Today's CPA Jan/Feb 2013 by The Warren Group

Todayâ&#x20AC;&#x2122;sCPA JAN/FEB 2013

T E X AS S O C I ET Y OF

C E RT I F I E D P U BL IC AC C OU N TANT S

WHERE TEXAS CPAS COME FROM FASB Accounting Standards Codification Minimizing the Legal Risks of CPA Practice, Part II Business or Pleasure?

Also: Circular 230 Update

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Contents

CHAIRMAN

JANUARY/ FEBRUARY 2013

VOLUME 40, NUMBER 4

Fred Timmons, CPA

EXECUTIVE DIRECTOR/CEO John Sharbaugh, CAE

EDITORIAL BOARD CHAIRMAN

Arthur Agulnek, CPA

Staff MANAGING EDITOR DeLynn Deakins ddeakins@tscpa.net 972-687-8550 800-428-0272, ext. 250

TECHNICAL EDITOR C. William Thomas, CPA, Ph.D. Bill_Thomas@baylor.edu

Greta P. Hicks, CPA Mano Mahadeva, CPA, MBA James F. Reeves, CPA C. William (Bill) Thomas, CPA, Ph.D.

WEB EDITOR Wayne Hardin whardin@tscpa.net

cover story

columns

20 Where Texas CPAs Come From

5 Chairman’s & Executive Director’s Message

CONTRIBUTORS Ali Allie, Melinda Bentley; Rosa Castillo; Kay Crider; Anne Davis, ABC; Donna Fritz; Chrissy Jones, AICPA; Rhonda Ledbetter; Linda Messing; Craig Nauta; Kim Newlin; Catherine Raffetto; Katey Selph; Patty Wyatt

DIRECTOR, MARKETING & COMMUNICATIONS Janet Overton Design/Production/Advertising

An analysis of accounting programs statewide.

society features 13 Spotlight on CPAs

Giving Thanks – Governmental Guru Acts Out of Gratitude for Her Happy Childhood

The Warren Group thewarrengroup.com custompubs@thewarrengroup.com

16 Circular 230

CLASSIFIED

Donna Fritz Texas Society of CPAs 14651 Dallas Parkway, Suite 700 Dallas, Texas 75254-7408 972-687-8501 dfritz@tscpa.net

Editorial Board Arthur Agulnek, CPA-Dallas; Kristan Allen, CPA-Houston; James Danford, CPAFort Worth; Greta Hicks, CPA-Houston; Baria Jaroudi, CPA-Houston; Tony Katz, CPA-Dallas; Jeffrey Liggitt, CPA-Dallas; Mano Mahadeva, CPA-Dallas; Alyssa Martin; CPA-Dallas; Dawne Meijer, CPA-Houston; Ty Moore, CPA-Houston; Jan Taylor Morris, CPA-Houston; Winford Paschall, CPA-Fort Worth; Marshall Pitman, CPA-San Antonio; Mattie Porter, CPA-Houston; Kamala Raghavan, CPA-Houston; James Reeves, CPA-Fort Worth; Barbara Scofield, CPA-Permian Basin; Brinn Serbanic, CPA-East Texas; Paul Willey, CPA-Dallas. © 2013, Texas Society of CPAs. The opinions expressed herein are those of the authors and are not necessarily those of the Texas Society of CPAs. Today’s CPA (ISSN 00889-4337) is published bimonthly by the Texas Society of Certified Public Accountants; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408. Member subscription rate is $3 per year (included in membership dues); nonmember subscription rate is $28 per year. Single issue rate is $5. Periodical POSTAGE PAID at Dallas, TX and additional mailing offices. POSTMASTER: Send address changes to: Today’s CPA; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408.

Today’sCPA

| JANUARY/FEBRUARY 2013

COLUMN EDITORS

IRS Revokes Covered Opinion Standards, Adds New Responsibility to Manager of Tax Function

17 Capitol Interest

It’s All About the Budget

technical articles 23 Initial Reaction to the FASB Accounting Standards Codification 26 Minimizing the Legal Risks of CPA Practice, Part II

Legal issues that may arise if a claim is made.

30 CPE: Business or Pleasure?

Classifying a hobby versus a business for tax purposes.

Count on TSCPA for Tax Season Resources

6 Tax Topics

One Tax Increase You Can Count On (More or Less)

7 Business Perspectives

Shake Things Up!

8 Accounting and Auditing

Accounting Equation for the Federal Government

9 Emerging Issues The American Dream Redux

11 Chapters

Chapters Use Football Tradition to Support Accounting Students

departments 14 Take Note 36 Classifieds 38 CPE Calendar See the digital version of

Today’s CPA online at tscpa.org.

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Chairman’s & Executive Director’s Message By Fred Timmons, CPA | TSCPA Chairman & John Sharbaugh, CAE | TSCPA Executive Director/CEO

Count on TSCPA for Tax Season Resources With all of the news recently about the “fiscal cliff” and potential tax law changes, this has certainly been a time of uncertainty for taxpayers and the CPAs who serve them. TSCPA is here to assist you with up-to-date information and resources you need for tax season and throughout the year. The TSCPA Tax Issues Community on TSCPA’s website offers tax news and information resources to help members provide tax solutions for their clients and employers. In the Federal Information section of the community, you’ll find links to IRS directories, publications, articles, news releases, AICPA’s online tax center, the Taxpayer Advocate Service site, and more. The community’s State Taxation section contains links to information on the Texas Margin Tax, including a Margin Tax Calculator, as well as links to Texas tax forms, the Texas Comptroller of Public Accounts and State Tax Automated Research System (STAR) websites, a State and Local Tax (SALT) Gateway, and more. There is also a section dedicated to providing resources on identity theft awareness and prevention, and a link to the Total Tax Insights calculator, which is a tool that gives a clearer picture of the types of taxes paid and their estimated amounts. In the Tax Issues Community’s Online Resources section, you can access: • forms, publications and the IRS tax calendar; • IRS contact lists; • information on electronic filing services, employees and getting started; • small business resources; • tools for other businesses and professionals; • facts about abusive tax scams and schemes;

• an online learning center and non-IRS resources; • other relevant issues. You can keep current on federal tax legislation and regulation throughout tax season with Resource Alerts and TSCPA’s Federal Tax Policy blog. There are also links available to several other tax-related blogs, including the TaxProf Blog, the Tax Foundation’s Tax Policy Blog, and Don’t Mess With Taxes Blog. Be sure to sign up to receive TSCPA’s free Tax Issues electronic newsletter that covers important updates throughout the year. There are links to access past issues of the Tax Issues e-newsletter. In addition, the work of TSCPA’s Federal Tax Policy Committee and Relations with IRS Committee is highlighted in the community. The Federal Tax Policy Committee solicits input from members and responds to actual and proposed federal tax legislation, regulations and administrative pronouncements. The primary focus is on issues of tax administration that impact CPAs as tax practitioners. The Relations with IRS Committee maintains communications between TSCPA and the IRS to exchange ideas and information on topics of mutual concern relating to the administration of existing federal tax laws and regulations. Through TSCPA’s Ask a Member program, you can connect with other members for informal consultation if you have questions, concerns or situations that arise and are outside your area of expertise. The Ask a Member program volunteers give informal assistance on an “as needed” basis, so you have access to the knowledge and experience of other Texas CPAs. TSCPA also offers a financial literacy website for consumers. You can encourage your clients, family and friends to visit the site at www.ValueYourMoney.org for

resources and tax planning tips for various age groups. At the site, consumers can find information to sign up for TSCPA’s free monthly electronic newsletter called Take Off! It includes articles on personal finance issues and other money matters. As we approach this busy time of the year, we hope you’ll take advantage of the resources, updates and information TSCPA provides to you. They can be valuable tax planning assets for CPAs. The Tax Issues Community is available in the Resource Center at tscpa.org. Under the Resource Center tab, scroll down to Member Communities, select Tax Issues, and log in as a member. ■ Fred Timmons will share some interesting stories or facts about Texas in each issue of Today’s CPA during his year as TSCPA chairman. The most powerful tornado in U.S. history touched down in Wichita Falls on April 2, 1958, with winds clocked at speeds of up to 258 miles per hour. The smallest state park in Texas measures 0.01 acre. Acton State Historical Park is the small burial plot of Davy Crockett’s second wife, Elizabeth. Some of the famous people born in Texas include: Patrick Swayze from Houston; Renée Zellweger from Katy; Matthew McConaughey from Uvalde; Tommy Lee Jones from San Saba; Carol Burnett from San Antonio; Sissy Spacek from Quitman; Joan Crawford from San Antonio; Roy Orbison from Vernon; Nolan Ryan from Refugio; and George Foreman from Marshall.

Fred Timmons can be contacted at ftimmons@tbsacpa.com. John Sharbaugh can be contacted at jsharbaugh@tscpa.net.

Today’sCPA

| JANUARY/FEBRUARY 2013

Tax Topics By Eric Johnson | Surgent McCoy CPE, LLC

One Tax Increase You Can Count On (More or Less) The constitutional holding of the Patient Protection and Affordable Care Act lifted, apart from Congressional repeal, the contingency hanging over the application of the two “Medicare” taxes that were included in that legislation. Thus, in 2013 a new .9 percent tax on certain earned income and a 3.8 percent tax on certain unearned income will apply. In this Tax Topics column, we will examine the tax on certain unearned income. Beginning in 2013, individuals, trusts and estates who have adjusted gross income in excess of certain levels will face a tax of as much as 3.8 percent of unearned income. The tax applies to married filing jointly taxpayers with modified adjusted gross income (MAGI) in excess of $250,000 ($200,000 for single taxpayers); estates and trusts, however, reach the threshold at approximately $12,000. The key point for individual taxpayers is that if the taxpayers arranged their affairs so that their MAGI does not exceed $250,000 (or $200,000, as the case may be), they are not subject to the additional tax. But business owners who sell their business are likely to have more than $250,000 gain that, unless spread out over several years, would in itself subject some or all of that gain on sale to the tax. As to the extent of the application, the tax is applied to the lesser of the net unearned income or the MAGI in excess of the thresholds discussed in the previous paragraph. For an individual taxpayer with income that is not net investment income in excess of the applicable threshold, all of the taxpayer’s net investment income is subject to the tax; if the other income is less than the threshold, only that part of the net investment income that does not exceed the excess of the MAGI over the threshold is subject to the tax. For example, a married couple that has $240,000 of other income and $20,000 of net investment income would, in addition to the regular (and AMT) income tax, be subject to the tax on the $10,000 of the $20,000 of net investment income that represents the $10,000 excess of the $260,000 ($240,000 + $20,000) MAGI over the $250,000 threshold. Net investment income is not as clearly defined as it could be particularly with respect to items like goodwill. It is broader than the definition used for the limitation on investment interest, including passive income like rents and pass-through

income in which the taxpayer does not materially participate. Sales of inventory or, it appears, property used in a trade or business are not included in net investment income. Among some of the planning techniques taxpayers should consider are: • In 2013 and later years, sales of non-publicly-traded investments, including a business, should at least consider the installment sale structure over a period of years if the amounts involved will enable the MAGI to be reduced below the threshold to reduce or eliminate the amount of net investment income subject to the tax in those years. • In 2013, reposition portfolio investments in municipal bonds since such income is not included either in MAGI or in net investment income. • In 2013, restructure compensation arrangements to convert currently taxable benefits to nontaxable ones to reduce the contribution of such to a taxpayer’s MAGI. In addition to fringe benefits, consider increasing the amount of elective deferrals to §401(k) plans or the employer’s contributions to qualified plans. • In 2013, invest in tax-deferred annuities and life insurance contracts that defer the recognition of investment income through the tax-exemption of the investment vehicle. One should note that this barely scratches the surface of what, barring a repeal in Congress, promises to be a complicating tax factor that will require expertise. Find out more in the upcoming CPE seminar “Strategies and Tactics in the New War Against Higher Individual Taxes.” Go to the CPE area of TSCPA’s website at tscpa.org to register. ■

Eric Johnson is the head writer for Surgent McCoy CPE, LLC, in Devon, Pennsylvania.

Today’sCPA

| JANUARY/FEBRUARY 2013

Business Perspectives By Mano Mahadeva, CPA, MBA | Column Editor

Shake Things Up! Companies need to periodically shake themselves up. Why? Because dramatic changes in business conditions today and in the future make change an imperative. Globalization is a force that touches businesses of all kinds. The Internet provides real-time capabilities across the world; cheap credit has given rise to unexpected competition and new products; cheap labor markets and limited pricing power will continue to add pressure on profits. Inaction may mean reduced options for survival. Taking thoughtful action may lead to enormous rewards. To be successfully positioned, it is important that a company understands its capabilities, processes and beliefs relative to the new world. It is a step that precedes the annual exercise of strategic planning, budgeting and forecasting, and should be a thorough and insightful exercise, which helps answer questions like, “Do we know who we are?” “Are we making money?” and “Why are we making money?” In the industrial age, it was much easier to succeed and carry on our business by adhering to a “best practice” way to do things. Today, however, due to a host of new challenges and uncertainty, we may be operating in a dysfunctional or even counterproductive manner by using the practices of yesterday. No one disputes that companies have to adapt if business conditions force a change or if a company is failing, but it is important to do so even if a company is succeeding today, as our present success may be due to a result of unrelated attributes. In 2002, the Oakland Athletics became competitive with larger market teams, with one of the lowest payrolls in Major League Baseball. They did so by taking advantage of empirical gauges of player performance. Instead of competing head-to-head with larger market teams like the New York Yankees and Boston Red Sox, Oakland’s General Manager Billy Beane went against conventional wisdom and undertook a contrarian, non-traditional approach to competing in the sport. He utilized a long-short arbitrage technique of dumping overvalued players and signing undervalued “rejected” players from other teams. Had they chosen to operate with conventional wisdom, it is possible that Oakland may have survived, but be placed at the bottom of the standings. Oakland’s honest assessment at its limited revenue capabilities helped the Athletics become a very successful franchise in Major League Baseball since. In the late 1990s, IBM transformed itself from selling computer hardware to become a provider of information technology services to their customers. This change resulted in the building and management of their customer technology platforms. Yes,

it was a major strategic change and a calculated risk, as in some instances, IBM customers purchased competitor hardware to be part of their technology platforms. Looking back, it is clear that IBM’s insight and resulting shift proved correct as services have become IBM’s core business today. Shaking things up is not an easy task. It is difficult enough trying to deliver this year’s results without having the need to stay ahead of the curve. Some companies have been successful at these efforts, while others failed miserably, with the rest falling in between. As an example, Hewlett Packard, a company which played a major role in the rise of Silicon Valley and is presently ranked third in global technology sales, is now under assault on all fronts. The company recognized the need to change, but could not pull off what had to be done as a result of conflicting and alternating directives. Chief executive terminations, claims of sexual harassment, boardroom spy scandals, and controversial acquisitions have added to this confusion, resulting in major questions about its outlook. Leaders of successful companies must be able to promote a vision and articulate it well. They need to have a sense of paranoia in that they assume that something will change and change soon. They must exhibit urgency, i.e., a determination to move forward and move forward now! They need to create companies that are agile and adaptive – agile in that they can do what it takes to get to their new destination, and adaptive in that they can rise above all the noise to make the correct interpretation and adjust to the new circumstances. In other words, the successful leaders will need to be equipped with these capabilities so that they can navigate uncertain circumstances or conditions! Companies better at adapting to environments of increasing volatility will most likely replace those which are inert, complacent or that live off past successes. It is essential for survival and a way of carrying out business. Asking questions about who we are, what we do and if we are making money, may lead to new ideas, innovations or fortunes. ■

Mano Mahadeva, CPA, is executive director with U.S. Oncology in Plano. He serves on both the Editorial Board and the Business and Industry Issues Committee for TSCPA. Mahadeva can be reached at mano.mahadeva@usoncology.com.

Today’sCPA

| JANUARY/FEBRUARY 2013

Accounting and Auditing By C. William (Bill) Thomas, CPA, Ph.D. | Column Editor

Accounting Equation for the Federal Government As we begin a new year, America faces seemingly insurmountable financial problems. Whatever your political affiliation might be, it’s hard to argue against the fact that the U.S. government is in a perilous financial position. If you haven’t yet, you should watch the American Institute of CPAs (AICPA) video, What’s at Stake: A CPA’s Insights into the Federal Government’s Finances*. The issues and the timing make the message of this video particularly compelling. Narrated by Greg Anton, chair of the AICPA board of directors, the video offers a nonpartisan and clear analysis of the financial report of the U.S. government, pointing out the following chilling facts: 1. The deficits of the federal government have been steadily increasing over the past decade, fueled by rampant spending and debt financing. As of Sept. 30, 2011, the most recently available fiscal year, the balance sheet of the federal government showed the following: total assets: $2.71 trillion; total liabilities: $17.5 trillion; accumulated deficit: $14.8 trillion.** 2. This balance sheet only footnotes the obligations for Medicare and Social Security (a whopping $46.3 trillion off-balance sheet), making the total deficit: $61.1 trillion! 3. The estimated net worth of all households in America combined is about $58 trillion. So, if we all sold 100 percent of our personal assets, paid off all our debts, and then shipped every cent of the net proceeds to Uncle Sam, the federal government would still be $3.1 trillion in hock! If the federal government were our audit client, for how many years would they have received a going concern opinion? By the way, the agencies of the federal government that account for the largest proportion of spending – Department of Defense (DOD) and Department of Homeland Security (DHS) – are not even audited, so we have reason to be skeptical about the reliability of even the reported figures. A further look into the Report of the Comptroller General

of the United States concerning the financial condition of the federal government as of Sept. 30, 2011 reveals the following additional facts: • Material weaknesses in internal control over financial reporting and other limitations on scope of work resulted in conditions that prevented the Government Accountability Office (GAO) from expressing an opinion on fiscal years 2011 and 2010. • Significant uncertainties, primarily related to the achievement of projected reductions in Medicare cost growth reflected in the 2011 and 2010 Statements of Social Insurance, caused GAO to disclaim an opinion on those statements as of 2011 and 2010. About $24.6 trillion, or 72.6 percent, of the federal government’s reported total present value of future expenditures in excess of future revenues for 2011 related to the Department of Health and Human Services Statement of Social Insurance, which received a disclaimer of opinion. • After 15 years of trying, major impediments continue to prevent the expression on an audit opinion on the federal accrual-based financial statements: (1) serious financial problems at the DOD have prevented its financial statements from being auditable (they hope to have this problem fixed by 2017); (2) the federal government cannot adequately account for and reconcile intra-governmental activity and balances

between federal agencies; and (3) the federal government has an ineffective process for preparing its consolidated financial statements. How can a government with the world’s most massive amount of regulation for business – through agencies such as the Securities and Exchange Commission (SEC), the Public Company Accounting Oversight Board (PCAOB) and the Federal Reserve – be in such shambles itself? How long can this continue? How many more years will the U.S. Treasury be able to print money (and incur debt) before the problems associated with our massive debt eventually come home to roost in the form of a devalued currency and a ruined credit rating in world markets? CPAs are beginning to speak out on the federal budget crisis. If you are interested (and what CPA wouldn’t be), get involved! Read more about it on AICPA’s website at aicpa.org/Advocacy/Pages/CPAsInsight. aspx. Then let’s hope our leaders in Washington, D.C., will take the problems of the national debt seriously and take action to start changing the trajectory of our country’s massive debt levels. * www.aicpa.org/Advocacy/Pages/ CPAsInsight.aspx. ** It’s hard sometimes to think in terms of trillions. One trillion dollars is equal to 1,000 billion dollars. ■

C. William Thomas, CPA, Ph.D., is the KPMG/Thomas L. Holton Chair and the J.E. Bush Professor of Accounting in the Hankamer School of Business at Baylor University in Waco. Thomas can be reached at Bill_Thomas@baylor.edu.

Today’sCPA

| JANUARY/FEBRUARY 2013

Emerging Issues By James F. Reeves, CPA | Column Editor

The American Dream Redux One summer day, out in the field, a grasshopper was hopping about, chirping and singing and enjoying himself. An ant passed by, huffing and puffing as it dragged a kernel of grain down to its nest. “Why don’t you come hang out with me for awhile?” said the grasshopper to the ant. “Dude, I’m busy storing up food for the winter,” said the ant, as he toiled away. “You should do the same.” “Why bother with winter? We have plenty of food for today,” replied the grasshopper, as he continued to sing. When winter came, the grasshopper had no food and found himself dying of hunger. As he saw the ant enjoying the grain it had stored away he realized, too late, that it is always best to prepare for the days of necessity. — Aesop THE COMING RETIREMENT CRISIS

While we’ve heard a lot recently about the fiscal cliff, budget deficits and healthcare, one important and related issue was not addressed during the political campaigns, as it was a message nobody wants to hear and wasn’t going to garner anybody any votes. This is not a feel-good story, but one that needs to be told. As baby boomers have begun turning 65, the country faces a potential retirement crisis of unprecedented magnitude. Consider: • 10,000 Americans are turning 65 every day and will continue to do so for the next 16 years or so; • most have not saved enough for retirement and depend disproportionately on Social Security for the basics of life; half of American workers have saved less than $10,000 for retirement, 75 percent have saved less than $30,000, and the average Social Security check for a retired worker is about $1,200 per month; • private sector defined-benefit pensions have been phasing out in favor of employee-directed, commercially run 401(k) plans, many with no employer matching; • The Pension Benefit Guaranty Corporation, the federal agency designed to cover failed pension plans, is currently running a deficit; • many public pensions across the country are grossly underfunded;

• from 1950 to the present day, the ratio of full-time private sector workers to Social Security recipients has decreased from 16:1 to less than 2:1; and • the federal government is $16 trillion in debt already.

OPTIONS AND POLICY PROPOSALS

Work longer, save more, reduce expectations … is this how the American Dream is going to evolve? While most workers, according to a Transamerica survey, plan to either work past age 65, and/or work part-time in retirement, many people physically can’t work longer. Most (69 percent) believe they could work until 65 and still not save enough for retirement. It’s not difficult to understand their pessimism, given they are already facing a world of wage stagnation, depressed home values, high unemployment rates, artificially low interest rates, and have experienced two major stock market crashes during the last decade. At some point, government will have to face the music. The appropriate policy solutions depend on who you talk to, which channels you watch or listen to, and what you read. Proposals can and will be very polarizing. The more conservative position is an “ownership society” with do-it-yourself pensions where individuals reap the benefits from investments in the markets over their working lives in lieu of government-sponsored programs. The opposite position is that individuals

are not equipped to handle planning for retirement and the government should step in and protect people from themselves. The conservative view will point to the grasshopper and the virtue of hard work, self reliance, saving and sacrifice. The opposite view will point out that to plan effectively, one must understand investment principles, and be able to accurately predict how long they will live, the likelihood of losing their jobs and whether they will become disabled, and then implement a disciplined plan over a 40-year working life – things ordinary citizens are not qualified or equipped to do themselves. Proponents of this view advocate mandatory 401(k) contributions invested and managed by the same agencies that manage public pensions, using commercial annuities within employer retirement plans, saver’s credits for lower and middle income workers, and expanded catch-up contribution allowances for 401(k)s and IRAs. Other proposals favor structural changes to Social Security; for example, by eliminating distribution options for those who haven’t reached full retirement age, thereby incenting workers to work longer, build up larger 401(k) balances, and reducing the period over which distributions will be made. In some corners, a desire to eliminate the cap on income subject to payroll taxes keeps resurfacing, while others propose continued on next page

James F. Reeves, CPA, is Senior Vice President, New Product Development at the Tax and Accounting business of Thomson Reuters. Contact him at jim.reeves@thomson.com, or visit his blog at http://jamesfreeves.blogspot.com.

Today’sCPA

| JANUARY/FEBRUARY 2013

Emerging Issues continued from page 9

implementing some sort of means testing – making the Social Security benefits formula less generous for higher income taxpayers. Policy choices also include the interest rate policies of the Federal Reserve, which has chosen to keep interest rates artificially low to stimulate the economy. At some point, the economy will gain steam and interest rates paid on savings and bonds will return to historical levels, driving more saving.

OPPORTUNITIES FOR CPAS

For every problem, there are opportunities. While elderly poverty on a large scale in the United States may be

inevitable, CPA clients are generally not the retirees facing a retirement in poverty. Many are the business owners, executives, professionals, investors and high net worth individuals who have planned, saved, made or inherited or otherwise acquired enough wealth for a comfortable retirement. Others, like the grasshopper, could have planned and saved, but chose consumption instead and now are scrambling to catch up. Others have met health or job issues, business reversals, or other setbacks along the way. And still others may be at an early enough stage in their careers to benefit from a long-term plan and execution. The point is that regardless of the policy decisions that are

We Go To Work For You.

sure to come, many if not most individual clients will need tax planning, retirement planning and investment advice. The Transamerica survey revealed that while nearly half of workers seek advice before making financial decisions, only 33 percent use a professional financial advisor, and only 11 percent rely on their accountant for retirement planning and investing. Given this backdrop, it seems to me that CPAs, the most trusted advisors, have a golden opportunity to add additional value and expand their footprints in the communities where they practice by helping individual clients realize the American Dream. ■

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Today’sCPA

| JANUARY/FEBRUARY 2013

Chapters By Rhonda Ledbetter | TSCPA Chapter Relations Representative

Chapters Use Football Tradition to Support Accounting Students Rah! Rah! Rah! TSCPA members have fun supporting their universities. There are lots of ways they do that – but few are as enjoyable as a tailgate party. There’s nothing like the casual atmosphere and good food to bring all kinds of people together. SOUTHEAST TEXAS

People of all ages are jumping at the chance to be at Lamar University football games, which are back after a two-decade absence. The Southeast Texas Chapter’s second year assisting the Lamar University Beta Alpha Psi Chapter with a homestadium tailgate event brought success. Thanks to BAP, it was in the middle of the grassy area allotted to student organizations, where the current and future CPAs’ presence was noticed. The chapter was identified by a large banner on the main table. The CPAs provided food and soft drinks, which were enthusiastically devoured. You just can’t have a cookout in that area of the state without boudin, and this was no exception. Volunteers also grilled hot dogs and sausage links. The enticing aroma attracted others and there was plenty of food to share. Nonaccounting students nearby who enjoyed a bite were impressed with the CPAs’ generosity, and perhaps were even a bit envious of the special treatment given to accounting students by the chapter. During the three hours before game time, about 50 were there, a big increase over the first year. Students who attended previously helped spread the word about the event, and it was included on the chapter’s Facebook page. Because it was an opportunity to network with potential employers as well as a social event, it was promoted at BAP/Accounting Society meetings and on the Accounting Student Organizations’ BlackBoard. Department of Accounting faculty let their students know about it and also attended. A great turnout was helped by gorgeous autumn weather with cool temperatures and low humidity, which are especially appreciated there.

CPAs, Beta Alpha Psi members and visitors enjoying the cookout at Lamar.

To add to the fun, chapter members and students formed several teams to get in on the Washers tournament nearby, hosted by the Lamar Athletic Department. The chapter’s organizer, Josh LeBlanc, banded together with student Michael Carl to work their way to victory over participants from a variety of groups. “The second annual tailgate is bigger and better than the first!” exclaims BAP advisor and Department of Accounting Chair Gisele Moss, Ph.D., CPA. She continues, “This event is one that many students looked forward to the last few months. It’s a perfect way for them to socialize and network with the local CPAs. Lamar’s Accounting Program is lucky to have such a wonderful

relationship with the Southeast Texas Chapter.”

SAN ANTONIO

In a different interpretation, during football season the San Antonio Chapter held a tailgating-themed workshop for area college accounting majors. Because there are nine area campuses, they did not want to single out one specific school’s sporting event. Instead, all accounting students and professors were invited to the chapter office for “Friday Night Lights – Tailgating with SACPAS.” The Education and Accounting Careers Committee, co-chaired by Maria Martinez, CPA and Bethany Eggleston continued on next page

Rhonda Ledbetter is the TSCPA chapter relations representative. Contact her at 972-687-8508 or at rledbetter@tscpa.net.

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Chapters continued from page 11

CPA, had overall responsibility for pulling this off. Chapter volunteers personally visited several of the nine campuses in advance to drum up interest. There was attendance from the following: • Our Lady of the Lake University; • St. Mary’s University; • Texas A&M University – San Antonio; • University of the Incarnate Word; and • University of Texas at San Antonio. Deserving special mention, two students drove more than 150 miles from Texas A&M International University in Laredo to participate. A total of approximately 100 students and professors attended, despite the fact that a major deluge of welcome but inconvenient rain started as people were driving to the office. Capitalizing on a very hot trend, a Blazin’ Burgers food truck was hired. What a huge hit! Participants were happily unaware that it was actually a

last-minute replacement for the first vendor, which cancelled unexpectedly. Chapter volunteers mingled with the students while they checked in, ordered their food and ate. There were burgers and fries, and even stuffed Portobello mushroom sandwiches. Because of the ongoing downpour, one of the food truck employees went the extra mile to shuttle back and forth between the truck and the lobby to take orders and deliver food. For its tailgating sponsor, Weaver, and soft drink sponsor, Becker, the chapter reserved the lobby of the building where its office is located. Additional sponsors had tables in the chapter facility where students could drop off résumés and learn more about upcoming internships. The evening progressed to a program featuring three panelists and a moderator talking about careers in accounting. The event was a great success and there’s already buzz about the next student activity.

San Antonio area accounting students and their professor at the food truck.

YOUR CHAPTER

Do you have a connection with a university in your area? Volunteer to be a link between students and your chapter. Contact your chapter president or executive director. ■

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Spotlight on CPAs By Anne McDonald Davis, ABC

Giving Thanks – Governmental Guru Acts Out of Gratitude for Her Happy Childhood

Diane Terrell, CPA-Abilene, is most passionate about three things: her family, governmental accounting and helping children. “I am so blessed to have had a happy childhood,” she recalls. “I feel every child deserves the same opportunity. It saddens my heart when children are robbed of this, sometimes in unspeakable ways. So I feel compelled to give back to not-for-profits that serve children – whether that involves time, leadership or monetary resources.” The Abilene Christian University graduate’s practice concentration is external audits of governmental entities and peer reviews with Davis Kinard, where she has spent her entire 20-plus-year career. When Terrell makes up her mind, she tends to stick with it – says she’s known that she was going to be an accountant since middle school. She explains: “I’ve always loved math … it came very easily to me. I remember a fellow eighth grade classmate saying to me, ‘You ought to be an accountant.’ And I decided, yes, that’s what I want to do. “My brain just thinks about numbers, constantly analyzing data or situations. Sometimes it drives my husband and daughter crazy, because they say I ask too many questions … I think with a 13-yearold at home, there are never ‘too many questions.’ I suppose these are good qualities for an auditor to have.”

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Terrell’s father, Johnnie Dukes, is also a math enthusiast who applied his advanced degrees to an engineering career. He and her mother, Nelda, raised the budding CPA and her two younger sisters in Fort Worth where she played t-ball, piano and flute, and graduated salutatorian from high school. With such happy memories, Terrell initially thought she’d return to her home town after college, but Davis Kinard snared her first. (She assures that Fort Worth is still “close enough to visit.”) At her Abilene firm, she’s found a work home that allows her to concentrate her professional energies on the area of practice that intrigues her most and that encourages their staff to contribute to the better good. “My firm strongly expects community involvement and I felt pressured to join something,” Terrell admits about her initial foray into volunteerism. “So I chose something I would enjoy and be passionate about – I decided to focus on children.” Her first experience was as a “Big” (a mentor) for Big Brothers Big Sisters. This led to serving on their board and when the Make-a-Wish Foundation opened up an Abilene office, Terrell went to their ribboncutting and volunteered to serve on that board also. Her longest tenure has been with one of the local Kiwanis clubs. She enthuses: “Their mission involves making the world a better place in the lives of our children. One hundred percent of the net proceeds from our annual fundraiser, Chili Day, are invested in our local community for organizations that serve kids.” For several years, Terrell has co-chaired her Kiwanis club committee, “Young Children Priority One,” that buys fleece and makes blankets to be given out by the Police Department’s Children’s Advocacy Center, which ministers to children in difficult situations (domestic violence, fire, abuse). She also volunteers to prepare the club’s annual Form 990 pro bono so the club can preserve those funds for the community. She shares: “My husband and I had a stillborn baby 11 years ago … I was 21 weeks along. Ever since then, I feel even more compelled to give back to children’s

organizations, like children’s homes or the local children’s hospital. I always think of the daughter we lost when I give to these organizations.” Terrell’s volunteerism extends to her profession. She’s been a member of the Texas Society of CPAs since the beginning of her career and most recently served as president of the Abilene Chapter. “Some view service to the profession as a burden; I view it as an honor and privilege,” she asserts. “I challenge our members to volunteer in some capacity. Just like anything in your life – marriage, church, work – the more you put into it, the more you get out of it. The more you invest, the more you are blessed.” And Terrell clearly feels “blessed.” She says she still looks forward to going to work every day. “The inner workings of the various governmental entities are fascinating to me,” she smiles. “To go from just a citizen who pays my taxes or water bill to seeing where these taxes go, what it funds, is exciting to me. I also love research. Governmental entities have their own set of accounting standards that increasingly differ from standards for for-profit and not-for-profits. Even after 20-plus years, I continue to learn and expand my knowledge base of this industry.” This passionate professional may relish the workday, but she also enjoys coming home to spend time with her husband of 17-plus years, Wayne; “tween” daughter, Audrey; and cats, Oreo and Tiger. She describes their home as “in the country … well, two miles outside the city limits” where they have seen wild turkeys, jack rabbits, a friendly neighborhood duck, bullfrogs, skunks, tarantulae and of course, various snakes, scorpions and mice. Whether watching the local wildlife or a movie with the family, or just curling up with a good book for some quiet time, Terrell enjoys the life she has been given. She muses: “I used to have a plaque hanging on my wall as a child. It said ‘Aim for the stars. You may not reach them, but you will fly higher than if you never aimed at all.’ I guess I live by that philosophy … if you are going to do something, give it your best.” ■

Take Note WebEd Delivers Quality Educational Programming Directly to You

The TSCPA CPE Foundation, Inc. continually strives to evolve course topics and delivery methods to meet the ever-changing education preferences of our members. As your education needs change throughout your career and within your busy schedule, we stand ready to meet those needs in a way that is most convenient and efficient for you. All the while delivering the highquality courses you’ve come to expect from the TSCPA CPE Foundation. In addition to our popular live conferences and seminars, as well as our onsite course offerings for your firm or company, CPAs can earn valuable and relevant continuing education credit online through WebEd. CPE Foundation’s Kay Crider sums it up with this description. “WebEd is designed to put the programs at your fingertips delivered in video and self-study formats. We’re confident CPAs will appreciate the flexibility of course schedules and breadth of topic offerings to help them meet their continuing education needs.” There are three ways you can take advantage of WebEd: • Gather a group in your office for education delivered directly to a computer in a conference room setting. • Meet your peers at one of the 16 locations across Texas for a webcast delivered in a classroom setting. • Participate independently from your home or office via a computer. And even though you’re participating through the web, in some cases you still have the option to interact with the presenters and ask questions. The option to take CPE when it’s convenient for you without taking more time away from the office or incurring travel expenses is a big benefit for today’s busy CPA. No matter what you do with your CPA license, you will find the best courses to help you stay up-to-date and in tune with the latest issues and regulations. From accounting and auditing to financial planning and communications to technology, WebEd delivers a vast course catalog to choose from. You can find dates, times, and registration details for WebEd programs in the CPE section of www.tscpa.org.

TSCPA’s Grassroots Seminar On Nov. 28, 2012, TSCPA held a Grassroots Seminar in Austin for TSCPA legislative volunteers. The excellent program included presentations by legislators, legislative consultants and Texas Tribune executives. CPAs with long-term experience as legislative volunteers talked about how to be an effective key person and the importance of the CPA-PAC. TSCPA’s legislative agenda (see the Capitol Interest article) was discussed and everyone left ready to work for CPAs during the upcoming Austin legislative session. The program was moderated by Larry Edgerton, CPA-Permian Basin, Chair of TSCPA’s Legislative Regional Coordinators, and TSCPA’s legislative agenda was presented by Legislative Advisory Committee Chair Leroy Bolt, CPA-Abilene, and Bob Owen, TSCPA’s Managing Director for Regulation and Legislation. Program leaders included: • Senator Tommy Williams, (R-The Woodlands), Senate Finance Committee Chair; • Representative John Otto (R-Dayton), Vice-Chair of the House Ways and Means Committee; • Jack Roberts, legislative consultant to TSCPA; • Rusty Kelley, legislative consultant to TSCPA; • Evan Smith, Executive Editor and CEO, Texas Tribune; • Ross Ramsey, Executive Editor, Texas Tribune; • CPAs Manny Cavazos (Austin), Penny Dear (Austin), Jeff Harris (Houston), Willie Hornberger (Dallas), and Jim Smith (Dallas). Because there are 44 new legislators going to Austin this session, TSCPA is looking for additional volunteers to work as a key person for these new legislators. If you know a legislator and would be willing to serve as a key person, please contact Linda Messing at lmessing@tscpa.net or 1-877-592-0526 ext. 124. Messing can explain the process and get you started. Even if you don’t know your legislator, but would be willing to develop a relationship, Messing can help you with the process.

CGMA Designation for Management CPAs AICPA and the Chartered Institute of Management Accountants (CIMA) created the Chartered Global Management Accountant (CGMA) designation for CPAs working in business, industry and government. It offers research, career tools and access to a global community of management CPAs. It is available to members of AICPA who meet the qualifying requirements. To learn more about the CGMA designation, visit their website at www.cgma.org. AICPA and CIMA have put together a collection of resources to help CGMA designation holders position themselves as CGMAs; communicate their value and skills to their employers, clients, colleagues and others; and – most importantly – make sure they get the most out of their designation. Among the resources available is a report titled “How Management Accounting Drives Sustainable Success,” which provides an overview of the role of management accountants. You can read and download the report on the CGMA website. It is available at cgma.org/ Community/DownloadableDocuments/Role_Of_Management_Accounting.pdf.

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Accountants Confidential Assistance Network

Disciplinary Action

As a result of a decision by the Executive Board of the Texas Society of CPAs, the following member had his TSCPA membership: The Accountants Confidential Expelled – Assistance Network (ACAN) is a • Bryan Nicholas Polozola of Richardson effective Dec. 15, 2012. The action was peer assistance program dedicated based on the revocation of Polozola’s certificate by the Texas State Board of Public to helping Texas CPAs, CPA candidates and accounting Accountancy. On March 26, 2012, a judgment of conviction was entered against students who are dealing with alcohol, chemical Polozola in the U.S. District Court for the District of Columbia, finding him dependency and mental health issues. A 24-hour guilty of one count of making false statements to the Securities and Exchange hotline is available at 1-866-766-ACAN to help people Commission staff during investigative testimony. Polozola testified that he who need assistance. You can also contact Craig Nauta was unaware of a $49,350 payment made on his behalf to his former employer, at cnauta@tscpa.net. All information is kept strictly when in fact his attorney made the payment in order to compensate the former confidential. For more information, go to tscpa.org, employer for monies Polozola converted to his own use. select Resource Center, and then scroll down and click on Accountants Confidential Assistance Network.

Membership Suspensions Members Expelled The following people have had their membership in TSCPA expelled by the Executive Board under TSCPA Bylaws Article III, Section (4B)(1). This action was a result of the revocation of their CPA certificate by the Texas State Board of Public Accountancy. • Ronald D. Hall, Amarillo; • Michael Thomas Mason, Jr., Austin.

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The following people have had their membership in TSCPA suspended by the Executive Board for non-compliance with TSCPA Bylaws Article III, Section (4A)(1) for non-compliance with the Texas State Board of Public Accountancy’s continuing professional education requirements. Suspended for a period of three years – • Timothy William Burns, CPA, Austin; • Terri J. Cartwright, CPA, Fort Worth; • Pamela J. High, CPA, Murphy; • Jonathan L. Hughes, CPA, Dallas; • Julia H. Schreiber, CPA, Cypress.

Feature By E. Lynn Nichols, CPA, Nichols Patrick CPE, Inc.

IRS Revokes Covered Opinion Standards in Circular 230 and Adds New Responsibility to Manager of Tax Function In a move some of us knew was coming, but really could not talk about, on Sept. 14, the Internal Revenue Service (IRS) revoked Section 10.35 of Circular 230 and issued Proposed Regulations that strengthen Section 10.37. There is now no reason (there probably never was, by the way) for CPA firms to have a “Circular 230 disclaimer” in their outgoing correspondence and e-mails. Those disclosures were an attempt to limit liability for tax advice that had nothing to do with Circular 230 in the first place. The proposed regulations will no longer require practitioners to fully describe the relevant facts and the application of the law to the facts in the written advice itself. They also eliminate the use of Circular 230 disclaimers in documents and transmissions, specifically addressing the use of Circular 230 disclaimers at the conclusion of every e-mail or other writing as a way to remove the advice from the covered opinion rules. Treasury and the IRS expect amendments in the proposed regulations, when adopted, will put a stop to the use of this type of disclaimer. The proposed regulations adopt one standard for all written tax advice in Section 10.37, and do away with the complex covered opinion

rules in section 10.35. Proposed Section 10.37 specifies that a practitioner must base all written advice on reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts the practitioner knows, or should know. Further, the practitioner is required to use reasonable efforts to learn the facts relevant to any written advice. I believe oral advice is still covered under Sections 10.33 and 10.34, by the way. The proposed regulations warn that a practitioner must not, when evaluating a federal tax issue, consider the possibility that the return will not be audited or that an agent would miss the item. However, the tax advisor may take into account the possibility that an issue raised in an audit might be settled for less than the entire possible liability. Because the proposed regulations remove the concept of covered opinions from Circular 230 altogether, practitioners rendering tax opinions on municipal bonds will be subject to the professional standards applicable to all written tax advice. Other changes to Section 10.37 create new risks for managers responsible for Circular 230 compliance. Persons with principal authority

and responsibility for that portion of a firm’s practice governed by Circular 230 (I can’t think of any part of my practice that is NOT governed by Circular 230!) are to be responsible for establishing procedures that ensure compliance with all provisions of Circular 230 – not just those directly related to tax advice and tax return preparation. Of much less interest to most of us, the proposed regulations modify the use of expedited proceedings against practitioners who have not paid their federal tax obligations, only permitting expedited suspension of those who have not complied with filing obligations for the immediately preceding four of five annual returns. Settling some fears expressed after publicity on two delegation orders that assign investigation duties to the IRS Return Preparer Office (RPO), the proposed regulations clarify that the Office of Professional Responsibility (OPR) has exclusive responsibility for matters related to practitioner discipline, including disciplinary proceedings and sanctions. Editor’s Note: Federal tax updates are available in podcasts from Nichols Patrick CPE, Inc. Go to the CPE section of TSCPA’s website at tscpa.org, scroll down and select Podcasts. ■

E. Lynn Nichols, CPA, is with Nichols Patrick CPE, Inc. Visit the website at www.npcpe.net.

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Capitol Interest By Bob Owen, CPA | TSCPA Managing Director, Regulation and Legislation

It’s All About the Budget The elections are over; now the governing begins. The drafters of the Texas Constitution, demonstrating unusual wisdom, decreed that the Texas Legislature would only meet in odd-numbered years for 140 days. Here we are starting the 83rd session of the recently elected Texas Legislature. Every legislator was up for re-election in 2012. Before we get into what the legislators will be doing for those 140 days, let’s talk a bit about the election’s impact on the body and how the Legislature operates. ELECTION CONSEQUENCES

The Texas Senate includes 19 Republicans and 12 Democrats, the same numbers as the 2011 session, but there are five new senators and one more new one yet to be elected. Sen. Mario Gallegos (D-Houston) passed away shortly before the election and a special election to fill that seat is necessary. Six new senators are more new senators than anyone can remember in a long time. Five of the new senators are Republicans and all five are more conservative than the ones they replaced, so despite the numbers being the same, the Senate will be more conservative than in the past. But the numbers do mean that the Republicans still don’t have a two-thirds majority. This is especially significant in the Senate, because the Senate rules, at least in the past, require a two-thirds majority of senators to get a bill to the floor for a vote. Lt. Gov. David Dewhurst, fresh from a stinging loss to now-U.S. Senator Ted Cruz, appears to be working hard to re-establish his conservative bona fides. In naming the Senate committee chairs for this session, his appointments are more conservative than in the past. To be fair, there are fewer moderates to choose from and those senior Republican senators who are perceived to be moderate did retain their committee chairmanships. The Senate is not a conservative sweep, but will be more conservative than last session. The Texas House has 95 Republicans and 55 Democrats, a drop from the Republican super-majority of 102 for the 82nd Texas Legislature. The Republicans still have enough control to rule the House, but they will have to get a few Democrats to go along on issues that require a two-thirds or three-fourths majority, such as proposed constitutional amendments or use of the Rainy Day fund. The biggest news about the House is the huge number of new representatives. There are 44 newly elected House members, along with 23 members now serving their second term; that’s a lot of new and inexperienced faces, which will undoubtedly complicate the smooth flow of legislation during this session. With this many people who don’t already know what won’t work, it should prove to be an interesting session, even if the results don’t change much. Like the Senate, the House will be a more conservative body than last session. The 2010 elections were a sweep for conservatives and while the 2012 results were not as overwhelming, a number of new conservative legislators were elected, while some moderate representatives did not stand for re-election. What does it mean to have a more conservative Legislature? One pundit suggested the conservative social agenda would go through the Legislature like a sharp knife through butter. While that might be a little exaggerated (more like a sharp knife through sausage),

there is little doubt that such things as Voter ID reprise, abortion restrictions, public school vouchers and drug testing for welfare recipients will be prominently featured.

THE BUDGET

A conservative Legislature also has implications for the state’s budget. In 2011, legislators went to Austin facing a $21 billion budget shortfall. They had so much trouble balancing the budget that the so-called “balanced budget” they passed will run out of money to pay for Medicaid in March. The first thing this new conservative Legislature must do is pass a supplemental appropriations bill totaling about $5 billion to pay those Medicaid bills for the remainder of the fiscal year. The good news is that the state’s revenue picture is much better this session and there are actually funds available. Almost every type of state revenue collection is exceeding expectations. Sales tax collections are over estimates in double digits; oil and gas severance taxes are exceeding estimates by 48 percent and 84 percent respectively. The Rainy Day fund will approach $8 billion by the end of the year and some suggest that even the Margin Tax will collect amounts originally intended in 2012. Legislators are not facing a Texas fiscal cliff anything like they did in 2011. That’s the good news. Some legislators have even speculated that some education funding cuts from last session could be restored. While Speaker of the House Joe Straus (R-San Antonio) hasn’t gone that far, he has said the Legislature will fund education enrollment growth for the next biennium (something they did not do in 2011). That’s where the conservative nature of the Legislature comes into play. Some conservative legislators have suggested the public schools have fared just fine under the budget cuts and it is not necessary to restore the 2011 cuts in education. To say the revenue situation is much better now than then does not mean the state is flush with cash. It does look like there may be enough revenue to fund or at least nearly fund normal budget needs for the next biennium. There are still major long-term infrastructure issues facing the Legislature that cannot be resolved within existing state revenue streams. Here are a few sobering facts: • There are six lawsuits against Texas claiming that current public school funding is unconstitutional; both inadequate and unfair. • Public school funding and Medicaid are projected to consume 89 percent of the state’s revenues; that leaves 11 percent for everything else. continued on next page

Bob Owen, CPA, is TSCPA’s managing director of regulation and legislation. Contact him at bowen@tscpa.net.

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Capitol Interest continued from page 17

• It takes all the growth in state revenues just to fund the projected Medicaid expenditures. • There is no money for new roads. • It is estimated to take $29-$40 billion to ensure sufficient future water resources for the state. The Medicaid monster threatens to undermine the Texas budget if not for the next biennium, certainly beyond. Legislators have stated that Medicaid is on an unsustainable cost trajectory, even before considering increased enrollments required by the federal Affordable Care Act, frequently referred to as Obamacare. Gov. Rick Perry has emphatically stated that Texas will not participate in the expanded Medicaid program dictated by Obamacare and the U.S. Supreme Court says that’s allowed. Perry says that Texas can’t afford it and that the federal government can’t either – the U.S. will have to borrow the money to fund the costs. I leave the discussion on whether to participate in the expanded Medicaid program to others, but it appears that the state cannot afford to pay for Medicaid in the future regardless. Perry and some state legislators are asking the Feds to give Texas a block grant for Medicaid and let Texas design its own program. These leaders are convinced that Texas can take care of its citizens at less cost without the federal mandates. The Medicaid dilemma must be resolved to preserve the long-term fiscal health of the state. Infrastructure issues are the other long-term predicament that needs to be resolved sooner rather than later. The longer addressing the infrastructure of the state is postponed, the more expensive it becomes to catch up. Last session, the Legislature authorized approximately $10 billion in new road construction, half of that funded by bond debt. Texas is currently in hock to the tune of about $50 billion for the roads recently built or in progress. According to budget knowledgeable people, there are no more funds available for new roads. Revenues are barely sufficient to maintain current highways. About two-thirds of Texas gasoline taxes are dedicated to road construction and maintenance. According to one source, Texas collected less gasoline taxes this year than we did three years ago. The per gallon tax rate has not been raised in Texas in 20 years. Because of more fuel efficient cars, more cyber shopping, work-athome arrangements and who knows what else, a gasoline tax based on consumption will likely continue to decline. Here are some current ideas on increasing revenues for roads: • Require all gasoline taxes to be used for road construction and maintenance. This means public education and the Department of Public Safety would have to be funded with other revenues. Even the legislator who suggested this recognizes it could not be done overnight, but would require a phase-in over a number of years. • Change the gasoline tax to be based on the price of gas rather than consumption – sort of like a gasoline sales tax. • Dedicate vehicle sales tax revenues to roads – here again it means replacing that revenue in the general fund from some source. • Increasing the vehicle registration fee by $50 (that’s doubling the fee). This would supposedly raise enough revenue to solve all the major metropolitan traffic problems in the state. Evidently, Texas’ vehicle license fees would still be substantially below those of other major states even after the $50 increase.

Several years ago, Texas leaders recognized the long-term water issues facing Texas. With the state’s rapid population growth, the state must provide more water resources or the well will run dry. The Legislature duly passed a water resource and conservation plan for Texas with a lot of hoopla and self-congratulations. It was no small feat, because of all the different constituencies with a toe in the water; but the plan has never been funded. Without an appropriation, it’s just a pipe dream. Two financing possibilities have been suggested for water development. • Establish a revolving water fund, with the initial contribution from the Rainy Day fund, to provide a source of funding for various water projects, with revenues from those projects reimbursing the revolving fund. While this might be just a drop in the bucket, it would be a start. • Levy a tap tax. A “few cents” added to everyone’s water bill (perhaps a little more than a few cents for commercial users) would supposedly raise $25 billion; a substantial start on the $29-$40 billion three-year-old estimate of what is needed. The question is whether the 83rd Texas Legislature will entertain any idea that involves raising revenues. The urgency to get started on water resources is underscored by the extremely long time it takes to get a new reservoir completed from start to finish. One legislator opined that he didn’t believe he would see a new reservoir completed in Texas in his lifetime because of the state and federal laws and regulations surrounding reservoir development. Evidently, if all the constituencies can’t agree, the project cannot go forward. The people who own the land, the people whose watershed is affected, the people who want to use the water, the people over whose land the water pipelines must be installed, the EPA, OSHA, and no telling how many other government acronyms must all agree? Wow! Budget transparency is another key issue for Perry and Straus. Both have decried the Legislature’s 20-year-old practice of levying revenues supposedly for some specific purpose (parks improvement, trauma center support, etc.) but never appropriating the expenditure. The state collects the money, puts it in the bank and those bank balances help balance the budget. Currently, the state has approximately $5 billion in the bank. If these funds were used for their original purpose, legislators would have to find an equivalent $5 billion in new revenue to balance the budget. Straus appointed a special House committee to study this issue. Initial reports out of the committee indicate that the best they might do this session is pass a law to keep the $5 billion number from growing. Another reason it is unlikely that any of these long-term financial issues will be addressed this session is the aforementioned six lawsuits against the state claiming school funding is unconstitutional. School funding is a huge part of the state budget. Even the possibility that the Legislature might have to do school finance reform mandated by the courts is enough to give legislators a responsible excuse for delay on all other financial issues. It is unlikely the school lawsuits will be resolved before the regular session ends on Memorial Day, May 27, 2013. If the Texas Supreme Court rules against the state, it likely will be up to the Legislature to do something sometime. It might mean a special session, but only

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the governor can call a special session. It might mean the issue is not addressed until 2015, the next time the Legislature meets in regular session. The state budget, correctly known as the Appropriations Act, is the only bill the Legislature must pass. If they don’t pass a budget in

TSCPA’s Legislative Agenda Before each legislative session, TSCPA’s Legislative Advisory Committee (LAC), which consists of 25 legislative savvy CPAs from all across the state, reviews the legislative environment and recommends an agenda to the Executive Board. As part of this process, the State Taxation Committee (STC) makes recommendations to the LAC for changes in state tax law that might improve simplicity, consistency and technical efficacy. The STC recommendations this year all involve the franchise (margin) tax. In addition to the STC recommendations, the LAC proposed that TSCPA oppose any efforts to levy a sales tax on professional services and making some changes in the Accountancy Act. The LAC recommendations, including the franchise tax items, were all approved by the Executive Board.

SELF-DIRECTED, SEMI-INDEPENDENT STATE BOARD OF ACCOUNTANCY

The Texas State Board of Public Accountancy (TSBPA) currently operates as a self-directed, semi-independent (SDSI) state agency. That means TSBPA operates outside the state appropriations process. It is allowed to fund its operations from license and examination fees, and it must remit $700,000 per year to the state general fund. The governor and Legislature maintain oversight reports filed throughout the year, and TSBPA is still subject to state administrative procedures, employee compensation guidelines, audits by the state auditor, and the state comptroller administers the funds. The legislation authorizing SDSI for TSBPA is currently under Sunset Review. The Sunset Advisory Commission has recommended renewal of SDSI for TSBPA, and TSCPA is supporting that recommendation. A bill must be passed during the upcoming session to renew SDSI, and TSCPA will be supporting that legislation.

CHANGES TO THE ACCOUNTANCY ACT

The Accountancy Act is contained in Chapter 901 of the Occupations Code. Last session, TSCPA proposed some changes to the Act. The bill passed the Senate and the appropriate House committee, but died in the Calendars Committee in the end-ofsession logjam caused by the inordinate amount of time spent discussing the state budget on the House floor. The LAC has recommended that we try again in 2013. The proposed changes include: • Making changes in accountant-client privilege, first by restricting the circumstances when a CPA must reply to a subpoena seeking client information and second by making it clear that CPAs may respond to investigations by the Public Company Accounting Oversight Board and the Texas Securities Board without violating client confidentiality. Finally, also make it clear that in CPA firm

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| JANUARY/FEBRUARY 2013

regular session, the governor really has no choice but to call them back and keep calling them back until a budget is passed. It will be easier to pass the budget this session than last, but only by ignoring the major long-term infrastructure issues facing the state. ■

mergers or acquisitions, client’s permission is not necessary for those negotiations as long as the firms enter into mutual nondisclosure agreements. • Strengthen TSBPA investigations confidentiality by inserting a provision in the Texas Open Meetings Act that specifically exempts TSBPA enforcement committees from that act. While the Accountancy Act makes it clear TSBPA investigations are confidential, a specific reference in the Open Meetings Act would eliminate possible conflicts between the two laws. • Repeal the prohibition of TSBPA from waiving fees and penalties, even in extenuating circumstances, and repeal certain CPA examinations provisions that are out of date due to the computerization of the examination. CPAs Sen. Tommy Williams (R-The Woodlands) and Rep. John Otto (R-Dayton) have agreed to offer bills to implement these proposals.

FRANCHISE TAX RECOMMENDATIONS

TSCPA’s approach to tax legislation is to be a resource to legislators who have an interest in proposing or considering tax legislation. We do not ask legislators to sponsor a specific bill that includes all of our ideas, but provide our suggestions to legislators who are interested in offering tax legislation. We provide technical assistance and support for any bills that include our recommendations. The proposals are: • Make Texas franchise tax law consistent with the current Internal Revenue Code. • Offer an option for taxpayers to use the federal cost of goods for franchise tax purposes. • Make compensation and cost of goods sold deductions consistent with regard to payments to independent contractors and payroll taxes. • Make it clear that negative net distributive income, such as partnership losses, does not reduce the compensation deduction; i.e., is not treated as negative compensation. • Expand the compensation deduction for partnership net distributable income to include distributions to professional corporations and professional associations. • Clarify whether “capital gains” as used in the law really means “net capital gains” with respect to an entity’s qualification as passive. • Clarify that the flow-through funds excludable from taxable revenue are not restricted to collections of sales and use taxes. • Eliminate the “Finnegan” reporting requirement. Major changes to the franchise tax are not likely to be made this session. Now that the Texas Supreme Court has ruled the tax constitutional on two occasions, there doesn’t appear to be much appetite among legislators to tackle major changes.

■

Cover Article

WHERE TEXAS CPAS COME FROM Exhibit 1: CPA Examination Sections Passed – Top 10 Schools INSTITUTIONS

By Gordon Heslop, DBA, LLB (Hons), CMA, CIA, CFM, Virginia Fullwood, MBA, CPA, and Rafiu O. Fashina, MBA

fter the CPA examination was computerized in April 2004, the Texas State Board of Public Accountancy (TSBPA) began to display the pass rate statistics for Texas on its website. Statistics are made available for each exam section and by the university that the candidates attended. The university-based statistics provide useful information regarding the strength of different programs and supply the profession data with respect to where new CPAs originate, and in what proportion. They also provide information that universities can use to help evaluate their accounting programs. From its inception in April 2004 until the end of September 2012, a period of eight years and six months, of the 47,316 sections passed, 33,179 – 70.1 percent – came from only 10 schools. These details are shown in Exhibit 1. The top five schools alone, Texas A&M-College Station, UTAustin, University of Houston (Main), UT-Dallas and Baylor University, account for 24,754 – 52.2 percent – of the total sections passed. So while statistics are presented for 81 Texas schools, the top 10 schools really dominate in terms of the number of sections passed. Large schools with higher enrollments are expected to produce more successful candidates; therefore, the pass rates should also be considered. The pass rate is calculated by comparing the number of sections passed to the number of sections tested. Schools whose graduates passed fewer than 85 sections (10 per year) over this eight-and-a-half year period were eliminated from this analysis because the small numbers could produce an unreliable result. The top 10 schools by pass rate are listed in Exhibit 2.

SECTIONS PASSED

Texas A&M - College Station

8123

Univ of Texas - Austin

7021

Univ of Houston - Main

4162

Univ of Texas - Dallas

3169

Baylor University

2279

Texas Tech University

2005

Univ of Texas - Arlington

1853

Texas State University

1671

University of North Texas

1476

Southern Methodist University

1420

Total (Top 10 Schools)

33,179

Total for all 81 Schools

47,316

Compiled from Texas State Board of Public Accountancy (TSBPA), 2004-2012.

Exhibit 2: CPA Examination Pass Rates – Top 10 Schools INSTITUTIONS

Candidates Total

Sections Total

Sections Passed

Percent Passed

Univ of Texas - Austin

6514

10,099

7021

69.5

Texas A&M - College Station

7927

12,119

8123

67.0

Texas Christian University

1208

1977

1213

61.4

Baylor University

2621

3794

2279

60.1

Southern Methodist University

1475

2373

1420

59.8

Southwestern University

170

258

142

55.0

Trinity University

712

1042

570

54.7

Austin Community College

524

743

406

54.6

Texas Tech University

2719

3782

2005

53.0

Abilene Christian University

946

1341

692

51.6

Total (Top 10 Schools)

24,816

37,528

23,871

63.6

Total (All 81 Schools)

67,368

96,111

47,316

49.2

Compiled from Texas State Board of Public Accountancy (TSBPA), 2004-2012.

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UT-Austin, Texas A&M-College Station and Baylor University are in the top five on this list also, and are joined by Texas Christian University (#3) and Southern Methodist University (#5). Of the two schools in the top five for the number of sections passed, but not for the pass rate, the University of Houston (Main) has a 42.7 percent pass rate (#22) and UT-Dallas a 44.8 percent pass rate (#16) compared to the #5 school, Southern Methodist University, which has a pass rate of 59.8 percent. The pass rate for the 10th school is 51.6 percent. The 20th ranked school has a 43.2 percent pass rate, the 30th 37.9 percent and the 40th 32.6 percent. It is not surprising that the flagship schools of the two largest state university systems and three prestigious private schools have the best pass rates. However, the number of successful candidates they produce, along with their pass rates, is quite striking in comparison to the other schools in the state. Texas has recently started permitting a few community colleges to offer the accounting courses required for a student to qualify to take the CPA exam. Texas community colleges that meet the TSBPA standards may be awarded the designation – Qualifying Education Credit for CPA Examination – by the Board. Three community colleges were granted such permission effective Jan. 1, 2004, and a fourth effective Jan. 1, 2005 (TSBPA, 2004-2005). It is difficult to definitively measure the results of this policy, at least at this stage, for two reasons. Only recently has the number of students taking this route begun to be significant, with 56.1 percent of the 938 total number of sections passed being since January 2010. Secondly, these graduates are not solely the product of the community college where they study accounting. They must already hold a college degree from a four-year school. Therefore, much of their education and study habits are a product of another institution, and not of the community college. To date, their combined pass rate is a respectable 45.7 percent, good enough to rank them 13th as a group, by pass rate, among schools with at least 85 sections passed. By far, the two biggest community colleges in terms of producing candidates who took and passed sections of the CPA exam are Austin Community College, with 406 sections passed for a pass rate of 54.6 percent, and Houston Community College, with 289 sections passed for a pass rate of 40.4 percent. Houston Community College, with a pass rate of just over 40 percent, has a better pass rate than 16 of the 33 schools with Association to Advance Collegiate Schools of Business (AACSB) accreditation and three of the 13 schools with the separate accounting accreditation. The pass rate statistics are not perfect. For example, it is not possible to capture the differing contributions that different schools made if a student completed their undergraduate study program at more than one university. Likewise, it is not possible to know how much success should be attributed to an undergraduate program if a student also earned a master’s degree in accounting at a different school. The Board has reported the schools based on the candidates’ input as to school attended and for this reason, there may also be some slight distortions. For example, two community colleges, which ironically have the highest pass rates of any schools, show candidates having passed a total of five sections of the examination, but they are not approved to offer the required courses. This has occurred because a small number of candidates, who have qualified to take the exam at another university, must have listed one of these colleges on their application form as the institution where they studied accounting. However, the statistics are so extensive, with 96,111 sections attempted and 47,316 sections passed, that despite such small distortions, they provide a very clear picture of the results on the CPA examination in Texas over the period studied. While the published

CPA pass rates are not the only way to measure the performance of accounting departments, they do provide a useful and interesting source of data. It is possible to see the size of a school’s output, which programs are successful and which are weaker, and which ones are improving over time. The complete totals for all schools reported by TSBPA for the eightand-a-half-year period under study are shown in Exhibit 3. ■ Exhibit 3: CPA Examination Results by Sections Passed and Pass Rate Institutions

Candidates Total

Sections Total

Sections Passed

Percent Passed

Abilene Christian University

946

1341

692

51.6

Amberton University

112

28.6

Angelo State University

479

659

296

44.9

Austin Community College

524

743

406

54.6

Baylor University

2621

3794

2279

60.1

Central Texas College

0.0

Concordia University at Austin

23.8

Dallas Baptist University

255

377

106

28.1

DeVry University

195

274

22.3

East Texas Baptist University

51.4

El Paso Community College

100.0

Hardin-Simmons University

146

199

44.2

Houston Baptist University

350

471

141

29.9

Houston Community College

527

716

289

40.4

Howard Payne University

26.3

Huston-Tillotson College

33.3

Jarvis Christian College

0.0

Lamar University

678

972

317

32.6

LeTourneau University

23.7

Lone Star College

261

337

153

45.4

Lubbock Christian University

105

144

36.8

McMurry University

35.6

Midwestern State University

402

518

243

46.9

Mountain View College

189

258

34.9

Our Lady of the Lake Univ.

135

174

20.7

Paul Quinn College

0.0

Prairie View A&M University

222

309

14.2

Rice University

76.9

Richland College

0.0

Sam Houston State University

1952

2695

1018

37.8

San Antonio College

0.0

Schreiner University

134

168

30.4

Southern Methodist University

1475

2373

1420

59.8

Southwestern Adventist Univ.

58.9

Southwestern Assemblies

33.3

Southwestern University

170

258

142

55.0

St. Edward's University

424

576

237

41.1

St. Mary's University

402

552

210

38.0

Stephen F Austin State Univ.

1254

1714

717

41.8

Sul Ross State University

58.1

Tarleton State University

422

574

248

43.2

continued on next page

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Cover Article Exhibit 3 Continued Institutions

Candidates Total

Sections Total

Sections Passed

Percent Passed

Tarrant County College District

80.0

Texarkana College

0.0

Texas A&M - College Station

7927

12119

8123

67.0

Texas A&M - Commerce

383

558

205

36.7

Texas A&M - Corpus Christi

671

903

279

30.9

Texas A&M - International

248

303

112

37.0

Texas A&M - Kingsville

164

209

23.9

Texas A&M - Texarkana

121

165

37.0

Texas Christian University

1208

1977

1213

61.4

Texas College

50.0

Texas Lutheran University

468

638

256

40.1

Texas Southern University

246

330

14.2

Texas State University

2774

3797

1671

44.0

Texas Tech University

2719

3782

2005

53.0

Texas Wesleyan University

191

281

33.8

Texas Woman's University

237

337

105

31.2

Trinity University

712

1042

570

54.7

Univ. of Houston - Clear Lake

2004

2687

951

35.4

Univ. of Houston - Downtown

1908

2482

667

26.9

Univ. of Houston - Main

7232

9756

4162

42.7

Univ. of Houston - Victoria

275

358

130

36.3

Univ. Mary Hardin-Baylor

192

267

34.5

Univ. of Central Texas

0.0

Univ. of St. Thomas

804

1048

398

38.0

Univ. of Texas - Arlington

2659

3753

1853

49.4

Univ. of Texas - Austin

6514

10099

7021

69.5

Univ. of Texas - Brownsville

196

244

32.4

Univ. of Texas - Dallas

4600

7073

3169

44.8

Univ. of Texas - El Paso

775

1006

432

42.9

Univ. of Texas - Pan American

509

674

207

30.7

Univ. of Texas - Permian Basin

366

500

161

32.2

Univ. of Texas - San Antonio

2344

3155

1222

38.7

Univ. of Texas - Tyler

646

883

335

37.9

University Incarnate Word

272

352

105

29.8

University of Dallas

251

342

148

43.3

University of North Texas

2276

3162

1476

46.7

Victoria College

0.0

Wayland Baptist University

35.7

West Texas A&M University

638

863

305

35.3

Wiley College

21.4

Total

67,368

96,111

47,316

49.2

Note: Compiled from Texas State Board of Public Accountancy (TSBPA), 2004-2012.

SOURCES

Texas State Board of Public Accountancy (TSBPA). (2004-2012). Candidate success rates – CBT-Uniform CPA Examination university comparison. Retrieved from www.tsbpa.state.tx.us/php/fpl/unvcompare.php. Texas State Board of Public Accountancy (TSBPA). (2004-2005). Texas Community Colleges awarded the Board designation - Qualifying Education Credit for CPA Examination. Retrieved from www.tsbpa.state.tx.us/ education/board-awarded-community-colleges.html

Gordon Heslop, DBA, LLB (Hons), CMA, CIA, CFM, is an assistant professor in the Department of Accounting at Texas A&M University – Commerce. Heslop may be reached at Gordon_Heslop@tamu-commerce.edu. Virginia Fullwood, MBA, CPA, is an instructor in the Department of Accounting at Texas A&M University – Commerce. Fullwood may be reached at Virginia_Fullwood@ tamu-commerce.edu. Rafiu O. Fashina, MBA, is a graduate assistant in the Department of Accounting at Texas A&M University – Commerce. Fashina may be reached at rfashina@leo.tamu-commerce.edu.

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| JANUARY/FEBRUARY 2013

Feature By Franklin D. Shuman, CPA, Christopher J. Skousen, Ph.D., and Nathaniel M. Stephens, Ph.D., CPA

Initial Reaction to the FASB Accounting Standards Codification The Financial Accounting Standards Board (FASB) issued Statement Number 168 titled, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162 in June of 2009. This statement established the FASB Accounting Standards Codification (FASB ASC) as the single authoritative source of nongovernmental U.S. GAAP. The effective date of the standard was for fiscal periods ending after September 15, 2009. FASB worked with AICPA and the SEC to produce a framework that would bring all authoritative accounting standards into a single source of GAAP. The Codification reorganizes the “thousands of U.S. GAAP pronouncements into roughly 90 accounting topics and displays [them] using a consistent structure” (Assurance 2009). Each topic is divided into subtopics, the number and length of which depends on the length and complexity of that topic. The desire of FASB is that the Codification would lessen the risk of non-compliance with standards, provide ongoing updates, facilitate with convergence to International Financial Reporting Standards (IFRS) and definitively establish that guidance not included in the Codification is not authoritative. “The benefits of the Codification are numerous, including the following: 1) Access to all authoritative literature in one place; 2) Immediate access to new guidance; 3) Reduced risk that a piece of literature may be overlooked; 4) More consistent structure to facilitate research; 5) Reduced research time; and 6) Context inclusion for a more complete understanding of the literature” (Williams 2009). The change to the FASB ASC represents a major shift from the GAAP hierarchy outlined in FASB Statement Number 162. The old GAAP was based on different levels of authority and was commonly referred to as the “house of GAAP.” These levels of authority were referred to as categories, and are listed here from most authoritative to least. Category A was the most authoritative and included FASB Standards, Interpretations, and Staff Positions, APB Opinions, and AICPA Accounting Research Bulletins. Category B consisted of pronouncements offered for public comment and issued by experts in accounting and included FASB Technical Bulletins, AICPA Statements of Position, and AICPA Industry Audit and Accounting Guides. Category C consisted of pronouncements not offered for public comment and issued by experts in accounting, and included the FASB Emerging Issues Task Force and AICPA Accounting Standards Executive Committee Practice Bulletins. Category D consisted of items that indicate widely recognized and prevalent industry practice and included AICPA Accounting Interpretation and Implementation Guides and FASB Implementation Guides. With the implementation of the Codification, U.S. GAAP now has two levels: authoritative and nonauthoritative. Under the “house of GAAP,” accounting standards were located in multiple documents and pronouncements. Under the FASB ASC, all accounting standards have been superseded and any

accounting literature not in the Codification will be considered “nonauthoritative.” The reason behind FASB’s development of the Codification was to address weaknesses in the U.S. GAAP structure in that it was difficult to understand and use, and to simplify the standard-setting process. Instead of issuing different kinds of pronouncements, such as statements, interpretations, and staff positions, FASB will update U.S. GAAP by issuing Accounting Standards Updates (ASU). Each ASU will be numbered by year and a sequential identifier (2009-01, 2009-02). In a news release related to the Codification, FASB Chairman Robert Hertz stated: “When the Codification goes live…U.S. GAAP will be completely reconfigured in a way that will vastly improve the ease of researching U.S. GAAP issues, superseding existing authoritative literature – including FASB’s Original Pronouncements. Preparers and auditors of financial statements need to familiarize themselves with the changes so that they are ready for the switch” (Williams 2009). continued on next page

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Initial Reaction to the FASB Codification continued from page 23

In response to Hertz’ statement, we asked the following question: Did users initially view the Codification as improving the ease of researching GAAP? To answer this question, as well as to determine general CPA attitudes toward the Codification at the time, when the Codification was quite new, we surveyed CPAs from across the United States.

METHODOLOGY

The survey was administered via the Internet using a third-party survey company. To get a representative sample of CPAs’ opinions concerning the FASB ASC, e-mails requesting participation in the study were sent to a sample of CPAs from across the United States. Over 100 CPAs responded to the survey, representing all levels within a typical CPA firm (i.e., staff, senior, manager, and partner). The majority of respondents were audit partners (60 respondents) who had an average of just over 24 years of public accounting experience. Overall, 81 of the 112 respondents identified themselves as auditors. The average respondent from all backgrounds had, on average, about 16 years of experience. Exhibit 1 provides information about the survey respondents. To gain a better understanding of the data, we e-mailed participants following their responding to the questions discussed above to ask them some open-ended questions regarding the Codification. The feedback we received from both the survey and the open-ended questions is discussed below.

RESULTS

In designing and conducting the survey, we sought to answer two primary questions related to the FASB ASC: 1. What was the respondents’ overall opinion of the change to the FASB ASC? 2. Did respondents believe the FASB ASC was more efficient and easy to use both in the short term and over a longer term? Both of these questions relate to the views and opinions of users of the FASB ASC at the time when the Codification was new. While users’ opinions today may differ significantly from their opinions at the time of initial adoption of the ASC due to exposure and experience with the new format, we believe it is interesting to examine initial perceptions of the ASC. To address the overall opinion of the change to the FASB ASC, we asked participants to respond to the following question, “What is your overall opinion of the change to the FASB Accounting Standards Codification?” In answering this question, respondents were given the options of “Very Much Like,” “Like,” “Neutral,” “Dislike,” and “Very Much Dislike.” Of the 112 respondents, 21 had never used the Codification. For those who had used it, the response to the overall change appears to be quite mixed. Approximately 44 percent of respondents indicated that they either liked or very much liked the change to the new FASB ASC, while approximately 35 percent indicated that they disliked or very much disliked the change. The remaining respondents indicated that they are neutral regarding the change. Considering the change of the Codification at the time the survey was conducted and the experience level of the respondents, this response seems to be quite favorable. There seems to be a

general conclusion even shortly after adoption that the change to the FASB ASC is a positive one, though there are some individuals in the sample who did not like the change. From the open-ended questions, it appears that in general users liked the idea of condensing the standards into one source, but many had some concerns regarding the design or functionality. For example, one participant said, “I liked the idea of a Codification, but still find it difficult to use.” Many participants indicated that they did not like the Codification because they were so familiar with the previous GAAP hierarchy that it felt like starting from scratch. One participant said, “I knew SFASs by number and topic; so it is like starting over.” Another said, “It just sounds so different quoting a database tables space instead of a topic statement like FASB 109.” It is very likely that as users become more familiar with the Codification, it will become more comfortable to them. To address the efficiency and ease of use of the FASB ASC, we asked respondents to indicate their level of agreement or disagreement with the following three statements. The FASB ASC: 1. makes it easier to find information I am looking for. 2. will save me time during the next 90 days. 3. will save me time in the next one year or more. Respondents expressed a general disagreement with the statement that the FASB ASC makes it easier to find information. Of the 90 respondents who had used the FASB ASC, 41 percent strongly disagreed or disagreed with the statement, with 32 percent agreeing or strongly agreeing. In contrast with Hertz’ statement, it appears that early use did not necessarily make it easier to find information, at least in the short term. This general negative response to the efficiency gains of the FASB ASC may be due, at least in part, by the start-up time being invested to learn the new structure. Experienced practitioners who were likely familiar with the “house of GAAP” were now required to learn a new system. We asked questions two and three to get an idea of whether startup costs were the driver of the responses to the first question. We expected that respondents would generally believe the time savings would come after an initial learning curve. Results are consistent with this expectation. Only 28 percent of respondents who had used the FASB ASC agreed or strongly agreed that the FASB ASC would save them time in the short term, while 42 percent disagreed or strongly disagreed. This result flips completely when looking at the longer term. Approximately 49 percent of respondents who had used the FASB ASC agreed or strongly agreed that the FASB ASC would save them time in the long run, compared with only 29 percent who disagreed or strongly disagreed. This response is encouraging and very much supportive of the FASB ASC. While the Codification was expected to take more time initially, most respondents agreed that in the long term it would save time. This is an important finding and at least partially supports Hertz’ statements. We believe as users become more familiar with the Codification over time, we will see attitudes change towards its ease of use. In addition, a new generation of accounting graduates is being trained in the Codification. These new accounting professionals are likely to be very comfortable with it since it’s the platform from which they research and obtain an understanding of GAAP.

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| JANUARY/FEBRUARY 2013

EXHIBIT 1 Interestingly, participants suggested that the concern with start-up time might at least, in part, be driven by a lack of training on the tools already available. One participant said, “The cross reference ability with the old FAS statements also gives the old timers the ability to go from our former way of thinking (FAS 113 to the number in the Codification) … I think without the cross reference feature, it would be difficult to easily use.” Of the 90 respondents who had used the cross-reference tool, 43 percent indicated that they were “satisfied” or “very satisfied” with this tool, while only 13 percent indicated that they were “dissatisfied” or “very dissatisfied,” the remainder being neutral. One feature that many participants felt had room for improvement, however, was the search function. In response to our open-ended questions, we received many complaints regarding the search function’s ability to help them find what they were looking for. Survey participants found at least two main problems with the search function. First, search results generally contain much less detail than is needed. Second, search results often return information that is irrelevant to the user. For example, one participant said, “The special industry stuff appears too frequently…for example, type in ‘revenue recognition,’ and you get hits about movies and films. Not a lot of people would want that to be their first choice in the topic content.”

Description of Survey Participants Title Audit Staff

Tax Staff

Audit Senior

Tax Senior

Audit Manager

Tax Manager

Audit Partner

Tax Partner

Partner-non-designated

Other

Total

112

Total Audit

Total Tax

Total Other

PERCEPTIONS OF CPAS

In general, we found that the CPAs we surveyed liked the change to the new FASB ASC, though approximately 1/3 either disliked or very much disliked the change. In general, those who disliked or very much disliked the change had more years of experience. Surprisingly, while a stated purpose of the FASB ASC is to save time by compiling all authoritative GAAP in one place, we find that generally respondents did not believe the FASB ASC makes it easier to find information they are looking for. However, we found evidence that while respondents believed that the FASB ASC would not save them time in the short term, the general belief was that the time savings would come in the longer term. Additionally, we found that perhaps some of the initial start-up costs were driven by a lack of understanding of the existing tools available in the ASC to make it easier to convert to the new structure. One interesting finding of this study is that although the expectation for time savings improves over time, still less than half of those who responded believe the FASB ASC would save them time in the long run (more than one year). We believe it will be interesting to see how perceptions of time savings change as CPAs get more experience using it. In addition, as the new generation of accounting graduates is trained, we believe the comfort level with the Codification will increase significantly on average. ■

Number of Respondents

Years of Professional Accounting Experience Years

Number of Respondents

0-10

11-15

16-20

21-25

26-30

31 or more

Undisclosed

Total

112

Mean Years of Professional Accounting Experience

REFERENCES

Assurance. 2009. “FASB debuts standards codification.” Accounting Today, Vol. 23 Issue 12, p14-14, 1/3p. Williams, Jan R. 2009. The FASB Accounting Standards Codification Project, GAAP Update Service, Vol. 9 Issue 3, p1-4.

Franklin D. Shuman, CPA, teaches as a Principal Lecturer at Utah State University in Logan, Utah. He may be contacted at: frank.shuman@ usu.edu. Christopher J. Skousen, Ph.D., earned his Ph.D. from Oklahoma State University. He currently teaches financial accounting at Utah State University. He may be contacted at: chris.skousen@usu.edu. Nathaniel M. Stephens, Ph.D., CPA earned his Ph.D. from the University of Arizona. He currently teaches auditing at Utah State University. He may be contacted at: nate.stephens@usu.edu.

Today’sCPA

| JANUARY/FEBRUARY 2013

Feature By Kenneth M. Horwitz, J.D., LL.M., CPA, and Richard E. Young, J.D.

Minimizing the Legal Risks of CPA Practice, Part II

In part I of this article (see the cover story in the November/December 2012 issue of Today’s CPA), we discussed a best practices approach and related issues to analyzing risk management for your accounting practice. In this second and concluding part, we will discuss legal liability and ancillary issues that may arise once a claim is made. TO WHOM CAN THE CPA BE LIABLE?

First, know your client. Many professionals believe their client is the person they know and with whom they have a personal relationship. The professional overlooks that he/she may really be providing services to the entity or partnership or married couple for whom the individual is speaking. The CPA owes professional duties to the client, not the representative. Be aware of when the representative and the entity client may have a conflict of interest. The CPA should discuss the perceived conflict with the client. The CPA must protect the client’s interests and should make sure the representative knows the CPA is not, in that context, the accountant for the representative. The CPA can owe duties to persons in addition to his/her client and, therefore, may face a lawsuit from not only the client

but from others. Some examples are claims made by persons that the CPA knew or should have known would likely rely on the CPA’s work, such as persons likely to rely on financial statements or tax returns. This may be so even if the CPA expressly states on the work that no one other than the client can or should rely on the work. For example, if the CPA knows or should have known the client was going to show the work to others for those people to rely upon in some way in spite of the disclaimer, the disclaimer is not a magic incantation that will relieve the CPA of responsibility. Other persons to whom a duty may be owed include persons connected to the client – spouses, partners, bankers, investors, taxing authorities, governmental agencies, creditors, and even opposing parties in a lawsuit. If the CPA knew or should have known that the complaining party (either specifically or a

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member of some general group) was likely to use (and rely on) the work in deciding to take some action or refrain from some action, then there is a risk that a court will decide the CPA owed a duty to that person to perform the accounting work in the ordinary careful manner of a CPA in the same or similar circumstance. If the court decides that duty is owed to that third party, the CPA can be held liable for the damages that resulted from a breach of that duty. In addition and for example, in the case of federal tax work, there are federal statutorily imposed standards for reporting, as well as the Circular 230 ethical standards of conduct; violation of these standards can lead to sanctions, including monetary penalties and loss of right to practice. The CPA can limit (but not eliminate) risk of third party reliance by inclusion of appropriate language in the engagement letter regarding use of the work product. Certainly, discussion by the CPA with his/her client as to who might be reading or relying upon the CPA’s work is appropriate. The CPA should evaluate how the accounting work may affect that person down the chain and how the work should be done with that in mind.

FIDUCIARY DUTIES

A fiduciary relationship is one that involves a special relationship of trust or confidence with a beneficiary. A fiduciary owes special and very high duties to his/ her beneficiary. Those duties include: (1) doing what is in the best interest of the beneficiary (even if it is against the fiduciary’s own interest); (2) disclosing all relevant facts to the beneficiary and using the utmost good faith and scrupulous honesty; (3) not placing herself or himself in a position where there is even a temptation for a conflict; and (4) ensuring that any transaction between the fiduciary and the beneficiary is fair and equitable to the beneficiary. A CPA’s normal client relationship is not a fiduciary relationship. CPAs should be wary of undertaking fiduciary positions with clients or practicing accounting services for beneficiaries where the CPA is a fiduciary. A CPA can become a fiduciary, for example, by acting as a trustee, corporate officer or director of the client, or the client’s partner. Every employee owes his/her employer certain fiduciary duties. A relationship as a close friend or family member of the client, or as a partner with another CPA, can also impose a

fiduciary duty. Fiduciary duties can expose the CPA to a very long period before the statute of limitations runs on claims, and if a breach of duty is proven, the CPA is exposed to possible punitive damages. This can not only expose the CPA to financial damages, but can be the grounds for professional disciplinary actions by the governing state board of public accountancy. In short, a CPA should only wear one hat – that of the CPA. If you feel that you must undertake other activities, act with great caution and care. These positions should not be undertaken lightly. If the CPA undertakes one of these relationships, he/she must take extra care to communicate, disclose, educate and advise, and obtain the consent of the beneficiary in all aspects of the accounting services. Needless to say, it is critically important to create, maintain and preserve excellent records of all activities.

STATUTE OF LIMITATIONS – WHEN ANY LAWSUIT AGAINST A CPA MUST BE FILED

The law requires persons who want to file lawsuits to act reasonably promptly in starting the lawsuit. The law imposes time periods on those persons by statutes of limitations – a deadline by which a lawsuit must be filed, or the claims are forever barred, no matter how meritorious. For CPAs, the most common lawsuit is for malpractice. Malpractice is the failure to act as a CPA using ordinary care would have acted in the same or similar circumstances. A lawsuit alleging malpractice must be filed within the later of two years of the date of the alleged negligent act or the date the client (using ordinary care) should have discovered the malpractice. If the claimant alleges intentional fraud, breach of fiduciary duty or breach of contract against the CPA (and not mere malpractice), the claimant has four years after the alleged fraudulent act or discovery of the breach or ending of the fiduciary relationship within which to file the lawsuit. This discovery element of the statutes of limitation rules that delay the starting time for limitations can make the time period uncertain. If the client alleges he/ she did not know of the bad act of the CPA, the date to start measuring the time limit is the date the client using ordinary care should have discovered the alleged

bad act. In the case of tax services, for example, a long history of Texas case law holds that the discovery does not occur until Internal Revenue Service (IRS) action (which may not occur until a number of years after a return is filed). A judge or jury has to decide that question based on the particular facts involved. Predicting the result of that (or any) decision based on any particular facts is never easy. There are also other situations that may delay the required starting time to file a lawsuit, such as if the client is not an adult, is incompetent, or is in the military and overseas. A CPA firm should set up a system so that all records are automatically and reliably kept for more than four years after the event in the records. In the case of tax services, as an example, this would be four years after the time to assess the tax has expired. An additional buffer period of at least two years (for a total of six additional years) would certainly be prudent. The system should automatically identify clients who (i) are minors, (ii) are trusts with minor beneficiaries, (iii) are or may become incompetent in the near future (such as clients who are very elderly or in bad health), or (iv) are in the military. The system should automatically keep these records for several years after the minors come of age, the death of the incompetent client, or completion of the military service of the client. If the CPA is an officer, director, employee, partner or agent of the client, or a partner with another CPA, or is a friend or relative of the client, the system should keep the records for the entire period of the relationship and until more than four years after that relationship ends.

SPOLIATION OF EVIDENCE

One of the pitfalls for all persons who face lawsuits is spoliation – the destruction, loss or alteration of records and other evidence of events before or during the lawsuit – when the party knew or should have known that a lawsuit was likely to result from the events. Spoliation can occur intentionally (when the party knowingly destroys or hides the evidence), by accident (hitting the wrong key on the computer), by negligence (careless thinking or not thinking about preserving data), or by bad practices (not regularly keeping data, not backing up data, not stopping an automatic purging of files or not continued on next page

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identifying and pulling data from the purge, and not training staff to recognize and save potential evidence). The penalty for spoliation before the lawsuit is filed usually is that the trial court can instruct the jury to presume the lost, destroyed or altered evidence would have shown that the CPA actually committed the complained of act, or caused the damage and sometimes even the amount of the damage claimed. The penalty for spoliation after the lawsuit is filed may include that kind of instruction, plus a sanction of paying the cost to reconstruct the evidence if possible, or even contempt of court (fine and jail time) if the court finds the spoliation to be intentional or reckless. Because of the time periods of the statute of limitations discussed above, the starting time period necessary for preserving potential evidence may be many years before a lawsuit is filed (if it ever is). Evidence that can be spoiled includes: • papers, • computer files, • time and billing records, • voice mail recordings, • text messages and e-mails, • bank records, • travel records, • diaries and calendars, • phone records, • internal notes and personal notes, and • electronic and hard copies of any of these, back-ups of any of these, and even deleted portions of these that might still reside in some technical part of the computer system. In addition to your required duty to preserve records for professional accounting purposes (including under tax statutes), you should set up a document retention system and procedures to recognize and identify an event that might give rise to a complaint or suit. Once your procedure identifies such an event, your procedure should protect any evidence from any purging practice. Your procedure should also automatically protect the evidence from access that might alter the evidence. For example, routinely opening a computer file to view it, or do ordinary maintenance or

accounting work, will automatically alter some part of the file; protection of this information may include a requirement to make a copy within which to do all future work. Importantly, your system should thereafter not allow the original evidence to be delivered to, or accessed by, anyone (including the client) not under your supervision or control.

EFFECTS OF A LAWSUIT AGAINST A CPA

If a CPA gets sued, he/she must, as a practical matter, hire a lawyer to defend the suit. If the CPA has malpractice insurance, the insurance company generally hires the lawyer and pays the legal fees and expenses incurred after the CPA’s deductible is used and up to the limit in the policy (although a policy can be negotiated so that the CPA can select his/her own counsel). Many policies have “disappearing limits” – each dollar spent on defense reduces the amount of coverage left from the policy limit if the case is lost and the CPA ends up with a judgment against him/her. So the cost of defense can be important even if the CPA is insured. There are only two ways lawsuits are disposed of – they are settled or they are tried. There are no other ways. In fact, 95 percent of all lawsuits filed are settled before trial. Most lawsuits are settled or tried within about two years of the filing date. The idea is to settle the case sooner than later before a larger legal bill is incurred. But human nature being what it is, it is difficult to get warring parties to settle any lawsuit early in the process. That means substantial legal fees will be incurred in almost any lawsuit. If a malpractice case goes all the way to trial, the CPA can usually expect the lawyer fees and expenses, along with the necessary accounting expert witness fees (another CPA), to run well over $250,000 over the two- to three-year period. Even if the case settles, some substantial portion of those fees will be incurred before settlement. In a few instances, the CPA can try to get reimbursed for legal fees from the complaining party in an accounting malpractice case, but it is rarely successful

under the current law. If the complaining party suing the CPA proves a breach of contract by the CPA, the court is required by statute in Texas to award the complaining party a judgment for reasonable and necessary legal fees. Any event that might give rise to either a malpractice, breach of contract, breach of fiduciary duty, or any other professional liability claim should be immediately reported by the CPA in writing to the insurance company, as well as the CPA’s own insurance agent. Also, for any claim that is made or lawsuit that is filed, an immediate report should be made to the insurance company and to the agent, and a defense requested. Cooperation with the insurance company in the defense is essential.

DAMAGES

If a court finds a CPA committed malpractice, the court can award the injured party actual damages – actual damages that naturally flowed from the wrongful act. If the court finds the CPA knew the injured party might face a special kind of damage if the accounting work was defective (such as have a loan inappropriately refused for a specific profitable business venture), the court could award the loss equal to the value attributable to that special damage. If the court finds the CPA committed actual fraud, breached a fiduciary duty, or committed some negligent act with willful disregard of the injury that might result, the judge or jury may award punitive damages against the CPA – damages designed to punish the CPA and to discourage others (CPAs or not) from committing such acts in the future. In determining how much a punitive damage award should be to accomplish these two goals, the jury or judge may consider the wealth of the CPA. The limit on the amount of punitive damages is the subject of great debate, but generally awards of up to three times actual damages are upheld by appellate courts. Some states like Texas have deceptive trade practices or consumer protection statutes that allow consumers of goods or services to sue for defective products or services or misrepresented goods and

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services. The Texas statute allows for the recovery of actual damages always, a multiple of actual damages if a knowing or intentional violation is proved, and legal fees. But a CPA will rarely face this statute since it excludes professional services, the substance of which is providing a professional opinion. But a CPA can still face the statute if the service was not providing a professional opinion but performing some nonprofessional service, such as inaccurate bookkeeping or a clerical task like not timely filing a return or extension. Of course, if a CPA settles or loses a malpractice or other civil lawsuit based on his/her professional practice, that fact

must be reported within 30 days to the Texas State Board of Public Accountancy (TSBPA). Many CPAs include in some of their engagement letters a provision purporting to limit damages. Note that in attest function work and federal tax services, such limitations may violate the AICPA Professional Standards or Circular 230 conflict of interest rules.

MINIMIZING RISK

As with any business, the practice of public accountancy has its own set of risks. However, by proper attention to the details of your practice and taking appropriate measures for risk

management, you can minimize (but not eliminate) the risks that you will get sued and of serious loss in the event that you are sued. These steps take effort, sometimes cost money, and frequently do not produce revenue; therefore, you may be tempted to avoid paying attention to these practice issues including steps such as the purchase of errors and omissions insurance that cost money out of pocket when there is no claim in sight. However, it seems clear that you as a CPA and a business adviser to your clients should undertake those prudent steps, steps that any businessperson should assume given the reality of business risks. â&#x2013;

Kenneth M. Horwitz, J.D., LL.M, CPA, and Richard E. Young, J.D., are attorneys with Glast, Phillips & Murray, P.C., a law firm in Dallas, Texas. Horwitz may be contacted at kmh@gpm-law.com and Young may be contacted at ryoung@gpm-law.com.

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CPE Article By Mary Recor, CPA

BUSINESS OR PLEASURE?

Curriculum: Tax Level: Basic Designed For: Public Practice, Tax Practitioners Objectives: 1.) To properly classify an activity as one for profit vs. one for pleasure; 2.) to analyze criteria utilized by the courts to make a determination with respect to classification; 3.) to gain deeper insight into the nine factors utilized by the courts Key Topics: Hobby losses; nine factors of the IRS; deductible business expenses; profit motive; elements of personal pleasure or recreation Prerequisites: None Advanced Preparation: None

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It is not uncommon to do something for no other reason than the sheer joy of doing it. Pleasure! Business, while not necessarily totally unpleasant, is done for a different reason entirely. Profit! Sometimes, what starts out as a “pleasure adventure” turns into a “profit adventure.” Whether the undertaking is for pleasure or for profit, the Internal Revenue Service (IRS) wants to know about your adventure. In both cases, they want to share in your revenue. Deductions, on the other hand, are another matter. Taxpayers and the IRS have a long history of not agreeing on how to answer this question. This article will examine several recent court cases that assess the criteria used to make the classification between hobby and business. An evaluation and study of the court’s rulings will provide assistance in obtaining a favorable outcome in the event someone needs to justify their adventure as one entered into for profit. The Treasury regulations1 provide us with a listing of the factors that the IRS uses to evaluate whether or not an activity is engaged in for profit. They can be seen in Illustration 1.

ILLUSTRATION #1 Manner in which the taxpayer carries on the activity. The expertise of the taxpayer or his/her advisors. The time and effort expended by the taxpayer in carrying on the activity. Expectation that assets used in activity may appreciate in value. The success of the taxpayer in carrying on other similar or dissimilar activities. The taxpayer’s history of income or losses with respect to the activity. The amount of occasional profits, if any, which are earned. The financial status of the taxpayer. Elements of personal pleasure or recreation.

ANALYSIS OF CASES

The first case2 to review involves Willard Christine who was employed by the Los Angeles Times as a reporter. Also, he engaged in author activities for his own interest. It was necessary to determine if his activities were engaged in for pleasure or if there was a profit motive. The answer would determine if Christine had deductible business expenses or if his expenses would be classified as hobby expenses. If the activity is classified as a business, all necessary and ordinary expenses are deductible (Sec. 162). If the activity is classified as a hobby, the amount of deductible expenses is limited to the amount of income received from the activity (Sec. 183). In response to the IRS’s review of a 2005 joint federal return, over 700 pages of documentation were submitted by Christine. Much of this material was considered illegible. All surrounding facts and circumstances determine the decision. A taxpayer’s profit objective need not be reasonable, but it must be bona fide. The court examined the nine factors: 1. Manner in which the taxpayer carries on the activity. Factor deemed neutral. 2. The expertise of the taxpayer or his/her advisors. It was recognized that Christine was an experienced writer, actively engaged in the writing business for approximately 60 years. He

had written books and had received royalties. The court deemed this factor favorable. 3. The time and effort expended by the taxpayer in carrying on the activity. The court had no doubt that Christine spent numerous hours on his writing activity. The IRS emphasized that Christine worked full time. They believed that his other writing could not rise to the level of a trade or business since he had a full-time job. The court disagreed: a full-time job does not preclude the possibility of another activity being classified as a separate trade or business. The court deemed this factor favorable. 4. Expectation that assets used in activity may appreciate in value. Factor is irrelevant and therefore neutral. 5. The success of the taxpayer in carrying on other similar or dissimilar activities. Christine had been supporting himself and his family for a “lifetime” as a writer, so this factor was easily satisfied. The court deemed factor favorable. 6. The taxpayer’s history of income or losses with respect to the activity. The court chose to examine factor #6 and #7 together. Refer to #7. 7. The amount of occasional profits, if any, which are earned. Christine had written a book on the history of a racetrack. He had spent four years on his research and sold the book for approximately $35,000. Also, he had received approximately $10,000 in royalty income from other book-writing activities. The court finds these factors (#6 and #7) are met and strongly support Christine’s position. These factors weighed favorably for Christine. 8. The financial status of the taxpayer. The IRS argued that Christine’s book writing activity generated a loss on his 2005 tax return and Christine was able to shelter his other income. Not until 2009 did Christine benefit financially from his activity. It did take some time, but from the start Christine possessed a profit motive. In the court’s judgment, Christine’s income of approximately $85,000 for 2005 was not so high as to make tax savings the primary objective for claiming expenses in connection with his writing activity. The court believed that he was a writer who desired financial success and intended to make a profit. The court deemed this factor favorable. 9. Elements of personal pleasure or recreation. Writing has been his occupation for 60 years. It is possible that he enjoys writing to some extent; this does not change the fact that he is in the trade or business of writing. The court deemed this factor favorable. After reviewing all the factors, the court was convinced that Christine engaged in his activity with a profit objective. Illustration #2 provides a chart that shows that not even one factor was considered unfavorable in this case and so it is not surprising that the court found favor for Christine. The next case involves a horse breeding and boarding operation. This is an area that the IRS pays special attention to as it is considered a hobby of the wealthy. Being able to indulge your hobby and write off the expenses of doing so can be very appealing. However, sometimes one does enter into such an activity with a sincere profit motive in mind. Such was the finding with the Helmick3 case. About 1980, Helmick acquired a parcel of real estate in a residential neighborhood. She conducted a small horse activity. continued on next page

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After her marriage, the property was held jointly; her husband joined the activity. Their primary residence was also located on this property. The activity involved both boarding and breeding. The boarding activity consisted of keeping horses belonging to third parties on their property and caring for those horses for a fee. The horse-breeding activities consisted of acquiring purebred Arabian stallions and mares for the purpose of producing offspring for sale. In connection with the breeding activity, the Helmicks purchased a two-year-old Arabian purebred stallion for $30,000 in 1984. Unfortunately, there was a problem with the horse’s previous owners. This prevented the Helmicks from obtaining a clear title; Helmick could not register the horse or its offspring as purebred Arabians, and the Helmicks lost some sales. It took nine years to obtain a clear title. From 1993 to 2002, Ms. Helmick spent her entire work week conducting the horse activity. Mr. Helmick had a full-time position and worked on the horse activity in the early mornings, evenings and on the weekends. They never hired full-time employees, but occasionally hire part-time assistants. From 1997 to 2000, the number of horses on the Helmicks’ property ranged from 40 to 60. Generally, they owned between 40 and 70 percent of the horses. The Helmicks planned to make improvements such as adding an outdoor arena for the horses to exercise. They took out a construction loan for this and other improvements. They believed these improvements would make their boarding business more profitable. It should be remembered that the property was in a residential area; the Helmicks encountered a zoning problem. The outcome of this conflict resulted in the Helmicks being given the right to continue to have 40 horses on their property, which was then zoned as an Equestrian Center. The downside: the Helmicks were now required to keep a minimum of 40 horses on their property to maintain this status. If they failed to keep the Equestrian Center Status, they would then be permitted to keep only two horses. After winning their zoning dispute, the Helmicks began the planned improvements. However, a dispute arose between the Helmicks and the contractor they had hired to do the work. As a result of the contractor dispute, the work ceased. Ms. Helmick was responsible for the bookkeeping. She did not maintain business plans or financial statements. The tax returns indicated substantial losses year after year. While the total loss approximated $400,000, this amount did not appear so staggering once other factors were considered. For example, certain items such as mortgage interest would still have been deductible – just elsewhere. This item coupled with depreciation expense softened the $400,000 figure to resemble an approximate amount of $163,000. In determining whether or not the Helmicks’ activity was engaged in for profit, the court applied the nine factors. 1. Manner in which the taxpayer carries on the activity. The IRS emphasized the failure to prepare business plans or financial statements indicated that a serious profit motive did not exist. However, the Helmicks did retain their receipts from the activity and entered them into a computer program. True, the Helmicks did not keep records in a professional manner that would be necessary to satisfy an outside investor, but their “shoebox” record keeping was adequate for their purpose – namely to

indicate whether or not they were earning a profit. With respect to the Helmicks not having a formal business plan, it was felt that they did have plans. This was evidenced by their zoning battle and plans to construct improvements. The court deemed this factor favorable. 2. The expertise of the taxpayer or his/her advisors. They were self-taught and classified as amateur owners in the equine industry. Factor was deemed neutral. 3. The time and effort expended by the taxpayer in carrying on the activity. Caring for over 40 horses proved that they spent time and effort in the activity – particularly since they never hired full-time employees. Ms. Helmick typically spent her entire work week in the conduct of the horse activity. Mr. Helmick credibly testified that he devoted mornings, evenings and weekends to the conduct of the horse activity. Clearly, they spent a substantial amount of time in connection with this activity. This time was spent not riding horses or attending horse shows, but rather performing dawn-to-dusk labor – often grueling and strenuous labor – of mucking stalls, shoveling hay, caring for sick horses, and guiding mares through the birthing process. The court deemed this factor to be favorable. 4. Expectation that assets used in activity may appreciate in value. The IRS assumed that the requisite profit motive as of any given year must involve an expectation that all past losses will be recouped, so that the activity will have generated a net profit over its entire course. The court believes this distorts the notion of profit motive for purposes of Section 183. Assuming that the Helmicks could never recoup their losses from years prior to 1997, if they expected to generate an overall profit from 1997 onward, then they cannot be said to lack a profit objective with respect to those later years merely because they would never recoup their losses from years prior to 1997. The Helmicks’ long-term goal was to profit from (i) creating a self-perpetuating herd of purebred Arabian horses and (ii) maintaining their property’s favorable zoning status as an equestrian center. The court took into account the appreciation of both the herd and the zoning status, because they were both assets that were used in the horse activity. The Helmick’s genuine belief that preserving the value of their herd and the favorable zoning status would eventually yield an overall profit was plausible. The court deemed this factor favorable. 5. The success of the taxpayer in carrying on other similar or dissimilar activities. The Helmicks were never involved in a similar and profitable business venture. The court deemed this factor unfavorable. 6. The taxpayer’s history of income or losses with respect to the activity. The Helmicks claimed an impressive string of losses. It is anticipated that a business is likely to incur losses in its startup phase. Accordingly, the Regulations4 provide that a series of losses during the startup phase may not necessarily be an indication that the activity is not engaged in for profit. The court recognized that the startup phase for an American horsebreeding activity is five to 10 years. The court concluded that the horse activity was not in its startup phase for the Helmicks and so this exception does not apply. The court deemed this factor unfavorable. 7. The amount of occasional profits, if any, which are earned. The activity was never profitable. The court deemed this factor unfavorable.

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8. The financial status of the taxpayer. The ability to offset other income with an activity’s losses may indicate the activity is not engaged in for profit. The Helmicks’ main income was Helmick’s salary, which never exceeded $65,000 during 1998 to 2002. The IRS noted that section 183 does not apply just to “wealthy individuals” and taxpayers with modest tax liabilities can have a motive to shelter those liabilities. However, “the wealth of an individual is a fact to consider in determining the applicability of section 183.” The Helmicks’ middle-class status meant that they could not afford to maintain the horse activity simply for pleasure if there was no hope of future profit. We do not find it credible that the Helmicks would keep and care for 40 to 60 horses for the purpose of sheltering the modest salary. The court deemed this factor favorable. 9. Elements of personal pleasure or recreation. The fact that a taxpayer derives pleasure from an activity does not demonstrate a lack of profit motive. The record indicated that the Helmicks encountered hard physical labor. They did not use their horses for entertainment. If the Helmicks had pleasure as their goal, they would not have been concerned with maintaining the Equestrian Center status. Without this status, the Helmicks would still have been able to keep two horses, which they could have used for personal pleasure. The Helmicks found favor with the court’s decision: We conclude that the Helmicks engaged in their horse activity during tax years 1993 to 2002 with the actual and honest objective of making a profit, and that section 183 is inapplicable in this case. Looking at the chart in Illustration 2, it can be seen that three of the nine factors displayed an unfavorable result. It is important to remember that no one factor makes the decision – all facts and circumstances must be considered. Alton Emerson5 is the subject of our final review case. Emerson was engaged in an automobile drag racing activity. The issue: was there a profit motive? During 1995, he filed Schedule C in connection with his racing activity, Emerson Enterprise Racing, and reported a loss in excess of $70,000. In 1996, he reported zero income or loss from this activity. The only asset that belonged to Emerson Enterprise Racing was a race car. When purchased, this car could barely run. Emerson had invested over $100,000 in this car. The car was turned into a bright red dragster that could legally be driven on streets as well as for racing. The car was even featured on the front cover of two magazines in 1997, Hot Street Cars and Bracket Racing USA. A small number of cash prizes were won. Except for reporting $200 of winnings in 1994, petitioner never reported income from this activity. Emerson did not maintain a separate checking account nor did he keep any written records. During 1995 and 1996, Emerson was retired; he did not have any employment. He spent 40 hours per week on his drag racing activity and employed a mechanic on a contract basis. Because of a heart condition, his NHRA (drag strip) license had speed restrictions. Accordingly, to have any chance of winning “the money races,” his son had to drive the race car. Again, the court examined the nine factors. 1. Manner in which the taxpayer carries on the activity. No formal records or business plan were maintained. Taxpayer had no sponsor, although he did unsuccessfully attempt to obtain one. The taxpayer was aware that the hopes of winning “big money” required a sponsor to fund the large expenses involved in this activity. The court deemed this factor unfavorable.

2. The expertise of the taxpayer or his/her advisors. Emerson did read racing magazines and consulted with mechanics. There was no evidence that he consulted with professionals who had made a profit from drag car racing. The court deemed this factor unfavorable. 3. The time and effort expended by the taxpayer in carrying on the activity. Factor was deemed neutral. 4. Expectation that assets used in activity may appreciate in value. The sole asset of the business was the race car. This asset had cost the taxpayer over $100,000. When he attempted to sell it, the highest offer he received was $20,000. Generally, race cars do not appreciate in value. The court deemed this factor unfavorable. 5. The success of the taxpayer in carrying on other similar or dissimilar activities. Petitioner raced automobiles when he was younger, but had to discontinue because it was too costly. The court deemed this factor unfavorable. 6. The taxpayer’s history of income or losses with respect to the activity. Often the formative years of a business incur losses. The objective, however, is to turn this around. The taxpayer began this activity in 1992. Only small cash awards were received; however, over $150,000 had been invested. Losses were continuously generated every year. The court believed there was no possibility for this activity to become profitable. The court deemed this factor unfavorable. 7. The amount of occasional profits, if any, which are earned. The racing produced only a few small cash awards. True, an opportunity does exist to realize a substantial profit in a highly speculative venture. Automobile drag racing is, without a doubt, a highly speculative venture. Emerson did not convince the court that he ever had an opportunity to earn a substantial profit. He did not have a sponsor and the amount of losses incurred, as well as the amount he invested into the activity, far exceeded the few small awards. The court deemed this factor unfavorable. continued on next page

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ILLUSTRATION #2 FACTOR

CHRISTINE

HELMICK

EMERSON

Manner in which the taxpayer carries on the activity

Neutral

Favorable

Unfavorable

The expertise of the taxpayer or his/her advisors

Favorable

Neutral

Unfavorable

The time and effort expended by the taxpayer in carrying on the activity

Favorable

Neutral

Expectation that assets used in activity may appreciate in value

Neutral

Favorable

Unfavorable

The success of the taxpayer in carrying on other similar or dissimilar activities

Favorable

Unfavorable

The taxpayer’s history of income or losses with respect to the activity

Favorable (a)

Unfavorable

History of Income or Loss

Favorable

Unfavorable

The financial status of the taxpayer

Favorable

Unfavorable

Elements of personal pleasure or recreation

Favorable

Unfavorable

DECISION IN FAVOR OF:

Taxpayer

IRS

}

(a) Factor 6 and 7 considered together with respect to the Christine case. 8. The financial status of the taxpayer. It is supposed that a taxpayer with substantial income unrelated to the activity in question can more easily afford to operate the activity as a hobby. Emerson had income from several other sources. The court deemed this factor unfavorable. 9. Elements of personal pleasure or recreation. The absence of pleasure from an activity would indicate that a profit motive does exist. There is no question that Emerson obtained pleasure from his drag racing activity. In viewing the combination of other factors, the court deemed this factor unfavorable. Emerson did not find favor with the court and this victory went to the IRS. In looking at the chart in Illustration #2, we can see that Emerson had a poor case as not even one factor was weighed in his favor.

PLANNING

When a taxpayer’s recreational activity is beginning to become reasonably profitable, it is probable that this endeavor has become a business. This may be a good time for the tax professional to suggest making the endeavor that has become a business look like a business. Having a business plan is one suggestion that should be made to the taxpayer. It does not need to be anything complex. Initially, establishing some projections for anticipated revenue and expenses would be a good beginning. If the activity involves two people, partners, an annual meeting would be another good suggestion. Again, this does not need to

be anything elaborate. A business lunch to review the past year’s activities and successes to help plan for the upcoming year would be fine. The tax professional should consider the nine factors and begin to prepare to have a positive outcome for each applicable factor should it become necessary to defend that the activity is indeed a business and not a hobby. With proper advanced planning, the taxpayer can be shielded against an adverse outcome. Keep in mind that all facts and circumstances are considered and no one factor will make a determination. Whether one’s adventure involves writing, horses, auto drag racing or some other endeavor, it is permissible to obtain pleasure and still have a profit motive – just be prepared to substantiate the nine factors! FOOTNOTES 1. Treasury Regulation 1.183-2 (b) 2. Willard Michael Christine and Patricia Ethel Borgia, Petitioners v. Commissioner of Internal Revenue, Respondent (June 30, 2010) T.C. Memo. 2010-144 United States Tax Court 3. Marcia Trescott Helmick and Robert P. Helmick, Petitions v. Commissioner of Internal Revenue (September 22, 2009) T.C. Memo. 2009-220 United States Tax Court 4. Section 1.183-2(b)(6), Income Tax Regs. 5. Alton F. Emerson, Petitioner v. Commissioner of Internal Revenue, Respondent (April 12, 2000) T. C. Memo. 2000-137 United States Tax Court ■

Mary Recor, CPA, is an Assistant Professor of Accounting and Taxation for the City University of New York – College of Staten Island.

Today’sCPA

| JANUARY/FEBRUARY 2013

CPE Quiz Today’s CPA offers the self-study exam below for readers to earn one hour of continuing professional education credit. The questions are based on technical information from the preceding article. Mail the completed test by February 28, 2013, to TSCPA for grading. If you score 70 or better, you will receive a certificate verifying you have earned one hour of CPE credit – granted as of the date the test arrived in the TSCPA office – in accordance with the rules of the Texas State Board of Public Accountancy (TSBPA). If you score below 70, you will receive a letter with your grade. The answers for this exam will be posted in the next issue of Today’s CPA. Answers to last issue’s self-study exam: 1. c 2. c 3. a 4. b 5. d 6. c 7. a 8. c 9. c 10. d PARTICIPATION EVALUATION (Please check one.) 5=excellent 4=good 3=average 2=below average 1=poor 1. The authors’ knowledge of the subject is: 5__ 4__ 3__ 2__ 1__. 2. The comprehensiveness of the article is: 5__ 4__ 3__ 2__ 1__. 3. The article and exam were well suited to my background, education and experience: 5__ 4__ 3__ 2__ 1__. 4. My overall rating of this self-study exam is: 5__ 4__ 3__ 2__ 1__. 5. It took me___hours and___minutes to study the article and take the exam. Name _______________________________ Company/Firm________________________ Address (Where certificate should be mailed) ___________________________________ City/State/ZIP_________________________ Enclosed is my check for: ___ $10 (TSCPA member) ___ $20 (non-member) Please make checks payable to The Texas Society of CPAs.

Business or Pleasure? BY MARY RECOR, CPA

1 The Treasury Regulations provided several factors as guidelines to determine whether or not any activity is engaged in for profit. How many factors are provided in the Treasury Regulations?

6 In which case did the court deem the taxpayer’s “shoebox” to be adequate for their purpose – namely to indicate whether or not they were making a profit?

A. B. C. D.

Three Factors Six Factors Nine Factors Twelve Factors

2 With respect to Factor #2, what issue(s) contributed to this factor being deemed favorable for Willard Christine? A. B. C. D.

He had over 60 years experience in the industry. He had previously published books. He had previously received royalties. All of the above.

3 In the Willard Christine case, the IRS argued that Christine could not have a trade or business because of his other employment. The court differed by stating that: A. It is possible to have a trade or business if you do work no more than 20 hours on another job. B. A full-time job does not preclude the possibility of another activity being classified as a separate trade or business. C. A trade or business is possible only if you do not have any other employment. D. None of the above.

With respect to the Christine case, what assets were considered in connection with factor #4? A. B. C. D.

Daily journal Zoning for an equestrian center Racing car None of the above

5 In connection with the Helmick case, Factor #3 was deemed to be:

Willard Christine The Helmicks Alton Emerson All of the above

7 With respect to the Helmick case, the court recognized that the startup phase for an American horse-breeding activity is: A. B. C. D.

One to four years Five to 10 years 11 to 13 years None of the above

8 How much income did Alton Emerson report in connection with his drag racing activity through his career? A. $700,000 B. $0 C. $100,000 D. $200

9 Which case did not have even one factor weighed in the taxpayer’s favor? A. B. C. D.

Willard Christine The Helmicks Alton Emerson All of the above

10 With respect to Emerson’s sole asset, over time this asset: A. B. C. D.

Increased in value by $20,000 Could be sold for $20,000 Increased in value by 100,000 Could be sold for $100,000

A. Favorable B. Unfavorable C. Neutral D. Irrelevant

Signature____________________________ TSCPA Membership No._______________ After completing the exam, please mail this page (photocopies accepted) along with your check to: Today’s CPA; Self-Study Exam: TSCPA CPE Foundation Inc.; 14651 Dallas Parkway, Suite 700; Dallas, Texas 75254-7408. TSBPA Registered Sponsor #260.

Today’sCPA

| JANUARY/FEBUARY NOVEMBER/DECEMBER 2013 2012

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Today’sCPA

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Today’sCPA

| JANUARY/FEBRUARY 2013

TSCPA Continuing Professional Education Programs FEBRUARY MONDAY

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Todayâ&#x20AC;&#x2122;sCPA

| JANUARY/FEBRUARY 2013

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