Boards are legally liable for the actions of their organizations, and there are generally three “duties” that board members must adhere to: care, loyalty, and obedience.

• Duty of care: Board members are expected to exercise the care that a prudent person would exercise in a like situation.
• Duty of loyalty: Board members must act in the best interest of the organization, even if it conflicts with their own self-interests.
• Duty of obedience: Board members must uphold the mission of the organization. Often a nonprofit board will create various committees to demonstrate its commitment to these duties.

Accountability and governance

Large or small, all nonprofit organizations should be built on a firm foundation of fiscal accountability and good governance. While the audit and finance committees both are designed and intended to help a board fulfill the related fiduciary responsibilities, the duties of each are quite different.

The Finance Committee: Tends to be more operational and is typically a standing committee of the board, meaning it functions throughout the year. Committee members work closely with management and the finance staff. Their duties often include:

• Providing oversight in the preparation of annual operating and capital budgets and monitoring budgets to actual results regularly throughout the year
• Reviewing internal financial statements on a regular basis
• Overseeing the handling of all financial resources as well as any policies and procedures related to those resources
• Advising the board on significant financial decisions, including borrowing and investing
• Protecting the organization when a conflict of interest occurs
• Ensuring that good governance policies referenced in Form 990 are implemented
• Often participating in the hiring of finance and accounting team members
• Ensuring that financial reporting requirements, including tax return filings, are fulfilled
• Overseeing long-term financial planning
• Monitoring cash reserves
• Ensuring that financial activities of the organization align with its vision, mission, and strategic plan
• Reporting to the board and/or executive committee about the financial condition of the organization

This committee may have audit responsibilities as well, including:

• Participating in corrective action plans for problems identified in the annual audit
• Monitoring the corrective action plans
• Meeting with the audit team to identify financial trends identified during the audit
• Evaluating the performance of the audit team.

• Who should serve on the finance committee? While members should all have some expertise in financial matters, they need not all be accountants. A diverse group of financial experts—accountants, attorneys, bankers, investment advisors, insurance professionals, even directors of other nonprofits—can provide perspectives that collectively serve the committee well. As well, not all committee members need to be board members. Non-board members can be recruited based on their areas of financial expertise. In addition to financial acumen, committee members should be:

• Independent, that is, able to make decisions without risk of conflict of interest
• Dedicated to the mission of the organization
• Available and willing to meet the time requirements of the committee

• A finance committee charter is often used to clearly define the roles and responsibilities of potential committee members, and will include practical policies and procedures, such as:

• A clear statement of the committee’s purpose and scope of responsibility
• The committee’s relationship to the board and other committees, such as the audit committee
• The committee’s size and the time members are allowed to serve
• Meeting schedules
• Reporting requirements
• Committee governance procedures

The Audit Committee: Usually works in partnership with the finance committee, but their duties are more related to governance than operations. In high performing organizations, the audit committee helps management review and maintain the effectiveness of internal controls and external financial reporting. Audit committee duties may include:

• Reviewing the financial statements and any other information provided to the public
• Overseeing the organization’s internal controls and compliance with policies and procedures
• Possibly overseeing the annual audit process, usually to ensure the objectives of financial reporting and auditing are achieved
• Reviewing compliance documents such as Form 990 and charity filings, and recommending approval by the appropriate officer
• Reviewing any and all fraud prevention practices and policies
• Working with internal auditors throughout the year

• The members of the audit committee must be independent and have financial expertise. While it is not a requirement of nonprofits, at least one member should have the skills, knowledge, and expertise to fully understand the required financial reporting of the organization. Such a “financial expert” is generally defined as someone with considerable experience analyzing, preparing, or auditing financial statements.

Since many nonprofit board members may not fully understand the nuances of the financial reports, often a member of the audit or finance committee will be relied on to interpret these reports for the board.

Like the finance committee, the duties and responsibilities of the audit committee are outlined in its
charter. The charter will outline the objectives of the committee, the steps to achieve each objective, deliverables, and the frequency of each action item. Many charters include calendars that specify guidelines and establish timelines and due dates for their duties. A committee charter should be action oriented, not merely a document on a shelf.

So, do you really need both? It is important to check state requirements, as some states require a nonprofit to have an audit committee once they have raised a certain amount of revenue. While it is considered an industry best practice to have both a finance and an audit committee, many smaller organizations do not have enough expertise available to have two separate committees. In that case, finance committee members typically assume the duties of both. Where both committees exist, detailed charters should be reviewed and updated regularly to clearly define the roles and responsibilities of each.

Board Orientation and Training

Since board members will have different skill sets, it may be advisable to conduct ongoing training as well as training for new members at orientation. Many board members will not have financial skills, and if they do, they might not have the financial acumen specific to a nonprofit organization. A training agenda might include:

• A review of each committee’s policies, procedures and responsibilities
• A review of the organization’s budget process
• An overview of the state laws governing nonprofit finances
• A review of terminology unique to nonprofits
• A review of basic nonprofit financial statements
• A review of other information a member might be asked to cast a vote on

• Organizations can look to paid consultants, their attorneys, or their auditors to provide board training.

Board committees play important roles in both financial oversight and governance. Highly functioning board committees are key to helping a board fulfill its fiduciary responsibility.

Read the full Summer issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

Article updated April 2024.

With each industry comes a wide array of disputed topics, many of which are shared throughout multiple industries. One of those shared disputes is the question of employee attraction and retention. Specifically, how can an employer within a specific industry attract and retain talent? As markets and businesses mature, attracting and retaining talent is becoming more and more competitive. There are numerous valuable incentives that Companies can offer to compete at the top of attracting and retaining talent. One of those incentives that can be beneficial to offer is a retirement plan. When a prospective employee is weighing options at different companies in their consideration, typically, pay, health benefits, and foundation are included in their choice. Often, those qualities are similar across multiple employers, and that is why a top-notch retirement plan could make the difference between accepting and rejecting your job offer. While a retirement plan can help solve the problem of attracting and retaining employees within an industry, it can be difficult for a typical industry to develop the perfect plan. One specific industry, however, faces unique challenges from banking to regulatory and tax laws, and developing the right retirement plan can be another difficult addition that a Company may face. That not-so-typical industry is known as the cannabis industry and this industry will most benefit from cannabis-specific professionals to help them navigate through these challenges.

HBK Cannabis Solutions was among the first CPA firms to specialize in accounting services for the cannabis industry and we have worked beside entrepreneurs in all industry segments—cultivators, processors, and retailers—from small businesses with a single facility to multi-location and vertically integrated operations. We can assess your current accounting system, advise, and install accounting that complies with GAAP and IRS rules. In addition, HBK is a member of the American Institute of Certified Public Accountants (AICPA) Employee Benefit Plan Audit Quality Center. Our professional staff serving employee benefit engagements uses this affiliation to keep abreast of the latest developments in accounting for employee benefit plans, communicating with AICPA staff and other members on technical benefit issues, and continuing education and technical research in the field. HBK CPAs & Consultants can help you determine whether you need an audit, help prepare you for an audit in the future, and conduct the audit.

HBK has summarized some tips to help your Company get started and remain guided along the way:

• Consult with your financial institution: A financial institution representative will be able to establish a meeting with potential third-party administrators, advisors, and investment managers who are familiar with the cannabis space.
  
  
• Structure: Your Company should be as transparent as possible with third parties when discussing the structure of your business. Advisors may back out due to your Company’s relationship with cannabis and that issue is best addressed at the forefront of the process. For example, if there is an entity structure in place where plant-touching employees are employed by a different company that does cannabis accounting and provides the retirement plan, it is best to share that information with all parties.
  
  
• Honesty: Businesses in the cannabis space are known to face challenges. The challenges that are specific to most cannabis companies and clients in your Company should be communicated with the professionals you are working with. It is important to be honest and upfront with cannabis clients as early in the process as possible.
  
  
• Advising: An advisor is a good choice of a professional to develop a relationship with, because advisors may understand many of the challenges faced by a cannabis business. Advisors are not just likely to understand these challenges, but they can aid cannabis businesses in solving them. One way to find out if an advisor is familiar with the cannabis industry is to ask trusted advisors for their past experiences with cannabis Companies and request to review a copy of their most recent SOC1 report.
  
  
• ERISA: Retirement plans are beneficial for companies and employees if operated efficiently. The cannabis industry, medical or recreational, is scrutinized enough by federal law; you don’t want compliance issues with the Department of Labor or the Internal Revenue Service over a retirement plan. It will be an important step to consult with an ERISA attorney to keep these issues out of your Company.
  
  
• Budget: Developing and maintaining a proper retirement plan does not come free of cost. It is important that your Company knows the potential cost of establishing and maintaining said plan. Your Company’s plan should make financial sense as there are many questions that factor into the cost of the plan. For example, will the employer or the plan be responsible for paying administrative expenses?
  
  
• Legal obligations: The focus of an employee benefit plan is that it is a long-term commitment to provide a financially secure retirement to participating employees. While outsourcing certain administrative functions of the plan is an option, you are ultimately responsible for plan oversight. It is crucial that your Company understands all of the legal obligations that are attached to the plan.

After a Company has implemented a retirement plan, the work may not be done. It is wise to consult with your individual CPA or CPA firm, as a substantial number of employee benefit plans are going to be subject to an employee benefit plan audit.

The first step in determining if your retirement plan needs an audit is to determine if your Company’s plan is classified as a “small plan” or a “large plan”. As of 2023, this determination is measured by the number of participants with account balances at the beginning of the plan year. Small plans generally have under 100 participants at the beginning of the plan year, while large plans have more than 100 participants. However, there is one exception to this determination which is called the “80-120 Participant Rule”. Exactly as it sounds, if the number of participants is between 80-120 and a Form 5500 was filed in the prior plan year, then your Company may elect to complete the return as it was filed in the prior year, whether that was small or large.

The main difference between the “small” and “large” plan is the type of form that is required to be filed. A small plan requires a Schedule I, which will not trigger an employee benefit plan audit. On the contrary, a large plan requires a Schedule H, which will. In the case that your Company is required by state laws to have an employee benefit plan audit, it is wise to acquire consulting services of a strong CPA firm to assist you with this process.

You have engaged independent auditors to perform an audit of your financial statements, which is required by one or more of your funding sources. The auditors have provided you with the audited financial statements and have issued an unmodified opinion, meaning that your financial statements are not materially misstated, which is what you expected.

However, they also provide you with a management letter on internal control (internal control letter) that appears to list in detail everything they found wrong with your internal control during the audit. You do a great job making sure all of the accounting transactions are properly recorded and immediately become defensive; you did not ask for this letter, so why was it prepared? What will your funding sources think if they receive this letter? Will they stop funding your organization? What does this letter mean? What is the difference between a material weakness and a significant deficiency? What do you need to do to make sure that you do not receive another letter in the future?

This article will address these questions and hopefully, show you the benefits of the internal control letter to your organization.

Why did the auditor prepare this letter? Auditing standards require auditors to communicate in writing to management about material weaknesses and or significant deficiencies in internal controls discovered in an audit. The auditor is required to gain an understanding of internal control as part of the planning process; however, that does not mean that internal control is required to be tested in all audits. In most cases, auditors use walkthrough procedures to gain this understanding. They will review the organization’s procedures, noting the internal controls that are implemented, and then follow specific transactions through the process to make sure that it appears that the internal controls are working properly.

What will your funding sources think if they receive this letter? Will they stop funding your organization? This letter is prepared for and intended for management and those charged with governance, i.e., the board of directors, the audit committee, etc. This is a tool to assist management in improving the organization’s internal control and should not be provided to anyone other than these specified parties. This letter is not intended to and should not play a role in the future funding of your organization by those requesting the audit.

What does this letter mean? What is the difference between a material weakness and a significant deficiency? As mentioned previously, the auditor is required to communicate to management about material weaknesses and/or significant deficiencies identified during the audit. In addition, the auditor may also include “other matters” in the letter. Here are some definitions to assist with this question:

Deficiencies in internal control – these exist when the design or operation of a control does not allow management or employees, in the normal course of performing their work, to prevent, or detect and correct misstatements on a timely basis. For example, an employee electronically submits an electronic payment to a vendor for $15,000, but mistakenly records an entry for $1,500 and bank accounts were not required to be reconciled, this error would not be detected or corrected, and is therefore considered a deficiency in internal control, depending on the potential impact to the financial statement it could be a significant deficiency or a material weakness.

Significant Deficiencies in internal control – this is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. For example, the organization’s accounts payable clerk prints all checks and provides them to the Executive Director to be signed without proper supporting documentation, i.e., approved invoices. One of the checks was mistakenly written for $3,500 instead of $2,500, the vendor was overpaid by $1,000, and since the difference was not significant, it was not questioned by the Executive Director.

Material Weakness in internal control – this is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statement will not be prevented or detected and corrected on a timely basis. For example, a new capital lease agreement is executed by the Executive Director for 20 new copiers and requested payments to be made electronically by automatic withdrawal, but mistakenly forgot to provide this information to the accountant. The organization does not perform bank reconciliation; these transactions will not be captured in the accounting records. In addition, the capital lease asset and obligation under the capital lease would not be recorded, which would result in a material misstatement to the organization’s financial statement.

“Other matters” in internal control – this could be a deficiency or simply another matter that the auditor wants to bring to the attention of management and those charged with governance. For example, the organization does not have formal job descriptions for the accountant that has been employed by the organization for more than ten years. If the accountant becomes ill and is unable to work for several weeks, it is likely that some of the accountant’s job responsibilities will not be done that could result in late tax filings, noncompliance with grants, etc. The auditor may want to inform management and those charged with governance of the matter.

The internal control letter breaks the deficiencies in internal control into the different types, material weaknesses, significant deficiencies, and other matters, as noted above. The internal control letter means that during the audit, it was noted that an internal control did not exist or the internal control was not working properly and did or could result in errors. The letter is a tool provided to management and those charged with governance to assist them in improving the internal control of the organization.

In addition to identifying the internal control deficiency, the auditor provides a recommendation to the organization to improve its internal control in order to eliminate those deficiencies. The auditor recommendations can vary in resources needed to implement the recommendation. It is the responsibility of management and those charged with governance to analyze the recommendation and determine if it is feasible to implement them, if another internal control could accomplish the same result at a lower cost, or if nothing should be changed and they are willing to accept the risk.

What do you need to do to make sure that you do not receive another letter in the future? The obvious answer would be to correct all of the deficiencies in internal controls that are provided by the auditor and make sure all existing internal controls are followed. The auditors are required to report on material weaknesses and significant deficiencies; if they do not exist, a letter is not required. However, with many small to medium-sized organizations, the costs to implement proper internal controls could be very costly. Therefore, I recommend that you start with eliminating the material weaknesses, those that have the greatest risk of a material misstatement. When analyzing the recommendations, try to find other lower-cost ways to improve the internal control.

However, should you be trying to avoid another internal control letter next year? The auditors have already done the work as required by professional standards; don’t you want to know what they have found and documented in their audit files? The letter should be used as a tool for ways to improve the internal controls within the organization. The organizations that are constantly analyzing and improving their internal controls are typically those that have fewer errors and misstatements noted during the audit.

You may think that the organization’s internal control is finally perfect, but then changes occur, you have accounting staff turnover, the organization changes their accounting software, the organization goes paperless, etc. When significant changes like this occur, typically, the organization is trying to quickly adapt to the change but forgets to adapt its internal controls. For example, an organization has decided to implement a paperless work environment. The organization’s accountant previously took the bank statement that was received by the bank, performed a reconciliation, printed it, and provided it to a supervisor to review and approve, which was done by initialing the reconciliation.

In the paperless environment, the bank statement is obtained online, an electronic reconciliation process is done, and then the supervisor is emailed that it has been completed and is ready for review. The supervisor opens the file, reviews it, and then closes it. Now, there is no documentation that the reconciliation has been reviewed. You may think that the review has been performed; therefore, internal control still exists.

However, how do you know that it has been done? Now, let us assume that the supervisor got behind on work after taking a few days off and forgot about reviewing the bank reconciliation. Now the control procedure has not been performed. If it is not documented, are we sure that it was done? It is important to include some form of sign-off procedure, even if it is in an electronic format. Therefore, an internal control letter is extremely important in years in which changes have occurred in the accounting or finance department or the organization itself to make sure that internal control procedures are adapted for those changes.

As you can see, if used properly, a management letter on internal control is a great tool to ensure that your internal control procedures are properly working and assist you in making improvements to prevent, detect, and correct misstatements that may occur.

Read the full Fall issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

Corporate reforms in the for-profit sector have prompted nonprofits to also re-evaluate their governance practices to enhance accountability. One way many organizations have responded is by establishing an audit committee or improving how theirs operates. Whether you need to create an audit committee depends on your organization and board.

Smaller nonprofits that don’t conduct outside audits probably don’t need an audit committee. They may have a finance committee instead, which oversees financial matters relating to the organization. Nonprofits that do have an audit committee should separate it from the finance or investment committee to achieve greater independence.

The purpose of the Audit Committee is to assist the Board of Directors in fulfilling its legal and fiduciary obligations and responsibilities with respect to matters involving the accounting, auditing, financial reporting, and internal control functions of the Organization.

Responsibilities and duties

In carrying out its duties and responsibilities, the following should be considered within the authority of the Audit Committee:

Financial Matters

The committee oversees accounting and financial reporting policies and practices, including the resolution of any disagreement between management and the independent auditors regarding financial reporting, to prepare or issue an audit report or related work.

The committee reviews the financial statements of the Organization and the results of the independent audit, including the audit of government grants and awards if any, underlying accounting judgments and estimates and the auditor’s internal control recommendations to management and management’s response.

Some audit committees will also assume responsibility for reviewing the annual Form 990 and Form 990T and any other related federal, state, or local tax returns/filings.

The duties of the committee include a review with management, internal auditors and independent auditors:

• the communications required by professional standards;
• acceptability, appropriateness, and consistency of application of accounting methods;
• unrecorded adjustments and omitted disclosures;
• reasonableness of judgments;
• degree of aggressiveness or conservatism in applying accounting policies;
• completeness and clarity of financial statements and related disclosures;
• review the conformity of the financial statements and generally accepted accounting principles.

Oversight of Internal Control Matters and Functions

The Audit Committee typically reviews and approves the internal audit function, including: (a) purpose, authority, and organizational reporting lines; (b) annual audit plan, budget, and staffing, and any changes thereto; (c) the charter for the internal audit function; and (d) the effectiveness of the internal audit function, including compliance by the internal audit staff with the Institute of Internal Auditors’ Standards for the Professional Practice of Internal Auditing.

Committee members must understand the scope of the review of the Organization’s internal controls and financial reporting by the independent auditors and Director of Internal Audit, and obtain reports on significant findings and recommendations, together with management’s responses.

Communicate with and review the activities and effectiveness of the internal auditors, including the review of internal controls relating to information technology security and controls. The Committee will review the results of internal audits and any significant findings and any difficulties encountered in the course of the internal audits, including any restrictions on the scope of the internal audit function’s work or access to required information.

Oversight of the Relationship with the Independent Auditors

Audit Committee members

• Have the sole authority and responsibility to select, evaluate, compensate, and oversee the work of any accounting firm engaged for preparing or issuing an audit report or performing other audits, review, or attest services for the organization. The independent auditor reports and is accountable directly to the Committee. The Committee has sole authority in its discretion to approve all audit engagement fees and terms and to terminate the independent auditor. The appointment of the independent audit firm and lead audit partner will be considered annually by the Audit Committee. The Audit Committee then advises the Board of Directors of its decision to continue with or terminate the engagement of the independent audit firm. The Audit Committee’s decisions regarding the use of the existing audit firm and lead audit partner versus the selection of a new firm and partner should be summarized in the Audit Committee’s meeting minutes.
• Confirm the independence of the external auditors in compliance with the independence rules of the American Institute of Certified Public Accountants (AICPA) and the U.S. General Accountability Office (GAO) standards via inquiries as to whether any additional relationships with or services provided to the organization, beyond the annual audit engagement, could have an impact on the auditor’s objectivity and independence. The Audit Committee should pre-approve all audit and non-audit services performed by the independent auditor. The Audit Committee may designate its Chair to represent the entire Committee for purposes of approval of non-audit services, subject to review by the full Audit Committee at the next regularly scheduled meeting.
• Obtain and review at least annually a formal written report from the independent auditors delineating the auditing firm’s internal quality-control procedures and any material issues raised within the preceding five years by the auditing firm’s internal quality-control reviews, by peer reviews of the firm, or by any governmental or other inquiry or investigation relating to any audit conducted by the firm. The Committee shall review steps taken by the auditing firm to address any findings in any of the foregoing reviews.
• On a regular basis, meet separately with the independent auditors to discuss any matters that the Committee or the independent auditors believe should be discussed in executive session.

Depending on the composition and size of the Board and organization, the Audit Committee may also provide oversight of corporate risk management and regulatory compliance.

Who should sit on the Committee?

Each member of the Audit Committee must be financially independent of the organization. Our experience has been that nonprofit audit committee members are not paid for their services. Each of the Audit Committee members shall be “financially literate,” which shall include the ability to read and understand fundamental financial statements. In addition, at least one member of the Audit Committee shall qualify as a Financial Expert and be appointed to such designation by the Board of Directors An Audit Committee Financial Expert shall be selected considering the following attributes:

• an understanding of generally accepted accounting principles and financial statements;
• the ability to assess the general application of such principles in connection with the accounting for estimates, accruals, and reserves;
• experience preparing, auditing, analyzing, or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the organization’s financial statements, or experience actively supervising one or more persons engaged in such activities;
• an understanding of internal controls and procedures for financial reporting;
• an understanding of audit committee functions.

The Annual Process

The Committee usually meets with representatives of the independent auditor at least annually, maybe more often to review and discuss appropriate matters within the scope of the committee’s responsibilities and duties. including, but not limited to:

• the planning, scope, approach, staffing, and identified objectives of the independent audit for the current fiscal year;
• the results of the independent audit and underlying accounting judgments and estimates;
• the auditor’s comments regarding the adequacy of organizations internal accounting controls;
• external auditor’s relationships with the Organization that may impact objectivity and independence;
• management’s representations regarding the integrity of internal controls and financial reporting systems and conformity of financial statements with generally accepted accounting principles;
• other relevant matters noted during the auditor’s examination, along with management’s response regarding such comments;
• assurance that auditors were not subject to undue influence by management during the course of the audit.

Annually, the Committee should meet with the internal auditors to discuss and determine the scope of the internal audit and to review the results of the internal auditor’s examination and management’s response regarding the auditors’ findings and recommendations.

As necessary or desirable, the Audit Committee is empowered to investigate any matter brought to its attention with full access to books, records, facilities, and personnel of the Organization and may request that representatives of the independent auditors, the internal auditors, or legal counsel be present at meetings of the Committee related to such investigation. In addition, the Committee should have the authority to retain, at the Organization’s expense, special legal, accounting, or other consultants or experts it deems necessary or appropriate to carry out its duties and to assist in the fulfillment of its obligations, including the provision of training to the Audit Committee members in order to meet the financial literacy requirements.

Please reach out to the Nonprofit Solutions Group for additional information on Audit Committees or if you would like more information on how HBK can help.

Taxpayers who recently moved, changed domicile, or recently changed filing status in a state may receive a residency audit notice from that state. These notices can be quite daunting, as residency audits are notorious for being long and arduous processes. Taxpayers must prove to the state that their filing status and residency within or outside of that state is legitimate to avoid unnecessary tax implications. The purposes of these audits are to prove that the asserted filing status is correct, taxpayers may be filing as nonresidents, part-year residents or full residents of a state.

Many states are notorious for their residency audit teams such as California, Connecticut, New Jersey, and New York however, due to the current nationwide deficits experienced by states due to the COVID-19 Pandemic, we anticipate more states to keep residency issues in their sights. We expect this to be an issue especially when taxpayers are moving from a high-income state to a low- or no-income state such as Arizona, Florida, Nevada, Tennessee, Texas, and Wyoming.

In addition to residency audits being a great way for states to recoup lost revenue, with the many changes due to the COVID-19 Pandemic, taxpayers have been moving away from large urban cities and relocating to new states all together. The influx of residency changes provides ample opportunity for taxpayers to assess their audit readiness and prepare themselves for a potential residency audit.

Domicile and Statutory Residency

Taxpayers can only have one domicile at a time, and a domicile remains intact until a new one is established, this means that once a state becomes a taxpayer’s domicile, that state will continue to be the taxpayer’s domicile until all ties have been cut and the new state has fully been adopted as the state of domicile. Domicile is typically where a taxpayer’s permanent home is (though not always), where the taxpayer intends to remain on a permanent basis and where the taxpayer keeps all items near and dear to them and spends the majority of their time. Domicile is a primarily subjective test, and the state will weigh each of these factors, though no single factor is determinative, However, the first four factors listed below are typically scrutinized more heavily. When analyzing domicile, we typically ask taxpayers which state the following items are in:

• State where near and dear personal property is located
• State where children and/or spouse are located
• State where real property is owned and used
• Business ties to the state in question

Other items

• State where vehicles/other property is titled and plated
• State of voter registration
• History of employment in the state
• State where doctors and other medical professionals are located
• State where other professional advisors are located
• Location of social clubs
• Location of charitable activities
• State of licensure
• Whether a declaration of domicile has been filed or a residence homesteaded

While this information comes off as intrusive and personal in nature, states have been known to interview friends, family and even doormen, request personal logs of days activities, obtain and review credit card statements, cell phone records and e-toll logs, request copies of airline tickets and moving receipts, analyze social media accounts, visit the real property locations to investigate and request additional information concerning corroboration of out of state activities.

In addition to this question of domicile, states will look to the number of days, or contact periods, that you have within their borders to see if a taxpayer has met the standards for “statutory residency.” A statutory resident is one who has been within the state and has generally spent more than 183 days or contact periods within that state. For many states, a contact period or a day is counted even if the taxpayer was only in that state for mere moments or hours, it does not necessarily require that the taxpayer spend the night in that state. In many states this is known as the 183-day test, if a taxpayer has more than 183 days of contact or activity within a state (other than travel through the state for international or interstate destined travel or certain medical confinements), they will be considered a statutory resident and have to file a resident return for the state. This is especially concerning in a COVID-19 world where many taxpayers are relocating or working remotely during the pandemic.

For taxpayers engaged in repeated travel into numerous states, those with vacation homes in other states or those that are temporarily located in another state it is critical that you track your travel plans, dates within each state and expenditures from within each of the relevant states relating to this travel. This will assist in proving that the 183-day test has not been met.

Likelihood of Audit and Audit Procedure

Depending on the states at issue the risk for a residency audit can be quite high. New York for instance is said to have over 300 auditors in their residency division that solely focus on issues of residency and income tax. This has allowed New York to generate over $1 billion in revenue over a five-year period. In states like California, the Board of Equalization is notorious for dragging some residency audit appeals out for decades and has ruled against taxpayers in residency audits on factors including the maintenance of a PO box in the state where mail (including the audit notice) was still being sent to and collected from. Even taxpayers who have moved abroad have fell victim to a California residency audit, with the state taking the position in many instances that travel and employment abroad were not sufficient to break an already established domicile within the state.

Residency audits can be long, detailed, and invasive processes, especially in instances where the taxpayer has left a high-income tax state and moved to a low- or no-income tax state. If you receive a notice of an intent to audit specifically over filing status involving residency, you should expect that these audits may take upwards of 6-9 months to fully resolve if all goes smoothly. If negotiations or appeals come into play the residency audit can be dragged out for well over a year.

During this time, a detailed analysis will be undertaken by your tax professionals as well as by the state auditors to assess every contact period and day spent in the auditing state. Although this inquiry may feel very invasive, personal information may need to be turned over to support and defend a position of residency. It is important to understand the entire impact of a residency filing position taken on a return. Not only will a change in residency under audit impact your income taxes in that new residency state, but the taxpayer may also still face income tax and residency status issues in the secondary state. This could drastically alter a taxpayer’s estate plan and impact their property if they are located in a home rule state. Depending on the year under audit and the outcome, the impact of an assertion of residency under audit could alter future tax years or years outside of the audit period. Remember, domicile once established requires affirmative steps to abandon and reestablish in a new state. This can cause issues for taxpayers when older tax years are audited, but there has been no substantial change in facts for all subsequent years resulting in the findings of that audit to potentially carry into all future years.

While no one wants to deal with an audit, a residency audit by a state can be a tiresome process. It is critical that you develop a plan and work with your HBK advisors to ensure that you are maintaining proper documentation regarding residency. This is especially important for taxpayers who have recently sold or planning on selling a business, moved, are planning on moving or are temporarily located in another state due to the COVID-19 Pandemic. Without proper planning and documentation, a taxpayer actually runs the risk of have multiple residencies and inadvertently increase the income tax filing obligations they have across the US. If you have received notice of an intent to audit due to residency by a state, please do not hesitate to contact your HBK Advisor to get this matter resolved quickly and favorably.

In late 2020, the IRS announced its campaign that would focus on auditing high-net-worth individuals’ income tax returns. This article will go through who may be targeted by this initiative and some areas that are likely to be examined under audit. While there has been scrutiny surrounding this initiative, this is not the first time that the IRS has launched an initiative like this. For the current campaign, the periods targeted in this initiative are believed to be from 2014 to the present.

Who Are High Net Worth Individuals?
While there is no statutory definition of who can be classified as a high-net-worth individual, it is common practice among financial professionals to identify those who have a tax liability above $100,000 as those that would fall within this category.

While this campaign is newly focused, is not the first of its kind. The IRS has had a global high wealth program or “wealth squad” focused on high-net-worth individual audits for some time. This group is known for taking a holistic approach to these taxpayers and looks at the complete financial picture of the taxpayer, including any partnerships, trusts, private foundations, corporations, or other relevant interests. Under the current plan, the IRS’s Large Business and International Division will focus on taxpayers who are considered high-net-worth that have significant pass-through activities and/or those that may have seen substantial tax savings under the Tax Cuts and Jobs Act (TCJA).

Planning and Reacting to Audits
If you are concerned about a potential audit, we recommend proactively cleaning up any books and records, organizational charts, and records for personal and charitable activities. We generally recommend that all documentation related to your tax return be retained for a minimum of three years, and ideally for seven years. A review of documentation and records by your HBK Tax Advisor can ensure audit preparedness.

If your return is ultimately pulled for an audit, be prepared to provide some of the following documentation:

• Foreign Asset Information, including bank account information, foreign trusts, business interest, inheritances, and other foreign activities;
• Related Entity Information, including trusts, partnerships, corporations, and S-corporations that are commonly owned, or owned by children and/or spouses;
• Gifting and Estate Plans; and
• Private Foundation Information.

These documents can take time to compile so being proactive and having them organized and readily available will save time and expense. If you receive an audit request, or other communication from the IRS, be sure to communicate with your HBK Advisor as soon as possible. Audits and notices have specific deadlines that will need to be met.

We can assist all individuals through all stages of audit preparedness, including the ability to perform a pre-audit review of all tax matters, allowing you to understand any potential risk areas in your tax compliance history. Please reach out to your HBK Advisor for more information.

Role of the Board, finance committee, and the audit committee

The Sarbanes-Oxley Act (“Act”) reshaped the landscape for board oversight of for-profit companies in the aftermath of the financial scandals that marred the early 2000’s. Though the Act does not directly affect not-for-profit organizations, the Act’s rules relating to board governance have impacted the roles of the board, the finance committee, and the audit committee of these organizations. These three bodies work together in tandem to provide oversight and guidance to their nonprofit organization.

Board of Directors

The board of directors has a fiduciary responsibility to the organization and is therefore obligated to act in the best interests of the organization. The board of directors is comprised of individuals who seek to further the organization’s mission in an oversight and advisory role. Although there is no limit on the number of individuals who can sit on an organization’s board of directors, an individual’s position on the board is limited, usually to a few years. A common practice is to have only a certain number of board members meeting their term limit in any given year so that the individuals who comprise the board do not change significantly on an annual basis. This governing body is distinctly different than the organization’s management, as the board focuses on the organization’s overarching mission, strategy, and long-term goals. In comparison, management carries out the goals set out and defined by the board of directors.

The Finance Committee

Depending on the size of the organization, the finance committee is sometimes combined with the audit committee. When operating separately from the audit committee, the responsibilities of the finance committee encompass all things relating to the financial health of the organization. First, the finance committee reviews the organization’s budgeted financial statements and seeks to understand the budget to actual variances throughout the year. Second, the finance committee counsels the board on any financial decisions for the organization. Examples include advising the board on the organization’s investment portfolio, recommending compensation for the organization’s management, and understanding the organization’s books so that they can ensure the financials are accurate and reflect the true activity of the organization for the year. Third, the finance committee is the committee that determines the policies and procedures that are reviewed by the audit committee. Examples of policies and procedures include their conflict of interest, document retention, whistle-blower, and other policies or procedures whose existence is reported for public disclosure on the annual Form 990. Additionally, this committee monitors the organization’s compliance with any laws and regulations and is responsible for reporting any deficiencies to the board at large.

The Audit Committee

The audit committee works with management to review all forms of the organization’s financial statements and annual tax filings in order to obtain an understanding of such documents. The audit committee disseminates the relevant information through the proper channels and to the appropriate people both at the organization and with the independent auditor. The audit committee directly engages an independent auditor and monitors the audit process. Upon completion of the audit, members of the audit team, usually the engagement principal and a lead member of the team, present a draft of the audited financial statements to the audit committee. It is the responsibility of the audit committee to review and understand the audited financial statements, and once they are satisfied with the draft audited financial statements, will recommend approval to the board. Another main role of this committee is to supervise the organization’s internal controls for financial statement reporting. The audit committee is also actively involved in assuring that management is compliant with the organization’s policies and procedures and takes an active role in reviewing those policies, examples of which include whistle-blower policies, anti-fraud policies, and other various policies that serve to guide the organization in the event of a discovery of errors or illegal acts. As a result, the audit committee is a key participant in any resulting investigations or legal proceedings brought against the organization.

The board, the finance committee, and the audit committee allow an organization to be more accountable and transparent and help the organization be successful when working towards its mission. Even though not all organizations are large enough to have all three bodies, all organizations should have a board of directors that acts in all capacities and that is separate from management. The board should have a top-level focus while the management implements the daily operations to achieve the overarching goal set by the board. For additional information or questions please contact your HBK advisor.

Whether this is your first nonprofit accounting audit, and you have no clue what to expect or you’ve been involved in the process for years, there are always ways to make it more efficient.

Rule #1 – Plan ahead.
When should you start planning for your annual audit? The answer is really, as soon as last year’s audit is done. So, you’re a bit behind already, right? Let’s get started. First, who should be involved?

Typically, the Board of Directors or the Audit Committee starts the process by hiring the independent auditor and executing an audit engagement letter. Other services, such as tax preparation may also be included in the audit engagement letter. The Board may choose to meet with the auditor before the audit fieldwork to establish a relationship, open the communication process, and set the tone for the relationship with the audit firm. Communicate all internal and external deadlines with the auditor. When is the audit draft to be presented, when is the final audit due? Will the audit be needed for grant or lending deadlines? If the auditor will also be preparing tax and compliance filings, know those deadlines and the expectations of meeting those or if extensions will be requested.

Once contracted, the accounting/finance director usually meets with the auditor and determines exactly what they expect and when and how information should be communicated. Typically, a “Document Request” list is provided well in advance of audit fieldwork. Most auditors now work with electronic documents and have a secure portal system to transfer audit information. If you are still a “paper only” shop, let the auditor know this as well. Ask who will be on the audit and tax teams for the engagement, so you know the new team members who may be asking for information.

The “auditee”, i.e. YOU, should determine who will most likely be involved in the audit process. No, it’s not just the accounting/finance staff. Besides the Board or its Audit Committee, the CEO, COO, program directors, development staff and all accounting/finance staff will most likely participate in the audit process. Each of these parties needs to know the timing of the audit and what is expected of them.

Certain professionals will also be contacted such as your banker, investment manager, attorney, payroll service, billing service and insurance agent. You may want to let them know your audit is beginning and identify the firm that may contact them regarding the audit.

Rule #2 – Be ready.
Try to provide all requested documents on the auditor’s timeline. It will allow the auditor to plan and document preliminary procedures for your engagement. Be honest, if you cannot make a deadline, communicate with the auditor. NEVER allow the fieldwork to begin if you are not completely ready but know that audit teams are scheduled months in advance, so rescheduling may be difficult.

If possible, make a private space available for the audit team to work. They will need workspace and WIFI access if available. Let them know the logistics of your organization. What are the working hours? Do they have to deal with security? Is parking available? How should the audit team reach other staff members they might need to question? How would you like to handle audit questions, email or come on in and chat?

Try to respond to inquiries and additional document requests as soon as possible. If you have any difficulties with any of the audit team members, discuss your issues with the team manager or partner, immediately. Once the fieldwork is done, obtain a list of “open items” needed to complete the engagement and reiterate expected timelines. Depending on the progress of the engagement, the auditor may be in the position to give you proposed adjustments for your books and records and a preliminary final accounting. Respond to the open items and last inquiries as soon as you can. The ability to meet deadlines is resting with you at this point. At this point, the Audit Committee may request a “check-in” with the auditor.

Management should be allowed to review audit adjustments, and findings and present additional information if needed. Management should also review a draft of all reports, tax returns and communications to be presented to the Audit Committee and Board. By this time, there should be no “surprises” for anyone involved in the process. Good communication is key throughout the audit.

Invite the auditor to make their presentations to the Committee or Board in person. This will allow the Committee and Board is further their relationship with the auditor and potentially ask private questions. Board members will appreciate the audit presentation, particularly if they are new to the board.

Once the audit and tax returns are approved and finalized, debrief with the auditor. Make sure your books and records agree to the final audit. Ask: What when right this year? What can we do better this year?

Rule #3 – Stay in touch.
Make the auditor a trusted advisor. They want to hear from you throughout the year, particularly if you are involved in anything with an audit or tax significance, such as:

• Starting or closing a program or service
• Obtaining a new grant or large new contract
• Starting a new fundraising appeal
• Entering into new debt, or long-term leases
• Converting to new software
• Changes in key personnel
• Unusual transactions
• Pending litigation
• Fraud or theft

It’s always better to solicit advice on handling these items as soon as possible so the impact on the audit is managed properly.

Rule #4 – Celebrate completing the audit.
Close the year and treat yourself and your team members. You’ll need them again next year.

Adapting to technological change is a challenge all businesses face. Some changes force the matter — like required compliance with privacy and cyber regulations — while others, such as implementing a vendor risk management program, may seem less urgent. Regardless, businesses must recognize the need for a particular change and act accordingly.

A recent study conducted by the Information Systems Audit and Control Association (ISACA) and the global consulting firm Protiviti revealed the top five technology challenges faced by businesses today as:

1. IT security and privacy/cyber security
2. Data management and governance
3. Emerging technology and infrastructure changes
4. Resource/staffing/skills
5. Third-party/vendor risk management

While all organizations face the same challenges, small and medium-sized businesses can find them more difficult to overcome, especially as they relate to number four on the list: a lack of resources, staffing and skills.

Monetary considerations aside, it is difficult to find qualified personnel. Addressing security, privacy, governance and infrastructure (effectivel, numbers one through three on the list) requires professionals with sophisticated skill sets. The difficulty and expense associated with trying to meet these demands internally make it more reasonable to outsource them.

We are here to help. HBK offers cost-effective solutions to address these challenges. We have IT professionals across numerous disciplines, from specialists in privacy regulations to technicians who facilitate infrastructure changes. Get access to the specific skill sets and resources you need when you need them. For more information or to schedule an appointment, call (724) 934-5300; or email me at MSchiavone@hbkcpa.com.