APD (Another Pointless Designation)

Today, Barry Melancon, President and CEO of the American Institute of Certified Public Accountants, announced the first-ever availability of the new CGMA designation, the Chartered Global Management Accountant, a joint venture of the AICPA and CIMA, or Chartered Institute of Management Accountants.  An introductory video is here ...

CGMA Announcement

So, you watched the video, but you're still not sure exactly what a CGMA is?  Join the club.  It sounds good, kind of important but in a really vague way.  Clearly, it IS Global, so there's always that.  I see Mr. Melancon is already a CGMA. Wow, that was fast!  Isn't there an examination or something?  Nope, just the ability to write a check.  Exams won't come until 2015, at which point the AICPA will have a better handle on whether or not folks are buying into the whole concept.

We live in a world of professional designations.  For example, in a former life I worked in the world of business valuation.  The oldest designations were ASA (Accredited Senior Appraiser - American Society of Appraisers), CBA (Certified Business Appraiser - Institute of Business Appraisers), CFA (Chartered Financial Analyst - CFA Institute), etc.   Then, along came the upstart CVA (Certified Valuation Analyst - National Association of Certified Valuation Analysts), which was marketed specifically to CPAs.  Not to be outdone, the AICPA countered with ABV, or Accredited in Business Valuation.   Which designations were worth pursuing?  "Get them all" was the advice at conferences.  It mattered to an expert witness to be more credentialed than the opponent's expert, and it mattered from a marketing perspective (I have more professional designations than my competitor, so obviously I'm smarter).

Otherwise, it didn't matter.  You were either a serious student of the art and science of business valuation, or you weren't.  I took the ASA's 4 weeks of training, the AICPA's Certificate of Educational Acheivement in Business Valuation program (all 8 days of it), and NACVA's training (all 5 days of it), and I can tell you the ASA program is far superior to the others.  The big differences were not to the valuation practioner; the big differences are the certification fees and annual professional dues, the primary revenue stream for any professional organization.  The AICPA now can boast not only the CPA (regular, several levels of Associate, and several levels of Affiliate) , but also the PFS (Personal Financial Specialist), the ABV, the CFF (Certified in Financial Forensics) and now the CGMA.  Ka-ching.

Of course, there is resistance to the whole CGMA concept (in addition to the fact that it's a pointless designation).  The Institute of Management Accountants, for example, is a rival designation grantor, and is understandably upset that the AICPA is trying to steal its revenue stream.  Perhaps the IMA will up their game, and transform into the GLOBAL Institute of Management Accountants.
 
In any event, the IMA shouldn't underestimate the AICPA.  From selling professional standards by which members must adhere, bombarding members with solicitations from "affiliates" selling everything from copiers and computers to cheap car rentals, cross-selling insurance from professional liability to life and disability, spinning off CPA2Biz to sell CPE (a good subject for another blog), the AICPA has made it clear that it will do whatever it takes to make money. 

Back in the day, the AICPA stood for professionalism, ethics and honor, and CPAs consistently placed at the top on each year's "Most Trusted Profession" list.  Of course, back then, Arthur Anderson's reputation for integrity was legendary.

Now, not so much.

Veteran's Day

On November 22, 1975, the aircraft carrier CV-67, USS John F. Kennedy, was conducting night flight operations in heavy weather off the coast of Sicily.  Escort ships in the battle group participated in the flight operations by conducting protective weaving maneuvers around the carrier.  One of the escorts was a guided missile cruiser, the USS Belknap, DLG-26. 

I was on the Kennedy at the time, serving as a computer technician with VF-14.  It was my second cruise.

The Belknap crossed in front of the Kennedy in a pattern designed to protect the carrier, but something went wrong.  Rather than correcting course, the Belknap continued the sharp turn and struck the Kennedy on the port side near the angle deck, cutting several gashes in the side of the carrier.  The Belknap also severed several JP-5 (jet fuel) lines on the side of the carrier, dumping jet fuel on the Belknap.  The fuel ignited, engulfing both ships in flames.  The heat was so intense that the aluminum superstructure of the Belknap melted to the deck.  Heavy smoke forced evacuation of the carrier’s fire rooms, forcing the carrier to go dead in the water.  General Quarters on the carrier lasted 12 hours.  Seven people on the Belknap died that night, and 23 were seriously injured. 

There was one casualty on the Kennedy, Yeoman 2^nd Class David A. Chivalette. I knew David.

David was an office clerk, and was trying to get to his GQ station (probably his office) when he was overcome by smoke.  He was 22 years old, and was due to be honorably discharged in a few weeks.  He was just in the wrong place at the wrong time.

We just celebrated Veteran’s Day.  When U.S. President Woodrow Wilson first proclaimed Armistice Day (later, Veterans Day) in 1919, he said "To us in America, the reflections of Armistice Day will be filled with solemn pride in the heroism of those who died in the country's service and with gratitude for the victory, both because of the thing from which it has freed us and because of the opportunity it has given America to show her sympathy with peace and justice in the councils of the nations”.

David Chivalette died in his country’s service.  While his death wasn’t as a result of some made-for-TV act of heroism, his sacrifice was complete. 

I think of David, and wonder.  I knew he wanted to go to college – that’s why both of us were in the military to begin with.  We both needed the GI Bill to afford college.  I wonder what he would have majored in, what he would do?  Would he marry?  Children?  Grandchildren? 

Our military is in harm’s way every day.  No one person is more important than another – they’re a team.  No one life is less valuable than another.  No one death is less tragic than another.  We should honor our military every day, not just one day a year.

This blog is for you David.  May you rest in peace.

Carried Interest - A Primer

One of the least-understood proposed tax provisions of the American Jobs Act of 2011 concerns the taxation of “carried interest” of private equity firms.  Is the current tax treatment of carried interest really a tax loophole?  What is a private equity firm?

Private equity firms are limited partnerships that provide a means for the pooled investment of several investors.  A typical structure is a general partner that syndicates the partnership, and several limited partners, usually institutional and wealthy individual investors.  The investment horizon is long-term, typically 10 years.  The general partner performs all necessary research and due diligence to identify qualified acquisitions, while the limited partners provide the funding.  These acquisition targets are typically existing but underfunded or undervalued companies.  The general partner creates value in the acquisition with operational and management expertise as well as requisite funding.  Investments in these targets are typically equity, and the exit strategy is a target IPO or sale of the target to another investor.  The limited partners, by definition, have no control over the management of the partnership.  Their investment is entirely at risk (they may lose it all), and their profit is only realized upon exercise of the exit strategy.

The general partner receives compensation in three ways – salary, performance bonuses, and carried interest.  A more common name for carried interest is “sweat equity”, and is a long-standing tenet of partnership law. The idea is that partners who contribute ideas and talent can participate in equity along with those who contribute only cash.  Upon exercise of the exit strategy, limited partners are paid some hurdle rate of return, say 8%, then remaining gain is typically split, say 20/80, between general and limited partners.  That 20% is the carried interest.  Current law states that the carried interest is a return of investment, and as such is treated as capital gain.  Since the investment is long term, the capital gain is long term.  Currently, the maximum tax rate for long-term capital gains is 15%, whereas the top marginal rate for ordinary income, e.g. salary, is 35%. 

So, general partners in private equity firms are taxed at 35% on salary and bonus, but at only 15% on carried interest.  The current proposal centers on that disparity, and claims that the carried interest is in fact compensation, and should be taxed as such, i.e. at 35%. 

There are several arguments for and against treating carried interest as compensation.  However, current tax law treats carried interest as capital gain.  There are also good arguments (with which I agree) for taxing capital gains at lower rates than ordinary income, but a thorough discussion is beyond the scope of this article.

Most of the arguments in favor of treating carried interest as compensation appear to be emotion-driven.  You need to look no farther than Stephen Schwarzman of private equity firm Blackstone.  Schwarzman is a VERY wealthy individual (and the tax treatment of carried interest has helped to make him so), and is the reigning poster boy for Wall Street excess and conspicuous consumption.  For example, he rented the Armory in NYC for his 60^th birthday party on 2/13/07 which featured a 30 minute private performance by Rod Stewart, who was paid $1M.  Total cost of the party was reportedly $5M.  (Schwarzman also donated $100M to the NY Public Library in 2008, but that didn’t get quite as much press for that.)  On 6/22/07, Schwarzman and partner Peter Peterson took Blackstone public.  Filings with the SEC in connection with the IPO disclosed his income, which at that time was over $1M PER DAY.  Around that same time, a research paper concerning carried interest by an obscure professor, Victor Fleisher, surfaced in the Senate Finance Committee hearings.  It’s no coincidence that Rep. Sander Levin (D-MI) introduced legislation on 6/22/07 to treat carried interest as compensation.  Interestingly, the Treasury Department at that time suggested, both in testimony to Congress and in various speaking engagements, that altering the tax treatment of a single industry raises tax policy concerns and that changing the way partnerships in general are taxed is something that should be done only after careful consideration of the potential impact.

Risk varies with directly reward.  A risk-adverse investor may choose to invest in FDIC-insured CDs, but his reward may be only 1%.  An investor in a private equity fund may have very large upside potential, but could also lose his entire investment. Capital is mobile. Taxing one industry sector at the expense of another may only result in movement of capital without any actual tax benefit. The cost of capital has a tax component that all investors consider.  No change in tax policy should be considered in a vacuum.

Honestly, this entire debate reminds me of Congressional hearings in 1969, where the news of a mere 21 wealthy individuals that paid no income tax at all spurred the creation of the Alternative Minimum Tax.  The root causes were subsequently addressed by legislation, particularly the Tax Reform Act of 1986, but we’re still stuck with the AMT.

By the way, here is a video of a recent appearance of Schwarzman in NC.

Data Analysis on a budget

Warning!  Extreme auditor geek content!  This blog discusses an example of data extraction and analysis software used by auditors, and is probably of little or no interest to the general public.

My audit practice consists entirely of non-profit organizations.  Almost all of these organizations use Quickbooks; the others use or outsource to some other GL software that is exportable to Excel.  In an effort to become as efficient and effective as possible, I use data extraction and analysis software during the course of all audits; specifically in audit planning, risk assessment, and audit procedures in response to that assessment. 

There are a number of software products included under the heading of CAATS (Computer Aided Audit Tools) available for this purpose, including Caseware’s IDEA, ACL, etc.  A Wikipedia article discussing CAATS is here.  As a sole practitioner, cost is a consideration.  Also, due to the size of my NPO audit clients (revenues from $250k to $3M) and volume of transactions, Excel limitations (# of rows, etc.) are never exceeded.  Therefore, I chose ActiveData for Excel, an Excel add-in.  (Disclaimer – I am not an employee or commissioned salesman for ActiveData.  I just use their software.)

In all audits, Quickbooks transaction data is first exported to Excel, and preliminary analysis is performed.  For example, revenue sources and vendors are grouped and summarized, and the top X% are considered, then cut and paste to PPC NPO-CX-3.1.  A quick comparison of vendor address to employee/Board member address is performed.  A comparison of vendor summaries across two periods is performed and considered.  Benford’s Law analysis is performed and considered. If it is determined that internal controls will be relied upon, the ActiveData sampling functionality is used for sample selection and procedure documentation.

Other preliminary tests specific to the client are performed, and serve as input to NPO-CX-7.1 for risk assessment.  Once preliminary risk assessment is complete, ActiveData is again employed in the conduct of the audit.  For example, journal entry analysis in response to PPC NPO-AP-2 #4, search for related party transactions per PPC NPO-AP-2 #10, search for check number gaps, subsequent sampling, etc.

In addition to the familiarity of Excel, ActiveData also has very useful Help functionality, reference materials such as “Top Audit Tests Using ActiveData for Excel” by Michelle Shein and Richard Lanza (which stays in my laptop case at all times), and several YouTube instructional videos.  For example, a video discussing sampling functionality is here, and a video discussing Benford’s Law analysis is here.

ActiveData’s website is here.

Obviously, ActiveData is just one tool in the audit bag.  But, all in all, it’s a lot of functionality for $250!

In Praise of Social Media

A recent article on CNN.com discussed the rapid emergence of women as the current “Power Users” of Social Media.  On average, I think women are far more adept than men in developing and maintaining relationships, so it makes sense to me that they excel at Social Media.

After reading the article, I considered my own use of Social Media.  I use Facebook and LinkedIn regularly, but for two entirely different purposes.  For me, Facebook is for family and friends, and LinkedIn is for business.  Of course, I have business contacts that are also friends, but in general that defines my usage. 

As background, I am a CPA with a small but technically demanding practice.  My two primary practice areas are tax and non-profit audits, including OMB A-133.  Tax season is immediately followed by Audit season, and I average 60 hours/week all year.  I have an administrative assistant, but no professional staff.  If I have a technical question, there is no one down the hall to ask – I have to find the answer myself. There is no depth to my bench.  (I‘ve been a sole practitioner since ’05, with larger firm experience prior to that.  I plan to compare the two in a future blog.)

 

My research resources for tax and audit are very good, but I occasionally get questions from clients outside of my areas of expertise that I simply don’t have an answer for, and don’t have the resources with which to quickly find the answer.  For example, a client recently asked a question involving NC sales tax liability on the disposition of machinery in liquidation.  I had a preliminary answer that made sense to me, but nothing authoritative to cite.  I had an audit deadline looming, zero spare time, and needed a correct answer fast.  What to do?

Over the years, I’ve developed a resource network.  We all have to some extent.  Social Media in general, and LinkedIn in particular, has provided a platform to greatly expand that network.  To that end, I’ve consciously cultivated LinkedIn contacts with “Big 4” and large national and regional accounting firms, attorneys, AICPA technical managers, government officials - people who are experts in their (sometimes VERY specific) field.  To be honest, the vast majority of my LinkedIn contacts are people that I’ve never met.  In LinkedIn, any contact request requires me to indicate how I know the person, e.g. former coworker, classmate, someone I’ve done business with in the past, friend, etc.  There is no choice for “I think you are smarter in your specific area of expertise than I am, and I may need to pick your brain at some point, if that’s OK with you”, so I redefine and click "friend".

So, for all you LinkedIn contacts who have no idea who I am, but accepted the contact request anyway, THANK YOU!  I appreciate your contact very much! Please realize that I think you are the best in your field!  Also, please know that I consider this network of contacts a two way street.  If there is ever anything I can do for you, just ask.

Back to the Sales Tax question.  I emailed the question to a LinkedIn contact, Tony Buffkin.  Tony is Senior Manager with Dixon Hughes Goodman’s State and Local Tax Practice in Charlotte, and is a former KPMG National Technical Leader in the Sales Tax Systems Practice and a former Division Director at NC Department of Revenue.  He is a recognized expert in sales tax (among other things).  Within 10 minutes, Tony responded with the answer, including an authoritative citation.  Problem solved. 

Thanks again, Tony!  And, THANK YOU for accepting me as a LinkedIn contact!

Hey Boeing, ya'll come on down!

Knox Marlow, a "retired" tax attorney, recently blogged about Tom Geoghegan's article in the WSJ regarding Boeing's plans to locate their new 787 Dreamliner aircraft plant in South Carolina, and Boeing's related problems with the NLRB.  In Geoghegan's article, titled "Boeing's Treat to American Enterprise", he comments on the "union busting" motivations of Boeing. Boeing's commercial plane operations are in Seattle (union), while South Carolina is a right-to-work state (non-union).

Tom Geoghegan is a Harvard-educated labor lawyer practicing in Chicago. The byline to his article is "When major firms move to the South, it's usually a harbinger of quality decline", and goes on to suggest that Southern union-busting has resulted in inferior schools and, in turn, "poorly educated and low-skilled workers that are simply unable to compete".  I would point to BMW's success in South Carolina, or Mercedes in Alabama.  I also think Geoghegan's agenda is fairly transparent.  And, as a Southerner, I was of course offended by his remarks.

But, education IS important to firms who consider relocating. How does the quality of education (whether or not caused by the presence or absence of unions) in the South compare to the rest of the country? I've seen various surveys, for example this one from U.S. News and World Report, which suggests the South is behind the rest of the country. Of course, it’s a subjective question.  Perhaps you can point me to more encouraging statistics.

North Carolina has recently made state-wide reductions in education funding, and those reductions are having dramatic effects locally. Fortunately, here in Salisbury/Rowan County, we have talented and capable administrators who are willing to "take one for the team" and reduce administrative costs first to make sure teachers and classroom resources aren't cut. But, their bag of tricks may have been all used up for 2011-2012.  It’s 2013 and forward that I'm worried about. Once the central office is cut to the bone, and the fund balance is used up, what then?

I don't know if more money translates to a better education, and I don’t have any answers for improving our education system. I do think that education has never been more important than right now. What we do today will affect our children and grandchildren for decades.  We owe it to them to do the best we can, regardless of the cost.

Meanwhile, I’d like to personally invite Mr. Geoghegan to Faith for the Fourth!  Son, you just haven’t lived until you’ve had a deep-fried Twinkie!  Later, we’ll get us a mess of contraband fireworks and go blow something up.

Repatriation - Another Opinion

 

The June 22, 2011 edition of the Salisbury Post printed an opinion from Jim Rogers, CEO of Duke Energy, titled “Let’s repatriate overseas profits”. The article discusses corporate profits “trapped” overseas, and how that money can be brought back to the U.S. to help rebuild the economy.

 

What is meant by “repatriation”? Corporations with earnings from foreign subsidiaries must pay income taxes on that profit to the foreign host country. On the corporation’s U.S. tax return, income from all sources is taxed, but a foreign tax credit is allowed for taxes paid to a foreign country, so the same income isn’t taxed twice. When foreign income that has not yet been taxed by the U.S. is brought back to the United States, or “repatriated”, tax on that income is then due at the current corporate rate of 35%.  So in theory, at the end of the day, the corporation pays 35% tax (and no more) on earnings of all operations, foreign and domestic.

As Mr. Rodgers states, the U.S. corporate tax rate is the second highest in the world. Multi-national companies go to great lengths to “offshore” as much profit as possible. Google, for example, is reported as saving $3.1B in taxes through the use of sophisticated tax shelters called the “Double Irish” and the “Dutch Sandwich”, which involves foreign subsidiaries In Ireland, the Netherlands and Bermuda.

The proposal, creatively named the Freedom to Invest Act and contained in H.R. 1834, would “refresh” IRC Section 965 to temporarily provide a 5.25% tax on earnings distributed by a controlled foreign subsidiary to its U.S. parent, rather than the normal 35% rate – essentially a “tax holiday” for repatriated corporate earnings. The bill is sponsored by Rep. Brady of Texas and 10 others, including Sue Myrick, and has been endorsed by Sen. Hagan.

The use of foreign subsidiaries can dramatically lower effective tax rates. The problem is in returning those profits to the U.S. so they can be spent in the U.S. Current U.S. repatriation law negates any deferred tax rate gains, so the corporate goal becomes repatriation at minimal tax cost. Currently, most tax-minimizing repatriation shelters are based on IRC Section 368(a)(2) which governs tax-free reorganizations of corporations. For example, the “Killer B transaction”, so named because it is based on Section 368(a)(2)(B), is a cross-border triangular reorganization that has the effect of repatriating foreign earnings of a subsidiary to the parent corporation without a corresponding dividend to the parent that would be subject to U.S. income tax. The “Deadly D”, named for IRC Section 368(a)(2)(D), is another repatriation strategy involving a reorganization that allows one U.S. company to transfer to a foreign subsidiary the assets of another acquired U.S. company, enabling the foreign subsidiary to kick offshore cash back to the U.S. company parent without incurring repatriation taxes. “Outbound F”, is another reorganization-based shelter.

The temporary repatriation “tax holiday” was created in 2004 to entice corporations to repatriate foreign earnings. Reasons given by multi-national corporations to repatriate in 2004 are the same as now, to altruistically boost the economy. Sen. Hagan said “A repatriation holiday can encourage economic activity at a fraction of the cost of fiscal policy”.  Jim Rogers states “At a time when our country’s economy needs a shot in the arm and our federal government can no longer afford stimulus funds, American businesses stand ready to step up and inject $1 trillion trapped overseas by punitive federal tax law” and “We need congressional action now to unlock this cash so it can be put to work here at home to spur our economic recovery in the U.S.”

Similar arguments were made during the last repatriation holiday in 2004, called the Homeland Investment Act. So how did that work out? According to a study released by the National Bureau of Economic Research, "Repatriations did not lead to an increase in domestic investment, employment or R&D, even for the firms that lobbied for the tax holiday stating these intentions”. An estimated $300B was repatriated, of which 92% was used for share buybacks and corporate acquisitions.

Michael Mudaca, the assistant secretary for tax policy at the Treasury Department, stated “In 2004, when the U.S. enacted a repatriation holiday, the goal was to encourage U.S. multi-nationals to pay bigger cash dividends from their overseas subsidiaries and use the cash to make investments in the United States. Unfortunately, there is no evidence that it increased U.S. investments or jobs, and it cost taxpayers billions”.

An example is Dell, which promised to use the money to build a new plant in Winston-Salem. They repatriated $4B in 2004, and spent $100M on the plant (which they later acknowledged they would have built anyway), then used $2B for a share buyback. By the way, Dell also obtained $7M in local incentives to open the Winston-Salem plant, and subsequently halted production there in 2010.

Repatriated earnings of Pharmaceutical companies in 2004 went mostly towards acquisitions of other companies.

An estimated $100B of repatriations was never “trapped” offshore in the first place. Corporations, aware of the impending enactment of the 2004 Act, off-shored profits of U.S. operations into foreign subsidiaries, then “round-tripped” them back at the reduced rate.

Repatriated profits go straight to the bottom line of the corporation’s earnings at a bargain tax burden, and would provide a nice bump in profitability and resulting share prices. Although Congress is trying to provide penalties if job loss occurs within a 2 year window, the actual amount of the penalty is around $8,700 per employee, hardly enough to dissuade layoffs. Based on what the corporations actually did in 2004, rather than what they said then and now, it is likely that job creation and capital investment resulting from repatriation now would be insignificant, and the cost to the taxpayer would be the total amount repatriated multiplied by 35% minus 5.25%.

Don’t be deceived. This idea is driven by corporate greed, not corporate concern for the U.S. economy. Multi-nationals have gone to great expense to shelter the earnings at issue from U.S. tax. Denying repatriation merely puts them on a level playing field with domestic-only companies. Their earnings are “trapped” overseas by their own design and intent.

The real problem is the corporate tax rate. To compete in a global economy, we should truly simplify the tax code and lower the top rates.