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| Hotline Frequently Asked Questions (FAQs) Welcome to the NYSSCPA’s “frequently asked questions” section of its web site. These questions and the answers are of a general nature and intended to be of use to members and others visiting our site. The staff updates this section to reflect the best information it has to share with users in a multitude of disciplines twice a year. The information contained herein comes from a variety of sources: telephone inquiries to the Society’s technical hotline, the standing committees of the Society’s volunteer structure, the staff, members, and other interested parties. We strive to provide FAQs that are helpful to you, assist you in your work and enhance your membership experience. FAQs are designed to provide general information and serve as a quick reference. They neither substitute for one’s own research and judgment nor constitute an opinion of the Society, of any of its committees or of its staff. References to appropriate standards-setting bodies and to authoritative literature is made whenever possible. Members having a technical inquiry may call the NYSSCPA’s technical hotline at 212-719-8309. Please contact the Society if you have suggestions or improvements regarding FAQs by e-mailing klazarus@nysscpa.org. The following are composites of some recent inquiries, as an educational tool for members who may have encountered similar situations. Stock Brokerage Committee | Closely Held and S Corporations Committee | Relations with the Internal Revenue Service Committee | Taxation of Individuals Committee | Trust and Estate Administration Committee | Accounting and Review Services Committee | Auditing Standards and Procedures Committee | CPA Exam Task Force | Higher Education Committee | Agri Business Committee | Litigation Services Committee | Real Estate Committee | Employee Benefits Committee | Exempt Organizations Committee Q:
The Securities and Exchange Commission (SEC) has just approved
my company as a registered broker-dealer. It’s close
to the end of the fiscal year and I barely expect any revenues
for the period. The expense of the audit at this time would
be an undue burden to bear. Can our firm obtain a waiver
from having an audit for this first, short period? To illustrate its position, the SEC issued a “no action letter” in December 2005 to address situations similar to the above. Exemptions outside the scope of the letter can be requested, but one can anticipate that it may be more difficult to obtain approval. Go to http://www.sec.gov/divisions/marketreg/mr-noaction/nysenasd121605.pdf to see a copy of the letter. The Commodity Futures Trading Commission will consider written requests for waivers on a case-by-case basis. The CFTC has not adopted a written policy on the question for futures commission merchants (FCMs); relief for introducing brokers (IBs) is available in Rule 1.10(b)(2)(ii)(B). For FCMs and IBs who are already under the oversight of the SEC, it will consider relief in a manner consistent with that offered by the SEC wherever possible. Last, it should be noted that applicants for registration with the CFTC would usually have undergone an audit during their application process, before operations as a registered FCM or IB can begin. Q:
Who is required to register with the SEC? Q: Who
is a broker? For example, each of the following individuals and businesses may need to register as a broker:
Anyone who participates in the activities described below may need to register as a broker:
Q:
Who is a dealer? Unlike a broker, who acts as an agent, a dealer acts as a principal. The law generally defines a “dealer” as any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise. Sometimes it’s easy to tell if someone is a dealer. For example, a firm that advertises publicly that it makes a market in securities is obviously a dealer. Other situations can be less clear. For instance, each of the following individuals and businesses may need to register as a dealer, depending on several factors:
Anyone who participates in the activities described below may need to register as a dealer:
Q:
Should I register as a broker or a dealer? Note: Anyone acting as a broker or dealer must not engage in the securities business until properly registered. The SEC expects anyone already engaged in the business, but who has not yet registered, to cease all activity until properly registered. Q:
Who must register with the CFTC? Closely Held and S Corporations Committee Q: What constitutes stock basis in a Subchapter S corporation? A: A shareholder’s original basis in stock is the purchase price paid for the stock or the fair market value of any property given in exchange for the stock. Stock acquired as the result of a gift typically brings over with it the donor’s basis in the stock. However, this does not apply if the sale of the stock would result in a loss. In that case, the basis is the lower of the fair market value or the donor’s basis in the stock. Stock acquired from a decedent will have a fair market value basis either measured at the date of death or on the alternate valuation date, if elected. Adjustments to a shareholder’s stock basis are as follows:
Additionally, if a shareholder’s stock basis is reduced to zero, any net decrease due to losses and deductions is then applied against a shareholder’s debt basis, which is the amount owed to the shareholder by the corporation. Distributions can only be charged against stock basis. Restoration of basis in future years applies first to debt basis and then to stock basis. Q: My client is considering forming a new entity. What are the differences between an S corporation and a limited liability company (LLC)? A:
An S corporation can only have a citizen or resident of the
A corporation or partnership can be a member of an LLC, as opposed to an S corporation, which cannot have these entities as shareholders. S corporations have a limitation of 100 shareholders. LLCs, on the other hand, do not have this restriction. S corporations require an election to be filed with the Internal Revenue Service (IRS) and New York State (NYS), and LLCs do not need to do this. LLC members are responsible for payroll taxes on all LLC earnings for which they materially participate. S corporation shareholders are responsible for payroll taxes for the salary that is taken from the S corporation and not for the income on the S corporation K-1. LLCs must take a publication ad in a newspaper for six weeks. S corporations are not bound by this requirement. S corporation shareholders are not responsible for uncollected sales tax if the corporation defaults. Members of LLCs would be liable. Appreciated property can be distributed to members without recognition of gain (see Code Section 731(b)), while shareholders of S corporations must recognize the gain. LLCs can make disproportionate allocations and distributions to its members (see Code Section 704). S corporation shareholder must allocate and distribute everything proportionately. And finally, LLC members can exchange appreciated property for membership interests without the recognition of gain or loss (see Code Section 721). S corporation shareholders do not have this option. Relations with the Internal Revenue Service Committee Q:
Which returns are mandated to be e-filed in 2007? Partnerships with more than $10 million in assets that file 250 or more other returns are also required to e-file for years ending on or after Dec. 31, 2006. Those partnerships that filed electronically in 2006 using the legacy system will have to switch to the MeF system for filing in 2007. Also, all private foundations and charitable trusts with years ending on or after Dec. 31, 2006, that file at least 250 other returns are required to e-file regardless of size. Detailed information regarding e-filing requirements for all returns is available on the IRS Web site at www.irs.gov. Always check with your software provider to be sure it is gearing up for these required 2006 tax-year filings. You must also review your internal procedures to be sure you can properly coordinate the e-filing with your clients and your tax-return transmitter. Q: When should I contact the Taxpayer Advocate Service (TAS)? A: You should contact TAS if you have an ongoing issue that has not been resolved through normal channels or processes. You should also contact TAS if your client is about to suffer, or has suffered, a significant hardship as the result of an action the IRS is about to take or has taken. An extreme example is a taxpayer in need of a quick tax refund in order to pay for a medical procedure. In addition, TAS can help resolve problems if you have experienced a delay of more than 30 days in resolving an issue or if you have not received a response to correspondence by the date promised. Before you contact TAS on behalf of a client, be certain to have a fully executed Power of Attorney form either on file or ready to be faxed to TAS. Without a Power of Attorney, TAS will not be able to discuss any aspect of your client’s problem with you. It is also important to note that TAS cannot usually stop a lien from being filed or a levy against your client’s funds in the absence of demonstrating hardship. An argument that a lien or a levy is in error can be made after the fact, and the funds will be returned if you prove your case. A mere error by itself, however, is not classified as a hardship. Taxation of Individuals Committee Q: I am planning to sell the house that I have owned and lived in for the past two years. Can I take the exclusion of gain on the sale of the residence which was previously a rental property and acquired in a like-kind exchange? A: You must own the principal residence for at least five years prior to its sale in order for the exclusion of gain rule to apply. However, you only need to use the property as a principal residence for at least two years. The required five years of ownership and two years of use need not be continuous. You also have to recapture the depreciation taken over the years when the property was a rental property. In other words, you must report the amount of depreciation taken on the property as income subject to 25 percent capital gain tax rate. If you meet the ownership and use tests, you might be able to exclude up to $250,000 on a single return or $500,000 gain on a joint return. For further details and reference, see Code Sec. 121(d)(10), as added by the American Jobs Creation Act of 2004 (P.L.108-357). Q: Can I make a nondeductible contribution to a traditional IRA (Individual Retirement Account) or to a Roth IRA if I have no taxable compensation? A: No. It doesn’t matter that no deduction will be claimed for the IRA contribution because, in order to be permitted to make a contribution to an IRA, whether it is a traditional, deductible or nondeductible IRA, or to a Roth IRA, you must have taxable compensation. Compensation includes wages, salaries, tips, professional fees, commissions, self-employment income and taxable alimony (IRS Publication 590). Q: Can I take a Section 179 deduction on my individual income tax return in connection with my Schedule C business if my Schedule C is showing a loss? A: If you or your spouse has earned income from other sources such as wages or income from another active trade or business, such as another Schedule C on a jointly filed return, they are combined to determine the business limitation for purposes of Section 179. If the combined amount equals or exceeds the potential Section 179 deduction, you may take the deduction even though the Schedule C that the fixed asset is connected with shows a loss (Form 4562 Instructions). Trust and Estate Administration Committee Q:
The sole beneficiary of a trust established in New York moves
to California. The sole trustee remains in New York. Is there
a California filing requirement?
For the case in question, both New York and California will have filing requirements. Q:
Can a trustee distribute capital gains to a beneficiary with
the beneficiary being taxed on those gains instead of the
trust?
Q:
Can a New York resident trust be changed so that no New York
Fiduciary Form IT-205 would be required? “If a decedent was domiciled in New York state at the time of his or her death, his or her estate is a resident estate and any trust created by his or her will is a resident trust. If an irrevocable trust consists of property of a person domiciled in New York state when such property was transferred to the trust, it is a resident trust. However, no New York state personal income tax may be imposed on a resident trust if all of the following conditions are met.
Q: A New York state resident establishes an irrevocable trust for the benefit of the resident’s child, who also lives in New York. The trustee is the resident’s attorney, living in New Jersey. The trust’s only asset is a brokerage account containing stocks, bonds and a money market fund. The account was established at a New York brokerage firm. Is the trust taxable in New York? A: The trust is a resident New York trust that is not taxable in New York. New York tax law (sec. 605(b)(3)) defines a resident trust in part as an irrevocable trust having property “of … a person domiciled in this state at the time such a trust, or portion of a trust, became irrevocable …” However, section 605(b)(3)(D) of the tax law exempts from New York taxation any resident trust where all the trustees are domiciled outside of New York, the entire corpus of the trust is outside of New York and all the income and gains are from sources outside of the state. The location of intangible property, such as stocks, bonds or money, is in the state where one or more of the trustees are domiciled. The above trust is a resident New York trust because a New York domiciliary irrevocably established the trust. The location of the trustees or of the beneficiaries is irrelevant when determining the residency of the trust. However, since the trustee of the above trust is a resident of New Jersey, the assets are all intangibles and there is no New York source income, the trust is not taxable in New York and therefore need not file a New York fiduciary income tax return. Q: Does the transfer of a remainder interest from a life estate require that a gift tax return be filed? A: Yes. Under Code Section 2511(a), any transaction in which an interest in property is gratuitously passed or conferred upon another, regardless of the means or device employed, is subject to gift tax (Reg. Section 25.2511-1(c)). In addition, the transfer must be complete and irrevocable before the gift tax applies. For example, a donor was deemed to have made an incomplete gift when he transferred his personal residence to his sons and retained not only a life estate in the property, but also the right to have his personal residence transferred back to him (PLR 200308046). A gift of a future interest, such as a remainder interest in a life estate, is not eligible for the annual exclusion for gifts, currently $12,000. Calculating the value of the gift to be reported entails applying to the fair market value of the property the appropriate remainder factor based on the age of the transferor and the applicable IRC Section 7520 rate for the month in which the gift was made (see IRS Publication 1457). Accounting and Review Services Committee Q:
If we issue a compilation report omitting all disclosures,
can we include an emphasis paragraph in the compilation report? An accountant may include an emphasis paragraph on a matter when management has presented selected information even though substantially all disclosures have been omitted, as long as the matter discussed in the emphasis paragraph is disclosed in the selected information. Q:
In a compilation or review engagement, what is the accountant’s
responsibility in communicating to management if a CPA finds
evidence or information regarding fraud or an illegal act
that may have occurred? When matters regarding fraud or an illegal act involve senior management, the accountant should report the matter to an individual or group at a higher level within the entity, such as the manager (owner) or the board of directors. The communication may be oral or written. If the communication is oral, the accountant should document it. When matters regarding fraud or an illegal act involve an owner of the business, the accountant should consider resigning from the engagement. Additionally, the accountant should consider consulting with his or her legal counsel and insurance provider whenever any evidence or information comes to his or her attention during the performance of compilation or review procedures that fraud or an illegal act may have occurred, unless such illegal act is clearly inconsequential. Q: Can we issue a review report on financial statements that omit disclosures? A: No. Paragraphs 16 through 18 of SSARS No. 1, which provide guidance for reporting on statements that omit substantially all disclosures, only apply to financial statements that the accountant has compiled. Q: If we issue a compilation report stating that we are not independent, must we explain why we are not independent? A: No. Paragraph 19 of SSARS No. 1 states that an accountant is not precluded from issuing a report with respect to a compilation of financial statements for an entity with respect to which the accountant is not independent. If the accountant is not independent, he or she should specifically disclose the lack of independence. However, the reason for the lack of independence should not be disclosed. Q: Can we issue a review report if the accountant is not independent? A: No. Paragraph 45 of SSARS No. 1 states that an accountant is precluded from issuing a review report on the financial statements of an entity with respect to which he or she is not independent. Q: Are the titles “Balance Sheet” and “Statement of Income” appropriate for statements prepared using a comprehensive basis of accounting other than Generally Accepted Accounting Principles (GAAP), meaning Other Comprehensive Basis of Accounting (OCBOA)? A: No, unless the titles are modified. Such unmodified titles are generally understood to be applicable only to financial statements that are intended to present financial position, results of operations or cash flows in conformity with GAAP. Paragraph 4 of SSARS No. 1 refers to SAS No. 62, paragraph .07 (AU section 623.07), which provides guidance with respect to suitable titles for financial statements that are prepared in conformity with OCBOA other than GAAP. Auditing Standards and Procedures Committee Q: What are the current CPA firm responsibilities concerning fraud in performing review-level services on a client financial statement issued pursuant to a SSARS engagement, including consideration of documentation through the use of checklists or programs? And will the lengthy and detailed fraud checklist for this type of engagement be time-consuming to prepare? A: The Statements on Standards for Accounting and Review Services were amended by SSARS No. 12 in December 2005 to parallel changes made in the Auditing Standards (SASs) to better clarify CPA and client responsibilities concerning fraud when a CPA is engaged for services in which historical client financial statements are issued. The amendment to SSARS was designed to similarly emphasize terminology and concepts concerning fraud in the revised audit literature, which are principally to be reflected in revisions to the structure of engagement letters with management and representation letters received from clients. The CPA’s engagement cannot be relied upon to disclose errors, fraud or illegal acts that may exist. However, the CPA will inform the appropriate level of management of any material errors and any evidence or information that comes to his/her attention during performing procedures under SSARS that fraud may have occurred. In addition, the CPA will report any evidence or information regarding illegal acts that may have occurred, unless they are inconsequential. Management is responsible for the prevention and detection of fraud, and that it has no knowledge of any fraud or suspected fraud affecting the entity involving management or others where fraud could have a material effect on the financial statements, including any communications received from employees, former employees or others. Accordingly, while the CPA has an awareness of fraud in performing a review or a compilation under current standards, it is not contemplated that he or she will necessarily design procedures to detect material misstatements due to fraud or illegal acts. Based on the nature and limitations of engagements performed under SSARS, documentation in work files is limited. For example, in a review such documentation would include an engagement letter evidencing an understanding with the client and a representation letter. It would also include documentation of the accountant’s knowledge of the client’s business and the accounting principles and practices in the industry in which it operates, as well as his/her inquiry and analytics procedures and unusual matters related thereto and their disposition. However, while use of a checklist concerning certain of these matters may be useful, SSARS does not specify the form or content of working papers. Accordingly, while a checklist concerning fraud might be useful, it is not required in a review, and care should be taken in selecting a checklist appropriate to the level of service being performed, which is less than an audit. Such practice aids are available from secondary sources commonly accessible outside the actual SSARS literature. Q: Has the pass/fail grading on the CPA exam been replaced with a numerical grade? A: The NYSSCPA recommended to the State Board of Accountancy that a numerical grade be given. That Board has recommended to the Board of Regents that the change be implemented, but to date, no action has been taken. The exam administrator, however, has already started issuing grade reports in numerical format Q: Has the 18-month window within which a candidate must pass all four parts of the exam been amended? A: The State Board of Accountancy has recommended to the Board of Regents a change that would alter the window to six testing periods after a candidate passes the first section of the exam, rather than beginning the 18-month term on the date the candidate passed the first section. The Regents are expected to act on this provision in the near future. Q: I have an undergraduate degree in a major other than accounting. What are my options for pursuing a career in public accounting? A: New York state currently accommodates four educational options to sit for the CPA exam. They all require 150 hours of academic credit, and include (source: www.op.nysed.gov/cpa2006educregs.htm):
Q: Should I get a master’s degree? A: New York state does not require a master’s degree. However, a graduate degree will allow you to gain advanced skills and knowledge to meet your client and career needs. Q: What coursework do I need to complete? A: Your additional 30 hours must comply with the above criteria. Please visit www.op.nysed.gov/cpalic.htm#educ for more specific details. Q: I graduated with a degree in accounting, but I am not working for a public accounting firm. What other experiences will count toward the one-year experience requirement for the CPA license? A:
The following information was taken from The New York State
Education Department Web site (source: www.op.nysed.gov/cpalic.htm#educ): “Experience
in private or governmental accounting or auditing of a character
and for a length of time satisfactory to the State Board may
be determined to be substantially equivalent to audit experience
obtained by independent accountants engaged in public practice
which includes the attest function. “These
examinations shall culminate in the submission of independent
reports on financial records and statements that are relied
upon by a third party. “Experience
must be attested to by a CPA licensed in a division of the
Q:
For cash-method taxpayers, what are the IRS’s general
rules for deductible prepaid expenses for livestock and farming
operations? Q:
For cash-method farming operations, what are the general rules
for inventory? Q:
When a CPA takes on a litigation support engagement whereby
he would be working for his current client and his current
client’s attorney, would the CPA put himself in a conflict
of interest situation when he identifies himself as an expert
who is independent? As an expert, would the CPA have to rely
upon the books and records of the company and/or the tax returns,
both of which he was involved in preparing? Top
of Page Q:
What is the tax impact of a real estate partnership in which
the partners have refinanced and are about to redistribute
the money? Depending on a number of factors, including the amount of the distributions and the operating expenses of the partnership, the characteristic of the partnership’s interest expense is subject to change. Normally, the interest expense would be treated as passive, like any real estate rental activity. However, if tracing is applicable, the individual partners receiving distributions must determine what kind of interest expense is related to the distribution based on what they do with the distribution. If the money is deposited into stocks and bonds, it would be investment interest. If used to invest in real estate, it would retain its passive character. If it is used to buy a boat, it would be personal interest, and therefore nondeductible. Q:
How should bonuses paid after year-end be handled for both
income tax deduction and Internal Revenue Code (IRC) section
409A purposes? There are two deferred compensation issues. The first concerns timing bonus payments for them to be tax deductible on the return of the employer on account of which the bonuses are paid. The second concerns the application of IRC section 409A. For achieving the deduction, Temp. Reg. section 1.404(b)-1T provides that compensation paid during the 2 1/2 month period after the end of the employer’s taxable year is deductible in the preceding year because it is not considered deferred compensation. The second issue is the application of IRC section 409A, which imposes specific restrictions on deferred compensation. If a bonus arrangement is deemed to be deferred compensation, it may be subject to IRC section 409A. If the arrangement conforms with the statute, bonuses are currently includible in gross income subject to an additional 20 percent tax, plus a cumulative interest charge at the underpayment of the tax rate plus one percentage point. IRC section 409A does not apply to deferred compensation that satisfies its so-called short-term deferral rule. Therefore, if a bonus program satisfies this rule, it is not considered deferred compensation and is exempt from IRC section 409A. To qualify for the exemption, the bonus payment must be required to be made (under the terms of a written document) on or before the 15th day of the third month (i.e., March 15 for a calendar year taxpayer) following the year-end of the year in which the bonus was earned. If the client has adopted a written document reciting the short-term deferral rule, the payments will not be subject to IRC section 409A, as long as it is paid by the end of the year. Q:
Does an S corporation shareholder need wages for retirement
plan purposes? Exempt Organizations Committee Q:
Are contributions to tax-exempt organizations that do not
have an IRS Determination Letter tax deductible? Therefore, a donation to a church or an organization with less than $5,000 in annual gross receipts is deductible by the donor as a charitable contribution whether or not the organization has applied for and received tax-exempt status from the IRS. Additional information and exceptions to this requirement can be obtained from IRS Publication 557 at http://www.irs.gov/publications/p557/ch03.html#d0e3309. Q:
What is the difference between a public charity and a private
foundation? Although both types of organizations are tax-exempt under section 501(c)(3), private foundations are subject to certain excise taxes and reporting requirements that do not apply to public charities. Additional information and exceptions to this requirement can be obtained from IRS Publication 557 at http://www.irs.gov/publications/p557/ch03.html#d0e4612. Q.
When and what types of small or inactive tax-exempt organizations
are required to file the e-postcard? Small tax-exempt organizations whose gross receipts are normally $25,000 or less are not required to file Form 990, Return of Organization Exempt From Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax. With the Enactment of the Pension Protection Act of 2006 (PPA). These small tax-exempt organizations will now be required to file electronically Form 990-N, also known as the e-postcard, with the IRS annually. The PPA requires the IRS to revoke the tax-exempt status of any organization that fails to meet its annual filing requirement for three consecutive years. Therefore, organizations that do not file the e-Postcard (Form 990-N), or an information return Form 990 or 990-EZ for three consecutive years, will have their tax-exempt status revoked as of the filing due date of the third year. Additional
information and exceptions to this requirement can be obtained
from the IRS at http://www.irs.gov/charities/article/0,,id=169250,00.html. |
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