Since September 15, 2009, the financial statements of a not-for-profit (NFP) entity have been subject to Accounting Standards Codification (ASC) Topic 740, Income Taxes (formerly known as FIN 48). FIN 48 applies only to taxes based on income. An NFP’s income is generally exempt from federal and state income taxes. As a result, FIN 48 reviews for NFPs typically focus on the entity’s exempt status or its unrelated business income.
With the FIN 48 requirements now in place for NFPs, primary emphasis is often given to income tax considerations when reviewing financial statements for NFPs. Exposure related to nonincome taxes, especially sales and use taxes, is often overlooked. This item focuses on the importance of properly accounting for and considering the impact of nonincome taxes as they apply to NFPs. To address these issues, an understanding of ASC Topic 450 is required.
Overview of ASC 450
The Financial Accounting Standards Board’s (FASB) ASC Topic 450, Contingencies (formerly known as Statement of Financial Accounting Standards (FAS) 5), addresses the proper accounting treatment of nonincome tax contingencies. ASC 450 defines a contingency as a situation involving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur. ASC 450 thus applies to any nonincome taxes for which an NFP may be liable.
ASC 450 requires an estimated loss from a loss contingency to be accrued by a charge to income if it is probable that a liability was incurred at the date of the financial statements and the loss can be reasonably estimated. “Probable” means that a future event or events are likely to occur. The risk of audit detection should not be considered in reporting loss contingencies under ASC 450.
A disclosure of a contingency, not an accrual, is required even if the above conditions have not been met. Disclosure is required when there is at least a reasonable possibility that the loss may have been incurred. This disclosure must indicate the nature of the contingency and an estimate of the possible loss.
ASC 450 Applied to NFPs
What does all this mean for an NFP? For starters, nonincome taxes must be analyzed to determine whether a loss contingency should be accrued or disclosed. Recognized nonincome tax liabilities are just that: They are liabilities, not contingencies. Neither accrual nor disclosure is required for recognized liabilities under ASC 450. However, unrecognized obligations require either the accrual of a contingency or a disclosure in the financial statements. Unrecognized obligations may include many tax types potentially applicable to NFPs: sales and use, excise, gross receipts (e.g., Washington business and occupation tax), payroll, and withholding taxes.
In states where the NFP has established sales tax nexus, it is important not to overlook a loss contingency related to these types of unpaid nonincome tax liabilities. Nexus is defined as a minimum number of contacts with, or presence in, a state that must exist before a state can impose any tax liability and reporting requirement on an entity. Nexus can be created in many ways, including:
- Owning or renting real or tangible personal property in a state;
- Hiring home-based employees in a state;
- Using subcontractors or employees that perform studies on behalf of the NFP; and
- Having employees or independent contractors conducting seminars in a state.
Thus, an NFP making taxable sales of tangible personal property or services in a state in which it has nexus is required to register with the state’s department of revenue and remit the applicable tax. In particular, sales of the following items, which NFPs often make, may be subject to sales and use tax:
- Paraphernalia (e.g., t-shirts, coffee mugs);
- Online database access; and
- Property provided free of charge (training materials).
As discussed above, other tax types may also apply, including excise, franchise, gross receipts, payroll, and withholding taxes.
If it is probable that a liability for nonincome taxes had been incurred as of the date of the financial statements analysis, the NFP is required to accrue the estimated loss under the standards of ASC 450. Disclosure on the financial statements would also be required, and at this point the NFP must also take steps to minimize its potential tax exposure.
An NFP that discovers it may have unpaid state tax liabilities can often participate in a voluntary disclosure agreement (VDA) to come into compliance with state tax laws. Under a VDA, a taxpayer agrees to pay past due tax liabilities and interest and to file tax returns prospectively. In return, the state department of revenue will typically agree to waive penalties and limit the lookback period for which the taxpayer will be required to file returns.
Even though generally exempt for income tax purposes, an NFP should be aware of its potential nonincome tax obligations. The NFP should perform an analysis for two reasons: (1) to determine whether an accrual or disclosure is required in order to meet its ASC 450 obligations and (2) to minimize its potential tax exposure. With the new FIN 48 requirements for NFPs now in place, it makes sense for an NFP to also perform a detailed ASC 450 review.
Neal Weber is managing director-in-charge, Washington National Tax, with RSM McGladrey, Inc., in Washington, DC.
For additional information about these items, contact Mr. Weber at (202) 370-8213 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with RSM McGladrey, Inc.