Current Regulatory Hot Buttons

By: Dan St. Clair, CPA
Audit Principal

 Each year CPAs, accountants, CFOs and auditors try to identify what the current issues are that the regulatory agencies will be looking for.  Over the past few years the focus has been on asset quality and revenue recognition, and that trend should continue into 2012.  Items scrutinized over the past few years include gains related to the sale of Small Business Administration (SBA) loans, recognition of origination fee income and reporting of deferred tax assets.         

We were recently at a state industry convention and the Regulatory Panel discussed several issues related to the reporting and classification of loans.  The foremost topic discussed was related to asset quality and internal grading of loans. Over the past few years there have been an increased number of credits that do not have adequate documentation to support the repayment of the loan balance.  Stale financial statements and tax returns are more and more common in loan files.  Having outdated financial statements does not support the current state of the borrower and can lead to the downgrade of a specific credit based on the lack of documentation alone.  The grading of the loan should be based on the borrower’s ability to repay and should not be solely supported by the underlying collateral.         

Another topic of discussion related to the adequacy of appraisals.  How current is the information? Was it properly done with reasonable assumptions and comparatives? Did the bank perform a desktop review?  If there are questions related to the repayment of a loan where the credit is collateral dependent, or if the credit is being moved into Other Real Estate Owned, an updated appraisal performed by an independent consultant is most likely to be expected.

The proper reporting of Troubled Debt Restructuring (TDR) was discussed at length.  It was noted by the regulators that many community banks still show zero amounts on their Call Reports related to TDRs.  Due to the current economic environment, it seems unusual to have so few of items where concessions have been made for borrowers experiencing financial difficulties. This appears to be an area  for increased questioning and is easily based on the reporting within the Call Reports.         

 There appears to be common themes in all of these and other regulatory discussions, mostly to increase the internal and supporting documentation related to decisions. Expectations related to regulatory capital percentages and allowance for loan and lease loss percentages continue to rise. There is a move towards more regulatory enforcement actions, which are becoming more common and are often accompanied by requirements to increase regulatory capital and loan loss coverage.  There also appears to be more scrutiny on how the bank compares with its peer group.  Outlying institutions that skew the peer group averages are being looked at very closely.        

So what can you do? Start preparing for your next exam now. Make sure your documentation is current and complete. Be honest with yourself about your borrower’s current situation. Lenders often give the borrower the “benefit of the doubt” that examiners are unwilling and unable to provide. Be conservative. If there are several situations that are border-line, don’t always round up. Make Enterprise Risk Management a primary focus. Take a portfolio view of the enterprise. Don’t just focus on the individual pieces. Take a step back and look at the big picture as well.

Troubled Debt Restructuring Rules

By: Dan St. Clair, CPA
Audit Principal

The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) No. 2011-02 to improve financial reporting related to Troubled Debt Restructuring (TDR). The FASB explained that additional guidance and clarification was needed to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of identifying whether a specific restructuring constitutes a troubled debt restructuring.  In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both a) the restructuring constitutes a concession and b) the debtor is experiencing financial difficulties.        

The creditor should carefully consider, and adequately document, their evaluation of whether it has granted a concession.  If a debtor does not otherwise have access to funds at a market rate with similar characteristics, the debt would likely be considered to be at a below-market rate, which may indicate that the creditor has granted a concession.  Other circumstances that could indicate a concession are unusually favorable terms or delays in repayments that are not deemed insignificant.        

For the evaluation of whether the debtor is experiencing financial difficulties, the creditor should evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without the modification.         

FASB Codification 310-40-15-5 states: A restructuring of a debt constitutes a troubled debt restructuring for purposes of this Subtopic if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.        

The key appears to be clear documentation of the thought process behind the modifications being made, including the comparability of the terms and rates being used and the economic status of the debtor.        

Has a concession been made?  A modification to reduce the interest rates or increase the repayment period would not be a TDR if the goal is to retain a borrower and keep them from moving to another lender or to match other, more favorable terms available to the borrower on the open market.         

Is the borrower experiencing financial difficulties?  In cases where payment default is probable, it would generally be appropriate to conclude that a debtor is experiencing financial difficulties.  In cases where the modification is to reduce expenses or increase cash flows but the repayment of credit is not at risk, this conclusion should be clearly documented.        

The documentation and related support should be clearly laid out to guide the examiner and lead the reviewer to the same conclusions.

IRS Examinations

By: Marilyn Fowler, CPA
Senior Tax Manager

  Over the past year the Internal Revenue Service has increased the number of examinations performed on banking entities. One of the best lines of defense is to have a Conformity Election, or at the minimum, an Express Determination Letter from the federal regulators.

The Conformity Election allows for certain items to be calculated the same for both book and tax purposes, thus saving valuable resources of the bank for tax return preparation and possible tax return examinations. Some of these items include: nonaccrual interest on loans, appraisal of Other Real Estate Owned (OREO) and charge-offs to bad debt expense.

In order to make this election with the IRS, an Express Determination Letter is needed from the federal regulators for the last federal examination before the first day of the year for which the election is made. For example, to have the election effective for the tax year beginning January 1, 2012 you would need the EDL by December 31, 2011. An EDL would need to be requested at each subsequent exam.

These are some of the key issues that the IRS are targeting when examining banks: large book/tax differences that reduce taxable income, fair market value of OREO foreclosures when determining the bad debt write-off and holding costs associated with OREO property.

Please feel free to contact Marilyn Fowler at 713-667-9147 if you would like to discuss these topics more in depth.

Credit Disclosures

By: Travis Williams, CPA
Audit Manager

As a reminder we wanted to mention Accounting Standards Update (ASU) No. 2010-20 – “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” again. This was issued in July 2010 and is effective for non-public companies with reporting periods ending on or after December 15, 2011.

This ASU provides new terminology for financing receivables (which includes loans) and requires more information to be disclosed relating to receivables and the allowance for financing receivables; however, it will not have a significant change in practice. Certain disclosures will now be required to be broken out into one of two areas: portfolio segment and classes of financing receivables.

• A portfolio segment is defined as the level at which a financial institution develops and document a systematic method for determining its allowance for credit losses.
• Classes of financing receivables generally are a disaggregation of a portfolio segment.

This ASU affects current disclosures and creates new disclosures as shown below. The changes to the current disclosure are as follows:

• The allowance roll forward will be presented by portfolio segment.
• The recorded investment in the receivable and the ending balance of the allowance for each portfolio segment will be disclosed in the allowance roll forward. This will be disaggregated on the basis of the impairment method (for example, individually evaluated for impairment, collectively evaluated for
impairment and loans acquired with deteriorated credit quality).
• The non-accrual status of receivables will be presented by class.
• The impaired receivables will be presented by class.
• All receivables past due 90 days or more and still accruing interest will be present by class.

The following are new disclosures for the current year:

• The credit quality of the loan portfolio will be presented by class by credit quality indicators. Examples of credit quality indicators include:
consumer credit risk scores, credit rating agency ratings, internal credit risk grades, LTV ratios, collateral, collection experience, etc.
• The aging of financing receivables will be presented by class.
• The nature and extent of troubled debt restructurings (TDR’s) that occurred during the period will be presented by class of receivable. This also includes any current modifications of receivables that would classify as a TDR to be disclosed by class.
• Significant purchases and sales during the period will be presented by portfolio segment.

This ASU can be found on the FASB’s website (www.fasb.org) and it provides illustrative disclosures in paragraphs 310-10-55-7 through 310-10-55-11 for the items mentioned above. If you have any questions regarding the new disclosures please contact Dan St. Clair or Travis Williams at 713.667.9147.

We at Briggs & Veselka want to be one of your most trusted advisors. You have spent a lifetime building your business, and now that you have reached a certain point in your career or your company’s development, you would like to explore options on how to transfer or sell your business to a third party. We want you to be able to rely on us and the trust built over the years to help you with these options.

Have you considered what you would need to do to sell your business for the best price? Are you getting unsolicited offers for your business and do not know what is the best way to respond?

B&V Capital Advisors, LLC (“BVCA”) is an affiliated company owned by Briggs & Veselka Co. that is here to help you thoughtfully work through those transition ideas at the pace you dictate and helps you take control of a confidential, controlled process that gives you answers to the questions you have about selling your business.

BVCA has teamed with the Boston office of Lexbridge International to help clients like you reach your goals. Our combined strength along with the involvement of your Briggs & Veselka shareholder that you have worked with over the years creates an environment that you can be comfortable with knowing your best interests are the number one goal.

Please contact your B&V shareholder  or Rick Hunter at B&V Capital Advisors for a complimentary meeting to discuss these important issues and how we can help your company.

If you own a business, chances are this asset is your most valuable but least liquid asset that you own. The advantages of getting a valuation of your business are described in the following article:

Read more….

The tax bill enacted at the end of 2010 provides a two year opportunity to use a $5 million exemption from federal gift tax for aggregate lifetime gifts ($10 million for a married couple). This exemption applies for 2011 and 2012 and is in addition to the $13,000 annual exclusion gifts that may be made free of federal gift tax ever year.

After 2012, the exemption falls back to the prior amounts of $1 million for aggregate lifetime gifts ($2 million for a married couple). The transfer tax exemptions and highest rates for the years 2009 to 2013 are displayed in this chart.

If you have a closely held business or a family partnership, then this might be an ideal time for you to pass the ownership along to family members. Combined with the slowdown in economic conditions, there may not be a better time for you to take advantage of this two year window and save estate taxes and gift or transfer your interests at low values.

If you would like more information on this opportunity and how it could affect your specific estate tax situation, then please call your tax shareholder  or a member of our valuation team, such as Mark Schaaf, Rick Hunter or Christy Bastian. We would be glad to set up a meeting to discuss those issues with you in context with your entire estate plan.

Brian Jordan, Senior Tax Manager at Briggs & Veselka and manager on the Taylor & Hill account, reached out to attorneys at Martens, Seay & Todd, located in Austin, Texas. Working with attorneys Jimmy Martens and Lacy Leonard, Brian assisted them during the process. His testimony in front of the judge during the trial proved to be pivotal in the ultimate decision handed down.

Taylor & Hill provides engineers to refineries and chemical plants. It also provides in-house engineering services. Taylor & Hill’s franchise tax report had originally reported based upon Cost of Goods Sold method.

The Texas Comptroller audited Taylor & Hill and denied its eligibility for the Cost of Goods sold deduction. The Comptroller disputed that Taylor & Hill could not amend its Texas franchise tax report to claim the compensation deduction. Instead, the Comptroller attempted to force Taylor & Hill to report its Texas margin tax based upon the statutory minimum deduction equal to thirty percent (30%) of revenue, but was unsuccessful in their efforts.

The Texas Attorney General recently stated that they will not be appealing the judge’s order in the case. The state has been ordered to refund the money from the tax that was assessed in the audit.

For more information refer to Taylor & Hill, Inc. v. Susan Combs, Travis County District Court Cause No. D-1-GN-10-004429, or contact Brian Jordan at bjordan@bvccpa.com or 713.353.1980.

Standard mileage rates increase for last half of 2011. The IRS has announced that the optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is increased 4.5¢ from 51¢ to 55.5¢ per mile for business travel from July 1, 2011 to December 31, 2011 to better reflect the real cost of operating an auto in this period of rapidly rising gas prices. This rate can also be used by employers to reimburse tax-free under an accountable plan employees who supply their own autos for business use, and to value personal use of certain low-cost employer-provided vehicles. The rate for using a car to get medical care or in connection with a move that qualifies for the moving expense also increases 4.5¢ for the last half of 2011 from 19¢ to 23.5¢ per mile.

Federal Unemployment Tax (FUTA) surtax is no longer in effect. Beginning July 1, 2011, the 0.2% FUTA surtax is no longer in effect. Thus, the FUTA tax rate, before consideration of state unemployment tax credits, is now 6.0%. Employers need to separately track FUTA taxable wages paid before July 1, 2011, and FUTA taxable wages paid after June 30, 2011, since the FUTA tax rates are different during those two periods. Employers whose FUTA tax is more than $500 for the calendar year need to make quarterly FUTA deposits. The next quarterly payment is due on Aug. 1, 2011, but that payment is based on taxable wages paid through June 30, 2011, so it will be computed using the 6.2% FUTA tax rate. However, the payment after that is due on Oct. 31, 2011, and it will be computed using the 6.0% FUTA tax rate if legislation is not enacted to retroactively reinstate the FUTA surtax beginning July 1, 2011.

Two bonus depreciation deductions for one expenditure. Under IRS regulations, businesses that trade in machinery or equipment for which they claimed bonus depreciation may qualify for another bonus depreciation deduction on the remaining depreciable basis if they swap for like-kind property that also is eligible for bonus depreciation. In effect, the business gets two bonus depreciation deductions for its expenditure on the traded-in property.

Real estate professionals allowed late election to aggregate rental real estate interests. The IRS has provided guidance that allows certain real estate professionals to make a late election under the regulations to treat all interests in rental real estate as a single rental real estate activity for purposes of the passive activity loss (PAL) rules. This election can make it easier to currently deduct losses from real estate activities. As a general rule, the election is made by filing a statement with the taxpayer’s original income tax return for the tax year. However, under new guidance, a taxpayer meeting certain conditions can make a late election on an amended return.

More courts treating basis overstatements as triggering 6-year limitations period. Late last year, the IRS issued final regulations under which an understated amount of gross income reported on a return resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items. The 6-year limitations period applies when a taxpayer omits from gross income an amount that’s greater than 25% of the amount of gross income stated in the return. Several courts had held that a basis overstatement is not an omission of gross income for this purpose. In response to these decisions, the IRS issued the new regulations to clarify that an omission can arise in that fashion. Recently, two Courts of Appeals (the Tenth Circuit and the District of Columbia Circuit) have upheld the regulations. While the momentum clearly is in favor of the IRS on this issue, others courts have rejected the regulations. Ultimately, the Supreme Court will have to resolve the dispute.

Regulations would toughen tax rules for owners of bankrupt disregarded entities. A taxpayer whose debts are forgiven generally has cancellation of debt (COD) income subject to exceptions including one for bankruptcy and one for insolvency. Some taxpayers have taken the position that the bankruptcy exception is available if a grantor trust (trust used in family or business planning) or disregarded entity (e.g., a single-member limited liability company taxed directly to owner) is under the jurisdiction of a bankruptcy court, even if its owner is not. Similarly, some taxpayers have contended that the insolvency exception is available to the extent a grantor trust or disregarded entity is insolvent, even if its owner is not. The IRS has issued proposed regulations that would clarify that the bankruptcy exception is available only if the owner of the grantor trust or disregarded entity is subject to the bankruptcy court’s jurisdiction, and the insolvency exception is available only to the extent the owner is insolvent. They would apply to COD income occurring on or after the date they are published as final regulations.

Trust’s investment advice fees. The Supreme Court has held that investment advisory fees paid by a trust were deductible only to the extent that they exceeded 2% of the trust’s adjusted gross income (AGI). Thus, such expenses didn’t qualify for the exception to the 2% of AGI limit in the tax law for costs paid or incurred in connection with the administration of a trust or estate that wouldn’t have been incurred if the property weren’t held in the trust or estate. However, for the sake of administrative convenience, the IRS has provided that, until final regulations are issued, nongrantor trusts and estates will not have to “unbundle” a fiduciary fee (i.e., separate the fee into components that are subject to the deduction limit and those that aren’t). As a result, until the regulations are issued, affected taxpayers can deduct the full amount of a bundled fiduciary fee without regard to the 2% floor.

Pictured here are the winners of the BKR International Chairman’s Award including Briggs & Veselka’s Lien Le, and Johnny Veselka who accepted the award on behalf of Carol Cantrell.

The BBB Awards for Excellence recognizes businesses and non-profits for their achievements and commitment to overall excellence and quality in the workplace. Proceeds from the event help fund the BBB Education Foundation which educates consumers about scams and fraudulent business practices in the Greater Houston area.

When asked what it means to Briggs & Veselka Co. to receive this recognition, John Flatowicz, Managing Shareholder, states ” We work hard to provide top notch service to our customers and clients and it is an honor to be recognized for our efforts. “

Laura Freudenberger, Christopher Bailey, Sheila Enriquez,
and Jason Sanders accepting the BBB Pinnacle Award on behalf of the firm.