25th Annual Health Sciences Tax Conference · · 2015-12-04system, without written ... unrecognized tax benefit (UTB) tabular rollforward disclosure. ... multiple-employer welfare

25th Annual Health Sciences Tax ConferenceAccounting for income taxes – exempt organizations

December 9, 2015

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Disclaimer

► EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

► This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

► Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP.

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

Accounting for income taxes – exempt organizations

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Presenters

► Terence M. KennedyErnst & Young LLPCleveland, [email protected]+1 216 583 1504

► Raymond LeeErnst & Young LLPAustin, [email protected]+ 1 512 473 3446

► Michael P. VecchioniErnst & Young LLPDetroit, [email protected]+1 313 628 7455


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Agenda

► Accounting for income taxes of exempt organizations► Uncertain tax positions► Deferred taxes and valuation allowances► Affordable Care Act tax exposures► Recent accounting pronouncements► Regulator focus on audited financial statements► Error corrections versus changes in accounting estimates► Income tax-related financial statement concerns► Tax provision best practices► Questions?


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Accounting for income taxes of exempt organizations


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Accounting Standards Codification (ASC) Topic 740

► ASC 740 addresses financial accounting and reporting for the effects of income taxes that result from an entity’s activities during the current and preceding years.► Exempt organizations – May not have any income tax effects

► Still document exempt status► Taxable subsidiaries and unrelated business income activities

► ASC 740 still applicable► Financial statement impact depending on materiality


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Review of overall exempt status

► Current documentation► IRS Select Check review

► Public charity status► Compliance with Section 509(a)(3) reporting requirements

► Transactions with officers, directors, trustees and key employees

► Governance issues► IRC Section 501(r) compliance

► Hospital specific

► Lobbying activities


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Taxable subsidiaries and unrelated business income tax calculations

► Unrelated business income taxes► New revenue sources/businesses► Estimated unrelated business taxable income► Alternative and foreign investments

► Taxable subsidiaries► Consolidated groups► Tax sharing agreements


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Non-income tax considerations

► Indirect taxes ► Property► Sales and use► Medical device excise tax► Other non-income taxes

► Tax-exempt financing► Compliance requirements

► Compensation reporting► State filing requirements


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Uncertain tax positions


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Accounting for uncertainty in income taxes

► Benefit recognition model► Tax position must meet minimum recognition threshold before

being recognized in financial statements

► ASC Topic 450 is not applicable to income taxes► Applies to all companies, including non-public entities► Determination that exempt status is highly certain► Review of less-than-highly certain positions


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Uncertain tax positionsPresentation

► Difference between tax benefit as (or to be) reflected in the income tax return and the amount recorded in the financial statements should be classified as either:► A current or non-current liability

Or ► A reduction of deferred tax assets (DTAs) for a temporary difference, a net

operating loss (NOL) carryforward, similar tax loss or a tax credit carryforward

► The amount expected to be paid in the next year should be classified as a current liability.

► Indirect tax effects on other tax positions:► State taxes often have an indirect effect on federal taxes. ► Indirect tax effects on other tax positions are not included in the

unrecognized tax benefit (UTB) tabular rollforward disclosure.


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Uncertain tax positionsPresentation – Accounting Standards Update (ASU) 2013-11

► Assume tax position is disallowed at the reporting date► If net settlement of a net operating loss, similar tax loss or tax credit

carryforward and an unrecognized tax benefit is required or expected, present liability associated with uncertain tax benefit as a reduction to related DTA for net operating loss, similar tax loss or tax credit carryforward

► If net settlement is not required or expected, present uncertain tax benefit as a liability; not combined with DTA

► Not expected to change DTA realizability assessment► Does not change disclosure requirements of uncertain tax positions► Effective for fiscal years and interim periods beginning after:

► Public entities: December 15, 2013 ► Non-public entities: December 15, 2014


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Uncertain tax positionsDocumentation

► Nature and extent of documentation required may vary based upon the character of the uncertain income tax position

► Distinguish between “highly certain” tax positions and tax positions for which greater uncertainty is present► Highly certain tax positions are based on clear and unambiguous

tax law► Clearly meets more-likely-than-not recognition standard and there is a

greater than 50% likelihood that 100% of benefit will be sustained


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Deferred taxes and valuation allowances


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Evaluating the need for a valuation allowance

► DTAs represent future tax deductions (or tax carryforwards/tax credits)

► Reduced by a valuation allowance (VA) if it is more likely than not (>50%) that some portion, or all, of the DTAs will not be realized► Evaluation is made on a gross basis – common pitfall► Based on weight of all available evidence► Depends on sufficient taxable income

► Consider four sources of income► Not existence of DTA; only realizability – common pitfall► Consider presentation of valuation allowance

(current/non-current)


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Evaluation of positive and negative evidence

► Weight given to evidence should be commensurate with the ability to objectively verify it

► Examples of positive and negative evidence include:

Negative evidence Positive evidenceCumulative pretax losses in recent history (generally three years) or projections of cumulative pretax losses – common pitfall

Existing contracts or firm sales backlog

History of carryforwards expiring unused Strong earnings history, exclusive of loss that created the future deductible amount, coupled with evidence that the loss is an aberration

Brief carryback, carryforward periods Implemented cost reduction plans that can be objectively verified (however, consider any effects on revenues)


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Cumulative losses in recent years

► Calculation► Cumulative pretax income or loss for three years (current year and

two preceding)► Annual calculation – common pitfall► Exclude only the cumulative effect of accounting changes

► Not an “on/off” switch► Does not, in itself, result in a conclusion of the realizability of

deferred tax assets – common pitfall ► Quantitative considerations► Qualitative considerations

► Significant piece of negative evidence that is often difficult to overcome


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Releasing a valuation allowance

► What framework do I apply when determining whether to release a valuation allowance?► Same framework ► Change in circumstance causes change in judgment about

realization in future years► Key considerations

► Extent of positive and negative evidence that exists► Ability to rely on future projections of income

► Return to profitability► Not an “on/off” switch► No quarterly rolling reversal


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Recap of common pitfalls

► Is the timing of reversal of deferred tax losses (DTLs) considered?► “Naked tax credits” resulting from indefinite-lived intangible assets

► Does a tax planning strategy result in a projection of future taxable income?

► Are DTAs recognized based on projections of future taxable income, when the company is in a cumulative loss position, has a going concern opinion or has recently emerged from bankruptcy?

► Is the company considering a rolling reversal of valuation allowance upon sustained profitability?

► Has a cumulative loss been considered a bright line or “on/off” switch requiring a valuation allowance?

► Is the valuation allowance presented appropriately on the balance sheet (current vs. non-current)?


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Key takeaways

► Must consider all sources of income in assessing realizability

► Determination of whether a company is, or is not, in a cumulative loss position does not, in itself, result in a conclusion as to the realizability of deferred tax assets

► Avoid common valuation allowance pitfalls


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Affordable Care Act tax exposures


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Affordable Care Act (ACA) considerations

► Employer mandate is generally effective January 1, 2015► Significant excise tax penalties for ACA failures► A company may need to recognize an accrual for the

resulting loss contingency► Employers should account for uncertainties resulting from

a lack of clarity in the provisions of the employer mandate (e.g., certain aspects of the definition of a full-time employee) under the loss contingencies accounting guidance (ASC 450)


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ACA considerations

► Key questions:► Have all potential full-time employees been identified and how?► Is there a system in place to appropriately track hours of service?

Is it compliant with ACA rules?► Was the population of contingent workers, interns, transfers,

international assignees, etc. reviewed under the “common law” definition of employee?► Form 1099 workers may be considered employees for the ACA.► Do any potential employee categories signal a risk under the ACA?

► Is the coverage offered considered “affordable” and does it provide minimum value?

► Has the company taken any steps to mitigate the risks associated with contingent workers?


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ACA considerations

► The ACA imposes a nondeductible fee on each covered entity engaged in the business of providing health insurance for US health risks.► A covered entity is generally any entity with net premiums written for

health insurance for US health risks during the fee year that is:► A health insurance issuer within the meaning of Internal Revenue Code (IRC)

Section 9832(b)(2) ► A health maintenance organization within the meaning of IRC

Section 9832(b)(3) ► An insurance company subject to tax under Subchapter L or that would be so

subject to tax but for being exempt under IRC Section 501(a) ► An insurer that provides health insurance under Medicare Advantage, Medicare

Part D or Medicaid ► A non-fully insured, multiple-employer welfare arrangement

► The permanent nondeductible fee can be a material item.


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Recent accounting pronouncements


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ASU 2013-06, Not-for-Profit Entities (Topic 958): Services Received from Personnel of an Affiliate

► Recipient not-for-profit should recognize all personnel services received from all affiliates (both for profit and not for profit) that directly benefit the recipient not for profit entity and for which the affiliate does not seek compensation

► Generally measured at the cost recognized by the affiliate in providing those services

► If cost measure significantly overstates or understates the value of those services, may elect to measure those services at fair value

► Effective for fiscal years beginning after June 15, 2014, and interim and annual periods thereafter


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ASU 2014-09, Revenue from Contracts with Customers (Topic 606)

► Developed to:► Improve comparability of revenue recognition practices across companies,

industries, jurisdictions and capital markets► Provide more useful information to users of financial statements through

improved disclosure requirements

► Replaces virtually all existing US generally accepted accounting principles (GAAP) guidance on revenue recognition

► Uses broad principles rather than prescriptive guidance► Requires more estimates and judgments than current guidance► Financial Accounting Standards Board (FASB) and International

Accounting Standards Board (IASB) Joint Transition Resource Group and other implementation groups have been created


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► As modified by the FASB in ASU 2015-14, the effective date for public business entities, certain not-for-profit entities and certain employee benefit plans is for annual periods beginning after December 15, 2017, and interim reporting periods within that reporting period.► This effective date applies to a not-for-profit entity that has issued, or is a

conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an over-the-counter market.

► Non-public entities are required to adopt the new guidance for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. ► Non-public entities are not required to apply the guidance in the new

standard in interim periods within the year of adoption.


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► Core principle: recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

Step 1: Identify the contract(s) with the customer

Step 2: Identify the performance obligations in the contract

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to the performance obligations

Step 5: Recognize revenue when (or as) each performance obligation is satisfied


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► Health care implementation issues► Application of Steps 1 and 3 for self-pay patients► Determination of the transaction price for third-party settlements► Application of the portfolio approach► Consideration received before Step 1 criteria are met► Changes in disclosure requirements from ASU 2011-07► Identifying performance obligation(s) and accounting for

refundable and nonrefundable entrance fees of continuing care retirement communities

► Prepaid health services► Contract acquisition costs


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► Tax technical considerations► Taxpayers will need to determine when and how any change in

revenue recognition for financial reporting purposes is recognized for tax purposes.► For taxpayers applying a deferral method for advance payments, the

amounts deferred for tax purposes are determined by reference to the amounts deferred for financial statement purposes.

► Taxpayers should consider whether a change in revenue recognition for financial statement purposes is also a permissible method for tax purposes.

► Taxpayers may need to review the methodology for compiling sales apportionment data.


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► Income tax accounting considerations► Current and deferred tax consequences of the cumulative effect

adjustment reported in the period of adoption► Requires careful consideration of the income tax accounting effect of

individual items included in the cumulative effect adjustment ► New temporary differences may arise or existing temporary

differences may be computed differently► Companies may need to revise their processes and data collection

tools► Valuation allowance considerations may change

► Changes in deferred tax assets, temporary difference reversals or expected future taxable income may affect judgments regarding the realizability of deferred tax assets


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FASB proposed ASU – presentation of financial statements of not-for-profit entities and health care entities (Topics 954 and 958)

► Objective is to reexamine existing standards for not-for-profit (NFP) financial statement presentation with a focus on improving:► Net asset classification requirements► Information about liquidity, financial performance and cash flows

► Proposed amendments would require NFPs to:► Present two classes of net assets: with donor restrictions and without

donor restrictions► Present intermediate measures of operations► Use the direct method of reporting cash flows provided or used by

operating activities


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Status of the FASB’s proposals on changes to simplify income tax accounting

► Companies that present classified balance sheets currently are required to classify deferred tax assets and liabilities as current or non-current, based on how the related assets or liabilities are classified.

► If a deferred tax asset or liability is not related to an asset or liability for financial reporting purposes (e.g., a deferred tax asset related to a net operating loss carryforward), the deferred tax asset or liability is classified as current or non-current based on the expected reversal date of the associated temporary difference.


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Status of the FASB’s proposals on changes to simplify income tax accounting

► The FASB reaffirmed its proposal to require companies to classify all deferred tax assets and liabilities as non-current. ► In addition, under this proposal, companies would no longer be

required to allocate valuation allowances between current and non-current deferred tax assets because those allowances also would be classified as non-current.

► While the FASB’s decision would change the way deferred taxes are classified on the balance sheet, companies would still be required to offset deferred tax assets and liabilities for each taxpaying component within a tax jurisdiction.


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Regulator focus on audited financial statements


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Regulator focus – realizability of deferred tax assets

► How evidence was weighted ► Cumulative losses► Consideration of the four sources of taxable income,

including the prominence of each source and the material uncertainties, assumptions or limitations associated with each source

► Timing and reason for changes in valuation allowance► Consistency of assumptions► Consistency of accounting with management discussion

and analysis (MD&A) disclosures


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Error corrections versus changes in accounting estimates


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Return-to-provision adjustments – change in estimate or correction of an error?

► A temporary difference is defined as:► A difference between the tax basis of an asset or liability

(computed in accordance with ASC 740) and its reported amount in the financial statements

► In preparing its tax return, a company may identify a difference between the tax basis used to compute a temporary difference and the tax basis used for the tax return.

► Differences may also arise related to income taxes payable, tax credit carryforwards or other income tax accounts.


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Change in accounting estimate

► Results from new information► Accounted for in the period of change or the period

of change and future periods if the change affects multiple periods► No retrospective adjustment or restatement

► May require disclosure depending on materiality and whether the change is expected to affect future periods


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Correction of an error

► Examples include:► A change from an accounting principle that is not generally

accepted to one that is generally accepted► Corrections of mistakes in the application of US GAAP► Corrections of mathematical mistakes► Oversight or misuse of facts that existed at the time the financial

statements were prepared

► Requires restatement of prior period financial statements (if material) or correction in current period if immaterial

► Determine if there are deficiencies in internal control


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Key takeaways

► A change related to a prior period that did not result from new information is an error and requires additional consideration under ASC 250.

► Refer to EY’s Financial Reporting Developments: Guide on accounting for income taxes, accounting changes and error corrections for additional information.


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Income tax-related financial restatement concerns


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Income tax-related financial restatement concerns

► General causes:► Application of tax technical rules

► Tax basis ► Intraperiod tax allocation

► Interim periods► Accounting for outside basis differences► Realizability of deferred tax assets

► Tax planning strategies► Deferred tax liabilities as source of income

Income tax errors continue to be a leading cause of restatements.


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Income tax-related financial restatement concerns – realizability of DTAs

► Same framework► Establishing a valuation allowance for the first time► Determining whether a valuation allowance continues to

be necessary

► Have all four sources of taxable income been considered?► Future reversals of existing taxable temporary differences

► Evaluate DTAs on a gross basis ► Consider the timing of reversal of existing taxable temporary

differences ► Common pitfall: DTAs evaluated on a net basis► Common pitfall: naked credits are used as a source of taxable

income


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Tax provision best practices


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► Accelerate work during quarters and interim:► Evaluate and record return-to-provision adjustments► Prove out deferred tax assets/liabilities, current taxes payable/receivable

► Prepare analysis before filing tax return to identify errors in the return

► Document/analyze state tax rates, including apportionment changes and the impact on deferred taxes, and foreign tax rates for changes

► Document outside basis differences, including indefinite reinvestment assertions and prepare outside basis difference calculations (consider previously taxed income and unrecaptured Subpart F income)

► Document valuation allowance considerations (four sources of taxable income) and prepare position paper

► Document uncertain tax positions► Consider tool to improve efficiency and accuracy of computations


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► Institute regular meetings with external auditors regarding contemporaneous issues (significant transactions, changes in business, etc.)

► Annually challenge prior year processes to identify areas for improvement► Simplify, standardize and add controls to existing Excel templates► Address technical issues early and prepare white papers for consideration by

management and external audit► Implement standardized global procedures► Consider the tax provision process a year-round area of continued focus► Identify a third party to assist with preparation or review of the provision (pre-

audit review) or co-source/outsource to free up internal time for review► Obtain assistance researching and documenting issues or preparing white

papers on tax accounting positions


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Questions?


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25th Annual Health Sciences Tax Conference · · 2015-12-04system, without written ... unrecognized tax benefit (UTB) tabular rollforward disclosure. ... multiple-employer welfare