• FASB’s ASU 2023-09 requires more detailed tax disclosures, including a breakdown by jurisdiction and a 5% threshold for key items. It applies to both public and private companies, with varying start dates.

• Some older disclosures are removed, while new rules require more detailed reporting on rate reconciliation and domestic versus foreign income (aligning with SEC rules).

• Companies should reassess tax controls to reduce the risk of restatements, material weaknesses, and SEC scrutiny.

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Correctly accounting for and disclosing income taxes under ASC 740 is complex. This is especially true this year given the effective date of Accounting Standards Update (ASU) No. 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures,” which the Financial Accounting Standards Board (FASB) issued in late 2023.

With the potential complexity of the ASU’s new requirements, it’s important to consider whether your processes, systems, and internal controls should be modified to facilitate effective implementation. This article walks you through the most important aspects of the ASU, as well as what to consider in designing strong internal tax controls that can help reduce reporting errors.

FASB Issues Final ASU to Improve Income Tax Disclosures

In response to feedback from the investor community requesting the disclosure of additional information pertaining to income taxes, the FASB issued ASU 2023-09 in December 2023. One of the ASU’s overarching themes is the disaggregation of information that may previously have been aggregated or commingled — a change that’s expected to provide greater transparency and consistency. In particular, the disclosure requirements seek to increase visibility into various income tax components that affect rate reconciliation, as well as the qualitative and quantitative aspects of those components.

Main Provisions

The ASU requires public business entities (PBEs) to disclose additional information in specified categories with respect to the reconciliation of the effective rate to the statutory rate for federal, state, and foreign income taxes. It also requires greater detail about individual reconciling items in the rate reconciliation if the impact of those items exceeds a threshold.

Under the ASU, PBE information pertaining to taxes paid (net of refunds received) must be disaggregated for federal, state, and foreign taxes and further disaggregated for specific jurisdictions if the related amounts exceed a quantitative 5% threshold. That threshold is determined by multiplying 5% by the product of pretax income (or loss) from continuing operations and the applicable federal statutory rate, and it essentially emulates the requirement in SEC Regulation S-X.

The ASU also describes items that need to be disaggregated based on their nature, which is determined by reference to the item’s fundamental or essential characteristics.

Updated Annual Disclosure Requirements

Rate Reconciliation

ASU 2023-09 specifies categories for which disclosures associated with the rate reconciliation are required, and each category has varying degrees of qualitative and/or quantitative disclosure.

PBEs

The following categories must be included in annual disclosures in the rate reconciliation in tabular form both in amounts in the applicable reporting currency and in percentages:

• State and local income taxes in the country of domicile net of related federal income tax effects.
• Foreign tax effects, including state or local income taxes in foreign jurisdictions. 
  • Reflects income taxes imposed by foreign jurisdictions.  
  • Disaggregation is required when individual reconciling items equal or exceed the 5% threshold. This would include the statutory rate differential between the foreign jurisdiction and that of the county of domicile.  
  • If an individual foreign jurisdiction meets the 5% threshold, it must be separately disclosed as a reconciling item. Further disaggregation is required for that jurisdiction for cross-border tax laws, tax credits, and nontaxable or nondeductible items that meet the 5% threshold.  
• Effects of changes in tax laws or rates enacted in the current period.  
  • Applies to federal taxes of the country of domicile.  
  • Reflects the cumulative tax effects of a change in enacted tax laws or rates on current or deferred tax assets and liabilities at the date of enactment.  
• Effect of cross-border tax laws. 
  • Applies to incremental income taxes imposed by the jurisdiction of domicile on income earned in foreign jurisdictions. When the country of domicile taxes cross-border income but also provides a tax credit on the same income during the same reporting period, the tax effect of both the cross-border tax and its related tax credit may be presented on a net basis.  
  • Disaggregation required when individual reconciling items equal or exceed the 5% threshold and by nature of the item.  
• Tax credits. 
  • Applies to federal taxes of the country of domicile.  
  • Disaggregation required when individual reconciling items equal or exceed the 5% threshold and by nature of the item.  
  • This category does not include foreign tax credits.  
• Changes in valuation allowances. 
  • Applies to federal taxes of the country of domicile. For example, any change in valuation allowance in a foreign jurisdiction would be included in the foreign tax effects category and separately disclosed as a reconciling item if greater than the 5% threshold.  
• Nontaxable or nondeductible items.  
  • Applies to federal taxes of the country of domicile.  
  • Disaggregation required when individual reconciling items equal or exceed the 5% threshold and by nature of the item.  
• Changes in unrecognized tax benefits.  
  • Aggregate disclosure of changes in unrecognized tax benefits is allowed for all jurisdictions.  
  • This category reflects reconciling items resulting from changes in judgment related to tax positions taken in prior annual reporting periods.  
  • When an unrecognized tax benefit is recorded in the current annual reporting period for a tax position taken or expected to be taken in the same reporting period, the unrecognized tax benefit and its related tax position may be presented on a net basis in the category in which the tax position is presented.  

The FASB has determined all reconciling items should be presented on a gross basis. However, it will allow net presentation of the effects of specific cross-border tax laws and the associated effects of foreign tax credits, as well as the netting of current-year uncertain tax positions and current-year tax positions against the relevant category. If a foreign jurisdiction meets the 5% threshold, it must be disclosed as a reconciling item. Irrespective of whether any foreign jurisdiction satisfies the 5% threshold, any individual item meeting the 5% threshold must be disclosed by nature.

PBEs must disclose the state and local jurisdictions that contribute to the majority (greater than 50%) of the effect of the state and local tax category, beginning with the state or local jurisdiction having the largest effect and proceeding in descending order.

If the information is not otherwise evident, PBEs must explain any disclosed reconciling items in the categories above, including their nature, effect, and underlying causes, as well as the judgment used in categorizing them.

It is noteworthy that the FASB decided to align the disclosure requirements with those in SEC Regulation S-X Rule 4-08(h)(2). The federal rate for a foreign entity should normally be that of the entity’s jurisdiction of domicile. However, if that rate is other than the U.S. corporate rate, both the rate and the basis for its use must be disclosed.

Entities Other Than PBEs

For entities other than PBEs, a qualitative disclosure of the nature and effect of the categories of items discussed above is required along with the individual jurisdictions that result in a significant difference between the statutory and effective tax rates. A numerical reconciliation is not required.

Income Taxes Paid

The ASU requires that all entities annually disclose the amount of income taxes paid (net of refunds received) disaggregated by federal, state, and foreign jurisdictions. It requires further disaggregation for any jurisdiction where the amount of income taxes paid is at least 5% of the total income taxes paid. In quantifying the 5% threshold for income taxes paid, the numerator of the fraction should be the absolute value of any net income taxes paid or income taxes received for each jurisdiction and the denominator should be the absolute value of total income taxes paid or refunds received for all jurisdictions in the aggregate.

Income Statement

The ASU makes some minor changes to the required income statement disclosures relating to income taxes, stipulating that income (loss) from continuing operations before income tax expense (benefit) be disclosed and disaggregated between domestic and foreign sources. It mandates the disclosure of income tax expense (benefit) from continuing operations disaggregated by federal, state, and foreign jurisdictions. Income tax expense and taxes paid relating to foreign earnings that are imposed by the entity’s country of domicile would be included in tax expense and taxes paid for the country of domicile.

Eliminated Disclosures  

ASU 2023-09 eliminates the historic requirement that entities disclose information concerning unrecognized tax benefits having a reasonable possibility of significantly increasing or decreasing in the 12 months following the reporting date. It also removes the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures. Entities should continue to disclose the types of temporary differences for which deferred tax liabilities have not been recognized under ASC 740-30-50-2(a), (c), and (d).  

Effective Dates and Transition  

All entities should apply the ASU prospectively with an option for retroactive application to each period in the financial statements. For PBEs, the guidance will be effective for fiscal years beginning after December 15, 2024, and for interim periods for fiscal years beginning after December 15, 2025. For entities other than PBEs, the guidance will be effective for fiscal years beginning after December 15, 2025, and for interim periods beginning with fiscal years beginning after December 15, 2026. Early adoption is allowed. 

When developing a plan to implement the new disclosure requirements, consider whether amounts meeting the 5% threshold are material to help guide an assessment of the jurisdictions and items that will be disaggregated in the disclosures. Specifically, it may be prudent to quantify those amounts in order to effectively assess the materiality of the amounts disaggregated. 

Given the potential complexity of, and the resources necessary to satisfy, the new requirements established by the ASU, consider whether adoption will be made prospectively or retrospectively. Also contemplate the modifications to processes, procedures, systems, and internal controls that will be necessary to facilitate an effective implementation process. Those considerations will be of particular importance for entities with foreign operations. 

Reducing Risk with Tax Internal Controls  

Two decades after the enactment of Section 404 of the Sarbanes-Oxley (SOX) Act, income-tax-related material weaknesses continue to plague companies — with a recent report showing that tax-related restatements account for approximately 12% of all restatements. 

Without proper internal controls, companies may be susceptible to reporting errors, which can lead to reputational risk and financial burdens stemming from remediation. Companies with strained or limited in-house resources must prioritize income tax accounting and reporting before it is too late.  

Correctly accounting for and disclosing income taxes under ASC 740 is increasingly important to mitigate a company’s risk of restatement, material weakness, and SEC comments. In-depth knowledge of tax and financial reporting, proper audit documentation, and clear and transparent disclosures can help reduce income reporting risk.  

While all public companies must be SOX compliant, many have not refreshed income tax controls since initial implementation, and new guidance has changed the standards required for compliance.  

Controls often fail because they are not adequately designed or operating as intended. For instance, it is unlikely that one overarching management review control can cover all the areas of an income tax provision or clearly identify the nature of the review procedures for each key provision component. Controls also might lack supporting evidence of performance and review. 

How MGO Can Help

Our dedicated team of tax professionals stays ahead of emerging guidance — such as FASB’s new ASU 2023-09 — to help your organization navigate complex requirements. We provide end-to-end support, from assessing current processes and strengthening internal controls to optimizing disclosure practices in line with the latest standards. By leveraging our practical experience and technical insights, we can help you mitigate risk, streamline reporting, and maintain robust compliance strategies to meet both immediate and long-term financial goals. Contact us today to stay ahead of these developments.  

The post FASB ASU 2023-09: Income Tax Disclosure Updates to ASC 740 appeared first on MGO CPA | Tax, Audit, and Consulting Services.

Key Takeaways:

• Maryland’s Winery and Vineyard Economic Development Grant Program reimburses 25% of capital expenses — helping businesses invest in equipment, production tools, and agricultural materials.

• Eligible expenses include fermenters, bottling equipment, irrigation systems, and vineyard supplies — but labor, repairs, and utilities do not qualify.

• Wineries and vineyards must send applications with detailed expense reports and documentation by September 15 to be considered for funding.

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For owners, managing cash flow while investing in growth is a balancing act. The Winery and Vineyard Economic Development Grant (WVEDG) Program offers a valuable opportunity to offset costs by receiving reimbursement for qualified capital expenses. If you’re planning to upgrade equipment, expand operations, or improve production efficiency, this grant can be a key financial tool.

What Is the Maryland WVEDG Program?

The Maryland Department of Commerce administers this grant to help wineries and vineyards invest in essential infrastructure, equipment, and agricultural materials.

How Much Can a Winery or Vineyard Receive?

The program reimburses 25% of your eligible capital expenses — reducing financial strain and enabling your business to reinvest in its operations.

With funding subject to annual state budget limits, early applications are critical to securing support.

Who Can Apply?

Your business may qualify for the grant if you meet one of the following requirements:

• You are a Maryland winery holding a Class 3 or Class 4 license issued by the Comptroller of Maryland.

• You operate a Maryland vineyard with at least one contiguous acre dedicated to growing grapes for wine production.

Reviewing eligibility criteria before making capital investments can help your business plan effectively and maximize reimbursement.

What Expenses Qualify?

The grant covers costs related to the purchase and installation of equipment and agricultural materials that directly support winery or vineyard operations.

Eligible Expenses Include:

• Winery equipment: Bottling machines, fermenters, presses, crushers, corkers, and refrigeration systems.

• Vineyard investments: Irrigation equipment, trellising, soil amendments, fertilizer, and fruit plants.

• Production tools: Barrels, pumps, labeling machines, tractors, and pruning equipment.

What’s NOT Covered?

The grant does not reimburse costs for:

• Labor
• Repairs
• Construction
• Utilities
• General supplies

If your winery or vineyards is planning capital investments, working with an advisor can help you determine which purchases qualify and how to structure expenses for the best financial outcome.

How to Apply

Your business must send an application along with detailed expense documentation to be considered for funding.

Application Process

1. Obtain business certification: Your business must be certified as a qualified entity through the Maryland Department of Commerce.

2. Submit a report of expenses: You need to provide a detailed breakdown of purchases, including receipts and invoices.

3. Meet the deadline: You must submit your application by September 15 of the calendar year in which the expenses were incurred. Grant amounts are confirmed by December 15.

Given the documentation requirements, your winery or vineyard may benefit from working with tax professionals to prepare exact reports and avoid missing eligible reimbursements.

Beyond the Grant: Tax and Financial Considerations

While securing grant funding is a key step, integrating it into a broader financial strategy can create even greater savings. Aligning capital purchases with state and federal tax incentives, depreciation benefits, and other financial tools can improve cash flow and profitability.

Working with an advisor can help your winery or vineyard:

• Improve tax benefits by aligning grant-covered purchases with deductions and credits.

• Maintain compliance by keeping audit-ready documentation for grants and tax filings.

• Plan for long-term financial success by balancing investment timing and funding sources.

Looking for guidance on tax-efficient planning, grant applications, or long-term financial strategies? Advisors familiar with the winery and vineyard industry can help you navigate these complexities.

Protecting Your Investment: Key Insurance and Risk Considerations

Applying for the Maryland WVEDG is a great opportunity to offset costs, but it’s essential to address key risk management and insurance factors to protect your business investments. Considerations include:

• Business personal property (BPP) coverage: Equipment purchased with grant funds — such as fermenters, bottling lines, and tractors — should be properly insured. When setting coverage limits, businesses should consider the full value of the equipment (not a discounted amount due to grant support). Additionally, the valuation method — replacement cost versus agreed value — should be carefully reviewed to ensure adequate coverage in the event of a loss.

• Contractual obligations and funding compliance: Grant recipients should review any contractual obligations tied to funding — including potential requirements to maintain specific insurance coverages or retain financial records for audits. Non-compliance could result in funding clawbacks.

• Loss payee provisions: If financing equipment or agricultural materials, lenders may require being listed as a loss payee on the insurance policy. This ensures they receive compensation in the event of a covered loss.

• Liability and business interruption: Expanding vineyard operations or upgrading production can introduce new risks. Reviewing liability coverage and business interruption insurance can help protect against potential disruptions and revenue loss.

Working with an experienced insurance advisor can help your winery or vineyard secure appropriate coverage, remain compliant with grant terms, and safeguard your long-term investment.

Act Now to Secure Funding

With the September 15 deadline, wineries and vineyards should start gathering documentation now to maximize funding potential. Since approvals depend on state budget availability, early submissions are recommended.

Navigating the grant application process while aligning it with broader tax and financial strategies can be complex. MGO works with winery and vineyard owners to find eligible expenses, structure capital investments to enhance tax benefits, and support compliance with reporting requirements to avoid delays or disqualifications. By taking the right steps now, your business can secure grant funding while strengthening your overall financial position.

The post Maximize Savings with Maryland’s Winery and Vineyard Grant appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• A new Accounting Standards Update requires public companies to provide more detailed expense disclosures in their financial statements.

• Implementing these changes may require modifications to the chart of accounts and adjustments to financial reporting systems.

• Companies should get a head start assessing whether current accounting systems can support the required disclosures and make necessary upgrades.

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In response to persistent calls from investors for enhanced transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2024-03, Income Statement – Reporting Comprehensive Income – Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses (DISE). This update introduces a new layer of financial statement disclosures, requiring companies to adjust how they collect and report financial data.

Subtopic 220-40’s New Disclosure Requirements

The finalized ASU requires public companies to provide additional details about specific expense categories in financial statement disclosures.

Currently, companies can consolidate several expense line items into broad categories on income statements. For example, line items like “cost of goods sold,” “cost of sales,” and “selling, general, and administrative expenses” can comprise various direct and indirect costs of producing and selling a company’s goods and services, as well as overhead and administrative costs unrelated to production and sales. This lack of transparency makes it harder for investors, lenders, and other financial statement users to assess the company’s performance.

Subtopic 220-40 requires organizations to disclose (in a tabular format) amounts recognized in each of the following relevant expense captions:

• Purchases of inventory using the expense or cost-incurred approach

• Employee compensation

• Depreciation

• Intangible asset amortization

• Depreciation, depletion, and amortization (DD&A) recognized from oil and gas-producing activities

In addition, companies must provide additional details about inventory and manufacturing expenses, including:

• Inventory purchased

• Employee compensation related to manufacturing

• Depreciation and amortization of manufacturing assets

• Costs capitalized to inventory and manufacturing expenses

• Changes in inventory balances

• Other items used to reconcile costs incurred to expenses recognized

• How the company defines “other manufacturing expenses”

Practical Implications for Public Companies

At first glance, providing more details on expenses might seem simple. However, implementing these changes can become complicated quickly. You may need to reconsider how you categorize expenses, modify your chart of accounts, and evaluate whether your financial systems can extract and present the necessary information.

Some considerations include:

• Accounting system capabilities: Your current systems may not be configured to capture expense details at the required level of granularity. Evaluate whether your general ledger software and reporting tools can generate the necessary disclosures or if they’ll need modifications.

• Adjustments to reporting packages: Review whether your existing financial reporting packages can accommodate these new requirements.

• Audit readiness: The enhanced level of detail required in financial disclosures means auditors will focus on total expense amounts and how those expenses are disaggregated. Make sure you allow enough time to align your internal reporting with the new requirements so your internal and external audits will go smoothly.

• Training and internal processes: Team members responsible for financial reporting will need training on new data collection and reporting processes.

• Industry-specific considerations: The requirements apply broadly to all public companies, but the impact varies by industry. Your company should analyze which line items are relevant to your operations and adjust reporting accordingly.

ASU 2024-03’s Scope and Effective Date

The updated requirements apply to all public companies, although some expense categories may not be relevant depending on your industry. ASU 2024-03 is effective for fiscal years beginning after December 15, 2026, and interim periods beginning after December 15, 2027. Early adoption is permitted.

Because the new disclosures are required for annual and interim reporting periods, you cannot simply address these disclosures at year-end. You need to ensure your accounting systems can support the level of detail required for these disclosures throughout the year.

Preparing for Implementation

Adapting to the new reporting standards requires advance planning and preparation. Begin by conducting a gap analysis to determine whether your current financial systems can support the new disclosures. Reach out to your IT team and other advisors as soon as possible if you need modifications to facilitate a seamless transition.

Other steps you may need to take include:

• Review the detailed FASB guidance to determine the specific disclosures required.

• Assess internal data collection processes to make sure you’re capturing all necessary expense details.

• Engage with internal and external auditors to discuss expectations and potential challenges.

• Test reporting changes in advance to identify and resolve issues before compliance deadlines.

• Monitor ongoing compliance to ensure you’re prepared to meet interim reporting obligations.

How MGO Can Help

The changes introduced by the FASB’s finalized ASU will improve financial statement transparency, but they also present challenges for companies that are unprepared. Begin your implementation efforts now with planning, system updates, training, and allowing time to make adjustments and avoid last-minute compliance struggles. By proactively addressing these changes, you can minimize disruptions and keep your financial statements clear, accurate, and compliant.

If you have questions about Subtopic 220-40, contact us today to connect with professionals who can help.

The post FASB ASU: Disaggregating Income Statement Expenses appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• Robust financial reporting is crucial for companies seeking investment.
• Common fundraising challenges for growth companies and startups include disorganized records, unrecognized tax exposure, and inability to produce timely and accurate financial reports for investors.
• To prepare for fundraising, companies should clean up their books, implement proper financial and operational processes, address industry-specific accounting challenges, develop internal controls, and prepare investor-ready reports.

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Raising capital powers your growth and innovation. However, all your time and efforts can be derailed without clear and accurate financial reporting.

Investors want to see clean books, accurate forecasts, and explanations for variances before they commit capital. By improving your accounting and financial reporting processes now, you will avoid delays or, worse, an inability to close the round.

Navigating Common Fundraising Challenges

Many growth companies — particularly startups — find themselves in a common predicament when it’s time to raise funds:

• Incomplete or disorganized financial records
• Lack of U.S. GAAP (Generally Accepted Accounting Principles) compliance
• Inability to produce timely, accurate reports for potential investors
• Unrecognized tax exposure and failure to optimize tax structure and credits

If this sounds familiar, you are not alone. Companies often reach out for help only after investors have requested data or raised issues they cannot address. Don’t put yourself in this position — get ahead of investor and diligence requests with proactive preparation.

Key Financial Information Investors Seek

When assessing companies, investors typically look for information such as:

• Historical and forecasted revenue run rate
• Customer acquisition costs
• Margins
• Key performance indicators (KPIs) specific to your business model/industry
• Cash burn rate and runway
• Accurate and up-to-date cap tables
• Proper revenue recognition
• Understanding tax exposures and structure

Without solid financial reporting processes in place, providing this information accurately and promptly can be challenging.

Steps to Improve Your Financial Reporting for Fundraising

Here are some key areas to focus on as you prepare your company for fundraising:

1. Clean Up Your Books

Before you can present compelling financials to investors, you need to get your books in order. Many early-stage companies operate with messy accounting records, often due to a lack of in-house expertise or resources. However, this can severely hinder your fundraising efforts.

Start by conducting a thorough review of your financial records. Look for inconsistencies, errors, or gaps in your data. You may need to recode transactions, reconcile accounts, or even restate past financial reports. While this process can be time-consuming, it is essential for creating a solid financial foundation.

2. Implement Proper Processes

Establish best practices for key financial processes, such as:

• Bill pay — Establish clear policies and define approval levels, responsibilities, and authorization.
• Payroll — Handle payroll efficiently and accurately, reflecting all compensations and deductions correctly. Partner only with cloud-based payroll providers that offer an annual SOX (Sarbanes-Oxley) compliance report. Review this report annually and confirm that recommended user controls are implemented to protect sensitive payroll data.
• Invoicing — Use integrated accounting software to centralize invoicing to reduce manual errors and automate routine tasks. Set clear timelines for invoice creation, approval, and delivery to clients to maintain a consistent revenue cycle.
• Key account reconciliations — Regularly reconcile key accounts such as cash, accounts receivable, and revenue to identify discrepancies and keep accurate records.
• Segregation of duties — Put controls in place to reduce fraud risk, such as having different people write checks and reconciling bank accounts.
• Periodic reviews of tax exposure — Conduct regular reviews to assess the impact of changes in customer demographics, employee locations, and business models on tax exposure.

3. Address Specific Accounting Challenges

Depending on your focus and business model, growth companies often face unique accounting issues that require special attention. For example, compliance with ASC 606 for revenue recognition — which can be complex. If you have raised a portion of your capital with simple agreements for future equity (SAFEs), make sure you have properly classified the funds.

For software companies, correctly capitalizing software development costs is crucial. These issues can impact your financial statements and valuation.

4. Develop Robust Internal Controls

Implementing strong internal controls improves the accuracy of your financial reporting and gives investors confidence in your data.

Establish clear segregation of duties in financial processes to prevent fraud. Implement regular review and reconciliation procedures to catch errors early. Document all your policies and procedures, creating a clear trail for auditors and demonstrating to investors that you have a well-managed financial operation.

5. Prepare Investor-Ready Reports

Investors want to see more than just your financial statements. They’re interested in metrics that provide insight into your company’s growth trajectory and operations.

Include detailed cash flow projections to show how you’re managing your runway. Develop realistic revenue forecasts based on historical data and market analysis. Create KPI dashboards that highlight the metrics most relevant to your business model. Prepare detailed expense breakdowns to demonstrate your understanding of your cost structure and ability to manage expenses effectively.

How MGO Can Help

With extensive experience working with growth companies and startups, our knowledgeable advisors can identify areas for improvement in your financial and tax processes and data, help you implement changes, and even assist in creating investor data rooms and presentations.

Reach out to our team today to get the support you need to fund your future growth and innovation.

The post Streamline Your Fundraising with Stronger Financial Reporting appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• In April 2023, the U.S. Tax Court made news when it ruled in favor of businessman Alon Farhy, who challenged the Internal Revenue Service (IRS)’s authority to assess penalties for the failure to file IRS Form 5471.
• IRS Form 5471 is the Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
• In May 2024, the U.S. Court of Appeals for the D.C Circuit reversed the Tax Court’s initial ruling — underscoring the significance of context in assessing penalties for international information returns.

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UPDATE (May 2024):

Recent developments in the Farhy v. Commissioner case have captured significant attention in the tax and legal sectors. On May 3, 2024, the U.S. Court of Appeals reversed the Tax Court’s initial decision, highlighting the importance of statutory context in penalty assessments for international information returns. This ruling emphasizes the need for a closer examination of statutory language, altering perspectives on penalty applicability for non-compliance.

The implications of this case extend to taxpayers and practitioners, as detailed in analyses by MGO (see below). The decision underscores the need for meticulous compliance practices and adept navigation of the complexities of U.S. international tax law, along with a deep understanding of judicial interpretations of tax regulations.

MGO’s professionals are well-positioned to assist clients in navigating the complexities arising from the recent Farhy v. Commissioner decision. With a comprehensive understanding of the changing landscape in penalty assessments for international information returns, we provide guidance to help companies adapt to new judicial interpretations and maintain compliance with evolving tax regulations.

ORIGINAL ARTICLE (published June 8, 2023):

On April 3, 2023, the U.S. Tax Court came to a decision in the case Farhy v. Commissioner, ruling that the Internal Revenue Service (IRS) does not have the statutory authority to assess penalties for the failure to file IRS Form 5471, or the Information Return of U.S. Persons With Respect to Certain Foreign Corporations, against taxpayers. It also ruled that the IRS cannot administratively collect such penalties via levy.  

Now that the IRS doesn’t have the authority to assess certain foreign information return penalties according to the court, affected taxpayers may want to file protective refund claims, even if the case goes to appeals — especially given the short statute of limitations of two years for claiming refunds. 

Our Tax Controversy team breaks down the Farhy case, as well as what it may mean for your international filings — and the future of the IRS’s penalty collections.  

The IRS Case Against Farhy

Alon Farhy owned 100% of a Belize corporation from 2003 until 2010, as well as 100% of another Belize corporation from 2005 until 2010. He admitted he participated in an illegal scheme to reduce his income tax and gained immunity from prosecution. However, throughout the time of his ownership of these two companies, he was required to file IRS Forms 5471 for both — but he didn’t.  

The IRS then mailed him a notice in February 2016, alerting him of his failure to file. He still didn’t file, and in November 2018, he assessed $10,000 per failure to file, per year — plus a continuation penalty of $50,000 for each year he failed to file. The IRS determined his failures to file were deliberate, and so the penalties were met with the appropriate approval within the IRS.  

Farhy didn’t dispute he didn’t file. He also didn’t deny he failed to pay. Instead, he challenged the IRS’s legal authority to assess IRC section 6038 penalties.  

The Tax Court’s Initial Ruling

The U.S. Tax Court then held that Congress authorized the assessment for a variety of penalties — namely, those found in subchapter B of chapter 68 of subtitle F — but not for those penalties under IRC sections 6038(b)(1) and (2), which apply to Form 5471. Because these penalties were not assessable, the court decided the IRS was prohibited from proceeding with collection, and the only way the IRS can pursue collection of the taxpayer’s penalties was by 28 U.S.C. Sec. 2461(a) — which allows recovery of any penalty by civil court action.  

How This Decision Affects Your International Penalty Assessments 

This case holds that the IRS may not assess penalties under IRC section 6038(b), or failure to file IRS Form 5471. The case’s ruling doesn’t mean you don’t have an obligation to file IRS Form 5471 — or any other required form.  

Ultimately, this decision is expected to have a broad reach and will affect most IRS Form 5471 filers, namely category 1, 4, and 5 filers (but not category 2 and 3 filers, who are subject to penalties under IRC section 6679).  

However, the case’s impact could permeate even deeper. For years, some practitioners have spoken out against the IRS’s systemic assessment of international information return (IIR) penalties after a return is filed late, making it impossible for taxpayers to avoid deficiency procedures. The court’s decision now reveals how a taxpayer can be protected by the judicial branch when something is deemed unfair. Farhy took a stand, challenged the system, and won — opening the door for potential challenges in the future.  

It’s uncertain as to whether the IRS will appeal the court’s decision. But it seems as though the stakes are too high for the IRS not to appeal. While we don’t know what will happen, a former IRS official has stated he expects that, for cases currently pending review by IRS Appeals, Farhy will not be viewed as controlling law yet.  

The impact of the ruling is clear and will most likely impact many taxpayers who are contesting — or who have already paid — IRC 6038 penalties. It may also affect other civil penalties where Congress has not prescribed the method of assessment in the future. 

How You Should Respond to the Court’s Decision 

You should move quickly to take advantage of the court’s decision, as there is a two-year statute of limitations from the time a tax is paid to make a protective claim for a refund. It’s likely this legislation wouldn’t affect refund claims since that would be governed by the law that existed when the penalties were assessed. Note that per IRC section 6665(a)(2), there is no distinction between payments of tax, addition to tax, penalties, or interest — so all items are treated as tax.  

If you’ve previously paid the $10,000 penalty, it’s important to file your protective claim now, unless you’ve entered into an agreement with the IRS to extend the statute of limitations, which can occur during an examination. Requesting a refund won’t ever hurt, but some practitioners believe the IRS may try to keep any penalty money it collected, even if the assessment is invalid — because, in its eyes, the claim may not be. Just know, you can file your protective claim for a refund, but may not get it (at least not any time soon).   

The Farhy decision could likewise be applied to other US IRS forms, such as 5472, 8865, 8938, 926, 8858, 8854. Some argue the Farhy decision may also be applied to IRS Form 3520.

How MGO Can Help

Only time will tell if the court’s decision will open the government up to additional criticisms for other penalty assessments. If you have paid your penalties and are wondering what your current options are, MGO’s experienced International Tax team can help you determine if you’re eligible to file a refund claim.  

Contact us to learn more.

The post How the Tax Court’s Ruling on Farhy v. Commissioner Could Affect Your Penalty Assessments appeared first on MGO CPA | Tax, Audit, and Consulting Services.

SOX was established to provide additional auditing and financial regulations for publicly held companies to address the failures in corporate governance. Primarily it sets forth a requirement that the governing board, through the use of an audit committee, fulfill its corporate governance and oversight responsibilities for financial reporting by implementing a system that includes internal controls, risk management, and internal and external audit functions.

Governments experience challenges and oversight responsibility similar to those encountered by corporate America. Governance risks can be mitigated by applying the provisions of SOX to the public sector.

Some states and local governments have adopted similar requirements to SOX but, unfortunately, in many cases only after cataclysmic events have already taken place. In California, we only need to look back at the bankruptcy of Orange County and the securities fraud investigation surrounding the City of San Diego as examples of audit committees that were established in response to a breakdown in governance.

Taking Your Audit Committee on the Right Mission

Governments typically establish audit committees for a number of reasons, which include addressing the risk of fraud, improving audit capabilities, strengthening internal controls, and using it as a tool that increases accountability and transparency. As a result, the mission of the audit committee often includes responsibility for:

• Oversight of the external audit.
• Oversight of the internal audit function.
• Oversight for internal controls and risk management.

Chart(er) Your Course

Most successful audit committees are created by a formal mandate by the governing board and, in some cases, a voter-approved charter. Mandates establish the mission of the committee and define the responsibilities and activities that the audit committee is expected to accomplish. A wide variety of items can be included in the mandate.

Creating the governing board’s resolution is the first step on the road to your audit committee’s success.

Follow the leader(ship)

In practice we see a combination of these attributes, ranging from the full board acting as the audit committee, committees with one or more independent outsiders appointed by the board, and/or members from management and combinations of all of the above. While there are advantages and disadvantages for all of these approaches, each government needs to evaluate how to work within their own governance structure to best arrive at the most workable solution.

Strike the right balance between cost and risk

The overriding responsibility of the audit committee is to perform its oversight responsibilities related to the significant risks associated with the financial reporting and operational results of the government. This is followed closely by the need to work with management, internal auditors and the external auditors in identifying and implementing the appropriate internal controls that will reduce those risks to an acceptable level. While the cost of establishing and enforcing a level of zero risk tolerance is cost prohibitive, the audit committee should be looking for the proper balance of cost and a reduced level of risk.

Engage your audit committee with regular meetings

Depending on the complexity and activity levels of the government, the audit committee should meet at least three times a year. In larger governments, with robust systems and reporting, it’s a good practice to call for monthly meetings with the ability to add special purpose meetings as needed. These meetings should address the following:

External Auditors

• Confirmation of the annual financial statement and compliance audit, including scope and timing.
• Ad hoc reporting on issues where potential fraud or abuse have been identified.
• Receipt and review of the final financial statements and auditor’s reports
• Opinion on the financial statements and compliance audit;
• Internal controls over financial reporting and grants; and
• Violations of laws and regulations.

Internal Auditors

• Review of updated risk assessments over identified areas of risk.
• Review of annual audit plan, including status of the prior year’s efforts.
• Status reports of ongoing and completed audits.
• Reporting of the status of corrective action plans, including conditions noted, management’s response, steps taken to correct the conditions, expected time-line for full implementation of the corrective action and planned timing to verify the corrective action plan has been implemented.

Establish resources that are at the ready

Audit committees should be given the resources and authority to acquire additional expertise as and when required. These resources may include, but are not limited to, technical experts in accounting, auditing, operations, debt offerings, securities lending, cybersecurity, and legal services.

Taking Extra Steps Now Will Save Time Later

While no system can guarantee breakdowns will not occur, a properly established audit committee will demonstrate for both elected officials and executive management that on behalf of their constituents they have taken the proper steps to reduce these risks to an acceptable tolerance level. History has shown over and over again that breakdowns in governance lead to fraud, waste and abuse. Don’t be deluded into thinking that it will never happen to your organization. Make sure it doesn’t happen on your watch.

The post Why You Need an Audit Committee appeared first on MGO CPA | Tax, Audit, and Consulting Services.

Much like a traditional CPA firm can provide different types of services related to an entity’s financial statements, i.e., audit, review, or compilation, based on need, when government agencies are considering an independent evaluation of performance of their programs or operations, the CPA firm’s advisory or consulting arm can step in and offer a number of engagement types based on the agency’s unique needs: consulting services engagements, attestation engagements (e.g., agreed-upon procedures), and performance audits. It all depends on if, and at what level, assurance is needed. The primary driver of what type of product should be considered is typically based on, for instance, issue complexity, taxpayer concerns or expectations, statute requirements, or increased need for transparency on the efficiency and effectiveness of operations. While the driver of the engagement may differ, time constraints and budget are also determining factors.

The primary focus of this article is to discuss the differences of the three aforementioned types of engagements — consulting services, agreed-upon procedures, and performance audits — and to provide guidance when a performance audit might be an option.

It is important to identify the differences between (1) performance audits, (2) consulting services engagements, and (3) agreed-upon procedures attestation engagements. On numerous occasions throughout my government service career and also while serving clients, questions have come up regarding the objectives sought, the scope of the engagement, and the engagement type when considering an evaluation of performance for a particular program or area of operations. Each of these engagements differ in purpose and reporting requirements, as well as potential cost, as shown below in Figure 1.0. These engagements are governed by different standards, formal reports are not always required for each, and independence is not always required (i.e., consulting services).

Performance Audits Defined

Performance audits are defined as engagements that provide objective analysis, findings, and conclusions to assist management and those charged with governance and oversight to, among other things, improve program performance and operations, reduce costs, facilitate decision making by parties with responsibility to oversee or initiate corrective action, and contribute to public accountability. *1

Furthermore, GAGAS states that management and officials of government programs are responsible for providing reliable, useful, and timely information for transparency and accountability of these programs and their operations. Legislators, oversight bodies, those charged with governance, and the public need to know whether (1) management and officials manage government resources and use their authority properly and in compliance with laws and regulations; (2) government programs are achieving their objectives and desired outcomes; and (3) government services are provided effectively, efficiently, economically, ethically, and equitably. *2

Agreed-Upon Procedures (AUP)

Based on my experience, it usually comes down to identifying a few factors that determine the engagement. First, the agency must determine the purpose and scope of the work, specifically what questions they would like to have answered. These questions can be broad or very narrow. For example, in an AUP, management may make an assertion about whether a subject matter is in accordance with, or based on, established criteria that is the responsibility of a third party and hires a CPA to add credibility to that assertion by performing specific procedures to test compliance with the criteria. If an agency needs to know something very specific and wants an independent party to perform specific procedures and tell them what was found, then an AUP is appropriate. However, an AUP report does not provide recommendations, an opinion, or conclusion about whether the subject matter is in accordance with, or based on, the criteria, or state whether the assertion is fairly stated. While the agency may want to use an AUP, some key steps that are taken in consulting engagements and performance auditing, such as planning, are not required in an AUP engagement. Also, risk is not assessed in developing the scope, nor does the auditor use a risk-based approach, which is required in a performance audit. Finally, in an AUP, auditors do not perform sufficient work to be able to develop elements of a finding or provide recommendations.

1 See Paragraph 1.21 of GAGAS.
2 See Paragraph 1.02 of GAGAS.

Consulting Services Engagement vs. Performance Audit

For a consulting services engagement or performance audit, the initial questions are then turned into the objectives of the engagement. If the agency wants an objective review of operations or a program to assist them in making decisions, for example, to assess the management of specific funds, and wants findings and recommendations to improve operations, then the agency should discuss the options of a consulting services engagement or a performance audit. From here, the decisions are truncated. The agency needs to consider whether the report is for an internal audience, such as governing officials, management, or staff, or an external audience, e.g., a regulatory agency or the public. If the communication is intended for internal use, then a consulting services engagement with observations and recommendations may suffice. For these engagements, findings, recommendations, and a conclusion is provided to assist management in decision making. Or, an independent third party, such as a CPA or an internal auditor, may be asked to answer the engagement’s objectives to an external audience, in which case a performance audit may be more appropriate due to the need for an independent, objective report that can withstand scrutiny and is subject to peer review. Sometimes there isn’t a choice; some agencies are bound by the government code or local ordinance to conduct audits under GAGAS.

Performance audits are typically the more costly engagement type of the three, given the amount of work required to conduct an audit and adhere to stringent standards. As we’ll explore in later articles, performance audits conducted under GAGAS provide the highest level of assurance among the three options, based on the level of work required. These audits involve developing the required elements of a finding and the documentary evidence required for planning, fieldwork, and reporting. The amount of work involved is much greater than in consulting services engagements, where observations and recommendations will suffice. Consulting services engagements are not audits and, therefore, offer no assurance. Similarly, in attestation engagements, where only specific procedures are performed, no assurance is provided. *3

Conclusion

Having been on both sides of deciding what engagement to recommend, either for an agency I worked at or to a client, it’s important to discuss the level of work required for each engagement type, the number of hours required to do the work under the appropriate standard within a reasonable time period, and the available budget. Finally, and most importantly, clients should understand that performance audits and consulting services engagements each have their place and serve unique purposes. A performance audit offers independence and objectivity at a step above a consulting services engagement, and might be the best option if a rigorous audit of a program or agency is needed. This is where the consideration of the agency’s need is paramount. There may not always be the budget or time available to conduct a comprehensive performance audit, nor a need for an in-depth evaluation or a legislative requirement to do so. In these instances, a consulting services engagement is a good option, especially when time and budget are factors. A consulting services engagement can provide a sufficient report with recommendations and advice. However, it’s important to make the agency aware of the limitations of non-audit services. In addition, the audience of the final report product and any regulatory requirements should strongly influence the decision-making process.

Forthcoming articles in this series will drill down and focus in more detail on the professional standards associated with performance audits as compared to other types of engagements, “why” an agency would want a performance audit instead of a consulting engagement or an agreed-upon procedures engagement, when a performance audit would be recommended, what key factors should be considered, and what are the expectations of the audience of the report. The third article in this series will focus on the reporting elements of a performance audit and a sample performance audit report.

*3  Attestation engagement standards are covered in GAGAS Chapter 7, and include agreed-upon-procedures, reviews, and examination engagements. Attestation examinations have the highest level of assurance, as an opinion is given; not so for the others. Auditors may use GAGAS in conjunction with other professional standards such as American Institute of Certified Public Accountants (AICPA), International Auditing and Assurance Standards Board (IAASB), or Public Company Accounting Oversight Board (PCAOB) standards. For financial audits and attestation engagements, GAGAS incorporates by reference for AICPA Statements on Auditing Standards and Statements on Standards for Attestation Engagements. In addition, the AICPA promulgates the consulting standards. AICPA standard committees have taken the position that only the U.S. Government Accountability Office (GAO) sets performance audit standards.

Sources of Information and Documentation Considered:

• Government Auditing Standards, issued by the Comptroller General of the United States
  – July 2018 Revision (effective for performance audits beginning on or after July 1, 2019; effective for attestation engagements for periods ending on or after June 30, 2020; early implementation is not permitted)
• United States General Accounting Office. Best Practices Methodology – A New Approach for Improving Government Operations. May 1995

Disclaimer: The views expressed in this article are those of the author and do not reflect the official policy or position of the GAO, AICPA, or Macias Gini & O’Connell LLP.

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