Tax accounting update and tax controversy issues

Tax accounting update and tax controversy issues

Tax accounting update and tax controversy issues September 20, 2018 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 2018 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 taxpayers facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2 Tax accounting update and tax controversy issues Presenters Terence M. Kennedy Ernst & Young LLP Cleveland, OH [email protected] +1 216 583 1504 Eileen Webb Ernst & Young LLP Pittsburgh, PA [email protected] + 1 412 644 0485

Page 3 Mackenzie McNaughton Ernst & Young LLP Minneapolis, MN [email protected] +1 612 371 6371 Tax accounting update and tax controversy issues Objectives Explain the structure of the IRS Tax Exempt and Government Entities Division. Identify current IRS exempt organization examination procedures. Review pertinent tax accounting matters that apply to exempt organizations.

Page 4 Tax accounting update and tax controversy issues Agenda Tax controversy and examination update IRS Tax Exempt and Government Entities Division Exempt organizations (EO) EO examination procedures EO examination issues Accounting for income taxes of EOs

Uncertain tax positions Deferred taxes and valuation allowances Tax accounting implications of tax reform Accounting standards update Tax provision leading practices Questions Page 5 Tax accounting update and tax controversy issues Tax controversy and examination update Page 6

Tax accounting update and tax controversy issues IRS Tax Exempt and Government Entities (TE/GE) division Page 7 Tax accounting update and tax controversy issues IRS TE/GE division One of four IRS divisions Divided into three segments: 1. Employee Plans (EP) Retirement plans, IRAs and related trusts Plan participants and beneficiaries Employer sponsors of retirement plans

2. Exempt Organizations Page 8 Organizations exempt from income tax under Internal Revenue Code (IRC) Section 501 (including private foundations and organizations described in IRC Section 170(b)(1)(A)(except clause (v)) Political organizations described in IRC Section 527 Organizations described in IRC Section 4947(a) Prepaid legal plans described in IRC Section 120 Welfare benefit funds described in IRC Section 4976 Tax accounting update and tax controversy issues IRS TE/GE division

3. Government Entities/Shared Services (GE/SS) Page 9 Federal, state and local governments Indian tribal governments Tax-exempt bonds Tax accounting update and tax controversy issues IRS TE/GE division Mission To provide our customers with top quality service by helping them understand and comply with applicable tax laws and to protect the public interest by applying the tax law with integrity and fairness to all

Customer profile Page 10 Customers include small local community organizations, municipalities, major universities, large pension funds to small business plans, state governments and participants of complex tax-exempt bond transactions Tax accounting update and tax controversy issues IRS TE/GE division Activities Education and communication to help customers understand their tax responsibilities Rulings and agreements to provide an emphasis on up-front compliance, such as the determination and voluntary compliance programs

Examinations to identify and address non-compliance Customer account services to provide taxpayers with efficient tax filings, as well as accurate and timely responses to questions and requests for information Coordination with other IRS divisions and oversight entities, including the Department of the Treasury, Department of Labor, Pension Benefit Guaranty Corporation, Congressional committees and state governments Page 11 TE/GE Office of Chief Counsel responsible for private letter rulings, drafting guidance and regulations Tax accounting update and tax controversy issues IRS TE/GE division Leadership team David Horton Acting Commissioner

Robert Choi Acting Deputy Commissioner Justin Abold-LaBreche Acting Director, Government Entities/Shared Services Catherine Jones Acting Director, Employee Plans Christie Jacobs Director, Indian Tribal Governments/Tax Exempt Bonds Margaret Von Lienen Director, Exempt Organizations Page 12 Steven A. Martin Director of Rulings and Agreements Maria Hooke Director of Exempt Organization Examinations

Steven M. Martin Director of Compliance Planning and Classification Tax accounting update and tax controversy issues IRS TE/GE division Exempt organizations Director Margaret Von Lienen Rulings and Agreements Determinations Determinations Quality Assurance EO Knowledge Management Program Management

Examinations Page 13 Examination Programs and Review Five Examination Field Areas Exempt Organizations Compliance Area (EOCA) Tax accounting update and tax controversy issues IRS TE/GE division 2017 reorganization Some exam-related functions consolidated across TE/GE division Exam functions still separate within each segment (EO, EP, GE)

Consolidated the EO, EP and GE exam case identification and selection functions to one division under the GE/SS division Newly formed office of Compliance Planning and Classification (CP&C) Steven M. Martin, Director Page 14 Tax accounting update and tax controversy issues IRS TE/GE division 2017 reorganization New CP&C office includes the former EO Compliance Strategies Critical Initiatives (CSCI). Analytics and issue identification Planning and monitoring, including EO annual workplan

Former CSCI functions listed in Internal Revenue Manual (IRM) 4.75.8 Federal, state and local (FSL) functions moved from GE into EO Page 15 Important for employment tax exam implications Tax accounting update and tax controversy issues Polling question no. 1 Which of the following is not one of the main activities of the IRS TE/ GE division? Education and communication Rulings and agreements

Issuing Treasury regulations Examinations Page 16 Tax accounting update and tax controversy issues EO examination function Page 17 Tax accounting update and tax controversy issues EO examination function TE/GEs EO group examinations Employment tax (ET) activities EO has jurisdiction over the employment tax returns filed by tax-exempt organizations. For an EOs employment tax responsibilities, refer to:

Page 18 IRM 4.23.2.4.3, TE/GE Employment Tax Program Responsibilities IRM 4.75.12.5, Examination Jurisdiction Reorganization brought FSL function within EO to broaden employment tax knowledge (FSL/ET). Tax accounting update and tax controversy issues EO examination function TE/GEs EO group examinations International activities EO has jurisdiction over tax-exempt organizations that conduct activities outside the United States.

Compliance responsibility includes identifying whether charities maintain adequate discretion and control over funds transferred overseas to determine that the funds are being used for exempt purposes. Page 19 Tax accounting update and tax controversy issues EO examination function TE/GEs EO group examinations Patient Protection and Affordable Care Act (ACA) activities Page 20 EO oversees compliance by tax-exempt hospitals with the ACA. This oversight includes reviewing: Compliance with the ACA as described in IRC 501(r), Additional Requirements for Certain Hospitals

Excise tax under IRC Section 4959, Taxes on Failures by Hospital Organizations See IRM 4.75.9.3 for information on the ACA Review Group and identification of hospital facilities. Tax accounting update and tax controversy issues EO examination function TE/GEs EO group examinations EOCA The purpose of the EOCA is to achieve the following: Address potential non-compliance primarily using correspondence contacts Perform an in-depth compliance review of an EOs operations and activities Leverage EO examination resources to increase contacts in the EO community The EOCA manual contains the overview and functions, which include the following: Exempt Organizations Compliance Unit (EOCU) ACA hospital review groups Page 21 Tax accounting update and tax controversy issues EO examination function EO examinations

The EOCA performs a variety of work, including: Educational workstreams Compliance checks Case building Office/Correspondence Examination Program (OCEP) Compliance reviews Page 22 Tax accounting update and tax controversy issues EO examination function TE/GEs EO group examinations EOCU audits are derived from the following sources: Compliance initiative projects Compliance checks with questionable entries, large, unusual or questionable (LUQ) items and partial or no replies EOCA classification Service-wide programs and projects Case Selection and Delivery group at the EO examinations level Page 23

Tax accounting update and tax controversy issues Polling question no. 2 Over which of the following activities does TE/GEs EO segment not have jurisdiction? Tax-exempt organizations that conduct activities outside the United States State unrelated business income tax returns filed by exempt organizations Employment tax returns filed by exempt organizations Compliance by tax-exempt hospitals with the ACA Page 24 Tax accounting update and tax controversy issues EO examination issues

Page 25 Tax accounting update and tax controversy issues Current EO examination issues Discussion of recent taxpayer examination experiences Unrelated business income examinations Section 501(r) examinations Employment tax examinations Tax-exempt bond examinations Page 26 Tax accounting update and tax controversy issues Current EO examination issues

TE/GE FY18 Work Plan Annual publication communicating the TE/GE division accomplishments and areas of focus Specific reference to areas of exam and compliance Page 27 Compliance strategies Supporting organizations: examine entities that state they are supporting organizations and filed the Form 990-N Previous for-profit entities: examine organizations that operated as for-profit entities prior to their conversion to IRC Section 501(c)(3) organizations

Private benefit and inurement: examine organizations which show indicators of potential private benefit or inurement to individuals or private entities Data-driven approaches: Models: continue to improve Forms 990, 990-EZ, and 990-PF compliance models and test the newly developed model for Form 5227, Split Interest Trust Information Return Private foundations: continue to examine private foundations based on potential anomalies found on their Form 990-PF filings Tax accounting update and tax controversy issues General EO examination issues TE/GE FY18 Work Plan Page 28 Compliance checks: EO exam will continue to use compliance checks to determine whether an

entity is adhering to recordkeeping and information reporting requirements. Compliance checks include: Combined Annual Wage Reporting (CAWR) employment tax: tax-exempt employers that had discrepancies between Form W-2 and Form 941/944 CAWR Federal Unemployment Tax Act (FUTA): exempt organizations that are required to, but fail to file Form 940 Form 990-T non-filer: IRC Section 501(c)(7) organizations that reported investment income on Form 990/990-EZ, but did not file Form 990-T Financial assistance policy: tax-exempt hospital organizations that did not comply with IRC Section 501(r)(4) Tax accounting update and tax controversy issues General EO examination issues

TE/GE FY 18 Work Plan FSL/ET items of focus Page 29 Compliance strategies: Form W-2/1099 matches: examine entities where payments reported on Form 1099 should have been treated as wages subject to Federal Insurance Contribution Act (FICA) tax and income tax withholding FUTA tax: address situations where an IRC Section 501(c)(3) organization handles payroll that includes employees of a related IRC Section 501(c)(4) organization, but does not pay the FUTA tax on the employees of that IRC Section 501(c)(4) organization Notice CP 2100 backup withholding: examine entities that failed to comply with backup withholding requirements due to mismatched and/or missing taxpayer identification numbers on Form 1099 Tax accounting update and tax controversy issues General EO examination issues

Audit Technique Guidelines (ATGs) for Exempt Organizations ATGs recommend specific examination techniques, explain specialized business practices and terminology, and explore issues common to certain types of exempt organizations. The material in the ATGs is drawn from former Internal Revenue Manual (IRM) 4.76, Exempt Organizations Examination Guidelines, which was removed from the IRM in September 2017. For uniformity and consistency with other parts of the IRM, the IRS moved the technical guidance information formerly found in this IRM to ATGs. https://www.irs.gov/charities-non-profits/audit-technique-guides-atgs-forexempt-organizations Page 30 Tax accounting update and tax controversy issues EO examination procedures Page 31

Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.3: Start of Field Audit (01-18-2017) Publication 1 is a two-sided document that encapsulates eight specific rights, as well as explanations of the examination, collections, appeals process and refund claims. Page 32 When Publication 1 is enclosed with the initial information document request, contacts to third parties for information not in the possession of the taxpayer can occur 10 calendar days after the letter was sent. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.4 (01-18-2017) Interview Under IRC Section 7602(a)(3), examiners are authorized to take testimony from persons concerned, under oath, as may be relevant or

material to the inquiry. Interviews provide information about the taxpayers financial history, business operations, and books and records that are not available from other sources. Interviews should be used to obtain information needed to make informed judgments about the scope and depth of the examination and correctly resolve issues. Interviews are used to obtain leads, develop information and establish evidence. Interviews should be conducted with an individual having sufficient knowledge of the organizations activities and operations. Page 33 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.4 (01-18-2017) Interview Page 34 IRC Section 7521(c) states that an examiner cannot require a taxpayer to

accompany an authorized representative to an examination interview in the absence of an administrative summons. The examiner can request the taxpayers voluntary presence at the interview as a means to expedite the examination process. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.5.1 (01-18-2017) Evaluation of Internal Controls Examiners should evaluate the existence and effectiveness of an organizations internal controls and expand or contract the scope of the examination accordingly. Examiners should discuss internal controls with the organizations officers or management early in the examination. This should generally be done during the initial interview. Examiners should explain the significance of internal controls in the context of tax-exempt organizations. In doing so, the examiner should emphasize the importance of proper stewardship of the tax subsidy afforded by the rest of the taxpaying public. Page 35 Tax accounting update and tax controversy issues

EO examination procedures IRM 4.75.11.6 (01-18-2017) Tour of Facilities Regulation Section 301.7605-1(d)(3)(iii) states: Regardless of where an examination takes place, the Service may visit the taxpayers place of business or residence to establish facts that can only be established by direct visit, such as inventory or asset verification. The Service generally will visit for these purposes on a normal workday of the Service during the Services normal tour of duty hours. The physical observation of the organizations operation, or tour of business site, is an integral part of the examination process. Page 36 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.8 (01-18-2017) Audit of Books and Records

Page 37 An examination of books and records will establish whether an organization is both organized and operated for tax-exempt purposes, what related returns have been or need to be filed by the organization and whether any tax reported is reasonably correct. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.8 (01-18-2017) Audit of Books and Records While reviewing books and records, keep in mind the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), P.L. 114-113 requirements. The PATH Act requires all revocations to be treated the same. Page 38 All revoked exempt organizations now have declaratory judgment rights. Therefore, the examiner is strongly encouraged to create an administrative

record file or folder at the beginning of every Section 501(c) and (d) audit and to keep it up to date as the audit develops. While the examiner is not required to create an administrative record file or folder until there are indications of a proposed revocation or an adverse change in foundation status, the IRM indicates that it works to the examiners benefit to start one early. See IRM 4.75.32.4.1, Preparation of the Administrative Record, and IRM 4.75.32.6, Examiners Responsibility. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.8.1 (01-18-2017) Governing Instruments For organizations exempt under IRC Section 501(c)(3), Section 501(c)(9) and Section 501(c)(17), a determination application that includes the organizing documents is required to be filed prior to the receipt of a determination letter. No other code section requires the filing of an application for exemption prior to filing the Form 990. Procedures for closing cases where no determination application was filed (and was not required) are found in IRM 4.75.16.5.9, Status 36 Cases.

For organizations exempt under a group ruling (identified by the group exemption number) there will be no determination file for the specific entity. Page 39 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.8.1 (01-18-2017) Governing Instruments Page 40 The examiner should review the organizations governing instruments to identify the following: Any amendments or changes that would jeopardize the organizations exempt status Any committees with special responsibilities

Who controls the organization, both ultimately and in day-to-day operations Duties of officers, especially noting which officials are authorized to disburse funds and make decisions affecting the operations of the organization Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.8.3 (01-18-2017) Minutes The examiner should review minutes for the year under examination, prior years and subsequent years. At a minimum, coverage should include at least the year before and the year after the return under examination. The examiner will expand the review as circumstances warrant. When, or if, challenged over the ability to request the minutes of prior and subsequent years when auditing just a single year, notify the organization that the examination concerns any activities conducted in the year under examination that were started, carried on or concluded in a prior/subsequent year. Alternatively, obtain managerial approval to expand the examination into prior and subsequent years.

Page 41 Tax accounting update and tax controversy issues Polling question no. 3 Which of the following is typically not one of the purposes of an interview as part of an examination? To obtain leads To develop information To establish evidence To identify any amendments or changes to governing documents that would jeopardize the organizations exempt status Page 42 Tax accounting update and tax controversy issues

EO examination procedures IRM 4.75.11.8.7 (01-18-2017) Leases, Mortgages, and Loans Consider reviewing questionable leases, mortgages and loans, particularly those with officers or other related parties. Determine whether private individuals are receiving any form of inurement or whether the organization has executed any agreements not in furtherance of its exempt purpose IRM 4.75.11.8.10 (01-18-2017) Financial Records Page 43 A review of the financial information generally reveals important information about the organizations activities. Additionally, it verifies that the information reported on the tax return is correct. Sampling of the transactions also determines the strength or weakness of the internal controls. Tax accounting update and tax controversy issues EO examination procedures

IRM 4.75.11.9 (01-18-2017) Reconciliation of Books and Records The examiner should reconcile the return to the organizations books. This is necessary to verify all transactions reported on the return have been recorded in the books. IRM 4.75.11.10 (01-18-2017) Comparison of Prior and Subsequent Year Financial Information Page 44 Compare the year under examination with prior and subsequent year income and expense statements to identify any large or questionable differences between years. Identification of amounts reported in only one year, but not other years, may indicate unusual, one-time transactions. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.11 (01-18-2017) Review of Chart of Accounts

The examiner should review the chart of accounts for unusual accounts or accounts that should appear but are absent. IRM 4.75.11.12 (01-18-2017) Review of Financial and Management Reports Page 45 Review audit reports (both external and internal), as well as the management letter from the exempt organizations CPA. The latter report provides useful information on internal controls and the organizations accounting procedures. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.13 (01-18-2017) Accountants Work Papers Request and review the accountants tax reconciliation workpapers. They provide a good starting point for reconciling the return to the books.

Tax reconciliation workpapers, unlike audit workpapers, should be requested at the beginning of an examination. There is a need for these workpapers, since they include the final balance tying the return to the general ledger and other analyses necessary to complete the return. Page 46 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15 (01-18-2017) Analysis of Accounts The following procedures can be performed during the pre-examination phase or in the field. To perform these procedures prior to the field visitation, the general ledger and chart of accounts must be obtained in advance of the audit requested in the initial information document request. Identify certain accounts for further analysis to determine the source of the revenue or expenditures. An organizations utilization of its resources and expenditures are important indicators of an organizations programs and activities. Page 47

Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15 (01-18-2017) Analysis of Accounts Page 48 Look for any unusual or nonrecurring items. Items may be unusual by amount, source or nature. Unusual in amount amounts which are much larger or smaller than typical entries to an account Unusual by source Source, as used here, means the journals from which the account was posted, as indicated in the folio column. There is a normal source pattern for most postings and any deviations from the norm should be investigated, such as a payroll entry in the office supplies account. Unusual by nature such as credit entries in accounts usually containing only debits or accounts which exist at the beginning of the year, but do not exist at

the end Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.1 (01-18-2017) Sampling Techniques With certain small organizations, there may be no need to sample documents, as the agent can review all of the records in the span of a day or two. All other organizations have far too many records to review in the limited time that an agent spends at an audit site. Sampling of the records provides an element of confidence in the amounts recorded on the books, assists in identifying issues to be addressed and aids in recognizing fraud. Statistical sampling is a procedure used to choose a portion of the whole to make a statement about the entire body of information, eliminating the examiners judgment on the items to be sampled. Page 49 Tax accounting update and tax controversy issues EO examination procedures

IRM 4.75.11.15.2 (01-18-2017) Income Analysis The income of an organization should be reviewed to determine the size, extent and nature of the income, as well as verifying that the amount reported is reasonably accurate. There are several purposes for analyzing income, including determinations of whether the income: Page 50 Supports the exempt purposes of the organization Is subject to unrelated trade or business, and/or excise taxes Is from related parties, potentially giving rise to inurement

Is properly classified for purposes of various tests Using the LUQ items originally selected on the return during the preexamination phase, select the corresponding accounts from the trial balance for further in-depth review. At the same time, review the trial balance for any additional LUQ items not previously identified. Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.3 (01-18-2017) Expense Analysis The expenses of an organization should be reviewed to determine the size, extent and nature of the expenses, as well as to verify that the amount reported is not only reasonably accurate, but also correctly classified as an expense and not an asset (such as prepaid expenses). Using the LUQ items originally selected on the return during the preexamination phase, select the corresponding accounts from the trial balance for further in-depth review. At the same time, review the trial balance for any additional LUQ items not previously identified. Page 51

Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.3 (01-18-2017) Expense Analysis Page 52 There are several purposes for analyzing expense, including determinations of whether the expense: Is in furtherance of exempt purposes Gives rise to potential inurement Is for a political and/or legislative expenditure Gives rise to additional tax liabilities (Chapters 41 and 42)

Triggers other filing requirements Is properly allocated against any unrelated business income Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.4 (01-18-2017) Balance Sheet Analysis Page 53 The purposes for analyzing the balance sheet include the following: Identifying potential inurement, private benefit or excess benefit transactions Identifying assets generating unrelated business income Analyzing the changes in net assets/fund balances and in net worth and

reconciling any increases or decreases with the income and expense statements Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.5 (01-18-2017) Tax Liabilities Page 54 Determine if an exempt organization is liable for certain taxes and, if so, determine the correct amount relating to the following Unrelated business taxable income, IRC Section 511-514 Transactions by private foundations, IRC Section 4940-4945 Lobbying activities, IRC Section 4911-4912

Political activities, IRC Section 527(f) and 4955 Excess benefit transactions, IRC Section 4958 Employment taxes, IRC Section 3101, 3111, 3301, 3402, 3406 and 3509 Gaming activities, IRC Section 4401 and 4411 Proxy tax on lobbying and political expenditures, IRC Section 6033(e)(2)(A) Black lung trust excise taxes, IRC Section 4951-4953 Tax accounting update and tax controversy issues Polling question no. 4 What is not a purpose of analyzing the organizations balance sheet?

Documenting that the item incurred is actually an expense and not an asset Identifying potential inurement, private benefit or excess benefit transactions Identifying assets generating unrelated business income Analyzing the changes in net assets/fund balances and in net worth and reconciling any increases or decreases with the income and expense statements Page 55 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.11.15.6 (01-18-2017) Accuracy of Return

Even though many organizations filing Forms 990-N, 990-EZ or 990 are not subject to the various taxes identified above, the forms are subject to public inspection and are relied upon by the public for a variety of purposes. Due to this public scrutiny of the Form 990 series of returns, considerations must be given to verifying the correctness and accuracy of the return. Amended returns may be accepted in most situations. In instances where the organization has incorrectly calculated the proxy tax, resulting in an understatement of tax, no amended return will be accepted, as the period for rolling over additional legislative expenses to the subsequent year ends when the return is examined. Page 56 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.12.3.1 (03-14-2017) Filing Checks Always Required Page 57 A filing check is always required for the following:

Form 990 in the case of any IRC Section 501(c) organization or IRC Section 4947(a)(1) trust, not a private foundation and not a black lung benefit trust Form 990-EZ in the case of any IRC Section 501(c) organization or IRC Section 4947(a)(1) trust, not a private foundation and not a black lung benefit trust Form 990-N in the case of any IRC Section 501(c) organization other than a private foundation, except those ineligible to file Form 990-N listed in https://www.irs.gov/charities-non-profits/form-990-n-e-postcardorganizations-not-permitted-to-file Form 5578 in the case of any IRC Section 501(c)(3) organization not filing Form 990 or Form 990-EZ that operates, supervises or controls a private school Form 990-PF in the case of any private foundation or IRC 4947(a)(1) trust treated as a private foundation Form 990-BL in the case of any black lung benefit trust exempt under IRC Section 501(c)(21)

Form 1065 in the case of any religious or apostolic organization under IRC Section 501(d) Form 5227 in the case of any IRC Section 4947(a)(2) split-interest trust Form 990-T in the case of any IRC Section 501(c) organization or government-owned college and university Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.12.3.1 (03-14-2017) Filing Checks Always Required Form 1120 in the case of any taxable private foundation that is a corporation or unincorporated association Form 1041 in the case of any IRC Section 4947 trust or any taxable private foundation that is a trust

Form 940, Employers Annual Federal Unemployment Tax Return (not applicable to IRC Section 501(c)(3) organizations) Form 941, Employers Quarterly Federal Tax Return Form 944, Employers Annual Federal Tax Return Form 945, Annual Return of Withheld Federal Income Tax Prior and subsequent year returns for each of the above Page 58 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.15.4 (07-18-17) Types of Audit Results

Page 59 Close each audited return under EO jurisdiction under one of the audit results listed below. Note that each change in tax or status must be either agreed or disagreed (except terminations and closing agreements). Disagreed changes are further classified as either with or without the taxpayers protest for appeal. No change No change with advisory No change with advisory, Form 5666, TE/GE Referral Information Report, required No change with advisory, Form 5666 required Inadequate Records Notice Revocation of tax-exempt status (IRC Section 501(c)(3) IRC Section 7428 case)

Revocation of tax-exempt status (Section 501(c) organizations other than (c)(3), and Section 501(d)) Modification of tax-exempt status (Section 501(c) organizations other than (c)(3)); see IRM 4.75.15.8.2 Reclassification of foundation status (Section 501(c)(3) organizations IRC Section 7428 case) Disqualification of tax-exempt status (Status 40 organizations IRC Section 7428 case) Disqualification of tax-exempt status (Status 36 and IRC Section 501(c)(12) or IRC Section 501(c)(15)) Closing agreement; See IRM 4.75.25, Exempt Organizations Examinations Closing Agreements Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.15.4 (07-18-17) Types of Audit Results

Termination of tax-exempt status; see IRM 4.75.16.5.10, Termination of Exempt Status Change in tax Allowance of a claim in full; see Exhibit 4.75.15-2 Allowance of a claim in full surveyed claim Disallowance of a claim in full or in part; see Exhibit 4.75.15-2 Disallowance of a claim in full or in part, plus additional tax or penalty; see Exhibit 4.75.15-2 Withdrawal of claim

Allowance of an abatement request in full; see Exhibit 4.75.15-2 Disallowance of an abatement request in full or in part; see Exhibit 4.75.15-2 Disallowance of an abatement request in full or in part, plus additional tax or penalty; see Exhibit 4.75.15-2 Withdrawal of abatement request Page 60 Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.17.1.6 (06-08-2017) Introduction Mandatory review provides technical services for EO examination field agents to enhance the technical quality of their work.

A specific list of cases subject to mandatory review are listed in IRM 4.75.16.6. In summary, mandatory review handles the following types of cases: Page 61 Church tax audits Church tax inquiries Revocations (other than by IRC Section 6033(j)) Modifications of foundation status Disagreed issues with protest

Disagreed issues without protest, in general Whistleblowers Worker classifications Joint Committee claim cases Tax accounting update and tax controversy issues EO examination procedures IRM 4.75.17.1.6 (06-08-2017) Introduction Page 62 Mandatory review performs the final review of the case before closure to Appeals (in the case of protests) or to the EO closing unit (formerly Examination Special Support (ESS)). When necessary, mandatory review prepares and issues 90-day letters (final adverse determination letters, statutory notices of deficiency and notices of determination of worker classification).

Mandatory review also handles requests for the following: Closing agreements Continuing professional education presentations Forms 1254, Examination Suspense Report, suspense Published instructions (IRM and interim guidance memoranda) Redactions of final audit reports, 90-day letters and corresponding cover letters Technical assistance Technical advice memoranda

Tax accounting update and tax controversy issues Questions Page 63 Tax accounting update and tax controversy issues Accounting for income taxes of exempt organizations Page 64 Tax accounting update and tax controversy issues Accounting standards codification Topic 740 Accounting Standards Codification Topic (ASC) 740, Income Taxes, addresses financial accounting and reporting for the effects of income taxes that result from an entitys activities during the current and preceding years. Page 65

Exempt organizations (EOs): May have a tax provision for significant unrelated business income activities (federal and state income tax) or significant income subject to tax outside of the US Need to evaluate and document continued qualification for tax exemption Taxable subsidiaries and unrelated business income activities ASC 740 applies Financial statement impacts, depending on materiality Tax accounting update and tax controversy issues Unrelated business income

Estimate unrelated business taxable income Include active businesses and pass-through income Consider reasonableness of expense methodology Profit motive for activities in a loss position Document everything Calculate tax and test against materiality thresholds Generally, current year tax and unpaid tax for the two preceding tax years are tested. Failure to file certain foreign information returns when required (e.g., Forms 5471, 926, 8865, 8621) holds open the year the return was triggered for federal income tax assessment.

ASC 740 rules apply in full. Page 66 Tax accounting update and tax controversy issues Taxable subsidiaries income tax calculations Taxable subsidiaries Consolidated groups Tax-sharing agreements Sufficient documentation supporting tax calculations Determination of tax years open for federal income tax assessment Page 67 Tax accounting update and tax controversy issues

Non-income tax considerations Indirect taxes Property Sales and use Private foundation tax lapsed public charity (including compliance with Section 509(a)(3) reporting requirements) Other non-income taxes Tax-exempt financing Compliance requirements

Compensation reporting State filing requirements Penalties financial and effect on statute of limitations Page 68 Tax accounting update and tax controversy issues Uncertain tax positions Page 69 Tax accounting update and tax controversy issues Accounting for uncertainty in income taxes Benefit recognition model

Tax position must meet minimum recognition threshold before being recognized in financial statements. ASC 450, Contingencies, 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 Page 70 Tax accounting update and tax controversy issues Uncertain tax positions Presentation 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 (DTA) for a temporary difference, a net operating loss 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 tabular rollforward disclosure. Page 71 Tax accounting update and tax controversy issues Uncertain tax positions Presentation Accounting Standards Update 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 Page 72 Tax accounting update and tax controversy issues Uncertain tax positions Documentation 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. Page 73 Clearly meets more-likely-than-not recognition standard, and there is a greater than 50% likelihood that 100% of benefit will be sustained Tax accounting update and tax controversy issues Polling question no. 5 Which of the following is not one of the steps taken when estimating unrelated business income for purposes of the tax provision? Include active businesses and pass-through income Consider reasonableness of expense methodology

Consider profit motive for activities in a loss position Document only material items Page 74 Tax accounting update and tax controversy issues Deferred taxes and valuation allowances Page 75 Tax accounting update and tax controversy issues Evaluating the need for a valuation allowance DTAs represent future tax deductions (or tax carryforwards/tax credits) Reduced by a valuation allowance 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 No existence of DTA; only realizability common pitfall Consider presentation of valuation allowance (current/non-current) Page 76 Tax accounting update and tax controversy issues 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 the following: Negative evidence Positive evidence Cumulative pretax losses in recent history (generally three years) or projections of cumulative pretax losses common pitfall Existing contracts or firm sales backlog History of carryforwards expiring unused Strong earnings history, exclusive of loss that created the future deductible amount, coupled with evidence that the loss is an aberration Brief carryback, carryforward periods Implemented cost reduction plans that can be objectively verified (however, consider any effects on revenues) Page 77

Tax accounting update and tax controversy issues 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 Page 78 Tax accounting update and tax controversy issues 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 Page 79 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 Tax accounting update and tax controversy issues 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)?

Page 80 Tax accounting update and tax controversy issues Tax accounting implications of Tax Cuts and Jobs Act (TCJA) Page 81 Tax accounting update and tax controversy issues Provisions affecting deferred taxes TCJA provisions Reduction in corporate tax rate from blended 35% to flat 21% Consider fiscal year-end implications State and local considerations Twenty-two states to automatically conform to federal tax changes as of the date of enactment Twenty additional states to conform on specific dates

Some states may choose to decouple from new federal tax provisions. Page 82 Accounting implications Date of enactment: December 22, 2017 Need to remeasure deferred tax balances at the new rate Review current tax payable (may be based on existing rate) Valuation allowances need to be remeasured. Recognize effects as a component of income tax expense from continuing operations Tax accounting update and tax controversy issues Tax carryforwards

TCJA provisions NOLs generated in years ending after December 31, 2017 will be allowed to be carried forward indefinitely, but NOLs generated in years beginning after December 31, 2017 will be capped at 80% of taxable income. Carryback of losses no longer permitted The corporate Alternative Minimum Tax (AMT) repealed; credits refundable or creditable against income taxes payable beginning in 2018 Additional limits imposed affecting the ability to use foreign tax credits Page 83

Accounting implications Could change realizability assumptions of DTAs Elimination of carrybacks Assessment of remaining NOL carryforwards Foreign tax credit limitations Change the nature of AMT credits to prepaid or refundable tax payment Tax accounting update and tax controversy issues Immediate expensing of qualified assets TCJA provisions Companies allowed to immediately write off the cost of new investments in certain qualified depreciable assets Effective date: qualified purchases

after September 27, 2017 Page 84 Accounting implications Adjust deferred tax liabilities for qualified assets acquired since September 27, 2017 Valuation allowance considerations Creation of new DTLs Changes to existing tax depreciation systems and schedules Tax accounting update and tax controversy issues Reduction or elimination of certain deductions TCJA provisions Limits deduction of net interest

expense to 30% of the businesss adjusted taxable income Limits deduction of other expenses, for example, deduction of certain meals and entertainment and Domestic Manufacturing Deduction (Section 199) deductions Page 85 Accounting implications Creates new, or expands number of, items that are treated as permanent differences Limits or eliminates deductions on certain entertainment and domestic manufacturing deductions Creates new, or changes to existing, deductibility of interest changes to existing process for recognition and tracking of related deferred taxes Tax accounting update and tax controversy issues

Implications of tax reform for fiscal year taxpayers Reduction in corporate tax rate results in use of blended rate for fiscal year taxpayers. Consider effects on deferred tax balances. Example: Taxpayer with a June 30, 2018 year end will pay the 35% corporate tax rate for approximately half of year-end income and the newly enacted 21% rate for the other half of year-end income. Consider the appropriate tax rate for deferred tax balances and temporary differences existing prior to enactment date, but reversing after the enactment date. Date of reversal determines whether the blended rate or the 21% rate is appropriate. Net operating losses generated in the fiscal year that includes January 1, 2018 are not subject to the 80% limitation, but limitation will be in effect for all future tax years. Consider realizability of NOLrelated DTAs. Page 86 Tax accounting update and tax controversy issues

International tax reform Section 965 Transition Tax repatriation of post-1986 earnings and profits of specified foreign subsidiaries Treated as a component of income tax expense from continuing operations in the period of enactment Consider the effect on the balance sheet classification between current and noncurrent over the eight-year payment period Global Intangible Low-Taxed Income (GILTI) Notice 2018-67 GILTI income to be treated as Subpart F income, even if derived from insurance activities Foreign Derived Intangible Income (FDII) To the extent that an exempt organization has FDII, it is accounted for as

a special deduction. Tax benefit is recognized no earlier than the year in which the FDII is deductible on the tax return. Page 87 Tax accounting update and tax controversy issues Polling question no. 6 What is the effective date of the TCJA provision which provides for immediate expensing of qualified assets? Qualified purchases after September 27, 2017 Qualified purchases after December 31, 2017 Qualified purchases after September 27, 2018

Qualified purchases after December 31, 2018 Page 88 Tax accounting update and tax controversy issues Accounting standards update (ASU) Page 89 Tax accounting update and tax controversy issues Not-for-profit financial reporting and disclosures ASU 2016-14 Disclosure requirements: Additional information will be required to provide users with an understanding of an entitys exposure to risks. The Financial Accounting Standards Board (the FASB) notes that presenting a classified balance sheet may be an effective way for organizations to comply with

many of the new disclosure requirements. Net asset classifications: As a result of the new standard, the three existing classes of net assets (unrestricted, temporarily restricted and permanently restricted) will now become two: Net assets without donor restrictions Net assets with donor restrictions Effective date: Page 90 ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, will be effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Tax accounting update and tax controversy issues

Deferred tax assets ASU 2015-17 DTAs and DTLs classified solely as non-current assets Purpose simplify balance sheet reporting Effective date: Public companies annual periods beginning after December 15, 2016 Other businesses (includes most EOs) annual periods beginning after December 15, 2017 May elect to use prior to effective date Page 91 Tax accounting update and tax controversy issues Revenue recognition ASC 606

The FASB and International Accounting Standards Board issued converged new revenue recognition standards in May 2014: 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 American Institute of Certified Public Accountants task force created, with various working groups formed to address industry issues, current status of the working group issues are included Effective dates: Public entities (including conduit bond obligors): Non-public entities: Page 92

Annual periods beginning after December 15, 2017, and interim periods therein Annual periods beginning after December 15, 2018, and interim periods beginning after December 15, 2019 Tax accounting update and tax controversy issues Accounting for leases ASU 2016-02 The new FASB lease accounting standard, ASU 2016-02, Leases (Topic 842), was issued on February 25, 2016: Lessees are required to put most leases on their balance sheets and recognize expenses on their income statements. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The guidance also eliminates real estate-specific provisions for all entities. Page 93

Tax accounting update and tax controversy issues Tax provision leading practices Page 94 Tax accounting update and tax controversy issues Tax provision leading practices Accelerate work during quarters and interim: Evaluate and record return-to-provision adjustments Prove out deferred tax assets/liabilities and 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 Page 95 Consider tool to improve efficiency and accuracy of computations Tax accounting update and tax controversy issues Polling question no. 7 Under ASU 2016-14, the three existing classes of net assets (unrestricted, temporarily restricted and permanently restricted) will be divided into which two categories?

Net assets with donor restrictions and net assets without donor restrictions Restricted use net assets and unrestricted use net assets Controlled net assets and non-controlled net assets Unlimited use net assets and limited use net assets Page 96 Tax accounting update and tax controversy issues Tax provision leading practices 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 Obtain assistance to prepare or review the tax 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 Page 97

Tax accounting update and tax controversy issues Questions Page 98 Tax accounting update and tax controversy issues You should now be able to Explain the structure of the IRS Tax Exempt and Government Entities Division. Identify current IRS exempt organization examination procedures. Recognize applicable tax accounting standards that impact exempt organizations. Page 99 Tax accounting update and tax controversy issues EY | Assurance | Tax | Transactions | Advisory

About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. 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 Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. 2018 Ernst & Young LLP. All Rights Reserved. 1809-2858082 US SCORE no. 04325-181US This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com

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