
McLaughlin: The readiness assessment is determining what the user organization needs in order to narrow down the scope. Who is responsible? Who is involved? How many are involved? The next question for a SOC 1 is what controls are necessary. Security: logical and physical, program change control, systems operations, and backups.
13. What problems occur post-engagement, for example do clients refer to themselves as SSAE 16 Certified like they did with SAS 70?
McLaughlin: People are becoming more sophisticated about management’s assertion. There will always be rogue organizations, but most are recognizing the boundaries of what they can or can’t say. On the face of the report we put Private and Confidential. They will share with their customers.
Thomas: Yes, and they like to make inappropriate claims in their news releases. In some cases they also like to post all or a portion of the report on their website, which is also prohibited. At Weaver, we try to advise our clients on the appropriate language to use when describing their accomplishment, including sometimes reviewing their news releases.
The need for CPA audits and reviews is expected to explode based on the Jumpstart Our Business Startups (JOBS) Act stock offering exemption. Section 4 of the Securities Act of 1933 is amended to permit crowdfunding investments in the stock of companies defined as emerging growth companies (EGC) of up to $1,000,000. Non-accredited investors may invest 5% of their annual income that is under $100,000 or $2,000 each.
The JOBS Act, signed April 5, recognizes crowdfunding as an offering of unregistered securities through a registered Internet intermediary website or broker from a large pool of investors. With only eight months remaining before the SEC issues its final standards for crowdfunding, the time for CPAs to begin preparing is now.
Different offering amounts have different SEC standards. If an EGC plans on raising between $100,000 and $500,000 their financial statements would have to be reviewed by a CPA. Those looking to raise more than $500,000 and up to $1 million are required to have their financial statements audited.
To invest in an exempt EGC, “you are limited on crowdfunding to 5% of $100,000 net worth or income. If the net worth is [between] $100,000 and $1 million, its 10%,” said Executive Director and founder of the National Crowdfunding Association (NLCFA), David Marlett.
Prior to enactment of the JOBS Act entrepreneurs and charities had success on the Internet raising money from contributors in exchange for rewards or completed products. Carl Esposti, founder of crowdsourcing.org runs the research firm Massolution which identified 452 crowdfunding platforms (CFPs) worldwide. Esposti told CPA Magazine that these CFPs raised almost $1.5 billion in 2011.
To learn about the impact of the JOBS Act and what it could mean for CPAs, we talked with Marlett a little more. Marlett is an attorney and non practicing CPA who describes himself as being like a vampire hunter who’s job is to weed out the hucksters they may be involved in crowdfunding.
“This entirely revolutionizes our financial system, this eight-decades-old law since the 1933 SEC act,” said Marlett. “The industry will need counsel on how much equity to give away. January 1, the gates are open. They [the SEC] may take longer. It’s good it didn’t start yet because nobody knows what they are doing. There would be too much fraud.
Douglas S. Ellenoff, a member of the law firm Ellenoff Grossman & Schole LLP, attended meetings between several department heads of the SEC and the crowdfunding industry in April. Ellenoff told CPA Magazine a $25 to $35 thousand audit fee for a private placement (including due diligence), which has been normal over the last 20 years, will be too high for a crowdfunding deal.
Richard Salute, a CPA with JH Cohn in New York, told CPA Magazine that you can’t speculate on the audit costs.
“99% of the time there must be comfort given outside of the financials,” said Salute. “There are also tax implications for the investor and the entity. The real question is going to be that historical information is not as essential as the business plan and how management can execute the plan. I believe the entity needs to create adequate transparency. This will separate the wheat from the chafe. There may be sustainability plans that predict a near term business model, which will help toward valuation which will drive this asset class.
“[SEC] Chairwomen Schapiro wants the rules to be clear to protect the investors. The secret sauce is the efficiency of the raise. It tries to take friction out of the process. Under Reg. A, you did not have to issue financials.
“To my way of thinking, it’s not just the fees; it’s the value you attribute to the stock, if you are getting a quid pro quo. An audit under generally accepted auditing standards requires 100-300 hours at $150 an hour, up to $250 an hour. A review would be much less, but you can’t speculate on it,” Salute warned.
Not everyone is a crowdfunding fan. Some believe the legislation increases the likelihood that individuals will invest in startups and lose money because the companies are riskier. The director of investor protection at the Consumer Federation of America sees Crowdfunding as something that has precisely the same place in the average person’s investment portfolio that lottery tickets do. Salute found this statement disappointing.
“If it is seen as a lottery ticket, it reduces the job formation possibilities and detracts capital formation,” said Salute.
The JOBS Act prevents States from policing crowdfunding offerings until an alleged fraud has been committed. People will now need to do more research before they use the online sites.
“Yeah, so there is going to be fraud,” said Marlett. “Every individual has a criminal intent sometimes. It [the JOBS Act] can’t limit this. So we do have rules to limit investors, to immediately know when the limits are reached. Humans are very creative about cheating each other.
“I have been in the boiler rooms where the idea is to take your money, to strategize, to come up with these things. We need to protect the grandmother who invests $2000 and then is asked for more money the next year. The danger is not grandmas’ $2000, but the over regulation that makes it [funding] too expensive.
This changing startup environment has revealed a tremendous opportunity for CPAs. The JOBS Act will now introduce new entrepreneurs to the world of professional accounting much earlier causing a rise in demand for CPAs.
“The existing companies may be able to raise money more easily, but there will be more startups,” said Marlett. “CPAs can make money just getting companies ready. The minimum $100,000 [level] may not even have a CPA.
This new market focus for CPAs will require new skills and the enhancement of old skills. Marlett explained the finer details.
“The secret sauce of crowdfunding is thirds. The perfect balance, the golden mean of the Greeks was the perfect thirds,” explained Marlett. “Number one is the pledge you [the investors] are making to an escrow agent, but you [the crowdfund issuer] have to reach your ask. There have to be [say] 99 others willing to make the pledge. It helps encourage investment. The issuer cannot spend it because the escrow agent will hold it. Number two is the 2% fraud, which empirical data shows [crowdfunding] reduces fraud. Number 3 is [when] right around 40% of pledges are made then the total will be made. Who makes the 38% and who makes the final 62%? The original [group] are friends, family and community. So [then] the unknowns become interested. This is the perfect balance the Greeks believed.
Marlett emphasized how important it is for CPAs to mobilize, be proactive and take this new challenge head on immediately.
The Blue Ribbon Panel (BRP) concluded that the current U.S. accounting standard-setting process has systemic issues involving (a) an insufficient understanding of the needs of users of private company financial statements and (b) an insufficient weighing of the costs and benefits of GAAP for use in private company financial reporting.
These issues have caused a lack of relevance for a number of accounting standards — for example, those on variable interest entities, uncertain tax positions, fair value measurements, and goodwill impairment — for many users of private company financial statements.
Since it also appears that the least relevant standards for private company users are often the most complex, the BRP believes that private companies are incurring significant unnecessary costs for GAAP financial statement preparation and audit, review, or compilation services.
There are approximately 28 million private companies in the United States. Many are very small businesses that have no reporting requirements other than filing income tax returns. However, a significant number of private companies are required to prepare GAAP financial statements by lenders, bonding companies, regulators, and others.
These increasing instances of nonacceptance, coupled with a concern about the overall complexity of GAAP expressed by many private company preparers and their CPA practitioners led the BRP to conclude that, at a minimum, the current accounting standard-setting system needs to be improved to better address the needs of users of private company financial statements in a cost-effective manner.
The new board would consist of members that are representatives of the private company sector and would work closely with the FASB. The new board would have the responsibility to conduct outreach to private company stakeholders and provide input and feedback to the FASB. Nothing would preclude the FASB from receiving input from private companies, but the specific responsibility for seeking such input would reside with the new board.
According to Mark Zyla, a CPA practicing in Atlanta, “Standard setters do not understand decision-useful information from the perspective of private company financial statement users and have not weighed the costs and benefits of GAAP for private company financial reporting. These shortcomings have led to standards that lack relevance for many users and to standards with a level of complexity that is a burden for private companies and their CPA practitioners.
The BRP recommends a U.S. GAAP model with exceptions and modifications for private companies, with process enhancements. A supermajority of BRP members further recommend that a separate private company standard-setting board under the Financial Accounting Foundation (FAF) be established to ensure that those enhancements are made and result in appropriate and sufficient exceptions and modifications for private companies.
Billy Atkinson spoke as a representative of NASBA with a consensus opinion of several committees to report there was no need for a separate board. It is the minority opinion of the 18-member panel.
“The State Boards determine the standards. So we are asking the state board members what they think,” Costello said.
The FAF has formed a board to review the recommendations from the BRP.
Depending on the report of the state boards this information will also be made available to FAF.
David Costello, CPA, is the outgoing CEO of NASBA and has led the public accountancy profession for several years. His departure will be sorely missed.
In 2002, CPA Magazine selected Tax All-Stars in various areas of specialization. Each CPA selected was provided with their own baseball card facsimile. Since then, CPA Magazine has recognized several tax gurus in its annual Top 40, 50 or 100 CPAs across this great country of ours. The Top 50 rankings only permitted about 25 words of tax advice from each of these beacons of tax tactics. The All-Star recognition provided a few more words on the back of the framed photo of the CPA All-Star.
For 2011, we searched for representative experts to guide our CPA readers based on the theme of each issue. This issue, the theme is personal tax, now personified by the form number, ‘1040 tax.’ To grace the pages of an authoritative print magazine in a decade where few printed magazines remain, each CPA All-Star in this issue unselfishly provided responses to very useful questions for our readers who extended returns for their clients and can still take advantage of this sage advice without amending.
The well deserving CPA All-Stars for this issue are: Bill Briggs, CPA, Lisa Foley, CPA and Jerry Love, CPA. If you have nominations for CPA All-Stars for Business Tax, Tax Research, Succession Planning or Tax Season, please contact us soon so everyone can benefit from their storehouse of tax acumen.
William “Bill” C. Briggs, CPA, is the head of the tax department at Citrin, Cooperman & Company, LLP in Philadelphia. With nearly 20 years of experience, Briggs specializes in tax planning and compliance services for closely held corporations, partnerships and high net-worth individuals.
Lisa DeVaughn Foley, CPA, is the president of Lisa DeVaughn Foley, PSC (a member of Baldwin CPAs, PLLC) in Richmond, KY. Lisa has been in the field of public accounting for over 16 years and is a member of the AICPA, Kentucky Society of CPAs and the Society’s Continuing Professional Education Committee.
Jerry Love, CPA, is the owner of Jerry Love CPA, LLC, a full service tax, accounting and business-consulting firm located in Abilene, TX. Over the past 35 years Love served as president or chairman of more than 14 nonprofit organizations. In 2009, CPA Magazine listed Mr. Love as one of the Top 40 Tax Advisors to Know During a Recession.
CPA Magazine: Personal taxes and 1040 tax prep affect all taxpayers; what attracted you to personal tax?
Briggs: What attracted me to personal income taxes was the fact that with proper planning you can potentially save people money, and on those occasions, when I am successful with an idea that saves someone money, it gives me a good feeling and sense of pride.
DeVaughn Foley: My main attraction to personal tax preparation was, first and foremost, being able to work with and help individuals by making a difference with their finances. Secondly, the ever-changing rules and regulations affecting 1040 tax preparation provide an environment of continued learning and growth that I see as challenging and rewarding.
Love: It seemed to be expected that if you are a CPA you know a lot about taxes. Add to this that it is a rewarding challenge to help someone minimize his or her tax liability.
CPA Magazine: Do you believe 2010 is one of the most complex years for tax planning and why?
Briggs: Each year seems complex, especially when there has been a recent tax change, but 2010 brings its own unique challenges. We have had several tax law changes in 2009, and the most recent tax law change was adopted very late in the year. Most of an individual’s tax planning is done throughout the year and in 2010, the rules changed near the end of the game.
DeVaughn Foley: 2010 is absolutely one of the most complex years for tax planning in recent times. A total of four tax bills were passed during the year with many changes that can significantly impact individual taxpayers. Additionally, the final bill now known as The Tax Relief Act of 2010 was passed in late December, leaving very little time to digest the bill and take action on planning opportunities for our clients for the current 2010-tax year.
Love: It is a very challenging year because of how late the Congress made changes and the fact that they made changes in so many of the bills that were passed. In the past, we often had one major tax bill that included most or all of the significant changes.
CPA Magazine: With 2010 behind us what is the most significant thing CPAs can do to prepare their clients for 2011, and how should they advise them?
Briggs: In 2011, there are significant benefits available as a result of the most recent tax law change. Informing clients about the benefits available and helping them plan throughout the year is the best way to help our clients prepare and hopefully, save money.
DeVaughn Foley: I will be focusing on income tax rates with my clients moving forward. We now know with certainty what the regular income tax and capital gain/dividend rates are through at least 2012, so shifting taxable income into 2011 and 2012 will be important as rates will most likely have to increase at some point in the near future including the looming Medicare tax on net investment income in 2013.
I will also be focusing on estate and gift planning for clients in 2011 and 2012. The Tax Relief Act of 2010 provides a $5 million exemption per individual for estate and gift taxes, which will need to be considered for current gifting opportunities.
Love: If the client has a potentially taxable estate, they need to address estate planning.
CPA Magazine: For taxpayers extending until October 17, what is the best advice CPAs can provide their clients for 2010?
Briggs: Extensions are merely an extension of time to file. It is not an extension of time to pay. Even if a client is planning to extend, we should get an idea of what they are going to owe and pay by April 15 in order to avoid penalties and interest.
DeVaughn Foley: Remember the extension is for filing only! We need to work with our clients to properly estimate any tax due and pay that balance on April 18, 2011 to avoid costly penalties. Also, encourage your clients to gather their information as soon as possible so any tax issues are addressed early or tax planning opportunities are not lost due to passage of time.
Love: Get as much of the client’s information together and to their CPA several weeks before April 18 so that an adequate estimate of their taxes can be made to allow the client to make a full payment of the estimated taxes with the extension.
CPA Magazine: In 2010, converting to a Roth IRA was recommended to pay taxes before they increased and to keep income out of estates. Without a tax increase and a $5M exemption for estates, what is the situation for clients who converted from traditional IRAs in your view?
Briggs: First off, an individual can reverse their decision regarding the conversion by the due date of the return (including extensions). With that said, the conversion, under the right circumstances, makes sense because the future growth would be earned tax-free. Also, the idea that taxes will not increase is not necessarily correct. The current freeze on the Bush Tax Cuts is only for two years, so the conversion now may save taxes in the future.
DeVaughn Foley: A Roth conversion, despite no tax increases and the new $5 million estate exemption, still has many benefits. First and foremost, post-death distributions from the Roth IRA to beneficiaries are tax-free. Clients will have paid tax at the low rates in existence now and will be able to leave tax-free money to their heirs who could possibly be in a higher bracket upon receipt of a taxable, traditional IRA regardless of the $5 million estate exemption.
Secondly, tax rates are going up at some point, so converting at lower rates makes sense and thus any earnings can continue to grow tax-free in the Roth format. Lastly, Roth distributions, if taken (not required, unlike RMD rules for traditional IRAs), will not factor into the 3.8% Medicare surtax in 2013.
Love: I believe the Roth conversion is a complex area that requires careful consideration on a client-by-client basis. To some extent, the consideration is a financial analysis of the time value of money in addition to the need to make estimates for what future tax laws will set the tax rates for income taxes and if there will be further changes to the estate taxes.
CPA Magazine: The American Recovery Act of 2009 expanded the HOPE education credit and renamed it the American Opportunity Tax Credit (AOTC). How do clients take advantage of this credit for 2010?
Briggs: The American Opportunity Credit is available for 2010. The credit amount is the sum of 100 percent of the first $2,000 of qualified tuition and expenses plus 25 percent of the next $2,000 of tuition paid for a maximum credit of $2,500. The credit amount phases out ratably for taxpayers with adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).
A big benefit to this credit is that up to 40 percent of the credit amount is refundable should a taxpayer’s tax liability be insufficient to offset the credit. In other words, a student could get 40 percent of his/her credit even when his/her tax liability is less than $2,500.
DeVaughn Foley: The AOTC is allowed for qualified tuition and related expenses paid for each student’s first four years of college. The credit is 100% of the first $2,000 of expenses and 25% of the next $2,000 for a maximum credit of $2,500. The credit phases out for single taxpayers with MAGI of $80,000 to $90,000 and for married filing jointly MAGI of $160,000 to $180,000. The credit is computed on Form 8863 and 40% of the credit amount is refundable.
Love: By filing Form 8863 with their return (or amended return) to claim a maximum credit of $2,500 against their tax liability subject to the credit being phased out based on adjusted gross income. Subject to an exception, 40% of the credit for 2010 is refundable.
CPA Magazine: The Qualified Principal Indebtedness Exclusion of up to $2 million of cancellation of debt income for mortgage foreclosures in 2010 if used to acquire, construct or improve the taxpayer’s principal residence, but not for all foreclosures. How do you advise clients with foreclosures not included in this Exclusion?
Briggs: A foreclosure is the same as a sale for the balance of the mortgage and keeping track of what the potential gain or loss on that foreclosure is key. In dealing with the issue of cancelation of indebtedness, there are a number of exceptions to having to recognize that income. I work with my clients, who are unfortunately in those situations, to explore those exceptions and if the exceptions are not available, work on the timing of the transaction.
Love: If a client had discharge of indebtedness related to their personal residence in 2010, they should bring all relevant information to their CPA for analysis. The CPA needs to determine the amount of the discharge to ascertain if it was less than $2 million or more than $1 million if married filing separate.
Next, the CPA should ascertain that the discharged indebtedness was incurred in the acquisition, construction, or substantial improvement of a principal residence. It also includes refinancing of debt to the extent the amount does not exceed the amount of the indebtedness being refinanced.
The CPA should also verify with the client that the residence meets the definition of their “principal residence” as defined under the exclusion of the gain for the sale of their personal residence (Code Sec. 108(h)(5)).
And finally the CPA should document for the client that their tax basis in the residence is reduced by the excluded amount but not below zero. The form to complete and attach to the return is Form 982.
CPA Magazine: The credit for home energy-efficient upgrades, such as new windows and doors was worth up to $1,500 in 2010 but has been reduced for 2011; did clients take advantage of this credit, and how can they in 2011?
Briggs: In my experience, many clients did take advantage of the credit in 2010. There was quite a bit of advertising on these benefits, and it appears that many of my clients did take advantage before limitations were put in place in 2011 and beyond.
DeVaughn Foley: Many of our clients have taken advantage of the $1,500 credit over the 2009 and 2010 tax years mainly on qualifying windows, doors and/or heating units. A big factor in encouraging this credit has been the knowledge of vendors to use this credit as incentive in their sales pitch.
The Tax Relief Act of 2010 did extend the credit, but in a much-reduced state. For 2011, the credit is a lifetime credit of $500 (including previous years) which can be made up of no more than $200 for windows, $150 for certain furnaces and $300 for any other item of energy-efficient property meeting minimum energy standards.
An important note to keep in mind for 2011 is that if a taxpayer has taken an energy credit in any prior year totaling $500 then no further energy credit will be allowed on a 2011 return.
Love: I have had several clients who have installed energy efficient storm windows or have replaced either hot water heaters or central air conditioning units and will be able to claim the credit.
Many of these clients were making the replacement out of necessity and were informed by the service technicians that the equipment would qualify for a tax credit and the client was calling to verify this. A few saw advertising or heard about the storm windows qualifying and decided it was time to replace some windows.
CPA Magazine: 1099 reporting for payments over $600, non-credit card vendors in 2012, is a concern for most small businesses; how do you advise clients to deal with it?
Briggs: Hopefully, the expanded 1099 reporting will be repealed. The President said as much in the State of the address. However, if it is not repealed, small business owners should keep account of amounts paid by vendor and get Employer ID Numbers from those vendors.
DeVaughn Foley: We have been warning our clients since summer that 1099 reporting requirements are about to change — BIG TIME! We hope to see some changes or repeal in this area, but there are no guarantees. We have to plan on what we know. We are encouraging our clients to go ahead and start obtaining W-9s for vendors as they pay bills in 2011 in an effort to lessen the burden as 2012 rolls closer.
Love: We have been informing clients about this and the potential need to keep information by vendor in order to comply, including getting W-9 info from each vendor. However it looks like the Congress may repeal this. So we are continuing to hope for repeal of the requirement.
CPA Magazine: How do you advise clients taking the home office deduction on depreciation and decorating?
Briggs: Regarding the home office deduction, the taxpayer should keep a record of the square footage of the office as compared to the house in total. With regard to depreciation, keep track of the basis of the house including improvements. Decorating expenses should be limited to the actual office itself.
DeVaughn Foley: The main hurdle in the home office deduction is supporting the deduction with proof of exclusive and regular use of the space as a principal place of business or as a place to meet or deal with clients and customers in the normal course of business. If you meet this requirement, then the home office deduction is available to the taxpayer, which includes depreciation of the portion of the home so utilized over 39 years.
Once depreciated, this part of your home no longer qualifies for personal residence gain exclusion upon sale and depreciation will have to be recaptured at a current maximum rate of 25%. The depreciation portion of the home office is not optional — depreciation must be considered on gain calculations whether or not deducted on prior returns. Decorating expense of the home office is a depreciable item as well. Taxpayers must carefully consider the gain consequences of having a home office versus the current benefit of the tax deduction in their decision to claim a home office deduction.
Love: Generally, we advise clients to not depreciate their home because of the ability to exclude the gain when they sell it. We also talk to them about the nature of the home office and the extent that regulations require the exclusive use of the office space for business purposes.
CPA Magazine: How do you advise clients who take business travel deductions for foreign travel or educational cruises?
Briggs: Regarding foreign travel and education cruises, it pays to be smart and make an allocation between the cost that is related to the education or business as compared to the personal portion. It never pays to deduct 100 percent of the cost.
Love: As I understand this issue, the taxpayer has a burden of proof that the primary reason for the expenditure is for educational purposes related to their job or business. Therefore, they need to have supporting documentation that would support how much time they spent in the conference and the nature of the program including who sponsored it and the relevance to their production of income.
CPA Magazine: What are the most overlooked deductions by high-wealth taxpayers in your experience?
Briggs: Investment related expenses as well as business expenses that they incur and pay for personally related to their business.
DeVaughn Foley: High-wealth taxpayers with earned income often fail to realize they can setup a defined-benefit (DB) pension plan that can allow for very large current tax deductions. For instance, if a taxpayer over age 50 has $100,000 of earned income, they could possibly contribute the entire $100,000 into the pension and thus pay no tax on that income. DB plans involve many actuarial calculations so they can be expensive to maintain but for some wealthy clients, DBs provide a great tax deduction.
CPA Magazine: Are Health Saving Accounts (HSAs) benefitting small business clients, since the Health Insurance bill was enacted?
Briggs: I have seen Health Savings Accounts being utilized by many small businesses, especially with the cost of health insurance continuing to skyrocket.
DeVaughn Foley: We have not seen a big increase in usage of HSAs since the Health Care Reform Act was passed in 2010. The increase in HSA usage with our clients has been spurred more by economic factors than the Reform or tax deductions. Our clients have moved to HSAs as a way to control health insurance expenses for their small businesses. HSAs do provide a great way to put money away with tax-free growth for future medical expenses.
Love: Yes, I am seeing many more businesses establish health saving accounts as a method to contain the cost of health insurance, and I see many individuals participating.
CPA Magazine: What problems do you expect in the perception of Registered Tax Return Preparers compared to CPAs?
Briggs: I don’t see any problems in my experience in this area.
DeVaughn Foley: I fear the public perception that a “registered” preparer is comparable to a CPA will have a very negative effect on our industry. CPAs understand that the test for “registered” preparers is not stringent enough for this perception, but educating the public of the differences will be a difficult task.
As individual CPAs we need to stress the expertise difference in our local communities as well as seek support from State and National organizations to promote the value of being a CPA in response to new IRS registrations.
Love: I see the public being further confused by national advertising that implies that any one registered is competent when that will clearly not be the case.
CPA Magazine: How do you spend your free time when you are not dealing with taxes?
Briggs: In my free time, which is becoming less and less, I like to play golf, read and work on my model trains.
DeVaughn Foley: In my free time, I enjoy cooking and traveling with family and friends and attending and watching college football and basketball. Go UK Wildcats!
Love: My wife and I enjoy ballroom dancing and are members of a local group called Learn to Dance Club, which meets monthly to have a group lesson, dinner and time to practice our ballroom dancing. It is a great way to get some exercise while insuring at least one date per month. My wife is the President/CEO and I am the Treasurer.
Tapping into the knowledge of premier tax software developers comes as we celebrate 20 years of publishing periodicals for CPAs. While it has always been a tenant of journalistic purview to have articles written by practitioners, it now makes more sense to key into the vast reservoir of tax expertise the top tax developers must maintain in order to develop tax preparation and in some cases, tax research software for what amounts to all of the 20,000 readers of CPA Magazine. Every CPA is technology-dependent on the work tax software developers perform in order to be efficient and correct with every tax return they prepare. As the IRS recently learned, the majority of taxpayers use either a practitioner or tax software to complete their taxes. Indeed, since the onset of AMT software is essential. Of necessity, tax software developers have become more adept and not just to the technology, but the tax law and interpretation in order to make professional tax preparation evermore capable of determining the tax due.
Now that we have explained the rationale for having tax developers offer tax tips to practitioners, let’s just say we are glad we did. As we turn to the tips provided, we find a wide variety of tax ideas. Accounting Practice Sales offers tips on what to consider when allocating assets when selling your practice. 2nd Story Software suggests sending thank-you cards to clients and referring sources as cost-effective ways to build your practice. Taxsoftware.com quotes a survey from Synovate from February of this year that reveals more clients will spend their refunds on vacations (30% vs. 16% in 2006) and less on charity (15% vs. 20% in 2006). CCH Small Firm Services reminds practitioners of the importance of data storage and backup, reminding us of the record keeping requirements of e-filed returns found in IRS Publication 1345.
Intuit provides tips relevant to deductions available to clients seeking employment as well as eligible deductions for education expenses used to improve skills on the job. CCH, a Wolters Kluwer business concentrates its advice on the virtual office and social media, recommending that clients no longer have to come into firm offices for appointments. Thomson Reuters Tax and Accounting provides topical advice for reporting IRA conversions. Drake Software gets specific on incorporating an electronic filing system in the era of electronic filing in order to avoid a $50 penalty for failure to maintain a copy of each return prepared for three years. Fortunately for us, and our CPA readers, there is a diverse set of tips from a terrific group of tax thinkers.
Feeling a collective calm now that the bulk of tax season is over? Take advantage of this lull to get organized for tax season 2011.
First, make sure you have backup copies of returns and that all supporting documentation is scanned and attached to client returns. Update your client lists and contact information, add birthday reminders and schedule next year’s preparation notices.
In addition, use the down time to catch up on networking opportunities. Word-of-mouth and referral sources are the least expensive ways to acquire customers. Get involved in community events and attend local networking functions. Write personal thank-you cards to customers and be sure to recognize people who have referred your services.
Strategize for next year’s tax season. Set goals and expectations. What facets of your business need improvement or change? If you plan to make a software switch, allow for ample time to test new software and import client documentation. TaxACT will import data from PDFs of returns prepared by competitor software. You can try all the features in TaxACT 2010 Preparer Editions free of charge, starting in May.
Finally, stay current on your licensing and education, the ever-changing IRS rules and regulations, and, of course, don’t forget to do your own taxes.
Two tax questions often come up whenever a CPA is selling his or her practice.
One has to do with the allocation of the sales price. Generally, the price needs to be allocated between goodwill, fixed assets and the non-compete agreement. This allocation is most often done in conjunction with the buyer, but be aware that the allocation will make a difference in the tax you might end up paying as opposed to how the buyer will be affected.
Goodwill is most often the major portion and for the seller, usually the more here the better. But, the IRS does not like to see zero in the fixed assets column. Also, there are some possible legal implications to allocating some price to the non-compete, so be sure to consult an attorney.
The other major consideration is the entity you are in. Surprisingly, there are still CPAs operating as a C-Corporation, although, that will most likely cost them dearly when they get ready to sell.
Now is the time to review your entity status in order to see what tax implications will be involved in a sale, even if that sale is years down the road.
As we head into the Spring and Summer months, it’s time to start thinking about how your client engagements and firm marketing and recruitment plans will be impacted by new technologies.
Firms will be open to more technology-based solutions to address their business challenges.
If you ignore the technology curve, you will be at a disadvantage.
Virtual Client Interaction Solutions such as portals, video conferencing, and social media will change the way firms communicate with their clients and prospective clients.
There’s no longer a need for clients and potential customers to come in-office for an appointment.
Firms can schedule appointments, answer questions, request and receive source documents, provide consultation services and deliver tax returns digitally.
Engagement costs will decrease while customer satisfaction and retention rates should increase.
Answers will no longer be a phone call away — they will be a mouse click, interactive chat or video conference away.
Social media is increasingly important to a CPA firm’s marketing and recruitment strategy. It can be leveraged to engage clients, prospects and even future employees through one-on-one and group conversations. Social media is quickly changing the online marketing and recruiting strategies for thousands of businesses across the world. So if you haven’t given this exciting dynamic some thought, now’s the time to start developing your Social Media strategy and ride the wave to free exposure, stronger referrals, more valued clients, increased profits and a boost in your recruiting efforts.
During tax season, it’s easy for professionals to get distracted by their workload. It’s not until disaster strikes — through a computer crash, a flood or even a break-in — that they consider the effects of lost data. In order to protect your firm, it’s crucial to implement a data backup and storage plan.
This may sound like a daunting task, but in reality it can be accomplished by simply defining what, where and when.
What: Identify the information needed for your records, while keeping in mind professional regulatory demands. For record-keeping requirements for e-filed returns, see IRS Publication 1345.
Where: Make sure all stored files are organized in a way that lets you quickly find the documents you need. It’s also important to make multiple backups. Many professionals backup data daily to two storage devices, leaving one in the office and storing the other off-site. USB drives are ideal for this purpose.
When: The key to successful data storage resides in a regularly maintained back-up schedule. If you don’t have an automated backup system, create a reminder in your calendar or cell phone. Don’t forget that additional workstations such as home office PCs or field laptops will also need to store their data at regular intervals.
A trend emerging in data storage is a switch from physical devices like backup servers and tape to online systems. Online data storage can provide several benefits such as automated file backup, data encryption and 24/7 access — not to mention the relief in knowing your data is safe from potential disasters.
Treasury regulations require tax preparers to keep a copy of any tax return or claim for refunds they complete. Copies of returns must be retained and kept available for inspection for three years following the close of the return, which is the day that the return was presented to the taxpayer for signature. Failure to comply with this retention requirement can result in a $50 penalty for each failure, unless that failure was due to reasonable cause and not just willful neglect.
Tax preparers must also supply taxpayers with a copy of the tax return no later than when the return is presented for signature. The copy can be presented in any media, including a form of electronic media (for instance, a PDF version of the return saved on a CD or flash drive) that is acceptable to both the taxpayer and tax preparer.
The most efficient way to comply with these record retention and distribution requirements is to have a system that stores records as a by-product of the preparation cycle. This can be most easily accomplished by using tax software that includes an electronic filing system. The tax software produces the tax return (as a printed or electronic document) for the taxpayer, while the filing system stores all documents and helps the preparer meet the document retention requirement. Tax software also helps the preparer comply with the new federal e-file mandate.
Incorporating an electronic filing system into your tax-preparation business is an important step forward into the era of digital tax preparation.
The U.S. economy and the job market are showing signs of improvement. You may have clients who are looking for work or are engaged in work-related training. The government provides several tax incentives that might put some money back in their pockets when they file their returns. The Internal Revenue Code allows for certain expenses to be categorized as employee business expenses.
Tax professionals can deduct client’s expenses incurred in connection with searching for employment in his/her present occupation, even if he/she didn’t land the new job. The deduction will be disallowed if 1) the client is looking into a brand new occupation; 2) there is a significant time lapse between the end of his/her previous job and the search for a new one; or 3) the client is looking for his/her very first job. The following expenses qualify for the deduction: employment agency or counseling fees; resume preparation and postage; and travel and transportation.
Education expenses can be deducted even if the training eventually leads to a degree. However, the training must maintain or improve the client’s skill set in his/her current position and the training must be required by an employer or the law in order to maintain the client’s current salary or status. Deductible expenses include tuition, books and supplies. On the other hand, the deduction will be denied if the education is 1) needed to meet the minimum education requirements in your client’s position or 2) the program will qualify him/her for a new trade or business. For example, a person would not be able to deduct the cost of a medical degree if he/she had not already entered into the profession.
A change in the tax rules led many taxpayers to convert traditional IRAs (or other eligible retirement plans) to Roth IRAs in 2010 even though the conversion is taxable. You must file Form 8606 to report a conversion from a traditional IRA to a Roth IRA. On Part II of Form 8606, you report conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs. Rollovers from qualified retirement plans to Roth IRAs and in-plan rollovers to designated Roth accounts are reported on Part III of Form 8606.
Unless you elect otherwise, half the income from a rollover or conversion in 2010 is included in income in 2011 and the other half in 2012. Normally, you want deferral. But there are times when deferral may not be the best choice. If, for 2010, you have deductions that could offset the income and/or credits that could reduce or eliminate the tax on the income, you may want to elect to include the income from the conversion on your 2010 return. Also, if your income was low in 2010 and will be higher in 2011 and 2012, electing to be taxed on the conversion in 2010 may be the better choice.
You elect to be taxed in 2010 by checking a box on Form 8606 and entering the taxable amount of the conversion on the appropriate line of your return. If you choose to be taxed in 2010, you must do so for all 2010 conversions and rollovers to Roth IRAs. Once you make the election, you cannot change it after the due date (including extensions) for your 2010 tax return.
File for a six-month automatic extension, which gives you until Oct. 17, 2011, to have a clearer picture of your 2011 income. This will help you decide whether to make the election.
According to a new survey, 30% of taxpayers plan to spend their anticipated federal and state tax refunds on vacations. This is up dramatically from 16% from a similar poll in 2006.
More people plan to spend their refunds on savings or investments this year than in 2006 (66% v. 55%) or to pay off debts (59% v. 52%).
Fewer people plan to give their refunds to charity (15% v. 20%).
About the same percentage plan to make home improvements (31% v. 30%); buy products such as cars, electronics, or furniture (23% v. 24%); or pay mortgages or education loans (19% v. 20%).
Those who plan to “do something else” with their refunds rose to 38% in 2011, up from 27% in 2006.
The online survey was conducted Feb. 1 — 3, 2011 by Synovate, and has a margin of error of plus or minus four percent. The survey consisted of 1,000 responses by adults 18 years of age or older in the contiguous United States.

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