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This report summarizes key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) at the spring 2024 national meeting and the virtual meeting that was held on Feb. 20, 2024.  SAPWG discussed a variety of topics including tax credits, residuals, income taxes and more. Insurance organizations should note these changes as they may significantly impact their accounting in 2024 and beyond. Check out our insurance services page to learn more about Baker Tilly’s practice.  Adopted revisions to statutory guidance  All adopted revisions to statutory guidance noted below are classified as Statutory Accounting Principle (SAP) clarifications and considered effective immediately after adoption by SAPWG, unless specifically noted otherwise.
Exposed revisions to statutory guidance  All exposed revisions to statutory guidance noted below are classified as SAP clarifications and with the public comment period ending May 31, 2024, unless specifically noted otherwise.
Other actions
For more information on these topics, or to learn how Baker Tilly’s insurance specialists can help, refer to our insurance webpage and sign up for our newsletter. If you have further questions regarding the information presented above, schedule a 30-minute meeting with one of our specialists.

On March 16, the NAIC’s Statutory Accounting Principles Working Group (SAPWG) met to discuss the latest on tax credits, residuals, income taxes and more 

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Updates from the Statutory Accounting Principles Working Group’s March 16 spring national meeting

This report summarizes key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) at its interim meeting on Jan. 10, 2024.  SAPWG met to discuss current expected credits losses (CECL), reinsurance questions and bonds issued by funds. Insurance organizations should note these changes as they may significantly impact their accounting through 2024 and beyond. Check out our insurance services page to learn more about Baker Tilly’s practice. 
This report summarizes key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) at its interim meeting on Jan. 10, 2024.    SAPWG updates   SAPWG met to discuss current expected credits losses (CECL), reinsurance questions and bonds issued by funds. Insurance organizations should take note of these changes as they may significantly impact their accounting throughout 2024 and beyond.   Adopted revisions to statutory guidance   All adopted revisions to statutory guidance noted below are classified as Statutory Accounting Principle (SAP) clarifications and are effective Dec. 31, 2023.
Exposed revisions to statutory guidance
To learn more about what to expect as we move into 2024, and to hear how our insurance specialists can assist you and your team, connect with us.   Get the latest industry updates and climb to new heights with our insurance specialists leading the way.  

CECL Solutions

Updates from the Statutory Accounting Principles Working Group’s Jan. 10 interim meeting

This report summarizes key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) at the fall 2023 national meeting that took place on Dec. 1, 2023.   Insurance organizations should take note of these changes as they may significantly impact their accounting in 2024 and beyond. Check out our insurance services page to learn more about Baker Tilly’s practice.
This report summaries key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) at the fall 2023 national meeting that took place on Dec. 1, 2023.  SAPWG discussed a variety of topics including debt securities that do not qualify as bonds, current expected credit losses (CECL), tax credits, interest maintenance reserve (IMR), asset valuation reserves (AVR) and more. Insurance organizations should take note of these changes as they significantly affect their accounting in 2023 and beyond.  Adopted revisions to statutory guidance  All adopted revisions to statutory guidance noted below are classified as Statutory Accounting Principle (SAP) clarifications and considered effective immediately after adoption by SAPWG, unless specifically noted otherwise.
Other actions
To learn more about what to expect in 2024 and to hear how our insurance specialists can assist you and your team

At the recent NAIC 2023 fall meeting for the insurance industry, SAPWG discussed debt securities, tax credits, CECL, IMR, AVR and more.

Updates from the Statutory Accounting Principles Working Group’s Dec. 1 fall national meeting

In 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, also known as long-duration targeted improvements (LDTI), which impacts all insurers that issue long-duration contracts (life insurance, long term disability, etc.).   LDTI is a set of focused changes to improve, simplify and enhance aspects of accounting for long-duration contracts generally issued by life and annuity insurance organizations. The implementation effort will require significant changes to systems, processes and controls and will also require the accumulation of data that has not been previously captured and included in actuarial models. It is expected that there could be a significant impact on reported earnings with increased earnings volatility.   The changes to the ASU are intended to result in improvements to accounting records in the following ways:
Effective dates  The effective date of LDTI is dependent on the type of entity. For public business entities that meet the definition of an SEC filer and are not a smaller reporting company, LDTI is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. For all other entities, LDTI is effective for fiscal years beginning after December 15, 2024, and interim periods within fiscal years beginning after December 15, 2025.   What insurers should do now   The transition effort will require significant finance, actuarial, project management and information technology (IT) resources that will need to be sourced from internal reallocations, new hires and external assistance. If your insurance organization writes long-duration insurance contracts, you should begin evaluation of the impact of the changes on your internal processes, any internal controls over those processes and financial statement disclosures now to ensure you are prepared for implementation.   We recommend consulting your Baker Tilly advisor on the impacts to your organization. Baker Tilly’s dedicated team of insurance professionals, IT specialists and in-house actuaries can assist you in assessing data models, identifying opportunities to modernize, implementing transition processes and much more, including the design of internal controls that will be required resulting from the new guidance.   For more information on this topic, or to learn how Baker Tilly’s insurance industry specialists can help:

Actuarial Services

Accounting update to long-duration insurance contracts

This report summarizes key updates from selected task forces and working groups at the National Association of Insurance Commissioners (NAIC) 2023 summer national meeting. We encourage you to also review our separate report on statutory accounting updates from the 2023 summer national meeting.  Executive (EX) Committee   The committee adopted amendments to the Mortgage Guaranty Insurance Model Act (model 630), which removed Section 21 – No Private Right of Action in its entirety and the Nonadmitted Insurance Model Act (model 870) developed by the Surplus Lines Task Force in an effort to align provisions with the federal Nonadmitted and Reinsurance Reform Act of 2010.   The committee also received an update from the Accident and Sickness Insurance Minimum Standards subgroup on the Model Regulation to Implement the Accident and Sickness Insurance Minimum Standards Model Act (model 171), with the subgroup focusing on revisiting the proposed new subsection on short-term, limited-duration plans.   Climate and Resiliency (EX) Task Force  
Special (EX) Committee on Race and Insurance
Health Insurance and Managed Care (B) Committee  The committee received a referral from the Financial Analysis (E) Working Group to engage in discussions with CMS regarding state insurance regulators’ concerns with how the risk adjustment formula impacts the current or prospective financial solvency position of new health insurers entering the health insurance marketplaces. Property and Casualty (P&C) Insurance (C) Committee   The P&C Insurance Committee deliberated on various subjects, including the adoption of their spring national meeting minutes and several task force and working group reports. This included the adoption of the ‘Regulatory Guide to Understanding the Market for Cannabis Insurance: 2023 Update’ – an update of the previous white paper that was adopted in 2018. Additionally, the committee heard presentations regarding telematics and the need for regulatory guidance and underinsurance issues specific to homeowner’s insurance.   
Financial Condition (E) Committee   The Financial Condition Committee discussed a variety of topics including the adoption of the reinsurance worksheet and Interpretation (INT) 23-01, framework for insurer investment regulation, use of artificial intelligence (AI) and more.
Capital Adequacy (E) Task Force
Life Risk-Based Capital (E) Working Group
Joint meeting of the Financial Stability (E) Task Force and Macroprudential (E) Working Group   During the meeting, the task force adopted the June 20, 2023, and spring national meeting minutes, received updates on the Financial Stability Oversight Council (FSOC) developments and received updates from their working groups on the liquidity stress test (LST) project and newly adopted actuarial guideline AG53.
Receivership and Insolvency (E) Task Force
For more information on these topics, or to learn how Baker Tilly’s insurance industry specialists can help

Several topics were covered at the NAIC’s 2023 summer national meeting, including key updates from the Climate and Resiliency Task Force, P&C insurance committee and more

Life Sciences

Updates from the National Association of Insurance Commissioners’ 2023 summer national meeting

This article discusses significant and time-sensitive accounting method developments potentially impacting a wide array of taxpayers in 2023. Items covered include important reminders concerning the small business taxpayer simplified methods and revenue recognition timing method changes and recent updates to the automatic accounting method change list and the alternative cost method (ACM) of accounting for common improvement costs of real estate developers.  Monitor eligibility for favorable small business simplified methods   Taxpayers are reminded to review their 2023 gross receipts levels and tax shelter status, if applicable, and be prepared to timely file Form(s) 3115 if necessary to avoid missed tax planning opportunities under the small business simplified methods.  The small business simplified methods, which are available to taxpayers that meet the gross receipts test (and are not a tax shelter), include the overall cash method and exceptions from onerous inventory accounting, UNICAP and PCM requirements. In addition to providing simplification benefits, these methods can also generate potentially significant cash tax savings. Small business taxpayer method changes are generally automatic and subject to an eligibility rule that prohibits filing an automatic change if the same change was made in the five prior tax years. A limited eligibility rule waiver is available provided the taxpayer changes from the small taxpayer method(s) in the first year it no longer qualifies as a small business taxpayer.  Taxpayers whose receipts have declined in 2023 or that previously exceeded the gross receipts threshold by a small margin should be aware that the threshold is increased to $29 million in 2023, up from $27 million in 2022. This presents an opportunity for newly eligible taxpayers to adopt or change to the favorable small business simplified method(s) in 2023, including a taxpayer that used these method(s) previously. However, taxpayers should be cognizant that the limitation applies at a group (not entity) level; so foreign, acquired and new entities should not be overlooked when applying the gross receipts limitation, especially if the taxpayer has restructured or made acquisitions during the year.  Conversely, a taxpayer that fails the gross receipts test or becomes a tax shelter in 2023 must file Form(s) 3115 to change to permissible nonsmall business methods for 2023. In particular, a taxpayer that expects to need the limited eligibility rule waiver (discussed above) to make another automatic small business method change in the near term (a common occurrence) must file a 3115 for 2023 timely to qualify for the waiver. However, a passthrough entity that is generally profitable but incurs an unusual loss and becomes a syndicate (i.e., tax shelter) in 2023 should consider making the annual election to use the prior year (2022) taxable income to determine eligibility as a small business taxpayer and thereby avoid having to change off the small business simplified method(s) for 2023. A former small business taxpayer that becomes subject to UNICAP should be aware that these changes can be complex and time-consuming to implement. Therefore, these taxpayers should allow sufficient lead time to perform the necessary analysis and prepare supporting UNICAP calculations in connection with this method change.  In summary, the popular and widely adopted small business simplified methods provide valuable simplification and tax savings benefits. Taxpayers looking to avail themselves of these benefits should carefully monitor eligibility for these favorable methods and be aware of the increased gross receipts threshold ($29 million in 2023) and limited automatic change eligibility waiver to maximize planning opportunities under the small business taxpayer simplified methods.  Expiring automatic revenue recognition method change requires timely action  Taxpayers that still need to make changes to comply with the TCJA amendments to the “all events test” for recognizing revenue should be aware that the automatic change to comply with the new rule expires after 2023.   The amended “all events test” generally applies to an accrual basis taxpayer with an applicable financial statement (AFS), such as certified audited financial statements prepared under GAAP or IFRS. Under the amended “all events test”, income is recognized at the earliest of when it is received, due, earned or recognized in the AFS. Certain special methods are exempt from this rule (e.g., instalment sales, long term contracts, certain leases, mark to market transactions). Because it is a method of accounting, a Form 3115 filing (generally automatic) is required to comply with the new revenue recognition timing rule.  Thus, taxpayers that need to comply with the revenue recognition timing rule must act before the automatic change expires to avoid having to make the change non-automatically. Unlike an automatic change, a non-automatic change requires payment of a user fee (currently $11,500 per change) and a potentially lengthy IRS approval process, which most taxpayers prefer to avoid whenever possible.   Examples of common impermissible revenue recognition methods include deferring advance payments under the so-called two-year rule (now repealed), improperly following book PCM for long-term contracts, and forgetting to make mandatory adjustments to the AFS income amount. Mandatory tax adjustments to AFS income include increases for cost of goods sold and cost offsets and decreases for income amounts the taxpayer does not have an enforceable right to receive pursuant to the contract terms or under applicable law if the customer were to terminate the contract as of year-end. Additionally, taxpayers should be aware that other changes can trigger the new rule, such as issuing an AFS (e.g., where the financial statements were previously unaudited), or changing to the accrual method, such as a former small business taxpayer that must change from the cash overall method because it failed the gross receipts test.  The widely applicable TCJA revenue recognition amendments can be complex and time-consuming to implement. Thus, taxpayers must allow sufficient lead time to analyze and apply the rules to their businesses and act promptly to file Form(s) 3115 to comply with new rule before the automatic change expires to avoid costly, onerous non-automatic changes.   Consider tax planning opportunities to defer revenue in 2023  Taxpayers are also reminded to consider revenue recognition tax planning opportunities to replace deductions lost under expired and expiring TCJA provisions, such as the reduced business interest expense limitation, the research and experimental (R&E) expense capitalization requirement and the phase down of bonus depreciation. Although bipartisan support exists in Congress to delay or repeal these unfavorable provisions, no legislative relief has been enacted to date and the prospects for near-term relief are highly uncertain at this point.   In the absence of legislative action, taxpayers not currently using the deferral method for advance payments should review their short-term deferred revenue accounts for eligible advance payments received for common items such as gift card subscriptions and sales of goods and services, among others, and consider making the easy to implement automatic method change to defer income and save taxes.   Updated automatic accounting method change list issued  The IRS recently issued guidance containing an updated list of automatic accounting method changes, generally effective for applications filed on or after June 15, 2023 (now). While no new automatic changes were added (to the previously issued guidance), the list incorporates and modifies two recently issued automatic changes for R&E cost capitalization and the new natural gas safe harbor under the tangible property rules, revises numerous existing automatic changes, and deletes multiple obsolete changes and provisions.  Because many taxpayers will need to file automatic method changes for 2023 returns (e.g., to comply with TCJA provisions requiring R&E expense capitalization and amending the revenue recognition timing rule to make a mandatory change from the small business simplified methods), taxpayers and their advisors should act soon to familiarize themselves with the new guidance and be sure that 3115 filings comply with the updated procedures  Significant changes made to ACM of accounting for common improvement costs of real estate developers   The IRS recently issued updated procedural guidance for the alternative cost method (ACM) that real estate developers may elect to account for certain common improvement costs. The new procedures are effective for tax years beginning after Dec. 31, 2022. Former guidance may no longer be used after that date.  The ACM is an optional method for real estate developers to account for certain common improvement costs, such as infrastructure amenity items like sidewalks, sewer lines, playgrounds and tennis courts. Significantly, the ACM can only be used by accrual basis real estate developers that are contractually or legally obligated to provide the common improvements as part of a multi-unit commercial or residential project.  The ACM may accelerate deductions for common improvement costs, subject to certain limitations, and therefore may be preferable to accounting for these costs under the general economic performance rule. Despite the potential acceleration benefit, many taxpayers decline to elect the ACM due to the onerous reporting requirements (consents, annual statements and statute of limitation extensions).  However, taxpayers that have previously foregone the ACM may wish to reconsider because, although there are record retention requirements and the mechanics of the ACM calculation remain unchanged under the new ACM, the procedural aspects have been simplified, eliminating burdensome reporting requirements such as consents, annual statements and statute of limitation extensions. Additionally, the ACM is now treated as a method of accounting, which must be used for all qualified projects of the trade or business, thus eliminating the option under the old procedures to pick and choose projects. Significantly, the new procedures prohibit PCM contracts from using the ACM, and so taxpayers currently accounting for these contracts under the ACM will need to file Form 3115 to change to the all-events and economic performance tests. Three new automatic changes are added to make changes under the new ACM, including different options for taxpayers converting non-ACM projects to the new ACM. Certain changes and favorable temporary transition rules apply to the first tax year beginning after Dec. 31, 2022.  Real estate developers should reevaluate the ACM considering the simplified procedural guidance, but they should also be aware of the all-or-nothing approach and exclusion for PCM contracts. As noted, real estate developers not currently using the ACM may want to reconsider electing new ACM due to the reduced reporting requirements. Conversely, because the old ACM procedures may not be used for tax years beginning after Dec. 31, 2022, developers currently using this method should act soon to assess the tax impact of the new technical requirements, determine which method change(s) to make, and be ready to timely file Form 3115 to take advantage of temporary transition relief provisions provided under the new procedures.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

This article discusses significant and time-sensitive accounting method developments potentially impacting a wide array of taxpayers in 2023.

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Important accounting method updates and reminders for 2023

This article summarizes key accounting method areas for businesses to focus on in 2022. The topics addressed include high-dollar items affecting a wide array of industries such as revenue recognition timing, small business simplified methods and lease accounting income and expenses. New automatic change procedures to comply with the final revenue recognition regulations The Tax Cuts and Jobs Act of 2017 (TCJA) amended the revenue recognition timing rules to add a fourth prong to the “all events” test. Accordingly, under the new standard, income is recognized at the earliest of when it is received, due, earned or recognized in the financial statements. The final regulations issued pursuant to the TCJA refer to this as the “AFS income inclusion rule,” and it generally applies to an accrual basis taxpayer with an applicable financial statement (AFS) such as a certified, audited financial statement issued under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).  The procedures to comply with the final regulations are lengthy (70 pages), complex and contain multiple method changes, options and terms and conditions to consider. This discussion addresses common issues related to the new AFS income inclusion rule only. Affected taxpayers that have not implemented the final revenue recognition regulations, or have taken a position contrary to the rules, should act quickly to review their methods of accounting and file any necessary accounting method changes (Form 3115) because the final rules are now mandatory for all covered income items, with the exception of certain “specified fees.” Notably, the automatic change to comply with the AFS income inclusion rule is particularly time sensitive because this change is only available temporarily (i.e., for tax years 2021 through 2023). Thereafter, the change must be made under the more onerous and costly nonautomatic change procedures. Taxpayers should review revenue recognition methods, which can be a time-consuming process depending on the number and type of revenue streams, customer contracts and variations in terms and conditions (e.g., performance obligations, revenue offsets, contingency provisions). Common exposure items to be aware of include improperly deferring income from overlooked liabilities, misapplication of the “enforceable right” standard, impermissible use of the now-repealed “two-year” deferral method for advance payments and long-term contracts accounted for using noncompliant book percentage of completion methods. In particular, the issue of overlooked liabilities is common for taxpayers that make a tax revenue recognition method change in connection with implementing the new revenue recognition financial standard under ASC 606. Under ASC 606, the adjustment to financial statement revenue is determined based on net income rather than gross revenue. Conversely, the AFS income inclusion rule used to determine taxable income applies to gross income, without any offset for costs other than the limited exception provided for sales of certain goods under the optional cost offset method. Consequently, taxpayers need to carefully analyze AFS income and addback liabilities and cost offsets in accordance with the AFS income inclusion rule. Additionally, issues have arisen in connection with applying the new “enforceable right” standard that are discussed further below.  IRS raises issues with the enforceable right standard As noted above, under the amended “all events test,” an item of income is recognized at the earliest of when it is due, received, earned or reported in the AFS. Significantly, the final revenue recognition regulations provide that income “reported in the AFS” does not include amounts the taxpayer does not have an “enforceable right” to recover if the customer were to terminate the contract at the end of the tax year (regardless of whether the customer actually terminates the contract).  IRS officials at a recent ABA tax conference noted that the enforceable right standard may not cover common situations, such as the three scenarios noted below: State tax refund claims – The enforceable right standard appears inapplicable because the tax authority is not the taxpayer’s customer and there is no contract between the parties. This situation raises the issue of whether a taxpayer might be required to include the refund in income (e.g., because it was reported in the AFS) even though the amount is not realized as of year-end (e.g., because the government has not approved the refund), which appears contrary to the TCJA. Volume purchase discounts received by a purchaser – According to the IRS, the enforceable right standard may be inapplicable to discount income received by a purchaser from a vendor because the discount is a purchase price adjustment rather than a revenue item, and the party paying the discount is a vendor and not a customer of the purchaser. Consequently, guidance might be necessary to address the treatment of this income (e.g., where discount income is included in the AFS but the contract may be terminated before the discount is earned).  Insurance policy renewal commissions received by insurance agent from insurance company – The IRS noted this type of arrangement falls outside the traditional customer relationship contemplated under the enforceable right standard and questioned whether the enforceable right standard was properly applied in an example in the final regulations. Under the facts in the example, the taxpayer (insurance agent) receives a renewal commission from the insurance company if a policy is renewed. The example concludes that the taxpayer does not have an enforceable right to a renewal commission for a particular policy because the carrier could cancel the policy prior to renewal.  The IRS indicated that it plans to study situations not addressed in the enforceable right standard rules and will consider providing a broadly defined definition of the term “customer.” The IRS also requested input from commentators to assist it in formulating additional guidance addressing more fact patterns that may be eligible for the enforceable right exception. New lease accounting standard  Taxpayers required to adopt the new financial standard for lease accounting under ASC 842 in 2022 (e.g., privately held businesses) may need to devote considerable tax resources to address the tax implications of the standard. Under ASC 842, book lease accounting changed significantly in areas such as lease classification, lease acquisition costs, lease termination payments and sale/leaseback transactions. In particular, the new standard substantially modified the treatment of operating leases by a lessee. Under the new standard, the lessee is required to account for these leases on the balance sheet as right of use (ROU) assets with an offsetting liability, rather than as “true” leases (rent expense) under the previous accounting principles.  Although the tax lease accounting rules remain unchanged and, as in the past, do not follow book treatment, significant effort may be required to address the tax implications of the new financial accounting standard. Taxpayers impacted in 2022 by the lease accounting standard should consider the following action steps:  Review book and tax lease methods, which can require extensive lead time, depending on the volume and complexity of lease agreements, general ledger accounts and items affected and data availability. In particular, taxpayers that implemented new lease accounting systems and processes will need to ensure that these new enhancements capture the information needed to maintain the historical tax methods and calculations.  Where the tax treatment does not follow the book lease accounting standard, taxpayers will need to create new or revise existing book/tax adjustments for various lease-related income and expenses such as rent, interest, depreciation, amortization, lease acquisition costs and      sale/leaseback transactions. Determine whether method changes (Form 3115) are required for noncompliant or non-optimal lease accounting methods. Fortunately, automatic changes are available for many common lease-related items such as lease classification changes, tenant improvement costs, lease acquisition expenses, lease termination payments, rent income and expenses under section 467 rent agreements and rent income subject to the new AFS income inclusion rule discussed above.  New procedures for small business taxpayer simplified method changes  The TCJA increased the gross receipts threshold for favorable small business simplified accounting methods, including the cash overall method, inventory accounting and uniform capitalization (UNICAP) method exceptions and the exemption from PCM for certain “small” construction contracts. The expanded eligibility provided in the TCJA and the final regulations issued thereunder resulted in wide adoption of these small business simplified methods by taxpayers looking to save cash and simplify their tax compliance. Procedures issued to implement the final small business taxpayer regulations favorably add automatic changes to accommodate common situations, such as permitting taxpayers with inventory to automatically change to or from the cash and accrual overall methods.  Significantly, the procedures also facilitate taxpayers needing to make frequent automatic changes to or from the small business simplified methods by providing a permanent waiver of the eligibility rule that prohibits a taxpayer from making the same automatic change within five tax years. However, the waiver is subject to a key restriction that requires the taxpayer to change from the small business taxpayer method(s) in the first year it becomes a “former small business taxpayer” and is disqualified from using the small business simplified methods (e.g., taxpayer exceeds the gross receipts threshold or becomes a tax shelter). Consequently, small business taxpayers using the simplified method(s) will need to carefully monitor their gross receipts levels and tax shelter status and be prepared to file Form 3115 timely if they require the waiver to make an automatic change to a different permissible method. Conversely, changes that fail to satisfy the eligibility rules must generally be made under the more onerous and costly nonautomatic method change procedures. A pass-through entity that is typically profitable but expects to incur a net operating loss for 2022 (e.g., due to COVID, inflation or supply chain issues) should consider making an election to use the prior year’s (2021) taxable income to avoid disqualification as a syndicate (tax shelter) and remain qualified for the favorable small business taxpayer methods. Under the final regulations, the election is made on an annual basis (not permanently), thus providing added flexibility for pass-through entities to benefit from the favorable small business simplified methods. Additionally, a former small business taxpayer required to implement a UNICAP method change should allow sufficient time to comply with the final UNICAP rules, which may require significant effort, particularly for producers with intricate or complex book inventory accounting practices (e.g., numerous standard cost calculations, significant uncapitalized direct costs or variances, intercompany inventory transactions).  Updated list of automatic method changes issued The IRS recently issued an updated list of automatic accounting method changes that replaces the existing list and includes numerous modifications. Taxpayers filing automatic accounting method change applications (Form 3115) for 2022 are required to use the updated procedures.  The new list incorporates recent guidance issued to implement legislative amendments (e.g., TCJA, Coronavirus Aid, Relief and Economic Security (CARES) Act), comply with final regulations under the TCJA for items such as the revenue recognition timing provisions and small business taxpayer simplified methods discussed above, and make various depreciation changes (bonus, qualified improvement property, 30-year alternative depreciation system (ADS) life for residential rental property placed in service by an electing real property trade or business, certain late or revoked depreciation elections, ADS depreciation changes for a controlled foreign corporation (CFC) under global intangible low-taxed income (GILTI) rules). Other significant modifications include deleting obsolete provisions (e.g., temporary transition relief to implement depreciation changes and to revoke or make late elections), prohibiting automatic changes for section 174 research and experimental expenditures and software development costs subject to the capitalization provisions under the TCJA, and providing important clarification in certain situations regarding the automatic change eligibility rule that precludes filing an automatic change if the same item was changed within the five prior tax years. See the separate article above for an update on the TCJA amendments to section 174 research and experimental expenditures. Because many taxpayers will need to file automatic method changes in 2022 (e.g., to comply with TCJA final regulations or in connection with ASC 842 lease accounting standard adoptions discussed above), taxpayers and their advisors should be aware of the new guidance and ensure that 3115 filings comply with the updated procedures. For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Read our article to discover key accounting method areas for businesses to focus on in 2022. 

Coronavirus Recovery & Growth Resources

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2022 accounting method issues and developments 

Client's need An emerging growth company required assistance reviewing their financial statements prior to closing their Series A financing round. The goal was to assist them with their complex financing, accounting and corporate governance needs in preparation for a possible high-dollar acquisition. Baker Tilly solution Emerging growth technology companies have complex needs that require seasoned and dedicated resources. In order to help the client meet their financial goals, Baker Tilly professionals did the following: Worked with client to develop a revenue recognition model for a new medium and format of digital entertainment in light of changing accounting literature for revenue recognition under ASC 605 and 606 Gained an understanding of the monetization strategy for intellectual property and worked with the client on developing a capitalization strategy of podcast intellectual property Performed accounting for complex debt and equity instruments, including issuance of Preferred Stock, Simple Agreement for Future Equity (SAFE) and stock options Results achieved The Baker Tilly team was able to help the client successfully close a Series A financing round and prepare them with an exit strategy that led to a high-dollar, successful acquisition.

Baker Tilly assists emerging growth technology company with their complex financing, accounting and corporate governance needs in preparation for a possible high-dollar acquisition.

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ASC 606 Revenue Recognition

Financial Statement Audit

Baker Tilly assists emerging growth technology company with $300 million sale 

video In the third webinar in our insurance hot topics series, Baker Tilly’s accounting and tax professionals address recently issued or pending U.S. GAAP and statutory accounting guidance that will impact insurance companies, followed by a discussion on tax legislation in the next Congress, recent tax developments affecting insurers and tax planning for year-end under the CARES Act. Part one:  U.S. GAAP and Statutory accounting update  Identifies issued U.S. GAAP and statutory accounting guidance that may have an impact on insurance industry companies Evaluates pending U.S. GAAP and statutory accounting guidance that may have an impact on insurance industry companies Discusses the basics of the new guidance and how it may impact your company Part two:  Federal tax update  Evaluates  how the composition of Congress might affect the tax policies of the Biden administration Reviews updates on IRS discount factors for 2020, life insurance reserves and net operating loss provisions Assesses tax planning under the CARES Act to maximize your company’s tax benefit

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Insurance hot topics virtual series: accounting, tax and statutory update

On July 29, 2020, the IRS and Treasury Department released proposed regulations to implement the small business taxpayer simplified accounting method provisions enacted under the Tax Cuts and Jobs Act (TCJA) for tax years beginning after Dec. 31, 2017. The proposed regulations clarify the gross receipts test requirements and provide guidance for implementing the small business taxpayer simplified method provisions. However, positions taken on the treatment of syndicates and the inventory accounting exception are likely to be less favorably received and may create additional uncertainty, complexity and administrative burden for affected taxpayers. Although these regulations are not yet effective, taxpayers may rely on them for taxable years beginning after Dec. 31, 2017, provided they consistently implement all the applicable rules for each adopted provision. Background  The TCJA favorably amended certain small business taxpayer methods of accounting to increase the gross receipts test threshold to $25 million, index it for inflation and eliminate the requirement that the test be met for all prior tax years. These changes enable more taxpayers to use the cash method of accounting and can exempt them from the often costly and onerous uniform capitalization (UNICAP) requirements, comply with the percentage-of-completion method (PCM) rules and accounting for inventories. However, under the TCJA small business taxpayer provisions, tax shelters (including syndicates) remain ineligible for the small business taxpayer simplified methods regardless of their gross receipts levels. For purposes of this rule, a syndicate is defined as a partnership or other entity (other than a C corporation) which allocates more than 35% of the entity’s losses for the taxable year to limited partners or limited entrepreneurs.  UNICAP exception The proposed regulations, which are generally taxpayer favorable, remove the now obsolete small reseller exemption and replace it with the UNICAP small business taxpayer exception enacted under the TCJA.  The 2017 tax reform increased the gross receipts threshold to $25 million from $10 million and extended the UNICAP exception to producers as well as resellers. However, unlike the small reseller definition that generally included only receipts from sales of goods and services, the small business taxpayer test includes income from other sources such as interest, dividends, rents and royalties. This has implications for other simplifying conventions under the UNICAP rules. For example, the addition of receipts from other sources may cause a taxpayer to exceed the threshold and require an accounting method change. There are also special rules for farm trades or businesses. Cash method of accounting The proposed rules reflect amendments made by the TCJA to the gross receipts test for taxable years beginning after Dec. 31, 2017. As noted, the TCJA increased and indexed the gross receipts test threshold but left other cash method provisions unchanged, such as the short year and aggregation rules and the exclusion of tax shelters from using the cash method. Unfortunately, the proposed rules also contain unfavorable provisions that may significantly limit use of the cash method in certain circumstances. Syndicates  Consistent with pre-TCJA rules, syndicates are classified as tax shelters ineligible to use the cash method. Syndicate status will only apply for a year in which the entity has a loss and not in a year the entity is profitable and meets the gross receipts test. Thus, a syndicate’s eligibility for the small business taxpayer methods may change yearly and, further, may not be determinable until after year-end, which can significantly complicate tax planning and delay tax reporting for these entities.  Syndicates, or tax shelters, are defined much more broadly than one would anticipate. A “tax shelter” for this purpose is an entity, other than a C corporation, if more than 35% of the losses during the taxable year are allocated to limited partners or limited entrepreneurs. A “limited entrepreneur” is a person who has an interest in an entity (other than a limited partnership interest) and who does not actively participate in the management of the entity. The proposed regulations may actually increase the likelihood of an entity becoming a syndicate because the section 163(j) business interest limitation does not apply to small business taxpayers. Although intended to simplify the process of determining an entity’s syndicate status, this rule may also create a trap for the unwary if the entity is profitable after taking into account the interest limitation, but has a loss and is a syndicate under the 35% loss rule because the interest deduction is not limited for this purpose.  Affected entities may need to evaluate the trade-offs of implementing strategies to avoid a tax loss (e.g., election to opt out of bonus) versus losing eligibility for the favorable small business taxpayer simplified methods of accounting. To allow adequate time for planning, the proposed regulations provide an election that permits a taxpayer to apply the 35% loss rule by electing to use the allocated taxable income or loss of the immediately preceding taxable year, rather than the current-year amounts.  Taxpayers should carefully consider whether the election is beneficial because it applies for all purposes for which status as a tax shelter is relevant (e.g., section 163(j) interest deduction limitation) and is irrevocable unless the taxpayer obtains IRS permission.  In summary, the proposed rules related to syndicates are generally unfavorable and have implications beyond the small business taxpayer simplified methods (e.g., section 163(j) small business taxpayer provisions). Additionally, entities that move in and out of syndicate status may be prevented from making frequent changes back to the cash method in years they cease to be a syndicate. Consequently, entities treated as syndicates may derive limited or no benefit from the favorable small taxpayer provisions if the proposed rules are finalized in their current form. The Treasury Department and the IRS continue to study the definition of a tax shelter, which may indicate that changes to these rules could be forthcoming. Inventory exception The TCJA provided welcome simplification by permitting eligible small business taxpayers to either treat inventory as non-incidental materials and supplies or, alternatively, to follow the inventory method of accounting used in its applicable financial statements (AFS) or, if the taxpayer does not have an AFS, in the books and records prepared in accordance with the taxpayer's accounting procedures. The proposed regulations provide guidance for implementing this inventory accounting exception for small business taxpayers. However, several proposed provisions limit book/tax conformity, potentially resulting in added complexity and administrative burden and undermining the legislative intent to simplify inventory accounting for small business taxpayers.  For example, the proposed regulations allow small business taxpayers to treat non-incidental materials and supplies as “used or consumed” in the later of the year the taxpayer provides the item to the customer or the year the items are paid for (cash method) or incurred (accrual method). The regulations also permit taxpayers to use most inventory accounting methods to identify these non-incidental materials and supplies, with the exception of the last in, first out (LIFO) and lower of cost or market (LCM) valuation methods. Finally, guidance is provided on the definition of AFS, the types and amounts of costs that can be recovered for tax purposes, and when such costs may be taken into account. Some of the additional requirements and restrictions are surprising and contrary to the simplification purpose expressed by the Treasury Department and the IRS. If finalized in their current form, these provisions could require significant taxpayer resources to analyze and reconcile differences between book and tax inventory and accounting records, which may effectively reduce or eliminate the benefit of using the small business simplified inventory method for many. Long-term contract exceptions The proposed regulations incorporate amendments made by the TCJA that modify the small construction contract PCM exception and homebuilder UNICAP exemption to increase the gross receipts threshold and revise the PCM lookback rules to reflect the repeal of corporate alternative minimum tax (AMT) and the enactment of base erosion and anti-abuse tax (BEAT). Notably, the modified lookback rules apply to both small and large taxpayers. Additionally, the proposed rules clarify when and how a taxpayer adopts a method of accounting for a long-term contract and provide guidance for determining the classification of long-term contracts when a taxpayer becomes a small business taxpayer or ceases to qualify as a small business taxpayer.  Accounting method changes   The proposed regulations provide no method change procedures and generally direct taxpayers to use existing guidance to implement changes to and from the small business taxpayer simplified methods.  In August 2018, the IRS issued procedures for eligible small business taxpayers to obtain automatic IRS consent to change to the small business taxpayer simplified methods, generally effective for tax years beginning after Dec. 31, 2017.  Under these procedures, the rule prohibiting the filing of an automatic method change if the same item was changed within the past five tax years (including the year of change) is temporarily waived for changes filed for a taxpayer’s first, second or third taxable year ending on or after Dec. 31, 2017. Thereafter, a taxpayer requesting a change within the five-year waiting period is required to apply under the more onerous and costly advance consent procedures. Although the TCJA favorably modified the gross receipts test so taxpayers could requalify for the small business taxpayer simplified methods, the proposed rules unfortunately appear to limit a taxpayer’s ability to make such changes on a frequent basis.  For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

The IRS and Treasury Department released proposed regulations to implement the small business taxpayer simplified accounting method provisions enacted under the Tax Cuts and Jobs Act (TCJA)

Small Business

Small & Family Business Coronavirus Resources

Proposed regulations issued to implement TCJA small business taxpayer simplified accounting methods

The opportunity zone (OZ) space is among the innumerable sectors of the economy adversely impacted by COVID-19. From reservations on the part of potential investors due to liquidity considerations, to questions about the viability of going concern on the project side, uncertainty abounds. In an effort to alleviate some of these concerns, in June, the IRS continued its efforts to provide taxpayers with coronavirus-related compliance relief via OZ-focused Notice 2020-39, which relaxed many of the program’s timing requirements. Pandemic aside, additional compliance questions remain unanswered after 544 pages of comprehensive final regulations were released in December 2019. This article serves as a reminder of the relief provided by Notice 2020-39 as well as an overview of the remaining gray areas as they have emerged in practice. Lastly, we provide a brief comparison of what could be next for the OZ provisions, based on details on the respective candidates’ tax platforms that have been released ahead of the forthcoming presidential election.  Notice 2020-39 The IRS provided investors and qualified opportunity funds (QOFs) extensions to comply with many rules that require time-sensitive actions to take advantage of the OZ tax benefits. For a more detailed discussion of Notice 2020-39, but in summary, the provided relief automatically: Allows taxpayers until Dec. 31, 2020, to invest eligible gain in exchange for a QOF investment if their 180-day investment period otherwise would have ended on or after April 1, 2020, and before Dec. 31, 2020. Deems a QOF’s failure to meet the requisite 90% asset test standard to be due to a reasonable cause and, consequently, no penalties will be due if the QOF’s: (1) last day of the first six-month period of its taxable year or (2) the last day of its taxable year falls between April 1, 2020, and Dec. 31, 2020.  “Stops the clock” on any 30-month substantial improvement period being utilized by a QOF or qualified opportunity zone business (QOZB) to qualify its property as QOZB property (QOZBP) from April 1, 2020, through Dec. 31, 2020. For example, if as of April 1, 2020, a QOZB was two months into its 30-month period over which it plans to renovate a building, the third month would not start until Jan. 1, 2021.  In addition to the automatic relief, the notice also confirms that the national emergency declaration issued by the president in reaction to COVID-19 triggers the availability of the federal disaster relief included in the OZ regulations. Specifically, a QOZB will have more time to acquire or construct property, or start a business within an OZ pursuant to a working capital safe harbor (WCSH).  QOZBs generally can apply up to two consecutive 31-month WCSH periods to carry out a written plan for the aforementioned purposes, but the OZ regulations allow for “not more than an additional 24 months” in light of a federally declared disaster. It is unclear based on the wording of the regulations and the notice whether the additional 24 months is automatic or if QOZBs must demonstrate they need the extra time based on facts and circumstances. However, informal commentary by IRS officials suggests the latter is true. We therefore strongly recommend that QOZBs utilizing this relief provision be diligent and thorough in maintaining documentation to support its need to do so, should it be questioned or challenged upon IRS examination. Unanswered OZ compliance questions QOF decertification process Despite the welcome relief provided by Notice 2020-39, the scope of the economic crisis surely has caused investor groups and project managers to question whether staying the course of their OZ plans is economically feasible. When the decision is reached to dissolve a QOF, the regulations prescribe a voluntary decertification process whereby a QOF withdraws its status as such and, as a consequence, its investors are deemed to have inclusion events and must recognize their deferred gains.  However, the regulations delegate designing the decertification process to the IRS and, to date, no guidance or forms have been released on the matter. We do know that under the regulations, decertification will not be effective until the month that follows the month specified by the QOF, which cannot be any earlier than the month the QOF applies for decertification. As such, to the extent decertification is planned for 2021, fund managers must take care to maintain the 90% asset standard through the month subsequent to the designated decertification month to avoid penalties.  What is reasonable cause? As discussed, a QOF that fails to hold 90% of its assets in QOZBP will be charged potentially steep penalties, unless it can demonstrate that the failure was due to reasonable cause. Despite being lobbied by taxpayers and practitioners to detail what constitutes reasonable cause for this purpose, the Treasury Department declined to do so when finalizing the OZ regulations. As a result, once Notice 2020-39’s automatic relief period ends on Dec. 31, 2020, taxpayers who run afoul of this requirement will have to determine whether their facts and circumstances present an adequate defense to penalty assessment.  The preamble to the final OZ regulations do provide a hint in pointing to Section 20.1 of the Internal Revenue Manual (IRM) as the standard for determining whether reasonable cause has been established with respect to the 90% asset test. The IRM in general outlines that reasonable cause requires the taxpayer to have exercised “ordinary business care and prudence,” and their failure to comply with the law at issue was due to circumstances beyond their control. Potential instances as outlined by the IRM may include the death, serious illness or unavoidable absence of the person with the sole authority to direct the QOF’s actions; fire, casualty, natural disaster or other disturbance; an inability to obtain records; reliance on erroneous advice. It is critical to note that these are merely examples and may not on their own rise to the level of reasonable cause.  Zero divided by zero still undefined  To determine whether the 90% asset standard has been met, a QOF must divide the total QOZBP over its total assets. If the quotient is greater than or equal to 0.9, no penalty is due; if less, the QOF must self-assess a balance due. As part of this exercise, a QOF can exclude from both the numerator and the denominator contributions of capital it received no longer than six months before the testing date, so long as those contributions were continuously held in cash, cash equivalents or debt instruments with terms of 18 months or less. For QOFs whose only assets are these excludable contributions, this presents a mathematical quandary as it must report zero for its QOZBP over zero for its total assets — a result that is undefined. This is a common fact pattern in a QOF’s initial year, e.g., investors contribute cash to the QOF just a few days before Dec. 31, and the QOF still holds this cash on Dec. 31. The QOF should not be assessed any penalties in this scenario, as the ability to exclude recently contributed capital is clearly available so that fund managers have adequate time to deploy the funds to acquire “good” QOZBP. However, as a matter of compliance, it is unclear whether the quotient should be reported as one or zero. If the former, no further calculation is necessary (greater than 0.9); if the latter, a calculation would be required, but the result would be zero as the QOF has no balance of “bad” assets to assess a penalty on. Informal commentary from the IRS promotes the former approach; however, we are hopeful the form instructions will be updated in due course to reflect this. For the time being, we recommend that QOFs with the “zero divided by zero issue” check the yes box on line 14 of the Form 8996 to avoid confusion with the IRS. Challenges for existing property owners In spring 2020, Treasury issued technical corrections to the final OZ regulations. The final OZ regulations contained an example in which an individual realized gain from the sale of real property to a QOF and then invested that gain in the buyer QOF. The final OZ regulations disallowed the individual’s investment under the step transaction and circular cash flows doctrines. The property acquired by the QOF was also deemed a “bad asset” because it was acquired from a related party. For OZ purposes, “related party” is defined as more than a 20% ownership interest.  Prior to the issuance of the technical corrections, many practitioners believed that existing OZ landowners could sell land to a QOF and then subsequently acquire a less than 20% ownership interest in that QOF. The technical corrections established that the step transaction and circular cash flow doctrine will be applied even if the existing property owner acquires a less than 20% ownership interest in the QOF. What remains unclear is whether an existing OZ property owner can use unrelated gains to acquire an interest in a QOF. For instance, assume an individual both sells real property to a QOF and sells stock to an unrelated third party. Can that investor use the gains from the sale of the stock to acquire an interest in the QOF? This issue remains gray. Existing OZ property owners should exercise caution and consult with tax advisors before proceeding with such a scenario.  OZs post-presidential election The potential for significant tax legislation in 2021, of course, not only hinges upon the outcome of the presidential election, but also the results in both chambers of Congress. That said, it should be noted the available information surrounding the tax platforms of both the Trump and Biden campaigns include mentions of changes to OZs.  Few details have been offered by the Trump campaign, though “expanding opportunity zones” is among them. It is unclear what this would entail, but it stands to reason (and the president’s advisors have alluded to) it would mean additions to the existing 8,766 OZs designated by Treasury.  The Biden campaign’s platform echoes long-standing bipartisan calls to add reporting requirements to the program rules and corresponding reviews by Treasury to ensure that the program is achieving its intended benefit of aiding low-income communities. Additional incentives would be created to encourage partnerships between OZ project management and local not-for-profits and community leadership, to promote coordination such that the benefits to the local economies and job creation are optimized. We encourage you to reach out to your Baker Tilly tax advisor regarding how any of the above may affect your tax situation.  For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

This article serves as a reminder of the relief provided by Notice 2020-39 as well as an overview of the remaining opportunity zone gray areas that have emerged.

International Tax

Opportunity Zones

Property Tax

Tax Advocacy & Controversy Services

Opportunity zones – reminder of COVID-19 relief and remaining areas of uncertainty

Authored by Michelle Hobbs Since the spring, taxpayers across the country have turned kitchens, living rooms, bedrooms or other rooms of their homes into temporary offices. With so many people currently working from home and the likelihood that this could continue for the foreseeable future, a reasonable question becomes whether a home office deduction is now available. This article will address the requirements to take this deduction on a tax return. Business use of home In general, certain taxpayers can deduct business expenses related to their personal residence for space used exclusively and regularly in connection with a trade or business. Self-employed taxpayers or individual partners in partnerships can qualify. Employees working from a home office are no longer eligible to take a home office deduction. This itemized deduction was suspended from 2018 through 2025 to help “pay for” the doubling of the standard deduction under the Tax Cuts and Jobs Act (TCJA). Eligibility for a home office deduction is created if the space is exclusively used (and is the principal location) to meet with patients, clients or customers in the normal course of business, or is where management or administrative functions (such as billing, maintaining books and records, ordering supplies, scheduling appointments, etc.) are performed. Occasional duties conducted at other locations, including hotels and customer sites, will not necessarily preclude the taxpayer from qualifying for a home office deduction. There are special rules for daycare providers not discussed in this article. Once it is determined the taxpayer can take a home office deduction, certain expenses of the home are divided between personal and business use. Personal expenses cannot be used in this computation. Costs directly associated with the trade or business, such as painting or repairs of the business space, would be deductible in full as a home office expense. Indirect expenses, including homeowners insurance, rent (if the taxpayer does not own the home) and utilities, are allocated to the home office using the percentage of the home being used for business (typically determined through a square-footage allocation). The same percentage of mortgage interest and real estate taxes would be deducted as part of the home office deduction instead of an itemized deduction on Schedule A. Homeowners can also depreciate (accounting for the wear and tear of the structure but not the land) the business portion of their home. Permanent improvements made to the home office can be depreciated as well. However, depreciation of the home office has to be recaptured as ordinary income once the home is sold. In other words, the cumulative amount of depreciation deducted is not eligible for the primary residence sale exclusion.  The home office deduction is limited (using a formula) if total business expenses are less than the gross income. Any carryover can be deducted the following year subject to the same limitation. In addition, special rules exist when taxpayers operate more than one business in the home or have more than one place of business. Simplified method In an effort to reduce the recordkeeping burden on taxpayers, the IRS introduced the simplified method to determine the home office deduction amount. Instead of tracking separate expenditures of the home as described above, merely multiply $5 by the allowable square footage of the business portion of the home (using the smaller of 300 square feet or the actual space). The deduction cannot exceed the net income (receipts less nonhome-related expenses) from the business use of the home. Using this method means taxpayers do not need to adjust the amount of mortgage interest or real estate tax reported on Schedule A when itemizing deductions. The home office space is also not depreciated under the simplified method (meaning no recapture is necessary upon subsequent sale).  Taxpayers can alternate between using actual expenses or the simplified method from one tax year to the next. However, any carryover of actual expenses cannot be used in a tax year when the simplified method is used to compute the home office deduction.  IRS resources In addition to your Baker Tilly tax advisor, the IRS website has several resources available to assist taxpayers in taking advantage of the home office deduction. Form 8829, Expenses for Business Use of Your Home, with its instructions, along with Publication 587, Business Use of Your Home, and FAQs - Simplified Method for Home Office Deduction can all be used to help determine eligibility and calculation. For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

This article will address the requirements to take the home office deduction on a tax return.

Paycheck Protection Program (PPP) Solutions

Home office deduction

As we write our annual tax-planning letter, we are constantly reminded that this is no ordinary year. The fall continues to be dominated by a highly partisan election, a second wave of COVID-19, an economy struggling to recover from the worldwide pandemic and a wildly fluctuating stock market. Adding to this mix of uncertainty is the ever-changing tax landscape. 2020 has seen not only continued guidance relating to the Tax Cuts and Jobs Act (TCJA), but also the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act contains numerous revisions to the TCJA, which in some cases require taxpayers to redo returns two years after the fact. The CARES Act also introduced the PPP loan program, the rules for which were written hastily and leave several important questions still unanswered.  All of this created a perfect storm for taxpayers — businesses and individuals alike. Besides continuing economic uncertainty, tax rates could be in play depending on the election results. The prospect for increasing rates could hinge on control of the Senate, especially if the Democrats win the White House. While a change in control of the House of Representatives is not anticipated, if Republicans retain their majority in the Senate, it is unlikely any meaningful rate changes would be enacted. In addition, the economic downturn, coupled with trillions of dollars of enacted stimulus legislation, has created a federal deficit exceeding $3 trillion annually. At the end of June (the close of the government’s third quarter), the deficit represented 13.1% of GDP, a level not seen since World War II. To reduce this amount, anticipate either higher tax rates or a combination of spending cuts and restrictions on deductions. In terms of limiting deductions, remember the business interest limitation using 30% of adjusted taxable income is temporarily increased to 50% through 2020 (returning to 30% in 2021). Furthermore, 100% bonus depreciation is set to expire for assets placed in service after Dec. 31, 2022. Congress may choose to limit other deductions in attempts to raise revenue. While many are facing difficult times, business does not stand still. Solid financial and tax planning is needed now more than ever. With our year-end letter, we have always urged readers to not only do their annual tax planning, but to use this period to conduct a full financial review of their portfolios and estate planning as well. This year, such a financial review is not just recommended, it is critical. In the coming weeks and months, managing cash and minimizing current taxes is even more important as the economy recovers. The CARES Act presents some one-time opportunities for taxpayers to reduce taxes and obtain refunds from prior years. For example, while the TCJA had repealed the net operating loss (NOL) carryback rules, the CARES Act reinstated them for 2018, 2019 and 2020 losses. If you have a taxable loss in 2020, careful analysis is needed to maximize the tax benefit of such loss since a 2020 loss can be carried back five years. However, losses incurred in 2021 will no longer be eligible for any carryback. As a result, this represents your last chance to recover tax payments made in 2015 through 2019. If you need cash currently, look into filing an NOL carryback return as soon as possible after year-end to expedite your refund. In addition to these NOL changes, our 2020 year-end tax-planning letter focuses on tax topics with the above economic and political backdrop in mind. We examine multiple pieces of CARES Act and TCJA guidance (including Paycheck Protection Program debt forgiveness, the employee retention credit and payroll tax deferral), analyze pass-through loss and cancellation of indebtedness strategies, summarize tax capital reporting, define the home office deduction as well as review a myriad of international and state and local tax changes.  As always, your Baker Tilly advisor is ready to assist you in meeting your financial and tax objectives. Contact an advisor
Visit the sections below for more information about the most pressing year-end tax issues: Business interest limitation rules (section 163(j)) – Where do we stand? Will refunds from losses become a lifeline for struggling businesses? Loan modifications: Take care of them so they don't take care of you Lease modifications: Beware of potential tax ramifications Tax issues created by PPP loan forgiveness Limited liability companies in a loss environment Carried interests in 2020 and beyond Final 2020 bonus depreciation regulations Partnership tax capital – 2020 reporting requirements loom Employee benefits and executive compensation update Proposed regulations issued to implement TCJA small business taxpayer simplified accounting methods Home office deduction Opportunity zones – reminder of COVID-19 relief and remaining areas of uncertainty Residency rules and state trust taxation – Beware the traps State and local tax update U.S. international tax update Conclusion We will continue to keep you informed of the latest developments by sending updates to assist you with planning throughout the remainder of the year. 
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments. For more information on this topic, contact our team.

Baker Tilly’s 2020 year-end tax focuses on tax topics with the above economic and political backdrop in mind. Our professionals look at international, federal, state-and-local and compensation tax issues among other areas.

Private Wealth

Lease Accounting (ASC 842 and GASB 87)

Research & Development Credits

2020 year-end tax letter

Our client’s need Our client is a leading designer, marketer, and distributor of high-quality fashion eyewear in North America and, consequently, maintains a significant investment in inventory that is subject to the uniform capitalization (UNICAP) rules under section 263A. In general, the UNICAP rules require taxpayers to capitalize additional costs to inventory such as inventory purchasing, storage/handling, and an allocable portion of inventory related to general and administrative (G&A) expenses. The client’s UNICAP calculation had not been reviewed or updated in several years and, due to growth in the inventory levels and the materiality of the UNICAP adjustment, the tax engagement team recommended Baker Tilly’s national accounting methods group specialists review the UNICAP calculations to determine whether the methodology was tax compliant and optimal. Baker Tilly solution Through a detailed review of the client’s business operations and inventory accounting procedures and calculations, the Baker Tilly accounting methods specialists identified opportunities to accelerate inventory deductions for non-capitalizable costs and by electing alternative allocation and capitalization methods. After presenting our findings and recommendations to the client, an accounting method change application (Form 3115) was filed to implement the proposed UNICAP methodology. Results achieved As a result of the accounting method change, our client reduced the amount of capitalized inventory costs by approximately 30 percent. Moreover, this benefit is expected to increase over time commensurate with anticipated growth in inventory and sales levels. Thus, the client will continue to benefit from the new UNICAP methodology prospectively and can employ the tax savings realized from the method change to finance further expansion of its operations. We also provided our client with the custom documentation and templates necessary to maintain and sustain the new methodology in future years. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Manufacturing & Distribution

Accounting method change cuts inventory costs 30 percent

Our client's need A national rental real estate developer appropriately capitalized the costs associated with their project, at the beginning of production period, under Sec. 263A rules regarding the capitalization and inclusion in inventory costs of certain expenses. Like many real estate developers though, recent economic conditions caused the developer’s project to become stagnant and production ceased.  Though production ceased, the costs associated with the project, such as property taxes, insurance, and interest on the loans, still became due.  Baker Tilly solution As a response to the ongoing costs, Baker Tilly’s specialized real estate tax team filed a Form 3115, Application for Change in Accounting Method, requesting permission to change our client's method of accounting for its interest capitalization. Under Reg. Section 1.263A-12(g)(1), there are special tax rules that relate to the capitalization of interest. According to the regulations, if a project's production period for the designated property ceases for at least 120 consecutive days, a taxpayer may suspend the capitalization of interest for that project. Instead, the taxpayer may expense the associated interest costs until production activities resume. Results achieved The IRS approved the change in accounting method and the developer was able to benefit from a current year deduction of roughly $2.3 million. This approach can be utilized again for any delayed projects that the interest costs associated with it continues to be capitalized. For more information on this topic, or to learn how Baker Tilly real estate specialists can help, contact our team. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Retail

Change in accounting method nets rental real estate developer $2.3 million tax deduction on stagnant property

Our accounting methods professionals specialize in identifying, substantiating and documenting federal accounting method changes. By ascertaining and employing the most favorable methods of accounting, we can accelerate deductions and defer revenues to significantly increase a company’s cash flow.

A thorough review and an accounting method change recommendation by Baker Tilly helped our client reduce its inventory UNICAP adjustment by one third with the potential for further savings.

If a project's production period for the property ceases for at least 120 consecutive days, a taxpayer may suspend the capitalization of interest for that project. Baker Tilly helped a client expense the associated interest costs until production activities resume.

Regardless of a company’s financial and operating status, tax planning can provide a variety of strategies to help companies preserve, acquire or maximize cash. Implementing an accounting methods change is one such strategy.

We help not only existing businesses establish beneficial tax accounting methods, but also startup, acquired and reorganized companies adopt efficient methods as they begin anew.

ASC 606 revenue recognition tax implementations

Tax reform revenue recognition and small business simplification amendments 

Advance payments (gift cards, memberships, subscriptions, goods, services)

New procedures on small business taxpayer accounting methods

IRS provides transitional guidance on advance payments

Tax reform webinar series: accounting methods and tax credits

Baker Tilly’s accounting methods team identifies and implements the most favorable federal methods of accounting for our clients.

Gary is a tax partner with more than 30 years of public accounting experience.

Scott is a tax director based in Baker Tilly’s Orange County, California office.

Gabriel is a partner with Baker Tilly and the regional tax leader for the West region.

Contributing to clients’ success by accelerating tax deductions, increasing tax credits, reducing cash taxes and mitigating risks

Baker Tilly’s tax team contributes to clients’ success by accelerating tax deductions, increasing tax credits, reducing cash taxes and mitigating risks.

Baker Tilly offers specialized federal tax compliance and planning expertise to help businesses optimize value while minimizing their tax burden.

Baker Tilly provides IRS audit and appeals representation and supports IRS installment agreements and offers in compromise, requests for penalty relief, private letter ruling requests and IRS voluntary disclosures – offshore and domestic.

Baker Tilly's tax advocacy and controversy team understands what you need to do to lower your risk of audit, but also knows how to help you if you are faced with a federal or state examination.

Baker Tilly's research and development credit professionals can help you find R&D activities in areas you may not have thought qualify.

Accounting Methods

Updates from the Statutory Accounting Principles Working Group’s March 16 spring national meeting

Updates from the Statutory Accounting Principles Working Group’s Jan. 10 interim meeting

Updates from the Statutory Accounting Principles Working Group’s Dec. 1 fall national meeting

Accounting update to long-duration insurance contracts

Updates from the National Association of Insurance Commissioners’ 2023 summer national meeting

Important accounting method updates and reminders for 2023

2022 accounting method issues and developments

Baker Tilly assists emerging growth technology company with $300 million sale

Insurance hot topics virtual series: accounting, tax and statutory update

Proposed regulations issued to implement TCJA small business taxpayer simplified accounting methods

Opportunity zones – reminder of COVID-19 relief and remaining areas of uncertainty

Home office deduction

2020 year-end tax letter

Accounting method change cuts inventory costs 30 percent

Change in accounting method nets rental real estate developer $2.3 million tax deduction on stagnant property

Tax

Federal Tax

Tax Advocacy & Controversy Services

Research & Development Credits

Gary Grush

Scott L. Jackson

Gabriel Torre

Our accounting methods professionals specialize in identifying, substantiating and documenting federal accounting method changes. By ascertaining and employing the most favorable methods of accounting, we can accelerate deductions and defer revenues to significantly increase a company’s cash flow.

Accounting method change cuts inventory costs 30 percent

Change in accounting method nets rental real estate developer $2.3 million tax deduction on stagnant property

Our accounting method services:

Income

Deductions

Article

Article

Article

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